Decomposing the Trust-Informality Relationship: Dimensions and Demographic Heterogeneity Across OECD Countries

Every society relies on a quiet, unspoken agreement between its people and its government. Citizens agree to follow rules and pay taxes, and in return, the state provides services, security, and a functioning economy. When this agreement holds, the economy runs smoothly on the books. But when the agreement frays, a hidden layer of economic activity emerges. This is the shadow economy, a vast network of unregistered work, untaxed income, and informal business that operates just outside the official view. It is not a fringe phenomenon; in many wealthy nations, it represents a significant portion of all economic activity, meaning governments collect less revenue than they could, and workers lack the protections of formal employment. For decades, economists believed that the size of this hidden economy was driven by two main forces: how high the taxes were and how strictly the government enforced the rules. If taxes were too high or police too lenient, people would simply go underground.

However, a closer look at the data from wealthy nations reveals a puzzle. The size of the shadow economy does not always match the tax rates, and the chance of being caught for breaking the rules is often so low that it cannot explain why some countries have large hidden economies while others do not. This suggests that something else is at work, something rooted in human behavior rather than just cold calculation. Researchers have long suspected that trust plays a central role. If people believe their government is honest and fair, they are more likely to follow the rules voluntarily. But trust is not a single, simple feeling. It is a complex mix of different beliefs about how the state behaves. A new study by Oliwia Wyciszkiewicz and Friedrich Schneider digs into this complexity, asking not just whether trust matters, but exactly which parts of trust matter, and for whom. By examining data from twenty-five wealthy nations, they have mapped out the specific qualities of government that keep the shadow economy small and those that do not.

The researchers began by gathering a massive amount of information from two recent surveys conducted by the Organisation for Economic Co-operation and Development. These surveys asked over 100,000 citizens in twenty-five countries to rate their trust in public institutions across seven different areas. These areas included whether the government treats people fairly, whether it responds to complaints, whether it is reliable and competent, whether it is honest and free of corruption, and whether it is open and transparent. They also measured general trust in the political system and trust in other people. The team then combined these survey answers with independent estimates of the size of the shadow economy in each country, which were calculated using a sophisticated method that infers hidden economic activity from observable economic patterns. By merging the feelings of the people with the hard numbers of the economy, they created a detailed picture of how different types of trust relate to the size of the hidden economy.

The results painted a clear and surprising picture. The study found that not all trust is created equal. Four specific dimensions of trust were strongly linked to a smaller shadow economy: the belief that the government is responsive to citizens, that it treats everyone fairly, that it is reliable and competent, and that it is open and transparent. When citizens felt their government listened to them, treated them equally, delivered services well, and shared information openly, the hidden economy was smaller. The most powerful of these was responsiveness. The data showed that for every point increase in citizens' belief that the government adapts to their needs and feedback, the size of the shadow economy dropped by more than three percentage points. This effect was so strong that it held up even when the researchers accounted for other factors like unemployment and the overall tax burden.

In contrast, other common ideas about trust did not hold up. The study found that general confidence in the political system, or a broad feeling that the government is honest and free of corruption, did not predict the size of the shadow economy once other factors were considered. Similarly, trusting other people in society did not make a difference. This suggests that citizens are not reacting to the state as an abstract idea or a distant entity. Instead, they are reacting to the concrete, daily quality of their interactions with it. It is not enough for a government to be generally "good" or "honest" in the headlines; it must be responsive, fair, reliable, and open in its specific actions. The research explicitly rules out the idea that simply fighting corruption or boosting general morale is enough to shrink the hidden economy. If a government is honest but unresponsive, or fair but incompetent, the shadow economy remains large.

The study also looked at who in the population is most sensitive to these changes in trust. The researchers discovered that the relationship between trust and the shadow economy is not the same for everyone. It is strongest among women, older citizens, and people born in the country. These groups tend to be more skeptical of the government's performance, and when that performance improves, they are the ones who are most likely to return to the formal economy. The effect is also strongest for middle-income households. For high-income citizens, the size of the shadow economy did not seem to change based on trust levels at all. This suggests that wealthy individuals may rely more on enforcement and financial infrastructure to stay compliant, or they may have the resources to navigate the formal system regardless of how much they trust the government. Low-income citizens responded strongly to fairness and reliability but less to responsiveness, perhaps because they feel less connected to the benefits of public services.

Perhaps the most significant finding concerns the timing of these effects. The researchers tried to see if a country could shrink its shadow economy simply by improving its trust scores over a short period. They looked at changes between 2021 and 2023 and found no evidence that short-term improvements in trust led to immediate reductions in the hidden economy. The relationship only appeared when comparing different countries to each other, not when watching a single country change over time. This implies that trust acts like a deep, accumulated stock, built up over decades of consistent behavior, rather than a quick fix that can be achieved in a single election cycle. The returns on building a responsive, fair, and open government compound over generations, which explains why some nations have maintained small shadow economies for a long time while others struggle despite recent reforms.

Ultimately, this research shifts the conversation about how to fix the shadow economy. It suggests that the solution lies not in harsher penalties or higher taxes, but in the specific, measurable qualities of how a government treats its people. When a government listens, treats people equally, delivers on its promises, and speaks clearly, it builds a form of trust that encourages people to stay in the formal economy. This is a slow, structural process that requires patience, but the data shows it is the most effective way to bring the hidden economy into the light. The study concludes that while we cannot force people to comply through fear alone, we can build a system where compliance feels like the natural and right thing to do, provided the government earns that trust through its daily actions.