Underground economy

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The underground economy or black market is a market consisting of all commerce on which applicable taxes and/or regulations of trade are being avoided. The term is also often known as the underdog, shadow economy, black economy or parallel economy.

In modern societies the underground economy covers a vast array of activities. It is generally smallest in countries where economic freedom is greatest, and becomes progressively larger in those areas where corruption, regulation, or legal monopolies restrict legitimate economic activity.

Contents 1 Categories of the Underground Economy 1.1 Scope, Size and Measurement 2 Pricing 3 Consumer issues 4 Traded goods and services 4.1 Transportation Providers 4.2 Illegal drugs 4.3 Prostitution 4.4 Weaponry 4.5 Alcohol and tobacco 4.6 Copyrighted media 5 Appearance and disappearance 6 Modern examples 6.1 Wars 6.2 Prohibition in the United States 6.2.1 Of alcohol 6.2.2 Of smoking 6.3 Clearstream 7 See also 8 References 9 External links

[edit] Categories of the Underground Economy

In a seminal study, the Ludwig von Mises Institute divided the underground economy into four main categories^[1]:

1. Economic activity yielding income that is not reported to the tax authorities.

2. Economic production that violates one or several other mandates, such as compulsory government licensing and rate making, inspection and label laws, labor laws, government regulations of agriculture, export and import controls, government control over money and banking, governmental control of energy production and distribution, and countless others.

3. Productive activity by transfer beneficiaries who draw Social Security benefits or receive public assistance. Their freedom to work is severely restricted.

4. Productive activity by illegal immigrants without residence status. They may pay income taxes and other taxes, but must remain underground for fear of deportation.

Although tax evasion is one category of underground economy, in the other categories income taxes laws may be fully complied with -- it is the failure or inability to comply with other, non tax laws that drives the activity "underground".

[edit] Scope, Size and Measurement

The measurement of the size of the underground economy is subject to a large margin of error. Economists seeking to measure its size have often looked at the volume of cash in circulation, although a large part of the underground economy takes place via bank accounts located in tax havens. Discrepancies between the growth of officially reported spending (GDP) and the growth of cash in circulation may be used to infer growth in the size of the underground economy, but these estimates are subject to a considerable amount of judgement, and are controversial. Still other methods of measurement include the Household electricity approach.

The growth of online commerce may have increased the size of the underground economy. The auctioning website, eBay has over 40 millions of regular users. The sellers are legally responsible to pay taxes,^[2] however it is speculated that these can be easily evaded^{[citation needed]}.

The underground economy, when trading decisions are not the result of coercion, is arguably a free market, since, by definition, it lacks governmental intervention. However, various governments have engaged themselves in the underground economy^{[citation needed]}, thus blurring the line between public intervention and its absence.

[edit] Pricing

Goods acquired illegally can take one of two price levels:

• They may be less expensive, than legal market prices, as the supplier does not incur the normal production costs or pay the usual taxes. This is usually the case in the underground market for stolen goods.
• Alternatively, illegally supplied goods may be more expensive than normal prices, as the product in question is difficult to acquire or produce, dangerous to deal with or may hardly be available legally. This is usually the case in the underground market for goods that are illegal to purchase, sell or possess.

[edit] Consumer issues

Even when the underground market offers lower prices, consumers are likely to continue the purchase of the legal counterparts, when possible, due to the following reasons:

• The consumer may — justifiably — prefer legal suppliers, as they are both easier to contact and can be held legally accountable in case of product faults
• In some oppressive jurisdictions, customers may be charged with a criminal offence if they knowingly participate in the unregulated economy, even as a customer.
• Consumers may feel that they incur a physical risk to their person, whilst dealing with black market goods, depending on the goods and how they are acquired
• Consumers may feel that the black market supplier conducts business immorally, particular if

However, in some cases consumers may actively prefer the underground market, particularly when government regulations unnecessarily hinder a legitimate service. Examples include:

• Unlicensed taxicabs. In Baltimore, it has been reported that many consumers actively prefer illegal taxis, citing that they are more available, convenient, and priced fairly. ^[3]

• Highly marginalised groups, such as undocumented immigrants, may effectively be excluded from the aboveboard economy and thus may undertake most of their purchases and employment in the underground economy.

