The hidden, grey, black, cash, informal, or shadow economy and SMEs

 

Perhaps the only thing more obscure than the various names attributed to the shadow economy is our knowledge of it as a financial and social epidemic. In part one of this two-part series, we’ll be discussing its power, significance and chokehold on the global financial landscape.

The global shadow economy is the second largest in the world, with $19 trillion currently being moved in cash through B2B payments annually, across global supply chains.

And yet the majority of the world continues to overlook it, choosing only to focus on digitising the most affluent nations, whose need for attention is markedly less.

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Back up a step, what is the shadow economy?

The shadow economy refers to all economic activity that occurs in cash and without taxation or regulation. Although it’s often associated with illegal trade, the shadow economy is driven equally by legal activities, making it all the more prevalent.

The key to reducing, and eventually dissolving, the global shadow economy lies in the world’s emerging markets. As a percentage of GDP, the shadow economy accounts for 25-60% in South America, 13-50% in Asia and approximately 40% in Sub-Saharan Africa.

SMEs (Small to Medium Enterprises) will play a crucial role in this shift, given their influence on both their local economies, and the global macro-economic landscape.

According to the World Bank, SMEs contribute up to 60% of total employment, and 40% of national income (GDP) in emerging markets.

Contrary to popular belief, SMEs, who have had a long history of being underserved by banking, are deeply affected by the current state of affairs, in which they, more so than any other member of the supply chain, are increasingly disconnected from financial services, and the move towards global digitalisation.

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How?

Put simply, cash.

Cash is the lynchpin of the global shadow economy. It’s also the primary means of payment for the majority of the world’s SMEs, particularly in emerging markets. They use it to pay their suppliers, employees, and themselves.

Many don’t have bank accounts, and the ones that do simply use them as shells, because of the supposed security derived from physically seeing their money.

Despite the prevalence of cash, this form of payment and exchange is catastrophic for SMEs:

  • SMEs are compelled to undertake lengthy and complex accounting and reconciliation processes on account of the inherent un-traceability of cash.

  • Furthermore, SMEs’ manner of reconciliation is practically never aligned with what banks need to provide them with access to capital, which is crucial to business stability and growth.

  • In addition to limiting their access to financial credit, SMEs are also burdened with numerous safety risks and concerns on account of cash-use. The potential for robbery and violence is incredibly high -

Even in the highly digitalised US, retail businesses lose $40 million annually to cash-theft.

All these negative consequences snowball into one thing: complete, and utter macro-economic stagnation.

Knowing that they can’t escape cash because of their lack of access to financial services and not wanting to on account of deep-rooted government-scepticism, SMEs continue to tip-toe in the shadow economy, derailing their growth, and innovative potential, and consequently, their country’s.

Instead of expanding the size of their businesses, increasing their offerings, or thinking creatively about diversifying, SMEs, notably in emerging markets in Asia, South America and Africa, choose to fly under the radar, maintaining the status quo at the cost of valuable income, experience, and broader economic stimulus.

How have SMEs become so disconnected?

Despite having the technology to transform the global financial landscape to finally start harnessing SMEs, we have failed thus far. Outside of China, there exist almost no examples of fully digitised supply chains. There are two primary reasons for this:

  • Cost

  • Geography

Many shadow economy participants live and work in remote, disconnected locales, which limits their access to financial services. In addition to having more branches in urban, developed areas, banks also tend to have less assistive services in these areas due to the higher costs of maintaining these branches, essentially isolating the very people who need their services most, thus perpetuating the use of cash.

In part two of our series, we’ll be identifying what can be done. Stay tuned to hear about key change-makers, whose involvement is pivotal to transforming the current situation.

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