1 Introduction

The conventional wisdom of development economics postulates that high and growing levels of informal sector size are one of the most serious impediments in achieving sustainable economic development across the world (Gutiérrez-Romero 2021; Chatterjee and Turnovsky 2018; Elbahnasawy et al. 2016; Bologna 2016). Indeed, as claimed by Elbahnasawy et al. (2016), a sizeable informal economy promotes the inefficient use of scarce resources, encourages the adoption of low-return technology and small-scale production, and distorts investment, all of which ultimately hinder economic growth. Moreover, a large informal sector can distort competition and prevents more efficient formal firms from gaining market share, consequently reducing economic growth (Bologna 2016; Farrel 2004). Given the central role played by the dominance of the formal economy in improving economic performance, an obvious question that arises is why the informal economy continues to grow in some countries while shrinking in others. This question highlights the need to have a better understanding of the forces behind the changing size of the informal sector. Despite significant attention being given to understanding the consequences of a large informal sector, its historically-rooted determinants remain largely unexplored in the literature. However, there are theoretical arguments that, although conflicting, can justify the existence of a link between accumulated statehood experience and the size of the informal sector.

Chanda and Putterman (2007) argue that the early existence of state government confers a developmental head start, which provides conducive conditions to reduce the size of the informal sector. Such an early-start developmental advantage enables the state government to solidify power and create a strong bureaucracy (Bockstette et al. 2002), thereby strengthening its fiscal and legal capabilities (Becerra et al. 2012). Consequently, the state’s ability to fight against tax evasion is improving and thus contributing to a decrease in the size of the informal sector. Likewise, accumulated statehood experience can also reduce inequality between groups, which in turn can reduce the size of the informal sector. As documented by Ang (2020), a more established state has a greater capacity to reduce inter-group differences through unifying language and religion. This, according to Dell’Anno (2016), can contribute to a less persistent informal economy within a country. Vu (2021a) countered this view by demonstrating that societies with a long history of statehood suffer from institutional stagnation, which may result in persistent income differences between groups. According to this author, old and autonomous states may be conducive to the emergence of powerful elites. These entrenched groups eventually turned into maximizing private gains with the cost borne by the rest of the population.

Statistically, all indications are that older states suffer less from the persistence of the informal economy. Gabon, for example, is a country with an average informal sector size of 52% of the economy between 1991 and 2015 (Medina and Schneider 2018). Yet, it is also one of the countries that have the shortest length of state history, according to the state antiquity index compiled by Ang and Fredriksson (2018). In contrast, some established states such as Japan, a nation that emerged more than two millennia ago, enjoyed an early start in the form of sustainable formation of state government (Ang 2020), which made it harder for the informal economy to survive. Indeed, according to Medina and Schneider (2018), Japan, with an average informal sector of 10% of the economy between 1991 and 2015, is one of the countries with a small informal sector. This evidence suggests that an early and durable history of political organization can potentially contribute to reduce the size of the informal sector.

Against this backdrop, we hypothesize that a long history of statehood results in a less persistent informal sector. Following the approach of Gutiérrez-Romero (2021), the persistence of the informal economy is defined as an economy in which much economic activity is hidden from official authorities for monetary, regulatory, and institutional reasons. Therefore, like Gutiérrez-Romero (2021), we use estimates of the size of the informal economy provided by the Medina and Schneider (2018) database. This database uses the night lights approach of Henderson et al. (2012) to capture economic activity which relies on satellite data. State history for its part is measured using the extended state antiquity data of Ang and Fredriksson (2018).

This paper makes two important contributions to the empirical literature on the informal economy. First, the paper is the first one to examine whether the length of statehood experience affects the size of the informal economy in the long run. Second, it tests the constructivist theory which maintains that economic outcomes are mainly shaped by state development (Barth 1969). The organization of the article goes as follows: Sect. 2 gives an overview of the theoretical and empirical literature. The empirical methodology is discussed in Sect. 3. Section 4 presents the results and discussions while Sect. 5 concludes.

2 Literature review: an overview of theoretical and empirical literature

The central idea of this paper postulates that state history exerts a persistent effect on the current size of the informal sector. From a theoretical point of view, a careful review of the literature linking the age of the state to the size of the informal sector shows that this link remains conflicting. Although many theoretical arguments stated that countries with statehood experience typically have a small size of the informal economy, there are other arguments, which on the contrary address that point of view.

