Study: Black Markets Protect European Economies

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European researchers have concluded that a big enough shadow economy can protect a country from recession. The Financial Times reports:

Unofficial, or “shadow”, economies can help shield European countries during a recession – but illicit activity has to be on a sizeable scale, according to report by Germany’s Deutsche Bank.

Countries with a high prevalence of moonlighting builders, unrecorded cash transactions, missing invoices, tax evasion or illegal activities such as drug dealing, have seen smaller contractions during Europe’s worst downturn since the 1930s than more honest neighbours, researchers at the Frankfurt-based bank have concluded.

The relationship works, however, only if the “shadow economy” is large – such as in Greece, where George Papandreou, prime minister, acknowledged this month that the public services are riddled with corruption. The “most unfavourable level of shadow market activity”, according to Deutsche Bank’s calculations, was exactly 14.3318 per cent of official gross domestic product.

Support for the idea that a large informal sector can help in a downturn came from Professor Friedrich Schneider of Linz University, Austria, an expert on “hidden” or “black” economies. “People earn extra money, and nobody works in the shadow economy in order to pay into a savings account – so the money is spent on consumer goods, boosting demand,” he said. Greece’s large black economy was “welfare increasing,” Professor Schneider added. “The only loser is the state”.

It’s known that shadow economies act as important buffers for developing countries. From CER:

It enhances exports (and competitiveness through imports), it encourages technology transfers, it employs people, it invests in legitimate businesses (or is practised by them), it adds to the wealth of the nation (black marketeers are big spenders, good consumers and build real estate), it injects liquidity to an otherwise dehydrated market. Mercifully, the black economy is out of the reach of zealous and ignorant missionaries such as the IMF. It goes its own way, unnoticed, unreported, unbeknownst and untamed.

It doesn’t pay attention to money supply targets (it is much bigger than the official money supply figure) or to macroeconomic stability goals. It plods on: doing business and helping the country to survive…As long as it is there, the countries in transition have a real safety net. Their governments are advised to turn a blind eye to it, for it is a blessing in disguise.

It will be interesting to see if shadow economies have a role in creating more stable outcomes for some countries, once the global economy picks up steam again.

Image: MindMillion