The Informal Economy: Exploring Drivers and Practices 9781138068377, 9781315158013

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The Informal Economy

During much of the twentieth century, informal employment and entrepreneurship was commonly depicted as a residue from a previous era. Its continuing presence was seen to be a sign of ‘backwardness’ whilst the formal economy represented ‘progress’. In recent decades, however, numerous studies have revealed not only that informal employment is extensive and persistent but also that it is growing relative to formal employment in many populations. Whilst in the developing world, the informal economy is often found to be the mainstream economy, nevertheless, in the developed world too, informality is currently still estimated to account for notable per cent of GDP. The Informal Economy: Exploring Drivers and Practices intends to engage with these issues, providing a much-need ‘contextualized’ approach to explain the persistence and growth of forms of informal economic practices and entrepreneurial activities in the twenty-first century. Using a diverse range of empirical case studies from Europe, Africa, North Africa and Asia, this book unpacks the different varieties of forms of informal work and entrepreneurship and provides a critical analysis of existing theorizations used to explain such phenomena. This book’s aim is to examine the nature and persistence of informal work and entrepreneurship, across a variety of empirical settings, from within the developed world, the developing world and within transformation economies within post-socialist spaces. Given its worldwide, interdisciplinary and multidisciplinary approach and recent interest in the informal economies by a number of disciplines and organizations, this book will be of vital reading to those operating in the fields of: economics, political economy and management, human and economic geography and economic anthropology and sociology as well as development studies. Ioana A. Horodnic is a Lecturer in the Faculty of Economics and Business Administration at Alexandru Ioan Cuza University of Iasi, Iasi, Romania. Peter Rodgers is a Lecturer in Strategy and International Business at Sheffield University Management School, UK. Colin C. Williams is Professor of Public Policy at Sheffield University Management School, UK. Legha Momtazian has been a Marie Curie Research Fellow at the Sheffield University Management School, UK.

Routledge Studies in Entrepreneurship Edited by Susan Marlow

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This series extends the meaning and scope of entrepreneurship by capturing new research and enquiry on economic, social, cultural and personal value creation. Entrepreneurship as value creation represents the endeavours of innovative people and organisations in creative environments that open up opportunities for developing new products, new services, new firms and new forms of policy making in different environments seeking sustainable economic growth and social development. In setting this objective the series includes books which cover a diverse range of conceptual, empirical and scholarly topics that both inform the field and push the boundaries of entrepreneurship.   6 Entrepreneurial Learning The Development of New Perspectives in Research, Education and Practice David Rae and Catherine L. Wang   7 Entrepreneurship and Knowledge Exchange Edited by Jay Mitra and John Edmondson  8 Entrepreneurship in Small Island States and Territories Edited by Godfrey Baldacchino   9 Entrepreneurship and Cluster Dynamics Edited by Cristina Boari, Tom Elfring, and F. Xavier Molina-Morales 10 The Habitual Entrepreneur Paul Westhead and Mike Wright 11 Toward Entrepreneurial Community Development Leaping Cultural and Leadership Boundaries Edited by Michael W-P Fortunato and Morgan R. Clevenger 12 The Informal Economy Exploring Drivers and Practices Edited by Ioana A. Horodnic, Peter Rodgers, Colin C. Williams and Legha Momtazian

The Informal Economy Exploring Drivers and Practices Edited by Ioana A. Horodnic, Peter Rodgers, Colin C. Williams and Legha Momtazian

First published 2018 by Routledge 711 Third Avenue, New York, NY 10017 and by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Routledge is an imprint of the Taylor & Francis Group, an informa business © 2018 Taylor & Francis The right of the editors to be identified as the authors of the editorial material, and of the authors for their individual chapters, has been asserted in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. Library of Congress Cataloging-in-Publication Data A catalog record for this book has been requested ISBN: 978-1-138-06837-7 (hbk) ISBN: 978-1-315-15801-3 (ebk) Typeset in Sabon by Apex CoVantage, LLC

Contents

List of Figures and Tables Acknowledgements

vii ix

Introduction1 IOANA A. HORODNIC, PETER RODGERS, COLIN C. WILLIAMS AND LEGHA MOMTAZIAN

PART I

The Drivers of the Informal Economy9   1 Tax Morale and Informality in Post-Socialist Contexts

11

DIANA TRAIKOVA

  2 The Many Shades of the Grey Economy in Romania

25

RODICA IANOLE-CĂLIN, CĂLIN VÂLSAN AND ELENA DRUICĂ

  3 Evaluating the Perceptions and Realities of Envelope Wage Arrangements Among Students in Moldova and Romania

41

IOANA A. HORODNIC AND COLIN C. WILLIAMS

  4 Book-Launching Informalities on the Right Side of a Nineteenth-Century Walnut Table

61

MARCELLO MOLLICA

  5 Assessing the Frequency of Informal Payments for Health Services in Lithuania ADRIAN V. HORODNIC, CLAUDIA I. CIOBANU, COLIN C. WILLIAMS AND PETER RODGERS

73

vi Contents   6 Labour Market Institutions and Undeclared Work: A Multilevel Analysis of Central and Eastern European Countries

91

ADRIANA ANAMARIA DAVIDESCU (ALEXANDRU)

PART II

The Nature/Character of the Informal Economy

115

  7 The Role of Informal Work in the Livelihood Strategies of US Households

117

EMILY J. WORNELL, LEIF JENSEN AND ANN TICKAMYER

  8 From Goods to Emotions: The Transformation of Informal Practices in the Republic of Georgia

139

COSTANZA CURRO

  9 Looking for Freedom in Grey Areas: Approaches to Informality As a Space for Negotiating Goals of Neoliberalism in Developing the Cooperation Sector

157

LIGA RUDZITE

10 Gifting Practices in Informal Trade in Response to Elites’ Rules and State Regulations on the Myanmar-Thailand Border173 BUSARIN LERTCHAVALITSAKUL

11 Bazaar and Local Governance: The Case of Legalizing Informal Economic Practices in the Batkhela Bazaar, Pakistan

191

MUHAMMAD SALMAN KHAN

12 Intrapreneurship and Capital Accumulation Knowledge Among Trainees in the Nigerian Informal Economy

211

AKEEM AYOFE AKINWALE

13 Informal Competition, Firm Productivity and Policy Reforms in Egypt

229

NESMA ALI AND BORIS NAJMAN

About the Contributors Index

255 265

Figures and Tables

Figures 1.1 3.1 5.1 6.1 6.2 10.1 10.2 13.A1

Integrated model of ethical decision making in business 15 Envelope wage practice during studentship in Moldova and Romania: Initiator and remuneration (%) 50 Predicted probability of informal payments for a ‘representative patient’ in Lithuania: By acceptability of corruption, age and NUTS III region 83 The caterpillar plot of Central and Eastern European countries101 The mean probability of participation in undeclared work activities for Central and Eastern European countries 107 Myanmar and Upper Thailand, with author’s own research site encircled 175 Trading route passing through checkposts controlled by Myanmar officers and by the Wa family 176 Sector of activity 251

Tables 1.1 3.1 3.2 3.3   3.A1 5.1

Exemplary consequence estimation for different formality scenarios18 Envelope wage practice and the willingness to accept an envelope wage agreement during studentship in Moldova and Romania 48 Envelope wages distribution amongst students in Moldova and Romania: By tax morale, job preference, socio-economic and spatial characteristics 50 Students receiving envelope wages vs. unemployed students accepting envelope wages if having a job: Logistic regressions 53 Sample distribution 59 Informal payments by patients and acceptability of corruption in Lithuania, by region 77

viii  Figures and Tables 5.2 5.3   5.A1 6.1 6.2 6.3   6.A1 7.1 7.2 7.3 7.4

7.5

10.1 12.1 12.2 12.3 12.4 12.5 13.1 13.2 13.3 13.4 13.A1 13.A2 13.A3 13.A4

Informal payments by patients and acceptability of corruption in Lithuania, by socio-economic variables 78 Logistic regressions of the propensity to make informal payments for public healthcare services in Lithuania 81 Variables used in analysis 89 The distribution of perceived risk of detection, expected sanctions and labour market institutions 99 The correlations between country-level variables and the participation in the undeclared work 102 The empirical results of multilevel logistic regression of propensity to participate in undeclared work 103 The description of country-level explanatory variables 111 Frequency and per cent of household livelihood strategies 121 Descriptive statistics of households by livelihood strategy, per cent or mean and standard deviation 122 Results of multinomial logistic regression showing correlations with household livelihood strategies choice 125 Results of multinomial logistic regression showing correlates of household livelihood strategies choice, restricted to households that are attached to the formal labour market 127 Results of multinomial logistic regression showing correlates of household livelihood strategies choice, restricted to households that are attached to the formal labour market, stratified by metropolitan status 129 Posts in Southern Shan State where Shan traders are being informally taxed 180 Socio-economic characteristics of the respondents 220 Logistic regression of socio-economic characteristics and practice of intrapreneurship 220 Opinions on the practice of intrapreneurship in fashion and furniture industries 222 The respondents’ opinions on capital accumulation knowledge224 Cross tabulation of the trainees’ own innovation and monetary rewards 224 Governorate-level indicator construction: First step estimation236 Regional indicator of informal competition intensity (IRIC) 237 IRIC and formal firms’ productivity 239 Difference-in-difference estimation 244 Regions and governorates 249 List of variables included in our regressions 250 Panel distribution 252 Productivity measures 253

Acknowledgements

This work was supported by the European Commission’s Framework 7 Industry-Academia Partnerships Programme (IAPP) under grant no. 611259 entitled ‘Out of the shadows: developing capacities and capabilities for tackling undeclared work’ (GREY). The usual disclaimers apply.

Introduction Ioana A. Horodnic, Peter Rodgers, Colin C. Williams and Legha Momtazian

During much of the twentieth century, informal employment and entrepreneurship was commonly depicted as a residue from a previous era. Its continuing presence was seen to be a sign of ‘backwardness’ whilst the formal economy represented as ‘progress’ (Geertz, 1963). In recent decades, however, numerous studies have revealed not only that informal employment is extensive and persistent but also that it is growing relative to formal employment in many populations (OECD, 2002). Indeed, Jütting and Laiglesia (2009) highlight how two-thirds (1.8 billion) of the globe’s working population work in the informal economy. Whilst in the developing world, the informal economy is thus often found to be the mainstream economy (Jütting & Laiglesia, 2009), in the developed world too informality is currently a significant component of many economies, accounting on average for 17.9% of GDP in the EU28 and 8.3% in Australia, Canada, Japan, New Zealand and the United States (Schneider, 2016). Until now, as this opening paragraph reveals, a ‘size matters’ approach has dominated the literature on the informal economy. There has been an overwhelming emphasis on quantifying its magnitude and how this varies spatially. If the informal economy is to be tackled, however, then the starting premise of this book is that there needs to be a move beyond this ‘size matters’ approach so beloved of economists. Rather, what is required is an understanding of not only the drivers of the informal economy but also its character and characteristics, manifested in the practices of informal economic activity. Unless these are clearly articulated, then policy solutions cannot be developed to address this phenomenon. This book’s primary aim is to provide a much-needed new perspective on the nature of the informal economy by evaluating not only the drivers of such work but also the multifarious practices that take place within this sphere. In doing so, the core objective is to provide a much-needed ‘contextual’ approach to explain the persistence and growth of forms of informal economic practices in the twenty-first century across the globe. Using a diverse range of empirical case studies from Europe, Africa, North America and Asia, this book unpacks the different varieties of informal work and

2  Ioana A. Horodnic et al. entrepreneurship and provides a critical analysis of the existing theorizations used to explain this phenomenon. Moreover, whilst much of the extant literature in the informal economy sub-area belongs in narrow disciplinary fields, this book provides a much-needed multidisciplinary perspective on the core research questions it addresses so as to encourage dialogue across disciplines relating to the reasons for the persistence and growth of informal economic activity across the globe in the twenty-first century. With this book, we therefore aim to move away from the mono-disciplinary and normative approach that sees informal economic practices as temporary and mere economic phenomena to be liquidated. Theoretically, this collection of empirical studies shifts theoretical debate beyond mere structuralist explanations of informality, which has characterized much of the work on the prevalence of informal economic practices in the Global South (Castells & Portes, 1989). In addition, it moves extant academic debates well beyond dualist approaches to informality/formality (informality as a mainly rural Global South phenomenon ‘withering’ away under the pressures of economic transition). Informed by the work of Routh (2011), we argue that any account of the ubiquity of informality has to encompass both ‘marginal’ activities of dubious economistic worth (subsistence agriculture for example), and subcontracted or ‘entrepreneurial’ activities linked to the formal.

