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Evaluating the magnitude of the shadow economy: a direct survey approach Colin C. Williams

The magnitude of the shadow economy 369

Management Centre, University of Leicester, Leicester, UK Abstract Purpose – Until now, in the absence of direct survey data, economists have had to rely on indirect methods that employ proxy indicators to evaluate the size of the shadow economy. The purpose of this paper is to report the results of the first direct survey of business perceptions of the magnitude of the shadow economy. Design/methodology/approach – This paper reports the results of a UK survey of business perceptions about the prevalence of the shadow economy in their sector, namely the Small Business Service’s 2004/2005 Small Business Survey of 7,505 small businesses. Findings – Some 14 per cent of UK small businesses report that they are negatively affected by the shadow economy, with the average size of shadow work being estimated as 8 per cent of trade in their sector. The sectors identified as most affected by the shadow economy are land transport, construction, the motor vehicle trade, and hotels and restaurants, with new businesses and peripheral regions most affected. Research limitations/implications – This survey is based on business perceptions of its magnitude in their sector rather than first-hand accounts of the amount of shadow work that businesses conduct. Practical implications – These results display that it is wholly possible to conduct more direct surveys on the magnitude of the shadow economy so as to facilitate targeted public policy action. Originality/value – This is the first direct survey in the advanced economies of business perceptions regarding the magnitude of the shadow economy. Keywords Economic sectors, Small enterprises, United Kingdom Paper type Research paper

Introduction What is the size of the shadow economy? Is it equally prevalent across all regions, sectors and types of business? Or is its impact more heavily felt in some regions, sectors and businesses than others? If so, which regions, sectors and businesses are most affected? This paper seeks answers to these questions. Until now when estimating the magnitude of the shadow economy in advanced economies, and in the absence of direct survey evidence, economists have had to rely on indirect methods that use proxy indicators of its size. Here, however, the results of the first survey on business perceptions of the prevalence of the shadow economy are reported, namely the Small Business Service’s (SBS) 2004/2005 Small Business Survey (SBS, 2006). The author would like to thank the Small Business Service (SBS) for producing the cross-tabulations of the results of the 2004/2005 Annual Small Business Survey so as to enable this paper to be written. He is also grateful to the reviewers for their detailed and constructive comments on an earlier version of this paper. As always, however, the usual disclaimers apply.

Journal of Economic Studies Vol. 33 No. 5, 2006 pp. 369-385 q Emerald Group Publishing Limited 0144-3585 DOI 10.1108/01443580610706591

