# **Introduction**

The shadow economy covers a wide range of activities that are, by definition, difficult to observe and measure.<sup>2</sup> Consequently, there are also as many ways to define the shadow economy.<sup>3</sup> In our paper, the following definition is used in correspondence with the European Commission (EC, 2004), OECD (OECD, 2004) or related research (for instance Schneider et al., 2010): the shadow economy covers production of goods and services that is lawful by its nature, but is intentionally not declared to the public authorities. That means, this definition excludes any illegal activities and also household production.

Shadow economy and informal labor markets are closely connected: by its very definition, any activity taking place in shadow economy involves informal labor market to some degree.<sup>4</sup> Economic subjects may be either excluded from the formal labor market by lack of opportunities or exit the formal sector voluntarily because of both monetary and nonmonetary benefits of informality. These two motives may be considered as complementary with different accent on each of them in different social and economic environments. Perry et al. (2007) link the voluntary exit motive mainly with independent workers acting as selfemployers, while majority of salaried employees is considered to be involuntarily excluded from formal labor market in Latin America and the Caribbean. Usually, the exclusion motive is perceived far less important in developed countries (see Oviedo et al., 2009). Turning into shadow economy might pursue several goals, from avoiding payment of taxes and social security contributions to avoiding complying labor market, environmental or other standards and administrative procedures. Furthermore, the phenomenon has many dimensions, from full non-compliance and non-reporting of employment or business activities to under-reporting of employment, wages etc.

Despite being usually referred to in a negative perspective, shadow economy can also comprise some positive aspects (e.g. opportunity to escape dysfunctional and inefficient government regulations). These are, however, generally limited to less developed countries and in European context, the inefficient regulation might be addressed together with efforts to fight shadow economy (OECD, 2004).<sup>5</sup> Consequently, shadow economies in Europe represent rather an obstacle to economic development, bringing substantial costs. These can be identified in several areas on both micro and aggregate level, ranging from direct impact on public finance, performance of firms and situation of individuals.

Among the most important negative consequences and costs of shadow economies are usually cited: revenue losses in form of taxes and social security contributions which necessitate larger burden put on formal workers; deficient protection of informal workers by labor standards and social protection system; lower productivity of informal firms given by small size, restricted access to capital, technologies and markets, no legal enforcement of contracts

> 2 A variety of names has been used in the literature to describe this highly complex phenomenon. For instance: hidden, informal, undeclared, clandestine, moonlight, parallel, underground, second, irregular, illicit, unofficial economy.

> 3 For a broader discussion of the definition of the shadow economy, see e.g. Thomas (1992), Pedersen (2003), Enste (2003) or OECD (2004).

> 4 Informal work can take many forms, from a second job together with a regular employment to nonparticipation in formal labor market at all. For a discussion on this topic see Schneider (2003).

> 5 On the other hand, Enste (2003) cites a research done by Friedrich Schneider, showing also the positive aspect of the issue, given by the fact that about two-thirds of the income earned in the informal economy is spent in the formal sector, having a stimulating effect there. Furthermore, the author claim that about two-thirds of the value added produced by the informal sector would not be produced in the formal sector if the informal did not exist.

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