Obama Finally Brings Growth — To the Shadow Economy


Stack of cash

If as many Spaniards were out of work as official figures suggest, pointed out Victor Mallet and Guy Dinmore in a 2011 article in the Financial Times, "Spain would not be as peaceful as, barring a few demonstrations, it has so far been." Spain's unemployment rate has gone up since then, and while the country isn't exactly thriving, there's no rioting or mass starvation, either. Clearly, there's a huge gap between official data and what people are actually doing, and occupying that gap, they reported, are off-the-books jobs, untaxed businesses and lots of cash in an active shadow economy. As noted at Reason 24/7, Rick Newman of U.S. News & World Report has spotted a similar mismatch — this time in the United States. Income isn't rising. Neither, really, is credit-card debt. But consumer spending is marching along at a healthy clip. Once again, unofficial economic activity beyond the reach of tax collectors and regulators seems to be taking up the slack.

Writes Newman:

Household spending has held up surprisingly well in recent months, even though new taxes have reduced paychecks and other problems are holding back the economy. Incomes haven't risen by nearly enough to explain the entire boost in spending. Nor has the use of credit cards.

When your teenager starts wearing expensive clothes and flashing bling he couldn't possibly afford through his part-time job, you start to wonder where the money is coming from. Some economists are asking the same question about consumers who seem more flush than they ought to be. The answer may lie in the large "underground" economy that doesn't show up in official statistics.

He goes on to cite Bernard Baumohl of the Economic Outlook Group, who recently wrote (PDF):

[S]evere recessions have historically driven jobless Americans into the shadow economy, and we suspect the destructive nature of the last downturn and the prolonged weak recovery pushed a record number of people into that murky world of cash transactions. Doing so allows them to earn money without reporting their income, leaving more available to spend. …

Despite the sharp drop off in the labor force participation rate, consumer spending has nevertheless continued to surge. One explanation is that many of those who have left the labor force since the last recession have managed to earn income in the shadow economy and their spending still shows up in the official retail sales and personal consumption data.

Adds Newman:

That may help explain one troubling trend—a sharp decline in the labor-force participation rate, which measures the percentage of the adult population considered to be either employed or looking for work. The participation rate has dropped from a peak of 67.3 percent in 2001 to 63.5 percent today. The last time it was that low was 1979. Some economists think this reflects a worn-out workforce resigned to long-term decline. But it might show a migration of workers from the official economy to the underground one instead.

There's always a bit of a data lag, but income figures haven't looked good for several years. In September 2012, the Census Bureau reported that "[r]eal median household income in the United States in 2011 was $50,054, a 1.5 percent decline from the 2010 median and the second consecutive annual drop." Household income is actually down 5.7 percent since the "recovery" began, Sentier Research reported that same month.

And let's not forget that lovely New Year's gift we all got in the form of a payroll tax hike.

And yet … consumer spending has been rising. Retail sales were up 1.1 percent in February. Even if you leave out car purchases and the big jump in gasoline prices, reports the Los Angeles Times, "so-called core retail sales increased a solid 0.4% in February, and this measure was revised up to 0.3% for January from 0.1% previously estimated."

Or as the federal Bureau of Economic Analysis puts it:

Personal income decreased $505.5 billion, or 3.6 percent, and disposable personal income (DPI) decreased $491.4 billion, or 4.0 percent, in January, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) increased $18.2 billion, or 0.2 percent. In December, personal income increased $353.4 billion, or 2.6 percent, DPI increased $325.7 billion, or 2.7 percent, and PCE increased $14.8 billion, or 0.1 percent, based on revised estimates.

Real disposable income decreased 4.0 percent in January, in contrast to an increase of 2.7 percent in December. Real PCE increased 0.1 percent, the same increase as in December.

But, this is America. So, we're all running up the credit cards, right? Except, we're not. While overall consumer debt is moving, revolving credit — the interest-laden purchases we put on plastic — is barely budging. According to the Board of Governors of the Federal Reserve Bank, revolving credit was up all of 0.1 percent in January, and down 4.4 percent in December. So Americans aren't running up unsecured debt in a crazed spending spree.

But, Americans are spending something.

Newman's theory about a growing shadow economy makes a lot of sense. That's a very interesting development, because the United States has traditionally had a very small shadow economy relative to other developed nations. The most recent estimate from Professor Friedrich Schneider of the University of Linz puts the U.S. shadow economy at 7.2 percent, compared to Switzerland at 8.2 percent, with percentages going up from there. Given the divergence between official figures and consumer activity, that 7.2 percent figure may not hold anymore.

And the thing is, once people slip into the shadows, it's hard to get them back. Writes Schneider (PDF):

But even major tax reforms with major tax rate deductions will not lead to a substantial decrease of the shadow economy. Such reforms will only be able to stabilize the size of the shadow economy and avoid a further increase. Social networks and personal relationships, the high profit from irregular activities and associated investments in real and human capital are strong ties which prevent people from transferring to the official economy.

Once people get used to operating in the shadows, not paying taxes, using cash, dodging paperwork, it becomes increasingly difficult — and unattractive — for them to come back above-ground.

After years of conservative accusations that the Obama administration is trying to turn the United States into Europe, that charge may actually be coming true. We just didn't know that the model for the transformation was Spain's crisis-fueled underground economy.

I wrote at length about tax collection and the shadow economy here.