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Does the underground economy hold back financial deepening? Evidence from the Italian credit market

  • Giorgio Gobbi

    ()

    (Bank of Italy, Department of Structural Studies on the Italian Economy.)

  • Roberta Zizza

    ()

    (Bank of Italy, Department of Structural Studies on the Italian Economy.)

The paper investigates the relationship between the underground economy and financial deepening. Entrepreneurs can only access external finance by disclosing credible information in formal documentation. This may be impossible for many informal producers, who lack proper accounting records. Similarly, irregular workers may have difficulty borrowing to finance consumption and house purchases. Using panel data on local credit markets in Italy, we find that the share of irregular employment has a strong negative impact on outstanding credit to the private sector. According to our estimates, a shift of 1 per cent of employees from regular to irregular work corresponds to a decline of 1-2 percentage points of GDP in the volume of business lending and of 0.3 percentage points in outstanding credit to households. By contrast, the feedback effects of financial deepening on the size of the informal sector are weak and statistically not significant. Applying a difference-in-difference approach that exploits the exogenous variation induced by the regularization programme for immigrant workers launched in 2002, we also find that irregular labour has a negative effect on banks� decisions to enter local credit markets.

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Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 646.

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Date of creation: Nov 2007
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Handle: RePEc:bdi:wptemi:td_646_07
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