The 'Shadow Sector' helped Russia overcome the effects of Western sanctions

By Rhod Mackenzie

The impact of sanctions on the Russian economy has significantly contributed to the positive impact of the shadow sector, according to an article by the Higher School of Economics.It is worth noting that the article is not so much about breaking the law as about circumventing the sanctions. How avoiding the regulatory burden helps such a business stay in the shadows. It is also able to adapt quickly to geopolitical restrictions, say HSE economists. At the same time, there is a risk of under-payment of taxes: analyst believe that the authorities should do more control the "grey" sector (various estimates put its volume at up to 11% of GDP).

How the shadow sector affects the economy
The presence of the grey sector has helped to partially mitigate the impact of sanctions on the country's economy. This is stated in the article "Russia under sanctions: the shadow economy is a factor in flexibility" by the authors of the Centre for Structural Policy Research at the National Research University at the Higher School of Economics, published in the November issue of the magazine "EKO"

The so-called 'shadow sector or grey area is capable of ensuring the creation,production and distibution of goods and services that cannot be legally produced under strict restrictions, economists at the Higher School of Economics believe. The reason for this is that the regulatory burden in the shadow economy is low, and such a business adapts quite quickly to external influences.

"Often, the government of a sanctioned economy is tolerant of the activities of the shadow sector and even loosens the controls somewhat to help firms circumvent sanctions and mitigate the shock," the authors note in the article. In the spring of 2023, in response to the departure of Western companies, Russia legalised so-called parallel imports - permission to import certain brands into the country without the consent of the rights holders, they recalled.

At the same time, shadow employment can be costly: the taxes lost can exacerbate the budget deficit, according to HSE economists. According to the Ministry of Finance, the budget deficit will amount to about 1% of GDP (about 1.5 trillion roubles) in 2023. So the government has incentives to limit the growth of informal economic activity, the authors suggest.

The article also notes that large-scale and effective mechanisms of state support and demand stimulation through state procurement, which the authorities offer in times of crisis, can reduce the motivation for "shadowisation". In general, with soft regulation, the informal sector can play the role of a stabiliser, alleviating shortages in markets for certain goods and filling niches when foreign producers leave, the HSE concludes.
What is the shadow economy?
There is no single definition of the shadow economy. It usually refers to the activities of citizens and businesses that are outside the control and accounting of government.

The authors of the HSE article understand the shadow economy as the totality of all market-economy production activities that are deliberately hidden from government authorities for one or more of the following reasons

To evade taxes and/or social security contributions;
to avoid legal labour market standards (such as minimum wages, maximum working hours, safety standards);
to avoid certain administrative procedures (filling in statistical questionnaires or administrative forms).
For workers, employment in this sector may be attractive for other reasons in addition to "saving" taxes. For example, it makes it easier to fill a vacancy: there is no bureaucracy and you can freely combine several jobs. However, this activity is not legal: for work without a contract, fines of 5-100 thousand roubles have been introduced for companies and 3-5 thousand roubles for citizens. In addition, such an employee may well not be paid and will not be able to prove that he has done the work.

The "grey" sector of the economy is difficult to quantify. Typically, the shadow economy accounts for an average of 15% of officially declared GDP in rich countries and about a third in countries with developing economies, says Pavel Sevostyano,Associate Professor of the Department of Political Analysis at the Russian Economic University. . The higher the tax pressure and the stricter the regulation, the greater the incentive to hide from it, he noted.

For Russia, there is no recent data on the size of the informal economy. According to the IMF and the World Bank for 2018, the size of the shadow sector in the Russian Federation exceeded 40%. For 2019, Rosfinmonitoring estimates this figure at 20% of GDP and Rosstat at 11.6%. The authors ditors sent an inquiry to both services. Earlier, Izvestia reportede that the Ministry of Labour at the end of 2022 identified 663 thousand Russians who worked unofficially.

The shadow economy includes not only grey imports, but also, for example, the concealment of income from tax and customs payments or "grey" salaries, noted Kirill Chernovol, a researcher at the Russia-OECD Centre of RANEPA. Such import of goods under sanctions restrictions can be useful for the economy in terms of the appearance in the country of spare parts and equipment not produced in Russia, he noted.

"At the same time, other aspects of the informal economy, such as the concealment of income and "grey" employment, have a negative impact, as they reduce the flow of funds into the budget and social insurance systems," Kirill Chernovol believes.
How to influence the informal sector
The HSE notes that the possibility of a flow of labour from the informal sector to the formal sector and vice versa is of great importance. For example, the formal economy, with the expansion of government contracts, can attract part of the workforce from the "grey" area.

Analysts urge that taxes (and other compulsory payments) should not be increased during crises, so as not to create additional demand for the black market. They also believe that it is necessary to control the stable threshold of informal turnover.

Pavel Sevostyanov of REU believes that another way to reduce the shadow economy is to promote electronic payments. . Countries where they are common tend to have a smaller grey sector, he explained. Russia is a country where investment in the digital economy is constantly growing, and this is why it is possible to reduce the share of the grey economy, the analys believes.
"Regardless of the short-term positive effects of the informal economy, a reduction in tax payments, for example, means that less money needs to be spent on healthcare, education or security," Pavel Sevostyanov concluded.

Since March 2022, the government has allowed some goods to be imported and sold without the permission of copyright holders, recalls Kirill Chernovol of RANEPA. This is a kind of whitewashing of "grey" imports, in which they will be taxed, reducing the damage to the economy, he argues.