THE SHADOW ECONOMY AND CORRUPTION IN GREECE

South-Eastern Europe Journal of Economics 1 (2006) 61-80
THE SHADOW ECONOMY AND CORRUPTION
IN GREECE
STAVROS KATSIOS*
Ionian University
Abstract
The paper highlights the interaction between the underground economy and
corruption, focussing on the regional dimensions of the problem in south-eastern
Europe. It discusses the theoretical approach to underground economic activities
and focuses on the determinants of the Greek economy, the tax and national
insurance burdens and the intensity of the relevant regulations in Greece,
concluding that Greece shows profound signs of a transition country in terms of the
high level of regulation leading to a high incidence of bribery and a large shadow
economy. The taxation problems arising from high administrative-compliance
costs and bribery indicate the urgent need for tax reforms designed to simplify
the regulation framework. Improvement of the quality of Greek institutions and
rationalisation of administrative-compliance costs are a prerequisite for successful
and urgently needed tax reforms in terms of reducing the overall Greek shadow
economy, through the simplification of the regulatory framework. The inability
of Greek governments to tax underground activities, and the relevant impact on
the scale of corruption, is related with a vast range of governmental activities
distorting and weakening its allocative, redistributional and stabilising role. The
paper finally argues that the strong and consistent relationship between the
shadow economy and corruption in Greece is closely connected with the reflexes
of those who are not willing or cannot afford to bribe central or local government
bureaucrats, or who have no connections to these bureaucrats, systematically
choosing the dark (shadow) side of the economy as a substitute for corruption
(bribery) and making the shadow economy complementary to a “corrupt state”.
JEL Classification: E26, H21, H26, K34, K42, O17
Keywords: shadow economy, corruption, government, tax reform, Greece
*Corresponding address: Megaro Kapodistria, 491 00 Corfu, Greece
e-mail: katsios@dflti.ionio.gr

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S. KATSIOS, South-Eastern Europe Journal of Economics 1 (2006) 61-80
1. Introduction
One of the most important challenges that national tax systems confront is the prob-
lem of taxing “unreported economic activities” (UEA), “informal economic activi-
ties” (IEA), the “informal economy” (IE), “underground economy” (UE) or “shadow
economy” (SE). The “shadow economy” consists of criminal activity, such as drug
sales, smuggling, prostitution, bookmaking, gambling and other unlawful enterpris-
es, as well as otherwise legal transactions that are mainly conducted in cash and
unreported to fiscal or other competent authorities; this part of the shadow economy
is also known as the “parallel economy”.
The explosion of free trade and economic integration throughout the world, and
especially in this hemisphere, facilitates the international activities of the shadow
economy and requires more strategic global law enforcement policies to combat
them. Unfortunately, political leaderships have not yet summoned the vision to even
conceptualize a comprehensive strategy, let alone start recommending, negotiating,
and implementing one.
It is obviously difficult to get accurate information about underground (shadow)
economic activities because individuals engaged in these activities wish to remain
unidentified. Hence there is little agreement about the size of the underground or
shadow economy relative to the total economy and any attempts at measurement may
be regarded as at least problematic1. Estimates suggest that the scope of underground
economy/unreported economic activity ranges from as low as 8-10% of GDP in cer-
tain OECD countries to more than 50% of GDP in some developing countries in Asia
and Africa2. The estimates of the size of the Greek Underground Economy are based
on the results of the studies conducted in the last decade by the Institute for Economic
and Industrial Research (IOBE) and the Institute for Tourism Research and Fore-
casts (ITEP). The researchers - having applied direct and indirect methodological
approaches to evaluating the main financial sectors and the Greek GDP - estimated
the range of the Greek Underground Economy at from 20% to 25% of GDP, ranking
Greece among the most problematic OECD economies. The underground economy,
defined as all off-the-books and unregulated activity, is considered as one of the main
negative effects deriving from serious structural problems of the Greek economy.
From the point of view of government policy, knowing the size of the shadow econ-
omy is less important than knowing who is operating there and how. Generally, no
1. Compare the interesting debate in Huw Dixon, “Controversy: on the hidden economy” Esti-
mates-Introduction, Giles Davis, “Measuring the hidden Economy: Implications for Econometric
Modeling and Vito Tanzi, “Uses and Abuses of Estimates of the Underground Economy” in Eco-
nomic Journal, Vol. 109, No 456, June 1999.
2. Comprehensive survey of existing evidence of the size of underground economies in Schneider
& Enste (2000), Shadow economies: size, causes and consequences, Journal of Economic Litera-
ture, Vol. 38, pp. 77-114 and in Schneider F. (2000).

