Economic black hole

We know it’s there and how big it is, but very little about what’s really happening in detail.

Some call it the Black Economy; others prefer to use a less critical phrase like the Informal Economy. Whatever term you use, it concerns a segment of a country’s economic activity that is derived from sources that fall outside of the country’s rules and regulations regarding commerce. The activities can be either legal or illegal depending on what goods or services are involved.

The informal economy is mysterious, not least because those who operate in it want to hide what they are doing, how they are operating, where the source of their wealth is, what they are doing with their income and wealth, and how they finance their activities. It’s like the Black Hole in space: we know it’s there and how big it is, but very little about what’s really happening in detail.

First of all, since it is extremely difficult to get statistics about the informal economy, it is difficult to assess the dynamics involved. For example, while we can tell from one quarter to another what is happening to the formal economy ̶ whether it is growing, in which areas it is growing or declining, whether there are misalignments between demand and supply, whether it is subject to inflation, etc ̶ we cannot do the same with the informal economy.

Secondly, the fact that the informal economy exists means that economic growth could potentially be higher. The country’s policymakers are constantly studying how to raise the growth rate, but how can you do that when you have a cauldron of activity on which you do not have a handle? Even more worrying, it means that government revenue is less than what it could be and that impacts the funds available for social welfare.

The causes

The causes of the black economy can be varied, ranging from the development stage of a country, through the tax regime to trade, unemployment, and governance. Each of these causes reflect the degree to which there is an incentive to participate in the informal economy than the formal one. For example, a high tax rate could induce informal economic activities for tax evasion reasons ̶ come on, you know what I’m talking about: the plumber who refuses to be paid by a cheque or Revolut and will only accept cash.

Examples of informal activities abound: not reporting or under-reporting income, underpayment of wages, sham contracting, visa fraud, customs duty fraud, tobacco excise evasion, money laundering, unregulated gambling, illegal and criminal activities, counterfeit goods, motor vehicle fraud, and illegal drugs. You name them, we have them all in Malta.

Other causes relate to corruption. If the only way that an entrepreneur can get a slice of a public contract is by corrupting somebody, then that has to happen in the black economy. No wonder that Yorgen Fenech set up 17 Black. From its Dubai base ̶ another black hole ̶ Fenech and a coterie of shady characters could conduct their dirty business without being accountable to anybody or being subject to regulatory compliance.

Statistical models

From time to time, researchers have tried to estimate the informal economy in various countries. Over the years, a number of statistical models have been developed to study multiple indicators, for example the so-called MIMIC model, but all have limitations. Earlier this year, an economist at the IMF ̶ Jiaxiong Yao ̶ came up with what he called an Augmented Factor Model Approach (AFMA), which makes more transparent the role of multiple factors or indicators in the dynamics of the shadow economy.

I won’t bother you with the detailed technical analysis conducted by Yao, but basically he used four indicators (such as currency in circulation, the labour participation rate, GDP per capita, and electricity consumption) to project them on 11 causes of the informal economy (the tax-GDP ratio, GDP per capita, control of corruption, regulatory quality, trade openness, etc). He did this for 126 countries ̶ advanced, emerging, and developing, and low-income ones.

What interests us here are the results for 21 advanced economies, including Malta. The chart shows the degree of informality between 2002 and 2021 ̶ dots below the 45 degree line indicate a smaller degree of informality in 2021 than in 2002. You won’t be shocked to see that in 2002 Malta had an economy with 60% informality. Thank you PN ̶̶ all above board …. sorry, had to run for the vomit bag.

Someone might be tempted to say that we have made progress: from 60% in 2002 we are down to 20% in 2021. Here I still have to reach for the vomit bag, because we have the fourth highest degree of informality in the EU. Most of our peers are below 10%. Compared to the Netherlands or Slovenia, we are still big outlaws.

0 0 votes
Article Rating
Notify of
Inline Feedbacks
View all comments