Institutions, trust and relations: a comparative analysis explaining informal economic activities

One often explains why people engage in the informal sector with the Allingham-Sandmo model, resting on taxation level, deterrence and risk aversion. This neoclassical approach explains noncompliance fairly well, but anomalies exist. Evenly parsimonious, Alejandro Portes develops a institutional and social capital approach introducing regulation, enforcement, and the social wiring of society. The extent of regulation fuels informal transactions, while effective enforcement inhibits it. Portes hypothesizes that informality is fostered by social relations and trust, and curbed by institutional trust. This paper tests Portes’ theory with data from the European Social Survey in 13 countries complemented with country level data on regulation and enforcement. Ordinary and multilevel logistic regressions largely confirm the predictions regarding regulation, institutional trust and social relations. The limited variation of enforcement in the countries studied and the measurement of social trust does not allow for a definitive assessment of the relevance of those variables.