The underground economy is a term used to describe the sum of all illegal economic activity taking place inside a country and relates to the part of the overall economy that escapes unrecorded and untaxed by the government.
It can be thought of loosely as a measure of financial corruption and lack of efficiency of a given country’s financial system.
Various other terms are also used interchangeably to describe the underground economy, including “shadow economy”, “black market”, “parallel economy” and “informal economy”.
There are two broad categories. The first includes the trading of goods or services that are illegal in and of themselves, while the second involves transactions in otherwise legitimate goods, that in some way do not comply with government regulations.
For example, the former type would include the dealing in illegal drugs, weapons, and prostitution in most places around the world, while the latter could describe the smuggling of products inside a country through customs.
Measuring its size
By definition, it’s extremely difficult to have an accurate picture for the size of any given country’s unrecorded economic activity.
It’s usually approximated using the discrepancies it causes in official statistics. For instance, data for a country’s national income and expenditure should in theory yield the same result.
In practice, however, the latter often exceeds the former.
The difference can be attributed to the shadow economy, as the income from an illegal or an untaxed activity will remain unrecorded in the system, but it will show up in the government’s expenditures data if it’s then used in a legal transaction.
It’s estimated that the global average of the black market runs at around 20 percent of the overall economy.
As would be expected, the figures vary widely between from one country to another.
The United States and the European Union as a whole fall just under the global average at around 18 to 19 percent.
In terms of actual money though, this is a whopping $2 trillion for each, leading to lost revenues of almost $500 billion every year for the governments involved.
In Latin America and sub-Saharan Africa, the averages run higher than 40 percent.
Even within the European Union, the range is quite wide, with Switzerland and Austria on one end at 6 to 7 percent, and Bulgaria and Romania on the other at 28 to 30 percent.
Types of trade and participants
Technically, anyone who makes or attributes taxable income which doesn’t get reported to the relevant authorities participates in the underground economy.
That could, for example, be as simple as a babysitter or a house cleaner having a household working arrangement that doesn’t involve a receipt or national insurance.
Generally, though, the size of the black market is going to be affected more by larger economic activities than that, and usually ones that involve products that either feature high taxes or are illegal or banned.
Examples could include cigarettes in jurisdiction where they’re heavily taxed, trafficking of endangered animals or human organs, or forced labour.
Are there any positive aspects from the underground economy?
It’s perhaps no surprise that the growth of the underground economy is positively correlated to the emergence and intensity of financial crises and recessions.
When the latter hit, company layoffs come in large numbers leaving many people unable to find stable or proper jobs in the system.
While it’s generally accepted that the black market often exists at the expense of the normal economy, it’s also been argued that during hard economic times it can serve as a cushion to the overall system and a way of keeping the real economy from sinking further, as it keeps a part of economic activity flowing, even if that remains unrecorded.
In a similar manner, the black market can also be thought of as serving a purpose for people living in extremely corrupt jurisdictions.
It boosts overall economic activity through added demand and, in a perverse if not ironic way, it keeps tax revenues from being channelled through to corrupt officials.
Of course, the above scenaria should be considered the extreme, rather than the norm.
Under normal circumstances and proper functioning governing systems, the existence of the black market works against the collective common interest of the general population because due to the lost revenue, they don’t benefit from the full share of what they contribute.
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