”Measurement Without Theory” – Attempts To Quantify The Black Economy Are Of Limited Value To Policy-Makers

In terms of national income, how big is the black economy? In 1981, one economist suggested that as a percentage of Gross Domestic Product (GDP), it had grown from zero to 8% of GDP by 1971. It then grew dramatically to 22% in 1974, fell to 14% in 1975 and then fluctuated around this level. How did he know? Not through the application of well-developed economic theory, but rather through playing a game of magic numbers based on arbitrary and untestable assumptions.

That is the conclusion of Jim Thomas of the LSE, writing in the latest issue of the Economic Journal. Thomas criticises empirical work that attempts to measure the size of the black economy as being ”measurement without theory” – that is, for its failure to develop models based on sound economic theory to analyse the magnitude of unrecorded activities. As mere ”guesstimates” of their total size, such work is of limited value to policy-makers: it is also important to know who is doing what, where, why and how. Then we can see what should and/or can be done about legislating for or against the black economy.

Thomas notes that in assessing the various attempts to measure the black economy, it is important to be aware of the political dimension to some of this work. Perhaps a large and growing black economy is an indication that the economy is over-taxed and over-regulated and a neo-liberal adjustment is necessary to free it up. Alternatively, if a large part of the black economy is social security fraud, then maybe unemployment is not really as bad as it looks. Clearly, such political conclusions depend on having good theoretical as well as sound quantitative foundations and both these components are generally missing.

Thomas concludes that the search for the magic number corresponding to the size of the black economy as a percentage of GDP without providing economic theories to explain its determinants and structure has led economists into a blind alley in which the question of size has become an end in itself and more important issues are not addressed. No genuine policy conclusions emerge from the exercise, although some have been tacked on, varying according to the political persuasion of the author.

”Quantifying the Black Economy: “Measurement without Theory” Yet Again?” by Jim Thomas is published in the June 1999 issue of the Economic Journal. The author is in the Department of Economics at the London School of Economics.

Jim Thomas

0171-955-7523 | j.thomas@lse.ac.uk