Measuring the unobservable: estimating informal economy by a structural equation modeling approach

Abstract This article proposes a new approach to estimate the informal economy (IE) by using Structural Equation Modeling (SEM). Using a Monte Carlo Simulation and empirical analysis of the Italian IE as an example, we provide general conclusions on the reliability and limitations of the SEM approach to estimate the IE. Practical guidelines on how to apply this method and the way to deal with the most problematic issues are provided. We conclude that the SEM approach may be effectively used, as a complementary method to the National Accounting Approach, to adjust official statistics for the presence of the IE.