The Economist on the underground

The Economist on the underground economy

This week's (June 19) Economist's "Economic Focus" column highlights two studies on the underground or gray economy:"Economics focus: In the shadows"

Friedrich Schneider reports on "Size and Measurement of the Informal Economy in 110 Countries Around the World" According to Schneider's abstract,

"Estimates of the size of the informal economy in 110 developing, transition and OECD countries are presented. The average size of the informal economy, as a percent of official GNI in the year 2000, in developing countries is 41%, in transition countries 38% and in OECD countries 18%. A large burden of taxation and social security contributions combined with government regulations are the main determinants of the size of the informal economy."

Firms enter the underground economy to avoid the costs associated with these.

Diana Farrell of the McKinsey Group points out that high tax rates and regulatory burdens can slow growth by encouraging firms to structure themselves for success in the underground economy in productivity-sapping ways ("The hidden dangers of the informal economy" free registration required for access to the article). As the Economist puts it:

"In Russia, for example, large supermarkets, which have no choice but to obey the tax inspectors, have a 5% cost advantage over small shops. But informal outlets can save 13% by staying in the shadows. In other words, the productivity benefits of greater scale are swamped by higher tax rates. As a result some industries, especially labour-intensive ones such as retailing, stay fragmented and inefficient."