An "Unofficial" Analysis Of Economies In Transition An Empirical Framework And Lessons For Policy

We challenge the conventional view of how post-socialist economies function by incorporating the unofficial economy into the analysis of the overall economy. The interpretation of the dynamics of transition is then seen to differ. A simple framework for understanding the evolution of the unofficial economy--and the linkages between both economies—is advanced. It highlights the main characteristics of "unofficialdom," contrasting conventional notions of "informal" or "shadow" economies, and also focusses on the determinants of the decision to cross-over from one segment of the economy to the other. The empirical evidence, based both on micro-surveys as well as on a top-down ("macro-electric") comparative country methodology, suggests the potential usefulness of the overall framework. Integrating the unofficial economy into the study of the overall economy matters analytically and empirically. For instance, the interpretation of national income, of sectoral trends (such as trade, services, and exports), and of labor markets and household patterns take on an additional dimension, often leading to results that differ from analysis in which the unofficial economy is ignored. By the mid-nineties the Former Soviet counties are estimated to have over one-third of their activity in the unofficial economy, while in Central and Eastern Europe the average is close to one-quarter. Intra-regional variance is large, with some countries having 10-15% of their economy engaged in unofficial activity while others exceed 50%. The growth of unofficial activities in most post-socialist countries, and its mitigating effect on the decline in official output during the early stages of transition, have been marked. Although the preliminary nature of this investigation ought to be underscored, the cross-country empirical results appear to be broadly consistent with the hypothesized determinants of the unofficial economy dynamics. In particular, fast market liberalization, macro-stability and institution of a stable and moderate tax regime is emphasized. While widespread, most of "unofficialdom" in the region is found to be relatively shallow, i.e., subject to reversal by appropriate economic policies. The simple framework and evidence presented have implications for measurement and forecasting, and for policy-making. The lessons for policy (such as in social protection and taxation) are found to differ from conventional advice given. In other areas, such as liberalization and privatization, even faster reforms than often advocated are called for.