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Informality and Financial Development: A Literature Reviews

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  • Ohnsorge, Franziska
  • Capasso, Salvatore
  • Yu, Shu

Abstract

A large literature has documented an inverse relationship between financial development and the size of the informal economy, with some evidence that the link is depends on the institutional environment. The direction of causality, however, remains a matter of debate, making it hard to identify the right policy interventions for better economic outcomes. This paper reviews this literature. Drawing on the theoretical literature, it sketches out the various channels through which financial development can influence firms’ choice to operate informally at all or the degree to which they operate informally, or vice versa. In addition, this paper summarizes the empirical evidence that, at the moment, does not settle the question of direction of causality in a broad sample of countries.

Suggested Citation

  • Ohnsorge, Franziska & Capasso, Salvatore & Yu, Shu, 2021. "Informality and Financial Development: A Literature Reviews," CEPR Discussion Papers 16711, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:16711
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    Cited by:

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    2. Barra, Cristian & Papaccio, Anna & Ruggiero, Nazzareno, 2024. "Are cooperative and commercial banks equally effective in reducing the shadow economy? International evidence," Economic Modelling, Elsevier, vol. 138(C).
    3. Joseph Mawejje, 2024. "Government expenditure, informality, and economic growth: Evidence from Eastern and Southern African countries," African Development Review, African Development Bank, vol. 36(1), pages 125-138, March.
    4. Salvatore Capasso & Franziska Ohnsorge & Shu Yu, 2025. "From financial development to informality: a causal link," Public Choice, Springer, vol. 203(3), pages 539-572, June.
    5. Deininger, Klaus & Ali, Daniel Ayalew & Fang, Ming, 2025. "Impact of the Russian invasion on Ukrainian small and medium farmers’ productivity," Land Use Policy, Elsevier, vol. 148(C).
    6. Musa Abdullahi Sakanko & Joseph David & Nurudeen Abu & Awadh Ahmed Mohammed Gamal, 2024. "Financial inclusion and underground economy nexus in West Africa: evidence from dynamic heterogeneous panel techniques," Economic Change and Restructuring, Springer, vol. 57(1), pages 1-20, February.

    More about this item

    Keywords

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    JEL classification:

    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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