An institutional theory of the informal economy: some lessons from the United Kingdom

an article by Colin C Williams (Management School, University of Sheffield, UK) and Ioana Alexandra Horodnic ('Gh. Zane' Institute for Economic and Social Research, Romanian Academy Iasi Branch, Romania) published in International Journal of Social Economics Volume 43 Issue 7 (2016)

Abstract

Purpose
The purpose of this paper is to propose a new way of explaining participation in the informal economy as resulting from the asymmetry between the codified laws and regulations of a society’s formal institutions (government morality) and the norms, values and beliefs of the population that constitute its informal institutions (societal morality). The proposition is that the greater the asymmetry between government morality and societal morality, the greater is the propensity to participate in the informal economy.

Design/methodology/approach
To evaluate this institutional asymmetry theory, the results are reported of 1,306 face-to-face interviews conducted during 2013 in the UK.

Findings
The finding is a strong correlation between the degree of institutional asymmetry (measured by tax morale) and participation in the informal economy. The lower the tax morale, the greater is the propensity to participate in the informal economy. Using ordered logistic regression analysis, tax morale is not found to significantly vary by, for example, social class, employment status or wealth, but there are significant gender, age and spatial variations with men, younger age groups, rural areas and Scotland displaying significantly lower tax morale than women, older people, urban areas and London.

Practical implications
Rather than continue with the current disincentives policy approach, a new policy approach that reduces the asymmetry between government morality and societal morality is advocated. This requires not only changes in societal morality regarding the acceptability of participating in the informal economy but also changes in how formal institutions operate in order for this to be achieved.

Originality/value
This paper provides a new way of explaining participation in the informal economy and reviews its consequences for understanding and tackling the informal economy in the UK.

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The Shadow Economy

a research paper by Friedrich Schneider (Johannes Kepler University of Linz, Austria) and Colin Williams (University of Sheffield) published by the Institute of Economic Affairs (June 2013)

Summary

• Measurement of the shadow economy is notoriously difficult as it requires estimation of economic activity that is deliberately hidden from official transactions. Surveys typically understate the size of the shadow economy but econometric techniques can now be used to obtain a much better understanding of its size.
• The shadow economy constitutes approximately 10 per cent of GDP in the UK; about 14 per cent in Nordic countries and about 20–30 per cent in many southern European countries.
• The main drivers of the shadow economy are (in order): tax and social security burdens, tax morale, the quality of state institutions and labour market regulation. A reduction in the tax burden is therefore likely to lead to a reduction in the size of the shadow economy. Indeed, a virtuous circle can 
be created of lower tax rates, less shadow work, higher tax morale, a higher tax take and the opportunity for lower rates. Of course, a vicious circle in the other direction can also be created.
• Given this relationship, the high level of non-wage costs (averaging 39 per cent of total labour costs) and the penalty on individuals who move from earning one third to two thirds of the median wage (averaging 58 per cent of the increase in earnings for a one-earner couple) in the European Union should be a matter of real concern. The latter figure
is 79 per cent in the UK and thus low-paid UK workers have a huge incentive to supplement their incomes in the shadow economy.
• The number of participants in the shadow economy is very large. Although up-to-date figures are not available, at the end of the twentieth century up to 30 million people performed shadow work in the EU and up to 48 million in the OECD. Reliable detailed studies are not available for many countries. In Denmark, however, the latest studies suggest that about half the population purchases shadow work. In some
 sectors – such as construction – about half the workforce 
is working in the shadow economy, often in addition to formal employment. Only a very small proportion of shadow economy workers can be accounted for by illegal immigrants in most countries.
• In western Europe, shadow work is relatively prevalent among the unemployed and the formally employed. Other non-employed (for example, the retired, homemakers
and students) do relatively less shadow work. This has implications for policy in terms of the importance of social security systems that reduce the opportunities for shadow work among the unemployed and the importance of tax systems that do not discourage the declaring of extra income.
• Policies focused on deterrence are not likely to be especially successful when tackling the shadow economy. The shadow economy is pervasive and made up of a huge number of small and highly dispersed transactions. We should also be wary about trying to stamp out the shadow economy as we may stamp out the entrepreneurship and business formation that goes with it.
• There are, however, huge potential benefits from allowing 
the self-employed and small businesses to formalise their arrangements. Businesses cannot flourish if they remain in the shadow economy. They might be reluctant to formalise, however, if it involves admitting to past indiscretions. Worthwhile policies include: reducing business compliance regulation; amnesties; providing limited tax shelters 
for small-scale informal activity such as the provision of interest-bearing loans to relatives and friends; and allowing businesses to formalise using simple ‘off the shelf’ models. Such policies have been successful in other countries – and to a limited extent in the UK – with high benefit-to-cost ratios.
• Given that the shadow economy constitutes a high proportion of national income, and varies between less than 8 per cent of national income and over 30 per cent of national income in OECD countries, official national income statistics can often be misleading. Comparisons are made even more difficult because some countries adjust figures for the shadow economy (for example, Italy) and others do not.
• In less developed countries, the informal sector constitutes typically between 25 and 40 per cent of national income and represents up to 70 per cent of non-agricultural employment. In such countries, informal activity often arises because of the inadequacies of legal systems when it comes to formalising business registration.

Full text (PDF 96pp (A5)

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Tackling the hidden enterprise culture: Government policies to support the formalization of informal entrepreneurship

an article by Colin C. Williams and Sara Nadin (affiliation(s) not provided) published in Entrepreneurship and Regional Development Volume 24 Numbers 9-10 (December 2012)

Abstract

It is now recognised that many entrepreneurs operate wholly or partially in the informal economy. Harnessing this hidden enterprise culture by facilitating its formalisation is therefore a potentially effective and innovative means of promoting economic development and growth.

To start evaluating how this might be achieved, the aim of this paper is to understand entrepreneurs’ motives for operating in the informal economy so as to identify the public policy interventions required to facilitate the formalisation of this hidden enterprise culture.

Reporting a survey of 51 nascent entrepreneurs in North Nottinghamshire, of which 43 were operating in the informal economy, the finding is that entrepreneurs’ rationales for working informally differ according to both whether they operate wholly in the informal economy or have registered enterprises but trade partially off-the-books, as well as whether they view themselves as on a journey towards formalisation or not.

Different policy measures are therefore required to tackle each type of informal entrepreneurship.

The outcome is a tentative call for a more nuanced and bespoke policy approach for tackling the different kinds of informal entrepreneurship that comprise the hidden enterprise culture.

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