Shadow economies – will they revive global growth?

Most of us will know of the black market as the unlawful trade of goods and services. This is slightly different from the grey market, where trade occurs legally but through unofficial channels. So what exactly happens in shadow economies, and more importantly, what effect does it have on global growth and currencies?

Defining shadow economies

Most definitions encompass both black and grey markets. A 2002 IMF report gives the examples of a factory worker driving an unlicensed taxi, or a plumber not declaring his cash earnings. However, while the same report includes illegal drug deals in its definition, others define it simply as: legal activities that are concealed to avoid taxes and regulation.  

Taxes: the cure or curse?

A large portion of global wealth remains unaccounted for, mostly due to legitimate businesses that evade tax. Friedrich Schneider’s study of European money laundering shows that Romania’s informal sector represents some 28% of its official GDP, while a recent Bloomberg article reveals this figure to be 40% in Russia. However, Russia’s shadow economy has since shrunk by a third since 2001, when the government introduced a 13% flat-rate income tax. This gave Russia a GDP boost not seen since the fall of the Soviet Union. 

Currency valuation

In September 2015 the Bank of England reported that about half of its bank notes were being held overseas or used in shadow economies. Official exchange rates, therefore, unlikely reflect a currency’s real value. This proves the importance of getting trustworthy advice on currency comparison, especially before you make your next international money transfer or foreign investment. Our FX brokers provide a completely transparent service and will ensure you get the best rates on the market.

Additionally, this currency effect is likely to be more significant in emerging markets, where the shadow economy is vast. In India, for example, The Hindu reports that the informal sector could account for about 75% of GDP. A Money Cloud article recently suggested that if Indians stopped using cash completely, the country could recover $28bn US dollars. 

Looking ahead

Smaller shadow economies will mean an increase in transparent transactions, particularly across borders. The good news? Governments are already taking steps towards achieving this. Countries like Brazil and Portugal have introduced a scheme which offers lottery prizes, based on sales-tax receipts, in order to tackle tax evasion. Over in Colombia and Argentina, reduced VAT rates are given to credit card transactions in order to discourage the use of cash. In reality, however, Schneider says only 20-30% of the shadow economy can be legalised. This means cash-only trade will likely remain due to its untraceable nature, despite advances in payments technology and government crack downs. The effect on currency values (as mentioned earlier) will therefore continue, so check out our broker comparison tool before your next online money transfer.

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