Euro standards set to expose UK's hidden economy

The process of Euro-harmonisation reaches into all kinds of nooks and crannies of British life. One of the more obscure is the compilation of economic statistics. Unlike vexed issues like EU demands for straight bananas, this is not the stuff of headlines. But it will have far more of an impact on our lives. What we measure has an important effect on what we think about the economy.

The Office for National Statistics is undertaking several related projects in order to meet European national accounts standards set last year. The one on which commentators have focused is including estimates of criminal activities in measures of GDP.

The EU requirement is for an estimate of criminal activities between consenting parties - in effect, drugs and prostitution.

Much of the hidden economy consists of legitimate activity that is simply hidden from the eyes of the tax or trading standards authorities. This includes, for example, builders who omit to pay all the VAT due on repair work, or the self-employed cleaners who do not report some of the income they receive in cash. There is nothing illegal about the business itself.

This means that statisticians can actually get a pretty good idea of its extent from other measures. For example, cleaners might under-declare their income to the Inland Revenue but the people hiring them have no reason to under-report their expenditure. By comparing the expenditure, income and output measures of GDP - which should all be the same but are not - it is possible to estimate the size of the hidden economy.

According to last year's national accounts, it is running at about 1.25 per cent of GDP, or some pounds 7bn to pounds 8bn. This is down from 1.5 per cent in 1981 and as much as 3 per cent in the mid-1970s.

Its relatively small scale and decline in importance run against the conventional wisdom that the hidden economy is booming. But official statisticians describe recent estimates that it accounts for more than 10 per cent of GDP as ``lunatic''. The popular view derives from the fact that some areas of the economy - car boot sales, self-employment and so on - have grown enormously. But they are not very hidden.

Deregulation means that things that might have been illegal a decade ago are not now. What would once have been a sweatshop counts now as one of the thrusting small businesses that is making Britain the enterprise centre for Europe.

The ONS is updating its methods for measuring some of the more hidden bits of the hidden economy, but does not expect to have to make big adjustments to the GDP figures; unlike Italy, which found an extra 16 per cent of GDP in the mid-1980s, enabling it to overtake the UK as Europe's third biggest economy.

The big changes to our national statistics will stem from the less well- publicised European standards. There are several categories of these. One of the most significant will be the inclusion of intangible assets for the first time.

These range from computer software to artistic and cultural assets right up to the National Gallery. Spending on such items will count as investment. There are so few measurements of items like these that they are effectively far more hidden than what we normally think of as the hidden economy.

Publication of figures on intangibles will present a much clearer picture of the strengths of the economy, and will probably show the UK in a good light. We are pretty good at cultural assets and programming.

The focus on intangibles ties in with a new report from the Organisation for Economic Co-operation and Development on accounting for "human capital" - or in other words, measuring what people know.

The industrial economies are becoming increasingly dominated by knowledge and its related industries. Accounting for software, however, is easy compared to accounting for brain power.

Meanwhile, another controversial change to European standards that could have a huge effect on Britain's GDP is a new method for estimating the financial services industry. Currently its output is measured indirectly, mainly by looking at how many inputs it uses - much like the measurement of public services.

The Euro-method will involve measuring something more like value added in financial services based on interest margins earned by financial intermediaries. Thirdly, mineral exploration will no longer be treated as current expenditure but as part of the capital account.

There will also be presentational changes designed to make the statistics more useful for the purposes of economic policy. The anecdotal evidence suggests that the non-profit sector is growing by leaps and bounds.

More fundamentally, the ONS will start to publish a social accounting matrix. The national accounts, like a double entry book-keeping system, present the same information twice - one person's expenditure is another's income. A social accounting matrix can give the information as one cell in a grid of income and expenditure, just as the little-used input-output tables show purchases and sales by industry groups. The grid can be presented in as fine a detail as necessary.

The technique has existed since the early days of national accounting and has been widely used for developing countries. It has been revived because of a new interest in the impact of economic activity on different sectors of the community. It will allow a much more refined analysis of Government policy.

The distributional impact of tax changes will be clearer, for instance, or the tightness of the labour market at different skill levels.

All the planned changes go some way towards making the national accounts a more useful measure of well-being in a modern economy. However, radical critics would like to count some activities - such as crime - as a cost to the economy rather than an addition to GDP, as the Euro-standard proposes.

They would like to measure the household and voluntary economy, so far excluded from standard statistics because it is too hard to measure something for which there is no market value. As a separate exercise springing from the Peking women's conference, official statisticians are working on measuring household production.

Environmentalists would like to include costs such as the depletion of North Sea oil or the spread of pollution. The ONS is to publish a ``satellite'' set of environmental accounts next month rather than incorporating the green critique into the entire national accounts.

But national accounting is, after all, more than 60 years old. Within a few years official statisticians will no doubt be publishing figures that do reflect important economic shifts. When the numbers are available they will have a radical effect on the way we think about the economy. And who knows - intangible Britain might even allow us to overtake Italy again.