The shadow economy

"Implicit in much of the literature on the shadow economy is the view that shadowy activity is undesirable . However, it is not certain that all shadow economic activity should be discouraged. " In seeking to understand the size of the world economy, we are usually guided by official statistics on output, trade and investment. But there is a driving force in today's world market that has, hitherto, rarely been recognized for its tremendous economic impact. It is what we will refer to as the shadowy economy. Its oversight in the calculus of the influences on the international economy is due to the statistical opaqueness that is part and parcel of criminal and informal transactions. Economic activity that falls outside the purview of government accounting is known by various names: shadow, informal, hidden, black, underground, gray clandestine, illegal and parallel. (1) Implicit in each, save for informal, is that these economic activities include conscious efforts to avoid official detection. Indeed, some unrecorded activities, such as the drug trade, are illicit. Some activities, such as day labor, however, are legal but may include an illicit component, such as unrecorded payments. Still others, such as household production, are wholly legal. Finally, it may be that unrecorded activities occur in a sector of the economy that is simply unregulated, rather than illicit. As these nuances indicate, simply defining the shadow economy is a challenge. Although most authors agree that it is a "fuzzy concept,"(2) the notion that activity in the shadow economy has important implications for the official economy is essentially unchallenged. (3) Despite decades of study on the issue from an empirical and historical point of view,(4) little agreement has been reached on the fundamental constructs that underlie the shadow economy. The lack of consensus in formulating a unified theory of the shadow economy, or even a precise definition of the components that comprise it, suggests that important questions remain unanswered. To what extent does the exclusion of shadow economic activity distort official estimates of macroeconomic variables, including output, employment and inflation? What are the policy ramifications of these exclusions? What is the distribution of shadow economic behavior between unrecorded, but legal, and illicit activities? Can the overall size of the shadow economy be estimated, and is it changing over time? Do countries at different stages of development possess different types of hidden economies? What is the relationship between regulatory (in)efficiency and the size of the shadow economy? This paper gives an overview of issues relating to these questions. We begin by discussing definitions of shadow economic activity and why the study of the shadow economy is important. We then review methodologies employed in the estimation of the size of shadow economies and present size estimates for several transition, developing and developed countries. We conclude with thoughts for future research. DEFINITIONS Unquestionably, the shadow economy represents some form of unofficial economy. However, there is extensive disagreement regarding the definition of the term. To some extent, the shadow economy is a "(pre)concept in search of a theory,"(5) and differences in the definitions of the shadow economy stem from differing research objectives, such as estimating the size of the shadow economy or explaining the motives for shadow economy participation. In general, there are two approaches to defining the shadow economy The first considers shadow economic activity as simply unrecorded economic activity (the definitional approach), while the second defines the shadow economy in terms of behavioral characteristics--its economic activity therein (the behavioral approach). The former is descriptive while the latter provides underpinnings of a theoretical explanation for shadow economic activity. …