In recent years, increased interest has been expressed in the underground economy of the Federal Republic of Germany. This unobserved sector of economic activity has been featured in numerous newspaper articles and has become a concern to institutions engaged in economic policy. In its 1977 annual report, the Deutsche Bundesbank stated (p. 23) that “cash payment is unequestionably gaining ground in some fields, notably in the ‘grey areas’ of business activity where services are rendered without taxes and contributions to the social security system and are settled in cash.” Similarly, the German Council of Economic Advisers (Sachverstanndigenrat) (1980, paragraph 296; 1981, paragraph 373) stated that the growth of the “Schattenwirtschaft” indicates resistance against increasing tax burdens and excessive regulations.

To shed some more light on this neglected part of the German economy, this chapter attempts to estimate the size and the growth of the unobserved sector in Germany.

Definitions

As a first step, one must make an effort to clarify the confusion in the literature resulting from different definitions. Terms like “subterranean” or “underground” may be misleading because they create the impression of illegal and immoral activities. Most authors (Feige, 1980; Frey, 1981; Tanzi, 1980) define the unobserved sector as a complement of the observed sector. It includes therefore all those economic activities that are not measured by the current official measurement system.