Economics

Don't Mess With Shadow Economies. They Keep Countries Afloat

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Shadow economies — black markets, underground economies, whatever you want to call them — provide a refuge for people overburdened by taxes and regulations. Businesses that can't navigate a byzantine maze of licenses, permits and red tape, or discover their profit margins can't survive the appetites of revenue collectors, can nevertheless find life outside the legal economy. But shadow economies not only offer life to entrepreneurs and workers, they can even keep whole struggling countries on their feet. Economists now warn that stamping out shadow economies, as so many politicians vow to do, could be suicide in places where the aboveground world is a less than completely fertile environment.

From The Economist:

Friedrich Schneider, a professor at the Johannes Kepler University in Linz, Austria, has been assessing shadow economies for years. He reckons that much of Greece's shadow economy, perhaps as much as half, actually complements activities in the official economy, adding to welfare and overall GDP. Stamping it out altogether might do more harm than good.

How is it that the shadow economy "complements activities in the official economy"?

A government has the challenge of deciding whether the shadow economy is a blessing or a curse. And, argues Mr Schneider in a paper he has been circulating, it may not have a great interest in reducing it, for the following reasons:

  • Income earned in the shadow economy increases the standard of living of one-third of the working population
  • Between 40% and 50% of these activities have a complementary character, which means additional value-added and an increase in overall output
  • Foregone taxes may be moderate since at least two-thirds of the income earned in the shadow economy is immediately spent in the official economy
  • People who work in the shadow economy have less time for other things such as going on demonstrations

Greece is of specific concern here. It's a country where the shaow economy equaled an estimated 25.1 percent of GDP last year. Unsurprisingly, Greece is ranked 119th in the world in terms of economic freedom, where "licensing requirements remain burdensome" and "[l]abor regulations are restrictive, with the non-salary cost of employing a worker high and restrictions on work hours rigid."

But there are lots of places in the world today that have created discouraging environments for aboveboard economic activity. Then, off-the-books work becomes a necessity, and "stamping it out altogether might do more harm than good."

Yeah. We're looking at you, California.