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Black economy figures set to redraw EU economic landscape

From this year, official GDP figure for EU countries will include estimated figures from the shadow sector. Will this effectively rewrite the economic map of Europe or merely allow ailing states to artificially inflate their reported GDPs?

Photo: The Shadow sector: building blocks to a new European economic landscape. (Shutterstock)
The Shadow sector: building blocks to a new European economic landscape.

The recent decision by the Office For National Statistics (ONS), the United Kingdom's official statistical monitoring body, to include data for illegal activities (such as drug-dealing and prostitution) in the government's Gross Domestic Product figures has raised eyebrows both in the UK and abroad. In doing so, however, it is merely falling into line with the regulations of the European Union, which is trying to standardise GDP statistics across its member states. The practice does, however, beg two serious questions in particular – just what should be measured and how accurate can the measurements really be?

Europe's "shadow" economy, reckoned by some to be worth around Euros2.175 trillion (HK$23 trillion) and equivalent to about a fifth of the continent's entire economic output, has long been a source of consternation and frustration for GDP statisticians and EU bureaucrats. Different countries include different activities in their official GDP data and measure them in different ways.

The Germans, the Austrians and the Dutch, for instance, already include prostitution (which they regard as a legal and taxable occupation) in their figures. The Netherlands, where cannabis has decriminalised, includes the income from drugs sales. There are various other discrepancies elsewhere, making national GDP statistics difficult to compare. This makes life particularly tricky in the EU, which bases its levies and subsidies on the relative wealth of each of its member states.

As a result, later this year, the EU's rules on national income accounting – the European System of Accounts (ESA) – will be updated. This will require the EU's member states to include income from illegal activities – but only those that are entered into by mutual agreement. In other words – drug dealing is in, but burglary is out.

Britain's ONS accountants have already been to work. They have calculated that the income produced by drugs and prostitution is about £10 billion (HK$130.3 billion) a year – more than the net sum brought in to the UK economy by tourism, but still just 0.7% of overall British GDP.

The new rules may have a more profound effect elsewhere. Italy's national statistic office, ISTAT, says income from drugs, prostitution, black market sales of alcohol and tobacco, and even gunrunning will be included in its GDP from this year. It believes this move will increase the reported size of the Italian economy by between 1.3% and 2% – a welcome respite for Matteo Renzi's government as it struggles to meet its EU-imposed targets on reducing its budget deficit. Italy had pledged to keep its deficit to 2.6% of GDP in the coming year – now that its GDP figure will officially be higher, the deficit can be too. As a result, this will conveniently reduce the amount of unpopular spending cuts or tax rises the government has to impose.

Some critics have already labelled this a cynical attempt to combat the Eurozone's debt crisis. Eric Vernier, a Researcher for the French Institute of International Relations, says: "Putting this new statistical method on the table at the moment when everyone has budget problems is something of an issue. There has been a general acceptance of this accounting approach since the debt crisis. What matters most, though, is what actually goes into the state coffers."

The same trick is, perhaps fortunately, not available to the debt-stricken Greek government. It already includes prostitution in its GDP figures, making any recalculation likely to be negligible. Other countries, though, may find themselves with an unexpected economic boost. Poland's statisticians, GUS, say they expect their country's GDP to be raised up by anything between 1% and 1.3%. France, meanwhile, estimates that the new rules will lead to a huge 3.2% increase in the official size of its economy.

This is, however, unlikely to be due to an excessive amount of debauchery amongst the French. It has more to do with other less headline-grabbing modifications being brought in to the ESA at the same time. For France, it is the changes in the way a business's inventory is calculated and a reclassification of research and development spending that may have the greatest impact.

The exact means by which the statisticians have arrived at these estimates is, of course, an issue of some contention. Illegal activity is, by its very nature, difficult to quantify. Assumptions, then, have had to be made about such matters as the average income of cannabis dealers in Milan or how many clients a Parisian prostitute is likely to entertain in a week.

Those assumptions are partly drawn on existing data from other countries, notably the Netherlands – which has spent years trying to estimate the size of its drugs market through sociological surveys and the work of organisations that support addicts. Britain's ONS, for instance, has based its prostitution estimates on studies conducted by its Dutch counterparts. Just how accurate it is to base figures for one country on data from another – with inevitably different mores and laws – is, of course, highly debatable.

Despite the sterling work of the Dutch, it seems that Italy is actually the true European pioneer when it comes to measuring activities in the shadow economy. Back in 1987, the country opted to start monitoring the undeclared, off-the-books business activity that was flourishing outside the official statistics. This controversial move saw Italy's official GDP soar by some 18%, overtaking the UK to make Italy the fourth largest economy in the West. The event was labelled Il Sorpasso ("the surpassing") and was celebrated as a matter of national pride.

This episode underlines that the most important and significant element of any shadow economy may not be illegal activities, such as the selling of sex, drugs and bootleg booze, but simply those legal activities that are kept secret from the taxman. The scale of this inevitably varies widely from country to country. Although most nations now try to incorporate its estimated value into their GDP data, its sheer ubiquity suggests that those estimates are likely to be little more than educated guesses.

The most detailed study to compare the shadow economies of different countries was conducted by Friedrich Schneider, a Professor of Economics at the Johannes Kepler University of Linz. This suggested that the size of any country's shadow economy can vary from less than 9% of GDP in Switzerland and the US to more than two-thirds of the entire economy in Bolivia.

Even across the EU, Schneider's study found wide variations between, say, Austria and the UK on one hand (9%-12%) and the Eastern European members, such as Bulgaria (35%), on the other. This means that, effectively, more than a third of Bulgaria's GDP figure may rely on guesswork. The bigger the shadow economy, the bigger the inevitable discrepancies.

The size of the shadow economy also distorts other economic statistics. The official Spanish unemployment rate, for example, is 25.1, with more than a quarter of the population appear to be out of work. Experts, though, suggest that is about half as much again as the true figure, with many Spaniards employed in undeclared labour. The Spanish Ministry of Finance, Gestha, estimates that this accounts for an enormous 24.6% of all economic activity in the country.

Among the Eurozone countries, Spain may have a particular problem with this sort of fraud. One of the key measures of shadow economy activity is the amount of cash in circulation, especially what sort of cash. Nearly three-quarters of the money in circulation in Spain is in the form of Euros500 notes, which Gestha terms the "preferred instrument for those setting out to commit fiscal fraud". Not only that, but Spain has some 14% of all the Euros500 notes in the Eurozone.

Photo: “And not a word to the taxman…”: checking out the un-exchequered. (Shutterstock)
"And not a word to the taxman…": checking out the un-exchequered.

What's clear is that, as with all economic statistics, national GDP figures may not be quite what they seem. Bringing the proceeds of prostitution and dope-dealing into the accounts may have been done with the worthy aim of making the figures more easily comparable, but it is unlikely to make them any more accurate.

Robert Rea, Special Correspondent, London

Content provided by Picture: HKTDC Research
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