Structure of the Book This book contains thirteen chapters that are divided into two main parts. In Part I, we analyze the drivers of informality, seeking to further our understanding of the explanations which drive informal economic activities. Within this part of the book, chapters touch on debates about the importance of formal and informal institutions and their relation with individuals’ choice to participate in informal work as well as focusing on the drivers that impact upon the relationship and alignment between the formal and informal institutions, such as tax morale, norms, traditions, social trust and corruption. In the second part of the book, focus turns to exploring the nature of informal economic practices. Through a series of empirical chapters, Part II demonstrates the prevalence of multifarious forms of informal work across diverse global economic landscapes. Acting as a short guide, we now provide a review of the contents of each of these two parts of this book. Seeking to examine the drivers for engagement in informal economic activity, the book starts with a chapter entitled ‘Tax Morale and Informality in Post-Socialist Contexts’, written by Diana Traikova. The main contribution of this chapter is to explore the literature on ethics, social psychology, rural development and post-socialist entrepreneurship in order to understand the way tax morale in a post-socialist context in Bulgaria is linked to the decision to work informally and prepares the ground for a new way of

Introduction  3 empirical measurement of the phenomenon. The identified aspects are integrated into a theoretical model giving structure to the supposed causality flow within the decision-making process leading to informality. ‘The Many Shades of the Grey Economy in Romania’ written by Rodica Ianole-Călin, Călin Vâlsan and Elena Druică introduces the utility of agent-based models to understand the participation of citizens from a postcommunist country, namely Romania in informal economic activities. The paper shows how, in spite of growing prosperity in the last decade or so, the incidence of informal employment and tax non-compliance has increased in Romania. The authors conclude that this appears to be the result of the interaction between cultural traditions and a strong penchant for conformity resulting in social contagion across Romanian society. The issue of tax morality is further analyzed through the lens of institutional asymmetry in the chapter ‘Evaluating the Perceptions and Realities of Envelope Wage Arrangements Among Students in Moldova and Romania’, written by Ioana Alexandra A. Horodnic and Colin C. Williams. Their contribution advances existing understanding of the prevalence, distribution and attitudes towards envelope wage arrangements (i.e. under-reported income) amongst students. Reporting the results of a survey conducted in February–March 2016 with students in Moldova and Romania, the finding is that for students currently not working, the only variable which significantly increases the likelihood of them accepting an envelope wage arrangement if they were offered a job tomorrow is their tax morality. For those students currently in employment, however, envelope wage arrangements are more common among more vulnerable groups of students (e.g. those with financial difficulties). Building on fieldwork and participant observation in Sicily in Italy, the next chapter, ‘Book-Launching Informalities on the Right Side of a Nineteenth-Century Walnut Table’ by Marcello Mollica, takes an anthropological perspective and analyzes the way publishers have changed their selling behaviour at book launches following the global economic crisis in the Sicilian city of Messina. The author reveals how multilevel uncertainty and institutional distrust produced by ambiguous practices has not just involved informal transactions, but slowly turned them into culturally accepted norms within the community, and penetrated loci previously denied to them. The next chapter, ‘Assessing the Frequency of Informal Payments for Health Services in Lithuania’, written by Adrian V. Horodnic, Claudia I. Ciobanu, Colin C. Williams and Peter Rodgers, evaluates the relationship between extra payments or valuable gifts (apart from official fees) and the level of acceptability of corruption, as well as the socio-demographic, socioeconomic and spatial variations in the tendency to offer informal payments in Lithuania. Using logistic regression analysis of data from a 2013 Eurobarometer survey, the chapter outlines how patients with a high acceptability of corruption are significantly more likely to offer informal payments for healthcare services. Meanwhile, no significant association is identified

4  Ioana A. Horodnic et al. between other socio-demographic, socio-economic and spatial characteristics (e.g., gender, household size, occupation, type of community) and the likelihood of making informal payments. The first part of the book concludes with the contribution of Adriana AnaMaria Davidescu (Alexandru), who analyzes the impact of labour market institutions on the citizen participation in undeclared work in Central and Eastern European Countries. Her contribution ‘Labour Market Institutions and Undeclared Work: A Multilevel Analysis of Central and Eastern European Countries’ draws on a 2013 Special Eurobarometer survey and uses, in addition, data on institutions, which cover active labour market policies, minimum wages, employment protection legislation (EPL), tax wedge and union density provided by Eurostat, International Labour Organizatin (ILO) and Organisation for Economic Co-operation and Development (OECD). The empirical results of a multilevel analysis highlight that labour taxation and union density increases the incidence of undeclared work, while EPL and active labour market programmes (LMP) measures were associated with lower levels of undeclared activities. The second part of the book, turning its focus onto the multifaceted nature of informal economic practices, starts with the chapter ‘The Role of Informal Work in the Livelihood Strategies of US Households’ written by Emily J. Wornell, Leif Jensen and Ann Tickamyer. Using descriptive statistics and multinomial logistic regression on data from the first national-level survey of informal work in the USA, the authors find that informal work does play an important role in the economic security of US households, and income is significantly correlated to household livelihood choice between informal work and other livelihood strategies that do not include informal work (working for an employer, receiving outside help or being formally self-employed). Additionally, livelihood strategy choice varies significantly by metropolitan status, and informal work may be more important to the economic security of households in non-metropolitan households, where returns from employed work and self-employment are not as strong. Turning attention from the developed world to a post-Soviet transition economy, the next chapter written by Costanza Curro, ‘From Goods to Emotions: The Transformation of Informal Practices in the Republic of Georgia’ analyzes two social practices, conceptualized as coping strategies, in the Republic of Georgia, supra and birzha, in the framework of informal economy. Supra is a festive meal regarded as the core of traditional hospitality; birzha refers to a form of male street socialization. Drawing upon relevant literature and ethnographic data, the chapter discusses the role of supra and birzha as practices of informal exchange which enable the circulation of material and non-material items and highlights that, following bold neoliberal reforms in the 2000s and 2010s, the role of these practices as coping strategies has largely faded away. This study suggests that supra and birzha are still crucial ways to deal with shortages of a mostly emotional kind.

Introduction  5 The second part of the book then proceeds with the chapter ‘Looking for Freedom in Grey Areas: Approaches to Informality As a Space for Negotiating Goals of Neoliberalism in Developing the Cooperation Sector’ by Liga Rudzite. The study focuses on private sector development in the development of cooperation programming. It reveals how the majority of projects within this realm over the years have aimed to organize the business sector in the recipient countries into predictable trade and investment partners, mostly proposing initiatives to formalize informal firms and practices to boost economic growth. This chapter discusses opportunities to enrich the existing development scholarship, placing informal practices within the contours of critical development theory. Based on theoretical literature, this paper explores the opportunities to theorize the role of approaches to informal practices in negotiating wider goals of development cooperation practice—either as contributing to growth or degrowth, or providing an alternative way for looking at the concept of development. The following chapter, ‘Gifting Practices in Informal Trade in Response to Elites’ Rules and State Regulations on the Myanmar-Thailand Border’, written by Busarin Lertchavalitsakul, illustrates traders’ practices in conducting small-scale trade of two particular commodities—cattle and foodstuffs—among cross-border traders in response to informal tax payments set by a former armed group on the Shan State side. The traders’ reaction to such unofficial rules involves cash payments and the offering of gifts in kind to facilitate passage into a different political arena. Crossing the border into Thailand, traders are faced with state control and routinely offer gifts and other inducements to obfuscate the meaning of commodities and gain access to the other side of the divide. The study shows that everyday cross-border transactions coexist with the interaction between the implementation and performance of state authority and traders’ proactive and reactive responses. As a result, these exchanges often blur the imaginary line between gift and bribery. The next chapter, ‘Bazaar and Local Governance: The Case of Legalizing Informal Economic Practices in the Batkhela Bazaar, Pakistan’ explores the linkages between informal economic activity at a bazaar in Pakistan and local levels of formal and informal governance. To investigate these issues, Muhammad Salman Khan reports original empirical findings from the case study of Batkhela bazaar, Pakistan. The contributions of this chapter are two-fold. First, it shows the relevance of informal marketplaces and their traders associations to formal governance structures. Second, it demonstrates, beside electoral politics, how the dynamics of power links these marketplaces to local political actors with implications for formal governance of the region. The second part continues with the chapter ‘Intrapreneurship and Capital Accumulation Knowledge Among Trainees in the Nigerian Informal Economy’ by Akeem Ayofe Akinwale, which examines intrapreneurship

6  Ioana A. Horodnic et al. and capital accumulation knowledge among trainees in the fashion and furniture industries in Lagos State, Nigeria. The theories of planned behaviour and social capital were applied to sharpen the focus of the chapter. The primary data used for the study were derived from a structured questionnaire and key informant interviews (KIIs). The questionnaire was administered to 480 trainees while the KIIs were conducted among 60 trainers including 40 masters and 20 journeymen. The data from the questionnaire were subjected to descriptive and inferential statistics, while the KIIs were analyzed through ethnographic techniques. The findings revealed the practice of intrapreneurship with evidence of capital accumulation knowledge in the study area. The book concludes by analyzing the impact of the informal sector on the formal sector. In their chapter ‘Informal Competition, Firm Productivity and Policy Reforms in Egypt’, Nesma Ali and Boris Najman investigate the effect of competition stemming from informal firms on formal firms’ productivity in Egypt. Using the World Bank’s Enterprise Surveys and an updated two-step methodology of Guiso, Sapienza and Zingales (2004), the authors build a new regional-level indicator of informal competition intensity. Their estimation reports a positive and significant effect of this indicator on formal firms’ productivity that remains valid under multiple robustness checking. Using a difference-in-difference approach, the authors provide evidence that informal firms’ cost advantage is the main driver of the reported positive effect. The results underline the importance of tax reforms and effective regulation to be implemented in Egypt. In sum, this compilation of chapters advances knowledge on both the drivers of informality and the nature of informal economic practices. In doing so, the book seeks to transcend the dominant ‘size matters’ approach, which merely examines the magnitude of the phenomenon of the informal economy. From a policy perspective, there is little doubt that if the informal economy is to be addressed seriously, then far greater knowledge is required of not only the drivers of such activity but also its diverse characteristics, manifesting itself across various economic landscapes across developed, developing and transition economies. This book reveals that a ‘one size fits all’ approach needs to be transcended in this regard. It displays the urgent need for context-bound studies which reveal not only the multifarious drivers of such activity in different places but also the need for contextbound analyses of its diverse character and characteristics. Unless such an approach is pursued, and policy solutions are tailored to the contextual circumstances, then as this book reveals, it is very unlikely that policy will be effective in addressing this large and growing phenomenon that is a persistent feature across the global economic landscape.

References Castells, M. & Portes, A. (1989). World underneath: The origins, dynamics, and effects of the informal economy. In A. [0]Portes, M. Castells, and L.A. Benton

Introduction  7 (Eds.), The informal economy: Studies in advanced and less developed countries (pp. 11–37). Baltimore, MD: The Johns Hopkins University Press. Geertz, C. (1963). Old Societies and New States: The Quest for Modernity in Asia and Africa. Glencoe, IL: Free Press. Guiso, L., Sapienza, P. & Zingales, L. (2004). Does local financial development matter? The Quarterly Journal of Economics, 119(3), 929–69. Jütting, J. P. & Laiglesia, J. R. (2009). Employment, poverty reduction and development: What’s new? In J. P. Jütting & J. R. Laiglesia (Eds.), Is informal normal? Towards more and better jobs in developing countries (17–26). Paris: OECD. Organisation for Economic Co-operation and Development (OECD). (2002). Measuring the non-observed economy. Paris: Organisation for Economic Co-operation and Development. Routh, S. (2011). Building informal workers agenda: Imagining ‘Informal Employment’ in conceptual resolution of informality. Global Labour Journal, 2(3), 208–27. Schneider, F. (2016). Estimating the size of the shadow economies of highly-developed countries: Selected new results. CESifo DICE Report, 14(4), 44–53.

Part I

The Drivers of the Informal Economy

1 Tax Morale and Informality in Post-Socialist Contexts Diana Traikova

Introduction Undeclared work (informality) is defined as paid work, which is legal in other aspects other than it is not reported to the tax-, social security- and/ or labour law authorities (Polese & Rodgers, 2011). While it gives (a shortterm) competitive advantage to the given individual or firm, it is generally seen as a problematic phenomenon, because it undermines the solidarity principle of state budgets, and disadvantages rule-obeying tax-paying citizens and companies. In their review, Williams and Franic (2016) describe two major approaches aiming to tackle undeclared work through direct controls. The deterrence (stick) approach aims at increasing the costs and diminishing the benefits of participating in the informal economy. This includes increasing the actual and perceived likelihood of detection and sanction of tax law infringement, signalling that tax evasion is a ‘bad behaviour’. The incentives (carrots) approach seeks to increase the benefits of participating in declared work in an attempt to ‘seduce’ or ‘bribe’ individuals into working formally through offering benefits, which are not accessible to the informal agents. This approach is not so widespread in post-communist countries, where it is rather the exception. There is also a third approach, which is based on indirect controls, resulting in self-regulation, motivated by the intrinsic desire of taxpayers to work formally. It is seen as the most cost-effective way for tackling undeclared work, because no expensive control measures and enforcement are needed. Instead, the focus is on normative appeals, guaranteeing redistributive and procedural justice, social fairness and tax education. There is evidence from field experiments for high effectiveness of the intrinsic motivation for tax compliance (Dwenger, Kleven, Rasul & Rincke, 2016; Torgler, 2002). Williams and Franic (2016) found that in Bulgaria, a traditional post-communist country, there is a low association between undeclared work and risk of detection and penalties, but strong association between tax morale and the participation in undeclared work. Their definition of tax morale is based on the mismatch between the formal and informal institutions in the sense of ‘rules of the game’ (North, 1991).

12  Diana Traikova Also Williams and Vorley (2014) advocate that this institutional asymmetry between formal and informal rules is a key to understanding the underperforming entrepreneurship in transition countries. Although it contains the word ‘morale’, this definition of tax morale is not precise enough to bring more concrete insights about the ethical motivation of individual decision makers, when they intentionally choose to underreport their work. The current contribution suggests that it might be useful to observe the motivation for informal work through the prism of ethics and seeks to develop a tentative new way of measurement of tax morale. For this it adopts an aggregated theoretical model, integrating individual and situational motivational factors and reflects through it on diverse aspects of informality in post-socialist societies. Why should we deal with ethics? Regarding the empirical evidence from above, intrinsic self-regulation appears as a policy cost-effective option for tackling undeclared work, but it is feasible only if people do not see informal work as legitimate. If we want to understand informality (which is used here as synonymous of undeclared work), we need to understand how people legitimate it (Webb, Tihanyi, Irland & Sirmon, 2009). For this we need to understand if citizens as potential taxpayers see informality in its different degrees as something that is wrong, or not. Ethics is about recognizing good and evil, distinguishing between good and bad, right and wrong (Ferrell, Gresham & Fraedrich, 1989). Moral judgements inform the choices (among others) of employers, employees and unemployed. When they flag undeclared work as ‘wrong’, the self-regulation mechanism will hit the ‘brakes’ and the individual will most likely try to avoid this behaviour because it will cause him/her moral disutility. In this way, moral judgements will shape the attitudes of individuals as economic actors and should influence the set of business opportunities, which will be recognized as feasible and worth exploiting under the current post-socialist system in a particular society. The author could not identify studies proposing to tackle post-socialist informality in this way, most studies on tax morale stem from developed economies. Also, a solid body of ethical decision-making literature was found, which gradually developed and fine-tuned a theoretical model of ethical decision making for the purposes of the marketing research. Although not tailor-made for the study of undeclared work, the principles of moral judgements and choice are universal and can easily be applied to the case of informality. The paper proceeds with a short overview of the core terms of this literature, in order to introduce the reader to an integrated model of ethical decision making.

