How Big is the Underground Economy?

  • May 14, 2015

By Jock Finlayson

Statistics Canada recently published new estimates of the size and composition of the “underground” economy. According to the agency, “underground” or “hidden economic” activity amounted to some $42 billion in 2012, equal to 2.3% of Canada’s gross domestic product (GDP). There is some variation among the provinces. In Prince Edward Island, the underground economy is pegged at 3.3% of GDP, while in Alberta it is less than 2%. The figure for British Columbia is 2.7% of GDP, which is somewhat higher than the national average.

Many people – certainly in BC – will be surprised at this seemingly low estimate. Casual observation coupled with regular news stories on this province’s booming drug business suggest that “hidden” economic activity is more extensive than Statistics Canada believes. Before jumping to that conclusion, it’s important to look closely at what is being measured by the Statistics Canada researchers. They describe the underground economy as “consisting of market-based economic activities, whether legal or illegal, that escape measurement because of their hidden, illegal or informal nature.” However, in practice most illegal activities, including those related to drugs, prostitution and white collar crime, are excluded from their analysis. That helps to explain why the reported size of the underground economy in BC seems on the low side. In addition, the approach taken by Statistics Canada also misses a certain amount of “legal” economic activity involving households, the self-employed and small unincorporated businesses.

An earlier Business Council paper explored the topic in some detail. In that paper, we noted that World Bank estimates of underground economic activity, based on the broadest definition of the term, range from 8% to 30% of GDP for a cross-section of advanced industrial countries, with Canada coming in near the middle of the pack at around 15% of GDP. This is much higher than the figure reported by Statistics Canada. In part, the discrepancy reflects the more comprehensive measure of hidden activity used by the World Bank authors, who sought to capture all forms of illegal activity as well as household production for “own-use.” But it also speaks to the difference between the dollar estimates of production/spending that some researchers use to gauge the extent of underground economic activity, versus the “value-added” methodology that Statistical agencies rely on when computing GDP.

The underground economy (UE) is a complex subject. Unsurprisingly, it is hard to measure transactions that are unreported, deliberately hidden, and/or undertaken in the “shadows.” In our earlier work, we argued that the UE in British Columbia could be up to 5-10% of GDP, based on an expansive definition of the term that captures illegal as well as legal activities, household production for “own-use,” unreported home renovation spending, etc. We also suggested that BC has a proportionately bigger UE than most other Canadian provinces, for the following reasons:

  • our economy is heavily skewed toward self-employment and unincorporated small businesses, where unreported transactions are more common;
  • BC has a sizable and thriving illegal drug industry that involves several billion dollars of cash transactions every year;
  • home-building and home renovation represents a bigger slice of GDP and overall spending in BC than in other parts of the country – this matters, since Statistics Canada has found that (legal) underground activity is more widespread in construction than in any other industry.