Implications of the underground economy on current

Economy October 14, 2015 01:00

By Tongyai Iyavarakul
Lecturer

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For those of you who are not originally from Thailand like I am, can you summarise Thailand, or more specifically Bangkok, in one word? Interestingly enough, a list of terms that best describe Bangkok is given by the official tourism promotion website of



Indeed, a lot of things in Bangkok seem frenetic: Taxi drivers who don’t use the meter when a farang gets in, vendors of everything you can think of along the street, counterfeit products, and erotic dancers at Patpong. All these frenetic activities are examples of activities in the underground economy in Bangkok and, ironically, they are literally everywhere on the ground.

The underground economy, sometimes referred to as the shadow or the informal economy, is commonly defined as all “market-based production of goods and services that currently escape the official calculation of gross domestic product”. The term underground economy is rather broad and includes all kinds of legal and illegal activities, ranging from openly selling foods on the street to secretly trading illicit drugs in dark corners. The importance and the implications of the underground economy to policymakers are in fact not trivial.

First, the size of the underground economy is indicative of the part of the economy that wants to escape the formal sector. This could be for various reasons including the high tax rate imposed on commodities in the formal sector, or cumbersome procedures one must go through to get a licence to operate a business.

Second, a large undetected underground economy can hide important economic and social statistics, such as unemployment, crime rates, or even growth rates, as well as potential sources of government revenue.

Third, there is a close linkage between the formal and informal sectors. A prospering underground economy while the formal sector is withering may attract resources from the formal economy to the informal one.

Measuring the size of an underground economy has been a challenging task that economists have attempted for decades. Various methods have been proposed. A direct method is to use surveys, while indirect methods range from measuring the discrepancies between official and actual statistics such as labour force, estimations based on currency and electricity demand, to complicated statistical modelling. Although different methods provide different estimates, the ranking of countries in terms of the size of their underground economy remains relatively robust.

The causes of the growth of the underground economy are also of interest to many economists. Major causes discussed in the literature include heavy tax burdens and social-security contributions, heavy regulation in the labour market, high penalties for tax evasion, and lack of trust in public institutions.

In light of the major tax reform that the current government is initiating, the substantial size of the underground economy in Thailand gives a number of reasons the reform must be carefully done.

First, the reform may create a misallocation of resources between the formal and informal sectors. For example, an entrepreneur who is contemplating starting up a diner with a proper licence may decide to go underground if, say, a rise in the value-added-tax rate substantially increases his costs.

Second, the reform is unfair, as those who conform to the rules – the taxpayers – are punished.

Third, a shift in resources from the formal to the informal sector may fuel other social problems such as crime.

My opinion is that while tax reform is appropriate, it should come after a number of other reforms, such as attempts to incorporate those in the underground economy into the formal economy rather than pushing those on the ground to go underground.

Perhaps it is also time to consider again whether the decriminalisation of illegal activities that are obviously everywhere, such as prostitution and the consumption of soft drugs like marijuana and kratom, is appropriate in Thailand.

And last but not least, higher tax compliance can be achieved by ensuring the public that the government is more transparent and less corrupt. This would at least show the taxpayers what their money is spent on.

Tongyai Iyavarakul PhD is a lecturer at the School of Development Economics, National Institute of Development Administration. He can be reached at tongyai@gmail.com.