Time to shrink the shadow economy

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This article was first published in the September 2017 international edition of Accounting and Business magazine.

From cash transactions to unofficial employment, the shadow economy is accepted by most of us as a fact of life. But it comes at a cost: taxes are avoided, fair wages undercut, and health and safety standards ignored. The best estimate (made in 2011) of the value of the global shadow economy is US$10 trillion – if the shadow economy were a nation state it would be the second-largest economy in the world, employing 1.8 billion people. As facts of life go, this is a very significant one.

Many complex forces drive the shadow economy. For many people, working in it is a case of necessity rather than choice. But the world is changing, and technological development, the rise of the gig economy and rapid globalisation confuse an already complex issue. What will the implications be for the shadow economy in different countries? And what can and should we be doing about it? A new report from the ACCA, Emerging from the shadows: The shadow economy to 2025, attempts to shed light on these difficult questions.

The report defines the shadow economy as the market-based production of and payment for legal goods and services that are deliberately concealed from public authorities. It combines a detailed analysis of its drivers and its possible future development, with expert interviews and a global survey that help to improve understanding of why it exists.

Disruptive forces

The world is in the grip of disruptive forces, from economic power shifts and political uncertainty to rapid technological advance. This means there are many possible scenarios for how the shadow economy could develop over the coming decade. It could, for example, expand in the near future as household income is squeezed and employment opportunities are diminished by automation; on the other hand, the gradual elimination of cash from society will make it harder for those working in the informal economy to bypass the system. Overall, says the report, the forces at play ‘suggest that the shadow economy will become ever more complex to monitor, measure and potentially control’.

The report looks in detail at the emerging agents that could affect the evolution of the shadow economy over the coming decade. Those taking part in the survey were asked to identify the agents in each category (economic, business, socio-demographic, socio-environmental, governance, and science and technology) that they thought would have the biggest impact on the growth of informal activity. This revealed the major drivers of the shadow economy as being:

• a higher tax burden and complex tax system
  
  
• increasing pressures on small business, intense market competition and the rise of the independent worker
  
  
• rising unemployment, increasing poverty and limited access to education and training
  
  
• increased levels of corruption and changing social norms
  
  
• regulation that is detached from ordinary people’s lives
  
  
• increasing connectivity and adoption of digital technology, which offers users a degree of anonymity.

Overall, the shadow economy is expected to decline globally by 2025, from 23% of global GDP in 2011 to an estimated 21% in 2025. But this decline will not be uniform. Some countries, particularly emerging market economies, will probably see an increase in shadow activity as a percentage of GDP by 2025. The report forecasts the likely increase/decrease in informal activity (as a percentage of GDP) in 28 countries between 2011 and 2025 (see the table below for a selection). The average size of the shadow economy in each country today ranges from 7.69% of GDP in the US to 66.12% in Azerbaijan.

The report highlights the difficulties that countries with a significant shadow economy could face in the future, including rising poverty and inequality and poor public services. ‘There are many positives in how the world of work is evolving,’ it states, ‘but there are also risks. Given the tensions between the opportunities and risks, could the future of the shadow economy lie in its acceptance as a business fact of life, in effect decriminalising and legitimising those who, for whatever reason, work in the shadow?’

The role of professional accountants

The report argues that accountants need to have a firm grasp of the potential impact of the shadow economy on their own and their clients’ businesses. ‘They can help those who wish to escape from the shadows, while also advising those who, through necessity, continue to work in the shade,’ it says. But accountants are also committed to public value, and responsible and ethical behaviour. How best to strike a balance?

An ACCA survey carried out as part of the report found that 22% of respondents would not deal with customers or clients who they believed to be operating in the informal sector, and that 20% had strict policies in place to ensure compliance with the law. But only 7% said they were making efforts to improve their processes to handle shadow economy activities.

Whose responsibility is it?

Overall, opinion was split on where the responsibility for addressing the shadow economy should lie. Some 76% of respondents felt it should be with government, while 60% felt it was up to individuals to refrain from taking part in the shadow economy and to report shadow activity, and 45% wanted local communities to take the lead.

That said, professional accountants are willing to play an important role and see themselves as able to do so. The report offers a number of recommendations where the profession’s core ethical values and its role in creating public value can help address the shadow economy. They include:

• monitoring shadow activity
  
  
• working with policymakers to help them understand the problem and to develop robust solutions for it
  
  
• measuring and modelling the effect of developments such   as the rise of the sharing economy and virtual currencies
  
  
• mediating between the shadow and formal economies and helping businesses emerge from the shadows
  
  
• finding ways to use technology to monitor and measure the shadow economy
  
  
• working with government to educate staff and businesses and to help them to formalise their economic activity.

However, as the report points out: ‘On the one hand any steps to engage with the shadow economy sector could be seen as entering a minefield, with numerous potential dangers that could tarnish the reputation of individuals, firms and the profession as a whole. On the other, it is clearly a significant and growing sector of the overall economy, and accountants could play a role in helping clients make the transition from informal to formal status.’ Either way, the profession should remain close to the heart of this debate around the world.

Liz Fisher, journalist