Can innovation reduce the size of the informal economy? Econometric evidence from 138 countries

A substantial body of literature has examined the determinants of the informal economy. However, this literature has predominantly focused on proximate causes, such as unemployment and taxation, while largely overlooking the role of innovation. This paper contributes to filling this gap by studying the impact of innovation production on the size of the informal economy using a sample of 138 countries, spanning the period from 2007 to 2018. Estimations, based on the entropy balancing method for continuous treatments, demonstrate that innovation reduces the size of the informal economy, emphasizing the importance of innovation policies in addressing informality. This result remains robust across a wide array of controls, alternative estimation techniques, restricted samples, and different measures of both the informal economy and innovation. The study identifies economic development, domestic credit mobilization, and e-government as channels through which innovation influences the informal economy. Potential government policies are explored.