Literature Review of Relevant Ethical Terms and Theories Ethics comes from the Greek ethos, meaning character. Morality comes from the Latin moralis, meaning customs or manners (Thiroux & Krasemann,

Tax Morale and Informality  13 2012). In philosophy, however, the term ethics is also used to refer to a specific area of study: the area of morality, which concentrates on human conduct and human values. A moral issue is present where a person’s actions, when freely performed, may harm or benefit others (Jones, 1991). Undeclared work harms the overall society by depriving it from tax income for financing public infrastructure and services. It also benefits the individual directly in the short term because it increases the immediate disposable income of the entrepreneurs/employees, while not excluding them from using the e.g. public infrastructure. When one also considers the accompanying aspects of work safety, child allowances, diminished pension income and other well-known consequences of informality, it is evident that it clearly has a moral component. A moral agent is a person who makes a moral decision, even though he or she may not recognize that moral issues are at stake (Jones, 1991). This could be the entrepreneur deciding to work on his or her own account without paying (part of or even the full) insurance and taxes, a firm manager adopting the envelope wages as a common business practice or a potential employee, who is considering to take up such employment, not being aware that his/her pension later will be dramatically diminished. In developed societies, the widely accepted moral rules are to a high extent embodied in the written laws. As the literature on post-socialist informal employment well illustrates, this is not the case in transitional societies. Here an ethical decision is one which is morally acceptable to the larger community—a definition similar to the one used by Jones (1991) and adopting the legitimacy idea suggested by Webb et al. (2009). But how do moral agents arrive at their moral judgements? How do they decide what is good and what is bad? For this we turn to the moral philosophy, which has crystalized two main ways of reasoning: by looking at the consequences of a certain action, and by aiming to stick to generally valid moral ‘rules’. In order to account for the contextual and individual particularities, the situational and personal characteristics of the moral agents (potential taxpayers or evaders) should be considered. Each of these will be shortly introduced. Teleological (Consequentialist) Moral Philosophies In this moral view, all that counts for the goodness or badness of an act are the consequences. If there are several ways to solve an ethical problem, the moral agent should choose the one that leads to the best consequences (highest good and minimum bad). This sounds simple, but goes with some complications. We need to be aware that humans have only limited cognitive capacity and no perfect information. This means that most likely only a subset of the possible consequences will be identified, and maybe some of them will be anticipated in a wrong way. Differences in ethical decisions may be traced, in part, to differences in the set of perceived alternatives

14  Diana Traikova and their consequences. Another complication is the lack of clarity when it comes to whom the moral agent will take as a reference: the best for the self (moral egoism) or the best for all, for the society as a whole (utilitarianism). Also, it is very costly to investigate and estimate the consequences for the others without knowing their situation, preferences, needs, priorities, etc. In contrast, teleolologists believe that each moral act may look different, depending on the particular situation and context. They are against absolute rules. For example, telling the truth about tax evasion might be ethical in one situation, but not so in another, where this will lead to e.g. shutting down the business of a friend, who is the single bread winner for his family. Deontological (Non-Consequentialist) Moral Philosophies Deontologists are not concerned with the consequences, but aim to stick to some set of true and valid universal moral rules, believing that they are a warranty for ethical decisions. Every individual has a different set and ranking of rules she/he has accepted as worth obeying. These deontological norms mirror the personal values for moral behaviour and are contingent on the experienced socialization and the life course to date. For example there are the rules not to kill, to be honest, not to steal, not to cheat, to treat people justly, etc. (Hunt & Vitell, 2006). These can be universally valid norms or community-specific rules, which have proven efficient in governing e.g. the community life. It would be interesting here to probe for them in relation to tax compliance. Integrated Model for Predicting Moral Decisions Rational ethical decision making is only possible after an ethical dilemma (issue) has been recognized. There are several popular ethical decision-making models in the literature describing the solution of such dilemmas, which are partly overlapping. They have been reviewed in Ferrell et al. (1989). To extract the maximum explanatory power from each of them, these authors suggested aggregating the models and including only their nonredundant components. The building blocks for this consist of Kohlberg’s (1969) famous Model of Moral Development, Ferrell and Gresham’s (1985) Contingency Model of Ethical Decision Making and Hunt and Vitell’s (1986) General Theory of Marketing Ethics. The result of this aggregation is shown in Figure 1.1 below. Although not really new, this framework has remained unnoticed by the scholars of informality and tax morale. In the face of lacking clear understanding of what is the key of legitimation of undeclared work, it delivers detail-rich and relevant-for-the-practice insights, which are for now scarce in the field.

Tax Morale and Informality  15

Figure 1.1 Integrated model of ethical decision making in business Source: Adapted from Ferrell et al., 1989, p. 60.

Observing Post-Socialist Informality Through the Integrated Model Lens Every conscious business decision is embedded in a context. People live in societies and the rules for interacting and behaving there are installed over time in a way that facilitates the more or less smooth and sustainable functioning of the particular society. In transitional contexts, this adjustment of the rules is more dynamic, and sometimes the written (formal) rules are dysfunctional and are not obeyed that strictly as in more developed societies. When formal and informal institutions send contradicting signals about the acceptability of certain means and ends, we observe institutional incongruence/asymmetry (Webb et al., 2009; Williams & Vorley, 2014). The current paper proposes that how individuals choose in such ambiguous situations depends, among others, on their moral codes and personal ethics and this has implications for the spread of undeclared work as a business practice. This perspective is novel and deepens our understanding of the different nuances scholars of informality have observed so far. Recognizing the Moral Dilemma and Moral Disengagement Before any moral judgement can take place, the individuals should recognize that there is a moral issue in a given situation. All three theoretical

16  Diana Traikova models mentioned above agree on that. As defined before, a moral issue is present where a person’s actions, when freely performed, may harm or benefit others (Jones, 1991). If post-socialist citizens don’t see the practice of undeclared work as benefiting or harming others, they will not engage in its moral estimation and will not arrive at any moral judgement. This is called ‘moral disengagement’ (Bandura, 1999) and is quite common because moral dilemmas are unpleasant and accompanied by dissonance and high energy costs for their solving. Through moral disengagement individuals are freed from the self-sanctions and accompanying guilt that would ensue when the behaviour violates internal standards, and they are therefore more likely to make unethical decisions (Detert, Treviño & Sweitzer, 2008). Moral disengagement comes in different flavours. For instance, through moral justification people can rationalize harm to others in ways that make it appear morally acceptable. Think of hiring people informally and not paying them for sick leave with the reasoning that they would be unemployed otherwise, and be worse-off without the informal employment. With advantageous comparison, unethical behaviours are contrasted with even more harmful conduct, thus making the original behaviour to appear in a better light. So, the practice of envelope wages (having contract for a lower than the real wage and paying the difference to the employee in cash without reporting it to the tax and insurance authorities) can be seen favourably as compared to fully working without any formal contract, because it gives at least access to health insurance and some social benefits compared to the full informality. Another variety of disengagement is observed when individuals view their behaviours as a direct result of authoritative dictates (e.g. accountants of semi-formal firms change the numbers in the tax statements because their boss told them to do so); they may displace responsibility for their actions to the authority figure, negating any personal accountability for the unfavourable act (Detert et al., 2008). Also, adverse group behaviour may trigger diffusion of responsibility because no group member feels personally liable for the collective’s harmful behaviour. Knowing that working informally while receiving unemployment benefits is a widespread practice helps to avoid the feeling of guilt. Another way for moral disengagement is the ‘us versus them’ mind-set. When citizens feel exploited by the mafia, which is embodied in the government, they also don’t feel obliged to pay the taxes (partially or at all) and don’t undergo the complex ethical decision-making process. Crucial for the recognition of the moral issue as such is the ‘moral intensity’ (Jones, 1991). It is linked to an intuitive estimation of the sum of the harms and/or benefits of the moral act in question. Many moral issues are quite trivial in terms of consequences and fail to trigger the effortful decision-making process with a detailed mapping of all perceived consequences. When moral dilemmas are faced, intuitively recognized as serious consequences, they are more likely to prompt ethical behaviour than are the modest consequences (Jones, 1991). The decision to accept a short-term seasonal informal job will be less morally intense than a decision to commit for a

Tax Morale and Informality  17 longer term or to whistle blow the informal activities of a competitor firm, which provides employment for many families.

Personal Moral Development Kohlberg (1969) has suggested a model of the way moral decision making evolves and becomes more sophisticated over the lifetime. It has been extensively tested and verified (Trevino, 1986) and despite some criticism (Vitz, 1994), it is one of the prominent models in the field of moral reasoning. Kohlberg’s focus is on the reasons the individuals use to justify a moral choice and not on the content of the actual choice. Moral reasoning transforms from early childhood to adulthood. Kohlberg suggests three levels of moral development, each with two stages. With time, a person transits from stage to stage in an invariant irreversible sequence. At stages one and two (named ‘preconventional’), an individual is concerned with rewards and punishments and their own immediate interests. At stages three and four (named ‘conventional’), the benchmark for ‘right’ is the expectations of the larger society or some segment of it, like a family or a peer group. More specifically, at stage three one is interested in the opinion of the significant others, while at stage four the laws and the trends in the society as a whole are getting the focus of interest. At stages five and six (known also as the ‘principal level’), the individual sees beyond norms, laws or the authority of groups and individuals. According to Kohlberg, less than one-fifth of the USA population reaches the highest level of moral development. With regard to undeclared work, the particular level of moral development might be associated with different propensity to respond to diverse policy measures. For example, individuals at the punishment and rewards stage will be more receptive to deterrence measures, while those at the higher levels (principal) might be prone to follow the intrinsic motivation to comply, given the tax system is really serving to a higher degree the common good. It has been found that exposure to moral dilemmas and peers who are at a higher moral stage promote the moral development of the particular individual (Trevino, 1986). This can be utilized to raise the sensitivity to tax issues as morally loaded.

Possible Perceived Consequences Once the option for undeclared work has been identified as a moral issue, the moral agents will eventually try to come up with a list of possible behaviours and to estimate the consequences of each of the scenarios. The details of this part of the model are informed by the Hunt and Vitell theory (2006). For applying this theory, one should see the different degrees of formality as possible scenarios. For example, one can work fully formally and pay all due taxes and insurances, work semi-formally (as in the case of envelope wages) and pay just part of the due deductions or fully informally (without leaving any written record for the business activity) and avoid any

18  Diana Traikova contribution to the state budget. Then the possible consequences should be mapped. A simplified illustrative overview for the three levels of formality in post-socialist context is given in Table 1.1. Then, Hunt and Vitell suggest that for each consequence, its probability, desirability and the people affected will be analyzed. For example, not paying pension contributions affects the self, the immediate family and household members, but also the current beneficiaries of the pension system, which are unknown to the moral agent. Depending on his/her moral development and feeling of solidarity, different weights will be put to the different group of actors affected by the possible behaviour. Also, some actually relevant groups might be ‘forgotten’ and not considered while making the decision to work informally. Then the benefits and the losses for each of the groups are balanced and registered mentally. The final teleological (consequential) evaluation is informed by all three probabilities, desirability of the consequences and the importance in the perceived as affected stakeholders in order to arrive at the ethical judgement about the goodness or badness of the particular informality option (Hunt & Vitell, 2006). Table 1.1 Exemplary consequence estimation for different formality scenarios Full formality

Semi-formality (envelope wages)

Full informality

Costs for registration fees. Paperwork, accounting (time costs).

Cost for registration fees.

No registration costs.

Double accounting needed—more paperwork (time costs). Some more immediately disposable income from withheld tax/insurance contributions. Protection in court in case of contract violation to the degree of reported payments.

Less paperwork, accounting voluntary (less time costs). All the generated income is kept in the firm for spending.

Less immediately disposable income. Protection in court in case of contract violation.

Prospects to get higher pension.

Prospects to get the minimal pensions or just above it.

Full solidarity with the society—paying for public services and infrastructure.

Partial solidarity with the society—limited contribution to public services and infrastructure.

Not possible to rely on formal judicial system. Reliance on reputation and private contract enforcement (eventual violence). Prospects to get the very minimum on social pension only—poverty in old age. No solidarity—zero contributions to the social system.

Full formality

Semi-formality (envelope wages)

Full informality

Nothing to hide in case of audit, but high probability for controls, since on record. Need to follow the changes in the laws and to do costly adjustments (e.g. higher hygiene regulations require investments in costly installations). Access to the formal bank system and diverse support programmes. Sophisticated financial instruments applicable.

Something to hide, but legal façade in case of audit. More risky audits, and control attention unavoidable, since on record. Need to fulfil the legal requirements and eventual costly adjustments needed if legislation changes.

Pressure to stay invisible for the state administration—a control that may be fatal for the business. Danger from whistle blowers or random checks. Bribes and connections crucial for continuing business operations.

Access to the formal bank system and support possible, but lower credit ranking because of the lower income declared. Some transactions must be in cash. Possibility to work with both formal and informal suppliers, likely to stay below the VAT registration threshold. Less funds for financing the decisions of the government. Minimal or relatively low social benefits for employees. Labour legislation still applies and slows down eventual layoffs, but less costly. Employees are protected, but less unemployment money.

Ideally, all transactions must be in cash for preventing traceability and control attention. No access to official support programmes.

Need to work with formally registered suppliers for reimbursing VAT (interesting for larger firms). Financing the decisions of the government. Social benefits for the employees. Costly layoffs and slow restructuring ability. Employees are protected. Prospects of downsizing costs slows down upscaling.

Formal advertising possible. Growth possible if desired.

Source: Own presentation.

Formal advertising possible. Growth possible but only to some degree.

Pressure to work with informal suppliers and trusted business partners only. Reliance on reputation and high transaction costs. Not paying for financing the decisions of the government. Not paying any social benefits to employees, unless voluntary. Highest flexibility degree for down-/up-sizing. No compensations for layoffs enforceable, but employees can work undetected and receive unemployment benefits/wages from previous/parallel formal contracts. Reliance on mouthto-mouth adverts. Pressure to stay small—growth unlikely.

