Decarbonisation and informality: Empirical evidence on the shadow economy response to climate policy mix

What the paper says

The persistence of the shadow economy poses a significant challenge to effective climate governance, as informal firms often bypass environmental regulations and carbon pricing mechanisms. This study examines the impact of various climate and energy policy instruments on the size of the shadow economy in OECD and partner countries. Drawing on annual panel data from 34 countries between 2010 and 2023, the analysis employs fixed effects models, Driscoll–Kraay robust estimation, and the System Generalised Method of Moments (System GMM), with all calculations performed in R Studio. The results show that feed-in tariff schemes, renewable energy auctions, air emission standards, and fossil fuel excise taxes are associated with statistically significant reductions in informal economic activity. For instance, in the Driscoll–Kraay model, feed-in tariffs (β = −0.0626, p < 0.001), renewable energy auctions (β = −0.2578, p = 0.007), air emission standards (β = −0.1685, p < 0.001), and fossil fuel taxes (β = −0.7285, p < 0.001) all exert measurable downward pressure on the size of the shadow economy. Additionally, the dynamic panel model reveals a high degree of path dependence: the size of the shadow economy in previous years strongly predicts its current level (β = 0.9679, p < 0.001), indicating structural inertia that may limit the short-term effectiveness of policy reforms. Notably, time-fixed effects suggest that the year 2013 marked a significant turning point, with a marked decline in shadow economic activity (β = −0.227, p = 0.022), possibly reflecting the cumulative effects of climate legislation introduced in prior periods.