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Paddington Masamha: Shadow Economy – Zimbabwe’s economic brain tumour

By Paddington Masamha

The shadow (underground) economy is a major part of the Zimbabwean economy. A tangible number of urban and rural livelihoods are sustained by various incomes generated in these markets. Depending on time periods (pre- and post-election phases), government has been endeavouring to extinguish shadow markets.

Paddington Masamha
Paddington Masamha

The most well-known cases include Operation Murambatsvina, Operation Chikorokoza Chapera (No illegal Panning), various operations against foreign currency dealers and vendors are recognizable amongst the most popular shadow economy eradication exercises.

Robustly, the shadow economy has remained unabated and evolved to significantly influence central government policies. The recent case in point is the 20 February 2019’s public acceptance that the 1:1 parity peg has been subjected to a speculative attack by the parallel market. Given the pressure from parallel markets, the Zimbabwean government was forced to introduce, ‘…an inter-bank foreign exchange market in Zimbabwe to formalise the trading of RTGS balances and bond notes with US$s and other currencies on a willing-buyer willing-seller basis through banks and bureaux de change…’

Observably, whenever a government is faced with financial and economic vulnerabilities, the easy scapegoat is usually the shadow economy. Given increasing pressure from businesses and members of the general public, the usual temptation that government is faced with is the outright condemnation and enforcement approach to dealing with shadow activities.  Such is the existing policy direction of the Zimbabwean economy.

However, a random enforcement and criminalization approach without due regard to the causes and consequences of the shadow economy is counter-productive. Shadow economies are a world-wide phenomenon, both in under-developed, developing and developed economies. Instead of fighting their existence, prudent nations are researching on ways of making underground economies to be more serviceable and functional.

Understanding a shadow (underground) economy

Friedrich Schneider discourses that a shadow economy includes all market-based legal production of goods and services that are deliberately concealed from public authorities. This is done in an endeavour to avoid complying with various regulations and laws, pay taxes (income, valued added, etc.) and social security contributions, as well as complying with certain administrative obligations.

Understanding shadow markets requires the extensive knowledge of prevailing illegal activities within an economy. For instance, prohibited activities involving the supply of legal goods and services (e.g. smuggling of bales/mabhero) are widespread in Zimbabwean border towns such as Beitbridge, Chirundu, Victoria Falls, Forbes Border Post (Mutare) and Plumtree.

The widely common illegal activities of gambling (popularly known as njuga) are also common underground activities both in urban and rural dwellings. Money laundering which is more common with political heavyweights and business moguls deserves strong mention. The monetary and non-monetary tax evasion (e.g. barter of legal goods and services) and tax avoidance (e.g. employee discounts and fringe benefits) schemes form part of the shadow activity.

The criminal activities such as the sale of contraband cigarettes and drugs (e.g. cocaine, bhurongo, kirango etc.), the fencing of stolen goods and prostitution are part of illegal activities found in a shadow economy. The illicit activity which involves undeclared work and the popular black or parallel market activity form the pivot of the shadow economy. Noticeably, Zimbabwe has a more buoyant parallel market of both physical goods and foreign currency trading.

Imperatively, the taxonomy of underground economic activities by Friedrich Schneider includes the legal activities of unreported income from self-employment (e.g. wages, salaries and assets from unreported work related to legal services and goods). Empirical evidence shows that Zimbabwe is a highly informalised market (estimated to be above 60%). As such, the informal economy has a huge constituent of untaxed labour and undeclared profits.

For instance, the large scale interest of policy makers is largely on the informal trading activities such as vendors (e.g. vegetable markets, street vendors, etc.), informal market traders (popular places such as Mupedzanhamo, Magaba/Siyaso, Khothama, Kelvin), pirate taxes and commuter omnibuses (popularly known as Mushikashika and or Zvipipipi), street shoe manufacturers and traders, domestic production of goods and services (e.g. shebeens, brothels, candle producers, peanut butter producers, chicken rearing and egg production, etc.), informal colleges (e.g. crèche, extra lessons, security training courses, till operating courses etc.), cross-border traders, backyard hair salons, back door furniture manufacturing and carpentry works, car servicing, repairs and car breakers among others.

