KUALA LUMPUR: It is widely believed that the underground economy represents a significant share of economic activity and has been growing faster than the formal sector. It is present in nearly every country, although the size and impact vary widely.

The shadow economy, also known as the underground or informal economy, refers to economic activities that are not regulated by the government and bypass taxes or other legal requirements.

Rational Choice Theory in criminology explains that smart criminals enter the underground economy by weighing potential risks against rewards, often exploiting weaknesses in both structural and human governance.

According to the International Monetary Fund (IMF), the underground economy makes up roughly 23 per cent of global gross domestic product (GDP). It typically accounts for 10 to 15 per cent of GDP in advanced economies and 30 to 40 per cent in emerging and developing countries.

Countries like Switzerland, Singapore and Japan keep shadow economies under 10 per cent. In contrast, nations with weak institutions, complex taxes and low public trust struggle with large underground economies.

In 2024, the former CEO, Datuk Abu Tariq Jamaluddin  of  Inland Revenue Board of Malaysia(IRB) stated that the shadow economy  has grown to an estimated  RM350 billion(roughly 30% of the current GDP). 

The illegal tobacco trade costs Malaysia about RM10 billion annually, with around RM5 billion lost in taxes and high enforcement costs, while corruption is expected to drain RM60 billion each year. Former Auditor-General Tan Sri Ambrin Buang noted that corruption and mismanagement caused up to 30% of public projects to lose their value.

Hawala is an informal system for transferring money across countries through trusted brokers or money changers, without banks or physical cash and facilitate underground economic activities.

Digital technologies and the digital economy have transformed organised crime by creating a highly profitable, low-risk environment for illicit activities.

Research by the IMF shows a strong correlation between corruption and the size of the shadow economy.

Based on the Transparency International's Corruption Perceptions Index (CPI), countries scoring above 70 typically have underground sectors that make up less than 15 per cent of their GDP, while scores of 40 to 60 points correspond to 20 to 35 per cent of GDP, and scores below 30 often mean a shadow economy exceeding 40 per cent of GDP.

Malaysia's CPI score is in the 50s, placing it in the middle ground.

The underground economy is driven by weak rule of law, corruption, unemployment, poverty, limited access to formal opportunities, and low public trust, pushing individuals and businesses outside official systems.

The shadow economy reduces tax revenue, distorts competition, and limits investment, while workers lack protections and fair wages. It weakens institutions, fuels corruption, complicates economic measurement, and can slow long-term growth.

Japan, Switzerland, and Singapore manage the shadow economy through strong governance and political will, low corruption, transparent political financing, independent judiciaries, procurement reforms, and whistleblower protections.

A new 2025 EY study found that only data-driven, comprehensive policies can curb the shadow economy.

Putrajaya is combating revenue losses with e-invoicing, mandatory Tax IDs, digital reforms, expanding formal financing and using streamlined rules including AMLA enforcement, and incentives to enhance compliance, formalize businesses, and encourage inclusive growth.

The government aims to raise Malaysia's CPI score to above 65, placing it among the top 25 least corrupt countries. This means reducing its underground economy to below 20 per cent of GDP.

** Datuk Seri Akhbar Satar is a Professor in Crime and Criminology at HELP University.

** The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the position of Astro AWANI.