Canada and the Underground Economy

A 'new' spin tactic for politicians dealing with a rough economy: count the underground economy!

The Underground Economy and Canada: A Hoovering ~2% of GDP From 1992-2009

Statistics Canada yesterday released an update to its early September study on the underground economy in Canada from 1992 - 2009. Here are the main takeaways from the report:

In 2009, total underground activity in Canada was estimated at $35 billion, an increase of 77% from 1992, whereas nominal GDP grew by 118% over that same period. This estimate of underground economic activity was equivalent to 2.3% of GDP in 2009, down from 2.9% in 1992. 

The main reason for the slower growth of the UE compared to the total economy is that industries traditionally considered to be involved in the UE activity did not grow as fast as the overall economy, or as fast as other industries less impacted by the UE.

UE activity may be found in any industry. However, the three most significant industry sectors in terms of UE activity in 2009 were construction (29%), retail trade (20%), and accommodation and food services (12%). These industry sectors accounted for 61% of the total UE estimate.

To get a sense of comparison, the EU has estimated Italy's underground economy to represent 17% of Italy's total GDP.

The Pros and Cons of a Thriving Underground Economy

So what is this an interesting/vexing issue for policy makers. From page 2 of the introductory essay 2005's Size, Causes And Consequences of the Underground Economy: An International Perspective, by Christopher Bajada and Friedrich Schneider:

1.  Saps tax coffers, triggering increased taxes, which then saps tax coffers even more as the underground economy grows.  

"...If the growth of underground activities is caused by a rise in the overall tax and social security burden, together with institutional sclerosis, then the consecutive 'flight' into the underground economy may erode the tax and social security bases further adversely affecting the future provision of public goods and services.  The result can be a vicious circle..."

2.  Can't Make Good Economy Policy if You Don't Have Good Economic Data.

"A growing underground economy may cause severe difficulties for politicians, particularly their use of official indicators -- unemployment rates, labour force participation rates, income and consumption figures, just to mention a few -- that are unreliable in the presence of a growing underground economy.  Policy based on erroneous official indicators is likely to be ineffective or in the worse case, counter-productive."

3.  But the Underground Economy Still Helps, and Hurts, the Legitimate Economy.

"The effects of a growing underground economy of legitimate activity is quite important to consider.  On the one hand, a prospering underground economy may attract (domestic and foreign) workers away from legitimate employment and create competition for legitimate firms.  On the other hand, a significant portion of income (at least 2/3) earned in the underground economy is immediately spent in the legitimate economy, generating a positive impact in the legitimate sector that may otherwise not have come about."

"Stop Worrying": Stephen Gordon On Canada's Widening Trade Deficeit

Stephen Gordon explains why Canadians shouldn't worry about their widening trade deficit.  To boil down his already short article, Gordon points out that net exports are a component of a nation's GDP, and thus lower net-exports can lower a nation's GDP.  But falling net-exports can also lead to rising investment, which is also a component of national GDP.  So, falling net exports can be offset by rising investment.  And where does that lead us?  The conclusion from Stephen Gordon's helpful and concise piece in Macleans: 

...there’s no obvious reason to think that strong growth in net exports is positively correlated with strong growth in GDP: net exports fell in the expansions of 1982-1990, 2001-2008—and again in the most recent expansion..."

That said, what could be considered worrisome is the drop in the levels of both exports and imports: this is indeed a sign of a slowdown in overall economic activity. But that would have been bad news even if net exports had gone up.

People should stop worrying about the trade balance; the fact that the word “deficit” is used shouldn’t alarm you.