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Business and Labor

Is There a Growing Hole in the Official Economy? [Wonky]

“Black market speculant on graffiti. Kharkov, 2008.” by V Vizu, licensed under CC BY-SA 3.0.

(Analysis) Since the large job loss of the 2008-9 recession, reported measures of output and employment in the US economy remain very subdued. Good measures for labor utilization show no employment recovery of this production factor. Output remains depressed as well. Both measures strongly exhibit a (permanent?) shift downwards from the 2008-9 recession. An important question today is whether or not reported measures of output and employment are still relevant when assessing the US economy.

It is important from the outset to state directly that this analysis does not question the validity of reported statistics as accurate measures of the official economy. Claims that officially reported statistics are intentionally manipulated for political reasons are rightfully considered to be tinfoil-hat territory. Similarly, attacking officially reported measures as flawed because they are based on survey statistics is not a credible critique.

There is one area of the US economy that can perhaps explain much of the downward shift since 2008-9: the so-called shadow economy. Because reported measures of the US economy do not impute for levels of economic activity in the unofficial, unreported sector of the economy – the shadow economy – this sector could explain a possible hole in measures of the official economy since 2008-9.

Anecdotal evidence can support a conclusion that the shadow economy is growing. Whereas employment remains subdued, consumption is relatively strong. What is the source of income to fund this consumption, as households continue to deleverage? One possible explanation is unreported income received in the shadow economy.

Other evidence supporting a growing shadow economy is increasing use of cash for transactions. Measure of cash held as a percent of officially reported GDP is rising. Since transactions in the shadow economy are not reported – there is an attempt to hide these transactions from tax authorities – one possible interpretation of rising cash holdings is to fund transactions in the shadow economy.

In short, one explanation for subdued measures of both output and employment is that these measures pertain only to the official economy. They do not impute a level for the shadow economy. If more people have migrated to the unofficial sector of the economy, then that would partially explain the continued gap in both employment and output. Rebounding consumption, given continuing household deleveraging, could be evidence for unreported income from the shadow economy. Similarly, more cash flowing in the economy could be evidence of unreported transactions in the shadow economy.

If the shadow economy is growing, what does that portend for the US economy? First, governments will find it increasingly difficult to fund public services, as the shadow economy is by definition not reported – hence, it is not taxed. Secondly, policy prescriptions for the US economy become more difficult to assess, because the officially reported measurements are less meaningful. Third, productivity will probably suffer, as the shadow economy is very likely less productive than the official economy. This is because capital in the informal sector must remain minimal to avoid detection.

If the shadow economy is growing, then what is driving its growth? One likely explanation is that jobs shed by the official sector of the economy are permanently lost. As large corporations continue to grow their employment overseas to reap lower labor costs at the expense of American labor, very few, if any, of the jobs lost during the recession will come back soon. This might be one reason for subdued productivity in the US economy.

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