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63
matter how small or how large the shadow economy might actually be3, it has impor-
tant implications for public policy. In certain South-European countries the shadow
economy is widespread and to a certain extent the phenomenon is so deeply rooted
that one could think about the existence of a “natural rate of underground economy”4
or of a “complementary intersectoral economic environment”. The shadow economy
may be characterized as a constructed response by civil society to unwanted state
interference. The debate about an appropriate and effective public policy aiming to
reduce the scope of the underground economy for the benefit of public expenditure
has gained new importance in Greece since the last national elections, due mainly to
the European Commission’s pressure on the newly elected Greek government to deal
with the public debt and the explosive budget deficit5.
The purpose of this paper is to provide an overview of the critical factors which
must be taken into account by Greek governments in their effort to evaluate the situ-
ation of the shadow economy and to highlight the structural challenges which must
be faced in an effort to form a long term strategy to achieve its gradual integration in
the legitimate Greek economy.
2. Defining The Underground Economy
The dark side of the economy has neither a commonly accepted definition, nor a com-
monly used name, using instead a plethora of appellations like black; grey; hidden;
shadow; informal; illegal; unreported; underground; unrecorded; undeclared; second
and parallel. Confusion about the nature itself of the shadow economy is obvious; for
some it is also obvious that there is no single shadow economy but many, which are
characterized by the particular institutional set of rules that they circumvent and the
metric for measuring the dimensions of each underground activity is the aggregate
income generated by the activity6. The official term used in Greece “paraoikonomia”
3. Compare the different evaluations of Tanzi Vito (1999), “Uses and Abuses of Estimates of the
Underground Economy”, The Economic Journal, Vol. 109, No. 456, pp. 338-340, of Thomas Jim
(1999), “Quantifying the Black Economy: Measurement without Theory Yet Again?”, The Eco-
nomic Journal, Vol. 109, No 456, pp. 381-389 and of Giles David (1999) Measuring the Hidden
Economy: Implications for Econometric Modeling” The Economic Journal, Vol. 109, No 456, pp.
370-380.
4. Castelluci L. and Bovi M. (1999), “What we know about the size of the underground economy
in Italy beyond the ‘common wisdom’? Some empirically tested propositions”. Quaderni CEIS, p.
120.
5. Greece recorded a budget deficit of 6.1 percent of gross domestic product in 2004, the biggest
deficit in the EU since the introduction of the euro.
6. Feige Edgar (1990), “Defining and Estimating Underground and Informal Economies: The New
Institutional Economics Approach”, World Development, Vol. 18, No 7, distinguishes four specific
underground economies, naming them as: the illegal economy, the unreported economy, the unre-
corded economy and the informal economy.