[edit] Traded goods and services

In developed countries, some examples of underground economic activities include:

[edit] Transportation Providers

In areas where taxicabs, buses, and other transportation providers are strictly regulated or monopolised by government, an active black market typically flourishes in providing transportation to underserved communities. In the United States, some cities restrict entry to the taxicab market via a medallion system. This has led to an active market illegal taxicab operation. Customers range from black Americans living in urban neighborhoods to rural old-order Amish.

In other cases, illegal transportation providers have effected change in mainstream transportation. For example, "Chinatown" bus companies, which introduced low-cost bus or van service between major American cities without using existing bus terminals, have thrived while traditional bus companies declined. Many Chinatown bus companies are now operate legitimately, although without the high capital costs of maintaining public bus terminals.

[edit] Illegal drugs

Main article: Illegal drug trade

Beginning in the 19th and 20th centuries, many countries began to ban the possession or use of various recreational drugs, such as the United States’ famous “war on drugs.” Many people nonetheless continue to use illegal drugs, and a black market exists to supply them. Despite ongoing law enforcement efforts to intercept illegal drug supplies, demand remains high, providing a large profit motive for organized criminal groups to ensure that drugs are available. The United Nations has reported that the retail market value of illegal drugs is worth 321.6 billion dollars. [1] While law enforcement efforts do capture a small percentage of the distributors of illegal drugs, the high and very inflexible demand for such drugs ensures that black market prices will simply rise in response to the decrease in supply—encouraging new distributors to enter the market in a perpetual cycle. Many drug legalisation activists draw parallels between the United States’ experience with alcohol Prohibition and the current bans on various psychoactive drugs.

[edit] Prostitution

Prostitution is illegal or highly regulated in some nations throughout the world. In such areas it is classic study of the underground economy because of consistent high demand from customers, as well the high pay, labor intensive, and low skill aspects the work attract a continued supply of sex workers . While prostitution is observed in virtually every nation, studies have shown that it tends to especially flourish in poorer countries, and in areas with large numbers of unattached males, such as around military bases in third world countries. ^[4]

Prostitutes in such areas generally operate with some degree of secrecy, sometimes negotiating price and activities through codewords and subtle gesture. Additionally, in areas such as the Netherlands where prostitution is legal but carefully regulated, illegal prostitutes exist whose services are offered without regard for legal requirements or procedures. In Nicaragua legal prostitution is regulated and most upscale hotels require identification of both parties involved to help prevent the growing percentage of child prostitution.

[edit] Weaponry

The legislatures of most countries forbid or restrict the ownership of personal arms. These can range from cold steel weapons exceeding certain sizes to firearms, either altogether or by classification (e.g. calibre, automatism, etc), to explosives. The black market can supply such demands, by smuggling the arms from countries where they were either purchased legally or stolen. The purchase of personal arms via these channels can be of use to criminals, those wish to use them for self defence, and weapons collectors.

[edit] Alcohol and tobacco

Black markets can also form near when neighboring jurisdictions with loose or no border controls have substantially different tax rates on similar products. Products that are commonly smuggled to fuel these black markets include alcohol and tobacco.

It has been reported that smuggling one truckload of cigarettes from a low-tax U.S. state to those jurisdictions of the same country with the highest taxes can lead to a profit of up to $2 million. [2] The low-tax states are generally the major tobacco producers and have come under enormous criticism for their reluctance to increase taxes from their minimal rates. North Carolina eventually agreed to raise its taxes from 5 cents per pack to 35 cents, although this remains far below the national average. [3] However, South Carolina has thus far refused to follow suit and raise their taxes from seven cents per pack (currently the lowest in the U.S.A.) [4] Some law enforcement officials have expressed concern that the profits from tobacco smuggling may be directed to terrorist organizations. This has led to calls for the U.S. Congress to intervene by setting mandatory minimum tobacco taxes for all states.

[edit] Copyrighted media

Street vendors in many third world countries, particularly in Asia where loose enforcement of copyright law exists, often sell deeply discounted copies of films, music CDs, and computer software such as video games, sometimes long before the official release of a title. Innovations in consumer DVD and CD burners and the widespread availability on the Internet of cracks for most extant forms of copy protection technology allow anyone with a few hundred dollars to produce DVD and CD copies that are digitally identical to an original and suffer no loss in quality.

