America's 'shadow economy' is bigger than you think - and growing

The informal, or 'shadow,' economy is as big as $1 trillion. And in poor economic times, it's growing.

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    Pedestrians cross Malcolm X Boulevard on West 125th Street in Harlem, near the Apollo Theater, in 2008. Malcolm X is home to a flourishing 'shadow' economy, informal business arrangements that are on the rise during the economic slump.
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NEW YORK — A white sheet of paper tacked to a fence outside a Harlem church has one line written on it: Carlos lite-mover – mudanzas. It has a drawing of a truck and a phone number.

A man’s voice answers the number. Yes, he’ll use his truck to move people’s belongings. It’s a way to earn some cash. Is this a registered business he reports for taxes? No answer. He quickly hangs up.

Inside the church, a moseying custodian says certainly, many of the women who come to the Thursday night meeting have informal businesses. They sell food and makeup from their homes.

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A grandmotherly woman with a sweet smile arrives. “No,” she says, that’s not true. She quickly shakes her head with a furrowed brow.

Pinning down the informal economy is as tough as catching a fake Louis Vuitton vendor running from the police. But it’s huge in the United States – larger than the official output of all but the upper crust of nations across the globe. And, due to the recent recession, it’s growing.

Whether that’s good or not depends entirely on one’s point of view. The rise of the informal economy is either the flourishing of entrepreneurship among America’s poorest or a drag on legitimate businesses that play by the rules. Here, on Harlem’s Malcolm X Boulevard, you can find both.

Perhaps the biggest surprise about America’s shadow economy is its size. Long associated with colorful street hawkers in the developing world, the shadow economy makes up a larger portion of the economies of countries like Greece (25 percent) or Mozambique (more than 40 percent) than it does in the US. But because America’s economy is so much bigger, its shadow economy amounts to nearly 8 percent of its gross domestic product (GDP) – in the ballpark of $1 trillion, estimates Friedrich Schneider, an economics professor at Johannes Kepler University in Linz, Austria. That’s bigger than the GDP of Turkey or Australia.

There’s nothing particularly ominous about the shadow economy – at least, not the one Professor Schneider measures. He doesn’t include illegal activities like drug trafficking or counterfeiting. The transactions he looks at involve the legal production of goods and services that are not taxed and may violate labor laws.

Ironically, as recession shrinks the official economy, the informal one is growing.

“People have less ability to earn money in the official economy. They work in the shadow economy,” Schneider says. “It will grow this year by 5 percent, at least,” in the US.

Licensed and unlicensed on Malcolm X

Along Malcolm X Boulevard, street commerce is thriving. Vendors of incense, books, and nuts – many of whom have the proper licenses – line the sidewalks on a sunny day. One Harlem vendor is working doubly hard, dodging pedestrians as he runs with his cart along the street.

Why won’t he pick a corner and stop, like the licensed street carts? He has to stay on foot to avoid the police, he yells as he passes. Inside his cart: packages of white tube socks.

The positive view of such vendors is that informal work provides a space for entrepreneurship.

That fits with the findings of Robert Fairlie, an economist at the University of California at Santa Cruz. When he calculated his most recent “index of entrepreneurial activity” for 2008, he found an uptick in business creation in the US – but only at the lowest income levels.

It seems “when the recession hit, you got a lot of people going into necessity business,” he says in an interview.

The informal sector is also a safety net for the poor. “The informal economy is really something that emerges out of necessity,” says Carolina Valencia, associate director of research of Social Compact, a Washington-based nonprofit that estimates shadow economic activity to show low-income neighborhoods’ market strength to new businesses. “It makes sense that poor people and [immigrants] without the necessary paperwork would be more involved in these activities.”

Hard times for legitimate business

Here in Harlem, 10 percent of income is earned informally, Social Compact estimates. But its mom and pop shops have taken a severe beating. From July 2008 to the end of June this year, over a third of the neighborhood’s small businesses closed, according to the Greater Harlem Chamber of Commerce.

“Competition is competition,” says Gene Fairbrother, the lead small-business adviser in Dallas for the National Association for the Self-Employed. But competition from producers who don’t pay taxes and licensing fees isn’t fair to the many struggling small businesses who play by the rules.

Mr. Fairbrother says he’s seen an increase in the number of callers to his Shop Talk show who ask about starting a home-based business, and many say they’re working in a salon and would rather work out of their homes or that they want to start selling food from their kitchens. Businesses facing this price pressure should promote the benefits of regulation, he advises, instead of trying to get out from under it.

Dual economies

There are two informal economies, says Saskia Sassen, a sociology professor at Colombia University in New York. “You have a poverty kind of informal economy, and you have an informal economy that feeds into the high end,” she says. These are creative professionals such as freelance designers and performers. It’s the first group, however, that’s much larger in terms of manpower, she adds.

It is so dispersed that the US Bureau of Economic Analysis judges it isn’t worth the resources to measure its output when it makes its regular GDP calculations.
So while the US government is chasing the other side of the untaxed coin – wealthy Americans who avoid taxes by stowing their income abroad – a crackdown on the domestic informal economy doesn’t seem to be on the American agenda anytime soon.

For one thing, it’s a daunting prospect. The Internal Revenue Service or local tax authorities would have to track down thousands of elusive small vendors and follow up for payment to equal, by one estimate, the $100 million a year that the US could gain by taxing several hundred holders of Swiss and other foreign bank accounts. For another, it may be discouraging an activity that keeps lower-income Americans employed.

Off-the-books work “is probably neutral to good,” says Alfonso Morales, a professor of urban and regional planning at the University of Wisconsin at Madison. He argues that formal and informal economies are linked and cannot be neatly separated.

“People who make their money in unregulated businesses probably spend it in regulated ones,” he says.

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See also:

In Mozambique, informal street traders strive to survive

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