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S. KATSIOS, South-Eastern Europe Journal of Economics 1 (2006) 61-80
gives a surprisingly accurate 3-D picture, implying a parallel rather than a negative
phenomenon functioning independently, with a semi-organised structure.
Regarding the causes of the underground economy, one school of thought identi-
fies high tax rates as the main issue, that is, companies that operate in the unofficial
economy are simply trying to keep all of their profits for themselves. An alternative
view holds that when unregistered economic activity rises, the political and social
institutions that govern the economy are to blame. In fact economic theory suggests
that taxation, excessive regulations, efficiency of the bureaucracy and corruption are
the main causes of the shadow economy7; alike the bigger is the tax wedge8 the great-
er should be the shadow economy.
Facing the problem of defining the shadow economy, it might be appropriate to
include the production of legal as well as illegal goods and services. In this context tax
evasion associated with legal activities in the shadow economy is itself illegal and sub-
ject to criminal punishment. Additionally, money laundering issues offer a distinction
based on “public acceptance”: investment of tax evasion proceeds from legal activities
tend not to be viewed as money laundering as the proceeds are not related to “crimi-
nal” activities. Indeed the illegal sector of the shadow economy includes goods and
services and generally activities illegal per se such as distributing drugs, smuggling
and trading in contraband goods, prostitution and unauthorized gambling. In contrast
legal activities in the shadow economy include a wide range of goods and services that
are also produced in the legitimate (“above-ground”) economy, such as home repair
and renovation, entertainment, gardening, babysitting, private teaching etc.
Legal or illegal, the shadow economy includes in this sense only activities adding
to the total level of consumer satisfaction and representing a buyer-seller relation-
ship, thus excluding criminal activity like theft, forgery, robbery, extortion, fraud
and blackmail. Table 1 makes clear that a broad definition of the shadow economy
(underground economic activities) includes unreported income from all economic
activities that would generally be taxable were they reported to the authorities9.
7. Schneider and Enste (2000) op. cit.
8. Difference between the total cost of labour and after-tax earnings from work.
9. Feige (1990) defines the shadow (informal) economy as “those actions of economic agents that
fail to adhere to the established institutional rules or are denied their protection”, proposing his own
taxonomy as a way of specifying the relevant environment.

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S. KATSIOS, South-Eastern Europe Journal of Economics 1 (2006) 61-80
65
Table 1. A Taxonomy of Types of Underground Economic Activities*
Type of
Monetary Transactions
Non-monetary Transactions
Activity
Barter: drugs, stolen goods,
Trade in stolen goods; drug dealing and
ILLEGAL
smuggling etc. Produce or
manufacturing; prostitution; gambling;
ACTIVITIES
growing drugs for own use.
smuggling, fraud etc.
Theft for own use.

Tax Evasion
Tax
Avoidance
Tax Evasion
Tax
Avoidance
Unreported income
All do-it-
from self-employment;
Employee
Barter of legal
yourself
LEGAL
Wages, salaries and
discounts,
services and
work and
ACTIVITIES
assets from unreported
fringe
goods
neighbor
work related to legal
benefits
help
services and goods
* Structure of the table taken from Lippert and Walker (1997), with additional remarks from Frie-
drich Schneider (2002).
3. The Size of the problem
Focusing on Greece, we might as well use some data, which can allow us to see
the country’s position internationally. The following Table 2, based on the survey
of Schneider and Enste (2000) and Schneider (2000), gives existing evidence of the
sizes of underground economies around the world and serves to indicate approximate
magnitudes of the size and development of the underground economy, defined as
productive activities, i.e. using the narrow definition. Table 2 provides a rough com-
parison of the size of the underground economies relative to GNP for a selection of
Western European countries, Japan and the United States for the late 1990s, using the
currency demand approach10.
10. This approach by Cagan P. (1958), “The Demand for Currency Relative to the Total Money
Supply”, Journal of Political Economy, 66, Gutmann P.M. (1977), “The Subterranean Economy”,
Financial Analysts Journal, 34, and Tanzi V. (1980), “The Underground Economy in the United

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S. KATSIOS, South-Eastern Europe Journal of Economics 1 (2006) 61-80
Table 2. Size of the underground economy relative to GNP in various European
countries, late 1990s. Estimation based on the currency demand approach.*
Greece – Italy
27-30%
Spain
Portugal
20-24 %
Belgium
Sweden
Norway
18-23%
Denmark
Ireland - France – Netherlands -
13-16%
Germany - Great Britain

