No black and white solution to the grey economy

There is great interest today in comments from Treasury minister David Gauke about the informal economy. I have been posting irregularly recently as I have been focused on my annual lecture but – as it happens – this issue is a classic example of the category of a 'wicked problem' on which I have been focused.

Anyone who has been around social policymaking for any time will have encountered the occasional attempt to make progress on the informal economy. Even focusing just on smaller scale activity (not large scale rackets), the sector is very extensive, possibly as much as 5-10% of the formal economy, and in some deprived areas probably much more.

In theory, there are many economic, social and moral arguments for action.  The hidden economy has been estimated to cost the country some £35 billion in lost tax revenues every year.  Hundreds of thousands of people now working at the margins lack social and financial protection.  Their customers have few consumer rights.  And, the informal economy is unfair, not just on taxpayers but on legitimate businesses finding it hard to compete with untaxed and unregulated rivals.

If all that was needed was a reason for more punitive action, the problem would have been solved by now. In fact, despite swathes of research and, over the decades, many Government inquiries and initiatives, there is precious little evidence that any significant inroads have been made. Reducing the informal economy is a classic example of what some analysts call a wicked problem. It has many causes, multiple stakeholders, and is unlikely ever to be ‘solved’. Moreover any solution involves that hardest of policy tasks: changing social norms.

As regular readers know, I am an advocate of clumsy solutions (derived from the school of ‘cultural theory’) to wicked problems. These are solutions that combine the three major sources of social power: hierarchy, solidarity and individualism. As the RSA will recommend in a report on the informal economy, due to be published in a few weeks, this does seem like a good example of the need for clumsiness.

The hierarchical dimension of action lies in the regulations surrounding informal working and the enforcement of those rules. Given that the incentives for informal consumption are less strong than for informal working, one initiative here might be to increase significantly the penalties otherwise law-abiding folk face for paying cash in hand. In relation to solidarity the need is for national debate, community engagement and social marketing around the moral jeopardy of informal working, especially for those who play by the rules. Thirdly, there need to be policies to provide strong incentives to those in the informal economy to go onto the books.

As cultural theory suggests, clumsy solutions have to manage inherent tensions within and between hierarchical, solidaristic and individualistic motivations. For example, if the authorities were to be high handed and punitive in tackling low level informal working, community feeling is as likely to back the people being pursued as the case for enforcement (a reaction which might be reinforced by the ease with which the rich avoid taxes). Equally, if incentives to go straight are too great it will offend the sense of fairness among those who have always declared their earnings.

There are also questions about whether substantial informality may simply be an  inevitable consequence of having a developed economy in which there are costs associated with being a legal business. If this is the case, even a policy which successfully pushes a significant proportion of current informal workers into the formal economy may simply create a space to be filled from the huge reserve army of the underemployed. This may not be a bad thing, after all informal workers spend most of their money in the formal economy, but public expectations and policy prescriptions need to be adjusted accordingly.

In opening the issue while not offering trite solutions, Mr. Gauke is probably taking the right first step (although it is far from clear this was his intention). But if we are to make significant progress on an issue which has foiled policy makers here and in just about every other economy for generations we will need not just new policy tools but fresh analysis and stronger public sentiment.