Public-debt crises and bad equilibria: Lessons from the GIIPS Countries

by Maurizio Bovi

Vox
December 2, 2011

The countries most affected by the Eurozone debt crisis seem also to be characterised by bad institutions and large shadow economies. This column describes the bad equilibrium in which bad governments offer few and low-quality public services and make people less willing to pay for services. Firms stay underground, public receipts stay low, and governments remain inefficient. In sum, the presence of inept bureaucracy may be strongly associated with the shadow economy.

All the GIIPS countries (Greece, Italy, Ireland, Portugal and Spain) have been hit by the current government debt crisis (see eg Manasse and Trigilia 2011). Yet not all these countries have comparably sized shadow economies or levels of institutional inefficiency (widespread corruption, intrusive bureaucracy, excessive regulations, etc). My focus here is in the empirical cross-country connections linking tax evasion (here roughly equalised to the shadow economy) and bureaucratic proficiency across the OECD countries.1 My main aim is to underline how these variables interact in order to offer a tentative explanation of some of the recent economic and political developments in the GIIPS countries.

Admittedly, analysing data concerning the shadow economy, rule of law, and regulation sometimes requires near-heroic assumptions. But let us suppose that it is at least possible to have a rough (but sufficiently reliable) idea of the OECD ranking referring to the mentioned items. Then, one may organise the available evidence in a logical way to highlight a number of stylised facts (see Figure 1).

Figure 1. Institutions and the shadow economy

Note: Institutional Setting = labour market regulation index + legal environment index, both running from 0 to 10 (lower numbers mean worse bureaucracy). Source: Fraser Institute. Shadow economy as percent of declared GDP. Source: our computations (Bovi and Dell’Anno, 2010) on Schneider’s estimate. Data are 1990–2003 averages.

Figure 1 clearly shows that the better the institutional setting, the lower the level of tax evasion. In particular, it seems that the GIIPS countries are characterised by weak bureaucracy and big shadow economies. Accordingly, they lie in the lower-right corner of Figure 1. Italy and Greece show the worst situation. Among the GIIPS economies, a remarkable and evident exception is Ireland. Turning back to the large shadow economy–bad institutions angle, one may note the borderline presence of Belgium (more on that later on).

More