UNREGISTERED

ECONOMY

Assoc. Prof. Metin Ercan

Boğaziçi University
 UNREGISTERED ECONOMY
 General Information
 Size of Unregistered Economy and Work
 Causes & Determinants
 Adverse Effects

 SUGGESTIONS

2
Unregistered Economy - Definition
 Unregistered economy: Activities
 not completely identified by using traditional
measurement and techniques
 partially reflected in GDP accounts

 From a fiscal point of view

 Sum of all types of activities without the knowledge of tax
authority

3
Unregistered Economy – Different Names
 Other names used in literature
…underground, invisible, marginal, shadow, lost, black market, non-observed,
unofficial, undeclared, gray area, secondary, twilight, untaxed, untied, hidden,
informal…

economy

most suitable heading, and used

throughout the study

“UNREGISTERED ECONOMY”

4
Unregistered Economy - Types

 Underground production
 Avoidance from certain types of liabilities (e.g. VAT, income
tax, social security obligations)
 Partial declaration of the activities undertaken by
registered entities

 Informal production
 Activities that public authorities fail to recognize

5
Unregistered Economy - Types

 Illegal production
 Activities involving production, sales and storage of
products and services that are prohibited by law
 Activities that are legally allowed but undertaken by legally
unauthorized persons

6
Unregistered Work - Definition
 Unregistered work includes types of work
undertaken by

 Legal workforce not reporting partially or completely to

public authorities
 Illegal workforce (e.g. illegal workers, infant workers, etc)

7
Unregistered Work - Types

Production units by typ

Source: Hussmanss, 2001

Legend
Cell no:



1,5
2,6,9
: Contributing family worker, no contract, legal or social protection Doe
: Paid workers in both registered and unregistred firms and paid domestic workers by
households



3,4
7
9
: Registered workers in registered entities
: Producers of goods fow own final use by their households
Exis
: These types are unregistred because of the unregistred nature of the related entities

Segm


8
 UNREGISTERED ECONOMY
 General Information
 Size of Unregistered Economy and Work
 Causes & Determinants
 Adverse Effects

 SUGGESTIONS

9
 Unregistered Economy – In the World
 Stated as % of GDP, (1999-2000)
 Differs significantly accross continents/country groups
and/or individual countries
Africa (average 42%) Asia (average 26%) South America (average 41%)
Thailand 52,6 Bolivia 67,1
Zimbabwe 59,4
Sri Lanka 44,6
Panama 64,1
Tanzania 58,3 Philippines 43,4
Peru 59,9
Turkey 32,1
Nigeria 57,9
India 23,1 Colombia 39,1

Botswana 33,4 Israel 21,9

Mexico 30,1
Singapore 13,1
Cameroon 32,8 Argentina 25,4
China 13,1

South Japan 11,3 Chile 19,8

28,4
Africa

Transformation Countries (average 38%) OECD West Europe (average 18%)

Georgia 67,3
Greece 28,6
Azerbeijan 60,6
Italy 27
Ukraine 52,2
Belgium 23,2
Russia 46,1
Portugal 22,6
Romania 34,4
France 15,3
Yugosalavia 29,1
Netherlands 13
Poland 27,6

Hungaria 25,1 UnitedKingdom 12,6

Czech Republic 19,1 Austria 10,2

SlovakRepublic 18,9 Switzerland 8,8

Source: Schneider, 2002

10
Unregistered Economy - Size
 Across OECD countries (min, max and median values)
(% of GDP)

35,0
28,6 28,7
30,0 28,5
22,8
25,0
20,0
15,0 14,8 16,0 15,8
11,8
10,0
5,0 6,7 7,8 8,6 8,7
0,0 Average
89-90 94-95 99-00 01-02
Source: Schneider, 2002

11
Unregistered Economy - Size
 Differs across industries in emerging economies
 Unregistered portion increases as level of
sophistication decreases
Software 20

Electronics 20-25

Steel <30

Cement <30

Food processing 30

Automotive parts 30

Retail 80

Apparel 80

Construction >80

0 20 40 60 80 100

Source: McKinsey

12
Unregistered Economy in Turkey - Size
 Summary of studies for Turkey

Author
Fatih Savaşan
Çetintaş & Vergil
13
Unregistered Economy in Turkey - Size
 Summary of studies for Turkey (cont’d)

Author
Yılmaz Ilgın
Temel et al
14
Unregistered Economy in Turkey - Size
 Estimation for the size of unregistered economy in
Turkey differs substantially by,
 Year of study
 Type of method
 Author

 Significant amount of unregistered economy exists in

Turkey

15
 Unregistered Work – Size
 Reported in terms of
 Formal employment
 GDP

 Emerging markets: Differs across continents

(% of workforce)

