The term secret, underground or shadow economy, may instantly conjure images of illicit activity like drug deals and other forms of crime. While that type of activity can be considered a part of the underground economy, for the most part, it’s not quite so shady. Rather it’s simply any type of economic activity that is not reported to the government.
Underground economies are popular in places like Brazil and Southern Europe where it is common for people to be unable to find full-time employment or a regular job. High levels of taxation, government corruptions and regulatory barriers can also contribute to these numbers.
But due to uncertain economic circumstances, underground economies are also started increase in the United States as well. Housekeeping, construction and food service are just some of the industries where workers are often paid under the table.
Underground economies can provide advantages and disadvantages for the government and workers. This article will provide a broad picture of underground economies and the effects they may have on the futures of their countries.
How Big is the Underground Economy in the U.S?
It is difficult to put an exact number on how big the underground economy is, but estimates put it at 11% – 12% of U.S. gross domestic product. In 2018, the GDP was $20.8 trillion so that would put the underground at just over $2 trillion.
However, determining these numbers isn’t easy. Obviously, the idea is to use cash to avoid a paper trail. Therefore, deviations in the demand for cash is often considered in measuring underground activities.
In 2007, economist Friedrich Schneider estimated that 7.2% of the GDP was generated through underground economy including criminal activity like drug dealing. Although this was an increase as compared to previous years, it was still well below the global average of 13.9%.
Schneider attributed the spike in underground economies to the decline in the economy in the U.S. and around the world.
In 2008, the numbers continued to rise as the economy got worse. By 2012, the underground economic activity was up to $2 trillion dollars, accounting for 12% of the GDP.
Advantages and Disadvantages
Underground economies have both advantages and disadvantages.
On the upside, underground economies fuel the economy in general. They provide jobs for people that would otherwise be unemployed. This, in turn, puts more money into the economy in general as people have the ability to buy products which fuel businesses.
On the downside, underground economies mean a loss in revenue for the government. This gives them a limited ability to fund programs, make improvements and pay their workers.
A lack of money also means that governments will no longer be able to pay bond holders. As a last resort, the government may turn to a Central Bank to create money to pay bond holders but if the bank has to borrow a lot of this manufactured money, it can result in inflation.
And the government is not the only one to suffer from rising underground economies.
Workers that are paid in cash often do not get insurance and other benefits such as worker’s comp. Therefore, they have less legal protection. They are also unable to contribute to future social security benefits and it is much easier for them to become exploited.
Shadow economies are also difficult to measure and predict. This makes it difficult for countries to get a good grasp on how their economies are doing in general. Therefore, countries are challenged in determining financial forecasts.
Reasons for the Underground Economy
There are many reasons why the underground economy keeps growing. Economic downturns are a major contributing factor. If people can’t find regular employment, they may begin working under the table for themselves. They will also be more likely to accept any type of employment including what’s being offered by employers that don’t pay on the books.
When employer’s income starts to go down, they may be looking to cut corners too. Paying employees off the books or partially off the books gives them a way to cut back on tax expenses.
Employees also benefit by paying fewer taxes in these circumstances.
Undocumented workers also contribute to underground economies. Illegal immigrants cannot report their income to the government as doing so can lead to deportation. Therefore, many of them seek out underground work to help them earn some sort of income.
However, many immigrants get around these restraints by purchases fake documents including a fake social security card and green card. These papers can help them get better jobs and pay taxes on the salaries they earn.
Government corruption also drives underground economies. The abuse of power for private gain can cause businesses and workers to turn to the underground economy for refuge. Smaller countries with a strong, well regulated government tend to have less of an underground economy.
On the upside, many governments try to prevent growing underground economies by improving public institutions and by fostering public participation in government decision making and eliminating corruption. These improvements can bring countless benefits in countries where shadow economies account for a considerable percentage of the GDP.
What Countries Have the Largest Shadow Economies?
Although it is difficult to measure underground economies, recent studies have shown that Greece tops the list. Its subterranean economy accounts for 21.5% of the country’s GDP.
Italy is another country whose underground economy ranks highly making up for 19.8% of its GDP. Spain is also up there with a whopping 17.2%.
Developing countries have been known to top the list. In the late 90’s Africa, Nigeria and Egypt owed the majority of their GDP to underground economic activities. In Asia, Thailand had a shadow economy of 70% of the GDP and in Latin America, Bolivia had the largest underground economy coming in at 67%.
Transition countries are countries in which the economy is changing from a centrally planned economy to a market economy. When the Soviet Union was transitioning in the late 90’s, Georgia’s shadow economy rose to 64% while Russia’s was at 44%. In Central Europe, Bulgaria’s underground economy rose to 34%.
The Organization for Economic Co-Operation and Development (OECD) is an intergovernmental organization that works to stimulate economic progress and world trade. In the late 90’s, Greece and Italy had the largest shadow economies of all OECD countries accounting for 30% and 27% of GDP. These countries still top the list although percentages have gone down. However, financial forecasts show that the underground economy has grown in OECD countries overall.
The underground economy has had both positive and negative effects within their countries, but it is a trend that is destined to continue in the face of corrupt governments and economic hardships. What part does it play in your life if any?