The curse of the phantom economy

Because the phantom economy is, as its name suggests, a phantom, it is elusive, hard to pin down, and ultimately, incapable of direct measurement. Generally, its estimation is based on proxy indicators of its size, or indirect estimates are made on the basis of one or another econometric technique. Because it is concerned about not leaving paper trails most of its transactions take place on a cash basis. This has facilitated a number of econometric estimates based on the relationship which exists between cash held by the public and the level of economic activity.

While this relationship differs among economies, for most it is a fairly stable one over the short-to-medium term. Over the long run, institutional changes take place in the financial system, for example, credit cards emerged as a substitute for cash. Further, people's attitudes to using cash in transactions also change. As a consequence the relationship will vary in the long run in response to such changes.

Segments of the phantom economy

The phantom economy is considered by some to have two distinct segments to it. One is based on activity centred on illegal goods and services. Good examples of these are narcotics/drugs, illegal trafficking in persons, and prostitution - all of which are illegal in countries worldwide. The other is based on illicit activity centred on the avoidance of taxation. Here the trade or economic activity is legal. What makes it part of the phantom economy is that it avoids paying taxes and the regulation of such activity. Thus fuel is a legal good, but when it is smuggled across our borders to avoid taxation and regulation it becomes a part of the phantom economy. Other examples show that it can be far less organised and quite widespread, as for example when farmers avoid paying taxes on their produce, or when traders in the informal sector do not contribute to taxes.

The two segments can of course be related and involve the same set of persons, especially when it is highly organised. However, as a general rule, the first segment noted above is an integral part of the structure of organised crime. And, given the rapid globalisation of all aspects of social life over the past two to three decades in Guyana, this organised crime has become a transnationalised activity.

Some of the illicit activity may find itself in the official economy and therefore become captured in the estimates of GDP made by the Bureau of Statistics. This happens for example, when smuggled fuel enters the distribution channels of the gas stations and is sold as part of the normal supplies to unsuspecting purchasers.

All curse and no blessing

No matter from which angle this is looked at, as argued in this column two weeks ago (12.2.06) the phantom economy is all curse and offers no blessing or relief from the data that reveal the unrelenting prolongation of the economic depression in Guyana, now in its ninth year (1998-2006). Grasping at the phantom economy as an explanation of, or denial as to the existence of a prolonged economic depression is nothing more than grasping at straws in the wind.

To see why this is so, consider the following: Activities in both segments of the phantom economy do not pay taxes. The consequence of this is a shift of the burden of providing national taxes to those taxpayers who cannot evade taxes. This will include not only individuals like public servants and teachers, but firms that are engaged in legitimate business. In both instances it would constitute a disincentive for legitimate economic activity. Further the rewards that dealers in the phantom economy receive provide an incentive for others to follow, with the net result being the official economy suffers.

The gains for dealers are, however, not truly gains, since as I have indicated in my previous article on this topic (SS, 12.2.06) such gains are not sustainable. They occur despite efforts by governments worldwide to regulate, control and eliminate them. Since these efforts will not stop, in the long run the 'end game' result is certain. The phantom economy will either shrink to a controllable phenomenon leaving no real development behind it, or Guyana will become a criminalised state, which the international community will not tolerate.

The phantom economy by producing a distorted incentive/reward system generates not only a distorted system of resource allocation for the country, it also raises fundamental issues of governance. These issues of governance involve the state and all its arms (security, legislative, executive and judiciary) as well as the private business sector. The proceeds of the phantom economy have to be legitimized in the formal system, particularly the banks, even though as I have indicated above, most of its transactions are in the form of cash.

The phantom economy also has to have its own enforcement mechanisms and rules. For this a highly structured commandist system is usually put in place with the generals in charge and the foot-soldiers taking orders. This structure has been dramatised in many novels and movies so that readers are familiar with its general configuration.

What size?

