IN solving mysteries, Sherlock Holmes used to say that “once you eliminate the
impossible, whatever remains, no matter how improbable, must be the truth.”
We have been so used through our conventional training to look for keys under the
light of the lamp at night, that we often forget to look in the shadows.
We live in an age when we base all decisions on what statisticians produce as “facts
and numbers”.
The trouble with statistics is that all measurements are subject to errors and
omissions. Gross domestic product (GDP) statistics are notoriously inaccurate
because there are both measurement errors and conceptual errors of under-
measurement.
A measurement error of 5% either way when you are growing at 7% per annum is at
least discernible, because most of us would be able to know from a decline of 0.35%
is meaningful or not.
But when the advanced countries are growing only at 1% or less, it is so much more
difficult to know whether one is recovering or stagnating further.
The conceptual error in under-measuring output and wealth comes from the fact that
GDP measures production, but it ignores certain costs that are not easily measurable.
The most common ignored output measurement is domestic housework.
Statistically, if you married your former housemaid, GDP value goes down by the
value of her former wages!
The other areas of under-measurement are spillovers and externalities, such as
pollution costs, which are difficult to measure, and also the costs of resource
depletion, such as destruction of biodiversity in forests and marine life, including reefs.
The World Bank has estimated that if these pollution and resource depletion costs
are factored into many developing economies, their GDP growth would have to be
reduced by up to 2%-4% per annum.
There are of course two parts of the economy – the officially measured part, called
the formal economy, which is subject to law and taxation, and of course, the informal
economy. The informal economy or shadow market comprises all activities that are
not regulated or protected by the state.
These may include illegal activities, but also comprise activities that are typically not
subject to taxation (such as legal tax avoidance) or not regulated or measured, such
as casual labour and local trading in the rural areas.
Actually, in many rural and remote areas, as well as cities, the poor generate
business activities that are outside the watch of the police and often below the tax
levels.
How big is the shadow economy?
A study made by German Professor Friederich Schneider (2012) estimated that
between 1989/90 and 2007, the shadow economy in the the Organisation for
Economic Co-operation and Development or advanced and industrial countries
declined from around 16% to 13.9%, due to better tax and regulatory coverage.
After the global financial crisis of 2007, however, the shadow economy may have
grown as people who are unemployed have moved into the informal markets for part-
time jobs that do not pay any tax.
More recent analyses suggest that the average size of the shadow economy was
13% for the advanced countries and 36% for the emerging markets.
This meant that the size of the global shadow economy was nearly 26%, since the
advanced countries accounted for 42.9% of global GDP of US$77.9 trillion, whilst the
emerging market and developing economies accounted for 57.1% of world GDP in
2014.
If these shadow estimates are correct, world GDP may be underestimated by as
much as US$20 trillion.
In other words, we may have underestimated the resilience of the world economy to
stagflation because there is an element of the market that we don’t measure officially.
Advanced economies tend to have smaller shadow economies because of better tax
collection and records, but it does mean that the ability of their shadow economy to
create jobs in a period of stagflation, as is what is happening now, is limited.
On the other hand, the emerging markets have large informal markets, which means
that they have considerable potential to bring the “informal” into the “formal”
economy, improve the rule of law and also taxation and output.
Central bankers in emerging markets know very well that the rate of nominal money
supply (including currency) needs to grow 2%-3% faster that nominal GDP to take
into consideration the “monetisation” of the informal market (namely, its liquidity
needs).
Furthermore, the informal economy is growing through increased globalisation. In the
last decade, the world is becoming more interconnected through increased
international travel, labour migration, and cross-border remittances and capital flows.
The McKinsey Global Institute recently published its globalisation and digitisation
report, which estimated that over the last 10 years openness to global flows had
raised world GDP by at least 10% or US$7.8 trillion in 2014.
The interesting point is that as global trade grew, more and more trade is in services
that are becoming rapidly digitised.
This means that e-commerce can deliver goods and services faster and more
widespread to more customers, including in the informal sector than ever before.
MGI rightly pointed out that digitisation is reaching the emerging markets at speeds
and scale unimaginable only a decade ago.
As companies such as Alibaba, Tencent and Flipcart emerge, they are supplementing
the dominance of Amazon, Facebook and eBay in reaching out to Internet-savvy
customers in almost every corner of the globe.
For example, Facebook reaches out to 50 million businesses, whereas Alibaba has
over 10 million companies in China selling globally.
In other words, as smart phones and the Internet cover more and more customers,
particularly in the emerging markets, the lines between the formal and informal
markets are going to blur.
What are the social, political and economic implications of the globalisation of small
and medium startups?
The first implication is that even if the large advanced markets are aging and
struggling with their economic stagflation, there is considerable growth, innovation
and interconnectivity in the emerging markets. In the next decade, Chinese, Indian
and other emerging Internet platforms will be challenging the dominance of Amazon
and Google.
These digital platforms are not confined to domestic borders but are already reaching
out to global markets.
The second implication is that these startups can not only source talent, inputs and
know-how globally, they can also find customers, partners and investors at the global
level.
Thus, despite the gloom and doom in the advanced markets, I remain an optimist
about the emerging markets.
The reason is that never in history has so many (85% of the world’s population) had
access to Internet knowledge and technology. They may not be wealthy today, but
technology, demography and geography are shaping their destiny.
Look for light and hope from the shadows, the neglected bottom part of the economy.
Andrew Sheng is Distinguished Fellow, Asia Global Institute, the University of
Hong Kong
A version of this article appeared in The Star Online, 2 April 2016
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