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Firstly, therefore, this paper will review the methods so far employed to evaluate the magnitude of the shadow economy so as to reveal how economists have relied on indirect measurement methods that employ proxy indicators due to the absence of extensive and reliable survey data on this issue. Secondly, the SBS’s 2004/2005 Annual Small Business Survey will be introduced, thirdly, the results will be analysed in terms of both overall business opinions regarding the magnitude of the shadow economy along with the regions, sectors and businesses in which it prevails and fourth and finally, a discussion of its findings will be provided along with recommendations for future research. Before commencing, the shadow economy needs to be defined. This is known by a multitude of names such as the “informal”, “black”, “cash-in-hand”, “underground” and “hidden” economy or sector (Barros, 2005; Bahmani-Oskooee, 1999; Dessing, 2004; Gang and Gangopadhyay, 1990; McCrohan and Sugrue, 2001; Odedokun, 1996; Williams and Windebank, 2005). Indeed, some 35 different adjectives and six nouns have been variously used to denote this sphere (Williams, 2004, 2006). Despite this array of terms, however, a strong consensus exists on how to define such work. Shadow work involves the paid production and sale of goods and services which are unregistered by or hidden from, the state for tax and/or benefit purposes but which are legal in all other respects (European Commission, 1998; Feige, 1999; Portes, 1994; Thomas, 1992; Williams and Windebank, 1998, 2001). As such, it includes only paid work that is illegal because of its non-declaration to the state for tax and/or social security purposes. Paid work in which the good and/or service itself is illegal (e.g. drug trafficking) is excluded, as are businesses operating in a “non-cash” environment. Estimating the size of the shadow economy: measurement methods Given that shadow work is by its very nature hidden from, or unregistered by, the state, estimating its size is a potentially perplexing and difficult task. Until now, the methods used to measure its magnitude range from more direct survey methods to more indirect measurements that either seek statistical traces of such shadow work in data collected for other purposes and/or using proxy indicators to estimate its size (Bajada, 2002; Thomas, 1992, 1988; OECD, 2002; Renooy et al., 2004; Schneider and Enste, 2002; Williams, 2004; Williams and Windebank, 1998). The indirect methods used to study the shadow economy in advanced economies and beyond have employed various proxy measures and/or statistical traces. These range from a number of non-monetary indicators, such as various labour force estimates, the prevalence of very small enterprises and electricity demand, through monetary indicators, such as the number of large denomination notes in circulation, the cash-deposit ratio, level of money transactions or currency demand, to income/expenditure discrepancies either at the household and/or national level. In major part, these statistical traces and/or proxy indicators of its size have been employed due to the poverty of evidence available to analysts. Until now, that is, the vast majority of direct surveys of the shadow economy have tended to be small-scale intensive surveys, usually conducted on specific localities (Barthe, 1985; Fortin et al., 1996; Howe, 1988; Lemieux et al., 1994; Leonard, 1994; McCrohan et al., 1991; Pahl, 1984; Warde, 1990; Williams, 2004, 2006; Williams and Windebank, 2001). Nationally representative sample surveys have been seldom conducted (for an exception, see Pedersen, 2003). Two major limitations thus prevail so

far as the evidence base of direct surveys are concerned. On the one hand, direct surveys have so far usually investigated shadow work only in relation to service provision in particular (especially domestic services) and final demand (spending by consumers on goods and services) more generally, rather than intermediate demand (spending by businesses). Final demand, however, accounts for just two-thirds of total spending. There exists a strong case, therefore, for extending direct investigations to include business surveys rather than solely household surveys. On the other hand, most of the direct surveys so far have confined themselves to small-scale, often qualitative studies, of particular localities, groups or sectors, meaning that it has been difficult to gain any representative picture of the overall national level, nature and distribution of the shadow economy. To some extent, these limitations have started to be recognised. A consensus has emerged that, whatever the merits of the indirect measurement methods, there is a need to collect more extensive survey data using direct methods if the shadow economy is to be more fully understood. This is the conclusion of both OECD (2002) experts in their handbook on measurement methods and the most recent European Commission report on undeclared work (Renooy et al., 2004), as well as a host of academic evaluations of direct and indirect methods (Smith, 1986; Thomas, 1992; Williams, 2004, 2006; Williams and Windebank, 1998). Recently, therefore, and reflecting this, not only have the European Commission commissioned an evaluation of the feasibility of conducting a direct survey of undeclared work across the European Union along with a pilot study (European Commission, 2005), but so too have a host of national ministries, including Her Majesty’s Revenue and Customs (HMRC) in the UK, decided to commission the design of a methodology for conducting direct surveys of the magnitude and character of shadow work (HMRC, 2005). In sum, most direct surveys of the shadow economy have been so far small-scale, mostly locality-specific, studies that frequently take the household as the unit of analysis and examine only domestic service provision, rather than taking businesses as the unit of analysis and examining the full range of goods and services provision. In late 2004, therefore, the SBS in the UK took the decision to include a series of questions on shadow work in a nationally representative survey of small business owners so as to provide the first national survey of business perceptions of the magnitude of such work. Although, to repeat, a number of additional large-scale nationally representative direct surveys are now potentially in the pipeline, this 2004/2005 Small Business Survey of the SBS currently represents the only data set available in western nations on business perceptions regarding its magnitude. The 2004/2005 Small Business Survey The aim of the Annual Small Business Survey of the SBS in the UK is to gauge the needs of small businesses, assess their main concerns and to identify the barriers that prevent them from fulfilling their potential. It is based on telephone interviews and in the 2004/2005 survey a large representative sample of 7,505 small businesses (defined for the purposes of the survey as any business with 0-249 employees) across the whole of the UK was interviewed, with the sample weighted to be representative of UK small businesses. These telephone interviews were conducted in the fourth quarter of 2004 and the first quarter of 2005 (SBS, 2006).


