Shining light onto the Shadow Economy

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Net exports, investment, entrepreneurship, taxation, the housing market, the oil industry; all concepts which regularly feature in our newspapers headlines! However, despite having an estimated value of almost $10 trillion and employing half the workers of the world, business activities ranging from the likes of prostitution to babysitting and bake sales taking place in the shadow economy tends to remain in the shade.

So, to shine some light on the shadow economy, firstly, what exactly is it? Also known as the ‘black economy’, ‘hidden economy’, ’underground economy’ or ‘parallel economy’, the shadow economy refers to any economic activities which are concealed from public authorities to avoid complying with regulations, taxation and other red tape which business’ face.

The size of the shadow economy varies between countries. In 1987 when Italy started to take account of its shadow economy the economy grew by 18% overnight. In the US and UK the shadow economy is slightly smaller, accounting for about 7-8% of their respective economies but, in other countries such as Sub-Saharan Africa it can be as high as 60%!

Characterised by empowering criminals and thriving on immoral behaviour, the black economy has connotations of burglary, loan sharks and the drug industry. It makes official figures such as GDP, unemployment and living standards extremely difficult to measure and leads to a loss of tax revenue, increasing budget deficits and cuts on public expenditure.

However, many of those employed in the shadow economy such as teenagers babysitting and children running a lemonade stand are not what society would label criminals. Contrary to the uncertainty surrounding the official economy and the institutions regulating it, job creation is prospering in the shadow economy with government assistance replaced by self-sufficiency. Two-thirds of the income earned by the 1.8 billion people employed in these “off-the-book” jobs is spent in the official economy leading to boosts in economic growth. The shadow economy in this light generates widespread employment and engineers an unrestricted entrepreneurial zeal which can’t exist as freely in the formal economy due to bureaucratic restrictions.

Whilst there will always be a shadow economy of some sort where illegal trade takes place, there are ways to embrace and further the benefits of the shadow economy and reduce the darker side. One way is through widespread tax reformation and a reduction in bureaucracy, red tape and business regulation. This allows entrepreneurs to prosper equally as well in the official economy as they do currently in the shadow economy and perhaps even more as moving to the formal economy would allow increased advertising and growth which isn’t possible in the shadow economy as there’s a fear of becoming known to authorities. Lower tax rates would also deem the tax system more ‘fair’ which increases tax morale and encourages compliance. Whilst reducing the illegal activities which constitute a large proportion of the black market is an entire new discussion, one way, recently illustrated in India, is by taking certain bank notes out of circulation to be replaced by new ones. Whilst this faced much controversy in India, it forces those holding large amounts of ‘black’ money to trade it into banks in order to get the new currency; a movement which can be monitored by authorities and investigated where necessary.

By Chloe Pryce

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