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Aug 15, 2012 | 12:54 GMT

8 mins read

The Paradox of Italy's Informal Economy

Protesters in Rome wave Italian flags.
FILIPPO MONTEFORTE/AFP/Getty Images

Europe's economic crisis has reduced formal economic activity and regular employment in Italy. However, irregular economic activities have proved resilient. The irregular economy is a serious challenge for Rome because it limits the government's ability to reduce its deficit and improve its budgetary situation. But at the same time, irregular activities are helping some Italians mitigate the effects of the recession and therefore are staving off the widespread social unrest that has been seen in other eurozone peripheral countries. Maintaining a balance between the economic needs of the central government and its social and political constraints will be one of the main challenges in the final months of the technocratic government of Prime Minister Mario Monti.

In general terms, the informal economy includes a range of "off-the-books" activities, from undeclared jobs to tax evasion or underreporting of revenue. While sometimes there is a link between irregular activities and organized crime, not every form of informal activities is illegal. The irregular economy often involves legal activities that are performed without the oversight of the authorities.

Prevalence of Informal Economic Activity in Italy's Economy (2007-July, 2012)

There is no single way to measure the size of a country's informal economy. It takes several years for statistics institutes to process economic data, and thus the data provided by statistics offices and researchers is usually old. Moreover, the estimates vary according to the mathematical model that is used. For instance, according to the Bank of Italy, the informal economy has grown from 14.5 percent of Italy's gross domestic product in 2005 to 18.5 percent in 2008. Italy's national statistics institute, however, estimates that it has remained relatively stable — accounting for between 17 and 18 percent of Italian gross domestic product. Finally, Austrian scholar Friedrich Schneider estimates that Italy's irregular economy currently accounts for 21.2 percent of Italian gross domestic product, slightly down from 22.3 percent in 2007.

Whatever the true number, most official and independent analyses consider Italy to have one of Western Europe's largest informal economies — twice the size of Germany's and France's.

Tax Evasion

Tax evasion comes in several different forms. In the case of mid- to large-sized companies, the most common cases are tax evasion, underreporting of revenue and overestimating production costs. In Italy, this kind of evasion is mostly concentrated in the north, Italy's wealthiest and most industrialized area. Official statistics and anecdotes suggest that the richest regions of Italy, including Lombardy, Piedmont and Veneto, are responsible for the majority of cases of large-scale evasion.

In other cases of evasion, small companies and local shops avoid paying the value-added tax. These cases are more spread across the country but are particularly significant in tourist areas; it is very common for bars, restaurants and nightclubs across Italy not to issue receipts.

Finally, Italy has a significant problem with citizens underreporting income. Official statistics and anecdotal information detail numerous cases of Italian citizens who report earning less than 10,000 euros ($12,000) a year but own several properties and sports cars. In other cases, Italians receive unemployment insurance while working in the informal sector.

Tax evasion is often explained as a consequence of the high tax burden in Italy, where the tax rate is currently around 45 percent. There is an ongoing debate about the tax system in Italian politics. Since coming to power in November 2011, the Monti government has set its sights on tax evasion, and Rome has stepped up raids and inspections. In an effort to curb informal economic activities, in April 2012 the government imposed a ceiling on cash outflow to workers. Italians cannot be paid more than 1,000 euros a month in cash. The result of both policies has yet to be quantified.

Irregular Employment

Regular employment in Italy has been affected by the economic crisis in Europe. Unemployment in the formal sector rose to 10.8 percent in June 2012, from 6.1 percent in 2007. During the same period, irregular employment has been relatively stable. 

 

The resilience of the informal economy is in part explained by its flexibility; the irregular economy has more room to adapt its salaries and working hours since it is not constrained by fiscal or legal regulations.

According to official statistics, the agriculture sector accounts for a quarter of all irregular employment in Italy. This is why irregular employment is higher in the south, the country's main agricultural area. Irregular employment is also high in the service sector (18.7 percent of total irregular labor), particularly in activities related to tourism, such as at hotels, restaurants and bars. These activities frequently use cash, which makes them more difficult to trace, and are highly seasonal. Operations and inspections by the Guardia di Finanza, an Italian law enforcement agency, are common in tourist destinations during the summer months.

