Sex, drugs and accounting in Europe

Leonid Bershidsky

Europe has a new source of economic growth. In the next few months all European Union countries that do not already include drugs, prostitution and other illegal and gray-market businesses in their gross domestic product calculations will have to do so.

The 2010 version of the European System of Accounts becomes obligatory for GDP reporting by EU member states in September. It states unequivocally that “illegal economic actions shall be considered as transactions when all units involved enter the actions by mutual agreement. Thus, purchases, sales or barters of illegal drugs or stolen property are transactions, while theft is not.”

The ostensible goal is to make countries’ economic data comparable. Relatively permissive EU members such as Germany, Hungary, Austria and Greece, where prostitution is legal, already include the revenue it produces in their national accounts. Other countries with more prudish laws have been denied a statistical bonus. The same goes for drugs: Some of them are decriminalized in the Netherlands - and have long been included in the GDP calculation - while other countries have shied away from doing this, to their own statistical detriment.

Italy already includes much of its shadow economy in its GDP figures, but will now have to go further. Adding drugs, prostitution, and black market alcohol and cigarettes could increase Italy’s GDP by as much as 2 percent, according to Eurostat. In this way, Italy’s hookers and drug addicts would help Italian Prime Minister Matteo Renzi bring Italy’s budget deficit below the euro area’s statutory 3 percent of GDP. They would also help him to meet requirements to show declines in Italy’s debt to GDP ratio, which continued its steep rise to 132.6 percent as of December.

The United Kingdom, which also already includes part of its gray economy, and would only add $16.7 billion, or slightly more than 0.7 percent, to its 2009 GDP under the new rules. The British Office for National Statistics hasn’t done the calculations for subsequent years yet.

GDP measurements have long been a feast of creative accounting. Italy’s 1987 sorpasso, or rush to overtake the United Kingdom as the world’s fifth-largest economy, is an often cited example: It was achieved when Italy first started accounting for its untaxed shadow economy, adding about 18 percent to GDP.

To understand how these things happen, it’s useful to delve into the official methodologies. To estimate the drug market, for example, Statistics Netherlands figures out the number of heavy users from data provided by nongovernmental organizations working with addicts. It then accepts sociological data on the number of recreational users, corrects for some overlap between the two groups and literally guesses at the average daily drug dosage. There is no way to correct for factors such as the purity of heroin sold on the street. As for the price of the drug, the 2005 Dutch report on the calculation methodology contains the phrase “according to the Internet.”

Prostitution estimates are more precise in the Netherlands, although that sector is also partly in the shadows: Forced and underage prostitution, as well as unregistered freelancing, are as hard to assess as anywhere else. It can be calculated, for example, that a “window prostitute” in Amsterdam’s famous red-light district has, on average, three clients a day. It is harder to work out the rate for other flavors of the trade. The 2005 Statistics Netherlands report states optimistically: “As escorts and call girls have to travel, we assume they have only one client per evening.”

The U.K. National Statistics Office, whose methodology is based in part on Dutch studies, assumes that Britain’s approximately 58,000 prostitutes (a number based on a 10-year-old study by a charity organization) have a rather higher turnover. They serve an average of 25 clients a week.

Calculating GDP is notoriously difficult, but anyone who has read the methodological documents involving drugs and prostitution will find it hard to go on taking economic growth numbers seriously.

Statisticians could do even more to turn GDP estimates into a travesty. They could, for example, include bribes. The Organization for Economic Cooperation and Development puts the cost of corruption at 5 percent of global GDP and, according to the World Bank, more than $1 trillion is paid out in bribes every year. Corruption is known to reduce public spending on health, education and other useful pursuits, but why should it only be treated as a cost? It falls nicely under the definition of a voluntary transaction in the European System of Accounts. There is no substantive difference between the services of a prostitute and a corrupt bureaucrat. If Russia and Brazil accepted some of the international corruption estimates, they could stage their own sorpasso.

To remain meaningful, GDP calculations should be made less, not more inclusive. They would, of course, still be subject to the frailties of national statistical systems, but at least there would be a solid basis for comparison. Under the current rules, an increase in heroin use - even an imagined one - could help lower a country’s borrowing cost.

There is, of course, another solution: legalize, and therefore reliably account for, all the “consensual” illegal activities. I’m not sure the world is ready for that yet.

*The author is a Moscow-based Bloomberg View contributor.

BY Leonid Bershidsky