Definition and scope of the study

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According to the Handbook for the Measurement of the Non-observed Economy, the five groups of activities that are collectively said to comprise the non-observed economy (NOE) are: (1) the hidden or underground sector, (2) the illegal sector, (3) the informal sector, (4) household production for own final use, and (5) deficiencies in the basic data collection programme (see Chart 1).^Note1

The scope of this study is limited to market based productive activities carried out in selected components of the hidden, illegal, and informal sectors of the economy (i.e., the shaded areas in Chart 1). Some illegal production and all household production for own final use will not be included in the estimates. Statistical issues related to deficiencies in the basic data collection programme will not be addressed either.

Description for chart 1

2.1  Hidden sector

The hidden sector (also referred to as underground production in the Organisation for Economic Co-operation and Development (OECD) handbook) is defined as “those activities that are productive and legal but are deliberately concealed from public authorities” ^Note2 generally for the following reasons:

• to avoid payment of income, value added or other taxes;
• to avoid payment of social security contributions;
• to avoid having to meet certain legal standards such as minimum wages, maximum hours, safety or health standards, etc.;
• to avoid complying with certain administrative procedures, such as completing statistical questionnaires or other administrative forms.

The hidden sector includes both non-reported and under-reported production. In the latter case, it takes the form of under-reporting of revenues (or gross output), or over-reporting of costs (or intermediate inputs) in order to understate profits (or value added) to authorities or statistical agencies. This is labeled as skimming. In the former case, revenues, costs and profits are simply not reported.

In Canada, the hidden sector consists of skimming, construction-related activity, hidden rent, undeclared tips and export-related underground activities.

2.2 Illegal sector

The illegal sector represents illegal production of goods and services whose production, sale, distribution or mere possession is forbidden by law, as well as productive activities which are usually legal but become illegal when carried out by unauthorized or unlicensed producers.

Based on Blades (1983),^Note3 the following general types of illegal production are identified:

• production and distribution of illegal goods, such as banned drugs or pornographic material;
• production of illegal services, such as prostitution (in countries where this is illegal);
• production activities which are usually legal but which become illegal when carried out by unauthorized producers, such as unlicensed medical practices, unlicensed gambling activities, unlicensed production of alcohol;
• poaching, e.g. illegal fishing, hunting, tree cutting;
• production and sale of counterfeited products, such as watches and other products with false trade-marks and unauthorized copies of artistic originals, e.g., software, compact discs (CD) and videos;
• smuggling, in particular of tobacco, weapons, alcohol, food, people, both wholesale and retail;
• fencing (resale) of stolen goods;
• bribery;
• money laundering.

Unlicensed operations represent those productive activities which are usually legal but become illegal when carried out by unauthorized producers. This study includes the illegal manufacturing, sales and imports (smuggling) of alcohol and tobacco, which are the two most important cases of unlicensed operations in Canada.

Illegal operations represent the production of goods and services whose sale, distribution or mere possession is forbidden by law, such as the production and sale of narcotic drugs. This study does not attempt to measure activity that is forbidden by law, due to the difficulty of obtaining reliable source data in these areas.

2.3 Informal sector

The informal sector represents informal production activities associated with establishments that are not registered with fiscal or social security authorities. As a result, they are generally missing from survey frames of statistical agencies, such as the Business Register (BR) used by Statistics Canada.^Note4, ^Note5 These entities include unincorporated businesses operating legally as unregistered establishments of the self-employed with and without informal employees.

The informal production activities included in this study are child-care in the home, private household services, other personal care services, and direct sales of agricultural products. Although household expenditure on these services is likely captured by the Survey of Household Spending (SHS), and is part of expenditure-based GDP, it is believed that income from these activities could be potentially missing from the income side of GDP.

The estimate of direct sales of agricultural products represents undeclared income from individuals selling farm produce such as fruits, vegetables, eggs and honey on road sides or temporary stands directly to consumers. This income is potentially missing from the income component of the retail industry or implicitly included elsewhere through national accounts balancing adjustments. The expenditure on these products is captured by the SHS and is in the published GDP numbers.

Firms or establishments operating in other industries without being registered with the fiscal or social security authorities are not included in this study. Although it is possible that underground activity exists in other industries, they have been excluded until further research determines the magnitude of this missing productive activity.

2.4 Household production for own final use

Production of households for own final use is defined as those productive activities that result in goods or services consumed by the households that produced them.

All goods produced by households on own-account are included in the SNA production boundary, however, in Canada, in practice, only food grown by farmers for own-consumption is included. Services produced by households, on the other hand, are not included within the production boundary (e.g. cleaning, laundry) except for own-account rent, which already has a measurement methodology. Owner-occupied rent is counted in the official GDP, but not considered in this study.

2.5 Deficiencies in basic data collection program

The term “basic data collection program” is used to describe the statistical infrastructure and survey procedures that collect and process basic economic data.

The Canadian System of National Accounts (CSNA) and its feeder programs within Statistics Canada have developed a wide range of methods and procedures that address deficiencies in basic data collection. Statistics Canada data sources, from surveys or administrative forms, are subject to a quality assurance process that closely monitors and adjusts the data sampling and collection frames, employs a rigorous follow-up of surveys and subjects all data responses to validation checks to ensure the correctness and consistency of data.

After appropriate transformation to national accounting concepts, these datasets are used in the national accounts compilation process. Where these basic data are inadequate, the data gaps are filled and inconsistencies are resolved using indirect compilation methods that model the missing data using other related data (indicators) and that enforce accounting identities.

Given the various stages of data verification, integration and reconciliation carried out in the statistical system, this particular source of mis-measurement of the official GDP is not considered significant, and is not considered in this study.

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Notes

1. “Measuring the Non-Observed Economy: A Handbook” (Organisation for Economic  Co-operation and Development, International Monetary Fund, International Labour Organisation and CIS STAT (2002)).
2. Ibid., p. 37-38.
3. Blades, D. W. 1983. “Crime: What Should Be Included in the National Accounts and What Difference Would It Make.” The Economics of the Shadow Economy, Proceedings of the International Conference on the Economics of Shadow Economy, held at the University of Bielefeld, Series in Contemporary Economics, vol. 15.
4. The BR is a repository of information reflecting the Canadian business population and exists primarily for the purpose of supplying frames for all economic surveys at Statistics Canada. Only businesses with a business number issued by the Canada Revenue Agency are represented on the BR. For more details, see Definitions and Concepts Used in the Business Register, Business Register Division, Statistics Canada (February 13, 2009).
5. In Canada, small businesses with total taxable revenues before expenses of $30,000 or less in the last four consecutive calendar quarters and in any single calendar quarter do not have to charge GST/HST to customers.