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The decision by SBS to include questions on shadow work arose directly out of a SBC (2004) report that evaluated the extent and nature of shadow work and proposed ways of tackling small businesses working on a shadow basis. Throughout this report, the lack of evidence had been highlighted on not only the overall magnitude of shadow work but also the economic sectors, businesses and geographical areas in which such work takes place. Both the SBC (2004) report and the government response to this SBC report (SBS, 2005a), arising out of a request from the Chancellor of the Exchequer in his November 2004 pre-budget report to explore the validity of implementing its recommendations, agreed that improving the evidence-base was a necessary precursor to concerted and targeted public policy action. As the Rt. Hon Alun Michael, Minister of State for Industry and the Regions states in his foreword to the government response, “We do not have as clear a picture as we would like of the scale and nature of the informal economy” (SBS, 2005a, p. 1), with the government response itself stating that “the size and composition of the informal economy is uncertain” (SBS, 2005a, p. 5) and the final paragraph concluding that “more research is required both into the size and character of the informal economy” (SBS, 2005a, p. 19). This recognition of the lack of an evidence base was further reinforced by an Office of National Statistics report on data sources that highlighted the paucity of data on the shadow economy and the shortcomings of using indirect proxy indicators (ONS, 2005). Indeed, it was this background context of government recognition of the lack of direct evidence that the SBS decided in 2004, following the SBC (2004) report, to include questions on this matter in its Annual Small Business Survey. Here, the questions included in this survey are reviewed followed in the next section by the findings. Until now, most direct surveys of shadow work, as detailed above, have taken the household as the unit of analysis and focused upon shadow work in the domestic services sector. Those few that have taken businesses as the unit of analysis have been small-scale ethnographic studies based on face-to-face qualitative interviews conducted by academics and focusing on a small number of firms in particular localities working in a specific sector (Jones et al., 2004; Ram et al., 2001, 2002a, b, 2003). This SBS survey was thus the first contemporary attempt in the UK to conduct an extensive business survey on a nationally representative sample regarding the prevalence of shadow work. Indeed, given that small businesses employing less than 250 comprise 99.9 per cent of all enterprises in the UK economy (SBS, 2005b), this survey comprises a relatively comprehensive portrait of the impacts of shadow work on UK enterprises. To analyse business perceptions of the magnitude of the shadow economy, the following three questions were put to a random sample of one-half of all respondents: (1) Is your business affected by the existence of other businesses who are doing cash-in-hand work (i.e. business that is not going through the books)? (2) If yes, is your business affected: very significantly/significantly/neither significantly nor insignificantly/not very significantly/not significantly at all/do not know. (3) Thinking about the sector in which you operate (not your own business), what percentage of trade in your sector would you say is conducted on a cash-in-hand basis? Although it might be asserted that such questions produce little more than hearsay knowledge on shadow work, it can be also argued that there is perhaps nobody better

