Formal Trade and the Informal Economy: Evidence From GATT / WTO Membership

ABSTRACT In recent decades, an increasing number of countries have joined international trade agreements such as the General Agreement on Tariffs and Trade (GATT) and its successor, the World Trade Organization (WTO). However, the effects of trade liberalisation on labour markets and economic transformation remain debated. This paper investigates the influence of WTO accession on the size of the shadow economy across countries. A panel dataset of 153 countries is used from 1991 to 2017, and a difference‐in‐differences specification is employed. The findings show that WTO accession is associated with a reduction in the size of the shadow economy by around 1–2 percentage points. To explore the underlying mechanisms, a three‐stage least squares model is employed. The results suggest that WTO membership increases trade openness and reduces unemployment, both of which alleviate informality. These findings imply that global trade agreements like the WTO can accelerate the formalisation of economies and promote institutional and economic development.