Early estimates that I made of the size of the phantom (underground) economy for Guyana have been published in academic journals. These show its size in the 1980s to range between one-fifth and 100 per cent of the official economy. At that time the (phantom) underground economy was a response to the excessive government regulations, physical controls, and shortage of all goods and services. The government had widely boasted then of directly or indirectly controlling 90 per cent of the economy through its nationalisations and regulatory system. This, however, spawned the birth of industries aimed at reaping profits from the economic rents that flowed if you were able to beat the system. While almost every commodity was smuggled, the prize above all prizes was considered to be the United States dollar. A huge black market in foreign currency then ensued.

With the liberalisation of the economy under Hoyte's Economic Recovery Programme (ERP) these shortages disappeared - but not before immense suffering and pain. The main features of the ERP have been kept intact by the new PPP/C government and the illegal smuggling of goods has all but disappeared as a major phenomenon, although some has continued in commodities like beer and fuel illegally brought across our borders.

Today, the phantom economy is a creature born out of organised illegal activity of a trans-nationalised character such as drugs and trafficking in persons. It is not as in the previous instance the smuggling of goods into Guyana for domestic consumption and use.

Next week I shall continue with this discussion.

The crowding-out effect: The phantom economy and the official economy

There is a concept in economics known as the 'crowding-out effect,' which I have found to be very useful for capturing the imagery behind the relationship that has developed between the phantom economy and the official economy in Guyana. The notion of 'crowding-out' was first applied to the effect a rising share of government activity (purchases) would have on private investment and consumption in an economy. Such an increased share of government activity would lead to a reduction in the share of private activity. This would occur as it were by definition, because the government and private sector are two major parts of a country's total output or gross domestic product (GDP), so that an increase in one is often at the expense of the other.

The phantom economy, however, is not usually measured at the same time as the official economy, and is therefore not combined with it to provide a total. Consequently, the resultant crowding-out is not in this case definitionally true, but dependent on the logic behind the relation of the two.

From 'unofficial' to phantom economy

At the time when I analysed Guyana's 'unofficial economy' in the 1980s I found it was largely the product of restrictions, bannings, the necessity to obtain licences for all manner of things, high taxes and other similar restraints on the public's access to what at the time were scarce commodities and in particular scarce foreign exchange. Today's motivations behind the 'unofficial economy' are more related to organised crime, especially narcotics, trafficking in persons, money-laundering, prostitution and other similar criminal enterprises. It is for this reason that I have re-labelled it the 'phantom economy' in preference to other terms like the 'parallel economy' or the 'underground economy.' While still an 'unofficial economy.' this term makes clear both its transformation from the earlier version as well as its close inter-linkage with the phantom elements of the political and social structure of Guyana.

The IMF has re-visited the measurement of 'unofficial economy' in Guyana, making use of data not available for my earlier study but not producing any different findings. For my analysis the size of the 'unofficial economy' ranged from 27 per cent to 99 per cent of the official economy in the mid 1980s. The IMF study covered the period 1970-2000. Its results show that over this period the largest estimated size of the 'unofficial economy' was 101 per cent of the official economy in 1989. For longer periods it showed that in the decade of the 1970s the 'unofficial economy' averaged 40 per cent of the official economy; this rose to 71 per cent for the 1980s. In the 1990s this then fell to 47 per cent, which nevertheless exceeded the ratio of 40 per cent for the 1970s.

Based on this and other data, I had in a previous Sunday Stabroek column provided a rough estimate of the amount of resources in US dollars that was passing through the phantom economy. Currently this ranges from US$200 million to US$300 million. This figure is comparable to the estimation of US$150 million cited in the recent US report, on the basis that the lion's share of the phantom economy is attributable to the proceeds of the narcoeconomy.

This broad similarity in findings does not surprise me. One would expect this to occur once the studies are professionally done. For me, however, it is the magnitude of the problem, which is revealing. These figures are the equivalent of $40 to $60 billion Guyana dollars. At such a massive size the phantom economy must be crowding out the legitimate official economy.

Crowding-out

This crowding-out effect occurs in a variety of ways as a few examples would show. Thus legitimate businesses cannot compete with phantom businesses, when these latter serve as fronts for laundering dirty money. Similarly, if phantom businesses are there to generate losses for money-laundering purposes, then the burden of taxation on firms would fall disproportionately on legitimate businesses. Yet, all firms would expect to use the same facilities provided by government out of taxation.

