It’s time to observe the unobserved economy

Võ Trí Thành*

The unobserved economy is not a recent phenomenon, so not a new concept. Concern about the influence of unmeasured economic activities has been growing since the beginning of the 20th century. 

Back in 1914, economist Helfferich K. took the underground economy into account when estimating the size of Germany’s national income for 1888-1913.

Broesterhuizen G.A.A.M., in his paper, “The unobserved economy and the national accounts of the Netherlands”, in 1982 investigated the possible distortion of officially measured GDP caused by fraud by using sensitivity analysis.

The International Monetary Fund published a working paper in January 2018 which measured the shadow economy of 158 countries all over the world from 1991 to 2015 by using different methods. The paper showed that the average size of the shadow economy of the 158 countries was 31.9 per cent, with the largest being Bolivia (62.3 per cent of GDP) and the smallest being Switzerland (7.2 per cent).

According to the paper, the average size of Việt Nam’s shadow economy in the 1991-2015 period was 18.7 per cent.

Despite using different definitions and different methods to estimate the size of the unobserved economies, theses researches and studies show statistics are an important macro-economic basis for policy making. When the statistics are biased because of a large and growing unobserved sector, policies might miss their desired effects and sometimes even result in adverse outcomes.

According to the Organisation of Economic Co-operation Development’s handbook on measuring the non-observed economy released in 2002, a lack of economic coverage could cause the levels of gross domestic product and other data, such as poverty rates gauged by GDP per head or pollutant emission per unit of GDP, being downward biased, thus “giving an inaccurate impression of the economy and impeding international comparability”.

The unobserved sector is by nature usually attached to vulnerable, disadvantaged groups. With little endowment, these people just want to earn a living in a simple way such as opening a street food stand, shining shoes and picking up garbage from the streets. They are the workforce which are altogether called by economists and policy makers informal.

A lot of business activities in the informal sector are often characterised by a small scale, an absence of business registration, and workers not being supported or protected by the State.

The International Labour Organisation estimated that by 2016, the rate of informal employment in Việt Nam accounted for about 57.2 per cent of non-agricultural workers.

In the country, as many as 76.7 per cent of informal workers engaged in employment without any form of written labour contracts, and 97.9 per cent of them did not gain from social insurance.

If the Government can observe this sector, it could work out better social policies adaptive to the vulnerable, disadvantaged groups of people and suitable to the sustainable development goals so the target of “no one will be left behind” will be achievable.

Besides, the informal sector has gradually become an important part of the economy but is usually labour-intensive, low-tech, family-owned and requires much less complicated skills, making the whole economy less productive. It is time for the Government to recognise and value the contribution of informal workers by formalising their informal activities. It would help the Government increase economic productivity and allocate resources efficiently, thus improving the economic performance of the country.

Under the circumstance of budget constraints, the formalisation of the informal sector or making the unobserved sector accountable is one of the solutions that could increase State budget collection by expanding the tax base.

However, the informal sector is just one group that is conventionally deemed unobserved.

As defined by the OECD, the groups of activities most likely to be non-observed are those that are underground, illegal, informal or undertaken by households for their own  use as well as activities missed because of deficiencies in basic statistical data collection.

And the thorny issue here is to define exactly what should be measured and how to measure it. Only when we have a common perception of the things we want to measure, we can find the solutions.

Unfortunately, it is hard to tell clearly the difference between underground activities and informal or illegal activities, and the relationship between them, not to mention some activities deliberately hidden by subjects to evade tax. Therefore, official statistics do not properly reflect the magnitude of such activities.

Difficult but not impossible

Despite difficulties, economists still find ways to estimate the non-observed economy by conducting surveys and using calculations based on cash transactions outside the banking system. So it is still possible to observe unobserved things, but the cost is obviously not small.

Given the situation, the Government needs to define the measurement targets based on policy priorities so it will be able to focus its resource on the calculations more efficiently.

There are three policy priorities that need to be addressed. First, the vulnerable and disadvantaged people, especially those living in remote areas, ethnic minorities and children. It is necessary to protect and take care of groups maginalised by circumstances so they can contribute legally and productively to socio-economic development.

With a target of having one million of well-performing enterprises by 2020, the Government also has policies to turn household businesses into companies, so it must be capable of measuring the operation of these businesses to find ways to improve their efficiency.  

Last but not least, e-commerce and platform businesses have been mushrooming thanks to the development of information technology and social networks, but the Government has not been able to work out solutions to manage them, which could be deemed unobserved.

On the one hand, we need incentive policies to push innovation and creation and promote start-ups. On the other hand, we have to have concrete regulations in place to effectively manage them to turn them into a significant tax base, contributing to the State budget.

* Võ Trí Thành is a senior economist at the Central Institute for Economic Management (CIEM) and a member of the National Financial and Monetary Policy Advisory Council. The holder of a doctorate in economics from the Australian National University, Thành mainly undertakes research and provides consultation on issues related to macroeconomic policies, trade liberalisation and international economic integration. Other areas of interest include institutional reforms and financial systems.