positioned to estimate the proportion of trade conducted in the shadow economy in various trades than the businesses operating in these trades themselves. Having stated this, however, the results do of course need to be treated with some caution. They are business perceptions of the size and impacts of shadow work in their trade sector, not descriptions of the level of shadow work that businesses admit that they themselves conduct. Nevertheless, in the absence of other direct evidence, these data provide the first measure using a nationally representative sample of businesses of the prevalence and distribution of shadow work. Findings These three questions enable at least four different measures to be generated of the size of the shadow economy. These measures are: the proportion of businesses affected by shadow work; the share of businesses whose trade is affected significantly or very significantly by shadow work; the percentage of businesses stating that greater than 10 per cent of trade in their sector is conducted on a shadow basis; and the mean percentage of trade businesses cite as being conducted in the shadow economy in their sector. To commence this analysis of the results, therefore, business perceptions of the prevalence of shadow work for the whole nationally representative sample can be analysed using each of these four measures. The finding is that some one in seven (14.2 per cent) small businesses are negatively affected by shadow work and that nearly 1 in 15 (6.5 per cent) UK small businesses view shadow work as having a significant or very significant negative affect on their business. Indeed, when businesses were asked about the amount of shadow work taking place in their sector, some 1 in 6 (16 per cent) assert that 10 per cent or more of trade in their sector is conducted in the shadow economy and across all businesses, the mean proportion of trade conducted in the shadow economy is estimated to be 8 per cent. Magnitude of the shadow economy: regional variations Are there marked regional variations in business opinion on the prevalence and impacts of shadow work? Until now, the only evidence available on spatial variations have come from studies using indirect methods (Button, 1984) or direct surveys of a range of specific localities (Fortin et al., 1996), many of which take the household as the unit of analysis and focus largely upon provision in the domestic services sector (Van Geuns et al., 1987; Kesteloot and Meert, 1999; Renooy, 1990; Williams, 2004, 2005; Williams and Windebank, 1994, 1995). The SBS data thus provide one of the first analyses of the regional variations in shadow work in the UK (or elsewhere) using a more comprehensive range of goods and services provision and taking a nationally representative sample of businesses. As Table I reveals, regional variations in business opinion exist on the magnitude of the shadow economy. Businesses in peripheral rural regions, such as East Wales and the highlands and islands, more commonly view shadow work as a problem than businesses in other regions and estimate its size to be greater than businesses in other regions. This reinforces previous direct studies that identify the greater prevalence of shadow work in rural than urban localities (Williams, 2002, 2004). In sum, the shadow economy is concentrated in peripheral, more rural, regions of the UK. This, however, is not the only finding concerning its unequal distribution. Its scale and impacts in different sectors was also analysed.


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Table I. Business perceptions of the magnitude of the shadow economy: by UK region

England East Wales West Wales and Valleys Scotland Highlands and Islands Northern Ireland Total

Percentage affected significantly by shadow economy

Mean per cent of trade businesses estimate to be conducted in shadow economy in their sector

14 21

44 56

8 9

89 190

14 12

50 47

7 8

38

19

71

10

89 3,372

13 14

35 44

13 8

Percentage affected by shadow economy Responses 2.910 57

Source: SBS Small Business Survey (2004/2005)

Magnitude of the shadow economy: by sector Although many detailed qualitative studies exist of shadow work in particular sectors and occupations, such as the hospitality industry (Williams and Thomas, 1996), restaurants (Ram et al., 2002a, b), domestic services (Anderson, 2001; Hondagneu-Sotelo, 2001; Pfau-Effinger, 2006), garment manufacturing (Bender, 2004; Espenshade, 2004; Hapke, 2004; Ram et al., 2002b; Ross, 2004) and taxi driving (Jordan and Travers, 1998), there has been little overarching evaluation using direct surveys of whether such work is more likely to be found in some sectors rather than others. Indeed, so far as the UK is concerned, just two sources of evidence exist on whether the shadow economy is more prevalent in some sectors rather than others. The first is a cross-national survey by Pedersen (2003) that reveals how just under half of all shadow work (46.7 per cent) is to be found in the construction sector and another quarter (23.8 per cent) in a range of consumer services. The second data source is the English Localities Survey (Williams, 2006) that identifies remarkably similar results to the Pedersen (2003) study, with some 43 per cent of all shadow work found to be concentrated in the home repair and maintenance sector (46.7 per cent in the Pedersen study) and just over a quarter in domestic service activities. The problem, however, is that these studies either focus upon domestic services and/or fail to study intermediate demand (some one-third of GNP) and goods acquisition. As such, they currently provide a rather incomplete portrait of the prevalence and distribution of the shadow economy. This SBS survey, therefore, provides the first attempt to evaluate its overall prevalence in different sectors by those directly involved in these trades. As Table II displays, shadow work is not equally prevalent in all sectors. However, the sectors in which it is most pervasive depend upon which of the above four measures is used to measure its extensiveness. Taking the share of businesses in each sector negatively affected by shadow work as a measure of its sectoral prevalence, then such work is most extensive in the construction sector (which includes plumbing, plastering, joinery and painting) where 32 per cent of construction businesses state that they are negatively affected by its presence, along with land transport (including the renting of buses and coaches, taxi operations and furniture removal activities) where again 32 per cent of

