1993 SNA Updating - Issue 33

Illegal Activities

Giovanni SavioStatistics Coordination Unit, UN-ESCWA

Workshop on National AccountsCairo, 19-21 December 2006

SNA 1993 and illegal activities

According to 1993 SNA, illegal activities that have the characteristics of transactions (mutual agreement between parties) are treated the same way as legal actions: therefore, they should be recorded in the accounts (§ 3.54-56)

Thus, 1993 SNA departs from a moral point of view in considering illegal production

Lack of recording causes discrepancies, as incomes earned from illegal production are largely spent on the purchase of legal goods and services, on the acquisition of legal fixed or financial assets or other legal transactions. There is inevitably a discrepancy between supply and uses if illegal activities are not recorded (§ 3.54)

SNA 1993 and illegal activities

In addition to consistency of the overall system, comparability of national accounts figures between countries and over time is another major reason for inclusion of illegal activities

Some activities (ex.: production/distribution of alcohol, prostitution) may be illegal in one country and legal in another: exclusion may bias international comparisons

Distortions over time can also emerge if some activities switch from being illegal to be legal, or conversely (ex.: production and distribution of alcohol during prohibition in the USA)

SNA 1993 and illegal activities

There are “obvious practical difficulties in obtaining data on illegal production” (1993 SNA, §6.30), and in countries where illegal activities are quantitatively insignificant, efforts are better directed to reducing the amount of other NOE components

Since the publication of the 1993 SNA, the NOE Handbook (Ch. 9) has provided more examples of illegal activities and proposed further guidelines on theft and fencing, bribery, extortion and money laundering

The explanation of illegal activities in the 1993 SNA should be further clarified by providing examples based on, or references to, those in the NOE Handbook

Illegal activities in NOE Handbook

1. Production and distribution of illegal goods (i.e. banned drugs or pornographic material)

6. Theft and fencing (re-sale) of stolen goods

2. Production of illegal services, such as prostitution (in countries where this is illegal)

7. Bribery

3. Production activities which are usually legal but which become illegal when carried out by unauthorized producers (i.e. unlicensed medical practices, unlicensed gambling activities, unlicensed production of alcohol and poaching)

8. Money laundering

4. Production and sale of counterfeited products (i.e. watches and other products with false trade-marks and unauthorized copies of artistic originals, such as software, CDs and videos)

9. Forgery of banknotes, contract murders, espionage, etc. (generally of minor importance for NA)

5. Smuggling, in particular of tobacco, weapons, alcohol, food, people, both wholesale and retail

Thefts

The 1993 SNA discussion relating to the recording of normal rate of theft does not warrant any further clarification. In fact, many illegal actions are crimes against persons or property that in no sense can be considered as transactions. For example, theft can scarcely be described as an action into which two units enter by mutually agreement. “Thus, thefts of goods from households … are not … recorded under household expenditures” (§ 3.55)

Fencing or (re)sale of stolen goods

These activities are not treated in 1993 SNA, but will be included in the updating

Sale of stolen goods (fencing) involves interaction between two units by mutual agreement. If the units are involved in these activities on a regular scale, value added and trade margin are generated as part of the distribution of the illegal goods. It should be treated similar to the treatment of sales of second-hand goods

Sale of stolen goods (fencing) should be recorded similar to the recording of sales of second-hand goods – that is, recording the value added and trade margins of distribution activities

Extortion

Extortion payments are enforced by violence or blackmail. There is no mutual agreement and is therefore clearly not a transaction in line with the 1993 SNA. The revision is an agreement with the NOE Handbook (§ 9.25) that extortion should be recorded as an other changes in the volume of assets

Extortion payment should be recorded as an other change in the volume of assets account

Estimation issues

By their nature, illegal activities are very difficult to measure. People involved in illegal transactions have obvious reasons to hide their involvement

However, there are sometimes quite reasonable if unconventional data sources and methods to measure various types of illegal activity. The quality of these estimates is subject to more discussion than that of estimates for activities that are well covered in regular surveys

