As Bad Times Continue, Shadow Economies Grow


A few months ago, Robert Neuwirth caused a buzz with a Foreign Policy article, excerpted from his book, Stealth of Nations: The Global Rise of the Informal Economy, in which he described "System D" as the world's fastest-growing economy. He suggested that this untaxed, unregulated shadow economy holds out the most promising future for people around the world seeking to start businesses or simply earn a living. Now, two Turkish economists have found evidence that the crappy financial environment of the last few years has made the shadows an increasingly attractive place for anybody hoping to make money to hide.

Writing at VoxEU —

an online publication of the Centre for Economic Policy Research — Ceyhun Elgin and Oguz Oztunali of Bogazici University say:

For almost all country groups (except for the post-Socialist one), we observe a declining trend over time. However, the pace of the reduction seems to lose some momentum in the last decade. Somewhat more interestingly, we observe a spike staring in 2007. Considering the emergence of the global economic crisis, this could give further support for the hypothesis that the size of the shadow economy is countercyclical.

Basically, contrary to Neuwirth, Elgin and Oztunali say that shadow economies around the world had, by and large, been shrinking up until recently. That shrinkage slowed with the new millennium, and then reversed itself, big time, in 2007. For all regions the two economists studied, OECD-EU, Latin American and Caribbean, post-Socialist (Transition), Middle East and North African, sub-Saharan African, and Asian-Oceanian countries, shadow economies are now growing, in an impressive way. Measured as a percentage of GDP, shadow economies have now jumped up to an average (mean) of:

  • OECD-EU: 17.84%
  • Latin: 41.98% 
  • Post-Socialist: 37.37%
  • MENA: 31.50%
  • Sub-Saharan: 43.06%
  • Asia: 32.84%
  • World: 22.67%

The growth of the shadow economy has interesting implications. First, it helps to explain why countries like Spain, where unemployment now stands at a brain-buggering 24.4%, aren't now paving their streeets with the bodies of the starving. Obviously, some significant percentage of those people are working off the books. Also, it suggests that some of the "austerity" solutions bandied about recently may be working against each other. If, as shadow-economy expert Friedrich Schneider writes, "tax and social security contribution burdens are one of the main causes for the existence of the shadow economy," and "every available measure of regulation is significantly correlated with the share of the unofficial economy," then the business and labor-market deregulation slowly working its way through some of Europe's rule-bound economies is running smack into vocal insistence that governments hike tax rates and set tax collectors (even fancy foreign loaners) on the trail of tax scofflaws.

It's like trying to entice a beaten dog out of his hidey-hole with a treat in one hand and a club in the other. For now, you can probably expect those shadow economy figures to keep going up.

Brian Doherty discussed Robert Neuwirth and shadow economies here.