Uncovering illegal and underground economies: The case of mafia extortion racketeering

I propose a new approach to quantify the economic cost of hidden economies and apply it to the case of mafia extortion in Northern Italy. To quantify the extortion rate, unobserved in the data, I first show that extortion racketeering is linked to resource misallocation. Then, I implement a structural estimation based on matching the observed misallocation in markets defined as mafia-infiltrated, with that predicted from a model whose parameters are estimated using data on non-mafia markets or calibrated from the literature. The results suggest that the share of output that the mafia extorts from firms ranges between 0.5 and 5 percent of firm-level output for those firms that are subject to extortion, with an implied loss between 0.6 and 8 percent of aggregate value added.