Shadow economy: To legalise or to tolerate?

In many countries, and especially developing ones, illegal enterprises create a significant share of the gross product. The article studies possible directions of the state policy on the shadow economy, as well as the justification of such measures. The research methodology rests on a comparative analysis of approaches to the understanding of shadow economy within the framework of the modernisation theory and the new institutional theory. The paper applies the case study method to analyse various measures to combat the informal sector and contrast their efficiency. The study demonstrates that the approach that considers the shadow economy as an obstacle to economic development originates from the modernisation theory and does not reflect the recently discovered reasons why firms operate outside the legal system. Moreover, in some cases, a specialised policy aimed at stimulating legalisation may lead to the withdrawal of shadow business from the economy and an increase in the unemployment rate. Based on foreign experience, the article highlights two main public strategies to push business towards legalisation: the ‘cleansing strategy’, which implies driving up the costs of being in the shadows, and the ‘reconciliation strategy’, which entails reducing the costs of functioning in the legal field. The practice evidences that it is the ‘cleansing strategy’ that leads to negative consequences for the economy, which do not arise in the case of the ‘reconciliation strategy’. At the same time, the simplification of doing business in the country impacts only moderately on the size of the shadow sector, which is due to the limited possibilities of the policies of this kind and specific incentives for shadow entrepreneurs. The paper concludes that the ‘reconciliation strategy’ would be a more optimal strategy for reducing the shadow sector in the least developed regions of Russia.