Category: Economics

The Shadow EconomyThe Shadow Economy

QUESTION: The journal has approached this particular publication on Shadow Economies in an effort to explore the socioeconomic aspects of the subject. General themes have emerged that reveal instances of economic imbalances stemming from political, legislative and commercial action that enriches some and impoverishes others. These implications of shadow economies, which is in many cases a marginalization of the masses, relate to much of your work on the politics of power and justice among nations and people.

CHOMSKY: In everything I have read about it, there are properties that are rather common in discussing this topic. Whether we are discussing terrorism or crime or anything else, there is a strong tendency in the literature to focus on what you might call the retail rather than the wholesale aspects. In the case of criminal activities, for example, on terrorist activities of the weak rather than terrorist activities of the strong. And I think that the same is true in discussion of the shadow economy.

There are overwhelming elements of non-informal economies that are not discussed much. Tax havens for example, are probably a substantial element of the international economy. But these elements of “informal economies” are part of the world of the strong and privileged, so not very much is known about them. They are not the focus of a great deal of attention and investigation, like drugs. In fact there are major factors in the drug system that are much too little discussed, such as the reasons why peasant farmers turn to coca production. They are being driven to it by the very politics that the powerful states advocate. For example, if you try to drive peasants to agro-export and you undercut the conditions for production for local markets by massive imports, and also establish conditions under which export of major commodities undergoes sharp price fluctuations, then peasants will not have many choices. They are likely to turn to production of commodities for which there is always demand. And that has happened. Colombia is a good case. Colombia had, and has, possibilities for non-drug agricultural production, but they have very substantially been undercut by external intervention. One of the more important cases involves efforts to stabilize commodity prices. For large-scale agribusiness it is not all that important if prices oscillate. But if you are a small peasant farmer, you cannot say, “I am not going to feed my children next year because the price is too low.” Prices have to be stable if you want to be a small coffee producer.

There were Third World efforts to introduce commodity stabilization, but they were simply undercut by the rich countries. The United Nations Conference on Trade and Development (UNCTAD), in a core part of what was called “the new international economic order” back in the early 1970s, tried in one of its first major efforts to introduce measures to stabilize commodity prices. This would be analogous on an international scale to the ways every rich country stabilizes agricultural prices internally — by market interventions. The rich countries would not allow it — primarily the United States. That drives peasants away from coffee production.

Take Food for Peace Aid. In Colombia back in the 1950s, it sounded like a nice idea, except that it undercut domestic wheat production. So that eliminates another possibility. Once various possibilities are cut away and massive state terror is introduced — which happened, in no small measure from US initiatives to prevent efforts to ameliorate deplorable socioeconomic conditions — you end up with the drug culture. Those are massive factors in drug production, but they are not the ones that are being addressed in policy or much discussed, outside of specialist literature. The current drug war is not aimed at stabilizing commodity prices for coffee production, just to take one example of many. In fact even support for alternative crops is a very marginal aspect. Judging by the programs that are not on the agenda, the real motives can hardly be the professed ones, for many reasons.

QUESTION: How does the consumer and corporate power of wealthy nations contribute to shadow economies around the globe?

CHOMSKY: What I just mentioned was a case in point. That is not consumer power, it is corporate power. When the United States and other rich countries undermine the efforts by the G77 group of countries to work through UNCTAD to develop commodity stabilization programs, which would allow small peasant production, that is corporate power having a huge effect on shadow economies. But it is also much bigger than that. Take tax havens again. Nobody knows the scale of their use because it has not been studied much, but chances are that tax havens are a major factor in the international economy; probably well beyond drug money laundering, as pointed out by political economist Susan Strange in her most recent book.

