The dynamics of the black economy
Discussions on the black economy are rare. Neither politicians nor employers or employees organisations are persistent in defining their views on this phenomenon. This is understandable as economic experts struggle to define where the official economy ends and the “black” one begins. They often resort to euphemisms that make one wonder whether the black economy is indeed a negative influence on the official economy.
Let us start with some semantics. Most economists would agree with a quick description of the black economy as being “one where ‘black’ workers (of whatever ethnic origin) pay no taxes, reducing government income and increasing budget deficits, which can prompt higher taxes to make up for lost revenue, which in turn tempts more people into the black economy – a vicious circle of rising crime and decreasing government legitimacy. But even respected economists believe that the black economy is not all negative. This explains why we often find other terms to describe this phenomenon including “unofficial”, “clandestine”, “shadow”, “underground”, “hidden”, “submerged” and “grey”.
Measuring the size of the black economy is a difficult task and large divergences in such measurements make a sensible assessment on the relevance of this phenomenon that much more difficult. Friedrich Schneider, economics professor of Johannes Kepler University in Linz, is a respected academic who specialises in research in the black economy.
In a recent study he calculated the size of the black economy in 31 European countries including Malta. In 2011, according to Schneider, the average size of the black economy in these countries was 19.3 per cent of official GDP. Malta’s black economy’s size is calculated at 25.8 per cent of GDP – significantly higher than the average for these countries. The smallest black economy is to be found in Switzerland with 7.9 per cent of official GDP, while the highest is in Bulgaria with 32.3 per cent.
Determining to what extent the black economy is beneficial or harmful to the official economy is more difficult. When the Bulgarian Economy Minister Traicho Traykov declared in 2011 that “it is better to have a black economy than none”, most people were astonished not because of its substance, but because it came from a government minister.
It is a fact that many political leaders in most countries, including in the more fiscally virtuous northern Europe, acknowledge that the black economy has some merits and they are prepared to tolerate it, even if only unofficially.
As stated in a recent article in the Financial Times, “the hidden economy often enables valuable activity to circumvent bureaucracy, such as unnecessary licences”.
Without such activities, many societies would be poorer and fail to benefit from the money earned, which is usually spent in the formal part of the economy. Some argue that the shadow economy can be counter-cyclical, softening the negative impact on the formal economy in times of recession. “When wages go down, there is more incentive to move towards the black economy. It is almost a form of insurance, a way out,” says Pietro Reichlin, economics professor at Rome’s Luiss University.
We often wonder how distressed economies like those of Greece, and now Spain, manage to survive at all. Prof. Schneider has an explanation: “The underground economy is welfare-enhancing. Without the shadow economy, Spain would collapse. It is the only part of the economy that keeps the economy alive. You immediately get cash, you immediately earn something to feed your family.”
The difficult challenge for most EU countries will be that of providing the social welfare that our societies now take for granted while keeping public finances viable in the long-term.
Prof. Reichlin claims: “Among the main causes of the black economy is the level of taxation. The higher the tax and the regulatory burden the bigger the shadow economy in the country.”
But this does not always add up. Norway, Sweden and Denmark have high levels of taxation, excellent social welfare systems, but also a relatively small black economy.
Prof. Reichlin qualifies his statement by saying that there are also historical reasons shared by countries – mainly in the Mediterranean – that have a weaker rule of law, lower confidence in the state and a lower social capital. He sees the solution in “reforms to simplify and reduce taxes, lighten regulatory burden, decrease barriers to labour and improve the judicial system”.
If our aspirations for a more affluent society are to become a reality, we need to create incentives to help merge the black economy with the official one.