Fundamentally, the non-observed economy within a country constitute the underground economic activities (underground producers), informal and illegal activities. In short, all commerce that is not taxed form part of the shadow economy. As such, Zimbabwean shadow markets have become an economic brain tumour. An abrupt attempt to operate the tumour without due regard to its causes can instead kill the patient.

The causes of the shadow (underground) economy in Zimbabwe

Economic theories conversing the subject of shadow economies generally prescribe the common reasons which cause or drive the development and ultimate growth of underground economies. Zimbabwe, is not immune to such theory, as such, the following factors are easily identifiable within the economy as a whole;

De-industrialization and unemployment

Zimbabwean unemployment has over the years become one of the giant economic challenge. The problem of unemployment has largely been exacerbated by the massive de-industrialisation which has been triggered by the toxic macro-economic conditions within the economy.

The policy inconsistencies regarding the indigenization and economic empowerment laws, poor human rights records, violation of private property rights and political instabilities are some of the indigestible factors that have principally contributed to the demise of Zimbabwean industries and the uprooting of business investments.

Zimbabwean informal activities are largely driven by the economy’s poor labour absorption capacity. For instance, a significant number of graduates from state universities and colleges are failing to secure formal employment. However, informal activities such as vending, pirate taxes, domestic animal rearing projects and informal market trading are the easily accessible opportunities. Driven by the desire for quick-win stratagems, a significant number of the unemployed youths are pouring into the illegal trades of drugs, prostitution and a variety of criminal activities.

Increased regulation and excessive state involvement in the economy

The extent and intensity of regulation within an economy largely affects individual and corporate decisions within the official economy. For instance, labour market regulations (e.g. minimum wages or dismissal protections), labor market restrictions for foreigners (e.g. restrictions regarding the free movement of foreign workers), license requirements and trade barriers (e.g. import quotas) largely influence the desire to utilize informal channels.

Fundamentally, regulatory compliance procedures are recognized as an expense by employers. An increase in government regulations increases the cost of labour to firms within the official economy. Faced with increasing regulatory costs, employers usually employ a limited number of employees hence causing unemployment and ultimately an increased pool of informal employment.

Most corporates when faced with increased regulatory requirements, they simply pass on the costs to its employees (through reducing employee incentives) and also load their costs in their pricing policies. Driven by the desire to bring back normalcy in the economy, the Zimbabwean government’s appetite for regulatory controls and state involvement is on the extreme side.

For instance, unsustainable regulations which have proven counterproductive include the June 18 2007 price controls (where Cabinet Taskforce on Price Monitoring and Stabilization on June 25 ordered shops to slash prices of basic goods by 50 percent or to pre-June 18 2007 levels) and the 2008 Indigenization and Economic Empowerment Act. Coupled with other factors, such regulations largely worsened the already crippled Zimbabwean business environment.

Imperatively, the official economy needs optimum regulatory reforms which guarantee the ‘going concern concept’ of business. Once cumbersome regulations are enacted, businesses simply close office and the mushrooming of more informal and illegal activities becomes unescapable.

Higher tax rates and social security contributions

The shadow activities of tax evasion and smuggling are largely driven by excessively higher tax rates. For instance, a significant number of cross-border traders would rather pay ‘malaicha’ (cross border transporter) a minimal transport fare than to be exposed to the highly excessive import duty levied on taxable imports.

The well-known concept of smuggling goods ‘under the bridge’ within border towns pays homage to the excessively high tax system. Instead of charging equitable import duties (thereby creating more tax revenue through increased compliance), the tax authorities are losing more through the underground activities of tax evasion, smuggling and under-invoicing or under-declaring. 

The National Social Security Authority (N.S.S.A) has statutory or regulatory demands on the formal economy through a variety of social security contributions. The majority of informal businesses intentionally choose to remain informal so as to avoid the tax authorities (ZIMRA) and social security authorities (NSSA). Small entrepreneurs are more comfortable remaining small and enjoying their private gains and or losses without ZIMRA or NSSA regulatory interferences.