Such operations have proven very difficult for copyright holders to combat legally, due to their decentralized nature and the cheap widespread availability of the equipment needed to produce illegal copies for sale. Widespread indifference towards the enforcement of copyright law on the part of law enforcement officials outside of First World countries, as well as social acceptance, further compounds the issue there.

[edit] Appearance and disappearance

In the case of the legal prohibition of a product viewed by large segments of the society as harmless, such as alcohol under prohibition in the United States, the black market can prosper, allowing the black marketeers can reinvest profits in a widely diversified array of legal or illegal activities, well beyond the original item.

Underground markets can be reduced or eliminated by removing the relevant legal restrictions, thereby increasing the supply and quality of formerly banned goods, e.g. marijuana-trade debate. Removing legal restrictions will usually reduce the price of the goods in question, possibly resulting in more of them being bought and sold. This can be beneficial to the state, as the state:

• simultaneously decreases the illegal cashflow, thus making the performance of other, potentially more harmful, activities financially harder.
• can perform quality and safety controls on the traded goods, thus reducing the harm to the consumers
• can tax the trade, thus providing a source of revenue

This can, however, be seen by some people as the equivalent of legalising crime, in order to reduce the number of “official” criminal activities.

[edit] Modern examples

[edit] Wars

Black markets flourish in most countries during wartime. Most states engaged in total war or other large-scale, extended wars must necessarily impose restrictions on domestic use of critical resources, which are needed for the war effort, such as food, gasoline, rubber, metal, etc., typically through rationing. In most cases, a black market develops to supply rationed goods at exorbitant prices. The rationing and price controls enforced in many countries during World War II encouraged widespread black market activity.

During the Vietnam war, soldiers would spend MPC (military money) on maid service and sexual entertainment^{[citation needed]}, thus supporting their partners and their families. If the local then wanted consumer goods, which were sparse in the civil stores due to governmental import controls, he would purchase them for the double price from one of the soldiers, who owned a monthly ration card and thus had access to the military stores.^{[citation needed]} The transactions ran through the on-base maids to the local populace. Despite the fact that these activities were illegal, only flagrant or large scale black marketers were prosecuted by the military.^{[citation needed]}

[edit] Prohibition in the United States

Main article: Prohibition in the United States

[edit] Of alcohol

Prohibition period in the early twentieth century in the United States is a classic example of the creation of a black market, its activity while the affected good has to be acquired on the black market, and its end. Many organized crime groups took advantage of the lucrative opportunities in the resulting black market in banned alcohol production and sales. Since much of the populace did not view drinking alcohol as a particularly harmful activity (that is, consumers and its traders shouldn’t be treated like conventional criminals), illegal speakeasies prospered, and organizations such as the Mafia grew tremendously more powerful through their black market activities distributing alcohol.

[edit] Of smoking

This effect similarly is seen today, when jurisdictions pass bans on smoking in bars and restaurants. In such jurisdictions, smokeasies (businesses, especially barrooms, which allows smoking despite the legal prohibition) frequently arise. This phenomenon is very prevalent in many jurisdictions with smoking bans, including California,^[5][6] Philadelphia,^[7][8] Dublin,^[9] Utah,^[10] Seattle,^[11] Scotland,^[9][12] Ohio,^[13] and Washington, D.C..^[14]

[edit] Clearstream

The Clearstream scandal is an example of such tax evasion. Based in Luxembourg, Clearstream practices financial clearing, which means it centralises operations of multiple banks, some based in tax havens.

[edit] See also

• Agorism
• Counter-economics
• Informal economy
• Grey market
• Business ethics
• Wide boy
• Household electricity approach

[edit] References

[edit] External links

• Shadoweconomy.eu Publications and research on the shadow economy and tax evasion
• Official March 2000 French Parliamentary Report on the obstacles on the control and repression of financial criminal activity and of money-laundering in Europe by French MPs Vincent Peillon and Arnaud Montebourg, third section on “Luxembourg’s political dependency toward the financial sector: the Clearstream affair” (pp.83-111 on PDF version)
• The Underground Economy from National Center for Policy Analysis (1998)
• Going Underground: America’s Shadow Economy by Jim McTague (2005)
• The Underground Economy: Global Evidence of Its Size and Impact (1997)
• The Effects of a Black Market Using Supply and Demand
• Information on Black Market products
• Cold War Black Market Secrets