Or again, given the levels of poverty and scarcity of good jobs paying a living wage in Guyana, one would have expected the labour market to be a buyer's one. But this is not the case. Many workers set a reserve price on their labour based on returns reported by operatives in the phantom economy. The incentive/reward structure for labour has been undermined, just as the profit expectations of businesses have been. Both are increasingly replaced by expected rewards derived from participating in the illegal criminal economy, with the risks heavily discounted.

This situation also makes it exceedingly difficult to monitor or regulate the macroeconomy. The amount of cash as well as deposits in circulation in the phantom sector (which prefers to deal in cash so as to leave no paper trails) has to be regularly estimated if the Central Bank's open market policy is to work. Also, phantom deposits can be very mobile and subject to sharp swings, thereby causing monetary disruptions.

The phantom economy also crowds out the legal commercial processes of the court system. The phantom economy has its own rules to regulate its activities and enforcement mechanisms to sanction those who violate them.

Political solution

At this stage, the question arises as to how can Guyana cope with such a massive corrosive force as the phantom economy should it want to change course? Two points are essential to any constructive response. One is that the phantom economy is not a recent phenomenon. Its roots go far back to the widespread criminalisation of the population in the period of bannings and direct controls when, in order to avoid these controls, virtually the entire country legitimised their evasion as a politically correct response. The more the controls multiplied, the more the population found inventive (but illegal at the same time) ways to circumvent them.

The second and more important consideration is that the problem of the phantom economy is no longer a simple law and order one amenable to final resolution by our security forces, no matter how well trained and focused these forces may become. A political solution is a necessary, but not sufficient pre-condition. Securing this political solution is a task not only for all of us as the saying goes, but more specifically the two major political parties that have spawned its emergence. There can be no solution without both parties participating in it. Since political processes, however, are not static, both parties are themselves subject to change and indeed since 1991 both have changed? for better and for worse. The ruling party, simply because it is 'ruling' carries the preponderant responsibility for initiating a political solution to the nation's impasse.

Next week I shall explore these political economy issues further.

Blessing or blight: More on the phantom economy

Perplexing reality

With the stepped up activities of the security forces and heightened levels of anxiety in the country over crime, violence, and the narco-economy readers have remarked to me almost in a congratulatory tone, on what they perceive as the uncanny timeliness and predictive value of the series of articles I am currently presenting. These focus on the phantom economy and the pathological transformation of the state into a vehicle for criminal enterprise. I must confess that there is and can be no joy arising from accurately predicting the entrapment of Guyana on a slippery slope leading to its further impoverishment, social decay, political conflict, violence, and ruination. That there is not enough 'traction,' as I have previously argued, of goodwill, common sense and trust from which the country can self-generate an autonomous return to a 'normal' path of all-round development is a sad and deeply perplexing reality. What is at stake after all is not an abstraction called Guyana about which I write, but a real place in which we all live and look forward to a better future. Congratula-tions therefore are not in order. We should be all commiserating.

That apart, there is always the likelihood that although this Sunday column concentrates on broad trends and tendencies which govern the development of Guyana in the wider world, topical items will have to be introduced if only as the basis for beginning the exploration of the various subjects under discussion. This cannot be avoided and therefore from time to time such 'timeliness' may seem apparent, but this is a random outcome. Thus, I would suggest that no one can properly analyze the performance of the Guyana economy and its prospects as I am doing in the age of globalization without engaging issues of the phantom economy, governance, and the persistence of poverty. There is therefore neither need for, nor indeed expectation of congratulatory comments when such coincidences arise.

Re-visiting the crowding effect

Last week I had a preliminary look at ways in which the phantom economy is crowding out the official economy. I described for readers the insidious negative influence of this phantom economy on labour market behaviour, business opportunities, the business environment, and the business outlook of the country. There is therefore in this analysis at least a partial explanation of why there is a linkage between the crowding-out of the official economy and the persistent depression the economy has had to endure over the past eight years. As I have repeatedly indicated in this column, even though Guyana boasted a rate of growth in excess of 7 per cent per annum between 1991 and 1997, since the death of President Cheddi Jagan, the rate of growth has averaged less than half of one per cent (0.4per cent) for the period 1998-2006. Indeed the discussion of the phantom economy arose because of official spokespersons who have been insinuating that the lack of growth of the official economy did not matter as much as is indicated by these appalling figures, because the performance of the 'unofficial economy' more that compensated for this!