In fact, even the gross statistics, which as far as I know have not been much investigated, reveal what appear to be significant effects of these devices. The Commerce Department publishes detailed quarterly reports on Foreign Direct Investment (FDI). Out of curiosity, I was reading them regularly during the recent period of enthusiasm about “new emerging markets” in Latin America. For the Western Hemisphere (excluding Canada), roughly 25 percent of FDI was regularly going to Bermuda, maybe 10 or 15 percent to the British Caribbean Islands and roughly 10 percent to Panama. This reflects one aspect of corporate power: about half of FDI was going to what a benign view might consider as tax havens. The less benign view would be that the category of FDI covers methods for laundering criminal money — drug money or something else. But it is certainly not building steel mills. They do not do that in Bermuda or the Cayman Islands.

Fifty percent is not a small number. That is a big part of the economy. During this period of enthusiasm about emerging Latin American markets and the importance of FDI, I did not find a single paper in the professional literature that even talked about these points (although they were discussed by Doug Henwood in his invaluable journal, Left Business Observer). Perhaps there were papers — I do not know the technical literature that well — but I could not find them. Certainly there must be specialists who know a lot about it, but compared with the problems of the shadow economy that are discussed, this one seems substantial. So, that appears to be a case in which corporate activities are having a significant effect on the international economy, within “shadow economies” — violating the rules. Of course, wherever this money is, it is redistributing wealth, income and power upward, toward the richest sectors, apart from the effects it has everywhere else. The World Trade Organization recently ruled against the United States for permitting corporate use of what amount to tax havens as a technique of export subsidy. That apparently is a small fraction of this behavior on a global scale.

QUESTION: Is the shadow economy today the same as it has always been? Or, is it taking on new characteristics and evolving with globalization?

CHOMSKY: Globalization is a phenomenon that is new in some respects but quite old in others. As many have pointed out, by gross measures the global economy is not much different from what it was before: the First World War. Upon closer look, however, there are important differences. For example, the scale of speculative financial flows and short-term financial flows, is astronomically beyond anything it has ever been before. The distribution of production around the world, mostly administered by international enterprises, is also sharply different.

I think Barry Eichengreen pointed out one of the most striking differences. He was not really talking about this, but there are implications about it in his history of modern financial systems. He pointed out that in the late 19th century, economic decision-making had not yet been “politicized” by the rise of parliamentary labor parties, unions and universal male suffrage. The general public could be more or less excluded from decision-making. As a result, the costs of financial rectitude — keeping currencies stable and so on — could be simply imposed on the population. It was possible to have a situation where there would be no special constraints on capital flow and yet, still have a relatively stable economy.

By the 1940s, things had changed. There were unions, parliamentary labor parties and, in principle, large-scale suffrage. In order to compensate for this politicization of decision-making — meaning the public has a voice — it was necessary to institute capital controls and relatively fixed exchange rates. The luxury of imposing the costs on a defenseless public was no longer available, as it still is in the Third World through structural adjustment programs and other devices. The Bretton Woods system instituted regulated currencies and the option of capital controls to compensate for the inability to impose the costs on the population, as before.

There is a corollary relating to what is now called “globalization.” Since the mid 1970s, we have seen a system in which exchange rates float and limitations on capital flow have eroded. Following the same reasoning as before, we would expect a significant impact on popular sovereignty, on the ability of people to participate in economic decision-making through government economic management and social policies. These are options that erode under the threat of capital flight and attacks on currencies — under the “veto power” of the “virtual parliament,” as the process is sometimes called. That has happened, noticeably. There also has been a slow-down in growth and deterioration of other macroeconomic indicators. This is called “globalization,” but it is a particular form of integration of international society.

The particular form of globalization that has been imposed has specific consequences. It is not a matter of simply increasing interactions among countries; rather, of doing so in a particular fashion that happens to be geared to rights of investors and lenders, and concentrated private power generally, supported by the most powerful states and the international bureaucracies they have established. These are particular modes of “globalization” that are, in basic respects, incompatible with popular sovereignty in socioeconomic decision-making and with social programs concerned for the welfare of the general population; not maximization of profit and market control. Popular sovereignty is undercut by the focus on maximization of profit and control and financial liberalization that is a core element of contemporary “globalization.”

