Shadow economies | A declining trend over time with and a spike staring in 2007

Shadow economies – sometimes called the black market or informal economy – exist in every country. But how big are they? This column presents some new approaches to estimating their size and uses them to compare shadow economies across rich and poor countries over the last 60 years write Ceyhun Elgin and Oguz Oztunali on Vox.

Even though informality is a widespread phenomenon and poses serious social, economic, cultural, and political challenges across the world, many issues about its nature and consequences still remain largely under-explored or unresolved. For example, the evidence presented in the existing literature has failed to generate a consensus among researchers around the measurement of the informal sector. There are also many other open questions regarding the determinants and/or effects of informality, including even such basic ones such as whether the informal sector size is larger in low-income or high-income nations (see Dreher and Schneider 2010); whether taxes are positively correlated with informal sector size or not (see Schneider and Enste 2000, Friedman et al 2000, and Elgin 2010 among others) or whether the shadow economy and corruption are substitutes or complements (Dreher and Schneider 2010).

As the number of papers in the growing literature on informality indicates, there is an increasing focus on the economic analysis of the shadow economy. Yet one particular setback that, despite the development of various methods, still persists in the literature is the lack of significantly large datasets that would make informality subject to robust (applied) policy analysis. Even though there are various methodologies suggested for its measurement, this issue mostly arises due to the fact that the size of the shadow economy, by definition, is hard to measure and to subject to empirical analysis. Most of the suggested methodologies (see the next section for a longer review) are usually used for a particular country or even a region and could not be generalised to cross-country panel frameworks.

Findings in Charts

Figure 1. GDP-weighted shadow economy size (as % of GDP) over time

Figure 2. Evolution of the shadow economy in different income groups

For almost all country groups (except for the post-Socialist one), the authors observe a declining trend over time. However, the pace of the reduction seems to lose some momntum in the last decade. Somewhat more interestingly, they observe a spike staring in 2007. Considering the emergence of the global economic crisis, this could give further support for the hypothesis that the size of the shadow economy is countercyclical.

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