A longer history of statehood may be favorable for improving the institutional environment and reducing the size of the informal economy for several reasons. Firstly, experienced and stable states tend to have more competent bureaucratic capabilities. Indeed, as documented by Ang (2013), long-standing states may have more efficient public administration than newly formed states due to the advantage of having more experienced, trained civil servants and civilized citizens. Thereby, long-standing states are more likely to be equipped with strong fiscal and legal capabilities, which in turn can reduce the development of the informal sector. Secondly, a longer history of statehood can reduce social inequalities between groups and thus reduce the size of the informal sector. According to Vu (2021a), countries lacking statehood experience typically suffer from weakened fiscal and legal capabilities, leaving them with poor institutional quality. This may intensify disposable income inequality within a country by hindering a progressive distribution and redistribution of income. The said inequalities intensification will increase the financial costs associated with formal business activity, which in turn will increase the size of the informal sector (Gutiérrez-Romero 2021). Thirdly, early state development can make the political environment stable, which in turn stimulates the government’s incentive to invest in the efficiency of tax collection, and therefore the ability of the government to detect informal production. As sustained by Chanda and Putterman (2007), a longer history of statehood, which is often associated with stronger political integration, strengthens national identity by fostering state unification. The resulting unified state can harmonize social interaction and enforce social norms and rules, thereby reducing political instability that may increase the size of the informal economy, as shown by Elbahnasawy et al. (2016). According to these authors, a political system characterized by high levels of political instability will cause persistent inefficiencies in the collection of taxes and will increase the private sector’s incentive to participate in the informal economy.

There are theoretical arguments in contrast that support the view that a longer state history is associated with poor institutional quality, which undoubtedly leads to an increase in the size of the informal sector. According to that point of view, excessive duration of statehood eventually leads to the emergence of powerful elites and entrenched groups within a society (Olson 1986). The rise of these groups can result in persistent institutional stagnation, which can lead to persistent income inequalities. Specifically, as demonstrated by Borcan et al. (2018), powerful elites, who typically hold significant proportions of land and (natural) resources in (historical) societies, tend to establish abusive power structures in order to reduce any potential risks of expropriation of their privileges. For this reason, very long-standing states, albeit accumulating large fiscal capacity, are more likely to build up oppressive regimes and become resistant to calls for redistribution (Vu 2021a; Bentzen et al. 2017). The resulting income inequality will increase therefore the size of the informal sector (Gutiérrez-Romero 2021). Moreover, excessive statehood experience can promote corrupt practices, which in turn increase the size of the informal economy. On the one hand, excessive length of state history is associated with the prevalence of corruption for two reasons: (i) In older states, powerful interest groups are more likely to exploit public resources for personal gain, and (ii) Stable regime that emerges from the long duration of a state, increases the private sector’s willingness to pay bribes, as the business will be more inclined to wheel-and-deal with an incumbent whose position they assess to be more secure (Owen and Vu 2020). On the other hand, substantial corruption among law enforcement authorities, financial agencies, bureaucrats, politicians, and other regulators would essentially mean more bribery and greater rent-seeking in the formal sector (Duttat et al. 2013). Consequently, the cost of creating new businesses and staying in business in the formal sector may become quite costly. Thus, informal businesses may provide viable alternatives.

Despite the existence of these conflicting long-run theoretical arguments, the empirical literature has not empirically tested whether state antiquity affects the size of the informal economy in the long run. Nevertheless, there are empirical studies that have explored the existence of any long-term relationship between state antiquity and other contemporary economic outcomes such as economic development, financial development, institutions, and inequality. Among these empirical works, some find that a longer state history is associated with more favorable economic outcomes while others find the opposite.

