How Deep Is the Shadow Economy? (Ep. 90)
Our latest Freakonomics Radio podcast is called “How Deep Is the Shadow Economy?” It addresses what we know — and don’t know — about the gazillions of dollars that never show up on anyone’s books.
The conversation ranges from the macro to the micro — that is, from worldwide estimates of the size of the shadow economy to the actual off-the-books transactions (from drug dealing to freelance hair-cutting) that make those dollars flow.
We touch on research by the Turkish economists Ceyhun Elgin and Oguz Oztunali, who estimate that off-the-books transactions account for roughly 23 percent of world GDP (short version, full paper); and a similar World Bank study by the economist Friedrich Schneider, who has studied shadow economies — and the attendant tax evasion — for the past quarter century.
But the star of this podcast is Sudhir Venkatesh, the Columbia sociologist who is a regular Freakonomics contributor. Venkatesh has studied, up close and personal, the working lives of prostitutes, home cooks, drug kingpins, sidewalk auto-repairmen, and many others whose labor — licit and illicit — constitutes the shadow economy. If you are even a little bit interested in this subject, you should definitely read Venkatesh’s Off the Books: The Underground Economy of the Urban Poor (as well as his later book Gang Leader for a Day: A Rogue Sociologist Takes to the Streets).
Here’s Venkatesh from the podcast:
You have to be pretty creative if you’re going to try to measure the shadow economy. Many social scientists, particularly those that want to see what percentage of the shadow economy is in the country overall, they want big estimates, they’ll often do surveys. So they might ask people very directly, “Hey, how much did you work illegally in the U.S.?” Well there’s a problem — people might not be telling the truth. Other economists might say, you know, to avoid the truth-telling issue we’re just going to take careful estimates. And so they construct very elaborate models. Sociologists like me who don’t trust people at all and believe that we generally don’t tell the truth at all have to go and see someone perform something illegally. So that means we’ll go and watch them. And in my case I’ll spend years watching them. The problem is I might only end up watching two dozen people. It’s hard to figure out what the country is doing as a whole by watching two dozen people, let alone your neighborhood. So it’s a problem. And as creative as we want to be in trying to measure it, we often fall short.
One agency with particular interest in the shadow economy is the I.R.S., which estimates the annual U.S. “tax gap” — the difference between taxes paid and taxes owed — is about $345 billion. We’ve written about the tax gap before, and unless it magically disappears (ha!), probably will again.