In this paper, we interpret the shadow economy (SE) as encompassing all forms of economic activities, which are not reflected in the official statistics (Lacko, 1998, Schneider, 2000). This definition includes all activities which generate added value that are in the "statistical underground", (nonresponding, non-registering, or not surveyed enterprises), the "economic underground" (underreporting or unregistered enterprises), the informal sector, or the illegal sector. The World Bank (World Bank, 2001) distinguishes a total of eight types of SE operations that must be considered when properly accounting for SE activities.1 Measuring the shadow economy is a complicated undertaking that seeks to capture a wide range of economic activity, which its instigators are attempting to conceal. In this business, there are no right or wrong answers. What we are seeking is the best approximation. The international literature singles out Ukraine as a transition economy that has a particularly large SE sector (Kaufmann, 1996; Lacko, 1998; Schneider, 2000). A widely accepted study (Kaufmann and Kaliberda, 1996) suggests that Ukraine's GDP would be 40 percent larger if the shadow economy (SE) were included and that the economic decline between 1990 and 1999 (when positive growth resumed) would be 41 percent instead of the official 67 percent if the shadow economy were included (see Table A 1, Appendix A). Estimates of the relative size of Ukraine's SE range from 30 percent to 100 percent (Telgmaa, 1999). Moreover, experts believe that the structure of Ukraine's SE is unusual in that it is concentrated in large enterprises as opposed to the more common pattern of SE concentration in household and small enterprises (Johnson and Kaliberda, 1996).
The literature on Ukraine's shadow economy provides both a comforting and a disturbing message. The comforting message from this literature is that Ukraine's national output is not as small and that its economic decline has not been as dramatic as official statistics suggest. In effect, the SE has provided a buffer that has allowed ordinary citizens and small businesses to survive during hard times.
The disturbing side of Ukraine's shadow economy story is that such a large share of economic activity devoted to illegal or semi-legal activities cannot be healthy. Such an economy cannot collect taxes, will be corrupt, and cannot make appropriate macroeconomic choices. Ukraine's private enterprise sector cannot develop dynamically because SE enterprises cannot grow into larger enterprises as their access to outside capital will be limited. If the U.S. Silicon Valley entrepreneurs had not been able to leave their garage establishments for capital market financing they would never have grown into the giant concerns that spurred US growth in the 1990s.
