The Interplay Between Economic Freedom And The Shadow Economy In An Eastern European Country: Insights From Principal

The paper investigates the bond betwixt the sub-indicators that constitute the Economic Freedom Index and the shadow economy in Romania, during the period 2017–2023. By employing the Principal Component Analysis (PCA) method, the research highlights the intricate interplaybetween fiscal policies, integrity of institutions and informal economic activities. The period under scrutinywas chosen as a result of the updates of the Economic Freedom Index methodology in 2017. The set of sub-indicators was expanded in that year, incorporating independent dimensions of Judicial Effectiveness and Fiscal Health. The results show a robust connection betwixt great fiscal strain and the expansion of the shadow economy, with Tax Burden and Shadow Economy (% GDP) having significant positive loadings on the first principal component. In opposition, subindicators such as monetary and trade freedom showed negative correlations, suggesting that high taxation limits economic openness. The year 2020 is identified as an unstable equilibrium point. The pandemic crisis then accentuated economic pressures and disrupted the relationships between the indicators. The temporal analysis reveals a distinct shift from a more indulgent economic environment in 2017–2018 to a more regulated and more fiscally governed state in 2022–2023. The conclusions emphasize the importance of public policies that balance taxation and economic freedoms, reduce informality, and increase institutional transparency. The study contributes to the understanding of the shadow economy and economic freedom in the context of emerging economies, providing a solid basis for the formulation of effective public policies.