20  Diana Traikova Evaluation Against the Personal Moral Code Deontology as moral philosophy prescribes the reliance of some ultimate valid rules and advises to ignore the consequences. These rules may be established e.g. by religion, some personal authority, or higher intelligent instance (divine). Examples are the famous Kantian Golden Rule ‘Do not do to the others what you do not want to experience yourself’ or the ten commandments of the Bible. During communist times, the Party was the single authority setting the rules. The reliance on formal rules was strongly negated after the fall of communism, and the trend towards individualization and rebelling against the central government’s decisions took momentum in the turbulent years after the beginning of the transition. The ideological content of the communist textbooks was quickly removed and replaced with more pro-market statements. After all, the collective undertakings turned out to be part of an ineffective redistributive system. Many entrepreneurs embraced the new market freedom and tried their luck in the post-socialist capitalism aiming to avoid the state as much as possible. As the author sees it, currently the post-socialist societies favour the power of the market, celebrate the visible symbols of economic success and prosperity and pay much less attention to the socially weak and the economically dependent ones. At the same time the desire for safety, security and ‘going back to the roots’ is fuelling the rediscovery of the pre-communist family traditions. This ‘swing’ from one extreme to another is likely to be tempered by the disappointment of the less successful market actors and the underfunded social systems that are not able to cushion the business failure of some individuals and render the dreamt ‘bright future’ as ‘brutal capitalism’. As time passes by, the young transitional generations witness how well-educated and once successful members of the society quickly fall to a level where they need to scavenge the garbage bins or work informally on the side just to make ends meet despite receiving a pension. Against this backdrop, it is difficult to come up with a ranking of the relevant moral rules post-socialist citizens follow, in order to arrive at their moral judgements about undeclared work. This question should be investigated empirically. For example, it would be interesting to see to what degree the informally working feel that what they do is just, if they are grateful to the state and to the other workers who fully pay taxes or don’t care. Deontological thinkers do not provide guidelines for the case when the different rules contradict each other, and thus deontological reasoning alone might be problematic in the practice. For example, if one is supposed always to tell the truth, then under-reporting would be clearly immoral. At the same time paying fully the taxes and insurances might be accompanied with the feeling of being exploited. This contradicts the reparation and justice rules. If one sees under-reporting as means to get compensated, then under-reporting becomes moral. More systematic research is needed to enlighten these perceptions and eventually come up with a pattern and ranking of these rules for the respective society.

Tax Morale and Informality  21 Situational Moderators The literature suggests that the way individuals reason about what is moral depends also on the situation. In the Hunt and Vitell model (2006) there are constructs accounting for cultural, industry and organizational environments, capturing the specifics that might guide the choice of the optimal degree of formality/informality. The culture may be seen as reflecting the social consensus about if under-reporting work is an evil or a good act. Moral reasoning is triggered only when people can make a choice. Sometimes external circumstances ‘push’ individuals into undeclared work. For example, it was a popular practice in the beginning of transition in some Balkan countries to work for some employers who delayed the wages and did not pay for the tax and insurance contributions of their employees. In such a situation, the workers are deprived from the possibility to make a moral choice. The situation may also determine the temporal immediacy of the consequences of the potentially immoral act. The further in the future they are, the more likely that people will be ‘tempted’ into unethical behaviour (Jones, 1991). One can think about the delayed effect on diminished or lacking pension contributions on the eventual pension one will receive if/when reaching pension age. The concentration of the effect (Jones, 1991) is also important for moral reasoning. The more the benefits of paying contributions are spread among numerous beneficiaries, the less they should feel the improvement/ worsening of paying/non-paying taxes (‘a drop in the sea’ argument). Proximity of the expected consequences also guides moral choices (Jones, 1991). The knowledge that the tax contributions are not used to make a local hospital, but e.g. are spent for improving the motorways which are passing hundreds of kilometres from where one lives, may diminish the motivation to contribute (unless the solidarity feeling is high). Ferrell and Gresham (1985) propose also the recognition of an opportunity as a factor-influencing ethical choice. Decisions about what type of behaviour is appropriate in any given situation are viewed as being influenced by the opportunity for the individual to engage in unethical or ethical behaviour. If it is easy and not risky to evade taxes and insurances, one might opt for this otherwise ‘unethical’ choice. Individual Moderators Individual factors as professional background, personal bribing- or taxevading experience may influence the inclination to undeclared work. It would be also interesting to control for gender, years of schooling, and career path and income situation of the decision makers. Moral Intentions and Behaviour All three models used in the synthesized framework introduced above agree in that moral judgements are translated into moral intentions and only

22  Diana Traikova then are transformed (if in the actual control of the individual) into actual observable behaviour. This holds for any rational behaviour and lines up with the Theory of Planned Behaviour of Ajzen, 1991; Dubinsky & Loken, 1989; Fishbein & Ajzen (2010). Intentions are usually measured as a stated probability for conducting certain behaviour. For example, if the moral agent arrives at the conclusion that informal employment is immoral (without being prescriptive here!), she or he may be not ready to accept such job offers. This should be reflected in the stated intention to start an informal work. Still, sometimes people act against their moral convictions (because of too high rewards of the unethical choice or simply because of lack of choice). Then they feel guilty as described by Hunt and Vitell (2006). It is well documented that intentions are not a perfect predictor of behaviour, but still one of the best ones we have so far (Fishbein & Ajzen, 2010). Once the behaviour is conducted, people estimate the consequences. How did it go? Did the negative expected effects kick in? How about the positive ones? Was it a matter of luck or it was well controlled by the individual? If repeated, how likely is it that the same result will be reproduced? This feedback informs the personal experience, which is a sub-aspect of the individual moderators (see Figure 1.1).

Concluding Remarks The paper contributes to the fast-growing literature on undeclared work in Eastern Europe and post-socialist societies by offering an ethical view on the phenomenon through a well-developed theoretical work, borrowed from the field of ethics and marketing. Although still in the initial stages of conceptual development, the suggested framework can be fine-tuned for the field of informality—the model is universally applicable and easily overbridges the disciplines. It still needs to be fleshed up with questions, developed particularly for the investigation of informal work, but it opens a promising, detail-rich and still under-investigated look at the phenomenon. Future research should continue with the development of scenarios and testable hypotheses for a survey instrument, with the aim to come up with a moral profile of those planning to work informally or semi-formally. Only after understanding the legitimation logic of undeclared work can the government design effective measures to tackle it.

References Ajzen, I. (1991). The theory of planned behavior. Organizational Behavior and Human Decision Processes, 50, 179–211. Bandura, A. (1999). Moral disengagement in the perpetration of inhumanities. Personality and Social Psychology Review, 3(3), 193–209. Detert, J. R., Treviño, L. K. & Sweitzer, V. L. (2008). Moral disengagement in ethical decision making: A study of antecedents and outcomes. Journal of Applied Psychology, 93(2), 374–91.

Tax Morale and Informality  23 Dubinsky, A. J. & Loken, B. (1989). Analyzing ethical decision making in marketing. Journal of Business Research, 19(2), 83–107. Dwenger, N., Kleven, H., Rasul, I. & Rincke, J. (2016). Extrinsic and intrinsic motivations for tax compliance: Evidence from a field experiment in Germany. American Economic Journal: Economic Policy, 8(3), 203–32. Ferrell, O. C. & Gresham, L. G. (1985). A contingency framework for understanding ethical decision making in marketing. Journal of Marketing, 49(3), 87–96. Ferrell, O. C., Gresham, L. G. & Fraedrich, J. (1989). A synthesis of ethical decision models for marketing. Journal of Macromarketing, 9(2), 55–64. Fishbein, M. & Ajzen, I. (2010). Predicting and changing behavior: The reasoned action approach. New York: Psychology Press. Hunt, S. D. & Vitell, S. (1986). A general theory of marketing ethics. Journal of Macromarketing, 6(1), 5–16. Hunt, S. D. & Vitell, S. J. (2006). The general theory of marketing ethics: A revision and three questions. Journal of Macromarketing, 26(2), 143–153. Jones, T. M. (1991). Ethical decision making by individuals in organizations: An issue-contingent model. The Academy of Management Review, 16(2), 366–95. Kohlberg, L. (1969). Stage and sequence: The cognitive-developmental approach to socialization. In D. A. Goslin (Ed.), Handbook of socialization theory research (pp. 347–480). Chicago: Rand McNally. North, D. (1991). Institutions. Journal of Economic Perspectives, 5(1), 97–112. Polese, A. & Rodgers, P. (2011). Surviving post-socialism: The role of informal economic practices. International Journal of Sociology and Social Policy, 31(11/12), 612–18. Thiroux, J. P. & Krasemann, K. W. (2012). Ethics: Theory and practice (11th ed.). Boston: Pearson. Torgler, B. (2002). Speaking to theorists and searching for facts: Tax morale and tax compliance in experiments. Journal of Economic Surveys, 16(5), 657–83. Trevino, L. K. (1986). Ethical decision making in organizations: A person-situation interactionist model. The Academy of Management Review, 11(3), 601–17. Vitz, P. C. (1994). Critiques of Kohlberg’s model of moral develoopment: A summary. Revista Española De Pedagogía, 52(197), 5–35. Webb, J. W., Tihanyi, L., Irland, R. D. & Sirmon, D. G. (2009). You say illegal, I say legitimate: Entrepreneurship in the informal economy. Academy of Management Review, 34(2), 492–510. Williams, C. C. & Franic, J. (2016). Beyond a deterrence approach towards the undeclared economy: Some lessons from Bulgaria. Journal of Balkan and Near Eastern Studies, 18(1), 90–106. Williams, N. & Vorley, T. (2014). Institutional asymmetry: How formal and informal institutions affect entrepreneurship in Bulgaria. International Small Business Journal,33(8), 840–61.

2 The Many Shades of the Grey Economy in Romania Rodica Ianole-Călin, Călin Vâlsan and Elena Druică

Introduction: Why Is the Grey Economy an Issue for Romania? The grey economy is currently considered a structural feature of European Union, so much so that it has become an important item on the EU agenda (Renooy, 2007). It is relatively difficult to provide a precise and satisfying definition for undeclared work and the grey economy (Horodnic, 2010), but there is an emerging consensus that it incorporates all paid, legal activities, but unreported to the corresponding tax authorities (Special Eurobarometer, 2014). As a consequence, one can consider undeclared work and the grey economy as a specific case of tax non-compliance, manifested by tax avoidance, tax evasion or both. This practice is usually perpetrated by employers when they under-report the number of employees, the time worked, or both. The phenomenon seems to be omnipresent, but there are important differences between Western and Eastern Europe. The grey economy represents a significant quantity in the case of developed economies such as the UK, Germany, France, Italy, Spain and so on, and it is measured in hundreds of billions of dollars. When measured against the official economy, however, it represents only a small fraction thereof. Compare this with Central and Eastern Europe where the grey economy is between 15% and 31% of the official economy (Schneider & Enste, 2000; Schneider, Buehn & Montenegro, 2010; Williams, 2014). There is no doubt that informal employment and tax noncompliance are much more pervasive and have a much stronger impact on the smaller economies of the Easter European countries (Hazans, 2011). The differences do not stop here. In Western Europe, the grey economy is largely associated with a strong consumption component (Special Eurobarometer, 2014) while in Central and Eastern Europe, undeclared work and under-reported income are much more prevalent. A frequently mentioned motive for tax non-compliance seems to be associated with a desire to reduce the price levels for the goods and services representing the outcome of undeclared work. About 60% of the population in 28 European countries mentions this reason (Special Eurobarometer, 2014). Be that as it may, there are, however, other important contributing factors. These factors

26  Rodica Ianole-Călin et al. include, but are not limited to the level of social trust, social and cultural norms, and a number of social contagion mechanisms. Despite the economic significance, the research on undeclared work and tax non-compliance is surprisingly limited, and there are barely any insights into their diffusion mechanisms (Williams, Windebank, Baric & Nadin, 2013). The methods traditionally used to assess undeclared work fall under two main categories: analysis and comparison of aggregate macroeconomic data (this approach results in over-estimation and does not allow for a thorough evaluation of the socio-economic context); and surveys (this approach results in underestimation, especially in Central and Eastern Europe). In this paper, we are attempting to discuss the issues surrounding tax evasion and non-compliance stemming from undeclared work in the case of Romania, which is considered to be one of the European Union countries in which this phenomenon is the most prevalent. To be more precise, the country appears to be the second largest offender among the European Union countries, with a grey economy registering 28.4% of the official one (Schneider, 2013). It goes without saying that a large grey economy is skewing the way in which the public and policy makers perceive social and economic outcomes. Bringing things into broad daylight would certainly help to reduce the bias in economic performance metrics and would provide a clearer and more accurate depiction of extant inequalities, the nature of market competition and the tax system (Arezzo, 2014). The stakes associated with this phenomenon are high. On the one hand, the informal economy is distorting official statistics and can result in misguided economic and social policies. If policy makers ground their decisions in distorted metrics, the results will most likely disappoint. If, however, they reject the accuracy of the available information, decision making can become arbitrary. Either way there is a high chance that economic and social policies would not be effective. On the other hand, the informal economy has a significant impact on the character of the free markets that emerge. After a long period in which free economic initiative was relentlessly stifled, it is crucial that Romania, along with neighbouring former communist countries, nurture a strong entrepreneurial sector. There is plenty of evidence suggesting that the entrepreneurial ethos and a vibrant, dynamic economy go hand in hand. Entrepreneurship is essential for a well-functioning and prosperous market economy. As it will be shown later, Romanians have never truly forsaken their entrepreneurship spirit. Under the pressure of political, economic and social constraints it has taken alternative forms, manifested in non-compliance and tax evasion. After all, the grey economy represents the telltale of a lively underground entrepreneurial sector, but there is a twist. Williams and Vorley (2014) make the case that in the former communist countries of Eastern Europe there is an asymmetry between formal and informal institutions. Informal rules have been slow to catch up with the changing institutional landscape; this gap is detrimental to entrepreneurship

The Many Shades of the Grey Economy  27 and eventually threatens to undermine economic growth. There is no doubt that this phenomenon is present in Romania as well, but it is not clear whether here informal rules are merely slow to follow, or they are deviating altogether. The danger looming over the Romanian economy in the wake of this persistent gap is that a deviant underground entrepreneurship sector would result in a severely distorted market dynamic. At its core, entrepreneurship represents a high-risk endeavour. Recent studies paint a very dramatic picture of the average life expectancy of corporations (Daepp et al., 2015). Only a small fraction of entrepreneurs make it past the first few years of operations. A great many start-ups fail to thrive and go bust. This, however, does not extinguish the entrepreneurial ethos. Entrepreneurs have some very particular die-hard qualities. They embrace self-reliance, self-agency and are willing to assume significant responsibilities and costs even when the deck is stacked against them; or perhaps, precisely because they like to defy the odds. In the case of Romania, the danger is that underground entrepreneurship might distort the traditional risk and reward relationship as we know it. In the grey market, the Romanian entrepreneur who is short on economic assets and opportunities is now buying a call option whose premium is represented by the expected sanctions incurred if caught. Business risk is thus hedged and replaced with administrative risk, and the bulk of negative externalities are shifted on the shoulders of taxpayers. Romania acceded to the European Union in 2007, and in theory EU membership meant a boost to formal institutions in a bid to attain administrative harmonization and economic integration. One of the thorniest issues surrounding the accession process was fighting corruption and enforcing the rule of law. Obviously, the country passed the test, but barely. In theory, the institutional and political pressure brought about by the integration into the European Union should have reduced the asymmetry between the formal and the informal economy. However, this is not what appears to be happening. As it will be discussed later, it looks like in some instances the incidence of non-compliance has in fact increased. It is possible that the extra-layer of bureaucratic constraints might have in fact reduced the opportunity cost of non-compliance. It is not clear in the end what is the link between EU membership and the grey economy. In the next sections, we will debate the determinants of the grey economy. We start by analyzing economic factors: the choices made by economic agents stemming from the trade-off between the costs and the benefits of non-compliance. When referencing the scarce data that links the grey economy to income, demographics, education and economic development, there appears to be enough evidence indicating that, as expected, economic factors play an important role. At the same time, there are strong indications that social norms and culture represent another part of the informal economy puzzle. Romania has a strong cultural tradition in which rejection of authority, lack of social trust, simulated compliance and a drive towards

28  Rodica Ianole-Călin et al. social conformity are interwoven in a very intricate pattern of social norms. The chronic lack of social trust and the penchant for rejecting any form of authority while pretending to comply could explain why non-compliance has endured for so long. The strong drive towards conformity could explain why non-compliance, far from withering on the vine might be in fact gaining momentum, assuming new forms and directions. We explain the phenomenon of social contagion most likely responsible for the growth of non-compliance with the help of Agent-Based Models (ABM). Finally, in the last section, we conclude our discussion while briefly debating the extent to which economic and social policies can make a difference in the short-run.

