Financial development, financial inclusion, and informality: New international evidence

This paper explores the empirical relationship between informality and several indicators of financial development (FD) and financial inclusion (FI). We exploit a panel of 152 countries with annual information between 1991 and 2017. Using several panel cointegration techniques and four groups of countries (full sample, developed, developing, and Latin American countries), we find evidence of a negative long-run relationship between informality and several FD/FI indicators. Moreover, long-run weak exogeneity tests indicate that some FD/FI indicators empirically cause less informality. Specifically, we find that in developing countries financial development reduces informality when measured as “financial credit” and “bank credit”, whereas financial inclusion reduces informality when measured as “number of bank accounts”. Additionally, for both developing countries and the full sample of countries, we find evidence of double causality between informality and financial development when the latter is measured as “bank deposit”; for Latin American countries, evidence of double causality is found when financial inclusion is measured as “number of ATMs”. These results suggest that higher credit to the private sector and more bank accounts have contributed to reducing informality in developing countries in the long run.