South Africa 72%

Asia 65%

Latin America 51%

North Africa 48%

Source: ILO, 2002 16

Unregistered Work – Size
 EU member & candidate countries
First members New members (candidates)
(% of GDP)
(% of GDP)

Greece 20 Bulgaria 30

Italy 17 Romania 21
France 6,5
Lithuania 19
Germany 6
Hungary 18
Denmark 5,5
Latvia 18
Portugal 5

Finland 4,2 Slovenia 17

Belgium 4 Slovak Republic 15

Sw eden 3
Poland 14
UK 2
Czech Republic 10
Netherlands 2

Austria 1,5 Estonia 9

Source: European Commission, 2001

17
Unregistered Work in Turkey – Size
 Number of workers, 2003
 Totalemployment 21,1 mio
 Unregistered work 10,9 mio (%51,7)
 Max in agriculture sector (%91,7), min in utilities sector (%1)

Agriculture 91,2%
Construction 63,8%
TOTAL 51,7%
Transportation, Communications 43,9%
Wholesale, retail, tourism 42,2%
Production 30,7%

Financial Services 19,9%

Mining 14,5%

Social Services 13,6%

Utilities 1,0%

Source: DİE, 2004

18
Unregistered Work in Turkey – Size
 Various breakdowns (2003)
 Gender:
(% of workers)

Female 71,0%

Male 44,0%

 Job status:
(% of workers)
Contibuting family member 98,0%

Daily paid 91,0%

Own account 66,0%

Payroll 18,9%

Employer 18,4%

Source: DİE, 2004

19
Unregistered Work in Turkey – Size
 Unregistered workers by occupation
Scientific, technical,
Entrepreneurs,
ow n-account
Unidentified managers
w orkers Administrative
0% 1%
1% 1%

Trade and sales Workers in services

w orkers industry
10% 7%

Non-agriculture
production w orkers
Farmers 20%
60%

Source: DİE, 2004

 60% of unregistered workers as farmers

20
 Unregistered Work in Turkey – Size
 Educational breakdown of  Unregistered worker share by
total employment (2003) educational level
Vocational high school
8% Literate but not (% of workers)
University graduate
High school
11% Illiterate 3%
11%
7% Illiterate 95%
Literate but not graduate 87%
Primary school 66%
Middle school 42%
Vocational middle school 33%
High school 28%
Vocational high school 25%
Middle school Primary school
University 8%
Vocational middle 11% 49%
school
0%

Source: DİE, 2004

 7% of total employment  Share of unregistered workers

illiterate, 52% literate/not decrease significantly with
graduate or primary school higher educational level
graduate
21
Unregistered Work in Turkey – Size
 Relationship b/w Occupation & Educational Level
People with low education People with high education
tend to work in tend to work in

Occupations with Occupations with

• low degree of • high degree of

sophistication sophistication
• high share of unregistered • low share of unregistered
work work

 e.g. 58,8% of “primary school  e.g. 55,9% of university

graduates or less” work as graduates work as scientific,
farmers with 91,2 % technical or own-account
unregistered share workers with 11,4%
unregistered share

22
Unregistered Economy in Turkey - Cost
 High public cost of unregistered economy

 Recent estimates & comparable figures (2003)

23
 UNREGISTERED ECONOMY
 General Information
 Size of Unregistered Economy and Work
 Causes & Determinants
 Adverse Effects

 SUGGESTIONS

24
Actor-Factor Relationship

25
 Causes & Determinants of Unregistered Economy

INSTITUTIONAL ECONOMIC SOCIAL

 Tax and social  Market related factors  Cultural factors
security burden
Production  Geographic and
 Bureaucracy and Sales demographic factors
legal structure Distribution
 Role of the State
 Firm size
 Enforcement and
control  Globalization
 Income level and
 Underdeveloped
distribution
institutional structure
(complicated legal  Macroeconomic factors
and weak financial
 FDI
system)

26
Institutional Factors

27
Institutional – Tax and Social Security Burden
 Relationship b/w unregistered economy and tax &
social security costs (OECD countries)
30,0 GRE
Unregistered Economy (% GDP)

İTA
25,0
SPA
BEL
20,0 NO R DAN
SWD
CAN IRE
15,0 UK
FRA
GER NET
10,0 USA
SWT
AUS
5,0

0,0
30,0 40,0 50,0 60,0 70,0 80,0 90,0
Total Tax and Social Security Liabilities (% )

