One of the main distinctions of the Iranian economy is its relatively large underground economy. This part of the Iranian economy, which is known as unofficial, parallel, unregistered, gray or underground economy includes all legal and illegal activities for which no tax is paid or are not registered as part of the gross domestic product (GDP). The size of underground economy in every country depends on complexities of that country’s tax system, intensity of punishments, executive capacities of economic laws and tolerance of that society with regard to official corruption.

Iran is not the sole country where this dichotomy exists. What makes Iran stand out in this regard is that this situation is not solely a flaw, but in fact a byproduct of the laws and political structure of the country. This economy is the result of coexistence between the ruling system and their trade supporters in the market. On the contrary, in democratic and liberal systems, where such unregistered activities are closely monitored, the illegal economy has to deal with strict laws. Political and judicial officials of Iran have willingly or unwillingly fostered illegal part of the economy or it has been treated with extreme carelessness. It is true that some instances of illegal economic activities have received media attention and despite the fact that all political groups have warned about them, such activities have been seldom treated in a serious manner.

To come up with a clear picture of the underground economy, we must study it according to law and characteristics of people who are involved in such activities.

From a legal viewpoint, this part of the economy should be divided into two categories: legal or ultra-legal and illegal. The legal part comprises unregistered economic activities which are a common feature of almost all developing countries where such activities are ignored when assessing gross domestic product. Such activities include: value of services, family members, and added value which is a result of economic activities that are done outside the home; unregistered monetary exchanges, exchange of goods or barter trade among specialists and skilled workers; as well as true value of privileges considered for high-ranking officials and transfer of capital which has not been registered as part of payments.

Establishment of state-run institutions and semi-governmental charity institutions which act in parallel to official economy has created a suitable atmosphere for non-transparent trade

The ultra-legal part is a spin-off of private monopolies which have been given permits for foreign trade as well as exclusive rights for domestic distribution; credit market network out of the framework of state-run banking system, as well as a multitude of buyable transactions. Activities in this part of the economy include: access to special information as well as buying opportunities and some activities that enjoy dual nature and are sometimes considered legal and sometimes illegal due to different interpretations of the law. Therefore, they must be categorized quite arbitrarily.

Illegal economy encompasses those acts that are considered illegal standing alone or in conjunction with other factors. Such acts include: drug trafficking, smuggling, breaching intellectual property rights, money laundering, organized prostitution, dealing in body parts and fetuses, kidnapping, blackmail, dealing in protected antiques, and bribery during state transactions.

Iran’s underground economy is like a vast stage on which not only main performers, but also some spectators play a role (both legal and illegal). Main players include a large number of private firms protected by the government which are making money; a number of semi-governmental charity foundations; a wide network of non-transparent credit markets at bazaar and religious places which receive donations from the faithful; as well as some financial institutions which are not real banks including Garz-al-Hassaneh (interest-free loan) institutes and nonprofit credit institutes.

Second-hand players include merchants and businesspeople that evade foreign trade laws and hide true value of their transactions outside the country as well as at free economic zones. Other such players include travelers that purchase goods in excess of their customs exemptions, consumers that sell their commodity vouchers in the black market, small-time investors involved in speculations on foreign exchange and gold, employers who hide the number of their employees to evade social security costs and unemployment insurance premiums; sellers who sell medicines at a higher price, as well as physicians that charge their patients more than legal tariffs, small-time hoarders that buy needed goods in advance (such as automobiles, cellphones and houses) and sell them in the black market as well as many brokers who facilitate people’s relations with authorities and various governmental offices.

For example, some people solve problems related to private ownership through new laws and are paid a commission for doing that. They can also take heavy loans from the banks for their clients. Such go-betweens pay bills of driving offenses as well as overdue taxes without going through bureaucratic formalities.

Small players include family members every one of whom accepts a distinct role at home such as caring for children or washing dishes without being paid for it. Other small players include executives of small economic activities such as consultants.

