Question

1. What does the term ‘shadow economy’ mean?

2. How does the shadow economy affect GDP in different countries?

3. What are the main factors influencing the shadow economy?

4. Why is the shadow economy a challenge for the governments?

5. Reflection – the students also should include a paragraph in the initial response in their own words reflecting on specifically what they learned from the assignment and how they think they could apply what they learned in the workplace.

Answer 1

1.       The shadow economy refers to all work activity and business transaction that occur ‘below the radar’ – economic activity that is undeclared and for which taxes that should be paid are not.

Also known as the informal sector, the black economy, the underground economy, or the gray economy, the shadow economy includes criminal activities such as drug dealing and smuggling, as well as legal jobs, such as gardening, working in construction, or selling products to car drivers at traffic lights.

This part of the economy also includes situations where individuals are forced to work as slaves with no pay, or where work is carried out in exchange for things other than money.

When economists are calculating the GDP (gross domestic product) of a country, they do not include what goes on in the shadow economy.

This means that every country across the world is probably considerably wealthier than official statistics suggest

2.       Economic analysts differ in their estimations of the size of the shadow economy, but all agree on the fact the size of the shadow economy affects to some extent gross domestic product (GDP) figures and other key economic measurements. In short, underground economic activity not reflected in official economic activity figures causes GDP and other economic metrics, such as unemployment, to be less accurate.

GDP is calculated using the total of four components: personal spending, business spending, government spending and net exports. The shadow economy is primarily made up of transactions that constitute unreported personal spending and business spending.

The shadow economy is estimated to account for as much as one-third of the total economy in developing countries and slightly more than 10% of the total economy in developed countries. Estimates of the size of the shadow economy in the United States range between 7 and 11% of the total economy as of 2016. It is estimated that the inclusion of just part of the underground economy in the United Kingdom could increase the country's GDP by approximately 4%. The worldwide shadow economy adds up to trillions of dollars and has grown substantially in the wake of the 2008 financial crisis.

The primary concern in relation to the shadow economy's impact on GDP is that by rendering a nation's GDP a less-than-accurate figure, this can adversely affect government policies that are at least partially based on GDP numbers. For example, in the United States, the Federal Reserve Bank relies on GDP figures to make decisions about monetary policy, such as interest rates. If GDP numbers are not accurate, it is theoretically possible that the Fed may make an improper monetary policy decision that negatively impacts the economy.

There is an ethical or moral issue that arises in attempting to include the shadow economy in official GDP figures. The question that comes to the forefront is if activities such as drug sales or prostitution are recognized as activities that provide economic growth and contribute to a nation's GDP, on what basis then can the government brand such activities as illegal?

The other major concern of governments regarding the shadow economy is the issue of taxation. One 2011 study estimated that underground economic activity leads to approximately $400 billion to $500 billion in lost tax revenues annually.

3.       the main factors influencing the shadow economy the factors related to the design of the tax system and the institutional environment for its payment, collection, and administration, the following have the most significant impact on the extent of the shadow economy: size and structure of the tax burden; efficiency of the tax administration in collecting taxes; penalty policy; complexity and fairness of the tax system; and compliance costs.

                                                                                      OR

In general sense, the level of shadow economy is influenced by the following causal factors, inherent to the biggest part of industrial countries (Enste, 2015): tax burden and excessive contributions of social insurance; frequency and intensity of the regulation of officially recorder economy, extremely strict regulation of the labour market with untimely retirement, growing unemployment rate and limitation of possible work hours per week, which determine the search of illegal job. The countries with high scope of shadow economy usually show low degrees of tax paying morale (willingness to pay taxes), which is determined by the corruption, tolerated in authorities, as well as by low respect and loyalty to public organisations. Analysing the countries of Central and Eastern Europe, including the Baltic States, scholars point out slightly different reasons that determine the scope of shadow economy emergence and growth in these countries (Schneider, 2007). The reasons include lack of competence of official institutions (legal acts, bureaucracy, court practice); corruption, undermining trust in authorities; weak enforcement of legislation, inability or reluctance to protect property rights; high costs of business development and the burden of business administration; low probability to be caught as the one who avoids paying taxes or does an illegal work (this way, illegal activities are promoted); extremely high bureaucracy that determines “shadow business” while establishing or surviving in the market, and, finally, public tolerance of shadow economy, which determines complicated implementation of the measures designed to stamp out the “shadow”.

4.       Shadow economies present a major problem for governments worldwide, particularly in developing countries. Economic activity that takes place in shadow economies is usually untaxed and unregulated, reducing governments' fiscal revenues and eroding state power.