ShadEconomyCorruption_short.

ppt

Prof. Dr. Dr.h.c.mult. Friedrich Schneider E-mail: friedrich.schneider@jku.at

Department of Economics Phone: 0043-732-2468-8210
Johannes Kepler University of Linz Fax: 0043-732-2468-8209
A-4040 Linz-Auhof http://www.econ.jku.at

Corruption and Shadow

Economies: Some New Results

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 1

 Outline

1 Introduction: Statements about Corruption

and the Shadow Economy
2 Some Theoretical Considerations about
Corruption and the Shadow Economy
3 Interactive Effects between Corruption and
the Shadow Economy
4 Summary and Conclusions

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 2

 1. Introduction
Statements about the Shadow Economy and Corruption
(1) Corruption as well as the shadow economy are „hot“
scientific and political topics around the world.
(2) Numerous political statements that corruption as
well as the shadow economy cause severe damages on
the „official“ economy.
(3) „Unfair“ (Ruineous) competition between the
enterpreneurs working in the shadow economy or
being corrupt and the ones working in the official
economy and being honest!
(4) Mostly only one common policy measure: increase
effective punishment to get rid of corruption and the
shadow economy.

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 3

 1. Introduction

(5) The World Bank estimates the size of corruption for

the year 2006 of 1,300 (approx. 1.4% of World GDP)
and in 2007 of 1,400 (approx. 1.5% of World GDP)
billion dollars.
(6) The average size of the shadow economy accounts for
39% (of official GDP) in the year 2006/07 in 86
developing countries and in 40% in 25 transition
countries and 14% in 21 highly developed OECD
countries.
(7) Aim of this presentation is an empirical investigation
about the importance and interaction of the shadow
economy and corruption.

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 4

 2. Some theoretical considerations about the
Shadow Economy and Corruption

2.1. Definition of Corruption

ƒ Corruption is commonly defined as the misuse of public

power for private benefit.
ƒ The term „private benefit“ relates to receiving money or
valuable assets.
ƒ „Public power“ is exercised by bureaucrats, appointed
to their office, and by politicians.
ƒ Corruption can also happen in large (private)
corporations/firms (e.g. in Germany Siemens, VW).

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 5

2. Some theoretical considerations about Corruption and the
Shadow Economy

2.2. The Definition of the Shadow Economy

(i) The shadow economy includes all legal production and provision
of goods and services that are deliberately concealed from
public authorities for the following four reasons:

(1) To avoid payment of income, value added or other taxes,

(2) To avoid payment of social security contributions,
(3) To avoid having to meet certain legal standards such as
minimum wages, maximum hours, safety standards, etc., and
(4) To avoid complying with certain administrative procedures,
such as completing statistical questionnaires or other
administrative forms.

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 6

 2. Some theoretical considerations about the
Shadow Economy and Corruption

2.2. The Definition of the Underground and Informal

Household Economy

(ii) Underground (classical crime) activities are all illegal actions

that fit the characteristics of classical crime activities like
burgarly, robbery, drug dealing, etc.
(iii) Informal household economy consists of household enterprises
that are not registered officially under various specific forms of
national legislation.
(iv) These two sectors ((ii) classical crime and (iii) household
production) are not included in the shadow economy activities.

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 7

 2. Some theoretical considerations about the
Shadow Economy and Corruption

Figure 2.2.1: The size of corruption – Corruption Index

(Transparency International), Year 2006

CPI 2006
9 bis 10 (8)
8 bis 9 (5)
7 bis 8 (7)
6 bis 7 (6)
5 bis 6 (8)
4 bis 5 (14)
3 bis 4 (19)
2 bis 3 (17)
1 bis 2 (6)
k.A. (126)

Source: Transparency International, Berlin 2007.

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 8

 2. Some theoretical considerations about the
Shadow Economy and Corruption
Figure 2.2.2: The size of the shadow economy (in % of GDP)
worldwide – Year 2006/07

in % des BIP
0 bis
15 bis 30
30 bis 45
45

Quelle: Schneider (2007)

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 9

 3. Interactive Effects between Corruption and the Shadow Economy

Corruption leads to

(1) lower investment with the consequences of lower GDP growth,

(2) misallocation of resources, especially of educated people →

again lower GDP growth,

(3) reduction of (foreign) aid flows, again lower GDP growth,

(4) loss of tax revenues → lower public infrastructure → lower

GDP growth, and

(5) lower quality of state institutions and less effective court and
police system.

