MACRO ASPECTS OF THE BLACK ECONOMY IN DEVELOPING COUNTRIES - A Case study of India

MACRO ASPECTS OF THE BLACK ECONOMY IN DEVELOPING

COUNTRIES

A CASE STUDY OF INDIAArun Kumar

Based on `The Black Economy in India’ Published by Penguin, India.

Preliminaries

• Based on my book, `The Black Economy in India’ published by Penguin (India) and forthcoming book `Indian Economy Since Independence: Persisting Colonial Disruption’.

• Confusion about black economy, black incomes, black money and corruption.

• Some say size does not matter - does.• Remedy requires identifying correct cause.

Otherwise action is futile.

Preliminaries (Contd.)

Black money a tiny part of black economy

- It is only the part of black incomes that are saved in cash.

• Black savings take on many forms

- which are not only in cash, hence bigger than black money

- Assets, Inventories, flight of capital, Investments in legal and illegal activities

Preliminaries (Contd.)

• Cannot be anecdotal - need analytics to understand and tackle the problem.

• Black economy is bigger than corruption

- involves illegality where a bribe may or may not be paid

• Involves both public and private sectors. (Cowel)

Size

• Growing in size since the Fifties; Kaldor 4-5% in 1955; Now 50% of GDP.

• Based on Fiscal Approach.

• 4 distinct methods of measurement.

• Encompasses all sectors of economy. But most in the Tertiary sector.

• Number of cases and size of scams have exponentially increased since the Fifties.

  Why Consider Black Eco in Indian Context?

a. Significant compared to other major sectors or of govt.b. White economy cannot act as proxy for total economy.c. Economic laws applicable to totality of economy and not a part of it.d. Sectoral implications.e. Failure of Policy linked to it.f.  Has led to a change in the Economic Policy paradigm.

Loss of Output due to Black

Actual and Hypothetical Index of GDP

0.0500.0

1000.01500.02000.02500.03000.03500.04000.04500.05000.0

Year

Ind

ex

ActualWhite

Hypothetical

  Why is it a macroeconomic phenomenon?

• a.    Need to see the unity in its different aspects. Not just anecdotal.

• b.   Affects macro variables. Like, Y, Employment, I, S, X, M, Growth rates, etc.

• c.   Policy works at different levels. Macro comes first.

Impact (Some Macro Aspects)

Black economy has engulfed all the elite sections of society.

Black eco raises - the Savings rate,- Lowers the Investment rate- Increases the input output ratio- Increases inc. cap/output ratio …..

• Rate of Growth less than potential rate by 5% since mid Seventies

       Definitional aspects

• a. Nomenclature: 30 different names, like, parallel, underground, illegal, informal, etc.

• b.    Lack of analytical clarity in the literature.• i)     Black Income vs. Black Money.• ii)   Accounted & Unaccounted or Black & White.• iii)   Factor and Transfer incomes.

Definitional aspects (Contd.)

• c. Should be based on the institutional factors of the national economy being discussed.

• i)    Black inc. generated in illegal or legal activity• ii)    Involves illegality. Black economy implies

illegality. • Raises the issue whether illegal activity should be

counted in national accounts statistics? • Changing laws and perceptions about illegality.

Definitional aspects (Contd.)

• iii)   In India and most Developing world it is factor incomes property incomes not reported to tax authorities.

• Multiple Counting. • Planners vs. Tax Man’s Definition.• d. Differences with the advanced nations. Little

research in this field in the advanced nations.• e.    Need to rework the N AS

Black incomes in legal activities

• Profit (P) = Rev (R) – Cost (C).

• White Profit (Pw) = Balance Sheet Profit =

Declared R – Declared C

• Black Profit ( Pb )= Off-Balance Sheet

Profit = Undeclared R + Overstated C.

Revenue• R = p. q,

• Declared R = declared p x declared q,

• Undeclared R = under invoiced p x q + under invoiced q x p + under invoiced p x under invoiced q.

Cost • Cost = raw materials + wages and salaries +

purchased services + interest paid + depreciation.

• Assume interest paid and depreciation are as per norms

• Overstated C = Over invoicing of (purchased raw materials and services + wages) + the cost of the undeclared output.

• small amounts of output evasion leads to large amount of Pb

Wages are Inflated • Muster roll fudging and inflation of wage bill • Different methods in different sectors • The Corporate sector • Government projects or due to moonlighting in

Government • Private educational institutions

Consequences of misstatement of employment and wages.

• Paradox: O understated and L overstated in white

• O/L of the total economy higher than of the white economy.

• K/L for white economy is mis estimated • Because both K and L over estimated • Inc capital output ratio is raised by black

economy.

   Macroeconomic impact.

• a. Failure of Planning and resource mobilisation. Contradiction amongst other policies

• b. Growth and Stagnation.• Income distribution effect.• c. Investment, Unemployment and the multiplier.• d. Inflation• e. Forces a change in the Fiscal Policy Regime.

