Integrating the Unofficial Economy into the Dynamics of Post-Socialist Economies: A Framework of Analysis and Evidence

Abstract

The growth of the unofficial economy in the post-socialist economies of much of Eurasia suggests that economic reform should be accelerated - that even bolder stabilization, liberalization, and privatization efforts are called for. Incorporating the unofficial economy into the overall analysis also leads to different implications for tax policy and social protection.

Kaufmann and Kaliberda challenge the conventional view of how post-socialist economies function by incorporating the unofficial economy into an analysis of the full economy. Then they advance a simple framework for understanding the evolution of the unofficial economy, and the links between both economies, highlighting the main characteristics of unofficialdom, contrasting conventional notions of informal or shadow economies, and focusing on what determines the decision to cross over from one segment of the economy to the other.

The empirical evidence, based on both microsurveys and top-down (macro-electricity consumption) comparative country methodology, suggests the usefulness of the framework. Integrating the unofficial economy into the analysis of the whole economy sheds a different light on interpretations of national income, of sectoral trends (such as trade, services, and exports), and of labor markets and household patterns, often leading to a different interpretation.

Over a third of economic activity in the former Soviet countries was estimated to occur in the unofficial economy by the mid-1990s; in Central and Eastern Europe, the average is close to one-quarter. Intra-regional variations are great: in some countries 10 to 15 percent of economic activity is unofficial, and in some more than half of it. The growth of unofficial activity in most post-socialist countries, and its mitigating effect on the decline in official output during the early stages of the transition, have been marked.

The initial empirical results seem to support hypothetical explanations of what determines the dynamics of the unofficial economy. Kaufmann and Kaliberda emphasize the speedy liberalization of markets, macro stability, and a stable and moderate tax regime. Although widespread, most unofficialdom in the region is found to be relatively shallow - subject to reversal by appropriate economic policies. The framework and evidence presented have implications for measurement, forecasting, and policymaking - calling for even faster liberalization and privatization than already advocated. And the lessons in social protection and taxation policy differ from conventional advice.

This paper - a product of Country Department IV, Europe and Central Asia -was presented as a draft at the Odessa conference on Economic Transition in the Newly Independent States, August 1995, and will be published in Economic Transition in Russia and the New States of Eurasia, edited by B. Kaminsky (M. E. Sharpe, 1996).