As you may have guessed from the three weeks of silence, classes have started full-time and they are keeping me very busy. I'll give a quick update on academic stuff and then get on to what I've learned about the informal economy since I got here and why that matters in the first place.
SAIS is unique among the graduate programs for international relations in that it requires all students to specialize in economics. This is one of the reasons why I wanted to come here in the first place - to strengthen my economics background. This semester, I'm taking intermediate macroeconomics, corporate finance, weak and failed states and sitting in on a risk management class. Fortunately, I tested out of German, so that covers my language requirement for graduation. Since I still have access to language courses though, I'm taking Italian this semester. Once I get to DC I think I'm going to change to Spanish.
What I really want to talk about in this post though is the informal economy. You'll remember a couple of posts ago I wrote about my interest in the field of threat finance. Very closely related to threat finance and a much more researched field of study is the informal or underground economy. The two are very much linked.
I'm reading a book right now titled "Treasury's War" by Juan Zarate. It's a history of how the Treasury Department has developed a strategy of finding and shutting down terrorist or multi-national criminal financing over the past decade- specifically after 9/11. The thesis of the book is that the US Treasury Department, with its influence over financial institutions around the world, is uniquely positioned to collect financial intelligence on individuals deemed a threat to the US. Before 9/11, the Treasury Department was much more wary of manipulating its power over the global financial networks for political or even domestic security motives. It wanted to maintain neutrality in the markets. 9/11 changed that and the Treasury Department shedded its inhibitions. At first, the mission was relatively easy: terrorist and criminal financiers were easy targets, sending money through conventional networks and keeping their money in major, international banks. For the Treasury Department, it was only a matter of convincing bank presidents and local leaders of the value of shutting down suspect accounts.
However, over the past 12 years, threat finance has become much more sophisticated. Threat financiers have learned to avoid conventional financial vehicles and institutions for moving their money around. This is where informal and underground economies come into play. By definition, these economies are unregulated and decentralized - havens for tax evaders, drug traffickers, terrorist financiers and the like. The Treasury Department's success at shutting criminals and terrorists out of the formal financial sector made their job of maintaining pressure on illegal networks harder. It drove the illicit finances deeper underground where the Treasury Department has less visibility and less influence.
Italy is a great place to study the informal economy. Italy gets a bad reputation these days for its financial capabilities, but don't forget that modern banking was invented in Florence and northern Italy is one of the wealthiest regions of Europe. Italy doesn't lack wealth, it lacks the ability to centralize that wealth. Instead of flowing through regulated, centralized channels, wealth gets squirreled away and hidden out of reach of the central government. The strategies and tactics for doing this are fascinating.
But Italy is also an interesting case in that informal economies are built into the system. A professor of Italian economics came and gave a talk at SAIS a couple of weeks ago and she pointed out that Italy does not have the mega-corporate national giants that Germany and the US have. Italy has no GE, Siemens or Windows. Fiat is perhaps the biggest company in Italy but they are still pretty small in the grand scheme of things. The average Italian company is much more likely to small - around 14 employers. Really small. As a whole, these companies are generally very profitable and very good what they do, mostly being in the high-tech sector making specialty equipment or providing boutique services not found anywhere else. They make up most of Italy's exports.
While these small companies are a blessing to Italy's economy, they are also a curse when it comes to tax collection. It's much harder to police 10,000 small companies than 10 really big companies. Specifically, it's much more expensive to tax a decentralized economy. Each company makes up a very small chunk of the tax base and there aren't any obvious behemoths to keep an extra close eye on to make sure they are paying their taxes. Also, large companies have to keep their reputation in mind. Getting caught not paying your taxes is potentially more harmful to their business than a tiny firm of 20 people making motorcycle brake pads that nobody's heard of.
The decentralized nature of Italy's economy makes for a natural environment of doing things off of the books since it's less likely you'll get caught and if you do get caught, the consequences likely won't hurt your reputation with your customers.
This isn't to say that drug traffickers or terrorists are using tech firms in Bologna to move their money around, but Italy does have a general economic environment that is conducive to concealing the flow of money. It may be a bit easier here to set up a small company and misreport its primary line of business. In a country full of mom and pop shops, adding another to the pile will hardly get noticed.
Possibly contributing to the incentive to misreport business activity here are the multitude of very strict laws and measurements in place to prevent ililicit financial activity from happening. Italy has attacked the underground economy through higher and more taxes along with more bureaucracy. Raising the cost of doing business increases the incentives to do business off the books, so it creates a kind of self-defeating spiral.