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 10

 3. Interactive Effects between Corruption and the Shadow Economy

Hypotheses about the Interaction between Corruption and the Shadow Economy
Theoretically, corruption and the shadow economy can be either complements or
substitutes:
(1) The model of Dreher et. al (2004) and Rose-Ackermann (1997) show that
corruption and shadow economy are substitutes in the sense that the existence of
the shadow economy reduces the propensity of officials to demand grafts.
(2) To the contrary Johnson et al. (1997) and Thum (2005) model corruption and the
shadow economy as complements.
(3) Hindriks et al. (1998) also conclude that the shadow economy is a complement to
corruption, as the tax payer colludes with the inspector so that the inspector
underreports the tax liability of the tax payer in exchange for a bribe.
(4) Dreher and Schneider (2006) hypothesize:
Hypothesis 1: In low income countries, shadow economy activities and
corruption are complements.
Hypothesis 2: In high income countries, shadow economy activities and
corruption are substitutes.

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 11

 3. Interactive Effects between Corruption and the Shadow Economy

Table 3.1: Beta coefficients for OLS regressions of the Relationship between the Shadow
Economy and Corruption
Dependent Variable Shadow Economy Corruption
Independent Variable Corruption Shadow Economy
All High All Low High
ICRG index of corruption
Cross Section - - - - -0.47 (3.57***)
Panel, fixed effects 0.12 (2.63**) -0.10 (1.98**) 0.98 (2.88***) 1.32 (2.7***) -
Panel, random effects 0.10 (4.81***) - 0.16 (2.64***) - -
TI index of corruption
Cross Section - - - - -0.25 (2.35**)
World Bank Index of corruption
Cross Section - - - - -0.17 (2.76**)
DKM index corruption
Cross Section - - 0.29 (1.77*) 0.36 (2.49**) -

Notes:
* denotes significant at 10% level; ** significant at 5% level; *** significant at 1% level

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 12

 4. Summary and Conclusions

4.1 General

Finally to conclude – what do we really know?

(1) A shadow economy is a complex phenomenon, which is „present“
overall in the world with an average size of 34.3% of off. GDP for
145 countries (unweighted average) for 2004/2005.
(2) The worldwide extent of corruption was 1,000 bill.$ in 2004
(Kaufmann, World Bank, 2005).

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 13

 4. Summary and Conclusions

4.1 General (cont.)

(3) In summary there is empirival evidence that going underground is

an alternative preliminary to corruption in high income countries
(substitutive relationship) while corruption and the shadow economy
are complements in countries with low and middle income.
However, the results depend to some extent on how the regressions
are specified and how corruption is measured.

(4) Only if it is attractive to additionally engage in the official economy

and/or if corruption is strictly prosecuted, then, on the one hand,
shadow economy activities will be transferred into the official
economy, and on the other hand, it will be either too risky to be
corrupt or it will no longer be worthwhile.

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 14

 4. Summary and Conclusions

4.2 Conclusions for Austria

2005 2006 2007 2008

Damage caused by corruption 21 22 23 24
in billion Euro

This means that the GNP of Austria in the year 2007 would be 23
billion Euro higher in the absence of corruption.

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 15

 4. Summary and Conclusions

4.3 Conclusions for Germany

The damage due to corruption for the German Economy:

Year 2004 2005 2006 2007 Forecast 2008

Damage in bill. € 220 230 250 275 295

CPI 8,2 8,2 8,0 7,8 7,6 Æ Assumption:
Transparency Decrease of the CPI by
Index 0.2 percentage points;
i.e. an increase of
corruption

Source: Own calculations.

ƒ Without corruption the German GDP in 2007 would be higher by 275 bill. €.
ƒ The damage is primary caused by a decrease of productivity, increase of
bankrupty of “honest” firms, which did not get the contract due to
corruption.

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 16

 4. Summary and Conclusions

4.3 Conclusions for Germany

(1) If corruption could be reduced, e.g. by increasing the CPI (value 10

= no corruption and value 0 = highly corrupt country) to the value
2004 (up to 8.2), then the damage of the German economy would
be decreased by 25 bill. €. If corruption could be reduced to the
level of Switzerland (2007 Rank 7, value 9.0), the damage for the
German economy could be reduced by 48.0 bill. €.

(2) Measures to efficiently fight the shadow economy: transfer shadow

activities in the official one using incentive orientated policies.

(3) Measures to efficiently reduce corruption: strict laws and exclusion

of corrupt firms from public contracts for several years.

June 2008 © Prof. Dr. Friedrich Schneider, University of Linz / AUSTRIA 17