Download The Shadow Economy

NS4301
Summer Term 2015
The Shadow Economy
Shadow Economy I
IMF, Inclusive Growth, Institutions and the Underground
Economy, 2012
Main points
• Large underground (shadow) economies pose problems
for policy making
• A vicious circle can be set off as governments with large
informal economies may raise tax rates to make up
revenues
• Encourages further enlargement of the underground economy
• This may erode the institutional capacity of the government even
more
• Fragile states are at a heightened risk of falling into this vicious
circle
• Large informal economies render official statistics
unreliable and incomplete complicating formulation of
policies
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Shadow Economy II
• Benefits of a formal economy:
• Property rights
• Protection
• Access to credit markets
• Not widely available in shadow economies
• May discourage economic growth and deny economic
opportunities to many
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Shadow Economy III
• Underground economy
• may include both illegal and illegal activities
• constitutes large portion of economy in many countries
• Definitions of underground (shadow economy vary)
• Market based production of goods and services whether legal or
illegal that escape detection in official GDP statistics
• IMF uses – all market based legal production of goods and
services that are deliberately concealed from public authorities
• Cause is usually to avoid taxes or regulations
• On positive, side a breeding ground of future economic
growth within the formal economy
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Shadow Economy IV
What links underdevelopment and the shadow economy?
• De Soto links the problem of underdevelopment with key
institutional weakness
• Much of the productive capital in poor countries is
outside the system of formal property rights
• Unlike countries with mature property rights systems
where capital can be leveraged for productivity activity
• It is often very difficult to establish clear rights to property
• Productive capacity of the economy restricted due to this
fundamental institutional weakness
• Wider participation in the formal economy is hindered
• Encourages enclave like development that benefits few and
leaves out the many
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Shadow Economy V
• In De Soto’s view,
• The establishment of institutions that create (and protect)
property rights is the key that can unlock the potential for growth
within the informal sector
• Emerging economies – large size of the informal sector in
these economies
• Suggests that even higher rates of growth are potentially
available
• Several studies have linked the size of the shadow
economy to various measures of institutional
development
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Shadow Economy VI
Measuring the size of the shadow economy
• No direct measures of the size and composition of the
underground economy
• A number of indirect methods have been proposed
• Currency demand approach
• Since most transactions in the underground economy are
conducted in cash,
• this approach estimates the size of the underground economy
from the excess demand for cash
• Electricity demand approach
• Assumes that electricity usage is a good physical indicator of
economic activity and
• Estimates the growth of the underground economy based on the
difference between the growth of electricity consumption and the
official GDP growth
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Shadow Economy VII
Measurement of Shadow Economy Contd.
• Labor Force Approach:
• Estimates the growth of the shadow economy based on
the decline in labor participation assuming a constant
labor participation rate
• Multiple indicators multiple causes model:
• Estimates the size of the shadow economy based on multiple
observed variables that are presumed to cause it:
• Share of direct taxes,
• The size of the government
• Tax rates,
• The regulatory burden
• GDP per capita
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Shadow Economy VIII
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Shadow Economy IX
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Shadow Economy X
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Shadow Economy XI
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