As I find time to do more research on this topic, I'll keep updating on what I learn and provide more examples.
Have a good week!
SAIS is unique among the graduate programs for international relations in that it requires all students to specialize in economics. This is one of the reasons why I wanted to come here in the first place - to strengthen my economics background. This semester, I'm taking intermediate macroeconomics, corporate finance, weak and failed states and sitting in on a risk management class. Fortunately, I tested out of German, so that covers my language requirement for graduation. Since I still have access to language courses though, I'm taking Italian this semester. Once I get to DC I think I'm going to change to Spanish.
What I really want to talk about in this post though is the informal economy. You'll remember a couple of posts ago I wrote about my interest in the field of threat finance. Very closely related to threat finance and a much more researched field of study is the informal or underground economy. The two are very much linked.
I'm reading a book right now titled "Treasury's War" by Juan Zarate. It's a history of how the Treasury Department has developed a strategy of finding and shutting down terrorist or multi-national criminal financing over the past decade- specifically after 9/11. The thesis of the book is that the US Treasury Department, with its influence over financial institutions around the world, is uniquely positioned to collect financial intelligence on individuals deemed a threat to the US. Before 9/11, the Treasury Department was much more wary of manipulating its power over the global financial networks for political or even domestic security motives. It wanted to maintain neutrality in the markets. 9/11 changed that and the Treasury Department shedded its inhibitions. At first, the mission was relatively easy: terrorist and criminal financiers were easy targets, sending money through conventional networks and keeping their money in major, international banks. For the Treasury Department, it was only a matter of convincing bank presidents and local leaders of the value of shutting down suspect accounts.
However, over the past 12 years, threat finance has become much more sophisticated. Threat financiers have learned to avoid conventional financial vehicles and institutions for moving their money around. This is where informal and underground economies come into play. By definition, these economies are unregulated and decentralized - havens for tax evaders, drug traffickers, terrorist financiers and the like. The Treasury Department's success at shutting criminals and terrorists out of the formal financial sector made their job of maintaining pressure on illegal networks harder. It drove the illicit finances deeper underground where the Treasury Department has less visibility and less influence.
Italy is a great place to study the informal economy. Italy gets a bad reputation these days for its financial capabilities, but don't forget that modern banking was invented in Florence and northern Italy is one of the wealthiest regions of Europe. Italy doesn't lack wealth, it lacks the ability to centralize that wealth. Instead of flowing through regulated, centralized channels, wealth gets squirreled away and hidden out of reach of the central government. The strategies and tactics for doing this are fascinating.
But Italy is also an interesting case in that informal economies are built into the system. A professor of Italian economics came and gave a talk at SAIS a couple of weeks ago and she pointed out that Italy does not have the mega-corporate national giants that Germany and the US have. Italy has no GE, Siemens or Windows. Fiat is perhaps the biggest company in Italy but they are still pretty small in the grand scheme of things. The average Italian company is much more likely to small - around 14 employers. Really small. As a whole, these companies are generally very profitable and very good what they do, mostly being in the high-tech sector making specialty equipment or providing boutique services not found anywhere else. They make up most of Italy's exports.
While these small companies are a blessing to Italy's economy, they are also a curse when it comes to tax collection. It's much harder to police 10,000 small companies than 10 really big companies. Specifically, it's much more expensive to tax a decentralized economy. Each company makes up a very small chunk of the tax base and there aren't any obvious behemoths to keep an extra close eye on to make sure they are paying their taxes. Also, large companies have to keep their reputation in mind. Getting caught not paying your taxes is potentially more harmful to their business than a tiny firm of 20 people making motorcycle brake pads that nobody's heard of.
The decentralized nature of Italy's economy makes for a natural environment of doing things off of the books since it's less likely you'll get caught and if you do get caught, the consequences likely won't hurt your reputation with your customers.
This isn't to say that drug traffickers or terrorists are using tech firms in Bologna to move their money around, but Italy does have a general economic environment that is conducive to concealing the flow of money. It may be a bit easier here to set up a small company and misreport its primary line of business. In a country full of mom and pop shops, adding another to the pile will hardly get noticed.
Possibly contributing to the incentive to misreport business activity here are the multitude of very strict laws and measurements in place to prevent ililicit financial activity from happening. Italy has attacked the underground economy through higher and more taxes along with more bureaucracy. Raising the cost of doing business increases the incentives to do business off the books, so it creates a kind of self-defeating spiral.
As I find time to do more research on this topic, I'll keep updating on what I learn and provide more examples.
Have a good week!
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