The Impact of Remittances on the Informal Economy in Latin America: A Dynamic Nonlinear Analysis

This paper studies how remittance inflows affect informality in Latin America and the Caribbean using annual data for 22 countries over 2000--2020. System-GMM estimates show that remittances are positively associated with informality when measured with output-based shadow economy indices derived from Multiple Indicators and Multiple Causes and Dynamic General Equilibrium approaches. By contrast, this relation is weaker for labor-market proxies such as self-employment rate and informal employment share. System-GMM interaction estimates indicate that greater financial freedom attenuates the positive remittance--informality association, consistent with stronger financial systems channeling remittances toward the formal economy. The relationship exhibits nonlinear characteristics. Panel Smooth Transition Regression models identify statistically significant threshold behavior, with financial institutional access driving the regime switch in the remittance effect on the informal economy. In particular, the positive remittance--informality association is concentrated in low-financial outreach regimes and turns negative once access crosses the estimated threshold. Overall, remittances are more likely to coincide with informality where financial inclusion is weak, implying that economic policies targeting financial infrastructure and inclusion can increase the formalization payoff of remittance inflows, particularly in countries below the identified threshold. JEL Classification: F24 , O17 , C33 , O54 , E26 , C26