Japan
United States
8-10%
Austria
Switzerland

* Source: Compiled from Schneider Fr. and Enste Dom. (2000).
States: Estimates and Implications”, Banca Nazionale del Lavoro Quarterly Review, 135 Tanzi V.
(1983) “The Underground Economy in the United States: Annual Estimates, 1930-19809, IMF Staff
Papers, 30) estimates the currency as a function of conventional factors such as the interest rate, the
evolution of the payment system etc, plus black-money triggering variables like the tax burdens.
These are based on the hypothesis that the shadow economy transactions are carried out in cash for
the obvious reason – not to leave traces. Estimating the currency holdings based on the zero income
tax we compute the “excessive” (i.e. tax induced) currency holdings due to the shadow economy.
The size of the shadow economy is then calculated by multiplying the excessive currency by the
velocity of money prevailing in the regular economy. The other so called “physical input” approach
by Lacko (1998), “The hidden Economies of Visegrad Countries in International Comparison A
Household Electricity Approach”, in Halpern L.-Wyplosz C. (Eds) (1999), Hungary: Towards a
Market Economy, Cambridge University Press, Cambridge, MA, separates the electricity consump-
tion of households in two parts, one independent from the hidden economy and another related to
it. The output of this calculation is an indicator of the hidden economy, which is transformed to an
indicator expressing the magnitude of the shadow economy.

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67
According to these estimates two southern European countries, Greece and Italy,
have an underground economy almost one third as large as the officially measured
GNP, followed by Spain, Portugal and Belgium, with a shadow economy between
20-24 % of official GNP. The Scandinavian countries also have an unofficial econ-
omy between 18-20% of GNP, which is attributed mainly to the high fiscal burden.
“Central” European countries like Ireland, the Netherlands, France, Germany and
Great Britain have a smaller underground economy (between 13-16% of GNP) prob-
ably due to a lower fiscal burden and moderate regulatory restrictions. The lower
underground economies are estimated to exist in countries with relatively low public
sectors (Japan, the United States and Switzerland), and comparatively high tax mo-
rale (United States, Switzerland).
2.1 Developed Countries
Looking generally at the size and development of twenty-one highly developed OECD
countries, calculated using the latent estimation approach (DYMIMIC approach)11
in Table 3, the average size of the shadow economy has decreased over the period
1999/2000 to 2002/2003, a tendency also present, on a limited scale, in Greece.
The average size of the shadow economy in these countries in 1999/2000 was
16.8% of official GDP, and it decreased to 16.3% in 2002/2003; a decrease of 0.5
percentage points. If we consider single countries, Greece, Italy, and Spain have the
largest shadow economies by far in 2002/2003 with 28.2%, 25.7%, and 22.0% of
official GDP. The median country is Ireland with 15.3%, surrounded by Germany
with 16.8% and Canada with 15.2% of official GDP. At the lower end are the United
States, Switzerland and Japan with a shadow economy of 8.4%, 9.4% and 10.8%
of official GDP. The contraction of the shadow economy of the OECD countries is
mainly a result of decreased direct and indirect tax burdens, of government deregula-
tion, and of a liberalization of the labour markets.
2.2 The Transition Countries
In the late 1980s, initial efforts at estimating the size and development of the shadow
economy in the transition countries yielded extremely large figures. This was partly
due to the method used (physical input – electricity), and the results have since been
critically evaluated12. In Table 4, the case of twenty-five eastern and central European
11. For details Schneider Fr. (2005), “Shadow Economies around the World: What do we really
know?” forthcoming European Journal of Political Economy, and Schneider and Enste (2000),
op. cit.
12. Alexeev Michael and Pyle William (2003), “A note on measuring the unofficial economy in the
former Soviet Republics”, Economics in Transition, 11/1

