The remaining variable in specification {1}, the _Rule-of-Law_ index, which captures the tax morale, but also the perceived quality of the public services related to law and order, personal security and property rights, as well as the effectiveness of the fiscal system, as expected, has a highly significant negative effect on both types of informal employment (Table 3A, specifications [1a], [1b]). The exact interpretation of this effect is difficult because this index is more heterogeneous by construction than the other indices used here (Government Effectiveness, Investment Freedom, and Trade Freedom), and the contribution of each of the many index components is not identifiable. Moreover, among many components of the Rule-of-Law index, two (perception of tax evasion and perception of effectiveness of the fiscal system) are endogenous with respect to the past values of the share of informal employment<sup>17</sup> , thus adding some ―informality persistency‖ effect (similar to but weaker than if the model would include lagged values of dependent variables as explanatory). The weight of these components in the overall Rule-of-Law index is however so small (between than 0.02 and 0.05 for the countries and years in question) that, plausibly, this variable can be dealt with as exogenous in the informal employment model. However, same unobserved factors might affect both the (actual and perceived) quality of governance and the levels of informal employment and unemployment in a country, hence both _Rule-of-Law_ and _Government Effectiveness_ might still be endogenous. We have tested this with 2-step GMM instrumental variable estimates (Baum et al. 2007), and for Eastern and Southern Europe exogeneity was not rejected, with high enough _p_ -values, in all six models reported in Table 3A; Annex 2 provides discussion and details. Moreover, for dependent informal employment, the model with instrumented Rule-of-Law is very similar to model {1a}, with the only exception that the coefficient on tax wedge is smaller and not significant. Hence we keep specification {1} as is, with non-instrumented contemporary (to account for an almost immediate impact of tax morale on informality) Rule-of-Law. The results are similar (and available on request) if the lagged values of _RULE_LAW_ are used for countries/years where ESS field work has started earlier than in September of respective year, although these models have lower R-squared; if _RULE_LAW_ is lagged for all cases in the sample, the results are also similar but do not capture the tax wedge effect (and R-squared declines further).

However, as we focus on institutional factors rather than the persistency effect, our preferred specification is {2}, in which all variables can be treated as strictly exogenous or

> 17 We refer to _past_ values here taking into account the time lag between field work of the country-specific surveys underlying WGI (for the items in question, these are the and World Economic Forum Global Competitiveness Survey, with field work performed early in the calendar year to which the data refers) and ESS surveys (in most cases, late in the year for Eastern and Southern European countries, see Table 1).

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