Chronicle of the Middle East and North Africa

Shadow Economy Increases Social Inequalities in Arab Region

The shadow economy is widely regarded as the primary catalyst for the exacerbation of social inequalities and the accumulation of wealth and income.

Shadow Economy
Egyptian workers harvest wheat in Saqiyat al-Manqadi village in the northern Nile delta province of Menoufia, Egypt. Mohamed el-Shahed / AFP

Ali Noureddine

This article was translated from Arabic.

The shadow economy, also known as the informal economy, encompasses all economic activities conducted beyond the reach of state control and oversight by relevant authorities.

Typically, these activities arise due to tax evasion or practices that circumvent established administrative systems, including those pertaining to minimum-wage compliance, payment of social security contributions for workers, or the legal registration of establishments in commercial registers.

Various terms are commonly employed to describe these practices, including the parallel economy, the alternative economy or the black economy. The shadow economy typically consists of two interconnected facets.

Firstly, there are businesses and commercial ventures that operate without declaring their activities or business operations to tax authorities.

Secondly, there is a sector of informal labor within these establishments, comprising individuals who lack formal and regulated contracts, thereby compromising their inherent rights as workers.

The proliferation of the shadow economy is often regarded as a prominent characteristic of developing nations, wherein the share of shadow economy activities can increase to 40 per cent of the gross domestic product (GDP), accompanied by approximately 60 percent of the total workforce engaging in such activities.

Numerous Arab countries currently grapple with a significant shadow-economy proportion exerting control over economic activities.

In Egypt, for example, the shadow economy comprises around 55 per cent, while the proportions in Lebanon and the Gaza Strip are even higher at 62 per cent and 66 per cent respectively.

In countries afflicted by substantial security tensions, such as Syria, the shadow economy burgeons to an alarming 90 per cent.

Additionally, a considerable 59 per cent of Yemeni workers engage in shadow economy activities.

Conversely, in some other Arab countries this percentage is relatively lower, with Algeria at 30.86 per cent, Morocco at 34.1 per cent, and the United Arab Emirates at 26.54 per cent.

According to data from the International Monetary Fund, the shadow economy accounts for approximately one-third of the GDP in Arab countries, surpassing the prevalence rates of such activities in developed economies, where they typically range between 14 per cent and 16 per cent.

Shadow economy and social disparities

The shadow economy, along with the subsequent proliferation of unorganized and informal employment, is widely regarded as the primary catalyst for the exacerbation of social inequalities and the accumulation of wealth and income.

The prevalence of the shadow economy in any country has significant consequences, foremost being the decline in tax collection rates.

This, in turn, hampers the state’s capacity to allocate funds toward crucial issues such as social protection networks, accessible education, government healthcare and infrastructure development. Tax evasion, in general, undermines a key objective of tax policies, which is to facilitate the redistribution of resources and opportunities in favor of vulnerable groups.

In the case of Lebanon, decades of rampant tax evasion have fueled an extreme level of wealth concentration. Prior to the financial collapse in 2019, a mere 10 per cent of the Lebanese population possessed over 55 percent of the country’s GDP.

This staggering disparity positioned Lebanon as the second most unequal and wealth-concentrated nation in the Middle East and North Africa, surpassed only by the Kingdom of Saudi Arabia. The root cause of this situation lies in the drastic reduction of tax revenues, which plummeted to less than 15 percent of GDP, a sharp contrast to the 25 percent in the United States and 34 percent in the GCC countries.

The spread of the shadow economy has several consequences, and one significant outcome is the perceived inequality among residents who diligently fulfill their tax obligations and adhere to government regulations, while others choose to evade these responsibilities. This perpetuates the notion of evading legal rules as a prevalent societal issue over time.

Simultaneously, the shadow economy perpetuates significant inequality among workers and employees. Informal employment, which refers to work that goes unreported and unregulated by law, deprives individuals of fundamental legal protections, such as receiving a minimum wage or being registered for social security benefits.

Since workers in the shadow economy typically lack formal employment contracts, they often face difficulties seeking legal recourse to claim their rights from employers. Consequently, the prevalence of the shadow economy exacerbates the vulnerability of the labor force and undermines the establishment of adequate working conditions.

The spread of the shadow economy also exacerbates gender inequalities in the labor market, with studies indicating a significantly higher participation rate of men compared to women. This disparity can be attributed to the precarious working conditions prevalent in such economic activities.

There are many reasons for the spread of the shadow economy

There are several factors contributing to the proliferation and growth of the shadow economy and informal employment in Arab countries.

In Lebanon, the prevalence of these activities can be attributed to deficiencies in tax-enforcement mechanisms, widespread exploitation of illegal and unregulated foreign labor, and the lack of job security and workers’ rights.

In the case of Syria, the shadow economy’s share of the GDP expanded nearly threefold from 2010 to 2022 due to prolonged military conflicts, which resulted in the local economy operating outside government oversight and regulatory frameworks.

In the case of Egypt, the proportions of the shadow economy have historically increased due to micro-enterprises in the craft and agricultural sectors in rural areas evading government bureaucracy and complex procedures.

Similarly, in Jordan, these percentages have risen as a means to evade tax increases imposed by successive governments.

Yemen has experienced a significant surge in informal employment rates, particularly following the recent division within the country and the withdrawal of large areas from government economic and administrative regulations.

However, in all these cases, a recurring factor is the employers’ lack of confidence in the viability of transitioning to a structured economy and their reluctance to report their business activities to tax authorities. This trend was further fueled by the workers’ limited ability or unwillingness to collectively organize and secure the legal protections associated with formal employment.

Notably, the proliferation of local family farming in the Egyptian countryside contributed to the rise in informal employment rates, often without a perceived need for government regulations to address the matter.

The central issue lies in addressing informal employment, which thrives in the shadow economy, without inadvertently marginalizing vulnerable populations from the labor market.

Consequently, governments should prioritize implementing measures that encourage employers to disclose their commercial activities through administrative controls and regulatory frameworks rather than relying solely on coercive methods to combat this form of economic activity.

It is important to note that certain shadow economy activities arise from individuals working independently in various professions, unrelated to any specific employer, such as street vendors, for instance.

In response, governments should proactively seek out social protection networks capable of safeguarding these highly susceptible groups.

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