The fall of the shadow economy
In the spring, Vladimir Putin reported a record low unemployment rate of 3.5%. At the same time, economists – both independent and pro-Kremlin – drew attention to the fact that the "shadow" sector of the economy, responsible for about a third of Russia's GDP, had collapsed. This became noticeable back in 2022, after the start of the Russian invasion of Ukraine, but now the scale of the shocks has become obvious.
Before the war, the informal sector of the economy, according to various estimates , amounted to 20 to 35% of Russia's GDP – a very high percentage compared to most developed countries, but comparable to other developing countries. By the beginning of 2022, it provided work and income to 14.5 million people (a total of 75 million people work in Russia). During the year of the war, 1.2 million people lost their jobs in the informal sector. For the shadow economy, this is a rapid decline, which has become not only the strongest shock since the COVID-19 pandemic, but also broke all records over the past 11 years. This signals acute problems in the economy.
Informal economy on fingers
The shadow, or informal, economy is a term that is perhaps understandable intuitively, but in reality is quite confusing. The invention of the concept is usually attributed to Keith Hart, an American anthropologist, who included begging, street prostitution, gathering and other illegitimate ways of earning money. Today, the International Labor Organization divides informal workers into two groups: self-employed and those working for third parties. Self-employed, firstly, some owners of small businesses can be considered, and secondly, self-employed people can be precarious workers, such as seasonal workers. Employees in the informal sector are also divided into two groups. The first are those who work "under the counter", that is, people who receive salaries "in envelopes". The other group is “side jobs”, that is, those who provide additional informal services in the company, for example, by working on weekends or overtime for unaccountable cash wages.
In Russia, in recent years, most experts agree on estimates of the volume of the informal employment market – 13-14 million people. The largest number of informal workers are employed in trade, agriculture, including hunting and fishing, construction and transportation. The shadow sector provided a huge percentage citizens of Russia with work and income, especially in certain, often poorer regions, such as the Stavropol Territory, Ingushetia or Altai. Often, gray work for most of these people was almost no alternative way to earn a living. Where formal institutions generally failed to support jobs, wages, and social guarantees, it was the “gray economy” that came to the rescue.
The shadow sector provided a huge percentage of Russian citizens with work and income
The peculiarity of the Russian economy is that many small businesses are not ready to provide all employees with a salary corresponding to at least the minimum wage, HSE researchers write. This inevitably leads to job losses in the event of minor shocks or, for example, increases in the minimum wage. In combination with small unemployment benefits, this deprives most workers of a “buffer” period after being fired to look for a new formal job and pushes the majority to look for “grey” work – there, due to the low tax burden, such shocks are a little less noticeable, and the crisis can be experienced relatively painlessly .
Reasons for the collapse of the informal sector and real unemployment
The informal sector can shrink for a variety of reasons, including positive ones such as economic growth and an increase in the number of vacancies in the formal sector. Workers in the shadow sector, if possible, will prefer official work. For them, the transition to the formal sector almost always represents a significant improvement in the social situation and quality of life: they can count on greater protection of their rights, a stable salary without delay, funded pensions and other benefits and social guarantees.
In a macroeconomic sense, the displacement of the informal sector by the formal sector also looks positive: the overall level of poverty, economic inequality, and corruption are decreasing, and the level of crime is indirectly decreasing. This is exactly what pro-Kremlin experts and journalists insist on, speaking with one voice about growing “stability” and new jobs.
However, such a scenario is not applicable to modern Russia. The informal sector is shrinking at a record pace – by more than a million people over the past year, while positive structural changes in the economy rarely occur so rapidly. The last time such a crisis was observed during the coronavirus pandemic was accompanied by a significant increase in unemployment. Then the causes of the recession were fundamentally different, but the state of the economy was generally comparable to the current one.
The shadow sector is shrinking at a record pace – by more than a million people over the past year
In fact, the majority of those who lost their jobs in the informal sector do not find official employment, but, on the contrary, remain unemployed. as evidenced by a number of statistical indicators. According to Rosstat, more than 4 million people in the country are either only partially employed or are de facto unemployed, that is, on simple or unpaid leave without being fired – and this is only when assessing the formal labor force.
