Villa, EdgarMisas, Martha A.Loayza, Norman V.2016-03-092016-03-092016-02https://hdl.handle.net/10986/23917This paper contributes to the economic analysis of illicit activities and money laundering. First, it presents a theoretical model of long-run growth that explicitly considers illicit workers, activities, and income, alongside a licit private sector and a functioning government. Second, it generates estimates of the size of illicit income and provides simulated and econometric estimates of the volume of laundered assets in the Colombian economy. In the model, the licit sector operates in a perfectly competitive environment and produces a licit good through a standard neoclassical production function. The illicit sector operates in an imperfectly competitive environment and is composed of two different activities: The first activity produces an illicit good that nonetheless is valuable in the market (for example illicit drugs); the second does not add value to the economy but only redistributes wealth (for example robbery, kidnapping, and fraud). The paper provides a series of comparative statics exercises to assess the effects of changes in government efficiency, licit sector productivity, and illicit drug prices. From the model, the analysis derives a set of estimable macroeconometric equations to measure the size of laundered assets in the Colombian economy in the period 1985 to 2013. The paper assembles a data set whose key components are estimates of illicit income from drug trafficking and common crime. Illicit incomes increased drastically until 2001, reaching a peak of nearly 12 percent of gross domestic product and then decreasing to less than 2 percent by 2013. The decline overlaps not only in a period of high economic growth, but also after the implementation of Plan Colombia. The data set is used to estimate the volume of laundered assets in the economy by applying the Kalman filter for the estimation of unobserved dynamic variables onto the derived macroeconometric equations from the model. The findings show that the volume of laundered assets increased from about 8 percent of gross domestic product in the mid-1980s to a peak of 14 percent by 2002, and declined to 8 percent in 2013.en-USCC BY 3.0 IGORISKSCAPITAL MARKETSUNEMPLOYMENT RATESTOTAL INVESTMENTFOREIGN CAPITALMACROECONOMIC MODELECONOMIC GROWTHPRODUCTIONRELATIVE PRICECAPITAL ACCUMULATIONSTOCKDISPOSABLE INCOMEINCOMEINTERESTDEPRECIATIONPUBLIC INVESTMENTSPERFECT COMPETITIONEXPECTATIONSMONEY SUPPLYINTEREST RATEREAL GDPSUPPLIESDEPRECIATION RATEBANKING SYSTEMBALANCE OF PAYMENTSDOMESTIC MARKETEXPORTSNATIONAL SAVINGSECONOMETRIC ESTIMATESASSETRECESSIONWELFAREOPTIMIZATIONBONDSINCENTIVESEQUILIBRIUMGRAVITY MODELWORLD MARKETSINDICATOR VARIABLESVARIABLESNEGATIVE EXTERNALITYMARGINAL PRODUCTIVITYCAPITAL STOCKCONSUMPTION DECISIONSREAL INCOMEINPUTSRETURNS TO SCALEPAYMENTSWEALTHBANKRUPTCYAGGREGATE INCOMECENTRAL BANKDEVELOPMENTMONETARY INSTABILITYMACROECONOMIC STABILITYLABOR MARKETSTEADY STATESAVINGSTECHNICAL ASSISTANCECURRENCYDEVELOPMENT ECONOMICSMAXIMUM LIKELIHOOD ESTIMATIONECONOMIC CRISESEXPENDITURE FUNCTIONEXOGENOUS VARIABLESMONEYCURRENT ACCOUNTCURRENT ACCOUNT SURPLUSCONSTANT RETURNS TO SCALESURPLUSEXCHANGE RATESBASE YEARPRODUCTIVITYECONOMETRICSIMPERFECT COMPETITIONOVERLAPPING GENERATIONS MODELMARKETSDEBTEXPENDITURE FUNCTIONSOPEN ECONOMYBUSINESS CYCLETOTAL COSTSECONOMICS LITERATUREIMPORTSREAL INTEREST RATERECESSIONSGENERAL EQUILIBRIUM MODELUTILITYGROSS DOMESTIC PRODUCTINVENTORYDISTORTIONSLIBERALIZATIONTAXESUNEMPLOYMENTINCOME TAXESEXTERNALITYCONSUMPTIONGENERAL EQUILIBRIUMRISK NEUTRALMONETARY SUPPLYCAPITALWAGESDISTORTIONUNEMPLOYMENT RATEVALUELONG-RUN EQUILIBRIUMMACROECONOMICSDUTCH DISEASEFOREIGN INVESTMENTDEMANDINVESTMENT LEVELSUTILITY FUNCTIONCONSUMPTION GOODSAGGREGATE DEMANDREAL COSTECONOMYWorking PaperWorld Bank10.1596/1813-9450-7578