Vu (2021a) studied the link between statehood experience and inequality in a sample of 128 countries. Using ordinary least squares estimates, this author found that accumulated statehood experience, up to a point, strengthens fiscal and legal capabilities, leading to a more egalitarian distribution of income. In the same order of ideas, Ang (2020) examined the relationship between the length of state experience and linguistic diversity for a global sample of 133 countries. Following econometric estimates, this author finds that state history has significant explanatory power in accounting for the disparity in long-term linguistic diversity across countries. Specifically, the baseline estimates of this author suggest that a one standard deviation increase in the historical presence of states over the period 3500 BCE-2000 CE leads to a 0.268 standard deviations reduction in the persistence of linguistic diversity. Likewise, Ang and Fredriksson (2018) analyzed the relationship between state history, legal adaptability, and financial development in a large panel of 127 countries from 2000 to 2009. Using two-stage least squares estimates, these authors found that a country’s cumulative experience with statehood improves its ability to adapt its laws to local needs and enhances therefore the development of its financial system. In the same vein, Ang (2013) examined the relationship between state antiquity and modern financial development for a sample of 107 countries over the 2000–2009 period. Using two-stage least squares estimates, this author found that countries with long histories of nationhood tend to be associated with strong legal capabilities, which play a paramount role in shaping the historical development of modern financial architecture.

Besides these contributions, there are empirical studies that on the contrary, found that long history of nationhood tends to impede contemporary economic outcomes. Vu (2021b) investigated how political instability is related to the length of state history for a sample of 109 non-European societies. Following econometric estimations, this author found that a long history of statehood is linked to the persistence of political instability. In the same order of ideas, Harish and Paik (2020) analyzed the effect of state antiquity on economic development of European countries. Following econometric estimations, these authors found that a long history of statehood is associated with elite capture and subsequent institutional stagnation, which impede economic development. Likewise, Owen and Vu (2020) contend that excessive statehood experience is positively associated with the prevalence of corruption. In the same vein, Borcan et al. (2018) established that very long-standing states lagged behind those with an intermediate length of statehood in terms of income per capita.

3 Empirical approach

3.1 Regression model

We specify the following cross-country model:

$$INF_{i} = \alpha + \beta State_{i} + X_{i} \theta + \varepsilon_{i}$$
(1)

In this equation, \({INF}_{i}\) refers to the average of informal sector size over the period 1991–2015 of country i. \({State}_{i}\) is the variable of interest that measures state antiquityFootnote 1 inspired by Ang and Fredriksson (2018). \({X}_{i}\) is a \(6x1\) vector of control variables including vulnerable employment, regime durability, religion fractionalization in the year 2000, ease of doing business, soil fertility rate, and European dummy. \({\varepsilon }_{i}\) refers to the error term. Note that we cannot rule out the possibility that the causality between the modern-day informal sector and state history since 1 AD may run in the opposite direction. In addition, the alternative scenario of an omitted unobservable variable cannot be ruled out either. For example, as documented by Ang and Fredriksson (2018), there may exist substantial variation in the hierarchy of historical institutional structures which drives the formation of territorial states. To the extent that less egalitarian institutions were influential in the early development of the informal sector, such unobserved heterogeneity may generate a spurious relationship between state antiquity and the size of the informal sector. Therefore, to address these potential concerns of endogeneity, we would like to estimate Eq. (1) using two-stage least squares. For this purpose, we will use the following variables as instruments for the statehood experience: The average level of technology adoption in O AD and population density in the year 1400. The choice of technology adoption as an instrument for identifying the model is consistent with Tilly(1992), and Ang and Fredriksson (2018) who postulated that sporadic technological discovery methods of warfare and weapon systems were one of the key drivers giving rise to the formation of the state in ancient societies. Population density for its part is a suitable instrument because the transition from statelessness to statehood may be precipitated by some forces of population pressure. Indeed, a higher population density leads to more competition for territorial agricultural land or increased desirability for the rulers to provide public goods and services due to the benefits of economies of scale (Johnson and Earle 2000; Ang and Fredriksson 2021).

3.2 Data

In this study, we use a global sample of 127 countries with available data on the size of the informal sector and state antiquity for the period spanning from 1991 to 2015. The initial dataset contains all the 127 countries but 36 of them were dropped due to the unavailability of data on control variables. The data are sourced from Ang and Fredriksson (2018), Medina and Schneider (2018), World Bank (2020), Policy IV (2015), and the Quality of Government standard dataset (2020). The starting and ending year are governed by the informal sector size data availability. Indeed, these data are available from 1991 to 2015 in the Medina and Schneider (2018) database.

