Such activities are deliberately concealed from public authorities to avoid payment of income, value added or other taxes and social security contributions, or to avoid compliance with certain legal labor market standards such as minimum wages, maximum working hours, or safety standards and administrative procedures.
The shadow economy thus focuses on productive economic activities that would normally be included in national accounts, but which remain underground due to tax or regulatory burdens.
Although such legal activities would contribute to a country’s value added, they are not included in national accounts because they are produced in illicit ways, Financial Tribune reported.
Informal household economic activities such as do-it-yourself activities and neighborly help are typically excluded from the analysis of shadow economy.
Measuring the Shadow Economy
Approaches to measure shadow economy are divided into two groups: direct or indirect (including the model-based).
Four direct and micro methods of measuring the shadow economy are (i) Measurement by the system of national accounts statistics–Discrepancy method; (ii) Survey technique approach; (iii) The use of surveys of company managers, and (iv) The estimation of consumption-income gap of households.
Indirect approaches, alternatively called “indicator” approaches, are mostly macroeconomic in nature. These are in part based on: the discrepancy between national expenditure and income statistics; the discrepancy between the official and actual labor force; the “electricity consumption” approach of Kauffman and Kaliberda (1996); the “monetary transaction” approach of Feige (1979); and the “currency demand” approach of Cagan (1958) and Tanzi (1983), among others.
To present shadow economy estimates for 158 countries from 1991 to 2015, the IMF used Currency Demand Approach or Multiple Indicators Multiple Causes. MIMIC explicitly considers several causes, as well as the multiple effects, of the shadow economy. The methodology makes use of associations between the observable causes and the effects of an unobserved variable, in this case the shadow economy, to estimate the variable itself (Loayza, 1996).
When using the MIMIC approach, it is often a problem that GDP per capita or the growth rate of GDP or first differences in GDP is used as cause as well as indicator variables.
IMF Working Papers tried to avoid this problem by using a light intensity approach instead of GDP as an indicator variable. To overcome these problems, IMF Working Papers used a fully independent method, the Predictive Mean Matching Method (PMM).
Results on the Size of Shadow Economy
MIMIC and PMM samples are divided into three subgroups of countries, specifically “lower than 20% of GDP,” “between 20 and 40% of GDP,” and “higher than 40% of GDP”.
The mean value of the size of the shadow economy of 158 countries is 31.9. The median is 32.3, indicating that both values are quite close, so there is no strong deviation.
Shadow economy is estimated to account for 31.1% of Iran’s GDP using the Predictive Mean Matching Method and 17.9% using Multiple Indicators Multiple Causes on average for the 1991-2015 period.
The three largest shadow economies using the MIMIC Approach are Zimbabwe with 60.6%, Bolivia with 62.3% and Georgia with 64.9%. The three smallest shadow economies are Austria with 8.9%, the United States with 8.3% and Switzerland with 7.2%. The average shadow economy comes close to Equatorial Guinea with 31.8% and Suriname with 32.2% of official GDP.
Member countries of the Organization for Economic Cooperation and Development are by far the lowest with values below of 20% and the Sub-Saharan African countries and Latin American countries are the highest with average values above 36% (both averages over 1991–2015). In all country groups, a significant decline in the size of the shadow economy is recorded, with the average decline from 1991 to 2015 at 5.3%. High-income countries have the lowest shadow economy and low income countries vice versa.
Notably, IMF paper reads that, “An internationally accepted definition of the shadow economy is missing. Such a definition is needed in order to make comparisons easier between countries and methods, and also to avoid a double counting problem. Also, the link between theory and empirical estimation of the shadow economy is still unsatisfactory. In the best case, theory provides us with derived signs of the causal and indicator variables.”
Local Version of IMF Study
Seemingly inspired by the research carried out by IMF Working Papers, the Institute for Management and Planning Studies has estimated the size of Iran’s informal economy over different periods of time from the fiscal 1980-81 to 2014-15, says deputy head of the institute, Masoud Nili, who also serves as president’s special aide for economic affairs.
- Iran-Iraq War: Between 1980-88, the size of Iran’s informal economy rose from 25% of GDP to around 40%, thanks to the increase in the size of shadow economy in production sector. Factors of production were absorbed by the unofficial sector due to the decline in economic growth of wartime. According to the Central Bank of Iran’s figures, the country’s GDP (using the year to March 2005 as the base year), which stood at 686 trillion rials in the early years of the 1980s, grew to 789 trillion rial by the end of the war. As a result, the size of Iran’s informal economy increased from 171 trillion rials to 315 trillion rials.
- Post Iran-Iraq war: The second period under review in this study is between 1989-90 and 2000-1. The average size of informal economy was 38% of GDP. The average GDP is estimated to be 1,066 trillion rials and the size of dark economy was 405 trillion rials. The significant growth in informal economy back then is to blame on the rise in smuggling and the gray economy of the monetary market.
- Early 2000s: The third era is the years between 2001-2 and 2007-8. Over the years, the average size of informal economy reduced from 37% of GDP in 2000-01 to 31% in 2007-08 to reach 590 trillion rials.
- Between 2008-9 and 2014-15: A significant growth, from 30% of GDP to 34%, in the informal economy was recorded over these years due to high inflation rates, government intervention in capital market, low and negative economic growth, and international sanctions against Iran. Estimates show the size of informal economy has increased from 575 trillion rials to 700 trillion rials (using the year to March 2005 as the base year).