A growing underworld bazaar

Amid the recession, an unregulated marketplace worth $1.4 trillion undermines the economy -- and everyone's future

Published September 29, 2011 11:45AM (EDT)

Day laborers sit in a parking lot in Phoenix.  (AP/Matt York)
Day laborers sit in a parking lot in Phoenix. (AP/Matt York)

A day laborer waiting on a street corner for a morning's worth of work hacking brush. A sweatshop employer paying less than minimum wage and skimping on overtime. A woman running a day care center out of her apartment. Drug dealers, sex workers, unlicensed street food vendors. A plumber who deals only in cash or a farmer who trades food for help with the harvest.

What do they all have in common? They're part of the "shadow economy." Also known as: the underground economy. Pick an adjective, any adjective: informal, gray, black market, under-the-table, hidden, unobserved. There are many different names for the realm where taxes aren't paid, labor laws are ignored, and cash is king. But on at least one point most observers agree: the shadow economy -- in the U.S. and abroad -- is growing. And that's not healthy. In a shadow economy, workers are often unsafe and ruthlessly exploited, while governments are deprived of crucial revenue -- yet still forced to foot the bill for essential services.

In an era of seemingly permanent high unemployment -- what some call the "new normal" -- the shadow economy is where people end up after having been downsized or forced out of their homes or displaced by globalization. And while the shadow economy does offer opportunities for survival -- and even a modicum of upward mobility -- for desperate people in desperate times, it's also proof that capitalism as we know it just isn't working. Once upon a time, underground economies were seen as a problem for developing nations that hadn't figured out either democracy or how to manage an economy. But now, increasingly, the shadow economy is a developed world problem -- contributing to a growing disenchantment with the political process, and a growing sense that workers are on their own, scrambling for ever smaller pieces of pie at the bottom while those on the top consolidate their gains.

Both the shadow economy's size and speed of growth, however, are uncertain. When a sector of the economy's essential attribute is that it doesn't show up in the numbers collected by government or reported by employers, we're dealing, right off the bat, with an entity that is fundamentally hard to quantify. We don't even know, for sure, what the impact of the Great Recession has been on the shadow economy in the U.S. High unemployment has clearly forced workers to do whatever they can to get by, but it has also resulted in a stark decline in illegal immigration -- which, in the past, has been considered one of the biggest contributing factors to the growth of the shadow economy.

But most of all, we don't know exactly why the shadow economy is growing. On the one hand, conservatives and libertarians see the rise of underground economies as a necessary (and justified) response to high taxes and excessive regulation. The bigger the heavy hand of government, the harder people -- both workers and employers -- will try to escape. The "coercive power of the state," as Friedrich Hayek liked to say, is the enemy of true liberty.

Progressives and labor organizers have a diametrically opposed view: Globalization and deregulation have smashed the traditional employer-employee relationship, they say. In the dog-eat-dog world of global competition, the rules on the books are no longer being enforced and workers everywhere are getting squeezed. That construction worker willing to cut you a discount if you pay cash for your new porch is in part responding to pressures exerted by China and the global triumph of capital over labor. That shantytown bike mechanic hasn't been liberated from the state; he's been cut off from true participation in an economy that will allow him to prosper.

As Peru's Hernando de Soto, one of the first economists to truly appreciate the importance of the shadow economy, has emphasized repeatedly, the real challenge isn't necessarily to remove regulations, but to find ways to legitimize what's already happening, to make it easier for the dispossessed to move out of the shadows.

Watching Washington politicians demagogue about deficits and job creation while they drown the nation in endless partisan squabbling isn't getting us any closer to understanding what's really pushing the growth of the underground economy -- or pointing us towards a possible solution. Horse-race coverage of the latest government shutdown idiocy seems less and less connected to the everyday challenges of everyday lives. "We have to wake up to the world that we live in," says Martha Chen, a lecturer in public policy at Harvard's Kennedy School of Government who has studied the informal economy.

And that means paying attention to the street. So today, Salon, in partnership with New America Media, is launching a new series, "Inside the Shadow Economy." The first goal is to get a closer look at the people who make up the shadow economy. Their stories, their lives, will help illustrate some of the larger questions -- why and how this is all happening.

Beyond that, the greater challenge is to figure out what we can do about it. Resurrecting the power of labor in a globalized world is a monumental task -- it is decidedly unclear whether any single nation can do it on its own. But organizing a global worker's movement seems an equally quixotic enterprise. Refocusing government on the dire situation on the ground will require grass roots pressure and the smashing of outdated partisan paradigms. Finding ways to legitimatize the shadow economy while protecting workers from abuses may even demand that the developed world take some lessons from the experience of emerging nations. With economic growth sagging everywhere, it's going to be an uphill battle. But that doesn't mean we should stop looking for solutions, and we'll be exploring potential paths forward in this series.