We use Medina and Schneider (2018) informal sector size estimates as they offer several advantages. Their estimates have by far the largest geographical reach. These estimates have also been widely used and cited in the empirical and theoretical literature on informality (Gutiérrez-Romero 2021; Baklouti and Boujelbene 2020). More importantly, Medina and Schneider (2018) offer methodologically improved estimates upon previous MIMIC specifications by measuring the overall economic activity based on satellite data on night lights instead of GDP. In this way, they addressed the main concerns with earlier MIMIC estimates, which used GDP both as an exogenous causal factor of the informal economy and as one of the indicators being affected by the informal economy (Gutiérrez-Romero 2021).

State history refers to the depth of experience with state-level institutions (Bockstette et al. 2002). Consistent with Putterman and Weil (2010), we employ the state antiquity index (State), covering 39 half-centuries from 1 to 1950 AD, sourced by Ang and Fredriksson (2018). According to these authors, the state antiquity index is covered on a scaleFootnote 2 from 0 to 1 and is calculated as follows:

$${State}_{it}=\frac{\sum_{t=1}^{39}{(1+0.05)}^{1-t}.{SA}_{it}}{\sum_{t=1}^{39}{(1+0.05)}^{1-t}.50}$$
(2)

where \({SA}_{it}\) is the extent of state presence and 0.05(5%) is a discount rate which is applied to each of the half-centuries so that less importance is attached to states formed in the more distant past. Note that the estimates are insensitive to the use of alternative discount rate ranging from 0 to 15%. As documented by Ang and Fredriksson (2018) the extent of state presence (\({SA}_{it})\) in any particular 50 year period (t) for a country I is measured as the product of three sub-indicesFootnote 3 and 50:

$${SA}_{it}={State presence}_{it}x {State autonomy}_{it}x{State coverage}_{it}x50$$
(3)

where \(0\le {SA}_{it}\le 1\), \(t=\mathrm{1,2}\dots 39\). A score of 0 indicates no presence of state, 25 reflects that a country has a supra-tribal authority but its entire territory is ruled by a foreign authority, and 50 indicates the presence of an autonomous nation, and so on.

Six control variables are used and are consistent with the recent informal sector size determinants literature, namely, vulnerable employment, regime durability, social polarization, ease of doing business, soil fertility rate, and European dummy. Vulnerable employment is unpaid family workers and own-account workers as a percentage of total employment. As documented by Dell’Anno (2016), this variable is used to account for the labor market determinants of the informal economy. Regime durability, which provides a measure of the durability of a regime’s authority pattern in a given year, is used to capture the level of political instability (Elbahnasawy et al. 2016). Social polarization is captured by religion fractionalization in the year 2000. According to Elbahnasawy et al. (2016), a political system characterized by high levels of political instability and polarization will cause persistent inefficiencies in the collection of taxes and will increase the private sector’s incentive to participate in the formal economy. Ease of doing business captures the quality of the business environment, which is considered in the literature as an important driver of the informal economy (La Porta and Shleifer 2014; Massenot and Straub 2016). Soil fertility rate and European dummy are used to capture the unobservable heterogeneity specific to the geography and the continent, respectively.

Regime durability data are sourced by policy IV (2015) database, vulnerable employment data are from World Development Indicator (2020) database, while ease of doing business, religion fractionalization in the year 2000 and soil fertility rate data are sourced by the Quality of Government standard dataset (2020). Note that unlike the other variables used in this study, to obtain uniform cross-sectional data of our set of countries, the variables sourced by World Development Indicators and policy IV databases are average over the period 1991–2015.

4 Results

Figure 1 represents a scatter plot illustrating the negative relationship between state antiquity and informal sector size across countries. A long-standing established states are the ones with a small informal sector size. This is consistent with the theoretical arguments that support the idea that a long history of statehood reduces the size of the informal economy. This result, however, does not necessarily imply causality.

