INTRODUCTION

BACKGROUND

1.1 The ABS has reviewed the scope and methods used in making estimates of the Non–observed economy (NOE) for inclusion in the national accounts. The purpose of this information paper is to record the findings of that review in order to answer questions that arise from time to time about the NOE.

1.2 A major objective of this review is to estimate the magnitude of elements of the NOE which affect the national accounts, and the NOE's proportion of Gross Domestic product (GDP). This review will be repeated periodically. Adjustments to GDP will continue to be made for underground production, informal production and household production of goods for own final use, but not for illegal production due to the absence of regular and reliable data sources.

1.3 Transactions in the NOE that are not covered by estimates in the national accounts have implications for the quality of the national accounts and other business statistics. Whether legal or not, whether taxes are paid or not, economic activity generates income which forms part of the national income. This paper discusses:

• A definition of the NOE
• Current adjustments for underground transactions
• New research on an experimental estimate of the illegal drug economy of Australia.

1.4 Where necessary, the paper updates assumptions and measurements to reflect changes in the structure of the economy.

1.5 The ABS compiles the national accounts within the framework of the Australian System of National Accounts (ASNA). The ASNA, with limited exceptions, accords with the recommendations contained in the latest international national accounting guidelines, the 2008 System of National Accounts (2008 SNA). One of the main objectives in compiling the national accounts is to produce aggregate estimates of production, income, consumption, wealth and investment.

1.6 To do so accurately requires constructing estimates of classes of economic transactions that are difficult to measure including the NOE. The NOE is economic transactions absent from the basic data used to compile the national accounts because they are "underground, illegal, informal, contribute production for own use or are missed due to deficiencies in data collection". Statistical agencies are guided in measuring the NOE by an OECD publication titled Measuring the Non–Observed Economy: A Handbook, (the Handbook).

1.7 The Handbook draws on 2008 SNA definitions to define the NOE and promote a common nomenclature by outlining five components as presented in Table 1.

Economic Underground – Units are deliberately under/over reporting and/or do not register with the tax office	1. Underground production (cash economy) – deliberate concealment of legal activities to avoid tax payments.
	2. Illegal production – covers activities forbidden by law where there is mutual consent (e.g. illegal prostitution or illegal drug production).
	3. Informal production – broadly characterised as consisting of units engaged in the production of goods or services with the primary objective of generating employment and incomes to the persons concerned.
Other Non–Observed Economic activity	4. Household production for own final use – includes production of crops, livestock, construction of own houses, imputed rents, and domestic services.
	5. Statistical underground – production missed due to deficiencies in data collection e.g. under coverage of enterprises, non–response, under reporting.

1.8 Using the approaches outlined in this paper, the analysis indicates that the combined adjustments to the official GDP estimates for the five components of the non–observed economy are unlikely to be greater than 3% in total. Currently, the ABS only includes estimates of underground production and household production for own final use within aggregate national accounts statistics.


PREVIOUS STUDIES

1.9 In 2003, the ABS released an information paper on the underground economy detailing the data sources, methodology and adjustments made to income data. A summary of the findings of this work was published in the October 2003 issue of Australian Economic Indicators (cat. no. 1350.0). The ABS has subsequently reviewed this methodology and, where possible, derived updated outputs using current data.


SCOPE AND LIMITATIONS OF THE CURRENT STUDY

1.10 This paper aims to improve national accounts estimates. As such, the paper does not generate estimates of such concepts as "the cash economy", "tax evasion" or "illegal activity". However, the research does provide insight into these concepts, as they are closely related to the components of the NOE.

1.11 By its very nature, the NOE cannot be directly measured. Therefore, estimates of NOE activity must rely on limited indicative information and a variety of indirect methods – all of which can be regarded as contentious. It is likely that an unknown proportion of underground production is already captured in the observable data, owing to the data sources used and the estimation methods employed in collecting the observable data. For example, expenditure data captures the use of income that was generated from unobserved underground transactions.

1.12 In conducting the review, the ABS has sought to use the best research methods suitable for improving the quality of the Australian National Accounts. Other studies have used alternative methods based on the information available to those studies. For example, the estimates from a recent World Bank study Shadow Economies all over the World: New Estimates for 162 Countries from 1999 to 2007 are different to ABS estimates, and reflect not only a difference in methods, but a difference in study objectives.

1.13 The ABS invites comment on the methods, assumptions and results of the study from users of the national accounts and other organisations and researchers who are interested in the topic. The paper is experimental in nature and is intended as a means of fostering discussion.