Because if there's one thing that the stories of the shadow economy do tell us, it's that no matter how dire the situation, people will find a way to make it through the day. Change does happen. It might come from the street, instead of Washington, and it may need encouragement, instead of scorn. But disenfranchised will, eventually, find their voice. The sooner we hear it, and act, the better off we'll all be.

What is the shadow economy?

The standard estimate of the current size of the shadow economy in the United States ranges from around 8-10 percent of total GDP -- in 2010, an amount equal to around $1.4 trillion. In California alone, lawmakers are quick to cite numbers that place the underground economy at anywhere between $60 billion and $150 billion. But the critical issue isn't the overall size, but instead the rate of growth. One influential measurer of the underground economy, Austrian researcher Friedrich Schneider, pegged the U.S. shadow economy at 4 percent of GDP in 1970 and 9 percent in 2000. Others have concluded that the informal economy has been growing at a rate of 5 to 6 percent a year since the early 1990s -- faster than the "regular" economy.

Schneider is one of the more vocal advocates of the view that the size of the shadow economy is correlated with levels of taxation and regulation: "Countries with relatively low tax rates," he writes, "fewer laws and regulations, and a well-established rule of law tend to have smaller shadow economies."

But that doesn't quite jibe with historical trends in the U.S. over the past few decades, observes Pascale Joassart, a professor of geography at San Diego State and the co-author of a groundbreaking study of the growth of the "informal economy" in Los Angeles.

"The informal economy is growing," says Joassart, "but in the last 20 years, our economy has been deregulated and marginal taxation rates have gone down."

What's really going on, says Joassart, is that there has been "a restructuring of the economy which, in order to promote flexibility and global competitiveness, has led to greater reliance on part-time and contingent labor."

"This includes a large informal sector made up primarily of lower-skilled workers who are required to work (such as former welfare recipients) and immigrants who have limited protections," she says. "I would argue that it is a deregulation of the economy, including a decline in welfare programs and an increase in free trade and global competition, that has led to an increase in informal work in industrialized nations."

That deregulation, says Sara Flocks, policy director at the California Federation of Labor, goes hand in hand with a failure to enforce the labor laws currently on the books. Flocks acknowledges that one driving force in the growth of the shadow economy has been the desire of employers to avoid profit-cramping requirements like worker's comp, payroll taxes, minimum wages and overtime. But the difference now is that employers can easily get away with doing so, because no one is minding the store.

A study conducted by UCLA researchers in 2010, "Wage Theft and Workplace Violations in Los Angeles," reported that between "1980 and 2007, the number of minimum wage and overtime inspectors declined by 31 percent."

"And that's while the labor force is growing," says Flocks. "The labor force grew by 52 percent but enforcement has declined by 31 percent."

"The underground economy has always existed," adds Flocks, "and has always preyed on the most vulnerable workers -- immigrants, women, young people, and now increasingly seniors. But what's different now is that there has been a real erosion of the traditional employer-employee relationship. Employers are much more mobile and are using many different tools to make sure that they don't actually directly employ workers."

A selection from the wage theft study makes the point in even stronger terms:

Today, at the start of the twenty-first century, the nation is facing a workplace enforcement crisis, with widespread violations of many long established legal standards. The crisis involves laws dating back to the New Deal era that require employers to pay most workers at least the minimum wage and time-and-a-half for overtime hours and that guarantee employees' right to organize and bring complaints about working conditions. Also violated frequently are more recently established laws that were designed to protect workers' health and safety, laws that require employers to carry workers' compensation insurance in case of on-the-job injury, and laws that prohibit discrimination on the basis of age, race, religion, national origin, gender, sexual orientation, or disability.

High unemployment, unsurprisingly, has also been correlated with a larger informal economy. But what's interesting, says Joassart, is that in the past, the informal economy rose and fell in a cyclical pattern. In a recession, the informal economy would grow, but when the economy returned to health, it would decline. That pattern is no longer visible. Since 1990, the shadow economy keeps growing, irrespective of what's happening in the business cycle.

Welcome to the 21st century! The bottom line: Globalization has substantially shifted the relative power of labor and capital.

"What you have had is a huge labor injection of labor from China and India and all of that," says Martha Chen, "and you haven't had a commensurate injection of capital. So the labor-to-capital ratio is at a point where capital is really in the driver seat."

That's the ideological mathematics that explains both "the new normal" and the shadow economy.

When capital is in the driver's seat, government is no longer enforcing labor laws, and unemployment is high, workers have no leverage. Opportunities for jobs with benefits and good pay decrease, and everyone is forced to scramble for whatever is available. Increasingly, that means work that is completely outside the regulated sector. Work that is found in the shadow economy.

More: Dispatches from the shadow economy: An escort's story.

By Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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Economics Inside The Shadow Economy