Providers of specialized services such as physicians and engineers, accountants, and architects are engaged in a barter trade while workers and full-time civil servants have to be employed in two or three places just to make ends meet. Also, hawkers and smugglers are among other small players of this performance.

The main reason, however, is a non-democratic history and tribal structure of the government. A wall of distrust has been erected between the nation and the government for centuries and has caused people to hide their activities from the government as much as possible.

The government and ruling system (which is considered by people as avaricious, oppressive and colonialist) give a good reason to people to hide their true income from untrustworthy state authorities. Payment of taxes was exercised in Iran for the first time after Arabs conquered Iran. It was a punishment for non-Muslims and those who later became Muslims. Therefore, historical memory of the Iranian nation is awash with unjust taxes and this gives them illogical justification for tax evasion at a time when the main reason is no more existent.

Some religious regulations including Khums¹ and Zakah (Alms), which are given to religious authorities, lead to amassment of riches that are not calculated as part of the GDP. Such payments to sources of emulation as well as gifts and donations to religious shrines by people have always been used to promote educational services as deemed expedient by the same "sources of emulation". However, there is no accurate estimate of them because they are not registered anywhere.

The government once allowed ministries of intelligence and defense to embark on economic activities. Activities of those ministries are never revealed due to their secret nature. On the other hand, other ministries such as petroleum, commerce, economic affairs, as well as industries and mines have launched many companies which are involved in economic activities. They were meant to contribute to domestic economic activities and production, but their budgetary performance is not clear and they are immune against audits. Balance sheets of the said companies are never fully published. On the other hand, selling petrodollars by the Central Bank of Iran in the black market will lead to tax evasion and such transactions are not registered anywhere. Some authorities have unaccounted for facilities such as automobiles, housing and heavy budgets at their disposal without being supervised or audited. Establishment of such state-run institutions and semi-governmental charity institutions which act in parallel to official economy has created a suitable atmosphere for non-transparent trade.

Relations with influential figures have led to birth and growth of many private monopolies. Such monopolies in various production, foreign trade and domestic distribution sectors, own unaccounted for riches which are not registered anywhere and are considered by economists as economic rent.

Adopting unsuitable macroeconomic, and sometime erroneous, policies after victory of the Islamic Revolution in Iran has created another ground for such shadow economic activities. For example, lack of resilience and inefficiency of state banking system along with insufficiency of money market has led to growth of a big, unofficial credit network.

Unwillingness of banks for granting more loans to customers who are ready to take risks, but lack adequate mortgage, and on the other hand, willingness of those banks to grant big loans to state institutions has made small-time producers to take to the black market credit network. According to an unofficial report, about 20-25 percent of annual credits needed by the agriculture sector are provided by the market. While in 1978, market accounted for less than 20% of private sector’s credits; the figure now stands at more than 40%.

Instability of state regulations and apprehension about confiscation of property has directed investments toward the private sector. Continued slow growth of Iran’s official economy and persistent unemployment in the market, have exacerbated that problem. Low investment and low productivity of investment have slackened economic growth, and in addition to burgeoning population, have reduced per capita income and worsened poverty.

On the other hand, such measures as controlling prices, paying subsidies on a large scale in addition to distribution system for commodity vouchers and allocating budget to an emergency employment plan have all contributed to expansion and enlargement of underground economy. Controlling prices, has given rise to a black market, while paying hefty subsidies has encouraged fuel smuggling to neighboring countries.

Finally, a host of measures taken by the government (unequal taxes, high tariffs and increasing prices) in addition to inefficient regulations (which require a permit for investment and any type of economic activities) has encouraged many institutions whose economic activities are legal to get engaged in underground economic activities, that is, they refrain from registering their transactions.

Another important factor is low share of women in economic activities. Share of women from official domestic workforce stands at only 12% while the range of their unofficial activities is much wider. This has gotten women engaged in more home-bashed activities. In general, home-based workshops with less than five workers, which have been run by women, have been mushrooming in many big cities, but their production and revenues are not calculated as part of the GDP.

