On the economic rationale of estimating the hidden economy

Abstract

A substantial literature exists on tax evasion that explains the reasons for the existence of the hidden economy but very little work has been done relating the hidden economy to the recorded activities in the economy. In this paper we have provided some empirical results which show strong statistical relationships between the hidden economy and other economic activities. The hidden economy by definition is not directly observable, therefore an indirect procedure is required to estimate it. Until recently the estimates produced did not pass the basic statistical tests. Improvement of the estimation procedure is essential for serious analysis of the interdependence of economic activities. It is apparent that the presence of the hidden economy distorts many standard economic relations, hence in policy analysis the hidden economy estimates should be used to make the policies more effective. The co-movement of the hidden economy with other non-observable series make the estimation of the hidden economy a legitimate exercise to identify certain types of economic problems. It is difficult to envisage an economic system where all activities will be open and recorded. Therefore, the study of the hidden economy is essential for full understanding of the economic system we are living in.