Estimating the Size and Growth of Unrecorded Economic Activity in Transition Countries: A Re-evaluation of Electric Consumption Method Estimates and their Implications

39 Pages Posted: 26 Jan 2004  

Edgar L. Feige

University of Wisconsin - Madison - Department of Economics

Ivica Urban

Institute of Public Finance

Date Written: December 2003

Abstract

It is widely acknowledged that underground (unrecorded) economic activities play a major role in transition economies. Evaluations of the success and failure of the transition experience should therefore be based on total economic activity [TEA], namely, the sum of recorded and unrecorded economic activity. Substantive conclusions concerning the effects of unrecorded activities on the transition process as well as investigations of the causes and consequences of unrecorded activities have to date, relied extensively on estimates of unrecorded income based on variants of the electric consumption method [ECM] during the first half of the transition process. We first attempt to replicate these estimates employing improved data series. We then go on to extend and update alternative versions of the ECM estimates of unrecorded income for twenty five transition countries for the period 1989-2001. These new estimates enable us to examine the sensitivity of the results to alternative specifying assumptions, particularly, initial conditions. We find that our updated ECM estimates of the size of the unrecorded sector are not only highly sensitive to initial conditions, but they produce negative estimates of unrecorded income for many transition countries. Our findings are also compared to the new national accounting procedures that attempt to estimate exhaustive measures of the "non-observed economy". Our disturbing results call into question many of the substantive conclusions reached by other scholars who relied on earlier ECM estimates to draw inferences about the transition process as well as the causes and consequences of underground economies in transition. In short, while we conclude that ECM estimates of the size of the unrecorded economy are unreliable, it is still possible to use the growth rate of the unrecorded sector to make important inferences about the transition process by examining the dynamic relationship between recorded and unrecorded sectors. The extension of our data base to cover the entire transition period will hopefully result in new investigations employing panel data rather than the more traditional method of applying simple cross country test procedures.

Keywords: Underground, unreported, unrecorded, unobserved, hidden, informal, nonobserved, shadow economy, transition economies

JEL Classification: 017, O40 O5, D78, H2, H26, P20

Suggested Citation

Feige, Edgar L. and Urban, Ivica, Estimating the Size and Growth of Unrecorded Economic Activity in Transition Countries: A Re-evaluation of Electric Consumption Method Estimates and their Implications (December 2003). William Davidson Institute Working Paper No. 636. Available at SSRN: https://ssrn.com/abstract=489683 or http://dx.doi.org/10.2139/ssrn.489683

Edgar L. Feige (Contact Author)

University of Wisconsin - Madison - Department of Economics ( email )

1180 Observatory Drive
Madison, WI 53706
United States

Ivica Urban

Institute of Public Finance ( email )

Katanciceva 5
10000 Zagreb
Croatia

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