By Stephanie Jacob
In the first of a series of articles on the black economy, KiniBiz looks at what comprises this economy and tries to to get an idea of its size and value.
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In every economy, there is what is deemed as the formal economy and what is known as the informal economy. In a basic sense, the formal economy is what can be taxed and regulated and it is the basis of what is used to calculate a country’s gross domestic product (GDP – sum of goods and services produced) numbers.
The informal economy on the other hand, is what does not get captured in the official numbers and therefore is not accounted for in the estimation of GDP. It is neither taxed or regulated by the various government and regulatory agencies, which ultimately translates into a loss or revenue for the country.
What exactly is this informal economy?
According to KPMG Tax Services Sdn Bhd’s executive director Soh Lian Seng, there is no clear definition of what an informal economy is. He says that statistics are gathered usually depending on what particular aspect of the sector is being studied at the time, and this coupled with the difficulty of measuring hidden or illicit business activities makes its size or depth difficult to determine or value.
Also known as the unregulated or black economy, this area of the economy is fuelled by businesses that are both legal and illegal in nature – although technically, in the strictest sense the entire informal sector is illegal because its participants do not contribute in terms of taxes and rarely have the required licensing to be operating.
(For the purpose of this series of articles, we will differentiate the informal economy by dividing it into the legal segment and the illegal segment.)
A journal article published by Marliza Mohamed in the Malaysian Journal of Economic Studies, titled ‘Estimating the Underground Economy from the Tax Gap:The Case of Malaysia’ published in 2012 said that the unmeasured activities creates a gap between GDP and the potential economy, leading to the conceptualisation of a ‘second economy’ – or what we are calling the informal economy.
The journal article goes on to say that on the face of it, the informal economy may be seen as a positive thing as it creates employment and provides opportunities for the less fortunate or socially mobile; however it goes on to say these benefits are only short term and are outweighed by the long-term burden of socio-economic cost. Some of the negative impacts include inefficient goods and labour markets, distorted statistics, infringement of workers’ rights and loss of revenue from tax evasion – which collectively affect public finances and can create policy crises.
Who participates in the informal economy?
It might come as a surprise that many, if not all of us contribute to the informal sector either directly or indirectly; despite the fact that most of us pay our taxes and do not run unregistered businesses ourselves.
For example if you buy the latest DVD, you have just purchased a pirated copy of a copyrighted product; the same goes for that perfect replica Prada or Gucci bag you just got for a steal – both the DVD seller and the bag vendor are running illicit businesses that make up the illegal segment of the informal economy
Likewise if you are the betting type, and like to place stakes on sports activities with illegal bookies or online betting rings. In all of these instances, your money has been channelled into the illegal arm of the informal economy.
Of course these are the milder examples of the illicit activities, there are also the much graver trades like prostitution, human trafficking and drug pushing.
On the other hand you might contribute to the legal segment of the informal economy when hiring a foreign worker to do odd jobs around the house and settling the payment in cash; or getting an electrician to come and fix a wiring issue – if he does not have a registered business nor declares the payment to the Inland Revenue Board (IRB), you have contributed to the legal segment of the informal economy.
The same goes with babysitters, tuition teachers, and home and cottage industry owners who have not registered their businesses and do not file tax returns with the IRB.
The question is how much all this really adds up to, and if it is a significant sum or percentage that is going unaccounted for; while coming up with exact numbers is difficult there is data that shows that the informal economy in Malaysia is substantial.
For example in 2010, then home minister Hishammuddin Hussein said that the government believed that the illegal or illicit segment alone had grown to almost RM10 billion and included a slew of activities. More recently the country’s deputy finance minister, Ahmad Maslan was quoted in The Star Newspaper as saying that the country’s so called ‘black economy’ stood at 30% of GDP.
As for the legal segment a report commissioned by the Department of Statistics Malaysia in 2012 entitled ‘Informal Sector Workforce Survey Report’ suggested that 8.2% of the total employed workforce in 2012 was hired in the informal sector.
The report applied several criteria in determining an informal sector enterprise, the first being that the business was not registered with the Companies Commission of Malaysia or any other professional bodies, including the Local Authority. They also had to offer at least one of its goods or services for sale or barter; and the size of the business could not be more than 10 persons or be registered under a specific form of national legislation.
Some of the interesting details the survey highlighted was that of out 10.9 million people working in non-agricultural jobs in 2012, one million worked in the legal informal sector. Results also showed that a large proportion of the manpower at 62.9% was found to be working in urban areas, with male workers slightly edging females by 16.4% and the majority holding secondary level educations.
While not providing a monetary value for the legal segment, the report said that the jobs were in a diverse range of sectors including construction, manufacturing and retail; and the majority of workers were found to be Malaysians.
Even without solid financial details of the sector, it would be reasonable to assume that a portion of these one million workers should be contributing taxpayers – meaning that the country is losing revenue, and the tax burden is being unfairly shouldered by a smaller portion of Malaysian workers.
The question then becomes, what can the government do? With the vastly diverse mix of businesses that make up the informal sector, it is clear that there will not be a one solution fixes all. In fact, the situation probably requires a combination of the carrot and stick approach, particularly in bringing in businesses currently in the legal segment into the formal economy.
In the coming articles, Kinibiz will look at the two different segments separately to see how the government via agencies like the Inland Revenue Board and SME Corp can be used to both reduce the size of the informal economy, as well as to incorporate profitable and well run enterprises into the formal economy.
Tomorrow: The black economy
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