Prostitution, Drugs, and GDP: does the Reality Check Pay Off?

[source: Wikimedia][source: Wikimedia]

The European economic recovery seems to have found an unlikely helping hand. The UK, Ireland, Italy, Sweden, and Finland are among the nations now moving to include illicit activities in their calculations of Gross Domestic Product (GDP), the most widely-used measure of goods and services output across an economy.

By one estimate, the UK could add as much as £5.7 billion to the value of its GDP by including prostitution and about £4.6 billion by adding illegal drugs.  This is enough to boost the total size of the economy by 0.7%.  Not to be outdone, Italy will include smuggling of illegal goods as well, and these changes will begin this year.  Other nations in Europe are also expected to comply with a European Union call to standardise and broaden GDP calculations.

There are obvious motives for doing this.  Cynically, using illicit activities to boost GDP could help some countries stay under deficit-to-GDP ratios mandated by the EU, which is more than welcome for cash-strapped Spain and Greece.

There is an economic argument in favour too. In all EU countries except Romania, Croatia, Lithuania, and Sweden, selling sex services is legal, but brothels are not. Drugs are banned everywhere; and the lenience of the Dutch towards marijuana use is likely to be tightened soon. If drug sales and prostitution are not acounted for in a place where people spend half their income on drugs and paid sex, one could wrongly conclude that the population saved half its money. In addition, these are economic activities in the sense that they involve exchanging money for labour and services. This makes them legitimate, even if not legal output, and calls for them to be considered in the same way, at least economically, as selling muffins or working as a self-employed plumber.

Some economists question the merits and methods of measuring the shadow economy. Criminals go to great lengths to hide transactions and they are usually conducted in untraceable cash. In addition, these activites can rarely be taxed, which means they do not generate public revenues.  All of this creates tension when the annual monetary contribution of each country to the EU budget is adjusted in accordance with the newly-calculated, “broader” GDP.  This tension moved to the very core of the political argument in Britain last month over the size of Britain’s budget contribution to the EU. Prime Minister David Cameron vehemently opposed the additional £1.7 billion that Britain was asked to pay to the European Union, due at the beginning of this month.  Eventually a compromise was reached, and Britain is now expected to pay half the sum, due to the automatic rebate to its EU payments, with the due date extended interest free to the latter part of 2015.

But including income from illicit activities when calculating GDP should not be seen as a Eurocratic accounting trick designed to squeeze extra cash from disciplined, hard–working governments.  In some cases, it is the only way to realistically assess the impact of drug dealing and prostitution on the economy and to compare it to other sectors. In Spain, this recalculation raised GDP by €26.2 billion. Of course, some may consider this yet another sign of Spain’s economic demise as it reveals how important these “hidden” sectors of the economy have become. Spaniards consumed €5.4 billion in illegal drugs and spent €3.8 on prostitution, a staggering 0.87% of GDP. In Italy, illicit activities raised GDP by a whole percent. In light of these numbers the new calculation cannot simply be dismissed as it gives a more comprehensive picture of economic output in EU countries, even if that output is hardly what governments envisage as the coveted path to recovery.

However, it has proven immensely difficult to pinpoint exactly the output from illicit activities. Andrew Oswald, a professor of economics at the University of Warwick, rightly points out that “people breaking the law do not often send in forms to the government.” He claims that estimates of the shadow economy are likely to be inaccurate by at least 20-25%, as a result of the obvious measurement difficulties.

So how do national statistics agencies calculate the market value of illicit activities?

Simply put, they draw conclusions from what little data they can obtain.Take Spain, where prostitution is practiced with the tacit approval of authorities. On the outskirts of most Spanish cities, there are clubs frequented by prostitutes and their customers. The clubs sell drinks and rent rooms, economic activities that can be accurately measured, but the prostitutes are not registered and do not report the income they earn in these rented rooms.

So in late 2013, statisticians contacted ANELA, a trade association for such clubs. The statisticians asked the association to estimate the average revenue raised per day in 2002, 2007, and 2012. Similar methods were used to determine the revenue from drugs, with statisticians using government and police data on drug trade and anonymously interviewing drug users about their consumption.

But the statistics collected were estimates at best due to the lack of accounting practices and income reporting, and any GDP figures calculated based on them are likely to be inaccurate. That said, the accuracy of GDP estimates for illicit economic activity is expected to improve over time as estimation techniques advance, and even more so if those activities are made legal and taxed.

The moral dimensions of incorporating these economic activities into GDP figures has caused unease as well. It has been argued that counting the shadow economy sanctions illegal activities and contributes to the ongoing process of their “socialisation” and “normalisation.” Admitting that 1% of your annual output comes from illegal activities is seen by some as a sign of government weakness, and an inability to make citizens abide by the law and earn money honestly. Some countries, inspired by Britain’s vocalness on the issue, have expressed dismay at the fact that their exchequers are charged for activities that are not taxed and bring in no revenue for the government. They argue that contributions to the European budget should not be made in proportion to the country’s GDP but to its tax revenue, which is a better measure of a government’s ability to finance contributions to the European budget.

It is no wonder that the debate about the “new”accounting of GDP figures has reached a crescendo in the past weeks. It is no wonder either that George Osborne has sought to present the automatic rebate to which British EU payments are entitled as a fruit of his toil and negotiating skills, with which he supposedly brought stubborn Eurocrats to their senses. The fact remains that the UK, as well as other European countries that “benefit” from illicit businesses, will have to adjust their contributions to the EU budget accordingly. At the end of the day, or rather the year, it is European taxpayers who spend significant amounts of money on illegal goods and socially-marginalized services and then have to foot their government’s adjusted budget bill.