Shadow Economy Drivers in Bosnia and Herzegovina: A MIMIC and SEM Approach

This study explores the drivers and evolution of the shadow economy in Bosnia and Herzegovina—a transitional, post-conflict country facing persistent institutional fragility. Using the Multiple Indicators and Multiple Causes (MIMIC) model, an extension of Structural Equation Modeling, the paper estimates the size and dynamics of the shadow economy from 1996 to 2022. The model integrates macroeconomic indicators (employment rate, GDP per capita, tax revenues) and institutional variables (rule of law, control of corruption), with data primarily sourced from the World Bank. The results show that institutional quality, tax burden, and labor market conditions are significant determinants of the informal sector. The model demonstrates strong statistical validity (CFI = 0.986, RMSEA = 0.05), supported by robustness checks including unit root tests, structural break analysis, and the exclusion of controversial benchmarking methods. The shadow economy responds markedly to major shocks such as the 2008 global financial crisis and the 2014 floods. Findings provide valuable policy insights: strengthening institutions, simplifying tax systems, and encouraging formal labor market participation can significantly reduce informality. The study supports evidence-based reforms to enhance transparency, resilience, and sustainable development in Bosnia and Herzegovina.