The same is true of the distribution of production, which enables a lot of so-called trade really to be interactions that are internally or centrally managed within a basically totalitarian structure. We call it trade, but certainly a large proportion of it is centrally managed. It is not trade in any serious sense. I think economist Jeffrey Sachs is on target in calling these facts about cross-border flows “stunning.”

A common estimate — it is really a guess, since there is little careful investigation — is that roughly 40 percent of cross-border transfers are intra-firm, and that leaves out a significant amount. Outsourcing, for example, is in essence centrally managed. And if we were to count in the effects of strategic alliances we would find that, according to some estimates, 70 percent of world trade is in substantial degree centrally managed. That is a particular form of administration of markets by highly centralized systems that have various strategic alliances with one another and rely very heavily on powerful states to socialize cost and risk. It is one kind of globalization, with specific effects. But you cannot call that in itself “globalization;” it is one particular form of the design of international integration in the interests of corporate power. It tends to marginalize large numbers of people, which tends to lead to what are called shadow or informal economies. These terms are used for people bartering without paying taxes, but not for the massive use of tax havens to shift the burden to the general population and away from the rich, along with all of the other effects that it has on economies. I think that one has to be careful about these terms.

QUESTION: Frequently, terms having negative connotations are used in reference to informal economic activity — words such as shadow, gray, underground and black market. Do you feel that these are appropriate for understanding the dynamics of informal economies?

CHOMSKY: Yes, if you want to understand them, sure. Every social system, whether it is a family or an international economy, has some kind of norms. If it is an organized system, like states, the norms turn out to be enforceable rules. Sometimes they are backed by state force, or other forms such as Mafia force. If we consider the rules that are more or less codified in the state and interstate systems, economic behavior that does not conform to those rules could be called a “shadow economy.” The major component of that is activities such as tax evasion on the part of major corporations or money laundering, and so on. But since these are the prerogative of the powerful, they are not what are usually meant in discussion of “shadow economy.”

There are other aspects of interactions that violate rules and norms, which are carried out by the poor. That is what is commonly called the “shadow economy.” But if we are to be clear about it, they are all violations of the norms and rules, and those norms and rules themselves are designed in the interests of the powerful.

I think it is a good analytic tool, but we should use it without bias; that is, without a bias that leans away from the rich and powerful and towards the poor and defenseless. Which is not only true here; as I mentioned, it is true in other domains too. Take crime. Every criminologist knows that corporate crime — white-collar crime — is enormous in scale, and well beyond street crime in scale and effects. Since nobody really studies it in close detail, we do not have reliable numbers, but probably in orders of magnitude the numbers that are given in in any criminology texts are more or less accurate. According to some estimates, property crime carried out by corporations is maybe on the order of five hundred times as high as street property crimes. It is hard to count killings because we do not know how many of the worker-related deaths to attribute to willful negligence or violations of Occupational Safety and Health Administration (OSHA) regulations, but the numbers are surely high. It probably overwhelms the number of street killings.

The US is roughly similar to other industrial societies in level of crime, but it is quite different in terms of fear of crime and punishment of crime. That has been dramatically so since the onset of “globalization.” The US is, by now, off the spectrum in both of those respects. If we look at punishment, we find that it is not directed at those who are involved in major crime, but at those who carry out retail crime. In fact by now many of them are not involved in crime at all, except by newly-devised standards that criminalize certain victimless activities — typically those carried out by the poor, the “dangerous classes” as they have been called. The whole culture, the political and social culture of fear of crime, and harsh punishment of crime — both unusually high by comparative standards during the “globalization” era –focuses on the weak and defenseless, not on the rich and powerful, who are responsible for most of it.

I think we see a similar phenomenon when we talk about the shadow economy. It is not that the topics discussed are not important, they are. If we take a country like India, rough estimates are that the black economy may be one-and-a-half times the size of the formal economy, maybe more, so it is not small. On the other hand, what is called the black economy very often is not considering the fact that a multinational corporation has its corporate base in the Caribbean islands or Mauritius.