The Shadow Economy

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Description of the Shadow Economy


• There are a couple definitions of the shadow economy:

all economic activities that contribute to the officially calculated (or observed) gross national product but are currently unregistered.
market based production of goods and services, whether illegal or legal, that escapes detection in the official estimates of GDP.

• A more concise definition would be simply all commerce that is not taxed. As the shadow economy is contantly adjusting to changes in tax laws, societies' morals and so forth, a more precise definition than these is difficult to make.

• Activities that fall within the shadow economy include the sale of any illegal goods or services (e.g. prostitution, drug dealing, and gambling when they are illegal), as well as legal transactions that go untaxed (via payment in cash, money laundering, or otherwise). The following table illustrates the many transactions included in the shadow economy.


Methods for Measuring the Shadow Economy

• Measuring the size of the shadow economy is problematic, as many involved are hesitant to admit their activities.

• There are several methods for measuring the shadow economy:

o Sample surveying
o Comparing:
declared income and income measured by checks (such as IRS auditing)
the income and expenditure measures of GDP
the official labor force and the actual labor force

• Some methods correlate specific economic data to the size of the shadow economy, such as the demand for currency, the number of transactions in the economy, electricity use, or multiple factors.

Data on the Shadow Economy

• A 3-year study estimated the size of the shadow economy in 76 countries, based on the currency demand and electricity consumption methods. The percentage of the GDP taken up by the shadow economy varied widely:

o Thailand - 71%
o Mexico - 49%
o Italy - 20.4%
o Singapore - 13%
o United States - 8.2%
o Switzerland - 6.9%

Trends in the Shadow Economy and Their Causes

• The study above found a significant increase in the size of the shadow economy over a thirty year period in several developed countries.


• Causes for this increase include both economic and social changes. Sources identify stricter regulation of the official economy, earlier retirement, reduction of weekly work hours, and a heavier burden of taxes as economic factors in this tendency. Social factors include tax morale (the motivation to pay taxes) and the perceived fairness of the tax system.

Effects of the Shadow Economy

• The effect of the shadow economy on the economic growth of nations is disputed.

• One analysis indicates that growth of the underground economy hurts the economy overall by removing tax funds from public infrastructure.

• The neoclassical view is that the shadow economy contributes to economic growth by increasing competition and efficiency by stimulating an entrepreneurial spirit.

• Consequently, the inclusion of information about the underground economy into macroeconomic models is also debated.

Aspects of the Shadow Economy

Illegal Immigration


The debate over the problems with illegal immigration is extremely prominent at this time in the news in the United States. Many Americans are worried that unemployment is on the rise and that wages are on the decline because of this influx of workers. Currently Congress is working on legislation to truly stop the large amount of illegal immigrants coming into the United States every year for security purposes and to ensure that Americans do not have to worry about their jobs. Despite all of the concerns. Many economists argue that we actually need illegal immigrants in order for our economy to prosper. Illegal immigrants work in all of the jobs that Americans would never want to have. Furthermore, illegal immigrants generally work for wages that no American worker would accept, nor would the government allow the wage.


• Between 225,000 and 300,000 illegal immigrants are added to the United States population every year.

• 40% of illegal immigrants live in California.

• Illegal immigrants pay $1.9 billion in taxes and spend billions more with consumption.

• Of the 1.7 million illegal workers applied for citizenship in 1987:

o 21% of the workers held service jobs.
o 24% of the workers were laborers.


• Many economists, including Harvard economics Professor George Borjas, state that there is enough evidence to support the belief that many native workers are losing their jobs because of illegal immigrants.

• Illegal immigrants are actually creating jobs because of their large amount of purchasing power.

• Economist Jeffery Passel argues that immigration does not effect wages at all. He believes that for all types of workers wage expansion and deterioration are unrelated to immigration.


• The illegal drug trade has existed for as long as drugs have been outlawed.

Economic Effects

• The value of the illegal drug trade was estimated as $400 billion in 2000.

• National Institute on Drug Abuse (NIDA) estimated $181 billion in societal costs from the illegal drug trade.

• Aside from estimates regarding the drug trade itself, it has a ripple effect that extends to other aspects of the economy.

o The tax revenue that goes to inmates who were put in jail solely for drug related crimes.
o The tax revenue that is spent on the police force and DEA that devote their time to enforcing drug laws.
o An estimated 50% of judiciary time is spent on drug offenders.

Comparing Other Policies

• Countries in Europe have taken a different approach to handling the drug problem.

• The policy in the Netherlands saves resources by having the police deal with more serious crime and leave non-disruptive drug users alone. Consequently less tax revenue is used on drug offenders.

• Switzerland has had successful experiments with prescribing heroin to addicts, leading to the reduction of heroin-related crime and death.

• Not only do these policies of decriminalization and regulated administration work socially, they reduce that sector of the underground economy, and turn it into a regulated, taxed system.


• Counterfeit refers to any imitation item that is fraudulently passed off as real.

• Currency, documents, clothing, media items, pharmaceuticals, and all trademarked and copyrighted goods are subject to counterfeit.

• Counterfeit products encompass those that are nonfunctional and are only made to look like a product, and those that are generally of similar quality to the original but were made illegally, without the consent of the copyright owner.

• The reproduction of copyrighted and trademarked items is referred to as Intellectual Property crime.

• In addition to fake items being sold, “bootleg” items are those that are of similar quality to the original but sold at drastically low prices.

• the end user often knows they’re counterfeit but ignores that due to cheap prices.

Economic Effects

• Counterfeit products are estimated to exceed 6% of global trade.

• The FBI estimates that legitimate business loses between $200 and $250 billion dollars per year

• In addition to the hundreds of billions of dollars that Intellectual Property crime cost the public and businesses, there is a ripple effect that extends to many other aspects of the economy.

o It can potentially slow investment and innovation in the business world
o Law enforcement is forced to devote time and resources to stop counterfeiting
o Counterfeit products almost always escape taxation

• The city of New York loses an estimated $500 million in state sales tax due to counterfeit goods.


Schneider, Friedrich, and Dominik H. Enste. "Shadow Economies: Size, Causes, and Consequences." Journal of Economic Literature, volume 38 issue 1 (2000).