Effect and measuring of the Shadow economy

                                                                                          Author: Vsevolod Klivak

First of all, it shall be mentioned, that shadow economy is an umbrella term, which includes the black market and the underground economy. Although these terms mean not the same thing, in a broader sense they can be used interchangeably. In this blog post, points from measuring and descriptive will be pointed out.   From the quantitative side, you could measure the size of the shadow economy and the influence of it, but the real essence of the understanding is in the qualitative field. There some main effects of the SE.

Negative effect

·         The government can’t measure the actual state of the economy to help make policy

·         The government isn’t collecting the taxes that it should

·         Consumers are not protected from people selling fake/unsafe goods

·         Workers injured on the job don’t have recourse to required insurance

·         Workers don’t accumulate government pension benefits

·         Informal businesses have to stay small to avoid attracting attention. Big companies are more efficient.

Positive effect

·         contracts & no contracts

·         simple terms to abide

·         easier to do business with a person that has not pet peeves and delivers profit.

Notwithstanding there are many different aspects, which may give an intuition about the relation in the economy with the shadow economy. The most curious was a connection with the intelligence level. In the paper of Raufhon Salahodjaev concluded a claim, that Intelligence level and the Informal economy are negatively correlated. We also find that the results hold when we control for endogeneity of intelligence and for the presence of influential observation.

However, it is important to note that while estimates show that higher-IQ countries are negatively associated with the size of the informal economy, they should not be treated as direct evidence that a more intelligent population is a prerequisite to constrain shadow economy. These results suggest that if a government implements policies designed to reduce underground economy, intelligence offers a reasonable estimate of the level of acceptance of these policies.

Next curious example will be the article from the Gheorghe Zamana and Zizi Goschin about the correlation between economic growth and the SE in the Romanian economy system. Since the attempts to analyze SE based on only one indicator may be misleading, was developed a new synthetic index of SE that includes three relevant indicators: SE measured in euro per inhabitant, SE as a percentage of GDP and SE of each EU member state as a percentage of the total EU-28 shadow economy. That index calculations reveal that Romania is not among the countries with very large shadow economy magnitude, and is having low and stable shadow economy index values over 1999-2012. Although OLS was not sufficient to provide significant influence of shadow economy on economic growth, it was found a counteracting relationship between GDP and SE, therefore providing empirical support to the hypothesis that SE was linked to the economic development in Romania over 1999-2012. Nevertheless, it cannot be concluded, that the synthetic index may be descriptive enough.

Another engaging research about understanding SE in Eastern Europe was made by Ligita Gasparėnienėa, Rita Remeikienėa and Markku Heikkila. In this article under scope in the relation between SE and the economic situation in Ukraine. The results of the theoretical analysis and empirical research propose the following conclusions. The general impact of the shadow economy determinants can be multidirectional. The impact can be mitigated/reinforced considering the measures applied by the government for the reduction of the shadow economy.

Given calculations were revealed that the scope of the shadow economy in Ukraine is compositely influenced by the tax rate, overall employment rate, imports of goods and services, GDP per capita and participation of working-age people in the labour market. GDP per capita, more active participation of working-age people in the labour market and an increase in volumes of imports have a negative impact, while a tax rate increase and a growth of overall labour force have a positive impact on the scope of the shadow economy in the country. The impact of the latter factor is recommended to be confirmed by applying qualitative research methods.

Next paper by Mario Solis-Garciaa and Yingtong Xie tries to use a dynamic general equilibrium model approach for measuring the shadow economy. They proposed a methodology for measuring the size and properties of the shadow economy by using a two-sector dynamic deterministic general equilibrium model with four different variables: hours worked, investment-specific productivity, formal productivity, and shadow productivity. As it was found out the shadow productivity trend is endogenous, in the sense that it is an exact function of model parameters and the other three trends. After applying a methodology to a set of seven Latin American and Asian countries and document several empirical regularities that emerge from that analysis, the most important one being that the volatility of shadow sector output is considerably larger than the one informal sector output.

Conclusions

            Still, to this day there is no general approach to measure and understand the phenomenon of the shadow economy. There are more or less the same approaches to comprehend the roots of it, but it should be mentioned, that in different countries it may influence the economy in a good and bad way. The most prominent examples are coming from the emerging and transitioning economies. From the factors shall be said, that they may be endogenous and exogenous, but there is no methodology, where the influence of each factor could be measured.

            Shadow Economy is a great problem for the government, but for most of the part, it is the only way for people to survive. Although many approaches and visions towards SE were presented, still there is no clear macroeconomic concept of general understanding of the matter.

Sources

1.      https://en.wikipedia.org/wiki/Black_market

2.      https://www.investopedia.com/terms/u/underground-economy.asp

3.      https://marketbusinessnews.com/financial-glossary/shadow-economy-definition-meaning/

4.      https://pdfs.semanticscholar.org/6e64/96c443a875ae9c4ea2ed6476ccd12d2ea7ee.pdf

5.      https://www.quora.com/What-are-the-advantages-and-disadvantages-of-an-informal-economy

6.      https://www.sciencedirect.com/science/article/pii/S016028961500015X

7.      https://www.sciencedirect.com/science/article/pii/S2212567115002294

8.      https://www.sciencedirect.com/science/article/pii/S1822801116300303

9.      https://www.sciencedirect.com/science/article/pii/S0305750X15002077

10.  https://www.sciencedirect.com/science/article/pii/S0164070417300010