Trust, remittances, and the shadow economy: institutional and financial heterogeneity in a country-wave panel

Purpose This paper aims to revisit the relationship between generalised trust, remittances, and the size of the shadow economy by explicitly accounting for institutional quality, financial development, and cross-country heterogeneity. While previous studies, largely based on cross-sectional evidence, suggest that trust and remittances may influence informality, their causal roles remain unclear. Design/methodology/approach Using an unbalanced country-wave panel and standard governance measures, the paper relies on fixed-effects models and Fixed-Effects Two-Stage Least Squares as the preferred specifications, complemented by Random-Effects Two-Stage Least Squares following Balestra and Varadharajan-Krishnakumar (1987) as a robustness check. Slope heterogeneity is formally tested using the Pesaran–Yamagata procedure. To address measurement concerns, the analysis is replicated using both MIMIC-based and DGE-based measures of the shadow economy. Findings The results show that economic development and institutional quality – particularly legal system effectiveness – are the most robust determinants of the shadow economy. Generalised trust is positively associated with informality in several specifications, although its significance is sensitive to estimator choice and the shadow-economy measure. Remittances are associated with lower informality in several instrumental-variable specifications, with stronger associations in more financially developed environments; however, both trust and remittances are generally statistically insignificant under the alternative DGE-based measure. These findings highlight the importance of institutional quality and financial intermediation in shaping the relationship between trust, remittances, and informality. Originality/value This study contributes by jointly analysing trust, remittances, institutions, and financial development within a country-wave panel framework. By explicitly accounting for endogeneity, cross-country heterogeneity, and alternative measures of the shadow economy, the paper provides a more nuanced assessment of the roles of trust and remittances and highlights the central importance of institutional quality and financial development in reducing informality.