The Underground Economy Is Sizeable Economics Essay

An underground economy or shadow economy refers to illegal and unreported market transactions that are not recorded measured in government statistics. The GDP will be understated if the underground economy is sizeable.

According to a study by Dr Friedrich Schneider, the estimated value of the shadow economy in Europe was €2.1 trillion in 2010. The underground economy in Spain accounts for at 21% of the GDP based on a study by A.T. Kearney and Dr Friedrich Schneider.

The size of the shadow economy in 2005 and 2009 was estimated to be €186,232 and €204,974 Million euros respectively. The small increase of 0.1% could be the result the economic downturn in 2009.

One of the main reasons that led to the recession and the increasing budget deficit in Spain is tax evasion.

Based on a report by the National Statistics Institute of Spain (INE), Spain has a total population of approximately 47 million (47,190,493). According to the OECD, Spain’s unemployment rate had rose from 8.5% in 2006 to approximately 20 % in 2010.This was due to the economic recession in 2009.

According to the Ministry of Manpower, Singapore had a labour force of 2,594.1 in 2006 and 3,135.9 in 2010. The increase of 541.9 or 0.2% showed that Singapore’s labour force is increasing at a steady pace. In Singapore, the unemployment rate in 2006 was 2.5% and had decreased to 2.2% in 2010. This decrease shows that Singapore is effective in keeping its unemployment rate low.

One of the main causes for the high unemployment rate in Spain could be attributed to the fact that many Spaniards claim to be unemployed, but are actually working in the underground economy. Therefore, they do not have to pay taxes and are also able to claim unemployment benefits. Moreover, this reduces government spending and would result in wasted resources contributed to social security funds. Such resources could be used to develop the infrastructure of the country or other sectors of the economy. In addition, this causes governments to raise taxes in order to offset their losses in tax revenue. However, this will encourage more people to engage in join the underground economy. This is supported by a news article which was published on the Financial Times which states, “Among the main causes of the black economy is the level of taxation. The higher the tax and the regulatory burden the bigger the shadow economy of the country,” Prof Reichlin says. “There are also historical reasons shared by countries like Italy, Spain and Greece – a weaker rule of law, lower confidence in the state and a lower social capital.” He sees the solution in reforms to simplify and reduce taxes, lighten the regulatory burden, decrease barriers to labour and improve the judicial system.(quoted)

Due to the economic downturn in 2009, the underground economy was negatively affected. Furthermore, the government had also begun to pass down laws to curb tax evasion and encourage electronic payments. This is because underground economic activities reduce the tax revenue earned by the government. Hence, it caused the size of the underground economy to diminish.

Based on a report by A.T. Kearney, it revealed that the largest contributors of the underground economy were the construction, Hotel & restaurant and wholesale & retail trade sectors which represented 32%, 21% and 20%. This is reflected by the chart above. The reason behind the undeclared work in the construction sector was because they could avoid meeting legal standards and hiring illegal immigrants to cut costs. Such clandestine activities in the Hotel & restaurant sector include, small transactions made at motels or hotels for single day stays and for meals at unlicensed food joints. Underground activities in the wholesale & retail trade sector are cash transactions made that are not recorded and retail stalls that do not have proper licensing to sell their goods. In addition, the most common practice in the underground is the deliberate understatement of revenue to avoid tax.

C:UsersRyanDesktopSpain underground economy ADAS diagram.PNG

As shown in the graph above, the real GD P will be understated due to the underground economy. This is because, the transactions that occur in the shadow economy are not reflected in official government statements.

In conclusion, Spain’s shadow economy accounts for at least 1 fifth of its economy. Moreover, its size has also increased slightly between the 2006 and 2010. The contributing factor of the underground economy is the construction sector. The government should also have measures to mitigate the impact of the economic recession on the employment of its people. Lastly, a shadow economy is inevitable in every society and has both positive and negative impacts. If the underground economy is managed well by the government, it will be highly beneficial to the official economy and the people.