The Asia Times features a fascinating article this week on China’s gray economy and its relationship to the one that shows up in statistics…..

According to data from the Chinese National Bureau of Statistics (NBS), total income of urban residents amounted to 5.9 trillion yuan that year. If the findings of the survey are accurate, urban residents were 75% richer than officially calculated.

NBS statistics also showed that in 2005, income of farmers across the country totaled 2.4 trillion yuan. Hence national income amounted to 8.3 trillion yuan. But if the gray income is added, the figure jumps to 12.7 trillion yuan, or 53% more.

If this is true, then China’s gross domestic product (GDP) in 2005 may be much greater than the 18.2 trillion yuan reported by the NBS. The 4.4 trillion yuan gray income accounted for 24% of the country’s GDP. Hence China’s economy may be much larger than generally thought.

It’s astounding to me that no one has written on this before. Taiwan’s economy in its heyday was exactly the same way. As I recall, in a footnote in Money and Finance in the Economic Development of Taiwan Lee Sheng-yi estimated that the gray economy of Taiwan was a quarter the size of the white economy, and that estimate was undoubtedly low. I saw a government newspaper piece in the early 1990s that estimated Taiwan’s gray economy to be 75% of the size of its white economy.

The prevalence of the gray economy in is quite old. In Taiwan in the 19th century most production was off the tax rolls and more than 90% of the productive land went untaxed. Land reforms at the very end of the Qing colonial period, and at the beginning of the Japanese colonial period, brought more than tenfold increases in the amount of taxed land. Taiwan’s well developed local underground banking system has as one of its roots the high-interest loan systems in the agrarian economy during the Japanese period.

Such guerrilla capitalism remains a staple of local culture in both Taiwan and China. Bernard Gallin records in one of his books anecdotes about the theft of irrigation water from Japanese systems, and of course, anyone who has read the classic anthropological works on Taiwanese industrialization, such as My Mother-in-law’s Village, can adduce many instances of tax evasion, theft of services — especially electricity — and so on. In Taiwan it is common for bosses to keep three books — one for the tax man, one for the investors, and the reals one for himself. In disputes between Taiwanese businesses, the tax people are often brought in by one side to destroy the other (my wife’s business was destroyed that way). Tax evasion was so widespread that the government in Taiwan began a lottery based on receipts to get consumers to demand them, but still many businesses do not use them.

I have often wondered if one reason Taiwan’s income inequality is worsening is the slow destruction of this off the books economy through the forces of formalization, taxation, and globalization. As businesses shift from gray to white the subsistence profits they used to make shrink, paid off to taxes. Some forms of gray businesses have completely vanished (you know you’ve been here too long when you can say that your first date with your wife was to an MTV for A Chinese Ghost Story). Others face uncertain futures due to habitat loss — demand for urban land is impacting night markets, and the expense of land is so great, propped up by Taiwan’s developer-friendly land use laws, that many small business literally cannot get off the ground. The spread of local and global chain stores is demolishing many mom and pop businesses, from English cram schools to breakfast shops to small grocery and convenience stores. Global volume retailers like Costco, Carrefour, and B&Q lower incomes by supplanting independent business ownership with low paying service jobs, and by skimming off affluent urban customers who might still be buying hardware at the local mom and pop shop. As would-be business owners flock to the remaining gray business niches, competition becomes even more fierce, keeping prices down, but also driving down the subsistence profits petty capitalists need to stay alive — and locking into place low levels of service and quality — leaving the remaining businesses vulnerable to local and global chains offering better products and services who have not yet discovered, or discovered how, to move into a particular market.

Income inequality in China is already alarming — at least on paper, but remember how all that unreported income probably makes it appear worse than it really is — but the experience of Taiwan suggests that it is going to rise further as China’s economy becomes more globalized and its urban consumers shift their rising incomes to formalized, standardized, and taxed local and global chains running on modern business formats. Anyone can see how corrosive income inequality has become in Taiwan. One shudders to think what it will be like in China in the years to come.