Economics: The arithmetic of recovery is in the black

BRITAIN'S black economy is forging ahead in the recovery of the 1990s. With more people dodging the taxman, the Exchequer is losing revenue and policy-makers are in danger of underestimating the strength of economic growth and pressure on inflation.

The Inland Revenue estimated in 1992 that the black economy could add as much as 8 per cent on top of measured national income. By now this would be worth an extra pounds 50bn a year in output of goods and services, some pounds 20bn of which would flow into the taxman's coffers. On these figures, the black economy probably rivals the engineering, transport or construction industries in the amount of spending power it generates.

This is pretty small beer compared with more enterprising countries. The black economy is thought to add about 10 per cent to official national income in Germany and the US, 15 per cent in Belgium, 25 per cent in Italy and a spectacular 100 per cent in Russia, where the two economies are running neck and neck.

However, there are signs that Britain is slowly catching up. A host of recent economic indicators and surveys suggest that the black economy has been growing faster during this upturn than in previous recoveries - and faster than the official economy as well.

There are several possible explanations. Taxes are rising and incomes from employment have been growing at their slowest rate for a generation. This means there is more incentive for people not to declare their earnings, or to pay cash for goods and services when this allows them to avoid VAT. The increasing prevalence of car boot sales in recent years is perhaps the most visible illustration.

Similarly, employers may find it more worthwhile to employ people in ways that allow them to avoid National Insurance contributions and that give them greater flexibility to hire and fire. Many companies are facing stronger competition from low-wage rivals overseas, while others are under unusually intense pressure to cut costs, because consumers are not prepared to pay higher prices.

The latest labour force statistics from the Department of Employment provided evidence of growth in the black economy. The good news is that job creation may be more robust than headline figures suggest. The bad news is that most of these jobs are probably insecure, casual and low-paid.

Employment can be calculated in two ways - by asking individuals whether thay have a job, and by asking companies how many people work for them. The DoE carries out surveys using both methods. Unfortunately, they do not produce the same answer.

Both surveys show employment peaking at around 22.3 million in early 1990 and falling thereafter as the recession took hold. The survey of companies suggests that employment has now fallen below 21 million and is still dropping. But the survey of individuals suggests that job-shedding halted last year and that employment has risen by more than 100,000 since last summer to a little over 21.3 million by this spring.

Why the discrepancy? In a phrase that may yet come back to haunt him, Michael Portillo, the Secretary of State for Employment, said many of the jobs created by recovery 'may be the sort of work that employers don't care to declare'. These could be jobs where the wages are so low or the hours so short that the employer does not have to pay National Insurance or pension contributions. And casual work is not taxed under PAYE, if at all.

The savings are far from insignificant. The Low Pay Unit recently unearthed a supermarket in Stirling that was advertising 91 part- time vacancies, only four of which paid more than the pounds 56 a week at which National Insurance contributions need be paid. The LPU calculated that the total tax and National Insurance paid on these jobs would equal pounds 1,470.56 a year. But if they were replaced by 28 full-time jobs, the Exchequer would receive pounds 41,918.24.

The difference between the measures of employment is in part a typical pattern for this stage of the cycle. Company-based measures of employment tend to be higher when employment is falling and individual-based measures are higher when employment is rising. But the graphic shows that the difference is much more dramatic now than in the mid-1980s.

The employer-based and individual-based surveys differ most dramatically in construction, transport and agriculture. The extent of temporary and seasonal work in construction and agriculture makes them obvious candidates for 'cash-in-hand' payments; the same is probably also true for tourism. The difference in measures of employment in transport may be picking up growth in mini-cabbing, a favourite source of black-economy employment.

The Federation of Master Builders estimated in June that pounds 12bn of undeclared work would be carried out in its industry this year. This is one area of the black economy to which the Inland Revenue has been paying particularly close attention. Others include auditors, insurance agents, scrap dealers, car salesmen and guest- house proprietors.

Leo Doyle, an economist at Kleinwort Benson, believes that the employment figures generated by the individual-based survey imply growth in consumer spending half a percentage point higher next year than calculations based on the more subdued survey of companies. He argues that spending may have been boosted by hidden incomes rather than a falling propensity to save. Personal saving as a proportion of income may have stayed at recession levels. This would be consistent with reported rises in consumer confidence.

Growth in undeclared incomes might also help to explain why growth in high-street spending volume continued to accelerate last year, even when growth in household incomes (after taking account of inflation) began to fall.

Mr Doyle's conclusions are corroborated by evidence that more transactions in the economy are being carried out with cash rather than via cheque or credit cards. Apacs, an umbrella group for banks and building societies, was astonished to find that the number of hard cash transactions rose by 200 million to an estimated 16.8 billion in 1993, after years of decline. Link, the country's largest cash machine network, said last week that withdrawals in July reached a record 15 million. This figure was up 14 per cent on a year ago and surpassed withdrawals last Christmas.

Gross domestic product figures paint a similar picture. By definition, everything that is spent on goods and services should become someone's income, in the form of wages, profits or rent. But the Central Statistical Office's measure of national spending was 4.8 per cent higher in the second quarter than a year earlier, while growth in national income was less than 4 per cent. Undeclared income helps explain the difference.

The Inland Revenue and Customs & Excise can never hope to eradicate the black economy entirely. There will always be people prepared to pay cash for a cheap decorator, or to buy second-hand clothes from a car boot sale. But the 1990s are proving a decade of belt-tightening and middle-class insecurity in which the black economy may thrive to a remarkable degree. The Chancellor would do well to keep as close an eye as he can on this most vibrant sector of the British economy.

(Graphs omitted)