The Role of Economic Factors There is a modest stream of economic literature that posits tax evasion as the result of rational and self-interested decision making (Allingham & Sandmo, 1972). This notion is also reflected in the rational behaviour model of crime proposed by Becker (1993). Economic agents are costs minimizers who evaluate comparatively the tax rate, the probability of getting caught and the opportunity cost, that is, the corresponding losses entailed by the applicable administrative and civil sanctions. This model has received criticisms from various quarters because many serious offences, including violent crimes, genocide, etc. are the result of deviant behaviour (such as psychopathy) and are more readily explained by socio-psychological rather than economic factors (Cameron, 1988; Garoupa, 2003; Hayward, 2007). There is no doubt that this criticism is valid, but not all crimes need be explained by the same mechanism. In the case of economic crimes, such as tax evasion, advancing an explanation that resorts to an economic costbenefit analysis makes more sense. Whether a premeditated, cold-blooded cost-benefit calculation is in itself an indication of deviant behaviour is a completely different matter, but in any case, it does not preclude or exclude the main economic argument. One should mention here the argument that economic crimes in particular are very sensitive to the nature and strength of the penalty imposed in order to curb their occurrence. A carrot and stick approach to enforcing and increasing tax compliance represents a mixed bag and might eventually backfire resulting in higher non-compliance rates (Walsh, 2013). In theory, administrative and monetary penalties appear to be a good tool when applied to an ideal, pure competition market environment. In the presence of incomplete contracts they might produce unexpected and counterintuitive results (Gneezy & Rustichini, 2000). An approach based solely on incentives to comply and sanctions for not complying in order to solve the problem would fall under a pool equilibrium structure and would polarize individual behaviour: either comply fully or not at all (Lewis, Carrera, Cullis & Jones, 2009). This type of approach is more or less framing tax evasion as the equivalent of participating in an illegal gamble, which is by and

The Many Shades of the Grey Economy  29 large inaccurate. This is clearly an oversimplified picture, lacking realism, which is not capable of capturing the many shades of grey between compliance and non-compliance. There are many cases of voluntary compliance even in the presence of inefficient detection mechanisms or weak sanctions that cannot be accounted for by this model. Conversely, there are many cases of non-compliance even in the presence of stringent detection mechanisms and draconian penalties. One should also add to the array of relevant economic factors variables such as the complexity of the tax code, the quality of public spending and the credibility of fiscal authorities in the tax collection process (Arezzo, 2014). Given the complex interaction among all these factors, it is sometimes difficult to ascertain the best combination between economic incentives and enforcement that would result in the greatest disincentive to cheat. Romania represents an interesting case because it is one of the poorest countries in Europe and holds a fairly complicated tax regulation, Byzantine bureaucracy and a justice system that has been criticized for being corrupt and inefficient (Ristei, 2010). Judging by economic factors alone, there appears to be a strong incentive for tax evasion and non-compliance. The opportunity cost from playing by the rules can be significant in a country where income per capita is amongst the lowest. Dodging the government can take many forms, some of which are very subtle while others can be more blunt. As a general rule, undeclared work is performed without the appropriate labour standards, partially or totally unregistered, or masked through civil conventions in order to conceal the real number of hours worked per day (Comaniciu, 2014). A 2010 survey of households puts the number of self-reported employment at 5.7 million, while official government statistics show only 4.8 million employed (Pisică, 2011). The difference obviously belongs in the grey market. Most of the time, however, individuals have a legal employment contract consistent with the current minimal labour standard, specifying a minimal number of hours and the minimum pay allowed by the law. In reality, the legal contract is supplemented with informal employment clauses, based on verbal agreements between the employer and the employee (Stănilă et al., 2015). The subsequent work goes above and beyond the terms stipulated in the formal contract. The employee ends up receiving a significant amount of pay informally, pay that is not declared by either party, and hence not taxed by the government. The Romanian Center for Urban Social Studies has conducted a survey in 2015, finding that 44% of the rural and 38% of the urban population have purchased goods and services informally, without any official contract or receipt, from individuals working in the grey market. These products and services obviously do not appear in any official statistics and go untaxed, as does the income realized by those who provide them. There are no contributions made to unemployment insurance or social security. The fact that city dwellers are less likely to seek informal employment is suggesting that

30  Rodica Ianole-Călin et al. indeed, economic factors are at play here. There is a significant income gap between the rural and the urban population. Furthermore, the residents of Bucharest, the city with the highest income per capita in the country, are the least likely to seek informal employment (Vasile & Pisică, 2011). It is very telling that since 2000, income per capita has steadily increased in the larger Bucharest metropolitan area, while grey market employment has declined from 177,000 to 42,000 individuals in 2013. On a nationwide level, the south, representing the poorest region of the country, has the highest rate of participation in the grey labour market. Transylvania, where income per capita is above the national average, has a lower rate of informal employment than the national average. It is also interesting that married individuals are less likely to join in the grey employment market, yet as the size of the family increases, the situation changes. In fact, the likelihood of seeking informal employment grows directly proportional with the number of children per couple. This makes economic sense because the costs of raising a child are much more significant, and increase much faster than child tax benefits, family allowances and subsidies provided by the government. An industry breakdown of the scarce grey market statistics provides further insights into the role of economic factors. The least likely to engage in informal employment are those providing services and finance, that is, economic sectors where employment income tends to be high and very high (Vasile & Pisică, 2011). These are among the most heavily regulated sectors in the economy, with multiple checks and balances, making detection and enforcement easier. Last but not least, the nature of the economic activity imposes a natural restriction on the type of services that could be delivered informally. While it is easy to offer small repairs and renovation services informally, it is extremely unlikely to be able to offer informal banking and mortgage lending services without a large and well-organized infrastructure; except, of course, in the case of organized crime syndicates. At the other end, the most likely to engage in informal employment are those working in construction, agriculture and manufacturing. A breakdown of the goods and services purchased informally matches only to a certain extent the profile of those who are employed in the grey market, revealing that in Romania, non-compliance and tax evasion is a complex phenomenon, taking many forms, some of which go well beyond informal employment. Among the goods and services most often acquired in the grey market, we find residential and commercial renovations (26% of all informal purchases), farming and other agricultural services (19%) and food (14%) (Stănilă et al., 2015). It was somewhat expected that renovations would top the list, because they are the most amenable to tax evasion. It is hard to enforce compliance in an area where it is all too easy for work to go undetected, undeclared and hence untaxed, especially when it comes to residential renovations; residential renovations do not require complex contracts, and verbal agreements

The Many Shades of the Grey Economy  31 are sufficient in a majority of situations. It is also the type of work easy to fit in one’s busy schedule when the individual doing it already has an official full-time job. Last but not least, it is a work that requires a moderate to high level of skills, yet most of the time very little education, and commands reasonably good hourly rates. Agriculture is another sector where seasonal, part-time and informal labour is widely used because detection and enforcement are very difficult due to the nature of the work, and more importantly, due to the low level of remuneration. Before the communist period, Romania was mostly an agrarian economy, with the majority of the active population self-employed, each family working its own small and sometimes fragmented tract of land (Răvar & Capătă, 2013). During communism, agriculture was supposed to become intensive, modern, efficient and consolidated into large and very large farms. In reality, the process of collectivization that was accompanied by a massive industrialization resulted in a massive migration of the young workforce from all rural areas to a few major urban centres. This left behind very few who could do real work, and three decades of socialized and centrally planned farming later, Romania turned from a net exporter into a net importer of agricultural products (Balasan, 2013). The communist government tried to stave off the exodus of labour into urban areas, but its misguided and largely arbitrary measures could not redress the situation. By 1989, Romanian agriculture was in shambles, with a shrinking, aging and uneducated workforce, antiquated technology and depleted soil. After the fall of communism, rural areas continued to become increasingly impoverished, as labour migration to urban centres continued, this time drawn by the appeal of commerce and retail business. Agriculture remains to this day among the sectors with the lowest level of education, income and remuneration. Here, the cost of negotiating, registering and, in some situations, enforcing labour contracts would probably surpass the remuneration and other economic benefits generated by the work itself. Food products acquired informally come as a natural extension of the situation present in agriculture. Sometimes, there are small surpluses that do not warrant the effort and costs required by formal contracts and official distribution chains. However, there is also a cultural component to be considered here, one that reveals a very special relationship that Romanians had and still have with their food supply, as it will be discussed later. The level of education is another factor determining the propensity to seek informal employment and/or engage in tax evasion. Better education translates into a higher probability of playing by the rules. It is also true that better education results in better employment opportunities, and higher paying jobs, reducing the incentive to seek informal employment and supplemental income. From a gender perspective, men are more likely to evade paying taxes and seek informal employment, although younger individuals are less likely to do so. This is not easy to understand by simply appealing to purely economic factors. It might be the case that age and education are

32  Rodica Ianole-Călin et al. not only a proxy for economic factors, but also for cultural and other more subtle social influences. It is in this direction that one needs to look next.

Social Norms While economic factors are very compelling as discussed earlier, they don’t provide a complete account of the grey market, non-compliance and tax evasion. There is still a significant gap between fiscal policies and tax enforcement regimes, on the one hand, and subjective tax attitudes and fiscal consciousness on the other. Cullis and Lewis (1997) muse over the cost-benefit explanation to compliance behaviour while remarking that ‘the economic approach has obvious analytic appeal but lacks realism and humanity’ (p. 309). It makes a lot of sense to conceptualize a broader explanatory framework of influences and look beyond economic and financial variables, as individuals are not isolated entities whose behaviour is driven solely by rational choice. The range of non-economic factors is vast and has significant depth and breadth, including personal values, attitudes, perceptions, social norms, morality, social capital and political regime, to name the more obvious ones. Together, they form an intricate web of interactions. Social norms, through their shared perspective regarding correct, incorrect actions in different contexts, act as major determinants of tax compliance and undeclared work (Ostrorn, 2000; Torgler, 2003). Their influence can be exerted both internally—in terms of values related to honesty, fairness and truth—and externally, reflecting the prevailing views on social conformity. It is interesting that the resulting behaviour can be assimilated into prospect theories as long as one allows for framing taxes as losses and/or gains (Cullis, Jones & Savoia, 2012). There is one intriguing question pertaining to the relationship between social norms and compliance: are social norms eliciting to a certain extent compliant behaviour (somewhat not in line with the predictions of rational analysis), or is it rather the endurance of compliant behaviour that triggers the proliferations of social norms? Most likely, the relationship must be a two-way street. However, it is useful to make the distinction between descriptive norms that define what people do on average in a particular context, and injunctive norms that delineate the behaviours that would be commended or disliked in a larger social context (Cialdini, Reno & Kallgren, 1990). When approached from this angle, social norms generating tax compliance or the lack thereof should be considered descriptive norms, while social learning by observing the behaviour of other individuals probably belongs to the category of injunctive norms. It has been noted that a stronger identification of the individual who does the learning with those being observed and emulated leads to a stronger influence on the observer (Gino, Ayal & Ariely, 2009).

The Many Shades of the Grey Economy  33

Cultural Attitudes and Social Trust Social norms and learned moral habits lead to the formation of social trust, which significantly lowers the cost of collective action beyond kinship. It makes sense to posit that a higher level of social trust could lead to less tax evasion. It is not clear, however, whether undeclared work, although overlapping with tax evasion to a certain extent, would see a lower incidence (Sorensen, 2011). If tax evasion can be seen an individual decision, undeclared work is framed as a game with at least two players: a seller and a buyer of (undeclared) labour. Here, the higher levels of social trust might lead in the opposite direction: a higher level of social trust would generate more undeclared work. Moreover, when trust is strong but has a short radius, not extending beyond kinship, the result would be a lower level of trust in public institutions (Arezzo, 2014). The lack of broader social capital will act as a catalyst, leading to an increase in undeclared work, especially in atomized societies and economies dominated by small, family enterprises. Romania is a country where the radius of trust extends very little beyond the family, and the drive towards conformity is relatively strong. This allows one to distinguish between a strong, homegrown, cultural tradition of noncompliance manifested as feigned compliance and the phenomenon of social contagion. The low level of social trust is the result of a complex set of historical circumstances in which the Balkan nation has found itself over the last centuries. Medieval, and later modern Romania often found itself smack in the middle of political, territorial and economic feuds among the larger and much more powerful next-door neighbours. Often treated as noman’s land, or as a bargain chip in the countless power games among the Ottoman, the Russian and the Hapsburg Empires, divided Romanians had to endure, not only political but also cultural oppression. Every neighbouring power tried to siphon off as many economic resources as possible, at times through outright pillage, and other times through various taxes, levies and increasingly large sums of protection money, in exchange for a modicum of political and social leeway. The Sublime Ottoman Porte called these sums tributes, and ruthlessly enforced their payment through military force. Later on, after World War II, the communist period brought back economic hardship in a different form. Capitalists, peasants and even the middle class were expropriated of most of their wealth, and a rigidly planned and managed economy descended behind the iron curtain. The better part of the economy was represented by the heavy industry—outdated and technologically backward (Borzan, 2010). It produced and exported low grade steel, massive quantities of fertilizers, and many other industrial products that sold at rock bottom prices on Western markets. Agriculture had to endure the trials and tribulations of forced collectivization. It too had to export an increasing fraction of a constantly declining crop of grains, fruits and vegetables, and other food products. By the 1980s, both food staples and consumer goods were in very short supply.

