The so called ‘shadow economy’ refers to work and financial transactions that take place outside of the view of public authorities. Colin C Williams writes on the scale of this problem in Europe, noting that while the estimated size of the undeclared economy in the EU is around 18.4 per cent of GDP, it is far larger in some eastern European and southern European countries. He argues that a mix of deterrence measures, incentives, and indirect controls offers the best route for governments to bring undeclared work into the declared economy

Williams, Colin C

Williams, Colin C.

LSE Research Online

5/18/2015Europe’s hidden economy: how governments can bringundeclared work out of the shadowsblogs.lse.ac.uk/europpblog/2015/05/18/europes-hidden-economy-how-governments-can-bring-undeclared-work-out-of-the-shadows/The so called ‘shadow economy’ refers to work and ﬁnancial transactions that take place outside ofthe view of public authorities. Colin C Williams writes on the scale of this problem in Europe, notingthat while the estimated size of the undeclared economy in the EU is around 18.4 per cent of GDP, itis far larger in some eastern European and southern European countries. He argues that a mix ofdeterrence measures, incentives, and indirect controls oﬀers the best route for governments tobring undeclared work into the declared economy.Across the world, many businesses and individuals hide some or all of their monetary transactionsfrom the public authorities either for tax, social security and/or labour law purposes. Clearly, they can gain beneﬁtsfrom doing so, but there are also signiﬁcant wider costs that result. This undeclared economy creates risks for thehealth and safety of workers and damages working conditions, hinders employment creation, puts at greater risk theﬁnancial sustainability of social protection systems and undermines the legitimate business environment throughunfair competition.How big is the problem?Estimating the amount of undeclared work is akin to trying to count the number of rats in the sewers – by deﬁnition, itis hidden from view. Consequently, indirect methods are often employed using proxy indicators such as the amountof cash in circulation. The most widely-used indirect method – the DYMIMIC (dynamic multiple-indicators multiple-causes) technique – estimates the size of the undeclared economy in the European Union (EU) to be 18.4 per centof GDP, ranging from 7.6 per cent in Austria to 31.9 per cent in Bulgaria, with a clear East-West and North-Southdivide (see Figure 1). No Western and Northern European countries have undeclared economies larger than the EUaverage and most East-Central and Southern European nations have above average undeclared economies.Figure 1: Size of the undeclared economy in Europe by country (2012, percentage of GDP)1/6Note: Derived from Schneider (2013)If all this undeclared work was declared, then European public expenditure could increase by around one-ﬁfth, andhealthcare expenditure for example could be doubled.What activities take place in the undeclared economy?A long-standing view has been that the undeclared economy involves low-paid waged work conducted under‘sweatshop’ conditions. However, there is a continuum of wage levels in the undeclared economy, just as there is inthe declared economy. Although the mean wage is lower than in the declared economy, there is overlap, with someundeclared waged work being higher paid than declared employment. There is also recognition that some declaredemployees sometimes receive two wages from their employer; an oﬃcial declared salary and an additionalundeclared (‘envelope’) wage.However, much undeclared work is self-employment. At one end are proﬁt-motivated varieties. These range from‘bogus self-employment’, where a person works for one employer but is self-employed and pays no wage tax andhas no rights (e.g. dismissal protection, vacation entitlements), through to various forms of ‘proper’ self-employment.This ranges from registered traders conducting a portion of their trade oﬀ-the-books, to unregistered enterprisestrading wholly oﬀ-the-books. One outcome has been a re-reading of the undeclared economy as a ‘hidden2/6enterprise culture’. Indeed, in both OECD nations and developing countries, two-thirds of all businesses start-upunregistered in the informal economy.Yet other undeclared self-employment is more community-oriented and not market-like, ranging from for-proﬁtentrepreneurs conducting jobs for social rationales (e.g. when an elderly person