OECD countries than in other parts of the world. Among these “other” regions, Asian countries have the lowest shadow economy shares, while they are of similar magnitudes in transition economies, Latin America, and Africa. Note also that, over the years in question, the shadow economy shares have been increasing for all regions except the OECD, where the share has been (slightly) falling.

**Table 5.1: The average size of the shadow economy, as share of official GDP, for major regions. Percent.**

|Region|1999/2000|2000/2001|2002/2003|
|---|---|---|---|
|OECD|16.8|16.7|16.3|
|Transition economies|38.1|39.1|40.1|
|Asia|28.5|29.5|30.4|
|Latin America|41.1|42.1|43.4|
|Africa|41.3|42.3|43.2|

Source: Schneider (2006).

These averages mask great individual country differences, in particular in Latin America, where the fractions range from 20-25 percent in Chile and Argentina, to 60 percent or more in Peru and Bolivia.<sup>18</sup> In Asia, the shadow economy shares vary from a low of 13 percent in China and Singapore, to more than 50 percent in Cambodia and Thailand. In Africa the shares vary somewhat less, but also here one finds countries, such as Nigeria, Tanzania and Zimbabwe, with shadow economy shares close to the world’s highest, around 60 percent.

One factor here is the relationship between corruption and the size of the “shadow economy” not subject to ordinary taxation. This issue is discussed by Schneider (2006), who hypothesizes that the shadow economy and corruption are complements in lower-income countries. The reason is a tendency, in countries, for even quite large enterprises to operate totally outside of the formal economy – which is effectively feasible only if government officials are corrupt (accepting bribes or participating in the illicit activity).<sup>19</sup> In such countries a large hidden sector thus tends to “feed” corrupt government officials. Similar predictions are made by Johnson et al (1997, 1998) and by Hindricks et al (1999).

These issues are studied empirically by Dreher and Schneider (2006), for a panel of 70 countries from 1994 to 2002. The stated hypothesis is here largely confirmed by the authors (albeit, with a wide margin for uncertainty), in the sense that perceived corruption tends to be higher in countries with larger shadow economies; and shadow economies correspondingly tend to be larger when there is more corruption. Schneider (2006) finds, in particular, that variables measuring the burden of indirect taxation, and state regulation, have a large positive impact on the size of the shadow economy in developing countries. The effect of direct taxation is also positive but smaller (and only barely significant). The rate of unemployment has a large positive, and GDP per capita a similarly large negative, effect on shadow economy size. There is still substantial individual variation in the sizes of the shadow economies, for given levels of these variables.

These results might indicate that climate-related finance, were it to be used to lower the general burdens of taxation in lower-income countries, could give the additional benefit of reducing the size of

> 18 De Soto (1985), in an interesting analysis of the Peruvian shadow economy, provides a defense of this sector and it activity, mainly by pointing to the absence of alternative livelihoods for a majority of the Peruvian population. This is in our opinion largely beside the point: Had there been no taxation, the whole economy would have been one, “shadow” or not; the main (regrettable) point is that labor (and total factor) productivity tends to be lower in the “shadow” economy than in the official one.

> 19 In high-income countries, by contrast, the relationship could easily be the opposite, as hypothesized by Choi and Thum (2004) and Dreher, Kotsigiannis and McCorriston (2005a), and shown empirically by Dreher, Kotsigiannis and McCorriston (2005b).

20