Should Underground Economy Be Consider Important

Topics: Economics, Money laundering, Tax Pages: 5 (1773 words) Published: August 17, 2013
“Should underground economy be consider important and therefore recognized”

What is Underground Economy?
When government agencies calculate economic figures such as the Gross National Product (GNP), they rely on information gathered from legitimate income reports generated by companies, non-profit organizations and individual taxpayers. What these agencies cannot use in their economic forecasts, however, are the estimated billions of dollars in cash circulating through what is known as the "underground economy." The underground economy includes income generated through illegal means, such as prostitution or gambling, as well as legitimate but cash- based activities such as online auctions or bartering services. The underground economy, also known as the shadow economy, has been in existence as long as its legitimate counterpart. The difference is that the government has any number of methods for tracking the exchange of goods, services and currency in an above-board economy, but very few ways of tracking the activities of an underground economy. Prostitutes, gamblers and others earning illicit incomes are not likely to provide the government with accurate income information on their IRS tax forms, for instance. A cash-based underground economy works best without governmental interference.

Effect of Underground economy in the value of GDP
The underground economy Individuals and firms sometimes conceal the buying and selling of goods and services, in which case their production won’t be counted in GDP. Individuals and firms conceal what they buy and sell for three basic reasons: They are dealing in illegal goods and services, such as drugs or prostitution; they want to avoid paying taxes on the income they earn; or they want to avoid government regulations. This concealed buying and selling is referred to as the underground economy. Estimates of the size of the underground economy in the United States vary widely, but it may be as much as 10 percent of measured GDP, or more than $1 trillion. The underground economy in some poorer countries, such as Zimbabwe or Peru, may be more than half of measured GDP. Is not counting household production or production in the underground economy a serious shortcoming of GDP? Most economists would answer “no” because the most important use of GDP is to measure changes in how the economy is performing over short periods of time, such as from one year to the next. For this purpose, omitting household production and production in the underground economy won’t have much effect, because there is not likely to be much change in the amounts of these types of production from one year to the next. We also use GDP statistics to measure how production of goods and services grows over fairly long periods of a decade or more. For this purpose, omitting household production and production in the underground economy may be more important.

How the Underground Economy Hurts Developing Countries

Although few economists believe the underground economy in the United States amounts to more than 10 percent of measured GDP, the underground economy in some developing countries may be more than 50 percent of measured GDP. In developing countries, the underground economy is often referred to as the informal sector, as opposed to the formal sector in which output of goods and services is measured. Although it might not seem to matter whether production of goods and services is measured and included in GDP or unmeasured, a large informal sector can be a sign of government policies that are retarding economic growth. Because firms in the informal sector are acting illegally, they tend to be smaller and have less capital than firms acting legally. The entrepreneurs who start firms in the informal sector may be afraid their firms could someday be closed or confiscated by the government. Therefore, the entrepreneurs limit their investments in these firms. As a consequence, workers in these firms have less...
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