An important economic consideration

What would be the effect if illegal activity were included in the GDP?

An economist with the Bureau of Economic Analysis (BEA) recently posed an interesting question: Should we include criminal transactions in our Gross Domestic Product?

It is not a frivolous question but one that deserves serious consideration. Rachel Soloveichik is a research economist with the Department of Commerce’s Bureau of Economic Analysis (BEA), which prepares and reports on the status and growth of our Gross Domestic Product (GDP). Her investigation into the question is summarized in her report, “Including Illegal Activity in the U.S. National Accounts.”

The report includes an estimate of the effect on GDP if illegal activity were included. Rachel Soloveichik’s analysis indicates that “in 2017 the level of nominal GDP rises by more than 1 percent when illegal activity is tracked….” The biggest contributions would be by illegal drugs ($111 billion) and embezzlement, shoplifting, and other theft from businesses ($109 billion).

These amounts alone would be a size enough to affect growth rates in our measurements of GDP and such key variables as productivity. It could then conceivably be a significant factor in fiscal and monetary policy decisions.

Her question is one that has come up in economics before, but there has been no real consensus in our country on whether the answer is yes or no. The report by Soloveichik, though, begins by noting that the United Nations Statistics Division “explicitly recommends that illegal market activity should be included in the measured economy.”

In fact, some members of the European Union already do include parts of the illegal economy in their national accounting reports, and Canada recently joined in. It is still a piecemeal effort, though, with some countries including only the illegal activities that they believe they have serviceable data on – gambling and prostitution are more often in this category, with drugs a close third.

In some countries, illegal markets – the so-called “black market” —make up a critical portion of the economic activity. To some degree it has been accepted as part of the culture of the country, and very difficult to dislodge by law enforcement. Parts of these markets are controlled by organized crime and it can be hazardous to ask too many questions about their activity. This could pose a problem to economic analysis which relies on questions to validate its national accounts estimates.

How good the data really is, of course, is also still questionable. Legal economic activity in a developed economy can be tracked and validated through by using of multiple sampling techniques and confirming data such as tax collections, employment, retail sales, etc. We have none of this currently available, really, for illegal activity and that presents a major obstacle to its inclusion in national accounts. As the Soloveichik report notes, “But, BEA does not currently include illegal market activity because of challenges in source data and different conceptual traditions.”

There is an additional consideration that the report does not address. If we answer the “Can we?” question, that still leaves “Should we.” Even if we could figure out ways to get past the formidable statistical measurement challenges, would it make sense to include illegal activities on our books?

One perspective on that question is whether gambling, for example, is a good thing for our economy or our society. The recent death of Paul Volker evoked well-earned praise for the man who as Chairman of the Federal Reserve rescued our economy from the turbulent, destructive inflation in the 1970s.

That period was one in which the eroded value of savings, along with other factors, sabotaged our faith in the legitimate, productive economy and America turned more and more to speculation, including gambling, legal and illegal. And while the Federal Reserve, under Volker’s leadership, would eventually cure inflation, the speculation fever remained. Once the possibility of effort-free profits appears, more and more individuals, corporations, and governments find themselves unable to resist the temptation. The speculative urge that plagued the 1970s has since resurfaced in many areas, including expanded sports gambling and government-sponsored lotteries and horse parlors. We eventually paid a high price for our speculative behavior when the real estate and financial markets collapsed in 2007-08.

Would including drug dealing, gambling, prostitution and other illegal operations alongside legitimate economic activities tend to legitimize what is now considered criminal? Of course, it will. Eventually the glossary of mothers’ pride expressions would become more inclusive with “My son, the drug dealer,” and “My son, the procurer.”

Rachel Soloveichik’s analysis is thorough and her excellent report should be required reading for all those who will be deciding whether to include illegal activities in our economy’s measurement. It would be easy to follow the lead of the U.N., but would it be the right thing for our country? Don’t bet on it.

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