Fig. 1
figure 1

The relationship between state antiquity and informal sector size. Notes: The figure represents a scatter plot of the linear relationship between state antiquity and contemporary informal sector size across countries. The abbreviations of countries are obtained from the World Bank’s World Development Indicators

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Panel (I) of Table 1 reports the main results. More specifically, column (1) presents the relationship between state antiquity and the contemporary size of the informal sector estimated by Medina and Schneider (2018). Diagnostic tests at the bottom of this column indicate that the Wald exogeneity test of endogenous variables is significant, the Sargan over-identification test, and the normality test are insignificant. Firstly, a significant Wald exogeneity test means that we reject the null hypothesis of the test. In other words, state antiquity is endogenous as suspected. Therefore, the use of an instrumental variables estimation method is justified. Secondly, an insignificant over-identification restrictions test confirms the validity of instrumental variables used in our estimation. Lastly, an insignificant Skewness/Kurtosis residuals normality test indicates that the residuals of our estimation are normally distributed. In other words, consistent with Newey (1987), our estimation results are not biased.

Table 1 State antiquity and informal economy: estimations results
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We can now turn to the interpretation of the results of the estimations obtained in the first column of Table 1. Several observations are in order. First, the coefficient associated with the state antiquity variable is negative and significant at the 1% level. In other words, state antiquity reduces the size of the informal economy. More specifically, a 0.1-unit increase in the state antiquity index is associated with a 0.0936 unit- decrease in the size of the informal sector. Therefore, the divergence in the size of the informal economy among countries can be explained by the cumulative variations in their level of state experience from 1 to 1950 AD. This result is in line with Chanda and Putterman (2007) who stated that the early existence of state government confers a developmental head start, which provides conditions conducive to shaping economic development. Second, regarding the control variables, the results in the first column of Table 1 show that vulnerable employment, regime durability, and religion fractionalization in the year 2000 significantly affect the size of the informal sector. Precisely, we found a positive relationship between vulnerable employment and the size of the informal economy. This means that a higher percentage of vulnerable employment rate increase the size of the informal sector. Furthermore, we found that regime durability reduces the size of the informal economy. This result is in line with Elbahnasawy et al. (2016) who found that regime durability negatively affects the size of the informal sector. Capturing religion fractionalization by its historical value in the year 2000, we also found a negative relationship with the size of the informal economy. This finding is in contradiction with Elbahnasawy et al. (2016), who found that religion fractionalization is positively related to the size of the informal sector.

To further examine the relationship between state antiquity and informal sector size, we re-estimate the model (1) by using the informal economy estimatesFootnote 4 obtained from Hassan and Schneider (2016) as an alternative measure of the informal sector size. More importantly, except for European dummy, which had been retained, in line with the literature on the informal sector size determinants (Dell’Anno 2016; Hong 2017; Gutiérrez-Romero 2021), we incorporate new control variables in the estimations. Among these new control variables, we distinguish trade restrictions, rule of law, legislature fractionalization in the year 2000, control of corruption in the year 2005, the average distance to the nearest ice coast, longitude, ethnic fractionalization in the year 2000, Protestants as a percentage of the population in the year 1980, domestic credit to the private sector, remittances, and employment to population ratio.Footnote 5 We repeat two stage least squares estimation method for our sample of countries. The results are reported in Table 1 column (2). The sign, the value, and the statistical significance of the coefficient on state antiquity are found to be quite similar to those obtained in column (1). Therefore, our finding is robust for different indicators of the size of the informal economy (Table 1).

Table 2 Data sources
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5 Conclusion

The current study investigates how state antiquity affects the informal sector size in a global sample of 127 countries (see Table 3) for the period spanning from 1991 to 2015. The state antiquity index published by Ang and Fredriksson (2018) is used as a proxy for state history whereas Medina and Schneider (2018) informal sector size estimates is our main measure of the size of the informal sector. The empirical evidence is based on two stage least squares. Our finding is robust for the two different indicators of the size of the informal sector.

Table 3 List of countries
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The finding in this paper highlights that longer state experience reduces the size of the informal sector. Specifically, a 0.1-unit increase in the state antiquity index is associated with a 0.0936 unit- decrease in the size of the informal sector. One important implication comes from this finding. Young states with a large informal sector should be mindful that state building is a time-consuming process, and any radical transformation in order to accelerate state development beyond its realistic capacity, may increase the informal sector size and leads to disastrous outcomes. Our finding do not however give insights on the threshold at which the age of the state begins to significantly reduce the size of the informal economy. Therefore, future studies can improve the existing literature by assessing this threshold.