Finally, the government’s inability to impose legal restrictions and regulations has paved the way for overexpansion of the underground economy. Using cash in everyday transactions, absence of obligatory laws to necessitate registration of economic entities, shortage of experienced personnel and lack of enough financing budget, lack of experts to control economic activities as well as institutionalization of corruption has discouraged a big part of the economic firms to register and control their activities.

According to unofficial sources, 2-4 billion dollars of goods enter the country every year while $3 billion leaves the country. Financial turnover of drug trafficking has been estimated at $5 billion while the figure for embezzlement at state-run banks and companies has been mentioned at about $1 billion. Though these figures are not official, there is ample proof to uphold this.

Underground economy has a long record in the Iranian history both as a legal source of money and as a good ground for illegal activities in the market and tax evasion. It seems, however, that lack of monetary and financial transparency has expanded this economic sector. Nonetheless, real size of this market cannot be pinpointed. Economists working with the Central Bank of Iran have chosen a method based on two general indexes to show the volume of unofficial economy. Those factors include: average annual money demand by people and difference between the expenses of a middle class family and its earnings. Increased liquidity can also foster unofficial economy because most unregistered economic transactions are done in cash. On the other hand, when a household’s costs persistently surpass its earning while total debts of that family do not increase, it indicates that the budget gap in that family is being filled through unofficial resources.

Taking into account all the aforementioned factors, we can come to a general conclusion. Based on figures released by the Central Bank of Iran, ratio of liquidity to GDP, which amounted to 15.8% in 1979 (when the underground economy was the smallest), reached 244.35% in 1991 and increased to 573.3% in 2001.

It goes without saying that the said growth is not merely attributable to underground economy, but is possibly due to incessant growth of liquidity. Periodical statistics released in 2001, show that the earnings of a middle class urban family only covers 92% of that family’s expenses with the figure standing at 87% in rural areas. Therefore, to fill the said gap, family members use revenues resulting from unregistered activities. Although this figure has fallen with regard to urban families since 1991, it is clear that the reason is not downsizing underground economy, but the families have tried to reduce their expenses through economy.

Another index which has been thus far used to measure underground economy since the victory of the Islamic Revolution is nongovernmental jobs. Official reports show that between 1976 and 1996, governmental jobs have been on the decline for urban and rural workers while the number of jobs that amount to small production and need small capital, have been on the rise. Based on an unofficial report, 12% of the urban workforce consists of retail storekeepers, hawkers, private cars carrying passengers, and motor couriers. Low-income jobs have made family members to engage in several places to make up for low income.

Considering these figures, the volume of underground economy has been estimated at about 22-25 percent in early 1990s. Increased demand for money, widened gap between incomes and family expenses as well as increased nongovernmental jobs have increased that figure to 30-35 percent.

The growing underground economy is affecting all domestic economic activities. The negative effect of the expansion of underground economy is to deprive state Treasury from tax revenues and, thus, worsening budget deficit and reducing investments by the private sector. For this reason, providing state services need big loans. The biggest the underground economic activities, the weaker will be the provision of public services.

Also, problems caused by illegal nature of such activities will lead to wastage of resources. Non-transparent transactions will give rise to a private mafia as well as terrorist attacks inside and outside the country. Also, such activities will disrupt calculation of GDP and distribution system and undermine supervision over economic policies.

The positive effect, however, is that resilience of unofficial economy may cause governmental economic activities to become resilient in the long run. For example, financial independence of market-based credit networks cause stability under unexpected financial crises. On the other hand, since market-based credit network has been built on human relations and mutual trust, they reduce costs of information and implementation. Also, people who cannot be employed by the state-run sector will find jobs in those networks. In general, however, since underground economy leads to negative economic shocks, wastage of resources, inattention to investment priorities as well as lack of suitable control and supervision, its overall effect on the country’s economy is deeply negative.