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Russia: Analysis From Washington -- The Long Shadow Of The Second Economy

Washington, 24 September 1999 (RFE/RL) -- Russia's second or shadow economy is now so large and pervasive that it is likely to define whatever kind of legal economic arrangements do emerge in that country in the future.

That is the unsettling conclusion of a recently published study prepared by the Moscow Institute of Socioeconomic Problems of the Population of the Russian Academy of Sciences.

According to its authors, the earlier conviction in both Moscow and the West that "the scale of the shadow economy would diminish and the legal economy would grow as the country moved in the direction of capitalism" has not proved to be true.

Instead, they suggest, "just the opposite has taken place." In 1990-91, 10-11 percent of the country's GDP was produced by the shadow economy, but the illegal or semi-legal second economy accounted for 27 percent of GDP in 1993, 46 percent in 1996, and quite possibly more than half in more recent years.

Because of the size of this sector of the economy and because it is so interwoven with the legal economy, the new study argues that the rules of the game within the shadow economy are far more likely to define future behavior within what will emerge as the legal economy rather than to be fundamentally transformed by that legalization.

And because this is so, the study suggests, it is critical to understand both where the shadow economy came from, what its current rules of the game are, and how these are likely to play a role in the future as Russia moves to legalize many economic activities that are now part of the second economy.

According to the study, the second economy was relatively small during most of the Soviet period. Its authors cite a Western study which found that the shadow economy produced only three to four percent of Soviet GDP in 1973 -- a percentage far lower, the study notes, than in many developed market economies.

Until nearly the end of the Soviet period, the shadow economy performed two fundamental functions: On the one hand, it compensated for shortcomings in the functioning of the official legal economy. And on the other, it provided a field of activity for entrepreneurs who could not easily fit into Soviet institutions.

With the collapse of communism, these two functions fused, particularly under conditions of what many have described as "incomplete" marketization, a system in which the role of the state or at least its agents remained large and hence the social space for illegal activities actually grew.

The new Moscow study suggests that the shadow economic system now has six defining features: close ties between bureaucrats and entrepreneurs, continuing interference by the state in the economy, preservation of many old monopolies and the growth of new ones, high and repressive taxes that are easy to avoid, the impoverishment of much of the population, and the absence of a legal framework for the economic transformations that have occurred.

The study continues by observing that even though "approximately two-thirds of all enterprises" are almost unaffected by shadow activity in their activities, those firms that are involved are heavily so and that the behavior of these firms casts a long shadow on all the others, in many cases because the shadow economy produces higher incomes for those who practice it.

And it draws three basic conclusions:

First, until legal economic activity produces more wealth than the semi-legal or illegal activities of the shadow economy, many people will continue to turn to the shadow economy to seek their livelihood.

Second, the percentage of the country's GDP produced by the shadow economy will only begin to fall when the country enters into a long period of stable economy growth during which enterprises will be able to renew their technologies and thus generate real wealth on their own.

And third, even when this change takes place in Russia -- and the authors are optimistic that it will -- many of the values and patterns of the shadow economy will help to define the values and patterns of the future legalized market economy there for many years to come.