Spain's Economy Surges—Off the Books

Not that Europe is lacking for economic basket cases, but Spain
has been an especially fascinating train wreck to watch, with the
unemployment rate hitting
27 percent last year. Official statistics are so dismal that
they could be expected to produce riots in the streets; that they
haven’t is evidence that, somehow, Spaniards are finding ways to
eat and pay the bills. If some sort of invisible economic activity
were not under way,
pointed out Victor Mallet and Guy Dinmore in a 2011 article in
the Financial Times, “Spain would not be as peaceful as,
barring a few demonstrations, it has so far been.” Now comes
confirmation from the country’s government that the people of Spain
have, in fact, retained their ability to work and create jobs and
wealth—by staying as far under the state’s radar as possible.

A new
report from Spain’s Finance Ministry reveals that the shadow
economy—underground activity that would be legal, if subject to the
usual tax and regulatory regime—has grown steadily every year from
2008 through 2012, the most recent year measured. In that time, the
shadow economy increased from 17.8 percent of official GDP to 24.6
percent.

Perhaps unsurprisingly for a country troubled by state meddling
with the economy, the shadow economy is smallest in Madrid, the
seat of government, at 17.3 percent, and sharply larger in every
other region, hitting 31.1 percent in Extremadura.

And Spain’s economy is somewhat hobbled by government
interference. On the 2014 Index of Economic Freedom, Spain ranks at
49, and 22nd out of 43 countries in Europe. “Its score is 0.8
point lower than last year due to declines in the management of
government spending, business freedom, and labor freedom that
outweigh small improvements in trade freedom and freedom from
corruption.”

For Spaniards looking to climb out of the country’s economic
doldrums, not only are taxes high, but “Incorporating a business
takes 10 procedures and about three weeks, but completing licensing
requirements takes over seven months and costs more than the level
of average annual income. Labor regulations remain largely
inflexible hindering job growth in the private sector.”

The country has actually improved its overall economic freedom
ranking a bit over the past 20 years, but unevenly and with decline
in recent years, even as the Euro crisis made life difficult.

As they grapple with the growth of the shadow economy, Spanish
officials, like officials everywhere, will have to deal with the
fact that underground activity can develop its own inertia as
people get accustomed to living that way.

Writes
economist Friedrich Schneider (PDF):

But even major tax reforms with major tax rate deductions will
not lead to a substantial decrease of the shadow economy. Such
reforms will only be able to stabilize the size of the shadow
economy and avoid a further increase. Social networks and personal
relationships, the high profit from irregular activities and
associated investments in real and human capital are strong ties
which prevent people from transferring to the official economy.

Having given people ample reason to hide their activities and
experience in doing just that, Spain’s government may have a tough
time getting those underground entrepreneurs back into the official
economy.