GDP and illegal activities

The newswires are a flutter today with the ‘big’ news that the UK will be incorporating illegal drugs and prostitution activity into its measure of GDP, beginning with its data release in September 2014.

How big of news this is to you really depends on how much you follow EU statistical discussions. In reality, the European System of Accounts has recommended for years that all its 28 member states include the illegal economy in GNP. In ESA2010, it then laid down the obligation to do so by September 2014. So for many of us this is not really news. You should also know that it is not only illegal activities that have to be included, but also includes revisions to R&D and military expenses, and software must be valued.

However, for the last few weeks, member countries have begun to release their individual plans for doing so, including Italy, Spain, the Netherlands, and now the UK. That is probably why the media seems to think this is a ‘new’ thing.

The requirement from ESA is that illegal economic actions involving mutual agreement shall be included in GDP. What problem exists right now is that each EU country has been including varying degrees of illegal activity in their GDP, making cross country comparisons of GDP difficult. For example, the UK already includes the smuggling of alcohol and tobacco and this is why it will ‘only’ be incorporating illegal drugs and prostitution activity. By ensuring that all member states include the same illegal activities in their GDP, the hope is that GDP measures will be more directly comparable.

It also means that starting in 2014: GDP measures for these countries will suddenly jump (expected to jump around 2-4% depending on the country, which is no small amount); direct comparisons of GDP with other countries that do not include illegal activities will be difficult; and comparisons of GDP pre and post definitional change for these countries will be difficult. Indeed, I suspect many researchers will use the data and not be aware of the definitional change over their sample period. This is particularly true since the change will take place before the calendar year is up meaning that the last quarter GDP measure for 2014 will include illegal activity making the 2014 GDP figures the most difficult to use.

Now EU countries are at an advantage in terms of including illegal activities in GDP. There is a rich academic literature that exists measuring the underground economy in the EU and its member states. The EU and its member states also already measure the tax gap, which is an important measure along side the underground activities. The EU and its member states already have thrown a lot of resources at measuring the underground economy. ESA has also produced detailed guidelines for the member states to follow in producing their new measures. None of this exists for Canada, other than Statistics Canada’s dismal attempt at measuring our underground economy and I would not want to bet our statistical work horse (GDP) on that product.

That said, including illegal activities in GDP, even with all this support, is still a guessing game at best. This is a very difficult task and no way to confirm or deny the figures. Despite the shortcoming, the EU and its member states should be applauded in their efforts. Understanding the underground economy and associated illegal activities are important to understanding the health and well-being of a nation’s economy. Canada has a lot to learn from this exercise.


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