Off the mark: Black economy and black money

Published : 23 July 2011, 02:48 PM
Updated : 23 July 2011, 02:48 PM

During the penultimate hours of the final budget deliberations, where black money whitening was on the card, the Minister of Finance revealed a startling finding from a little-known study that between 45 to 81 percent of the GDP of Bangladesh is derived from black economy. Despite the very large range of uncertainty of the estimate, it was widely reported in the news media. The Minister had the difficult task of justifying (or at the least making it appear benign) the legalisation of black money through investment in the stock market at modest cost, a course of fiscal action that he had publicly repudiated on several occasions in the past.

If more than four-fifths of the economy is actually black economy, then presumably the black money holders are not really as bad a group of people as they are made out to be; they are more like the average person of the society and it would not be fair to single them out! The cue was picked up by the holders of black money and their allies to argue more vigorously for the opportunity of whitening black money. They were not disappointed.

The statement of the Minister gave the impression that black money and black economy are the two sides of the same coin even though that might not have been his intention. However, he did not clarify, nor did anybody else, that black money and black economy are not quite the same thing in Bangladesh. The confusion could be in part due to the unwitting application of western concepts to our economy, a practice that is regrettably widespread.

The author could not find the study, nor could he find anyone who has seen it. It has not been put up in the Ministry's website. Assuming that the author(s) of the study did not invent a new definition, one could follow the standard definition of black economy to examine what might be implied by the finding. Black economy, variously called the underground economy, shadow economy, parallel economy etc., refers to economic activities that are not reported to the taxman or the statistical office. Some authors make a difference among these terms. For example, shadow or parallel economy may include only unreported legal transactions, while black or underground economy includes all unreported transactions. Since these transactions are not reported or recorded, they do not show up in the national income accounts.

It may be mentioned that 'the income approach' of estimating national income, i.e. national income estimates derived by adding up the incomes of individual economic agents, is a reliable method of estimation in developed countries such as the USA. Hence, the extent of the black economy is a rough measure of the amount by which the national income is underestimated in official national accounts. The sway of the black economy is believed to range under 15 percent of GDP in the most developed countries, but increases dramatically for the poorer countries. Black economy contributing more than three-quarters of the GDP in such countries is not unknown. Hence, it would seem that the extent of the black economy in Bangladesh suggested by the study is not outlandish if we accept the standard definition of the term.

As indicated earlier, black economy activities could be either legal or illegal. All incomes, even when below the tax threshold level, have to be reported (and hence recorded) in developed countries such as the USA. Since black economy transactions are not reported, these give rise to illegal incomes or black money. Legal actions could be taken if the existence of such money is detected. In this case these two terms are indeed two sides of the same coin.

In contrast to the practice in developed countries, the people of Bangladesh are not required to submit tax returns if their incomes are below the threshold level (except under certain circumstances). The threshold level of income this year is Tk180,000. For farmers this is raised by an additional Tk 50,000. Since only a fraction of the population have incomes in excess of these amounts (only 0.7-0.8 million people pay income tax), a large part of the national income is exempted from reporting. Consequently, unreported incomes could amount to a large fraction of the GDP, but importantly these are not necessarily illegal. Unlike in some developed countries all unreported incomes are not black money in Bangladesh.

Black money arises out of transactions that are either expressly illegal, or legal but not reported in order to evade taxes. Since incomes on which due taxes have not been paid is illegal post fact, all black money is illegal according to the tax laws of the land. Such money must not be confused with the unreported incomes of the less fortunate section of the population who are exempted from reporting because their incomes fall below the subsistence threshold level as determined by the government.

Unreported incomes do not necessarily imply unrecorded incomes in the national accounts of Bangladesh. The Bureau of Statistics imputes values to unreported economic activities to arrive at an estimate of the total unreported income. Virtually all incomes in the agricultural and the informal sector are unreported incomes, and are estimated by the Bureau of Statistics through appropriate methods of imputation. Thus much of the unreported incomes are actually recorded and hence the black economy, defined as above, does not measure the extent to which the GDP is underestimated. Indeed, whether legally exempted unreported income should be included in black economy is a moot point.

It is also not the case that black money is not recorded. Most of the black money is spent on legal transactions; it is invested in different assets such as real estate or spent in conspicuous consumption. Much of it should be picked up in the GDP estimated by 'the expenditure approach' i.e. adding up all final expenditures made in the economy.
Since a very large part of the income earned by the population is not reported, and income reporting of the rest is admittedly of a poor quality, the Bureau of Statistics does not even attempt to measure the GDP of the nation by the income approach. Its estimates are based on the expenditure approach and the value addition approach. These methods should capture most of the final output produced in the economy. Hence, the extent of the black economy quoted by the Minister would appear to be rather too large.

The opportunity given to the black money holders to legalise their black money through investment in the stock market is showing the expected result. The stock market general index has risen by more than 25 percent in less than two months. Another bubble seems to be in the making. The Minister complained of foul play, but his complaint lacked credibility.

A problem with highlighting of such extravagant sway of the black economy from the highest level of the government is that it sends out wrong signals about the economy to both domestic and foreign communities. If up to 82 percent of the economy is black economy, then most of the monetary transactions in the economy could be construed as money laundering! Such a possibility could make foreign investors unduly cautious about investing in Bangladesh.

No one can legally challenge the right of an elected government to adopt any permissible fiscal measures. Concerned citizens may only protest to make their disagreement known. However, it is expected that a responsible government will not dabble in concepts or data that are more likely to confuse than illuminate. Transparency is an essential prerequisite of good governance.

M A Taslim is a professor of the Department of Economics, University of Dhaka.