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The Unofficial Economy in Transition

Simon Johnson, Daniel Kaufmann, and Andrei Shleifer
Pub. Date: January 1, 1997
Full Text: Web Page [173 KB]

Brookings Papers on Economic Activity,v0, n2: 159-221.

The unofficial economy has played a critical role in the transition from Socialism to Capitalism in Eastern Europe and the former Soviet Union. We provide a theory of the unofficial economy in transition. In this theory, unattractive combinations of taxes, bureacratic regulations, rent-seeking and public goods supplied by the government can lead to the movement of economic activity to the unofficial sector, reduction of the government’s tax collections, continued deterioration of public good provision, and poor overall economic performance. In contrast, attractive combinations of taxes, regulations, and public goods are consistent with solid public finances, a small unofficial economy, and good overall performance. We show empirically that this theory describes fairly well the differences in the economic structure and performance between the economies of Eastern Europe and the former Soviet Union. In particular, we use data on electricity consumption to estimate the size of the unofficial economy in a number of countries, and show the movement of activity between the official and unofficial sectors is critical to understanding transition experiences.

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