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By Chris Prentice on July 29, 2012

Shadow Economies on the Rise Around the World

Published in Businessweek.com

What is the Underground Economy?

First theory. "Underground economy" is a term that refers to those individuals and businesses that deal in cash and/or use other schemes to conceal their activities and their true tax liability from government licensing, regulatory, and taxing agencies. Underground economy is also referred to as tax evasion, tax fraud, cash pay, tax gap, payments under-the-table, and off-the-books.

Second theory. A black market or underground economy is a market in goods or services which operates outside the formal one(s) supported by established state power. Typically the totality of such activity is referred to with the definite article as a complement to the official economies, by market for such goods and services, e.g. "the black market in bush meat" or the state jurisdiction "the black market in China".

It is distinct from the grey market, in which commodities are distributed through channels which, while legal, are unofficial, unauthorized, or unintended by the original manufacturer, and the white market, the legal market for goods and services.

Worldwide, the underground economy is estimated to have provided 1.8 billion jobs.

Shadow Economies on the Rise Around the World

It turns out that countries have two economies: the official one and a shadow version. The official economy is the one that governments and banking institutions measure with gross domestic product, tax receipts, social security contributions, employment identification numbers, and the like. The shadow economy is all the money and jobs generated outside the official economy, whether legally or illegally. In more than 50 countries around the world, the shadow economy is at least 40 percent the size of documented GDP.

In percentage terms, the biggest shadow economy relative to official economic activity is in the former Soviet republic of Georgia. In 2007, the last year for which data were available, revenue from all Georgia's goods and services generated off the books amounted to 72.5 percent of official GDP. In other words, the government is losing out on billions of taxable dollars it could use to improve the national infrastructure, service debt, build schools and roads, even hire better tax collectors. At the other end of the scale, the U.S. shadow economy equaled only 9 percent of the country's official economy. Given U.S. GDP of $14.26 trillion, the world's largest, that could still be as much as $1.2 trillion in taxable income that slips through Uncle Sam's fingers each year.

The size of a shadow economy can be vitally important. As became painfully clear during the Greek economic crisis, one of the factors that nearly drove the country into bankruptcy was that Greek workers and companies skirted more than 31 billion euros in taxes, which is more than 10 percent of GDP.

In an updated report, Shadow Economies All Over the World: New Estimates for 162 Countries from 1999 to 2007, Greece comes across as a model of fiscal responsibility when compared with dozens of other nations. In the report's ranking from least to most shadowy, Greece is No. 57, with a shadow economy equal to 31 percent of GDP in 2007.

Wide Margin of Error

Nailing down shadowy numbers is difficult, of course. According to Friedrich Schneider, an economics professor at Austria's Johannes Kepler University of Linz who co-authored the study, the margin of error baked into the results is about 15 percent. Therefore, while the report says Georgia's shadow GDP in 2007 was 72.5 percent, that number could be less—or even more. What we do know is that Georgia's official GDP, according to the CIA's World Factbook, is approximately $20.3 billion, but if the shadow economy were added, it could potentially be as much as $30 billion or so.

Schneider points...
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