The expanding shadow economy.

• Author: Ayres, Ed
• Position: Cover Story

As globalization ties the world together more tightly, activities that are unaccountable are paradoxically increasing. They pose a growing threat to civil society - and a critical opportunity to reform the way we do business on this planet.

Going Non-Public

There is a popular impression, among the affluent and well-connected, that the global economy is now almost complete and almost everyone is a part of it. Transactions span the globe in seconds; people in the remotest corners of the world watch the TV advertising of multinational corporations; your VISA card is accepted in 224 countries and territories; and the international community, through agencies ranging from the World Trade Organization to Interpol, has become highly adept at both protecting economic activities and keeping them accountable. But that impression - of a powerfully and securely interfaced international system that now keeps track of us all - is a myth.

In fact, many of the world's most "productive" activities (in dollars generated or people employed) are taking place far beneath or beyond the grasp of accountable government or commerce. They are untaxed, unregulated, unsanctioned, and - often - unseen. Most of them are things we've heard about, but only fleetingly; we think of them as anomalies, rather than as any serious or systemic threats to our mainframe institutions. They range from black markets in illicit drugs, weapons, endangered wildlife, toxic waste, or ozone-depleting chemicals, to grey markets in unlisted securities or unapproved treatments for cancer. They include the enslavement of child prostitutes in Bangkok, of political dissidents in China, and of sweatshop workers in Los Angeles. They include the movements of poorly monitored and dangerously neglected populations of urban squatters, refugees, and economic migrants. And, of course, they include hundreds of millions of people who are not listed in official employment statistics - the so-called "informal sector." They also include a variety of other, even less publicized, pursuits that have in one way or another stepped off the path of public life. Though these activities are expanding in almost every country, we pay little attention to them (except in scattered news stories or academic journals), because as individual "problems" they do not yet strike us as all that pervasive. Yet collectively, they constitute a gathering challenge to the continuing stability of governments - and in some places, to the stability of life itself.

Together, these phenomena constitute the world's "shadow economy." That's not a precisely defined term, and some specialists may object that for purposes of developing useful policies, it's not helpful to lump together the struggles of impoverished street vendors or subsistence farmers with the evils of tax evasion or organized crime. Yet, as globalization gains momentum, some of the same c onditions that allow millions of productive people to become marginalized also allow millions of others to become deliberately evasive. There are compelling reasons, now, for decisionmakers to begin looking more closely at the implications of shadow activity as a whole. That means responding not just to the challenges of specific classes of hidden activity, but to the larger problem of unaccountability in general.

The Trouble With Invisibility

One reason for taking this broad approach is that unaccountable activity - that which is hidden from public scrutiny in some important way - has proliferated in all regions of the world, not just in the developing countries most associated with the informal sector. Of course, invisibility isn't inherently bad; most of us place high value on personal privacy. But when there's widespread, systematic hiding of economic activities that use public resources and have pervasive public impacts, it's a different story. Yet, that kind of hiding has become endemic among the rich as well as the poor, and among large corporations as well as microenterprises. In the United States, for example, while the value of informal work has been estimated at well over $60 billion per year, estimates by the Internal Revenue Service and others suggest that the magnitude of other U.S. shadow activity - tax evasion, black markets, organized crime, and the like - adds up to between 10 and 20 times that. And, according to an Internal Revenue Service study, about a quarter of that larger share is being hidden not by small-time cheaters but by large corporations. As much as 20 percent of economic activity in the United States may be in the shadow.

In other countries, the share of production in the shadow is even larger: it has been estimated at 24 percent of GDP in Hungary, 40 percent in Russia, and some 60 percent in Zimbabwe. It subsumes about three of every 10 jobs in South America, and six of 10 in Africa (see table, page 17). And, while some sectors of this unmonitored activity have always been there, others have erupted with alarming suddenness. Last year, for example, the magazine PC Week estimated that 90 percent of the computer software being used in Eastern Europe is being illegally produced - in an industry that a generation ago did not exist. According to a U.N. Research Institute study, the trade in illegal drugs has become the world's second-largest industry, larger than oil. According to the authors of the landmark book Squatter Citizen, the late-20th century explosion of illegal settlements has accounted for 70 to 95 percent of all new residents in the fast-growing cities of the developing world - producing large urban populations that lack the normal services and protections of government. And as reported by economist Ildiko Ekes of the Hungarian Research Institute for Economic and Social Affairs, the hidden economy is "growing fast" throughout the countries of Eastern Europe and the former Soviet republics. Ekes notes that since the end of the Cold War, corruption in those countries has become rampant; he adds, "Privatisation is always accompanied by an upswing of corruption all over the world." At a recent meeting of the World Trade Organization, delegates urged the organization to give "highest priority" to combatting such corruption, which they claimed is beginning to severely jeopardize the international system.

It would be too simple, then, to equate the shadow economy only with the chaotic expansion of impoverished Third World populations, though they are an important part of it. While it is true that for tens of millions of the world's poorest people this shadow is an economic prison from which they would dearly like to escape, for many others it has become a gold mine of opportunity for quick, untaxed or unregulated wealth-building. As economist Alejandro Portes notes, the economic underground is a phenomenon that "...simultaneously encompasses flexibility and exploitation, productivity and abuse, aggressive enterprises and defenseless workers." Investigating this elusive phenomenon is not a matter of exposing "good" or "bad" work, but of determining why mainframe institutions are being undermined by forces they may have greatly underestimated. These "mainframe" institutions are the ones we count on to preserve the environment, provide security and other essential public services (whether through government or through voluntary and visible self-regulation), and collect taxes to pay for these services. Yet, the more these institutions are undermined, the more they are deprived of the resources - the public revenue and sanction - they need to keep functioning.

A second reason for keeping the focus on accountability is that the risks to society entailed in hidden work are becoming larger. Arguably, most shadow workers are just trying to make a living in the most expeditious way (sometimes the only way) available to them. Many of these activities, however, drift easily into large-scale exploitation or crime. When activities are beyond the visible reach of public protections, there may be no barrier standing between harmless and harmful behavior. People who can't get bank credit, for example, sometimes get private, uncollateralized loans from their families; but when family loans aren't available, loan sharks may quickly step in. In countries racked by poverty or repression, refugees often indebt themselves to smugglers in order to obtain transport to safer havens, only to find upon arrival that they have become indentured laborers - virtual prisoners of their sweatshop "employers." Similarly, while working on the street offers economic short cuts that make it attractive to the poor, those same short cuts promise a convenient lack of interference to those who have anything to hide from official scrutiny. So, street sales become a venue not only for legitimate exchange, but for a spectrum of evasions: illegal goods, stolen goods, smuggled goods, counterfeits, and products evading international environmental laws.

In these areas, huge profits are to be made. For example, investigators have uncovered a thriving international black market in bogus airplane parts being clandestinely produced in Italy. The dealers, by avoiding the costs of getting the parts from a legitimate manufacturer and making sure they're made well enough not to disintegrate in mid-air, can retail them at a bargain price and still take a large profit. With products that are patently illegal, such as illicit drugs or wildlife, the illegality constricts the supply and drives the price up - again insuring a fat profit. A smuggled arawana (an endangered Asian tropical fish), for example, can bring up to $10,000 in the United States.

Some analysts are reluctant to characterize all such activity as criminal; they describe it as a natural response to massive unemployment, overly restrictive regulation, or excessive taxation. In Peru and Bolivia, for example, many Andean villages have improved their local economies by forming alliances with illicit drug...