Countries around the world are plagued by a phenomenon known as the shadow economy: informal labor markets that hide significant parts of national economies and budgets.
Bosnia and Herzegovina The Center for Policy and Governance seeks to help unmask this problem in the Western Balkans. IMPACT OF PMI— a global initiative helping organizations implement effective projects against illegal trade — awarded a grant to the center.
The center’s latest report, “Shedding light on the shadows: exploring the informal economy in four South-Eastern European countries”, focuses on informal work and the illegal trade in goods with high customs duties. STOP: ILLEGAL spoke with Executive Director Adis Muhović to better understand the report’s findings and what countries can do to address the problem of shadow economies.
STOP: ILLEGAL: What is the underground economy and why is it a problem?
Adis Muhovic: The underground economy represents an economic activity that is not registered with the authorities in the sense that it is neither taxed nor regulated. This means purchasing goods and services from unregistered suppliers, or rather from registered suppliers who do not issue a receipt for a transaction.
In the labor market, this manifests itself in two forms: most often through work without a formal employment contract, but also through under-declared work, where part of the full salary is neither disclosed nor taxed. Retail is the most affected sector; with other popular sectors being affected, such as construction, manufacturing, auto repair, transportation, excisable goods, storage, catering, housework, gardening and property maintenance. Ultimately, informal work and trade occurs when people believe they are difficult to detect and will not get caught.
This affects both markets and society as a whole. As a result of these illegal schemes, the reduction in public revenue diminishes the availability and quality of public services. Without a formal employment contract, people lose benefits and security and may be exploited. For example, monthly wages as low as 300 euros have been reported in the underground economy. Additionally, goods bought and sold often come from illicit trade. Additionally, “illegal purchasing” plays an important role in supporting local and global criminal networks and illegal activities. This represents a major problem for Western Balkan countries, already affected by systemic corruption and links of political elites to illegal activities.
STOP: ILLEGAL: How big is the underground economy in the Western Balkans?
Adis Muhovic: Between 27 and 30 percent of GDP, this figure is significantly higher than the European average of 18 percent. Our research shows that just over a quarter of people buy from unregistered suppliers, and 15% of them do so 10 or more times a year. Yet people do not necessarily “go out” to buy illegal goods or services. The underground economy is clearly visible; customers simply buy goods or services without a receipt, without considering whether a supplier is registered or not.
Cigarettes, cut tobacco and clothing are the most frequently purchased items. Among populations involved in undeclared purchases, our research found that the share of those who purchased cigarettes without a receipt or purchased illicit tobacco products ranged from 35 percent in Croatia to 69 percent in Montenegro. Our results concerning the share of excisable products acquired informally in the total consumption of these products suggest that this share is particularly high in the case of cigarettes. Combining the four countries, we could say that a quarter of total cigarette consumption comes from illicit purchases. This share is highest in Montenegro, where it represents more than 40 percent of total consumption. Besides cigarettes, we found that people buy auto parts, alcohol, medical and beauty services, fuel, even food, on parallel markets – and the list goes on.
Even though policymakers are committed to improving economies and tackling the shadow economy, the phenomenon itself remains extremely understudied. The lack of available data means that public policies have had limited success. We wanted to help by providing quality data and research on people’s motivations, perceptions and attitudes towards the underground economy. With the support of PMI IMPACT, we have collected and presented evidence of informal work and illegal trade in the region. By sharing our results, we hope to inform researchers/decision makers in social and political matters in order to help promote informed decision-making.
STOP: ILLEGAL: Why do people engage in the underground economy?
Adis Muhovic: The underground economy is somewhat normalized in the region, meaning people are more willing to engage in it and justify their actions. For some, poverty means that buying illegally is the only way to survive. Our data highlighted the cost of goods and services as the main factor, with 55% of people purchasing goods and services illegally due to price.
Informal work is more complicated. People evade taxes for various reasons. Often it depends on either the employer or the consumer perception, i.e. the belief that you are better off financially by doing so. Our research found that almost half, 40 percent, say employers insist on paying undeclared wages, and 36 percent view tax avoidance as a way to increase income. Taxes are another key driver of un(under)declared work, with before and after tax wages in the region ranging from 38.8 percent to 40.3 percent, slightly above the OECD average of 36.15 percent.
Although this is a complex issue, it demonstrates the lack of information; we found that 18 percent do not want to lose social benefits if they are paid legally and declare their income. In addition to low tax morale and the common feeling of high taxation, citizens evade taxes because they are dissatisfied with public services. But the disconnect and lack of understanding of how the underground economy and illicit trade worsen the economy is evident; less money going to public budgets means even worse public services.
STOP: ILLEGAL: What should governments and law enforcement do?
Adis Muhovic: Current deterrents are not enough to challenge public attitudes towards the underground economy. Of those surveyed, 45 percent believe there is a low or very low risk of being caught working with informal labor providers and unregistered businesses. Some 45 percent of citizens believe there is a very low chance of being caught working without a contract, and this figure rises to 49 percent if they work with a contract but receive partial cash pay. Additionally, 41% think there is little chance of being caught smuggling or illegally producing goods.
Solving these problems requires a multifaceted approach. First, we recommend boosting employment by reducing the gap between workers’ wages/taxes before and after taxes from current levels to a level closer to the OECD average. This brings more workers into the system and increases take-home pay, which boosts morale. It is also important to review and reduce any incentives for un(under)declared work, thus making informal work less attractive.
Governments must prioritize creating a favorable environment for businesses and entrepreneurs through regulatory changes. Excessive, in most cases lengthy, regulation and slow procedures and compliance processes push entrepreneurs into the underground economy. Each market will have specific needs, but they can be broadly classified as reforms promoting more favorable conditions and formal employment. It also means increasing surveillance and publicly prosecuting illegal business practices. Citizens need to understand that the likelihood of being arrested is much higher and the penalties are much harsher than they think.
Finally, authorities must increase public confidence. This means helping citizens understand the role that effective regulatory policies, as well as legitimate work, play in helping rather than hindering society. Public policies should aspire to shape an environment that discourages consumers from seeking cheaper and illegal alternatives to legitimate goods and services through the underground economy, as well as to bring the illicit part of the markets back to the formal economy. to enable the growth of public services. income.
At the same time, stricter but more flexible enforcement of existing laws will help strengthen public confidence as well as revenues. This means actively pursuing unregistered providers, but also establishing a partnership-like relationship and providing better support to businesses operating legally. Making compliance less costly and less stressful, while increasing the risks and reducing the profitability of informal operations, will encourage compliance.
Overall, lasting and effective change will be determined by government responses. If governments maintain the status quo and fail to remove financial and environmental barriers to employment and legitimate business, then society too will continue to follow the status quo.
To learn more about PMI IMPACT and how it helped its beneficiaries fight illicit trade.
