The Dark Side of Growth: Are Shadow Economies Undermining the Global Climate Goal?

Abstract

This study investigates the underexplored relationship between the shadow economy and environmental degradation and governance within the European Union, focusing on CO₂ and GHG emissions, and climate-related natural disasters, from 2012 to 2021. Employing both panel data econometrics and Elastic Net regularisation, the analysis reveals asymmetric effects: while a larger shadow economy is associated with lower reported GHG emissions, likely due to underreporting or less energy-intensive activities, it simultaneously increases vulnerability to climate-induced disasters. Furthermore, environmental taxes, although effective in mitigating emissions, show limited impact on disaster frequency, suggesting that fiscal instruments alone may be insufficient to foster climate resilience. Economic prosperity correlates with higher emissions and greater climate risk, highlighting a trade-off between growth and sustainability. The findings underscore the necessity of integrating informal economic activities into environmental governance frameworks, particularly in the context of the European Green Deal. Recognising and regulating the environmental footprint of the shadow economy is essential for achieving comprehensive and equitable climate goals. Future research should explore the role of institutional quality and fiscal transparency in moderating the environmental effects of informality. Overall, this study calls for a rethinking of climate policies to include both the formal and informal dimensions of economic activity.