34  Rodica Ianole-Călin et al. The informal market always had a special significance for peasants and rural areas. In the not-so-distant past, agriculture still represented the larger portion of the economy, and the late remnants of an antiquated feudal system lingered well into the twentieth century. Informal employment and informal market transactions were allowing many poor peasants to mitigate the burden of numerous taxes and duties. Second, because famine and food shortages were so frequent throughout history, Romanians developed a special relationship with their food supply, going at great lengths to shield it and protect it from the rapacious hands of foreign invaders, landlords and central authorities. To this day, many Romanians still prize food staples acquired outside the official market, not only because they are cheaper and evade taxation, but also because they represent an element of emotional comfort and a reliable anchor during troubled times. When considering the recurrent pattern of political, economic and social hardship, it comes as no surprise that non-compliance, tax evasion and the black market have become outlets for a stifled economy. The only way in which people could have ever hoped to lead a life that had at least the appearance of normality was through dodging the iron fist of the landlord or the government, seen as predatory, corrupt and insensitive to the plight of ordinary citizens. Under the false appearance of compliance and docility, the same ordinary citizens became masters of evading the scrutiny of the central authority and fuelled a subterranean market that at times became the only available safety net. Over the years, they learned to carry on with their lives. Feigned compliance became a coping mechanism, a survival strategy that outlived its main historical ‘raison d’etre’, and endured long after communism was gone. It is no coincidence then that Romania is ranking high among the European countries with the largest informal economies. The legacy of feigned compliance, however, entails another not so enviable a record. There is a direct relationship between the relative size of the informal economy and overall corruption. This might be so because non-compliance already represents a form of rejection of authority. From here to corruption, there is only one degree of separation. The 2014 Corruption Perception Index ranks Romania among the first four countries in Europe, and among the first 70 in the world (Corruption Perception Index, 2014). The informal economy and corruption move together, but corruption tends to have a more pronounced social and cultural dimension. Yet an additional consequence of the tumultuous past is a very strong drive towards social and cultural conformity. Conformity represents another coping mechanism that has several important survival advantages. On the one hand, there is strength in numbers. Sticking together, shoulder to shoulder with one’s brethren instils a robust feeling of security, and, at the same time, makes for a stronger voice. On the other hand, social and cultural conformity is the natural complement of feigned compliance; it makes individuals who evade taxation less conspicuous. The last thing one would want to do

The Many Shades of the Grey Economy  35 when cheating the taxman is to stick out like a sore thumb. The preference for social conformity is a universal constant, present at all times, and in all nations on Earth, for it is part of human nature. In the case of former communist countries of Eastern Europe, especially Romania, it has a special significance and an added intensity resulting in a peculiar social dynamic. In the early 1990s the country began the transition to a free market economy with a strong cultural heritage favouring a large and persistent grey market. It is extremely interesting what happened next. According to the Inspectorate for Labour and Fiscal Council, there were approximately 239,000 individuals in the grey economy in 1996, representing about 4.4% of the total workforce. By 2012, this number had swelled to 1,440,000, representing 23% of the workforce. It is not clear if enforcement and penalties became harsher or even more predictable than in the recent past. It is certain, however that after 2000, income per capita has steadily grown and Romania is now considered a country with a medium to high level of development. If anything, rational individuals should have been swayed into increased compliance by the newfound prosperity, albeit modest when compared with that of Western European countries. Following cost-benefit considerations alone, economic growth and the integration into the European Union should have reduced, not increased, the workforce employed in the grey market. It is hard to believe that social and cultural factors remained totally silent. In a country with such an intense drive towards conformity, this probably represents a glaring case of social contagion, notwithstanding economic motives. Individual and the resulting aggregate behaviour towards compliance and undeclared work changed with time as learned moral habits and social norms evolved under the influence of transition events.

Social Contagion It is probably useful to take a brief moment and provide a cursory summary of the mechanism underlying social contagion. The dynamic of this phenomenon is not at all trivial and the implications are sometimes surprising. Social contagion, like any type of contagion, takes place in a network of agents. The phenomenon can be therefore understood with the help of agent-based models (ABM) that are designed to capture precisely this type of interaction. Here, one does not have to make hard assumptions about the nature of factors—economic, social, cultural or political—and rational individual behaviour is not a requirement for understanding the aggregate behaviour of the system. Whether individual behaviour is rational or not becomes irrelevant. There is a quite a range of models of social contagion, but among those, a special class of models dealing with language learning is among the simplest and easiest to follow. At its core, this type of model explores how the properties of language users, that is, network agents, and the structure of the social networks can affect the course of language change. This is particularly relevant in the case

36  Rodica Ianole-Călin et al. of countries like Romania because the dynamic surrounding conformity is comparable to that of learning a new language when faced with a social context in which two or more competing languages are spoken. In order to adapt this model to understanding the broader economic and social behaviour of the network, one simply has to consider the grammar used by the agents as the equivalent of utility functions. One type of grammar stands for a utility function defined in terms of boundless rationality that is associated with agents with a preference for complying (grammar 0); and the other type of grammar stands for an utility function defined in terms of bounded rationality that takes into consideration social conformity, and is associated with agents with a preference for not complying (grammar 1). As a result, there are two distinct sources of utility: the first is represented by matching the desired course of action with the preference of the individual, and the second one is represented by matching the desired course of action with the prevailing social conformity norm. The language change ABM explores the social contagion mechanism in the latter case, when noncompliance becomes the result of adhering to a standard or surrounding pattern of social behaviour (Myles & Naylor, 1996). Individuals interact with each other based on the pattern of available connections. The network is formed through preferential attachment: agents enter the network one by one and seek to connect with those who already have many connections. In a social context this behaviour is highly intuitive, as individuals in general seek acceptance by and membership to groups that are mainstream and representative. The model can be run in three regimes. Under regime 1, individual behaviour can only exist in two distinct modalities, and individual agents switch their behaviour between compliance and non-compliance (or declaring or not declaring work), depending on their most proximate individual interaction. Under regime 2, individual agents switch from one type of behaviour to another, only when a pre-specified proportion of its neighbours are already displaying that behaviour. Under regime 3, the choice of behaviour is not materialized right away, but rather becomes manifested in the updated probability of displaying one behaviour or the other. Upon receiving input from its neighbours, the propensity towards either compliance or non-compliance increases, so that the agent in question will be more likely to adopt it in the next iteration (Wilensky, 1999). The model allows for a sink-state under regimes 1 and 2, which means that once the agent has adopted one of the two behaviour types allowed (to comply or not comply), he/she cannot switch back. It is debatable whether this represents a realistic assumption, but it has been shown that social norms are sticky, and they tend to persist for relatively long periods. The third regime allows for an intensity parameter α, used to model the salience of social conformity; and a logistic function used to model the adoption of a new utility function. The intensity parameter α can take values from 0 to 0.05 and it only becomes active when the logistic function is

The Many Shades of the Grey Economy  37 also active. Together they generate a bias in favour of supporting social conformity, that is, non-compliance and/or evasion. As α gets bigger, agents will tend to adopt the dominant social norm at an increasing rate and speed. The size of the network obviously influences the speed at which social norms and cultural biases take hold; yet the initial proportion of non-compliant agents and the salience coefficient α are central to understanding the direction in which this spread will take place. One should note that social contagion can go both ways, and the initial conditions of the system matter a lot. For initial proportions of non-compliance under 40%, it is also possible that compliance might spread throughout the network, becoming the dominant social norm. The power of social norms can be clearly seen in the cases where the initial proportion of non-compliant agents is set at 25%, and the salience coefficient α is set above 0.03. The adoption of new social norms occurs slowly, but eventually spreads throughout the entire network, with a handful of large hubs emerging. When the initial proportion of non-compliant agents is dominant, and the salience coefficient α is set above 0.03, the spread of non-compliance is almost instantaneous. The notions of slow and fast are relative, depending on the correspondence between the length of one iteration and actual time in real life. Romania started its transition to a free market economy with a high initial proportion of non-compliant agents, and with social norms engendering an intense drive towards conformity, (that is, with a high salience parameter). The dynamic between economic factors—such as salaries, income and enforcement, on the one hand—and cultural attitudes, lack of social and institutional trust, and a propensity towards social conformity on the other hand combined to make Romania into one of the most nurturing environments for a vigorous grey economy.

Concluding Remarks The topics of undeclared work and grey economy are extremely interesting, because they represent a textbook example of truly free markets, clear of any sort of regulation or administrative interference; yet they go relatively unnoticed in the economic literature, partly because there is little data available for research. These markets are partially governed by the actions of rational agents, who seek informal employment and evade taxation when the expected utility of economic benefits associated with non-compliance surpasses its costs. The benefits are represented by tax savings and otherwise unencumbered income, and the costs are represented by administrative and economic penalties. As such, poverty, a stifling bureaucracy, over-regulation and lax enforcement are powerful drivers of non-compliance. On the other hand, the behaviour of all individuals is governed to a certain extent by culture, learned moral habits and social norms, all of which

38  Rodica Ianole-Călin et al. represent a marked departure from rationality. Even when economic incentives might be weak, a pervasive cultural tradition that prescribes low social trust, conformity and the rejection of authority could readily result in non-compliance. The grey economy is present in all countries and all historical periods. Among those, the case of post-communist economies of Eastern Europe, in particular Romania, is captivating. Here, both economic and cultural factors have combined in a perfect storm to make the grey market roughly onefourth of the country’s GDP. This relatively small Balkan nation is poorer than most European countries, and has a pervasive cultural tradition that prescribes low social trust, conformity as a survival mechanism and the rejection of authority. Low income per capita provides the economic incentive for the grey economy, a cultural tradition based on lack of social trust and rejection of authority ensures its continuity, and a strong drive towards conformity fuels social contagion. The implementation of policy measures aimed at reducing informal unemployment and non-compliance is indeed a daunting task. Its benefits are obvious: think only of the higher tax revenues that the government could invest back into healthcare, education and other social programmes. Besides the obvious implications for policy decision making, the extant asymmetry between formal and informal institutions can distort the functioning of free markets and undermine long-term economic growth. It is not entirely clear what impact the accession to the European Union had on non-compliance and the grey economy. There is no question that Romania has experienced economic growth and a significant increase in prosperity in the last two decades or so. Unfortunately, in spite of recent growth in per capita income and wealth, there are other forces that offset the economic progress that has been made since the fall of communism. Lax enforcement, the persistence of corruption and a cultural context that favours social contagion have increased the incidence of non-compliance in the last decade or so. There is a silver lining, however: social contagion can work in both directions as illustrated by the agent-based, language-learning model. All it takes is the right set of conditions, which in practice might translate into gradual shifts in attitudes, social dynamic, level of trust and interaction patterns. Nonetheless, it is doubtful that one can programmatically steer cultural attitudes and moral habits. The last time it was tried in Romania it was the communist government who sought to eradicate individualism and opportunism by means of propaganda and administrative directives. The result was disastrous, as society rejected most of the values associated with communism. The rise in non-compliance in Romania can be traced back to those misguided policies. As much as one would want to sway the social and economic dynamic for the better, the inescapable conclusion remains that one cannot hurry time. Things will probably happen at their own pace, but it would be nice if one could find ways to nudge them in the right direction.

The Many Shades of the Grey Economy  39

References Allingham, M. G. & Sandmo, A. (1972). Income tax evasion: A theoretical analysis. Journal of Public Economics, 1(3–4), 323–38. Aquino, K. & Reed II, A. (2002). The self-importance of moral identity. Journal of Personality and Social Psychology, 83(6), 1423. Arezzo, M. F. (2014). Social capital and undeclared work: An empirical analysis in Italy from 1998 to 2008. Social Indicators Research, 118(2), 695–709. Balasan, A. C. (2013). Romania’s foreign trade between 1945 and 1989. CES Working Papers, 1, 1–11. Becker, G. S. (1993). Nobel lecture: The economic way of looking at behavior. Journal of Political Economy, 101(3), 385–409. Borzan, S. C. (2010). Politica economică din România comunistă în procesul industrializării 1948–1989: studiu de caz zona Dej-Gherla (Doctoral Dissertation). Cameron, S. (1988). The economics of crime deterrence: A survey of theory and evidence. Kyklos, 41(2), 301–23. Chirinko, R. S. (1990). Altruism, egoism, and the role of social capital in the private provision of public goods. Economics & Politics, 2(3), 275–90. Cialdini, R. B., Reno, R. R. & Kallgren, C. A. (1990). A focus theory of normative conduct: Recycling the concept of norms to reduce littering in public places. Journal of personality and social psychology, 58(6), 1015. Comaniciu, C. (2014). Theoretical and pragmatic approaches of undeclared work in Romania. Procedia Economics and Finance, 16, 198–205. Corruption Perception Index. (2014). Retrieved from www.transparency.org/ research/cpi/overview Cullis, J., Jones, P. & Savoia, A. (2012). Social norms and tax compliance: Framing the decision to pay tax. The Journal of Socio-Economics, 41(2), 159–68. Cullis, J. G. & Lewis, A. (1997). Why people pay taxes: From a conventional economic model to a model of social convention. Journal of economic psychology, 18(2), 305–21. Daepp, M.I.G., Hamilton, M. J., West, G. B. & Bettencourt, L.M.A. (2015). The mortality of companies. Journal of the Royal Society Interface, 12(106). doi:10.1098/rsif.2015.0120 Garoupa, N. (2003). Behavioral economic analysis of crime: A critical review. European Journal of Law and Economics, 15(1), 5–15. Gino, F., Ayal, S. & Ariely, D. (2009). Contagion and differentiation in unethical behavior: The effect of one bad apple on the barrel. Psychological science, 20(3), 393–8. Gneezy, U. & Rustichini, A. (2000). A fine is a price. The Journal of Legal Studies, 29(1), 1–17. Gordon, J. P. (1989). Individual morality and reputation costs as deterrents to tax evasion. European Economic Review, 33(4), 797–805. Hayward, K. (2007). Situational crime prevention and its discontents: Rational choice theory versus the “culture of now”. Social Policy & Administration, 41(3), 232–50. Hazans, M. (2011). Informal workers across Europe: Evidence from 30 European countries (World Bank Policy Research Working Paper, 5912). Horodnic, A. V. (2010). Official economy—underground economy relationship from the perspective of sustainable development (in Romanian). In G. C. Pascariu, R. Frunza & C. Alupului (Eds.), European union, global governance and sustainable development (pp. 232–9). Jean Monnet Conference (4th edition), 14–15 May. Iasi: Alexandru Ioan Cuza University Publishing House.