Therefore, social security contributions and tax regimes do influence the growth of a shadow economy. Empirical evidence shows that the burden of direct taxes (including social security payments) deters small scale entrepreneurs from operating in the official economy. Given the mandatory taxes and social security contributions, the increased drive towards backyard offices and home-based production activities is ubiquitous.

Poor governance standards and corruption

Economies which are largely command systems, bureaucratic and extremely dominated by corrupt government officials as well as institutions are largely associated with informal markets. In contrast, political regimes which promote the upholding of good rule of law (achieved through securing and safeguarding private property rights and contract enforceability) usually have formal economies.

Therefore, poor governance is the main driver of having a country with excessive regulation, punitive tax regimes, unemployment and a variety of excessive government interferences. Governance standards are further compromised given that corruption activities then dominate the official economy in an endeavour to circumvent the restrictive government regulatory frameworks. Imperatively, a heavily regulated economy combined with fragile and discretionary administration of state regulations provides bountiful and fertile grounds for shadow activities.

The Zimbabwean case is thus a prime case of how these interrelated issues are at play. For instance; given import controls, smuggling is the available option for informal traders. Once smuggling is on the picture, bribery of border control or border patrol officers (e.g. ZIMRA, police, army, etc.) is inevitable. Government then has a double conundrum of lost tax revenues and burgeoning corruption.

Academic research hypothesizes a direct correlation between a reduction of the level of corruption in a country and the extent of the shadow economy. As such, significantly corrupt states do have a robust or larger shadow economy. Countries which have bad equilibrium characteristics (where ‘tax and regulatory discretion and burden on the firm is high, the rule of law is weak, and there is a high incidence of bribery’) relatively do have a higher degree of an unofficial economy. Zimbabwe is a prime specimen.

Decline of civic virtue and loyalty towards public institutions

A nation’s tax morale is largely a by-product of the efficiency and effectiveness of public services. For economic inhabitants to be tax compliant, their drive is largely dependent on the psychological tax contract that entitles them to specific rights to the optimum quantity and quality of public goods and services. As such, in Zimbabwe given the poor state of public sector organizations, there has been a significant decline of the civic virtue. The tax morale is at its lowest ebb hence the increased desire to dodge or avoid the payment of taxes.

Noticeably, it is common practice for taxpayers to have a huge inclination to tax compliance if they get valuable public services in exchange with their taxes. Therefore, in an economy where tax authorities treat tax payers as partners (instead of subordinates), high morale and civic virtue to pay taxes is strengthened thus reducing the need for individuals and corporates to use the shadow economy. 

Earlier retirement and poor pension payouts

Early retirement is commonplace in any country. Early retirement can be voluntary or involuntary. Fundamentally, early retirement means less pension. As such before discoursing the issue of inflation, the pension amount from early retirement is on its own meagre to sustain livelihoods.

Many a times, early retirement usually puts a significant constraint on personal financial budgets and in most cases those who retire early run-out of cash inflows (regular incomes). This is so because some individuals retire when they are not emotionally ready to do so (involuntarily), some face serious health complications which consume all their savings, others retire when they still have dependents who rely on their pension whilst others will be indebted at retirement age.

Whatever the driving force behind the early retirement, the situation forces individuals to join the unofficial economy in an attempt to boost their incomes. As such, an economy which has higher incidences of early retirement will generally have a larger shadow economy.

Conclusion

In a nutshell, both legal and illegal underground economic activities are predominantly ‘off the book transactions’ which the government statisticians and the tax authorities fail to account for. Though shadow economies cannot be completely eliminated, the major driving force driving their growth is largely a government failure to address the economic variables which exacerbate the problem. As such, any serious antidote is to reverse the negative factors identified in this article.

Paddington Masamha is an independent Financial and Economic Analyst. He can be reached on email [email protected] and Twitter @PMasamha