8.1 (0) (0) 9.0 (0) 32.4 17.1 13.7

27.9 13.4 32.7 (0) (0) 2.7 4.0 1.1 11.6 1.7 9.0 8.4 14.2

223 15 1 379 5 376 267 235

156 433 105 1 12 41 25 96 893 59 146 306 3,774

Number Percentage affected surveyed by shadow work

5.0 1.7 3.9 6.5 6.5

0 0.4

1.4

18.3 (0) (0)

19.0 5.4

4.9

(0) 13.0 6.8

2.6 (0) (0) 3.2

Percentage affected significantly by shadow work

Note: In parentheses when respondents in a cell are less than 20 Source: SBS Small Business Survey (2004/2005)

A – agriculture, hunting and forestry B – fishing C – mining and quarrying D – manufacturing E – electricity, gas and water supply F – construction G – retail trade G – wholesale trade and commission trade G – motor vehicles, motorcycles and accessories: retail, repair and maintenance H – hotels and restaurants I – land transport, transport via pipelines I – water transport I – air transport I – storage and supporting transport activities, travel agents I – post, storage and communication J – financial services K – real estate, renting and business activities M – education N – health and social work O – other services Total

UK standard industrial classification index 2003

8 13 6 19 16

0 6

13

41 (0) (0)

30 29

11

(0) 23 19

9 (33) (0) 10

4 12 4 12 8

0 1

12

27 (0) (3)

9 16

5

(0) 9 9

4 (8) (0) 5

Percentage stating .10 per Mean per cent of trade cited cent trade is in shadow as conducted in shadow economy economy in their sector