Finally, construction has a high rate of informality — it makes up 10.5 percent of all irregular labor in Italy — since it often employs short-term workers who are paid in cash. The industrial sector, conversely, shows lower levels of informal labor. This is largely because industrial activities are subject to a more permanent oversight, both by the government and the trade unions. Big industries are also more difficult to "hide" from the authorities.

Irregular employment is directly connected to illegal immigration because most illegal immigrants find jobs in the informal sector. Statistics and anecdotes show that these workers are generally low-skilled individuals from North Africa, the Balkans and Eastern Europe. They usually receive lower wages than their Italian counterparts. Immigration, especially of the illegal sort, is a politically sensitive issue for Italy. During the government of Silvio Berlusconi, the members of the center-right coalition — which included right-wing Northern League and the National Alliance parties — pushed for tougher immigration policy. Even though the Italian center-left has a softer stance on the issue, immigration is likely to be a hot topic during the campaign for parliamentary elections in early 2013.

Politics, Economy and Safety Nets

The Italian economy is feeling the effects of the European crisis but to some extent is less affected than other countries in the periphery of the eurozone, such as Greece or Spain. While there have been some protests and strikes in Italy, the country has not experienced the same amount of social unrest as other peripheral eurozone countries.

One reason for this difference is that, unlike in Greece or Spain, the austerity measures that were applied by the Monti government have not significantly eroded the levels of salaries and pensions. The Monti administration has applied tax increases (mainly on property), pension and labor sector reforms, reductions in the number of civil servants, cuts to health care and liberalization of sectors such as energy, pharmacies or taxis. But these measures have not substantially affected household income.

Unlike Spain, Italy has not raised the value-added tax, a decision that would raise the cost of living and would directly affect Italian households. Moreover, unemployment is growing in Italy but is still at the eurozone average (around 10 percent). The unemployment insurance system in Italy has remained largely intact despite the crisis. According to recent measures taken by the Italian government, the economic crisis does not seem to have significantly changed the system of unemployment insurance.

Another reason for the disparity between Italy and the other eurozone peripheral countries is that the family structure is an additional safety net for many Italians. It is very common for young, unemployed men and women to return to their parents' homes. That gives them access to their parents' savings (and pensions), somewhat mitigating the effects of the recession.

Finally, the informal economy is another safety net for some Italians. The authorities, especially at the local level, are aware of this situation and tolerate — and often encourage — different kinds of evasion and ways to "cheat" the central government. Local political leaders see this as a way to avoid social unrest and sometimes to gain the support of voters. Particularly in the south, it is very common for men and women to underreport income or to declare that they are suffering from different kinds of illnesses or disabilities in order to receive special subsidies from the central government.

In this sense, the informal economy has somewhat lessened the effects of the crisis. If regular, irregular and even criminal activities are combined, Italy is a wealthier country than it appears. This disconnect between Italian national wealth as a whole and Rome's tax base puts the Monti government in a tough spot. Rome needs to increase its tax revenue to improve its deficit situation. This is why the central government is elevating its fight against tax evasion. At the same time, Rome knows that small-scale evasion works as a safety valve to the crisis, so it is willing to tolerate some degree of irregularities. In Italy as elsewhere, politics and economics can never be separated.

This strategy involves risk because some parts of Italy, especially in the south, are beginning to feel the consequences of mismanagement and tolerance of irregular activities. For instance, last month, Rome had to give a bailout of 400 million euros to Sicily, a region often characterized by administrative corruption, nepotism and inefficiency.

Italy is in a slow economic decline that began long before the current economic crisis. However, Italy has a number of economic, social and political tools that are preventing major episodes of social unrest. The interaction between politically motivated economic decisions from the central and regional governments, the family structure and the persistence of an irregular sector are all mitigating the effects of the crisis. Italy is currently facing widespread economic decline, but it is still very far from the levels of economic decline or social unrest that are affecting other nations in the eurozone periphery.

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