is charged less than the marketrate) to paid favours conducted for, and by, close social relations to help each other out (e.g. paying an unemployedfamily member to do your decorating so as to give them money, which they would not otherwise accept becausethey would see it as charity).What can policy-makers do about it?There are four hypothetical policy choices with regard to undeclared work: do nothing; move declared work into theundeclared economy; eradicate the undeclared economy, or transfer undeclared work into the declared economy.Table 1 summarises the various costs of the undeclared economy along with some potential beneﬁts that have beenso far less considered.Table 1: Costs and beneﬁts of the undeclared economy3/6Note: Derived from Williams (2014)The table shows that doing nothing is unacceptable; it leaves intact the various costs on formal businesses,undeclared enterprises and workers, customers and governments. The second option of de-regulating the declaredeconomy is also a non-starter because it results in a levelling down of working conditions. The third approach,eradicating undeclared work, is unworkable because it would with one hand squash precisely the active citizenshipand entrepreneurship that with the other hand governments want to foster. Moving undeclared work into thedeclared economy thus appears the most viable policy option. How, therefore, can this best be done?4/6Direct vs indirect controlsIt is not easy to change the behaviour of businesses, workers and consumers. Conventionally, governments haveviewed participants as rational economic actors and sought to ensure that the costs of operating in the undeclaredeconomy are outweighed by the beneﬁts of operating in the declared economy. As Table 2 shows, this isaccomplished in the direct controls approach usually by using ‘sticks’ to punish non-compliant (‘bad’) behaviour (i.e.negative reinforcement), although recent years have seen the increasing use of ‘carrots’ to reward compliant(‘good’) behaviour (i.e. positive reinforcement).Relatively less discussed in European policy circles until now has been the indirect controls approach which viewsparticipants more as ‘social actors’ and instead focuses upon developing the social contract between the state andcitizens to engender a voluntary commitment to compliant behaviour and thus greater self-regulation.Table 2: Policy measures for tackling Europe’s undeclared economyNote: Derived from Williams (2014)Interviewing senior government oﬃcials involved in tackling the undeclared economy in 31 European countries in2010, 57 per cent stated that the use of ‘sticks’ (i.e. deterrence measures) is accorded the most importance in theircountry, 33 per cent ‘carrots’ (i.e. incentive measures) and 10 per cent indirect controls.However, these diﬀerent policy measures to harness this sphere are not mutually exclusive. Indeed, there are atleast two ways of combining them. Firstly, a responsive regulation approach starts out by openly engaging citizensto consider their obligations and take responsibility for regulating themselves rather than need to be regulated byexternal rules. This facilitating of voluntary self-regulated compliance is then followed by persuasion throughincentives and only as a last resort for the small minority refusing to be compliant does it use punitive measures.5/6A second approach is the ‘slippery slope framework’ which pursues both voluntary and enforced complianceconcurrently by developing both greater trust in authorities and the greater power of authorities. Until now, however,there has been little evaluation of which sequencing and/or combination is the most eﬀective means of harnessingthis sphere.What is certain nevertheless, is that the currently dominant approach in Europe of using ‘sticks’ to elicit compliantbehaviour needs to change. The EU platform for tackling undeclared work currently being established by theEuropean Parliament could well facilitate this shift. Hopefully, it will do so.Please read our comments policy before commenting .Note: This article gives the views of the author, and not the position of EUROPP – European Politics and Policy, norof the London School of Economics. Featured image credit: Simon Hadleigh-Sparks (CC-BY-ND-SA-4.0)Shortened URL for this post: http://bit.ly/1JRXvFl _________________________________About the authorColin C Williams – University of SheﬃeldColin C Williams is Professor of Public Policy in the Sheﬃeld University Management School at theUniversity of Sheﬃeld.6/6

