Countries May Have Strong Incentives To Misreport Their National Accounts

The existence of an underground economy – a mix of illegal market activities such as selling proscribed drugs and legal market activities kept hidden perhaps for reasons of tax evasion – is an indication that official estimates of GNP may not be correct. But according to Vito Tanzi, writing in the latest issue of the Economic Journal, it by no means proves the case. Indeed, countries have an increasing number of incentives to report inflated or deflated estimates of GNP – the former to meet international obligations such as the Maastricht criteria or to qualify for some exclusive club like the OECD; the latter to benefit financially from subsidies or cheaper credit.

Tanzi is sceptical that current estimates of the underground economy can be used to correct the official statistics. Instead, he argues, better statistics must come mainly from more vigorous efforts by national statistical offices. He recommends that countries:
(1) guarantee total political independence to their statistical offices.
(2) give these offices the means to produce the best estimates possible.
(3) pay attention to the incentives – high marginal tax rates, rigid regulations – that push
individuals underground and that contribute to GDP data that are less reliable.

Tanzi notes that the underground economy is a phenomenon that continues to attract the attention of policy-makers, national accounts statisticians and economists – and to fascinate the rest of the population. Of particular interest is the relationship between estimates of the underground economy made by various economists and the official measures of national income and unemployment. These estimates seem to cast great doubt on the quality of the official statistics. It is commonly believed that the larger the estimate of the underground economy, the more biased in a downward direction will be the official estimate of national income and the more biased upward will be the unemployment rate. It is also believed that the underground economy has been growing in industrial countries. This would seem to imply that some countries, such as Italy, Spain and even Russia are much richer than the official statistics indicate.

Tanzi argues that various incentives have been created over the years that put pressure on national authorities to produce estimates that are higher or lower than the true, objective but unknown ones. Lack of financial and human resources, limited political independence and widely cited estimates of large hidden activities may, as a consequence, influence the results generated by the statistical offices.

For example, higher estimates of GDP make it easier for a country to comply with some international obligations – say, satisfying the Maastricht criteria – or they may help it to qualify for some exclusive group of countries, such as the G-5, the G-7 or the G-22. Lower estimates often provide some financial benefits in terms of access to subsidies or cheaper credit.

Perhaps recognising some of these potential biases as well as the likely deficiency of available GDP data, the European Commission has been pushing its members to produce national account estimates that are ''reliable, comparable, and exhaustive''. Yet many countries are still some way from being able to do so.

The connection between the estimates of the underground economy and the unemployment rate is also much less direct than generally assumed. The view that a large underground economy implies that the official unemployment rate is less of a concern is widely shared. But many of those participating in the underground economy are not in the official labour force because they are too old or too young or they are foreigners without work permits. Thus, only part of the output produced by the underground economy is produced by individuals who are officially unemployed.

Tanzi concludes that the current estimates of the underground economy are not yet robust enough to base strong conclusions on them: different researchers using different methods continue to produce estimates of the underground economy that are still widely divergent. Furthermore, no method has imposed itself as being clearly superior to the others. Therefore, these estimates cannot provide information for correcting the official statistics.

''Uses and Abuses of Estimates of the Underground Economy by Vito Tanzi is published in the June 1999 issue of the Economic Journal. Tanzi is at the International Monetary Fund and was among the first economists to pioneer the systematic quantitative study of the hidden economy in the early 1980s.