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David Howden on Europe’s Unemployment Crisis – Some Hidden Relief

23rd June 2012

 

  Professor David Howden, Associate Professor of Economics at St. Louis University, in Madrid on Europe’s Unemployment Crisis – Some Hidden Relief

 

 

Europe’s Unemployment Crisis – Some Hidden Relief

 

The countries that comprise the European Union are today in the throes of the most severe crisis in decades. This is most pronounced in the periphery, and especially in the Southern countries. In Spain total unemployment stands today at 19.4%, and for youths under 24 years of age the picture is even bleaker – 46% of them cannot find work, and those that can are typically on short-term contracts or at tasks that underemploy their skills. The rest of Europe is doing better, but in many cases not by much. On average over 8% of EU citizens are currently without work.

European Unemployment Rates (2011, %) Source: Eurostat

Anecdotal evidence suggests that while the official statistics tell a dire story, the reality is somewhat different. Europe’s south is well known for having a sizable black, or underground, economy. While this brings to thought drug dealers, thieves and illicit pornographers, these categories only encompass a small percentage of total underground activity.

In my recent book, Institutions in Crisis: European Perspectives on the Recession I devote an entire chapter to Europe’s underground economies. They are important for two reasons. On the one hand, with governments struggling to honor their debt obligations, they comprise a form of wealth operating outside of the grasp of tax collectors and government officials. On the other hand, they offer a cushion to a dire employment situation. While nearly half of Spanish youths cannot find official work a sizable lot of them can seek redress in the underground. (My own best estimate is that nearly 1 in 4 Spaniards today does some type of remunerated work in the underground economy.)

To understand the underground economy one must first seek out its causes. Some of these workers are performing illegal tasks – the drug dealer around the corner, or the thief lurking in the shadows both jump to mind. However, these types of activities account for a relatively small share of the underground economy. Operating outside the legal sphere is inefficient, difficult to organize and above all, a difficult business model to grow.

            The next group that jumps to mind are the tax evaders. Very few people seem to derive enjoyment from paying taxes. Not only that, but taxes are well known to have what economists call a “deadweight loss”. Since buyers are only willing to pay up to a certain amount for a good, and sellers must sell at a price above some minimum, a tax drives a wedge between some of these potential transactions. If I want my apartment cleaned and am only willing to pay up to 20 euros, and you will do it for no less than 18 euros, we’ve got a deal. Throw in a tax of any more than 2 euros however, and you’ll have to go without work and I’ll continue living in my mess. The gain we could have had is taken away. (And the government won’t have earned any tax revenue either!)

            Intuitively it seems as though many people would try to dodge their taxes and work in the underground economy to try to maximize these types of transactions. Paradoxically to some, however, the facts do not bear this out.

            Consider that the countries with the largest underground economies in Europe are all in the south. Portugal, Italy, Greece and Spain, at 20%, 22%, 25% and 20% of their GDP performed in the underground lead the pack. Although their taxes might not be what we could consider low, especially when compared with the Anglo or Asian worlds, they are low by European standards. At the other end of the spectrum we have countries like Finland and France, with only 14% and 11% of their total economic activity taking place hidden in the underground shadows. Finland and France both have among the highest tax obligations in Europe.

            Again, the lack of a relationship between tax rates and percentage of economic activity taking place unofficially makes sense if we consider the costs of operating in the underground economy. Typically transactions must be performed in cash so as not to leave an electronic trail for the authorities to follow. (For those who are curious as to how we gauge the size of the underground, we use cash as a proxy and assume that all underground transactions are cash based. We then compare the amount of cash being used in the economy relative to the amount that is reported as being used for tax purposes. Voila! The difference should closely mirror the amount of unreported activity.) While cash works well enough for small-scale purchases, for the bigger ticket items it is deficient to credit or an electronic transfer. Your bartender can easily enough not run your drink through the till and thus no one else would know that the transaction had taken place. But every single airplane that Easyjet purchases is officially recorded. And it takes a lot of drinks at the local pub to amount to the value of a new Airbus jet.

            Taxes might get in the way of some transactions, but they do not dissuade entrepreneurs from the majority of them.

            The largest determinant of the size of an economy is the ease of doing business – how clear are the regulatory processes, and how easy is it to legally register a new venture. In many places, notably in the south of Europe, highly bureaucratic business registration processes stop well-intentioned entrepreneurs from legally operating. A tax might not be welcome to the new entrepreneur, but at least he can treat it like a cost of business and plan accordingly. Not knowing how long it will take to register your business, on the other hand, or even whether your application will be accepted, will cause someone to forego the process completely.

            Today in Europe’s south there is a push to reduce the size of the underground economies. The typical methods suggested to do so are increased fines for violators and more officials performing random checks to ensure that everyone is “officially” working. Such policies are ill-directed and ill-advised.
 
         They are ill-directed because they don’t attack the root cause of the underground economy. Entrepreneurs are there mostly because it is too bureaucratic to operate in the formal economy. Unless you can reduce the difficulty that would-be entrepreneurs have in getting officially started, one cannot start to positively stamp out these unofficial activities.

            Such policies are ill-advised because they come at a time when many rely on the underground economy for employment. In Spain this is a viable alternative for many that cannot find official work. Making it more difficult to be employed in the underground will surely reduce the size of that unofficial economy, but it will not translate into a growing official economy. Only by making it easier for businesses to operate officially will we see growth in employment opportunities in these areas. Taking away the underground economy without engendering an alternative does nothing but harm those that today depend on such employment for their livelihood.

 

 

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