Europe’s hidden economy: how governments can bring undeclared work out of the shadows

5/24/2015Europe’s hidden economy: how governments can bringundeclared work out of the shadowsblogs.lse.ac.uk /politicsandpolicy/europes-hidden-economy-how-governments-can-bring-undeclared-work-out-of-the-shadows/The so called ‘shadow economy’ refers to work and financial transactions that take place outside of the viewof public authorities. Colin C Williams writes on the scale of this problem in Europe, noting thatwhile the estimated size of the undeclared economy in the EU is around 18.4 per cent of GDP, it isfar larger in some eastern European and southern European countries. He argues that a mix ofdeterrence measures, incentives, and indirect controls offers the best route for governments tobring undeclared work into the declared economy.Across the world, many businesses and individuals hide some or all of their monetary transactionsfrom the public authorities either for tax, social security and/or labour law purposes. Clearly, theycan gain benefits from doing so, but there are also significant wider costs that result. This undeclared economycreates risks for the health and safety of workers and damages working conditions, hinders employment creation,puts at greater risk the financial sustainability of social protection systems and undermines the legitimate businessenvironment through unfair competition.How big is the problem?Estimating the amount of undeclared work is akin to trying to count the number of rats in the sewers – by definition, itis hidden from view. Consequently, indirect methods are often employed using proxy indicators such as the amountof cash in circulation. The most widely-used indirect method – the DYMIMIC (dynamic multiple-indicators multiple-causes) technique – estimates the size of the undeclared economy in the European Union (EU) to be 18.4 per centof GDP, ranging from 7.6 per cent in Austria to 31.9 per cent in Bulgaria, with a clear East-West and North-Southdivide (see Figure 1). No Western and Northern European countries have undeclared economies larger than the EUaverage and most East-Central and Southern European nations have above average undeclared economies.Figure 1: Size of the undeclared economy in Europe by country (2012, percentage of GDP)1/5Note: Derived from Schneider (2013)If all this undeclared work was declared, then European public expenditure could increase by around one-fifth, andhealthcare expenditure for example could be doubled.What activities take place in the undeclared economy?A long-standing view has been that the undeclared economy involves low-paid waged work conducted under‘sweatshop’ conditions. However, there is a continuum of wage levels in the undeclared economy, just as there is inthe declared economy. Although the mean wage is lower than in the declared economy, there is overlap, with someundeclared waged work being higher paid than declared employment. There is also recognition that some declaredemployees sometimes receive two wages from their employer; an official declared salary and an additionalundeclared (‘envelope’) wage.However, much undeclared work is self-employment. At one end are profit-motivated varieties. These range from‘bogus self-employment’, where a person works for one employer but is self-employed and pays no wage tax andhas no rights (e.g. dismissal protection, vacation entitlements), through to various forms of ‘proper’ self-employment.This ranges from registered traders conducting a portion of their trade off-the-books, to unregistered enterprisestrading wholly off-the-books. One outcome has been a re-reading of the undeclared economy as a ‘hiddenenterprise culture’. Indeed, in both OECD nations and developing countries, two-thirds of all businesses start-upunregistered in the informal economy.Yet other undeclared self-employment is more community-oriented and not market-like, ranging from for-profitentrepreneurs conducting jobs for social rationales (e.g. when an elderly person is charged less than the market2/5rate) to paid favours conducted for, and by, close social relations to help each other out (e.g. paying an unemployedfamily member to do your decorating so as to give them money, which they would not otherwise accept becausethey would see it as charity).What can policy-makers do about it?There are four hypothetical policy choices with regard to undeclared work: do nothing; move declared work into theundeclared economy; eradicate the undeclared economy, or transfer undeclared work into the declared economy.Table 1 summarises the various costs of the undeclared economy along with some potential benefits that have beenso far less considered.Table 1: Costs and benefits of the undeclared economyNote: Derived from Williams (2014)The table shows that doing nothing is unacceptable; it leaves intact the various costs on formal businesses,undeclared enterprises and workers, customers and governments. The second option of de-regulating the declaredeconomy is also a non-starter because it results in a levelling down of working conditions. The third approach,3/5eradicating undeclared work, is unworkable because it would with one hand squash precisely the active citizenshipand entrepreneurship that with the other hand governments want to foster. Moving undeclared work into thedeclared economy thus appears the most viable policy option. How, therefore, can this best be done?Direct vs indirect controlsIt is not easy to change the behaviour of businesses, workers and consumers. Conventionally, governments haveviewed participants as rational economic actors and sought to ensure that the costs of operating in the undeclaredeconomy are outweighed by the benefits of operating in the declared economy. As Table 2 shows, this isaccomplished in the direct controls approach usually by using ‘sticks’ to punish non-compliant (‘bad’) behaviour (i.e.negative reinforcement), although recent years have seen the increasing use of ‘carrots’ to reward compliant (‘good’)behaviour (i.e. positive reinforcement).Relatively less discussed in European policy circles until now has been the indirect controls approach which viewsparticipants more as ‘social actors’ and instead focuses upon developing the social contract between the state andcitizens to engender a voluntary commitment to compliant behaviour and thus greater self-regulation.Table 2: Policy measures for tackling Europe’s undeclared economyNote: Derived from Williams (2014)Interviewing senior government officials involved in tackling the undeclared economy in 31 European countries in2010, 57 per cent stated that the use of ‘sticks’ (i.e. deterrence measures) is accorded the most importance in theircountry, 33 per cent ‘carrots’ (i.e. incentive measures) and 10 per cent indirect controls.However, these different policy measures to harness this sphere are not mutually exclusive. Indeed, there are atleast two ways of combining them. Firstly, a responsive regulation approach starts out by openly engaging citizensto consider their obligations and take responsibility for regulating themselves rather than need to be regulated byexternal rules. This facilitating of voluntary self-regulated compliance is then followed by persuasion throughincentives and only as a last resort for the small minority refusing to be compliant does it use punitive measures.A second approach is the ‘slippery slope framework’ which pursues both voluntary and enforced compliance4/5concurrently by developing both greater trust in authorities and the greater power of authorities. Until now, however,there has been little evaluation of which sequencing and/or combination is the most effective means of harnessingthis sphere.What is certain nevertheless, is that the currently dominant approach in Europe of using ‘sticks’ to elicit compliantbehaviour needs to change. The EU platform for tackling undeclared work currently being established by theEuropean Parliament could well facilitate this shift. Hopefully, it will do so.Note: This article gives the views of the authors, and not the position of the British Politics and Policy blog, nor of theLondon School of Economics. Please read our comments policy before posting. Featured image credit: SimonHadleigh-Sparks (CC-BY-ND-SA-4.0)About the AuthorColin C Williams is Professor of Public Policy in the Sheffield University Management School atthe University of Sheffield.5/5

Europe’s hidden economy: how governments can bring undeclared work out of the shadows

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