Table II. UK business opinion of the size of the shadow economy: by sector

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businesses are negatively affected, followed by the motor vehicle trade (which includes the sale, maintenance and repair of motor vehicles, as well as parts and accessories) where 28 per cent are affected, the retail trade where 17 per cent are affected, the wholesale trade where 14 per cent are affected and the hotels and restaurants sector where 13 per cent of businesses are affected by the shadow economy. This ranking of sectors where shadow work is most pervasive, however, does not hold when the percentage of businesses perceiving themselves as significantly or very significantly affected by shadow work is analysed. This reveals a different ranking. It displays that the shadow economy significantly affects the largest proportion of businesses in the motor vehicle trade (with 19 per cent suffering significant negative impacts from shadow work), followed by land transport (18 per cent of businesses) and then construction (13 per cent). Meanwhile, measuring its prevalence in terms of the greatest proportion of businesses reporting that more than 10 per cent of trade in their sector is conducted in the shadow economy, yet another rank ordering of the sectors is produced. Here, land transport (41 per cent of businesses) is found to be the sector in which shadow work is most commonly viewed as rife (defined here as being where greater than 10 per cent of trade is conducted informally), followed by motor vehicles (30 per cent), hotels and restaurants (29 per cent), construction (23 per cent), “other services” which includes community, social and personal service activities such as hairdressing, radio and television activities, artists and authors, fair and amusement park activities and dance instructor activities (19 per cent) and the retail trade (19 per cent). Finally, and measuring its prevalence in terms of the mean percentage of trade that businesses report to be conducted in the shadow economy in their sector, the finding is that the highest average reported level of shadow work is again in the land transport sector where a mean of 27 per cent was stated, followed by hotels and restaurants (16 per cent), storage and supporting transport (12 per cent), education (12 per cent), other services (12 per cent), motor vehicles (9 per cent), construction (9 per cent) and the retail trade (9 per cent). If businesses are correct in their estimates of the trade in their sector conducted on a shadow basis (and they are currently in a better position than anybody else to know), then over a quarter of trade in the land transport sector (including taxis, furniture removals and the renting of buses and coaches) is currently conducted in the shadow economy. To facilitate a comparison of the results, Table III summarises the rank ordering of sectors produced by these four measures. As can be seen, each produces slightly different results. This is problematic if these data are to be used to determine where public sector resources should be concentrated when dealing with shadow work. For example, although the first measure (i.e. the share of businesses in each sector stating that they are negatively affected by shadow work) strongly suggests that the land transport, construction and motor vehicle sectors stand out as sectors in which such work is rife, this is not the case if one uses the fourth measure (i.e. the mean percentage of trade estimated to be conducted in the shadow economy by businesses in each sector). Although this again identifies land transport as a sphere in which shadow work prevails, it is not construction and motor vehicles that come next but rather, hotels and restaurants, education (which includes driving schools and private training providers), other services along with storage and supporting transport activities (e.g. tour guides, travel organisers and supporting transport activities not included elsewhere such as call operatives in taxi firms).

Health and social work

8

Motor vehicles Construction Retail trade

Other services Education Storage and supporting transport

Hotels and restaurants Real estate, renting and business services Wholesale trade

Land transport Hotels and restaurants Storage and supporting transport Education Other services

Mean per cent of trade cited as conducted in shadow economy

Land transport Motor vehicles Hotels and restaurants Construction Retail trade

Percentage stating . 10 per cent trade is in shadow economy

Motor vehicles Land transport Construction Retail trade Other services

Percentage in sector affected significantly by shadow work


7

Land transport Construction Motor vehicles Retail trade Wholesale trade Real estate, renting and business services Manufacturing

1 2 3 4 5 6

Percentage affected by Rank shadow work


Table III. Ranking of sectors in which shadow work is rife: by four measures

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Care thus needs to be taken not to use just one measure when determining the targets for public policy action. Perhaps, the different rankings across the four measures would disappear if, for example, a four-digit SIC analysis were used. At present, however, such a detailed level of sectoral analysis is not possible due to the limited size of the data set. Further extensive research at a more detailed sectoral level is, therefore, perhaps required in order to identify the sub-sectors in which the shadow economy is rife as a precursor to concerted and targeted public policy action. The shadow economy: by length of time business established In recent years, there has been a growing recognition that shadow work is composed not only of sweatshop-like low-paid and exploitative work conducted by shadow employees but also more autonomous forms of shadow work conducted by people on a self-employed basis (MacDonald, 1994; Leonard, 1998; Williams, 2004, 2006; Williams and Windebank, 1998, 2005). Indeed, it has been recently estimated that some 23 per cent of all shadow work in England is conducted by those setting-up fledgling micro-enterprises and a further 47 per cent by the more established self-employed conducting some or all of their work on a shadow basis (Williams, 2006). Although the SBS data base cannot provide information on, for example, whether fledgling enterprises are more likely to conduct work in the shadow economy than more established businesses, it does provide an insight into whether younger enterprises are more likely to be affected by shadow work than more established businesses. As Table IV displays, and whatever measurement method is used, younger enterprises perceive the shadow economy as more of a threat to their enterprise than more established businesses. This raises some key issues for public policy. It shows that a significant minority of fledgling businesses are finding that the shadow economy is having a significant adverse impact on their attempts to establish themselves. If fledgling enterprises are to be helped to set up on a formal footing and to grow, therefore, it appears that the shadow economy is a significant concern for a large minority of small firms and a barrier stopping them from achieving their potential. These data, in other words, highlight how shadow work is particularly a problem for new businesses seeking to establish themselves and grow and unless it is dealt with, then new business development is likely to be curtailed. Discussion Having reviewed the findings of this direct survey of the magnitude of the shadow economy, it is necessary to evaluate on the one hand, how these new estimates compare with previous measures and on the other hand, any modifications required to this direct survey method in future studies. In order to compare the findings of this survey with previous studies, Table V presents previous estimates of the size of the UK’s shadow economy according to the different measurement methods used. This displays how different techniques produce widely varying measures of its size. For the period 2000 until the present, for example, estimates of its volume in the UK range from 2 per cent of GNP using a direct survey method (Pedersen, 2003) to 12.3 per cent using the cash demand approach of Schneider (2001). It is important to be aware, however, that the headline figure produced by this SBS survey that businesses report that an average of 8 per cent of trade in their sector is

