By Mcebo Zikalala
The shadow economy is a multifaceted macroeconomic phenomenon that usually occurs due to a country’s inability to monitor all economic activities within the economy. This is often as a result of time and resource constraints.
Shadow economy expert and Professor of Economics at Johannes Kepler University Linz, Freidrich Schneider observes that the shadow economy can best be defined as an amalgam of all unregistered income generation activities that contribute to overall income (gross domestic product (GDP) in a country. In 2011 Neuwirth reported that, the shadow economy accounted for approximately 10 trillion U.S dollars globally, making it the second largest economy in the world after the United States at 14 trillion U.S dollars. Therefore, we cannot deny the contribution of the shadow economy on our economy.
Our interest in developing a clearer understanding of the shadow economy comes from the fact that if all economic activities are officially registered they would all be liable to taxation and regulation. However, the reality is much different, the challenge which the shadow economy presents is that it allows economic activities to fall through the cracks without being captured by the government system. Subsequently, revenue generated from such economic activity goes undetected and escapes liability to taxation.
The role of taxation within the economy cannot be understated. Taxes are one of the basic policy instruments employed by the government to generate state revenue. State revenue forms the basis for driving and achieving national social and economic goals. Money collected from taxes contributes to the development of physical capital (roads, dams, etc.) for public consumption. Without effecting taxes, national developmental programs cannot be funded and ultimately implemented.
Shadow or informal sector economic activities tend to adversely reduce the tax base of a country by eliminating tax compliance for some business entities. If too many businesses operate in the shadows taxes are evaded, the budget deficit increases and overall economic growth is weakened. When the government does not have money to fund its economic and social development mandate, the availability and quality of public goods and services delivered by the government suffers, ultimately crippling the country’s development.
Swaziland aims to become a developed economy by the year 2022. In order for the country to realize the developmental potential outlined in the National Development Strategy (NDS) and the Strategy for Sustainable Development and Inclusive Growth (SSDIG), massive investments in pro-poor programmes have to be made. Needless to say, adequate economic resources are needed. From this view there has never been a more urgent need to regulate all economic activity in the country than now.
In this sense regulations are important for shaping economic growth. It is only through economic growth that the welfare of society can be secured. In the absence of regulations, a lot of distortions take precedence and that is counterproductive to economic growth.
While regulation is critical, its application must consider its implications on social development. The agricultural industry of Swaziland, for example, is governed by marketing boards, mandated to regulate services and price setting. Yet the country has been struggling to reach self-sufficiency in agricultural production for years now.
The question to ask ourselves is, have the regulatory bodies in the country done enough to incentivise rural households to commercialise their agricultural production. If not what have been the barriers to effect these positive changes?
Stringent regulations through the pricing system and market standards can contribute to an unfavourable environment prompting farmers to off-load their produce in the informal economy. In this sense, agricultural boards could possibly be indirectly promoting the prevalence of unregulated economic activities in the agricultural sector. How, one might ask? If the prices that farmers get from the agricultural boards are lower than prices informal traders are willing to pay, it makes greater business sense to supply the informal traders rather.
It gets worse: while farmers may benefit from selling their products in informal markets in the short-term this can be detrimental to the country’s development aspirations in the long-term. This is mainly because transactions in the shadows are hidden and untraceable – which makes it difficult to plan and coordinate the economy.
Whereas the drivers of the shadow economy may vary from one country to the next, one detail has remained constant throughout literature. Shadow economic activities originate from the inability of the economy to provide sufficient capital to cater for everyone within the economy. However, if the opposite was true, all economic activities would be regulated.
As a result of the capital limited nature of the economy, people are driven to operate in the shadows because they have no other alternatives to sustain their livelihoods. In Swaziland with youth unemployment at an astounding 51.6 percent as depicted by the Labour Force Survey of 2014, the shadow economy has become a buffer for unemployed young people that are unable to find remunerative formal occupation. This is evident as the Organization for Economic Cooperation and Development (OECD) in 2009 determined that about 1.8 billion of the world’s population are employed in the shadow economy.
Apart from providing a source of livelihood for both rural and urban unemployed people, the shadow economy also plays a significant role in the growth of the small and medium enterprises (SME) sector within the economy. Shadow economic activities have strong linkages with the SMEs sector as a large number of SMEs directly or indirectly depend on informal activities. In 2017 The Swaziland Revenue Authority reported that currently there are 20 586 fully-registered SMEs in Swaziland. Some of these businesses owe their humble beginnings to the shadows as they started out as informal enterprises.
Literature from prominent shadow economic authors suggests that the tax burden, high unemployment rate, bribes, the intensity of regulations, lack of access to financial resources, lack of technology, skills and capacity as well as institutions that are resistant to change drive many people to fend for themselves in the shadows.
Moving forward, it is imperative for Swaziland to estimate the size of the shadow economy. Additionally, it is also important to empirically test what the drivers of the informal economy are in the country. This will provide policymakers with enough evidence to formulate policies that can be used as a tool to nurture SMEs in the shadows to transition into the mainstream economy.
In view of this fact there are currently no empirical studies about the magnitude and drivers of the shadow economy in Swaziland. This suggests that there is a knowledge gap about the shadow economy. Studies on this particular topic are urgently needed to inform policy. To fill the void, the Swaziland Economic Policy Analysis and Research Centre (SEPARC) has commissioned a study on this particular subject and it is currently ongoing.
Mcebo Zikalala is a Graduate Intern Researcher at SEPARC. He conducts research on the shadow economy and can be reached at firstname.lastname@example.org. He writes in his personal capacity.