In addition, there are a number of alternative sources independent of Rosstat that try to estimate the real, so-called "hidden" unemployment. They talk about the real unemployment rate in the region of 13%. This is three times higher than the official figures, writes the FT, citing FinExpertiza, the Carnegie Center and Renaissance Capital.
The real unemployment rate in Russia may reach 13%
So, the very fact of the reduction of the informal sector in Russia does not necessarily directly correlate with positive trends in the economy. For example, the largest drop in employment in the informal sector, as mentioned above, occurred against the backdrop of the “covid” crisis due to a reduction in real incomes, consumption levels and a general weakening of the labor market. The growth of informal employment in the Russian economy often suggests otherwise and accompanies periods of recovery and growth. After a fall in informal employment due to the pandemic, it began to recover in 2021, when the country began to get out of recession. The same trend was observed before: the growth of informal employment was noticeable in 2016, when the country entered the stage of slow growth after the recession; the same was in 2018 and 2019.
However, even if we discuss only the numbers of formal unemployment, they still do not quite correspond to reality – or rather, they interpret it not quite honestly. The unemployment rate in the formal sector, excluding downtime, part-time employment and other critical indicators, could well have declined. However, speaking about the growth in employment, Vladimir Putin does not mention the mobilization and active recruitment of mercenaries: at least 300,000 conscripts are now officially listed as successfully employed on a full-time basis, significantly embellishing the unemployment statistics. The second reason affects unemployment in the opposite direction, lowering official estimates of the labor force: since the beginning of the war, according to various sources, from half a million to 1.3 million people have left the country, which, of course, pro-Kremlin experts also prefer not to mention once again.
The real reason is the fall in economic activity
There is another way to test the hypothesis that the fall of the shadow sector is a positive sign, by looking at the main indicators of economic growth and activity. In addition to positive markers from the state, including a formal drop in unemployment and GDP growth – by as much as 1.2% – there are alternative economic indicators, which the Center for Economic Policy Research recently wrote about in collaboration with the ECB. Hanna Sakhno, an economist at the University of Groningen and the lead co-author of the study, told The Insider that information from Rosstat is not enough: it has begun to publish much less data on standard economic indicators, changed the methodology for the remaining ones, and also closed access to some previously open data. Hanna specifically points out one of the main shortcomings of the GDP indicator itself and the methodology for calculating it, even in conditions of full transparency:
“GDP is calculated in such a way that everything that happens in the economy, both positive and negative, for example, recovery from earthquakes or major man-made disasters, is counted in GDP growth. Military aggression, in particular, always has a positive impact on GDP.”
Indeed, Russia is actively increasing its own military spending, having increased the budget of the Ministry of Defense by at least 9% in 2022, according to the Stockholm Institute for Peace Research. At the same time, Russia itself carefully hides the structure of such expenses.
To overcome the limitations associated with estimating real GDP and the shortcomings of the indicator itself, Hanna Sakhno's team explores a number of alternative ways to measure economic activity, such as real estate prices, air traffic, consumer basket estimates, service consumption, and so on:
“One of my favorite alternative metrics is the concentration of nitrogen oxide in the air, which we get from satellite imagery from a third party. Typically high concentrations of nitrogen oxide are found around large industrial and manufacturing areas, and we economists use it as a proxy for a standard indicator of industrial activity in an economy.”
This marker, in turn, speaks openly about the growing recession, the expert adds:
“We see that this figure in Russia has fallen markedly by mid-2022 and shows no signs of resumption. This may indicate a decline in industrial production, perhaps the closure of enterprises due to reduced demand (internal and external) or broken supply chains as a result of sanctions.”
Thus, the hypothesis of economic growth and organic growth of the formal sector does not seem to be supported by independent sources. As a result, the current decline in the shadow sector, as in all previous cases, seems to be connected primarily with the recession and the reduction in economic activity – and not with the growth of stability and the emergence of new jobs, as Vladimir Putin claims. Most likely, in the face of sanctions and a failed war, the recession will deepen.
The loss of jobs in the shadow sector, in turn, will only exacerbate it. Income shocks associated with job losses hit precarious workers particularly hard due to lack of access to social programs, unemployment benefits, and a lack of savings. Moreover, during recessions, the informal sector can often become a “mitigating factor” for people, and in the case of Russia, this buffer is the first to suffer, leaving the population more vulnerable to recession, falling incomes and poverty.