Invisible Markets, Visible Weaknesses

The Institutional Roots of Informal Economy in Southeast Europe

Institutional fragility and the rise of informal markets in Southeast Europe create fertile ground for financial crime. Recent research covering Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia and Serbia for 2012–2024 uses dynamic panel estimation to map how governance, macroeconomics and anti-money laundering (AML) regimes interact with informal economic activity. The findings point to persistent informality, unexpected effects from AML measures, and clear policy levers in contract enforcement and economic freedom. For practitioners and policymakers focused on financial crime prevention, these results underline where enforcement, inclusion and regulatory design must be better aligned.

The persistence of informality and implications for illicit finance

The econometric model reveals strong path dependence: the previous year’s level of informal activity is the single most powerful predictor of current informality. That persistence matters for financial crime because entrenched informal markets normalize unrecorded cash flows, opaque business practices and off‑record employment – conditions exploited by money launderers, fraudsters and corrupt networks. High persistence implies that one-off crackdowns or episodic AML campaigns are unlikely to dismantle structures that have become economically and socially embedded. Instead, long-term, coordinated strategies are needed that change incentives over time and integrate formalisation with anti-crime objectives.

Corruption control, contract enforcement and economic freedom – differentiated effects

The study finds that improved control of corruption is associated with a modest decline in informality. This aligns with the intuitive link between reducing bribery and the incentives to bypass formal channels. From a financial crime perspective, better corruption control weakens a principal enabler of illicit financial flows: when officials and businesses face higher detection and sanction risks, corrupt facilitation of money laundering and tax evasion becomes costlier.

More striking are two stronger institutional levers associated with declining informality: contract enforcement and economic freedom. Better contract enforcement reduces transaction uncertainty and the relative advantages of informal arrangements. For anti‑money laundering efforts, a predictable judiciary and enforceable contracts increase the attractiveness of formal finance, making transactions more transparent and traceable – thereby narrowing opportunities for laundering and hiding proceeds. Similarly, higher economic freedom – measured here in terms of lower regulatory burdens and transaction costs – reduces the attractiveness of off‑book activity by lowering the entry and operating costs of legitimate businesses. Policies that streamline business registration, lower compliance frictions and expand access to formal financial services therefore serve both economic and financial‑crime prevention goals.

Bastian Schwind-Wagner _Follow

"The persistence of informality requires sustained, coordinated policy action rather than episodic enforcement; long-term measures that combine judicial strengthening, regulatory simplification, and social protection will gradually reduce unrecorded economic activity. Policymakers should pair AML rules with financial inclusion to prevent de‑risking and ensure vulnerable businesses and workers remain within supervised channels.

Practical anti‑crime strategies must integrate macroeconomic stabilization and digital onboarding incentives to shrink the space for illicit finance. Success depends on consistent implementation, clear communication, and monitoring so reforms translate into measurable reductions in informal flows and associated criminal exploitation."

AML effectiveness and the paradox of de-risking

A counterintuitive result emerges around AML: stronger AML scores in this sample are associated with a slight increase in informality. This is consistent with documented unintended consequences of rigid AML regimes – most notably de‑risking. When banks and payment providers face heavy compliance burdens or uncertain enforcement, they may restrict services to segments deemed higher risk, notably small enterprises, migrant workers and cash‑intensive trades. Those customers then migrate to informal channels – cash networks, informal money transfer systems, or emerging fintech services operating in regulatory grey zones. For financial crime specialists, this highlights a critical trade-off: AML measures that are overly prescriptive or poorly calibrated without parallel inclusion policies can shrink formal financial transparency and push transactions into less observable channels, undermining the very goal of preventing money laundering.

Macroeconomic pressures as drivers of informal markets and crime vulnerability

The analysis confirms that inflation and unemployment are significant push factors into informality. Higher inflation erodes real wages and incentivizes cash transactions and rapid price adjustments that are difficult to track. Elevated unemployment drives individuals into informal work for survival. Both dynamics expand the volume of unrecorded economic flows, creating more opportunities for predicate offenses and layering in laundering chains. In crisis periods or where social protections are weak, informal markets act as an economic safety net – but also as a persistent conduit for illicit finance. For financial crime policy, this means that monetary and labor market policies, social safety nets and inclusion measures are part of the prevention toolkit: reducing macroeconomic stressors lowers demand for unregulated channels.

Digitalisation and fintech: opportunity and risk

Digital financial technologies hold promise for traceability and inclusion, yet their impact depends on institutional capacity. Where regulatory frameworks are weak, fintech can facilitate “digital informality” – fast, opaque payment channels that operate outside effective supervision. Conversely, when regulators adopt adaptable approaches – sandboxes, proportionate KYC rules, and incentives for onboarding small businesses – digital tools can extend formal access and transaction traceability, supporting AML objectives. Designing fintech regulation that balances innovation, inclusion and AML effectiveness is therefore a strategic priority for Southeast Europe.

Policy priorities to reduce informality and financial crime risk

1. Strengthen contract enforcement and judicial effectiveness. Clear, timely dispute resolution reduces the cost advantage of informal transactions and increases the traceability of commercial flows. For AML, an effective judiciary enables asset recovery, criminal sanctions and the enforcement of reporting obligations.
2. Promote economic freedom through regulatory simplification and targeted incentives. Reducing bureaucratic hurdles to formal registration and lowering compliance costs for small firms encourages formalization, expands the taxable base and brings transactions into monitored channels.
3. Recalibrate AML to avoid exclusionary outcomes. Risk‑based supervision, tiered KYC, and support measures for bankable small enterprises can reduce de‑risking. AML frameworks should be paired with financial inclusion policies so compliance does not translate into blanket denial of services.
4. Integrate macroeconomic stabilization with inclusion measures. Policies that mitigate inflationary shocks, support employment and strengthen social safety nets reduce the economic pressure driving people into unregulated work – thereby lowering the volume of informal cash flows that facilitate financial crime.
5. Harness digitalisation through proportionate regulation and onboarding incentives. Regulatory sandboxes, capacity building for supervisors, and incentives for responsible digital payment providers can accelerate formalisation while preserving innovation. Digital public infrastructure and interoperable ID systems can improve customer verification and transaction monitoring without excluding vulnerable users.
6. Adopt a long‑term, coordinated approach. Given the persistence of informality, short-term enforcement alone is insufficient. Sustained reform across legal, fiscal, supervisory and social policy domains is required to shift entrenched behaviors and reduce the structural opportunities exploited by criminals.

Concluding assessment for anti‑financial crime practitioners

This regional analysis of Southeast Europe underscores that the supply of financial crime opportunities is deeply rooted in institutional and macroeconomic weaknesses. Effective prevention requires linking AML policy to broader governance reforms, judicial capacity, financial inclusion and economic stability. Overly strict compliance regimes that lead to de‑risking can backfire by expanding unregulated channels; conversely, reforms that lower the costs of formality and strengthen enforceability reduce both informality and the vectors used by illicit actors. For investigators, supervisors and policymakers, the lesson is clear: fight financial crime not only with sharper enforcement but with smarter, inclusive regulation and sustained institutional development that make formal channels safer, cheaper and more attractive than the shadow alternatives.

Dive deeper

• Research ¦ Durguti, E. A., Kryeziu, N., Krivins, A., & Suárez Agudelo, C. (2025). Invisible Markets, Visible Weaknesses: The Institutional Roots of Informal Economy in Southeast Europe. Public Governance, Administration and Finances Law Review, 10(2), 137–156. https://doi.org/10.53116/pgaflr.8422 ¦ Link ¦ licensed under the following terms, with no changes made: CC BY 4.0