My contribution was designed to expose the grave dangers for the country if officialdom seemed to be taking this stance. Particularly when, as in the present case, the unofficial economy of Guyana had become substantially a phantom economy, with all that connotes at this present juncture of our development.

Crowding the informal economy

The phantom economy, however, does not only crowd-out the official economy, it also crowds out the 'informal economy.' In countries like ours there is usually a large and often thriving informal sector which operates outside officialdom, but not in the criminal sphere of transnationalised organised crime. Here myriads of small retail items are sold cheaply by traders and hucksters who, because of minimal overheads, can afford to do so and still make a small profit. The size of their profit would depend on the levels of retail margins for the various classes of goods they sell within formal trading and retail outlets.

The Robin Hood syndrome

Because the phantom economy uses in some instances retail business and establishments as fronts or outlets for laundering dirty money, sales from these outlets are not expected to generate a profit. Prices are very often heavily discounted. Indeed, some operators of these phantom businesses may even believe they are the modern-day Robin Hood exploiting the rich (countries) for the benefit of the poor (in Guyana). They see these cheap sales as their way of 'putting back something into the economy,' by helping to keep the cost-of-living low and affordable to the 'small man/woman.' The consequence, however, of these 'artificially' reduced retail margins is not what is intended. The informal sector's margins are as a result squeezed, and informal businesses cannot therefore thrive in these conditions. This is an unintended effect. The result, however, of putting pressure on the profitability of the informal sector is the further weakening of livelihoods in Guyana outside the phantom economy.

From all that has been said so far, therefore, instead of being a blessing the phantom economy is a blight for at least eight major reasons. It stifles business initiatives at the formal and informal levels. It operates as a disincentive to work by keeping the reserve price of labour artificially high. It makes macroeconomic management of the economy problematic because the authorities lose control of the money supply, credit and the flow of foreign exchange.

It adversely impacts on exports because of the high transaction costs firms incur for security purposes in order to prevent their operations from becoming victims of the illegal export of banned substances. It spawns corruption, waste and mismanagement of resources. It deters foreign investment and the repatriation of capital by Guyanese overseas because of fear of contamination. It encourages migration and facilitates as an adjunct the organised trafficking in persons.

Next week I shall explore these issues further.

The brazenness of power: Reason and reasonableness

Two features of the phantom economy stand out. One is its rise to prominence and public visibility over the past five years. Second there has been in recent times an increasingly open public condemnation and comment on it. It was five years ago, almost to date when I first explored these issues in the Stabroek News and along with it the degeneration of the state into a vehicle for criminal endeavours, or as I more bluntly put it, a criminal enterprise. There is no doubt as readers have intimated to me that the recent publication of the US Drug Control report has given cover for the timid so they do not have to continue playing ostrich. In the end, I believe, this can only bring good for Guyana. I therefore do not share the views of those who would spurn such folk and see in them an expression of the familiar Guyanese 'carrion-crow' or 'crab-in-the-barrel' syndrome, as they jockey for attention on a matter which they have tried very hard to keep a distance from before. There will always be 'Johnnys-come-lately,' but it is better late than never!

Recap

Over the past few weeks I had elaborated on some of the negative economic consequences of the phantom economy in Guyana. To recap briefly: in the external sector it has had three main negative effects 1) undermining the legitimate export trade by the risks of 'drug contamination' and the increased transaction costs incurred by legitimate exporters in order to secure their shipments 2) acting as a deterrent to foreign investment in Guyana because it makes the environment unwholesome and 3) facilitating the capital of flight out of Guyana. At the macroeconomic level, it has stymied efforts at monetary control, undermined the credit/financial system with suspected 'laundered money,' and has generated unpredictable swings in the foreign exchange market.

It has also undermined the labour market and the incentive structures for wage effort, basing as it does its rewards on illegal high-risk activities. The participants in this market, however, frequently understate the risks to themselves and therefore overvalue the rewards they receive.

