The $2 trillion shadow economy is the recession’s big winner

April 23, 2013

In this week's New Yorker, James Surowiecki considers one theory for the recent and drastic decline in the U.S. labor force. More and more Americans might be working off the books, in informal jobs that aren't counted by statistical agencies:


Psst, want a job?

Bernard Baumohl, an economist at the Economic Outlook Group, estimates that, based on historical patterns, current retail sales are actually what you’d expect if the unemployment rate were around five or six per cent, rather than the 7.6 per cent we’re stuck with. The difference, he argues, probably reflects workers migrating into the shadow economy.

“It’s typical that during recessions people work on the side while collecting unemployment,” Baumohl told me. “But the severity of the recession and the profound weakness of this recovery may mean that a lot more people have entered the underground economy, and have had to stay there longer.”

This "underground economy" could include anything from illicit activities — selling drugs, say — to off-the-books jobs in things like construction. There are plenty of examples of the latter: Bloomberg recently interviewed an unemployed woman who walks neighborhood children to their bus for $2 per kid. Surowiecki cites a study finding that "between eighty and ninety-seven per cent of nannies were paid under the table." And so on.

But those are anecdotes. Is there any hard data on the underground economy? Some. A 2011 paper (pdf) Richard Cebula and Edgar Feige estimated that as much as “18-19 percent of total reportable income is not properly reported to the IRS." That's as much as $2 trillion in underground economic activity, with about $500 billion in taxes that aren't being paid to the government.

And here's another suggestive piece of evidence that the shadow economy has been growing during the downturn. The amount of U.S. currency in circulation has been soaring in the last six years, from $803 billion in 2007 to $1.18 trillion in March. Some of that reflects growing overseas demand for dollars. But some of it could reflect growth in unreported economic activity in the United States — people getting paid under the table in cash, say.

If the shadow economy is in fact growing, that has upsides and downsides. It's certainly a good thing that people are finding ways to survive during a brutal downturn. But it's yet another sign that the formal economy is utterly failing to create enough jobs for everyone.

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Ezra Klein | April 23, 2013