40  Rodica Ianole-Călin et al. Lewis, A., Carrera, S., Cullis, J. & Jones, P. (2009). Individual, cognitive and cultural differences in tax compliance: UK and Italy compared. Journal of Economic Psychology, 30(3), 431–45. Myles, G. D. & Naylor, R. A. (1996). A model of tax evasion with group conformity and social customs. European Journal of Political Economy, 12(1), 49–66. Ostrorn, E. (2000). Collective action and the evolution of social noms. The Journal of Economic Perspectives, 14(3), 137–58. Pisică, S. (2011). Sectorul informal pe piaţa muncii (PhD Thesis). National Institute of Economic Research Costin C. Kiriţescu. Răvar, I. & Capăţă, M. (2013). Produsul social, cheltuielile materiale şi venitul naţional al României în anii 1859, 1900 şi 1912. Comparaţii 1938 faţă de 1912. Romanian Statistical Review, 6, 78–84. Retrieved from www.revistadestatistica. ro/wp-content/uploads/2014/02/rrs_06_2013_a6ro.pdf Renooy, P. (2007). Undeclared work: A new source of employment? International Journal of Sociology and Social Policy, 27(5/6), 250–6. Ristei, M. (2010). The politics of corruption: Political will and the rule of law in post-communist Romania. Journal of Communist Studies and Transition Politics, 26(3), 341–62. Schneider, F. (2013). Size and development of the shadow economy of 31 European and 5 other OECD countries from 2003 to 2013: A further decline. Linz: Johannes Kepler Universität. Schneider, F., Buehn, A. & Montenegro, C. E. (2010). New estimates for the shadow economies all over the world. International Economic Journal, 24(4), 443–61. Schneider, M. F. & Enste, D. (2000). Shadow economies around the world: Size, causes, and consequences. Journal of Economic Literature, 30(1), 77–114. Sørensen, J.F.L. (2011). Undeclared work: A dark side of social trust? The Journal of Socio-Economics, 40(6), 888–94. Special Eurobarometer 402. (2014). Undeclared work in the European Union. Retrieved from http://ec.europa.eu/public_opinion/archives/ebs/ebs_402_en.pdf Stănilă, L., Vasilescu, M. D., Cristescu, A., Popescu, M. E., Davidescu, A. A. & Ghinararu, C. (2015). Evaluări ale dimensiunii muncii nedeclarate: Abordări micro şi macroeconomice. Bucharest: Editura Universitară. Torgler, B. (2003). To evade taxes or not to evade: That is the question. The Journal of Socio-Economics, 32(3), 283–302. Vasile, V. & Pisică, S. (2011). Trends of employment in informal sector in Romania during crisis. Economic and social effects. Annals of the University of Oradea: Economic Science, 20(2), 234–53. Walsh, K. (2013). Understanding taxpayer behaviour—new opportunities for tax administration. The Economic and Social Review, 43(3, Autumn), 451–75. Wilensky, U. (1999). NetLogo. (ccl.northwestern.edu/netlogo). Evanston: Center for Connected Learning and Computer Based Modeling. Williams, C. C. (2014). Explaining cross-national variations in the size of the shadow economy in Central and Eastern Europe. Debatte: Journal of Contemporary Central and Eastern Europe, 22(2), 241–58. Williams, C. C., Windebank, J., Baric, M. & Nadin, S. (2013). Public policy innovations: The case of undeclared work. Management Decision, 51(6), 1161–75. Williams, N. & Vorley, T. (2014). Institutional asymmetry: How formal and informal institutions affect entrepreneurship in Bulgaria. International Small Business Journal, 33(8), 840–61.

3 Evaluating the Perceptions and Realities of Envelope Wage Arrangements Among Students in Moldova and Romania Ioana A. Horodnic and Colin C. Williams Introduction In order to reduce labour costs, employers have increasingly turned to the undeclared economy, such as by outsourcing work to this sphere, employing off-the-books workers, or not declaring fully their employees’ wages (Williams, 2014). In transition economies, under-reporting employees’ wages is used by a large share of employers (Horodnic, 2010). In doing so, they reduce their tax and social security payments and, therefore, labour costs by paying employees two wages: an official declared salary, which is detailed in a formal written contract, and an additional undeclared ‘envelope wage’ via a verbal unwritten agreement (Chavdarova, 2014; Williams, 2009; Woolfson, 2007). Indeed, a study in Baltic countries, which analyzed three components of the shadow economy—namely unreported business income, unreported employees and envelope wages—concluded that envelope wages represent a high share of the shadow economy. Envelope wages represent 52.3% of the shadow economy in Estonia, 42.9% in Lithuania and 39.2% in Latvia (Putniṇš & Sauka, 2015). The way in which this practice operates is that when employees are appointed, employers reach an agreement with employees on an official declared salary which is detailed in their formal written contract but, additionally, come to a verbal agreement about the receipt of an undeclared envelope wage which is hidden from the authorities for tax and social security purposes. The instigation of this illegal labour practice usually occurs at the job interview stage. Alongside the agreement to pay an official declared wage detailed in a formal written contract, the employer at the same time reaches a verbal unwritten agreement to pay an additional undeclared (envelope) wage based on a shared understanding that this verbal unwritten contract supersedes the formal written contract (Chavdarova, 2014; Williams, 2009; Woolfson, 2007). Of course, verbal agreements per se are not illegitimate, and in many nations hold the same credence in law as written agreements. However, this particular verbal agreement with the employee to pay an additional undeclared (‘envelope’) wage is illegitimate because both parties are mutually agreeing to fraudulently under-report the salary earned

42  Ioana A. Horodnic and Colin C. Williams by the employee in order to evade the full tax and social security dues owed by the employer and employee (Williams & Horodnic, 2017; Williams & Horodnic, 2015a). Examining what is known about the prevalence and distribution of this illegal wage practice, most previous studies reveal little since they have been small-scale studies conducted mostly in specific countries in Central and Eastern Europe. Nevertheless, some clues about the extensiveness of this practice can be extracted. For example, the share of employees reported receiving an envelope wage from their formal employer is 9.6% in Estonia, 11.7% in Lithuania, 22.5% in Latvia (Putniṇš & Sauka, 2015), 30% in Ukraine (Williams, 2007) and 60% in Moscow (Williams & Round, 2007). More extensive studies, using data from Eurobarometer surveys in 2007 and 2013 reveal that in 2007, across transition economies, Romania had the highest share of employees receiving envelope wages (22%) while the Czech Republic had the smallest share (3%) (Williams & Padmore, 2013). In 2013, the share of people receiving envelope wages in East-Central Europe decreased in all countries, except for Slovakia and the Czech Republic (Williams & Horodnic, 2015a). Even if at a first glance, it might be expected that employees would welcome such arrangements with their employers because otherwise they would not have a job or their salaries would be lower if the employer had to pay the full tax and social security contributions due, at EU level evidence shows that only one employee in three is happy with such an arrangement (Williams, 2009). It is usually the employers which impose this wage practice onto employees as a condition for obtaining the job. For employees, accepting under-reported wages reduces their entitlement to credit, pensions and social protection and also results in employers imposing additional conditions. For governments such arrangements result in lost public revenues (Williams & Padmore, 2013). There is also evidence that not all employee groups are equally likely to receive such wages. Envelope wages are most prevalent among vulnerable groups, such as younger persons, manual workers and the lower paid (Williams & Padmore, 2013). Across transition economies in East-Central Europe the finding is that those of retirement age are more likely to receive envelope wages, and so too are those with fewer years in formal education and those who have financial difficulties (i.e. difficulties in paying the household bills most of the time) (Williams & Horodnic, 2015a). Therefore, the tentative finding is that vulnerable employees are more likely to accept envelope wage arrangements and thus are more likely to be targeted by employers. Previous studies explaining this practice draw upon three theories of the wider undeclared economy to understand salary under-reporting. First, the ‘modernization’ thesis holds that undeclared work practices are more prevalent in less developed economies and reduce with economic development and the modernization of government. Second, a ‘neoliberal’ school

Envelope Wage Arrangements Among Students  43 of thought regards undeclared work practices as a result of high taxes and too much state interference in the free market. Third and finally, a ‘political economy’ thesis has asserted, in stark contrast, that envelope wages result from inadequate state intervention in work and welfare arrangements, which leaves workers less than fully protected (for a broader debate please see Williams & Horodnic, 2015a; Schneider & Williams, 2013). However, these theories that highlight country-level structural causes of this illegitimate practice fail to explain why some citizens in a certain country accept this arrangement and others do not. In other words, they fail to take agency into account in their explanations. Therefore, more recent studies advance a new way of explaining and tackling ‘envelope wage’ practices and the undeclared economy grounded in an institutional perspective. According to this new theory, under-reporting of salaries results from the asymmetry between the formal written rules and the unwritten socially shared rules not only at an individual level but also at a societal level (Williams & Horodnic, 2015a). As such, salary under-reporting results from employers and employees not adhering to the written codified laws and regulations and adopting unwritten verbal agreements that violate the formal written agreement. The aim of this paper is to test the validity of this institutional asymmetry explanation by examining a particular vulnerable population (i.e. students in two less affluent countries, namely Romania and Moldova). The novelty of this study is that it compares the likelihood of a student accepting envelope wages in a hypothetical scenario where no constraints and/or negotiation with the employer took place, with the actual likelihood of receiving a part of the wage cash-in-hand when the student was in reality employed in this manner. So far as the authors are aware, moreover, there is no previous study investigating the prevalence of envelope wages amongst students. This is rather surprising considering that a large number of previous studies on the informal economy as a whole show that along with other weak and vulnerable groups, students are more likely to be involved in undeclared activities rather than regular jobs (Olarinmoye, 2016; Williams, 2011; Feld & Schneider, 2010; Chavdarova, 2003; Hanousek & Palda, 2003; Schneider, 2003; Stefanov, n.d.). Renooy, Ivarsson, van der Wusten-Gritsai and Meijer (2004) underline that weak and vulnerable categories such as women, students and the formally unemployed usually obtain worse positions, lower pay and work longer hours than other groups. Yet other studies question the voluntariness of informal activities conducted by vulnerable groups and note that it is important to acknowledge that that for some groups (i.e. students), non-standard employment arrangements are preferred, while other groups undertake undeclared activities due to a lack of alternatives (Nikulin, 2016; Venn, 2008). Pfau-Effinger (2009) emphasizes that undeclared work is more attractive for students considering that their primary status as students offers them full insurance (including medical) and therefore they have less interest in a formal employment agreement.

44  Ioana A. Horodnic and Colin C. Williams The paper continues with introducing the data, variables and methodology used and then reports the results. The final section comprises the implications of the findings.

Methodology Population and Sample To evaluate which students are more likely to accept envelope wages, an online survey was conducted during February and March 2016 among students of the Faculty of Economics and Business Administration at Alexandru Ioan Cuza University of Iaşi. According to the Faculty of Economics and Business Administration (FEAA) internal records, during the academic year 2015–2016, 5,844 full-time students (both undergraduate and master programme/PhD programme) were enrolled in the main centre of the Faculty in Iaşi, Romania and 353 full-time students were enrolled in the regional centre in Bălţi, Moldova (no PhD programme available), of which 70% were females and 30% males. To establish the size of the representative sample needed, we used the following approach (Sullivan, n.d., Boston Univeristy School of Public Health; Penn State Eberly College of Science): n=

Z 2 * p * (1 − p) E2

Where: n = sample size; Z = the value from the standard normal distribution reflecting the confidence level that will be used (Z = 1.96 for 95% confidence interval); p = sample proportion (considering that the proportion of students which accept/would accept envelope wages at their job is not known, we here used the conservative approach which uses the proportion of 0.5 and results in the largest sample size); E = desired margin of error (e = 0.5 for 95% confidence level). Therefore, the required sample size is 385 students which was corrected for the small, finite population, as follows:

n1 =

n 1 + ( n − 1) / N 

Where: n1 = the corrected sample; n = the initial sample obtained; N = population.

Envelope Wage Arrangements Among Students  45 Thus, the required minimum sample for ensuring representativeness is 362 students. The hyperlink to complete the survey was promoted during tutorials and lectures to both students in Romania and Moldova and also posted on the Faculty Facebook page. Students were encouraged to share the questionnaire with their roommates and other student friends. As such, the questionnaire provided the option ‘other faculty (please specify)’ for those instances in which the respondent was not from FEAA. We obtained 510 responses, of which 497 fully completed every question (i.e. to the ‘complete and submit’ button). Thus, the sample size exceeds the minimum size required for ensuring representativeness. From the 497 students, 260 had not worked during their time as a student while the remaining 237 had been employed during their time as a student. The sample’s structure in terms of gender, faculty, programme of study, country and other demographic characteristics is available in Appendix, Table 3.A1. Questionnaire Structure and Variables The questionnaire started by asking the participants attitudinal questions regarding the acceptability of different types of informal work as well as the expected sanctions and risks of detection, followed by questions on whether the participants had purchased from the informal economy and finally, whether they had participated in the informal economy over the past year (by receiving envelope wages from their employer and/or by undertaking undeclared activities). Here, the focus is upon, first, the students’ views regarding the acceptability of envelope wages and second, the level of tax morality. First, to determine the students’ acceptability of envelope wage agreements, we here use two different questions in dependence with the employment status of the students. As such, those students that declared that they were currently working, or had worked during their time as a student, were asked if they had an envelope wage agreement with their employer. Thus, the dependent variable used is a dummy variable with recorded value 1 for persons who answered ‘yes’ to the question: ‘Sometimes employers prefer to pay all or part of the regular salary or the remuneration for extra work or overtime hours cash-in-hand and without declaring it to tax or social security authorities. Did your employer pay you all or part of your income this way?’, or otherwise 0. For the students who had not worked during their time as a student, the dependent variable used is a dummy variable with recoded value 1 for persons who answered ‘yes’ to the question: ‘If you would have a job offer tomorrow, would you accept to receive all or part of your regular salary or the remuneration for extra work or overtime hours cash-in-hand and without declaring it to tax or social security authorities?’. These two dependent variables allow us to compare the results between the hypothetical scenario where the respondents can declare their view of

46  Ioana A. Horodnic and Colin C. Williams the acceptability of envelope wages with no restrictions, and the actual practice where the respondents declare if they agree or not with such a wage arrangement. Second, to evaluate the association between the acceptability of envelope wages and tax morality, participants were asked to rate the six behavioural questions regarding the informal economy using a 10-point Likert scale (where 1 means absolutely unacceptable and 10 means absolutely acceptable), namely: someone receives welfare payments without entitlement; an individual is hired by a household for work and s/he does not declare the payment received to the tax or social security authorities even though it should be declared; a firm is hired by a household for work and it does not declare the payment received to the tax or social security authorities; a firm is hired by another firm for work and it does not declare its activities to the tax or social security authorities; a firm hires an individual and all or a part of the wages paid to him/her are not officially declared; and someone evades taxes by not declaring or only partially declaring their income. For each individual, an aggregate tax morality index was then constructed by collating the responses to the six behavioural questions. The Cronbach’s Alpha coefficient is 0.674 which is very close to the benchmark of 0.7 proposed by Nunnally and Bernstein (1994). Yet, the values between 0.6 and 0.7 are acceptable (according to Nunnally, 1967, cited in Glynn & Woodside, 2009; AERA et al., 1999). Here, this is kept in the original 10-point Likert scale format, meaning that the lower the index value, the higher is the student tax morality. In addition, a question regarding the ‘type’ of job the students would prefer was included to first investigate if this preference is associated with the likelihood of accepting envelope wages and second if it has a significant association with the tax morale index, considering that the question measures to a certain degree the willingness of accepting tax evasion when there is an opportunity of a higher income. Thus, the respondents were asked ‘What would you choose between the following?’. The independent variable is coded with 0 for those answered ‘To have a low income specified in your employment contract but in reality to receive a higher cash-in-hand income’ and 1 for those answering ‘To have all your income specified in your employment contract even if your net final income will be lower’. Drawing upon previous studies that identify the important socio-demographic and socio-economic variables (Horodnic, 2015) associated with the likelihood of accepting an envelope wage agreement (Williams & Horodnic, 2017; Williams & Horodnic, 2015a, 2015b; Williams, Horodnic & Windebank, 2015), the selected control variables are:

• Gender: a dummy variable with value 0 for females and value 1 for • •

males. Age: a continuous variable indicating the exact age of a respondent. Marital status: a categorical variable with value 1 for married or remarried, value 2 for single living with a partner and value 3 for single.