Macroeconomic impact (Contd.).

• f.  Various Budgetary Deficits and Debt Trap.• g. Raises Transactions costs and leads to a high

cost economy in spite of a low wage.• h. Savings and Investment rates. Consumption

propensity falls.• i.  Export, Import and BOP. • Import propensity rises.

  Macroeconomic impact (Contd.).

• j.  Monetary Policy. Velocities of circulation and stability properties of the multipliers.

• k. Opens up the Economy.• Policy failure and Capital Flight.• l.  Reduces the Effectiveness of state intervention.• m. Leads to more channels of evasion in time and

makes it easier to generate black incomes.

Macroeconomic impact (Contd.)

• Massive flight of capital with high opportunity cost since independence.

• Leads to shortage of capital.

• Concentrated in 3% of households – the real cause of inequality in India.

• 97% suffer due to black economy.

• 3% also lose due to lower growth, uncivilized conditions, pollution, etc.

     Microeconomic impact.

• a. Aspects of Policy Failure.• b. Social Sectors. Poor left at the mercy of

markets.• c. Growing Criminalization of Society.• d. Impact on National Security.• e. Social Waste. • Like ‘digging holes and filling holes’.

      Microeconomic impact (Contd.).

• f. Impact on the work ethic.• g. Impact on the quality of products and exports.• h. Reduces individual’s faith in collective action.• i. Increases alienation of individual from society.• The ‘usual is the unusual and the unusual the

usual’.

Debating Wrong Questions

• Ideology dominates. Conclusive Proof with Partial Data and Analysis impossible.

• False Dichotomies:• Public Sector vs. Private Sector• Organized vs. Unorganized Sector• Capital vs. Labour• Data for the Third World cannot be relied

upon for analysis

   Causes of Existence of the Black Economy.

• a.    High Tax Rate Hypothesis• b.    Degree of Controls and Regulation• c.    Political Economy. Conflict model• d.    Existence of the Triad. Link between Corrupt

Politicians, Executive and Businessmen. Criminals have entered the nexus.

Triad

It is systematic and systemic• Laws and rules systematically subverted

– Elite is largely lawless.• Triad underlies the black economy• It consists of corrupt businessmen,

corrupt politicians and corrupt executive• The corrupt executive consists of police,

bureaucracy and the judiciary.

Triad (Contd.)

• Criminal entered the nexus – either as politician or businessmen or both.

• Rapid growth of criminalization in Society

• Weakened rule of law in the country

• In 1984 all commissioners of income tax said 95% of their department is corrupt

• In 2002 MCD said in Delhi High Court that no honest engineer in PWD.

Nature of Laws

• Laws on paper differ from what they are – systematically subverted.

• Society needs rules to function by

• Otherwise jungle raj

• OK in short run but not in long run

• No perfect law feasible – if spirit is weak!

• Ingenuity in circumventing them

• More laws result in complexity

Political Aspects

• Large numbers of phones tapped - but information not used - Radia Tapes.

• Intelligence used for political blackmail and not cleaning the system

• Honesty has to be indivisible and systemic – enough individually honest people everywhere

• Lack of democracy in Political Parties

Corruption Cases Knowingly Spoilt

• Triad spoils cases deliberately – Hasan Ali, Liechtenstein disc, 2G and so on.

• Courts have often taken the investigative agencies to task.

• Contrast with Birkenfeld-UBS case in USA

• Contrast between Raju (Satyam) case in India and Madoff and Rajratnam cases.

Remedies (What will not work)

 Technical solutions not the remedy. Many Reports and hundreds of suggestions. Some:

• i)    Demonetization. Tried. Theoretically incorrect.• ii)    Voluntary Disclosure. Tried many times.• iii)   Decreased tax rates. Post 1971 experience.• iv)   Reduced controls and regulations. Post 1991

experience.• V) State Funding of Elections.

  Remedies. (What is needed?)

Need to break the Triad• i)  Accountability and Transparency at every level• ii)   Right to Information is the way• iii)  Need to impact Business, Executive and Politicians• iv)  Electoral Reform• v)   Inner Party Democracy• vi)  In brief, strengthen Democracy. It is a process.

Analytical Aspects

• Rise in the Savings rate.• Fall in the multiplier.• Fall in the rate of growth as compared to the

potential rate of growth.• Input output ratio higher.• Incremental capital output ratio higher.• P/W higher.• Employment and Wage bill inflated.

Conclusion: What may work

• Costs to society higher everywhere

• Transparency and accountability; all levels

• Principles needed – today it is whatever suits me.

• So marginalization of the good.

• Strong RTI needed

• Lok Pal bill required - for top echelons

Conclusion: What may work

• Without movements laws remain on paper

• Need to end banking secrecy

• Black money held abroad has to be tackled here in India

• Need for new parties and politics.

• Turning point maybe coming

• Need strong public opinion – UK example.

• Bali Ramayana - Ravana keeps fighting.