A Science for Everyone, Community

The Shadow Economy

There are some confusing terms about the economy.  Household production fits in with the things that you do for yourself that makes life a bit better.  “Underground economy” and “shadow economy” refer to transactions that could be considered black market.  Some things – drugs, prostitution, stolen merchandise – are in the underground economy practically by definition.  Other items can be either in the regular economy or in the shadow economy.”

“Italy also has a sizable underground economy, which by some estimates accounts for as much as 17% of GDP. These activities are most common within the agriculture, construction, and service sectors.”  This gives us the idea that it isn’t just an illegal immigrant involved.  The underground economy can include otherwise respectable citizens.”


Household production isn’t mentioned in the analysis – but here, in northwest Montana, a single product provides an example – firewood.  It benefits me to report the money that comes in from firewood sales.  It helps me qualify as a farm, and make deducting expenses and depreciation possible.  As household production, it probably cuts down the cost of heat by $700 – $1000 each winter.  For others, it’s an underground economy, advertised on facebook, unreported to the government.  The definition and source follows:

Investopedia puts the underground economy at 11 or 12% of the gross domestic product in the US. California’s Attorney General has an “Underground Economy Unit” and lists restaurants, janitorial work, the garment industry, retail, construction and car washes as the industries most impacted by wage theft. I don’t know – I recall talking about the US underground economy with a grad student.  With a student visa, he wasn’t allowed to work in the US – yet he had held a job somewhere in the southern US, in a business owned or managed by an Indian national, who sent the paycheck to his father in yet another country.  I think the term “wage theft” in that case would be accurate if you only looked at US records – and I doubt if it was reported to the IRS.

The Institute of Economic Affairs uses the term “shadow economy” and describes: “The main drivers of the shadow economy are (in order): tax and social security burdens, tax morale, the quality of state institutions and labour market regulation. A reduction in the tax burden is therefore likely to lead to a reduction in the size of the shadow economy. Indeed, a virtuous circle can 
be created of lower tax rates, less shadow work, higher tax morale, a higher tax take and the opportunity for lower rates. Of course, a vicious circle in the other direction can also be created.”

They go on to describe Denmark, where about half the population hires “shadow” workers.  Much of the “shadow economy” they describe is labor from people who have a regular job, performing a non-deductible service for other private parties.  The “shadow economy” is as much, or more, a place for our neighbors as for illegal migrants.

“In Canada, Schneider (2005) found similar reactions of people facing an increase in indirect taxes (VAT, GST). After the introduction of the GST in 1991 in Canada, in the midst of a recession, the individuals, suffering economic hardship because of the recession, turned to the informal economy, which led to a substantial loss in tax revenue. Unfortunately, once shadow economy habit is developed, it is unlikely that it will be abandoned merely because economic growth resumes (Schneider, 2005). The People who engage in shadow economic activities may not return to the formal sector, even in the long run. This fact makes it even more difficult for policymakers to carry out major reforms because they may not gain a lot from the reforms.”


Nearly 6 years ago, California passed legislation allowing legal marijuana sales – yet somewhere around 85% of the marijuana sold in California today is still in the “traditional” market – that’s right.  Despite having laws and a system that allows for legalized sales, the illegal market provides 5 times as much marijuana to users than the legal market. 

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