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S. KATSIOS, South-Eastern Europe Journal of Economics 1 (2006) 61-80
and former Soviet Union countries are presented. Turning again to the growth of
the shadow economy over time, the average size of the shadow economy of these
twenty-five eastern and central European countries was 38.1% of official GDP in
1999/2000, and increased to 40.1% in 2002/2003 - which is an increase of two per-
centage points over these four years. Georgia, Azerbaijan, and the Ukraine have the
highest shadow economies with 68.0%, 61.3%, and 54.7%, respectively. The median
country is Bulgaria, surrounded by Serbia and Montenegro with 39.1%, and Roma-
nia with 37.4%. At the lower end are the Czech Republic with 20.1%, the Slovak
Republic with 20.2%, and Hungary with 26.2% of official GDP. Before liberalization
most day-to-day products were produced in the underground, but with very different
motivating factors; there were few options in the official planned economy. When
these states turned into market economies, the motivating forces behind the shadow
economy changed; people suddenly faced a higher direct and indirect tax burden and
a different set of government regulations interfering in their business. This, coupled
with a general distrust of the state, rather than the necessity of survival, now drove
citizens underground13.
13. Schneider Driedrich (2004), The size of Shadow Economies in 145 Countries from 1999 to
2003, Working Paper, Johannes Kepler University Linz, p. 10.

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69
Table 3. The Size of the Shadow Economy in Twenty-One OECD Countries
Shadow Economy (in % of off. GDP) using
Country
the DYMIMIC and Currency Demand Method
1999/00
2001/02
2002/03

1
Australia
14,3
14,1
13,5
2
Austria
9,8
10,6
10,9
3
Belgium
22,2
22,0
21,0
4
Canada
16,0
15,8
15,2
5
Denmark
18,0
17,9
17,3
6
Finland
18,1
18,0
17,4
7
France
15,2
15,0
14,5
8
Germany
16,0
16,3
16,8
9
Greece
28,7
28,5
28,2
10
Ireland
15,9
15,7
15,3
11
Italy
27,1
27,0
25,7
12
Japan
11,2
11,1
10,8
13
Netherlands
13,1
13,0
12,6
14
New Zealand
12,8
12,6
12,3
15
Norway
19,1
19,0
18,4
16
Portugal
22,7
22,5
21,9
17
Spain
22,7
22,5
22,0
18
Sweden
19,2
19,1
18,3
19
Switzerland
8,6
9,4
9,4
20
United Kingdom
12,7
12,5
12,2
21
United States
8,7
8,7
8,4
Unweighted Average
16,8
16,7
16,3
* Source: Compiled from Schneider Fr. and Enste Dom. (2000)

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S. KATSIOS, South-Eastern Europe Journal of Economics 1 (2006) 61-80
Table 4. The Size of the Shadow Economy in 25 Eastern and Central European and
Former Soviet Union Countries*
Shadow Economy (in % of off. GDP) using
Country
the DYMIMIC and Currency Demand Method
1999/00
2001/02
2002/03
No.
1
Albania
33,4
34,6
35,3
2
Armenia
46,3
47,8
49,1
3
Azerbaijan
60,6
61,1
61,3
4
Belarus
48,1
49,3
50,4
5
Bosnia and Herzegovina
34,1
35,4
36,7
6
Bulgaria
36,9
37,1
38,3
7
Croatia
33,4
34,2
35,4
8
Czech Republic
19,1
19,6
20,1
9
Estonia
38,4
39,2
40,1
10
Georgia
67,3
67,6
68,0
11
Hungary
25,1
25,7
26,2
12
Kazakhstan
43,2
44,1
45,2
13
Kyrgyz Republic
39,8
40,3
41,2
14
Latvia
39,9
40,7
41,3
15
Lithuania
30,3
31,4
32,6
16
Macedonia, FYR
34,1
35,1
36,3
17
Moldova
45,1
47,3
49,4
18
Poland
27,6
28,2
28,9
19
Romania
34,4
36,1
37,4
20
Russian Federation
46,1
47,5
48,7
21
Serbia and Montenegro
36,4
37,3
39,1
22
Slovak Republic
18,9
19,3
20,2
23
Slovenia
27,1
28,3
29,4
24
Ukraine
52,2
53,6
54,7
25
Uzbekistan
34,1
35,7
37,2
Unweighted Average
38,1
39,1
40,1
*Source: Compiled from Schneider Fr. and Enste Dom. (2000) op.cit.

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