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

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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