The informal economy, also known as the underground economy or the black market, makes up a significant portion of the overall economy. It is estimated to be as much as 36 percent of the gross domestic product (GDP) of developing nations and 13 percent of developed countries’ GDP.1 However, as an article by Economist Paulina Restrepo-Echavarria in The Regional Economist points out, measuring the informal economy is quite difficult.
Direct attempts to measure the size of the informal economy typically have circumstances that make them problematic. Questionnaires and surveys, for instance, rely on respondents being truthful, which may not happen if it requires admitting to not reporting taxes.
Another direct measure involves calculating the discrepancy between income declared for tax purposes and that measured by selective checks. Restrepo-Echavarria gave an example of comparing the number of jobs declared by firms with the number of employed people found through household surveys, with the difference representing the informal workforce. “Once the informal number of workers is identified, informal workers can be attributed the same net compensation as similar workers in the formal economy.”
As Restrepo-Echavarria noted, indirect approaches “are macroeconomic approaches that try to use an indicator of the informal economy as a proxy for its size or growth.” The following are a couple of these approaches and the issues with each method. (Additional indirect approaches were covered in the original article, “Measuring Underground Economy Can Be Done, but It Is Difficult.”)
National Expenditure and Income Statistics
In theory, the income measure of GDP and the expenditure measure should be equal, so differences between the two are sometimes used to indicate the size of the informal economy. However, some of the differences are simply due to the way data are gathered for each measure, and these cannot be separated from the part due to the informal economy.
Restrepo-Echavarria wrote that the electricity/GDP elasticity ratio has been observed as close to 1. With electricity as a proxy for overall economic activity, the difference between it and official estimates of GDP provides an indicator of informal economic activity.
Several critiques have been offered regarding this approach:
Restrepo-Echavarria concluded, “Ultimately, the approach used to measure the informal economy depends on the specific question being asked by the researcher. For macroeconomic studies, indirect approaches usually suffice, but direct approaches are more generally used for microeconomic studies.”
1 Restrepo-Echavarria, Paulina. “Macroeconomic Volatility: The Role of the Informal Economy.” European Economic Review, August 2014, Vol. 70, pp. 454-69.
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