A painter offers his works for cash at half price by doing it outside the official economy and avoiding taxes. A bar owner accepts €5 ($6.80) in cash for a glass of wine, and then does not account for the sale. These are some of the irregularities that comprise Europe’s massive shadow economy which is estimated to be worth some €2 trillion annually.
In Germany and France the shadow economy is about one-eighth the size of the countries’ official GDP. Elsewhere, according to a study by Friedrich Schneider, professor of economics at Johannes Kepler University in Linz, Austria, it can be much higher. For example, it is estimated to equal almost 40 percent of the GDP’s of some Central and Eastern European countries
The research reveals that under-reporting has not been broadly addressed by European governments, according to Kepler. In fact, in evaluating 66 measures used to curtail the shadow economy, only 15 percent focused on sales under-reporting. Fewer still considered the increased use of electronic payments as a means of countering the shadow economy.
Kepler’s study, The Shadow Economy in Europe, was sponsored by Visa Europe and first presented in Brussels on 17 March at a ‘Crossfire Debate’ organised by the Friends of Europe, an open forum for debate on issues in the European Union (EU). Speakers included Jörgen Holmquist, European Commission director general for the internal market division; Andreas Pratz of consultancy AT Kearney; and Marc Temmerman, executive vice-president of Visa Europe.
Speeding up transformation
The principal motive for the event was to speed up Europe’s transfer to the use of electronic payments and the adoption of the Single Euro Payments Area (SEPA). Banks may be enthusiastic about SEPA, but are reluctant to make the heavy investment in software necessary until potential partners have done the same. They reflect a complaint from the European Central Bank (ECB) that no implementation end date has been set.
Indeed, in March this year, the European Parliament instructed the European Commission (EC) “to set an end-date, not later that the end of 2012, and to specify multilateral interchange fees (MIF) for card payments. This follows an earlier expression of concern over delays in implementing SEPA that came from the EU’s Economic and Financial Affairs Council.
Estimates for the investment cost to banks for SEPA run to €10 billion. EU internal market commissioner, Charlie McCreevy, has observed that the forecast operational cost savings for banks could be as much as €49 billion, “a five-fold return on investments”.
Speaking at the Brussels conference, Temmerman said that national authorities need to push harder to make SEPA a reality.
“We need standards everyone accepts,” he added. “And we need regulators and governments to help us come up with a model that helps everyone.”
Temmerman repeated calls for a “level playing field”. He wanted regulators and governments to enable “an equitable balance between all the players”. He pressurised the EC to “do whatever it takes”.
A call for fair play
The Visa Europe executive vice-president complained that the “four party system” was not being treated fairly by the authorities. This system, used by Visa Europe and by MasterCard, involves the issuing bank, the merchant’s bank, the card holder and the merchant. American Express operates under a three-party system.
Temmerman also pressed for equal treatment of electronic-payments and cash, the latter which is “subsidised”, and which enables the social cost of the shadow economy.
To return to the academic study on the shadow economy, this states there appears to be a strong correlation between the prevalence of electronic payments in a country and its shadow economy.
Countries with high levels of electronic payment usage, such as the UK and the Netherlands, have smaller shadow economies than those with minimal levels of electronic payments, such as Bulgaria and Romania.
The study shows that the group of activities where electronic payments would be of the most use in combating the shadow economy include cars and car parts, non-specialised retail stores, restaurants and bars, catering, and transportation, such as taxis and buses. It found a few others specific to an individual country. These are: in Poland, pharmaceutical retail; in Turkey, fuel sales; and in Italy and Spain, budget hotels.
By targeting these sectors, believes Kepler, governments could address 50 percent of the shadow economy in the three main industries.
High denomination banknotes
Leo Van Hove, professor of economics at the Vrije Universiteit Brussel, told EPI that the ECB ought to combat the shadow economy by eliminating high denomination euro currency banknotes, especially the €500 note. At present 37.4 per cent of the total value of bank notes in the Eurozone is held in €500 notes, which he believes is a good indicator of the size of the shadow economy.
“We could manage also without the €200 note, and even the €100 note, and get by having the €50 note as the largest in existence,” stressed van Hove.
In the background to the meeting was the position of MasterCard, though it was only lightly represented in Brussels. In December 2007, the competition division of the EC, announced that the company’s multilateral interchange fees for cross-border payment card transactions with MasterCard and Maestro-branded debit and consumer credit cards in the European Economic Area violated EC Treaty rules.
MasterCard immediately announced that it was appealing, stating that it “will appeal to the European Court of First Instance against… the Commission’s decision”.
In fact, MasterCard in June 2008 caved in to the EC ruling, by setting its cross-border interchange fees at zero. However, its appeal has not been withdrawn. Behind-the-scenes discussions are continuing, with MasterCard arguing for charges sufficient to compensate for the card holder’s payment “grace period” and merchant guarantees.