Source: Schneider, 2002

28
Institutional – Tax and Social Security Burden
 Tax wedge in OECD countries (2003)
50

45 42,7
41,5 41,2
39,0
40
36,8 36,2
35,6 34,9 34,3
35 32,2 31,6 31,3
29,8
Tax Wedge (%)

29,5
30 28,8
27,8 27,2 26,6
23,8
25 23,0 22,5
20,7
20 18,0 17,7 17,2

15

10

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Source: OECD, 2004

 Highest tax wedge in Turkey among OECD countries

29
Institutional – Tax and Social Security Burden
 Tax income/GDP in selected aggregates (2002)
France 44,2%

EU 15 40,5%

OECD Europe 39,0%

Germany 36,2%

UK 35,9%

Turkey 33,2%

Source: OECD, 2003

30
 Institutional – Tax and Social Security Burden
 Breakdown by tax types in selected aggregates (2002)

5,4
15,8 20,5 16,1 15,0 17,8 18,6
Other taxes 29,2
30,7 25,4 17,6
31,9
46,8 32,7

Indirect taxes
63,8 65,4
52,0 54,3 56,8
46,8
37,4
Income tax&social
security payments Turkey UK OECD EU 15 France USA Germany
Average Average

Source: OECD, 2003

 Low share of income tax & social security payments and high
reliance on indirect taxes in Turkey
31
Institutional – Tax and Social Security Burden
 Taxpayers/Workforce (2002)

Turkey 9,3%
Extremely low ratio of taxpayer /workforce
Germany 71,8% in Turkey
(High level of unregistered work)
USA 90,3%

UK 98,3%
Failure to collect income taxes

France 123,7%

Reliance on indirect taxes

Source: OECD, 2003

32
Institutional – Tax and Social Security Burden
 Indirect taxes / total tax revenues in Turkey
65,1% 65,9%

58,0% 58,7%
57,1% 57,3%

52,9% 52,9%
51,2%
47,7%
46,2%
44,5%

92 93 94 95 96 97 98 99 00 01 02 03

Source: Ministry of Finance, 2004

 Increasing reliance on indirect taxes as income tax

collection fails because of unregistered work
33
Institutional – Tax and Social Security Burden
 Increasing reliance on indirect taxes causes VAT
evasion
 VAT evasion in 3 transaction types
 Registered on both ends
 Registered throughout the value chain
 Lowest level of evasion

 Unregistered on both ends

 Unregistered throughout the value chain
 #1 source of VAT evasion

 Unregistered on one end

 Some of the firms in the chain operate unregistered
 Can be detected by effective enforcement
34
Institutional - Bureaucracy
 Corruption

According to Bovi (2002)

(for 21 OECD countries)

 1st half of ’90s:
Strong correlation b/w corruption and unregistered economy

 2nd half of ’90s:

Despite higher taxes, less corruption and less unregistered
economy with more efficient bureaucracy

35
Institutional - Bureaucracy
 Virtuous cycle in taxation & bureaucracy

36
 Institutional - Bureaucracy
 Link b/w bureaucracy and unregistered economy

Source: Worldbank, 2004

37
Institutional - Bureaucracy
 Number of tax employees and penalties for selected
countries

Source: McKinsey, 2004

38
Transparency and Unregistered Economy
 Accountability and the rule of law in public institutions
is essential in battling with corruption
 In case of lack of accountability, malfunctioning
bureaucracy cannot battle with unregistered economy
 When companies do not comply with accountability
and rule of law, those factors enforcing registered
activity are ineffective
 Under lack of transparency, bureacracy and
inspection become ineffective thus relieving the
inspectory role of state upon individuals and
companies
 Lack of trasparency reinforces unreigstered economy

39
Transparency and Unregistered Economy
 Comparison of Schneider’s study on shares of
unregistered economy dated 2002 and Corruption
Perception Index* of Transparency International
(% of GDP

80
Oranı (% GSYİH)

70
60
Share of
Kayıt Dışılıkeconomy

50
unregistered
40
economy
30
Share of unregistered

decreases
20
with more
10
transparency
0
0 2 4 6 8 10 12
Şeffaflık
Transparency (Yolsuzluk
(Corruption Algı Endeksi)
perception Index)

* Higher values point more transparency

40
 Turkey and Transparency
 Turkey ranks, Uluslararası Şefffaflık Örgütü’nün
 60th out of 163 countries in 2006 Corruption Perception Index (Ranks
18th in terms of size of GDP*)
 27th out of 30 countries in 2006 Bribe Payers Index

of Transparency INternational

 Lack of accountability and deficiencies in the bureaucracy

creates a fertile environment for corruption while low education
level, lack of trade liberalisation and supressio of free press
boosts corruption