18 14 14 8 14 8 13 14 14

No.

120 154 206 175 236 171 468 1,842 3,372

,1 1 2 3 4 5 6-10 .10 All


Percentage affected by shadow economy

Years established 9 7 4 5 8 2 5 7 6

Percentage of all affected significantly 29 27 21 19 13 9 11 15 16

Percentage estimating . 10 per cent trade is conducted in shadow economy

10 11 11 9 5 6 5 8 8

Mean per cent of trade businesses cited as conducted in shadow economy


Table IV. UK business perceptions of the magnitude of the shadow economy: by age of business

Table V. The size of the UK shadow economy as percentage of GNP: by time period and measurement method 2.0

4.3 14.0 17.2

2.5

1.5

7.9 7.2 12.6 8.0 8.4

9.7-12.9 3.6

1976-1980

8.5 6.2 15.9

5.5

1981-1985

9.6

13.2 9.7

1986-1990

Sources: Derived from Schneider and Enste (2002, Table 4.8) and Williams (2004, Chapter 3)

Direct surveys Tax auditing Income/expenditure discrepancy Physical input method Currency demand Cash deposit ratio Transactions approach MIMIC method Cash demand

1970-1975

12.5

10.6 13.1 14.3

1990-1995

13.0

12.7

1996-2000

380

Measurement method

12.3

12.5

2.0

2000-

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conducted in the shadow economy does not necessarily mean that the shadow economy represents 8 per cent of GDP. To identify the shadow economy as a share of GDP, a more detailed sectoral breakdown than currently available is required of the proportion of trade in each sector in the shadow economy, along with the share of national GDP in each sector, so that the overall proportion of GDP in the shadow economy can be calculated. It is also important to consider whether the current estimate is in anyway more accurate than previous estimates using different measurement methods. Many previous texts have evaluated the validity of the contrasting measurement methods used to estimate the shadow economy (OECD, 2002; ONS, 2005; Renooy et al., 2004; Thomas, 1992; Williams, 2004, 2006). The consensus is that indirect survey methods are very limited in their usefulness not only due to the proxies used being poor indicators of the shadow economy but also because these indirect methods provide little evidence on the nature of the shadow economy such as its sectoral characteristics. Besides, those who use such techniques, therefore, there is now little support either in the policy community (OECD, 2002; ONS, 2005; Renooy et al., 2004) or academic circles (Thomas, 1992, 1999; Williams, 2004, 2006; Williams and Windebank, 1998) for their continued application. The question that remains, however, is whether direct survey methods, and more particularly this SBS survey approach, provide a more accurate measure of the size of the shadow economy. Evaluating the above survey, although some might argue that it provides little more than hearsay knowledge on shadow work, there is perhaps to repeat nobody better positioned to estimate the proportion of trade conducted in the shadow economy in various trades than businesses operating in these trades themselves. Nevertheless, the results do need to be treated with caution. They are business perceptions of shadow work in their trade sector, not descriptions of the level of shadow work that businesses admit that they themselves conduct. The fact that there are some sensible and logical patterns produced by the responses, nevertheless, certainly suggests that these are not “off-the-cuff” or ungrounded replies by the respondents for if this were the case there would not be such strong patterns in the data as those shown above. There are, however, modifications required to this survey method in the future to improve the data collected and confidence in its validity. In designing the questions for the above survey, a fairly conservative assumption was made about the willingness of respondents to talk about their shadow work and for this reason respondents were asked about shadow work in their sector rather than directly about shadow work that they conducted. However, household surveys of shadow work reveal a willingness of respondents to openly discuss their participation and little under-reporting in that the reported supply of shadow work by households approximates to the level households as customers report that they receive on a shadow basis (Jones et al., 2004; Leonard, 1994; MacDonald, 1994; Pahl, 1984; Williams, 2004, 2006). In consequence, it is here recommended that future business surveys, in their pilot phase, test the feasibility of questions on the amount and nature of shadow work businesses undertake. Indeed, to evaluate the validity of the responses to these questions about the amount of shadow work conducted, the findings could be compared with the above data to investigate whether there is a shortfall between the amount respondents report they do and what those in the sector report is undertaken on a shadow basis. In order to improve


