Is Unofficial Economy a Source of Corruption?

This paper discusses the link between unofficial economy and overall economic efficiency. Special emphasis is put on tax evasion and corruption and their interaction with unofficial economy. First, we address the role of the state in the genesis of unofficial economy and corruption. Second part gives more insight into the multitude and ambiguity of definitions used to describe unofficial economy and the impact of the particular definition chosen on the final conclusions. Since we opt for the 'classical' definition of unofficial economy as unrecorded economic activity, we argue that unofficial economy in transition countries, according to this definition, does not hurt economic efficiency and growth. It is also important to make a distinction between unofficial economy and tax evasion as well as between unofficial economy and corruption. We give an argument in support of the view that those kind of activities are closer linked with official than unofficial economy, as the former uses them as a mechanism for protection from the competition. Unlike unofficial economy, these irregular activities pose more serious threat to general welfare, economic efficiency and growth. We conclude that both unofficial economy and irregular activities are caused by high degree of politicisation and reducing it gives positive impact in reducing both. In the final part we address the measures required and a policy design which could help preventing irregular activities. This would not completely eliminate unofficial economy, but would remove activities which impair economic efficiency and growth.