 Economic incompetitiveness is being tried to offset by non-

transparent ways of doing business
*IMF, World Economic Outlook Database, 2006 USD GDP ranking
41
Economic – Market Related
 Production
 Avoidance from high cost of production in registered economy
 Avoidance from regulation
 Concentration on labor intensive industries where enforcement
is more difficult
 Low sectoral concentration along with inefficient enforcement
drives unregistered activity
 Unregistered activity decreases with higher level of technical
sophistication in production and initial investment
 Higher traceability of input purchases from state providers or
legal imports lowers level of unregistered activity
 Unregistered activity is inversely proportional to the
development level of the production region
42
Economic – Market Related
 Sales
 To attain higher profit margins and/or sales volume by
avoiding costs of registered economy

 Distribution
 To create competitive edge against efficient and registered
distribution channels

 Corporate structure
 More institutional aspect may prevent unregistered activity

43
 Economic – Firm Size
Productivity per worker (USD)

47.452
As of 2000

33.101
27.696

20.682
18.376

5.947
% of total #
94,7% 3,3% 0,8% 0,4% 0,3% 0,4%
of firms

1-9 10-49 50-99 100-150 151-250 251-

Source: DİE, 2001

Size of firm (# of workers per firm)

 Unproductivitydue to scale forces small firms to go to

unregistered economy
44
Economic - Other
 Labor markets
To avoid high labor cost arising from labor unions
and collective bargaining
 Globalization
Global competitive conditions drives multinational
firms to shift to a flexible cost structure
 Macroeconomic causes
High inflation, unemployment, etc.
 Levels of FDI
 Income level and distribution

45
Social
 Cultural structure

 Geographic and demographic factors

 State-citizen relations

46
 UNREGISTERED ECONOMY
 General Information
 Size of Unregistered Economy and Work
 Causes & Determinants
 Adverse Effects

 SUGGESTIONS

47
Adverse Effects – Economic Impasses
 Vicious circle in taxation

Tax revenues
lost Tax rate
increase

Increase in
unregistered
economy

48
Adverse Effects – Economic Impasses
Low productivity – unregistered economy impass

“Scorpion” effect

O N
T I U
C A
“Contagion” effect

L I
P49
Adverse Effects – Economic Impasses
 Low productivity – unregistered economy impass
(cont’d)

(USD per worker, 2002

Source: OECD, 2004

50
Adverse Effects – Low FDI Levels
Share of Unregistered Economy (%GDP)

30
aaaaaa

51
Adverse Effects – Social Costs
 Workers’ inability to utilize legal and social protection
 Lack of access to social security system
 Deteriorationg working conditions – job security, working
hours, fringe benefits
 Lack of access to financial system

 Low quality and non-hygenic products

 Erosion in the tax-payer mentality and tax ethics of
corporations and individuals

52
 UNREGISTERED ECONOMY
 General Information
 Size of Unregistered Economy and Work
 Adverse Effects
 Causes & Determinants

 SUGGESTIONS

53
Road-Map to Stop Unregistered Economy
 General observations
 Needs to identify root causes of informality
 Institutional
 Economic
 Social
 Without tackling root causes, no permanent solution is
possible
 There are no standard recipes (sector-specific, tailor-made
solution based on production, distribution and sales)

54
Road-Map to Stop Unregistered Economy
 Main observations
 Multi-dimensional approach is a must (one-dimensional
focus doomed to failure)
 Strengthening of trust in government and government
institutions is recommended
 Connection b/w taxes and benefits must be made clearly
visible

55
Four-Pillar Road-Map
 Changing the system
(remove incentives to go unregistered)
 Reduction of administrative burden
 Tax reduction and revision
 Creation of new legal entities

 Enhancing access to registered economy

 Financialsupport for business start-ups
 Supporting small businesses

56
Four-Pillar Road-Map
 Enforcing the system
 Increased control by tax and labor market authorities
through
 Co-operation of authorities
 Strengthening existing controlling bodies
 New controlling bodies
 Changing attitudes and behavior
 Launching public awareness campaign
 Explaining the risk of going unregistered

57
Four-Pillar Road-Map
 Restructuring the Social Attitude
 Sociological factors and dynamics triggering unregistered
economy should be examined to arrive at tailor-made
solutions
 Credit card usage should be motivated
 A specialized call center for informing unregistered activity
should be established
 Informative campaigns must be made in order to
emphasize the link between tax revenues and high quality
social services and to motivate a culture towards tax
payment responsibility

58
Conclusion
 Unregistered economy has so complicated dynamics
that it cannot be fought through single dimension
symptomatic measures
 A collaborative master plan with a long horizon should
be designed

59