During the second half of the 1970's there has been a growing concern about the influence of unrecorded activities and fraud on the economy. This chapter examines the consequences of fraud on the reliability of macroeconomic statistics as a basis for economic policy making.

For policy making one needs statistics. When these statistics are biased because of a large and growing unrecorded sector, policy actions might miss their intended targets and may at times produce adverse macroeconomic effects. Feige and McGee (1988, Chapter 3) give some examples of what might go wrong because of distorted information. Distorted information and its consequences for public policy are also studied by Alford and Feige (1988, Chapter 2). This chapter studies the influence of fraud on macroeconomic statistics, particularly the gross domestic product (GDP). We use the term “fraud” to mean the nonreporting or underreporting of income to the tax authorities. Thus, income generated by illegal activities but known to the tax authorities (as is sometimes the case with prostitution) is not considered as fraud here. The chapter does not investigate what GDP would have been if everybody would have behaved in accordance with the law.

In an investigation of the influence of fraud on macroeconomic statistics it is of great importance that clear terminology is used. Following Heertje and Cohen (1980), the Central Bureau of Statistics (CBS) attaches the adjective “unofficial” to all flows of goods, services, and income that are not included in the national accounts. These flows are regarded as being in the “unofficial circuit.” An understanding of the results of this investigation requires that one understands the difference between fraud and the unofficial circuit.