Envelope Wage Arrangements Among Students  47

• Financial status: a dummy variable with value 0 for very comfortable/ comfortable and 1 for maintaining/struggling.

• Hometown: a dummy variable with value 0 for urban area and value 1 for rural area.

• Country: a dummy variable with value 0 for Moldova and value 1 for Romania.

Alongside these, two other demographic control variables specific to the analyzed group (i.e. students) were included, namely:

• Programme of study: a dummy variable with value 0 for undergraduate area and value 1 for master/PhD programme.

• Place lived during the academic year: a categorical variable with value 1

for parents’ house, value 2 for a rented apartment, value 3 for university campus and value 4 for relatives and other.

To evaluate who is more likely to accept envelope wages and the association between the likelihood of accepting envelope wages and the level of tax morality, only those respondents for whom data on each and every control variable was available are here used in the logistic regression analysis. Below, the results are reported.

Findings Of the 497 students who completed the survey conducted in Moldova and Romania, 237 were with students who reported that they work or have worked during their time as a student. Of these employed, 69% were from Romania and 31% from Moldova. To start evaluating envelope wage practices, Table 3.1 provides a comparative analysis of those students who had been employed and those who had not. This displays that 39% of those who had been employed selfreported the existence of an envelope wage agreement with their employer, while 54% did not confirm such a practice. The remaining 7% did not know or refused to answer. This means that approximately 4 in 10 students in Moldova and Romania received envelope wages for the work that they had conducted during their time as a student. Moreover, given the sensitive nature of the issue under investigation, this percentage should be considered as a lower-bound estimate since there may be significant differences between the real and self-reported situation. Even so, with a prevalence of 39%, it seems to be that an envelope wage for their employment during their time as a student is a common practice in Moldova and Romania and an issue that needs to be addressed. As Table 3.1 displays, when asked if they would accept all or part of their regular salary or the remuneration for extra work or overtime hours on a cash-in-hand basis and without declaring it to tax or social security authorities; in the case of a job offer being made to them tomorrow, 31%

48  Ioana A. Horodnic and Colin C. Williams Table 3.1 Envelope wage practice and the willingness to accept an envelope wage agreement during studentship in Moldova and Romania

Existence of an envelope wage agreement/ acceptance of envelope wage agreement Yes No DK/Refusal Attitude towards not having declared the full salary to the tax or social security authorities* Happy with this Would prefer full declaration It depends DK/Refusal Verbally agreement exists/would agree* To work longer working hours than is in the formal contract Not to take full statutory holiday allowance To do different tasks than is in the formal contract No additional conditions Other Job preference Lower income in employment contract, higher cash-in-hand income All income in employment contract, lower net final income DK/Refusal

Employed (%) N = 237

Not working (%) N = 260

39 54 7

31 50 19

28 40 28 4

19 34 37 10

52

63

18 27

13 29

33 1

13 1

35

37

50

46

15

17

*Applies only to those students having accepted/would accept envelope wage arrangements

of students who do not work would accept an envelope wage agreement. The percentage is lower compared with those who actually receive envelope wages (31% compared with 39%), but it should be noticed that a further 19% of the students do not know or refused to answer (indicated by ‘DK/ Refusal’ in the table). When examining the attitude towards not having declared the full salary to the tax or social security authorities (Table 3.1), 40% of the employed students would prefer full declaration, 28% were happy with this situation and a further 28% answered that it depends. If those without a job were to have a job offer tomorrow, only 19% of unemployed students would be happy with an envelope wage agreement, showing at first sight a more pronounced negative attitude towards envelope wages. Interestingly, however, of those not working, 37% answered that it depends and a further 10% do

Envelope Wage Arrangements Among Students  49 not know or refused to answer. This reveals that in the case of a job offer tomorrow, there are unemployed students who are open to negotiation in the case of a discussion with their future employer regarding the possibility of not declaring their full salary to the tax or social security authorities. This is further supported by the fact that in the case of an additional verbal agreement, only 13% of students who do not work would reject additional conditions to those in the formal contract. When examining the actual prevalence of envelope wages, 33% reported no additional conditions via verbal agreements. However, 52% of those employed work longer hours than is in the formal contract, 18% do not take their full statutory holiday allowance and 27% verbally agreed to do different tasks than is in the formal contract. Turning to the willingness to accept an envelope wage verbal agreement if having a job offer tomorrow, Table 3.1 reveals that 63% of those not currently working will agree to work longer working hours than is in the formal contract, 13% will agree not to take full statutory holiday allowance and 29% will agree to do different tasks than is in the formal contract. Table 3.1 also reports the variation of the envelope wage practice and the willingness to accept an envelope wage agreement according to the level of net income. The share of those preferring a lower income in their employment contract and a higher cash-in-hand income is higher in the case of students without employment compared with those students currently employed (37% compared with 35%). Indeed, it seems to be that those students not having a job are more likely to accept an envelope wage agreement if they will receive a higher cash-in-hand income. According to Table 3.1, of those not currently working, while 31% would accept an envelope wage agreement in the case of a job offer tomorrow, 37% would prefer a lower income in their employment contract and a higher cash-in-hand income. This is also supported by a comparison with employed students: 50% of those currently employed would prefer all the income in formal employment contract and a lower net final income while only 46% of students not having a job would prefer such an arrangement if having a job offer tomorrow. However, of those having or who had an envelope wage agreement during their time as a student, a large share (70%) reported that the arrangement was initiated by the employer (Figure 3.1). A further 15% of envelope wage agreements involved both the employee and the employer (joint idea) and just 2% of agreements were initiated solely by the employee. Analyzing the data in Figure 3.1, it can be also noticed to be more common for those who have received an envelope wage during their time as a student to have been paid for both regular and overtime work (39%) or for overtime or extra work (37% of envelope wage agreements). Just 21% of envelope wages were part of the payment for regular work. To analyze the population groups more likely to receive envelope wages, Table 3.2 reports the prevalence of such arrangements amongst students in

70

It was initiated by the employer It was a joint idea (involving both employee and the employer) It was employee initiative

15 2 13

DK/Refusal

Both regular and overtime work

39

Overtime, extra-work

37

Part of the payment for regular work DK/Refusal

21 3

Who suggested the arrangement:

Remuneration for:

Figure 3.1 Envelope wage practice during studentship in Moldova and Romania: Initiator and remuneration (%) Table 3.2 Envelope wages distribution amongst students in Moldova and Romania: By tax morale, job preference, socio-economic and spatial characteristics

Tax morale Above the mean Below the mean Job preference Lower income in employment contract, higher cash-in-hand income All income in employment contract, lower net final income Gender Female Male Age Above the mean Below the mean

Employed envelope wages (%)

Not working willingness to accept envelope wages (%)

Yes

No

DK/ Refusal

Yes

No

DK/ Refusal

38 35

53 60

9 5

42 19

48 57

11 24

47

46

7

52

31

17

37

58

5

18

62

20

36 46

56 48

8 6

30 36

50 49

20 15

38 40

54 53

8 7

29 33

53 48

18 19

(Continued )

Envelope Wage Arrangements Among Students  51 Table 3.2 (Continued)

Marital status Married or remarried Single living with a partner Single Place living during academic year Parents’ house A rented apartment University campus Relatives/other Financial status Very comfortable/ comfortable Maintaining/struggling Programme of study Undergraduate Master/PhD programme Hometown Urban Rural Country Moldova Romania

Employed envelope wages (%)

Not working willingness to accept envelope wages (%)

Yes

No

Yes

No

21 48

71 48

8 4

31 36

61 43

8 21

39

53

8

32

49

19

42 43 33 39

53 49 58 56

5 8 9 5

33 33 30 25

49 48 51 50

18 19 19 25

27

68

5

35

48

17

46

47

7

32

48

20

41 33

51 62

8 5

31 31

50 50

19 19

35 46

60 44

5 10

28 36

52 46

20 18

56 32

39 60

5 8

33 31

56 48

11 21

DK/ Refusal

DK/ Refusal

Moldova and Romania and the willingness of students who do not work to accept envelope wages, according to tax morality, job preference and socio-economic and spatial characteristics. This reveals that while the prevalence of envelope wages is quite similar regardless of the value of tax morality index (38% and 35% respectively), the situation changes when considering the willingness of currently unemployed students to accept envelope wages. Assuming the occurrence of a job offer tomorrow, 42% of currently unemployed students with low tax morality (i.e. a high tax morality index) would accept an envelope wage agreement, and only 19% of currently unemployed students with high tax morality would agree to such an arrangement. Indeed, 24% of unemployed students with high tax morality do not know or refused to answer, emphasizing a high share of unemployed students who do not know how they would react when having a job offer.

52  Ioana A. Horodnic and Colin C. Williams Variations also exist when considering student’s net final income from their job/future job. Some 47% of students preferring a lower proportion paid as a formal wage and higher cash-in-hand income and 37% of students preferring all income in the formal wage, currently have an envelope wage agreement with the employer. Differences between those preferring a higher cash-in-hand income and those preferring a lower net final income are more obvious in the case of students not having a job. Thus, 52% of currently unemployed students preferring a lower income in employment contract and a higher cash-in-hand income would accept an envelope wage agreement if having a job offer tomorrow and only 18% of unemployed students preferring all income in the employment contract and a lower net final income would accept such an arrangement. Turning to the socio-economic characteristics, Table 3.2 reveals that envelope wage prevalence is higher amongst men than women (46% of men compared with 36% of women) and amongst single or single people living with a partner than married or remarried students (39% and 48% compared with 21%). Similarly, students living on the university campus during the academic year are less likely to have an envelope wage agreement with their employer than those living in a rented apartment, parents’ house or with relatives (33% compared with 43%, 42% and 39%), and those who are feeling very comfortable or comfortable with their financial status are less likely to accept envelope wages than those having a more difficult financial situation. The uneven distribution of envelope wage practices is also revealed when analyzing spatial variations in Table 3.2. The percentage of students receiving envelope wages is higher for those having their hometown in a rural area than those with their hometown in an urban area (46% compared with 35%). Also, 56% of students in Moldova received envelope wages but only 32% of students in Romania. Analyzing the socio-economic and spatial characteristics of currently unemployed students who would accept envelope wages if they had a job offer tomorrow, the finding is that, even if variations can be observed, they are of a smaller magnitude (see Table 3.2). However, a higher share of currently unemployed students reporting that they do not know or refuse to answer can be noticed. The tentative conclusion after analyzing these descriptive statistics is that socio-economic and spatial variations exist in the prevalence of envelope wages more than in the willingness of currently unemployed students to accept such payments. Instead, a relationship appears to exist between tax morality and the willingness of currently unemployed students to accept envelope wages if having a job offer tomorrow. To test whether these descriptive findings are significant when holding constant other variables, Table 3.3 reports the results of two logistic regressions. First, the propensity of currently employed students to receive envelope wages, and second, the propensity of currently unemployed students to accept envelope wages if a job was offered, are evaluated. Both regressions are testing the association of various independent variables, namely tax

Table 3.3  Students receiving envelope wages vs. unemployed students accepting envelope wages if having a job: Logistic regressions Employed

Not working

DV: Envelope wages

DV: Willingness to accept envelope wages

Tax morale

0.128 0.184* (0.103) (0.103) Job preference (Lower income in employment contract, higher cash-in-hand income) All income in employment –0.424 –1.472*** contract, lower net final income (0.415) (0.422) Gender (Female) Male 0.680 0.0407 (0.451) (0.514) Age 0.0927 0.00657 (0.0841) (0.0721) Marital status (Married or remarried) Single living with a partner 2.204** –0.724 (0.943) (1.181) Single 1.365 –0.257 (0.884) (1.067) Place living during academic year (Parents’ house) A rented apartment –0.0313 –0.228 (0.485) (0.593) University campus –0.615 –0.413 (0.558) (0.591) Relatives/other 0.0868 –0.703 (0.779) (1.138) Financial status (very comfortable/comfortable) Maintaining/struggling 0.928** –0.122 (0.443) (0.456) Programme of study (Undergraduate) Master/PhD programme –0.560 –0.442 (0.517) (0.964) Hometown (Urban) Rural 0.466 0.322 (0.428) (0.435) Country (Moldova) Romania –1.262*** 0.799 (0.424) (0.680) Constant –3.980* –0.753 (2.368) (2.066) N 139 127 Pseudo R2 0.1381 0.1411 Log likelihood –81.095709 –71.881753 χ2 25.98 23.62 Prob > 0.0171 0.0348 Notes: Significant at *** p