Some important problems are discussed in connection with estimation of drugs

Estimation issues

Parts of some illegal activities may be implicitly included in the system of NA (double counting problem), e.g. prostitution. Income from prostitution may be declared as income from legal “personal care” services and expenditure on prostitution may be declared, but similarly disguised, by the purchaser

However, in most cases usual sources for NA will not have information on illegal activities, thus direct methods for compiling estimates are to be preferred

Probably the most useful approach is to use the basic identity:

domestic output + imports = interm. cons. + final cons. + capital formation + exports

Estimation issues

Estimates of value added resulting from this identity can be confronted with direct observations on income generated from illegal activities

For any given illegal activity, data should be collected, as far as possible independently, on each of the three angles: supply, use and generated income

In many cases, data for one of the angles may be completely absent or very weak. In that case, the identities can be used to compile the missing data

General sources ofinformation

Several source can be used for estimation of illegal activities, among these:

– police and survey data on criminal activities – health care institutions and charities may also provide useful

information, e.g. on the number of addicts in the case of drugs, or the number of prostitutes

– more conventional data sources for the compilation of NA, e.g. labour force surveys and other household surveys

– special studies by universities and research institutes, although often not concerned with the money flows involved

– the last resort is to conduct a survey focusing on those aspects of illegal production for which it seems feasible to try and collect data

An example: estimation of drugs

Directly observed data are usually not available on the production, distribution and consumption of drugs. Studies by universities and research institutes may contain useful data, e.g. on domestically produced drugs

Usually estimates must be based on police data on seizures and estimates of the relevant seizure rates. For domestic consumption, estimates of the number of addicts and average quantities used seem to provide the most reliable data

If the country does not have substantial exports of drugs, the data on supply and use are complete, and can be confronted with each other. In such confrontation, data on seizure rates are to be considered as especially weak. Additional information on these rates, for example obtained by interviewing convicted criminals, may improve the estimates. Moreover, a sensitivity analysis using different assumptions on seizure rates may prove helpful

An example: estimation of drugs

If the country also exports drugs, the situation becomes much more complicated. Usually, exports can be estimated only as a residual item, i.e., as domestic output plus imports minus consumption minus seizures. As a consequence, the reliability of the estimates depends critically on the quality of the estimated seizure rates

As the identity in current prices shows, total domestic output consists of domestically produced drugs (at basic prices) plus trade and transports margins on both domestically produced drugs and imported drugs. The total of this figure can be considered to be the most important item, the distinction between output of domestically produced drugs and margin is less relevant

Total domestic output in current prices equals consumption plus exports minus imports. So, additional data on street prices, import prices and export prices are needed to arrive at an estimate

An example: estimation of drugs

Reasonably good data on street prices are usually available from police sources or research studies. Data on prices of imports and exports are much more difficult to obtain. As in the case of drug purities, one needs additional information on the structure of the drug distribution network

Sometimes, such information may be available from police and/or customs. Information on prices in neighbouring countries may also be applicable

To arrive at an estimate of VA, assumptions have to be made on the value of intermediate consumption. Assuming that drugs dealers take care of their own transport, intermediate consumption is rather low in the case of trade in drugs. A higher share of intermediate consumption has to be assumed in the case of drugs production itself. Often, technical coefficients are available for this purpose

An example: estimation of drugs

Dividing the resulting estimates of value added by estimates of the number of people involved in the drugs industry may give an insight into the plausibility of the value-added figures

The income generated by illegal drugs transactions is used, sometimes after laundering the money, for final consumption purposes, investment in non-financial and financial assets, etc. It can be assumed that these expenditures on legitimate items will be covered implicitly in the system of national accounts

References

1. OECD, IMF, ILO and ISCCIS (2002), Measuring the Non-Observed Economy: A Handbook, Paris: OECD available at: http://www.oecd.org/dataoecd/9/20/1963116.pdf