By Mangaliso Mohammed and Thabo Sacolo
THERE is growing interest on the shadow economy in Eswatini, especially questions about what it is and how it relates to the taxation of individuals and businesses.
The Eswatini Economic Policy Analysis and Research Centre (ESEPARC) conducted a study on the size and drivers of the shadow economy in Eswatini following observations that unemployment was too high at 28.1%, with 38% of the formally employed dependent on the shadow economy for extra income.
In other words, the shadow economy is an important piece of the economy in Eswatini and drawing the country’s attention to it can stimulate policy changes for economic recovery by increasing the contribution of private sector businesses to gross domestic product (GDP). Understanding the nature and dynamics of the shadow economy informs policy interventions needed to nurture and transition business activities occurring in the shadow economy into the mainstream formal economy.
What is the shadow economy and why does it matter?
Schneider (1994) defines it as all unregistered economic activities that would contribute to a country’s GDP if observed. The shadow economy is all legal business activity that happens between people or businesses that is not accounted for by government. These activities do not fall under government’s regulation radar, particularly tax regulation.
What it means is that if all business activities were to be registered and monitored by government, the value of goods and services produced within the Eswatini economy would be greater than current GDP estimates. At the same time, there would be a larger tax base from which government could generate national revenue for social and economic development. The motivation for complete registration and monitoring of business activities is not just a one directional benefit to government only: it also benefits entrepreneurs and businesses. With more businesses operating in the open under the same set of government regulations, it creates more opportunities for private sector growth where both individuals and businesses can compete and seize opportunities in a fair footing for income generation and wealth creation.
However, the idea of a completely formal economy where all business activities/transactions are registered is a utopian and impractical dream. There simply isn’t enough government time and resources to monitor all economic activities. The point of investing resources to understand the dynamics of the shadow economy is to acknowledge its contribution to the economy and create a conducive environment, including economic incentives so that a much larger share of businesses find it in their best interest to operate in the formal economy. Every country will therefore always have a shadow economy, in fact, the contribution of the shadow economy worldwide is estimated to be 13.7% of the world’s GDP.
In Eswatini, there tends to be mixed views on the contribution of the shadow economy to the overall national economy. Those against it view the shadow economy as a hindrance to the mainstream economy because it encourages tax evasion, which leads to a reduction in the country’s tax base. When the shadow economy grows much faster than the formal economy, it imposes serious penalties on the government’s ability to generate income to drive development and can be a significant contributing factor to the country’s deficits and slowing economic growth. On the other hand, advocates of the shadow economy argue that it is the cornerstone of the small and medium enterprises (SME) sector as it promotes entrepreneurship and income generation. They see the shadow economy as an enabling engine for employment creation for unemployed people within the economy.
In this view, the shadow economy offers an alternative economic pathway to support basic livelihoods, especially among the poor and marginalised in a country. At a national policy level, Eswatini adopted the 2030 Agenda for Sustainable Development Goals (SDGs) in 2015, which committed the country to creating decent work and economic growth as part of SDG 8 as well as reduce inequality as part of SDG 10.
Whether against or in support of the shadow economy, and noting that it is impossible to completely get rid of it, Eswatini has to formulate its own policy direction for graduating shadow economic activities into the formal economy to achieve the country’s developmental goals. Jutting and de Laiglesia (2009) provide evidence that the size of the shadow economy grows rapidly in periods of economic crisis because people who lose their employment in the mainstream economy are absorbed by the informal sector.
Drivers of the shadow economy in Eswatini
ESEPARC conducted the study to provide a benchmark on the drivers and magnitude of the shadow economy in Eswatini so that at a policy formulation level, government could determine an acceptable level of the shadow economy locally. Also, government could choose to influence the drivers of the shadow economy in order to reduce the number of people who depend on it as their main livelihood source by making the formal economy a much more lucrative business choice.
The study found that:
- The main drivers of the shadow economy are indirect taxation, self-employment, and formal employment. As expected, taxation is positively associated with the size of the shadow economy. This implies that an increase in the tax burden translates to an increase in the size of the shadow economy. Worth noting here is that tax evasion through opting to operate in the informal sector can be a cost to the society. Since government uses tax revenue to provide public goods (such as road infrastructure), theoretically at least, some of which are used by businesses. In light of this view, informal businesses are free riding on the formal sector’s contribution to government tax revenue. However, informal businesses can also create a stimulating effect since part of the income creates demand for goods and services produced in the formal economy.
Indirect tax, agriculture value added, regulation, and self-employment are positively associated with the size of the shadow economy. In other words, an increase of these variables is associated with an increase in the size of the shadow. The relationship between the agriculture sector and Eswatini’s economy is that when the share of the agriculture sector’s contribution to GDP increases, the size of the shadow economy also increases. This is not surprising given that Eswatini is an agro-based economy and implies that a significant portion of shadow economic activities occur within the agriculture sector.
Contrary to a prior expectation, unemployment has no impact on the magnitude of the shadow economy in Eswatini. This implies that high level of unemployment in Eswatini does not directly translate into a relatively large size of the shadow economy. This result implies that Emaswati are more inclined towards job seeking than entrepreneurship. Such inclination might be a factor of the education system that leans towards white-collar jobs to the detriment of technical and vocational education and training (TVET).
The shadow economy in Eswatini (2016) was found to be 37.4% of the formal economy and has been declining slowly over time. This means if all shadow economic activities were registered, they would contribute 37.4% more towards the current GDP value. In monetary terms, the shadow economy would add E20.5 billion towards the GDP value of Eswatini. This provides a valid case for the transitioning and harnessing of shadow economic activities in to the mainstream economy because of their economic potential.
The shadow economy accounts for a significant proportion of the formal Eswatini economy and its magnitude has been declining at a slow rate between 2000 and 2016. Policymakers should create a conducive business environment that can fast-track the reduction of the shadow economy and see more business activities in the formal private sector.