In the business sector it has undermined legitimate businesses by introducing an artificial reward structure that favours criminal endeavours. This makes the business environment 'unfriendly,' and the business outlook bleak. As we saw also last week it did not only crowd out business in the formal economy but in the informal hustle economy as well. The latter is mainly due to its impact on official retail margins, which are the main source of attractiveness for informal markets.

Crowding-out morality and legality

Although these constitute a formidable array of negative consequences for the economy, the adverse effects of the phantom economy go further. Consider the extent to which it has also undermined morality. Much of the brazenness of phantom power comes from the fact that moral precepts which guided young Guyanese through home and school have been turned on their heads. Instead of saying 'crime does not pay,' the phantom economy boasts 'crime does pay!' Instead of urging hardwork and industry as the surest foundation for personal and community advancement the phantom economy advertises 'getting something fuh nuthing.' Indeed no longer is the precept that: 'there is no such thing as a free lunch' valid, since the phantom economy advertises the lifelong provision of not only 'free lunches' but 'free meals' for all its participants and their families.

Participants in this trade very often 'dress their part' in the latest high-fashion brand-name clothes. Many have become role models for youths who otherwise see before them a lifetime of marginalization, privation and unfulfilment of their most basic aspirations if they do not join the 'gravy train' of narcotics.

This crowding-out of traditional moral precepts is tantamount to the crowding-out of law and due process. In our society today the most preposterous immoralities are defended by statements that, 'there is no law against it.' I have even heard a legal person (and hence official of the court and protector of due process) claim that a public official cannot have a private conversation by virtue of his official role. Laws of confidentiality and privacy do not apply. One wonders then at the lack of protection for Cabinet papers, 'secret' correspondence of the state, and other security information providing law enforcement arms of the state on the presumption that these will be legally protected.

The flight from reason

In this crowding-out of due process we see further the ultimate consequence of the phantom economy, which is nothing more nor less than the crowding-out of rationality itself. This is the ultimate brazenness of power. If one takes a step back from our situation in Guyana, none of what is occurring is rational, whatever might be the individual or group gain derived from it. As Guyana goes the way of Colombia, the society at large loses. Moreover, the key difference between Guyana and Colombia is that Guyana is a small, very poor and very open and therefore highly vulnerable society. It is racked by divisions within and external threats to its borders. It has large land boundaries which cannot be adequately patrolled, let alone protected. The damaging effects of a phantom economy are therefore incalculable when approached from a relative rather than absolute standpoint.

The total traded value of the phantom economy in Guyana may be far less in absolute terms than in Colombia but its proportional consequences are far more devastating. One of these, which we have noted repeatedly, is the strong association between the rise of the phantom economy into public prominence and the abysmal performance of the economy since 1998. Looking at the figures again, the recently published Bank of Guyana Statistical Bulletin (December 2005) shows that in 1997 the real GDP (at constant 1988 prices) stood at G$5.360 million. At the end of 2005, eight years later it stood at G$5.419 million, a minimal increase of just one per cent. Indeed the value of our real GDP in 2005 was the lowest since 2001; a remarkable state of affairs, indeed.

Ultimately the phantom economy crowds out not only morality and due process but reason itself. The most absurd and trite observations are bandied around without any thought or reflection on their implications. Thus persons claim 'crime has always and will always be in societies' as if this is an excuse for what is taking place in Guyana. But surely we all die, yet we still have medical services and we all want to improve them in order to prolong and provide a better quality of life. There are always traffic accidents, but still societies with well-regulated traffic laws and systems fare far better relatively than ours do. While complete eradication of crime is clearly impossible, a rational view would see that there is a wide range of possible outcomes we should be pursuing.

Some people even suggest that because the rewards of the phantom economy are high, it attracts the 'entrepreneurial type.' But this is the most specious reasoning of all. If mayhem and murder pays a high price can one's 'rational' response be separated from the moral and other consequences of being a paid murderer?

In the orgy of self-destruction the country does need more rational thought to go forward but not a flight from reason and reasonableness into specious delusions.