Factors of Informal Economy Development in Central Asia and the Caucasus

Informal economic activity poses significant challenges to fiscal capacity, regulatory efficiency, and inclusive development across the region. The purpose of this study is to identify and analyze the key factors influencing the level of the informal economy in Central Asia and the Caucasus. The empirical database is based on panel data for six countries (Kazakhstan, Kyrgyzstan, Tajikistan, Azerbaijan, Armenia, and Georgia) compiled from statistics from the World Bank and the IMF. A panel regression model with random effects was applied, taking into account the impact of macroeconomic and institutional variables. The results show that higher GDP per capita significantly reduces the size of the informal economy (coefficient –0.00026, p < 0.001), confirming the inverse relationship between income and the shadow sector. Financial development has a strong negative impact (–13.43, p < 0.001), highlighting the role of infrastructure and digital finance in formalization. Urbanization demonstrates a dual effect: in its early stages, it contributes to the growth of informal employment, but in mature urban systems, it reduces its level (–0.41, p < 0.001). Trade openness, on the contrary, positively correlates with the informal economy (+0.019, p<0.001), which indicates the risks of liberalization without accompanying digitalization of customs procedures. The findings confirm the need for targeted state measures to formalize the economy through digital tax infrastructure, expanded financial inclusion, and simplified business registration procedures. Future research may focus on examining tax distortions and wealth inequality as factors sustaining the informal sector.