A shadow economy is one comprising of activities which take place ‘under the radar’, meaning activities which are undeclared. These activities go unnoticed and as a result, taxes are not paid for them. Generally, these activities take place outside the official economy and range from criminal to non-criminal activities. This type of an economy is also known as grey economy, black economy and underground economy.
When a country calculates its GDP, it doesn’t take into account these
activities thereby underestimating it. Hence, we can say that each country is wealthier than what is projected through the GDP statistics. Let us take a look into the implications of such an economy and how it can actually help the economy do better and improvise its working.
Smuggling, illegal prostitution, drug dealing, human trafficking and the like are some examples of criminal activities taking place in a shadow economy. Also included are non-criminal activities of illegal employment and social fraud. Most of these activities are considered illegal and immoral by the concerned authorities, with strict laws in action regulating them. However, this is not to say that the black economy is not prevalent- it very much exists in a number of countries. It is difficult to accurately estimate the size of a shadow economy.
However, the money spent, which is not recorded as a transaction, can give a sense of statistics. In 2018, it was estimated that the shadow economy made up for a startling 31.9% of the world economy. Normally, the size of underground economies is huge in countries with high tax rates as people are encouraged to go ‘under the radar’ to evade taxes.
The impact of a shadow economy can vary from country to country. If we talk about developing countries, then the existence of a large shadow economy is said to harm the economic growth as reduced tax revenue hampers the demand in the economy. However, in some cases, the retained income which otherwise would have gone away as taxes, can actually boost the economic growth by stimulating demand. The shadow economy represents a huge part of GDP of a lot of developing nations.
For instance, in Uganda, it represents 94% of the GDP. It’s believed by economists that ample opportunities in employment are provided by the informal sector to the poorer sections. For these people, participating in such activities is the last resort. Factors like unpaid jobs, casual jobs and lack of opportunities push them to take this step. Thus, the development of a shadow economy is said to be a reaction of individuals who feel overburdened by the poor state of affairs.
In many countries, the rising taxes, reduced loyalty and respect for the state, weak tax morale and rising regulations are found to be the main reasons for the emergence of shadow economy. In such a situation, people feel helpless and are left with two options- either to stay or leave the official economy, the latter being the less attractive one due to lack of incentives at disposal. Specifically, in Eastern and Central Europe, there has been an even more enthusiastic participation in the black economy owing to other factors of weak institutions, high administrative costs, lack of competency, broad acceptance of illicit work, etc.
All these reasons encourage people to choose the ‘exit’ option. However, the more pressing issue is to undertake an objective analysis and interpretation and develop future courses of action to handle the situation effectively. What needs to be kept in mind is that shadow economy is nothing but a reflection of inefficient institutions. Why do people shift towards working in such an economy has been stated above and therefore, this can be an eye-opener for the authorities to wake up and improve their working, reduce taxes, developing transparent systems and basically increasing the attractiveness of the official economy. It’s imperative to know that fines and higher taxes will only worsen the situation. It will provide an even greater incentive for people to shift towards black economy. A vicious circle will be thus created wherein higher tax rates will encourage others to exit the official economy and so the state institutions will weaken even more.
In other words, a shadow economy can be viewed as an evolutionary process, giving birth to innovative ways of living and working outside the economy and making the whole socio-economic front more dynamic. However, one needs to remember how a shadow economy undermines the law of the land and respect for government. A link between fighting corruption and increasing institutional efficiency should be created and surely a change will be seen.