Digital Payments Can Reduce the “Informal Economy” and Boost GDP, New A.T. Kearney Report Shows
More than 23 percent of the world’s economy operates out of sight of governments, leaving more than US$10.7 trillion of economic activity unreported annually, according to a new study commissioned by Visa and conducted by A.T. Kearney with support from Professor Friedrich Schneider at the Johannes Kepler University of Linz, Austria.
The Digital Payments and the Global Informal Economy report, a first-of-its-kind study, measures the size of the informal economy across 60 countries over a 10-year period, and explores the role of digital payments in reducing the informal economy and boosting GDP and tax revenue in these countries.
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The global informal economy – legal, income-generating activities conducted off-the-books and outside of government purview – is substantial, exceeding US$10.7 trillion in value of economic activity, or 23 percent of global GDP. This in effect means governments around the world are unable to track nearly a quarter of GDP, resulting in both significant revenue leakage and major implications for a range of policy-making and investment decisions.
The study finds a strong inverse relationship between digital payments and the informal economy. In fact, increasing digital payments by 10 percent across all markets studied for five consecutive years can shrink the informal economy from 23 percent of the world’s economy down to 19 percent, the study finds. Consequently, governments that rely less on cash and more on digital payments, such as through cards and mobile payments, are more successful in reducing the informal economy.
When the informal economy shrinks, GDP increases due to a portion of previously unreported GDP shifting into the formal economy. The study finds that if all 60 markets studied increased digital payments by 10 percent each year for five consecutive years, this could collectively add US$1.5 trillion to global GDP by 2021.
Informal transactions can range from straightforward activities like buying a cup of coffee at a farmers’ market to complex scenarios like workers making clothing in a textile factory. The informal economy touches every sector, from agriculture and construction to education and professional services, to a varying degree. A dominant trait is reliance on unreported cash-only transactions.
Around the world, the informal economy has negative impacts on governments, businesses, and individuals. The informal economy limits governments’ abilities to provide services, damages business competition, fosters unfair labor practices, and leaves workers vulnerable in an unregulated environment with a limited safety net.
“The informal economy is one of the most pervasive challenges in modern society, yet one of the hardest to measure or understand,” said Daniela Chikova, Partner at A.T. Kearney.
Many governments around the world recognize the challenges posed by the informal economy, and are increasingly embracing digital payments as a way to reduce informal transactions. Since 2014, more than 65 percent of government policies aiming to reduce the size of the informal economy involved measures related to digital payments, compared to only 33 percent in 2007, the study finds. At the same time, the study finds a significant reduction in the number of measures utilizing law enforcement as a means to impact the ongoing presence of the informal economy.
“While informality remains a sizable challenge, shifting transactions from cash to digital payments holds great promise for individuals, businesses, and governments,” said Ellen Richey, Visa’s vice chairman and chief risk officer. “Digitizing payments can bring an array of benefits, including greater inclusion and stronger economic growth.”
The study explores a number of policy strategies that have the potential to impact the size of the informal economy, GDP and tax income. These include:
1. Encouraging government adoption of digital payments;
2. Incentivizing digital payments usage by offering value-added tax (VAT) rebates;
3. Subsidizing funds that support the development and expansion of acceptance infrastructure; and
4. Accelerating the use and acceptance of contactless payments.
A.T. Kearney, a leading global management consulting firm, sized the global informal economy across 60 markets that account for 94 percent of global economic output. The study uses the MIMIC (multiple indicators, multiple causes) methodology, a well-respected model that makes it possible to examine relationships between outcomes that are not directly observable—the informal economy, in this case—and observable input factors, such as unemployment and GDP. Professor Friedrich Schneider (Johannes Kepler University of Linz, Austria), a foremost expert in the field, implemented the model to calculate the study’s results. In this case, the MIMIC model used 10 years of data for the decade starting in 2007 and more than 30 variables to calculate the size of the informal economy, including economic indicators such as nominal and real GDP, unemployment, and taxation levels, along with socioeconomic indicators and indicators related to payment behaviors, such as the use of cash. Among the 60 markets in the study, there is variation with respect to the activities deemed legal and illegal by domestic laws (for example, gambling, tobacco sales, or the production of certain agricultural goods). Because the informal economy is comprised of legal income-generating activities, the study uses a consistent definition of legality across all markets, excluding universally illegal activities, such as human trafficking and the production and trade of illicit drugs and banned weapons.