Corruption and shadow economy in transition economies of European Union countries: a panel cointegration and causality analysis

Corruption and shadow economy are two critical problems which feed each other and pose an obstacle against the economic development of countries, especially those with weak fundamentals. Central and Eastern European countries have experienced an absolute political and economic transformation after the downfall of the Berlin Wall. This study researches the effect of corruption and rule of law on shadow economy in 11 transition economies of Central and Eastern Europe over the 2003–2015 term with panel cointegration and causality tests considering heterogeneity and cross-sectional dependence. The cointegration coefficients revealed a complementary interplay between size of shadow economy and corruption. Furthermore, the causality analysis indicated that there was a bilateral causality between control of corruption and shadow economy in all the cross-section units. However, there was a two-way causality between rule of law and shadow economy only in Bulgaria, Czech Republic, Poland and Romania. Furthermore, there was one-way causality from rule of law to shadow economy in Croatia, Estonia, Hungary, Slovakia and Slovenia.