Entrepreneurship and the Hidden Economy: An Extended Matching Model

This paper develops a labour market matching model in order to address the problem of the persistence of the hidden sector and of its regional concentration, as in Italy and in the enlarged Europe. The main novel features of the model are that entrepreneurial ability affects job productivity, and that regular firms receive negative externalities from the hidden sector, which may capture the pressure typically exerted by corruption and organized crime, and positive externalities from the other regular firms. At least one interior equilibrium emerges, thus providing an explanation for the so-called “shadow puzzle”, with the possibility that tougher monitoring may reduce both the hidden sector and unemployment. If externalities are non-linear, two equilibria may emerge, thus accounting for regional dualism. The “better” equilibrium is in fact characterised by a smaller hidden sector, higher levels of overall productivity, output, entrepreneurial ability used, extra-profits, relative wages, and more favourable externalities.