The present paper investigates the link between the shadow economy and FDI using the Granger panel causality test. For that purpose we use the shadow economy and FDI data for 145 countries of five data points 1999/2000, 2001/2002, 2002/2003, 2003/2004 and 2004/2005. The system GMM estimation results show that FDI causes the shadow economy and vice versa. The empirical evidence supports the hypotheses that higher FDI causes lower shadow economy and higher shadow economy causes higher FDI.
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