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confidence in the validity of the data collected, furthermore, it is here recommended that future surveys when asking respondents about the amount of shadow work in their sector, request from respondents either ranges and/or statements of the degree of confidence in their estimates. If these modifications to the survey method are made, and provision is made for a more detailed sectoral and geographical breakdown of the results, then this method will provide a much finer-grained understanding of the size and nature of the shadow economy along with a measure of the confidence of the resultant estimates than has so far been the case. Conclusions Until now, there have been few extensive direct surveys of the magnitude of the shadow economy and analysts have had either to rely on either indirect measurements of its size that use statistical traces of such work in data collected for other purposes and/or proxy indicators, or to extrapolate from small-scale direct surveys of particular localities, sectors or occupations. This paper has reported the first nationally representative survey of business perceptions of the magnitude of the shadow economy. The finding is that businesses on average report that some 8 per cent of trade in their sector is conducted in the shadow economy and that there are marked variations in the prevalence of shadow work in different regions, sectors and businesses. Not only is such work more prevalent in the land transport, motor vehicle and motorcycle repair, hotels and restaurants and the construction sectors, but is also more likely to be cited as having a negative impact amongst new business start-ups and in peripheral rural regions of the UK. What is now required is further research, based on the modifications to the survey method recommended above, to pinpoint in finer detail the spheres (e.g. specific sectors and regions) where public policy action needs to be targeted. These results provide a strong rationale for government pursuing such research by displaying not only that some one in 15 small businesses view the shadow economy as having a significant or very significant effect on their business, rising to nearly one in five businesses in some sectors, but also that it is precisely those fledgling enterprises upon which economic development growth rests that are most affected by the shadow economy. Hopefully, therefore, this paper provides a strong impetus for adopting and experimenting with direct survey methods. If this begins to occur, then this paper will have served its purpose. References Anderson, B. (2001), “Why madam has so many bathrobes: demand for migrant domestic workers in the EU”, Tijdschrift voor Economische en Sociale Geografie, Vol. 92 No. 1, pp. 18-26. Bahmani-Oskooee, M. (1999), “The long-run relation between a black market exchange rate and the trade balance”, Journal of Economic Studies, Vol. 26, pp. 106-21. Bajada, C. (2002), Australia’s Cash Economy: A Troubling Issue for Policymakers, Ashgate, Aldershot. Barros, C.P. (2005), “Performance measurement in tax offices with a stochastic frontier model”, Journal of Economic Studies, Vol. 32, pp. 497-510.

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