Informal sector more damaging than shadow economy for GDP growth

Despite this increasingly sophisticated regulatory architecture, the research concludes that structural progress remains insufficient. The authors argue that enforcement systems have not adapted quickly enough to technological change. Digital markets continue to generate opportunities for tax evasion and informality, especially in platform-based gig work, cross-border freelancing, and small digital services that fall below national reporting thresholds.

The European Union’s long-running effort to shrink the shadow economy and close tax-evasion loopholes is failing to keep pace with economic growth, according to new research that signals a widening policy gap at the heart of the bloc’s fiscal stability. Despite years of legislative tightening, digital reporting systems, and cross-border cooperation programs, a substantial share of unreported economic activity continues to weaken government revenue, distort market competition, and drag down long-term development.

A newly published peer-reviewed article, “Dark Markets for Bright Futures? Unveiling the Shadow Economy’s Influence on Economic Development,” in Systems, examines the evolution and economic impact of both the shadow economy and the informal economy across the EU-27 from 2000 to 2022. The study combines bibliometric mapping, policy analysis, and advanced econometric modelling to assess how unobserved economic activities continue to shape growth trajectories in Europe.

The findings indicate that although member states have adopted increasingly sophisticated mechanisms to combat tax evasion and the shadow economy, the overall scale of unreported activity has not fallen proportionately to rising GDP per capita. This imbalance, the authors warn, undermines fiscal consolidation, weakens investment capacity, and perpetuates structural inequalities between Western and Eastern EU economies.

Persistent shadow markets are dragging down EU economic growth

The study maps two decades of academic research into the shadow economy, revealing the lack of conceptual clarity that continues to hamper policy interventions. While terms such as “shadow,” “informal,” “grey,” and “unobserved” economies are used interchangeably across literature, the authors differentiate them sharply. The shadow economy generally includes all unregistered but legal activities intended to avoid taxation or regulation. The informal economy, on the other hand, includes small-scale or subsistence activities that operate outside formal systems, often because participants lack resources or access to regulated markets.

This conceptual distinction is crucial because the study’s econometric analysis finds that the informal economy imposes a far stronger negative impact on economic development than the broader shadow economy does. Using panel least squares with both fixed and random effects, supported by structural equation modelling (SEM), the researchers demonstrate that countries with higher levels of informal economic activity experience slower increases in GDP per capita. The informal economy’s influence is consistently significant and negative throughout the 2000–2022 period.

Conversely, the shadow economy’s effect on growth is present but less direct. The authors find that its influence often operates through reduced tax revenues and diminished fiscal space rather than through immediate productivity losses. In several member states, shadow activities continue to grow even as official GDP expands, indicating that formal growth does not automatically translate into improved tax compliance.

The study’s empirical dataset, which covers the full EU-27, shows sharp regional disparities. Eastern European and Balkan member states exhibit some of the highest shares of shadow and informal economies. These countries tend to have lower income levels, weaker institutional capacity, and insufficient enforcement systems, resulting in higher vulnerability to unobserved economic activity. In contrast, Western and Northern EU states have significantly smaller shadow sectors, bolstered by stronger administrative systems, better digital infrastructure, and a deeper culture of tax compliance.

The authors also find that inflation and foreign direct investment exert small but positive effects on growth across their models. Tax revenues, however, do not emerge as strong mediators between the shadow economy and overall economic development. This suggests that simply increasing formal tax intake will not resolve underlying structural weaknesses unless accompanied by reforms that reduce incentives for informal activity.

EU policy measures strengthened, but shadow economy patterns have not shifted enough

The study provides a detailed review of two decades of EU tax and anti-evasion policy instruments. From the 1997 Code of Conduct on Business Taxation to the successive Anti-Tax Avoidance Directives (ATAD), the authors show how policy has gradually moved toward stricter oversight, transparency, and digital reporting requirements.

Major milestones in this evolution include the savings taxation directive, anti-money-laundering frameworks, the Common Consolidated Corporate Tax Base proposals, and DAC7 and DAC8 directives, which impose reporting obligations on digital platforms and crypto-asset service providers. More recently, the VAT in the Digital Age (ViDA) proposals aim to address revenue losses stemming from e-commerce and cross-border transactions.

Despite this increasingly sophisticated regulatory architecture, the research concludes that structural progress remains insufficient. The authors argue that enforcement systems have not adapted quickly enough to technological change. Digital markets continue to generate opportunities for tax evasion and informality, especially in platform-based gig work, cross-border freelancing, and small digital services that fall below national reporting thresholds.

The study also finds that academic research production correlates with better governance outcomes. Countries with higher research output on tax evasion and the shadow economy tend to have smaller shadow sectors. This suggests that expanded knowledge production, data collection, and analytical capacity may strengthen policy effectiveness.

But even as digitalisation improves the EU’s ability to monitor cross-border economic flows, gaps remain. The authors highlight that in many member states, tax administrations lack the operational resources, analytical teams, or integrated data systems needed to process and enforce the growing volume of digital information. This mismatch between legislative ambition and institutional capacity has contributed to the stagnation in reducing shadow-economy shares.

The study further emphasises the structural interdependence between income inequality, institutional trust, social services, and shadow-economy participation. In lower-income regions, informal work is often tied to survival strategies rather than deliberate evasion. Policy responses that emphasise enforcement without addressing underlying economic conditions are unlikely to produce durable results.

Stronger digital infrastructure, coordinated enforcement and updated economic strategies

The study further outlines a path forward for EU member states. First, the authors recommend scaling up the digital capabilities of tax administrations. Digitalisation has already transformed the enforcement landscape, but its full potential remains unrealised without integrated databases, automated cross-checking systems, and advanced analytics tools capable of identifying hidden revenue streams.

Second, the authors point to the need for deeper coordination across borders. The rise of remote work, digital marketplaces, and mobile service provision has blurred national boundaries. Fragmented enforcement approaches give rise to loopholes that sophisticated actors can exploit. Enhanced cooperation, shared intelligence, and harmonised standards are essential to reducing tax base erosion.

Third, the researchers urge policymakers to recognise the differing profiles of the shadow and informal economies. Because the informal economy has a more damaging effect on long-term growth, interventions should prioritise improving access to formal labour markets, expanding social protections, and reducing entry barriers for legitimate enterprise creation. By lowering the economic incentives that push households into informal activity, governments can strengthen both economic resilience and social cohesion.

Furthermore, the study warns that the EU cannot rely solely on economic growth to shrink the shadow economy. Between 2000 and 2022, GDP per capita rose substantially across the bloc, yet shadow-economy levels failed to decline in parallel. The persistence of unobserved economic activity highlights the need for more comprehensive strategies that combine regulatory enforcement with structural reforms targeting inequality, education, labour mobility, and digital participation.