The underground economy is one of the largest and most influential markets in the world
The sale of everything outside of the law is by its very nature
hard to track, but reputable sources peg it well into the trillions of dollars per year.
That’s bigger than the market for fast food, movies, fashion, and smartphones, combined
twice over.
This is something that can genuinely impact entire nations.
Not only do black market activities come with a significant human cost but the economic forces
involved can easily make the difference between a successful economy, and a struggling economy.
We have seen the positive and negative impacts that oil and gas discoveries can have on national
economies but the black market revenues in 2019 rivaled natural gas revenues worldwide.
so it’s not unreasonable to assume the impacts would be just as great.
To truly explore this market though we,
as always have to understand what makes the black market function.
So what is a black market? And spoiler alert it’s a lot more than selling drugs.
Why is it so large and influential?
what are the best ways to practically combat these illicit trades?
And if one were so inclined, how would they carve out a little black-market profit of their own?
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When someone thinks of the black market their mind will immediately race to
Mafia bosses running protection rackets, or Pablo Escobar with his mountains of ill-gotten gains.
Now these are certainly parts of the black market, but they do not define it.
In reality, the black market is the result of
Regulatory Rigidities
Controlled substances, guns, ill gotten kidneys and fake passports are all illegal to own,
illegal to buy and illegal to sell.
This is a very direct way that a government can control a consumer market.
Any type of transaction involving these items
is not sanctioned and the punishments are pretty severe for trying to accommodate this market.
This means three things.
One, that these transactions cannot be legally recognized,
you can’t pay taxes on them and you will need
Two, the parties involved will have to accept a cost
premium due to the risks involved in not having enforceable contracts,
meaning that if someone does you a dirty in one of these deals it is up to you to seek compensation,
because well obviously you can’t do it through a court. This can be risky and expensive.
And three the parties involved will have to accept a cost premium due to
the inherent risk-reward trade-off in dealing with items that could get you 25 years to life.
So the black market for outright illegal goods is filled with costly items sold by
people with the means to defend themselves and are not necessarily afraid of prison, right?
Well yes, but the black market is not entirely made up of these types of very
obviously illegal items.
One of the largest underground markets is for counterfeit goods, in 2016
this market rivaled the size of the drug trade.
Now counterfeit goods are still illegal, but for different reasons.
Nobody is going to OD on fake yeezies and you can’t haze someone with a fake
rolex, so they are inherently less dangerous to have in circulation.
But they defy intellectual property rights.
When a company designs a shoe, or a watch or even makes a video to put onto the internet,
they have the rights to exclusively share that intellectual property.
Because of this exclusivity, they are often able to charge a premium for their funny shoes,
plain-looking watches or Australian sounding economic commentary.
This premium allows designers innovators and content creators to profit off the
time and effort they spent developing the product they are bringing to market.
This premium also means that it’s very easy for a copycat to come in,
and replicate the product without having to invest into development and undercut the innovator.
Often times counterfeit goods are of extremely inferior quality,
but other times they are indistinguishable.
Authorities from around the world are very keen to to crack down on this market
because undercutting genuine innovation means that...
One there is no profit incentive to invest into research and development.
And two, the businesses that are innovating will be priced out so they won’t be able to continue.
This is often seen as a pretty benign market given that the only victims are
high price fashion houses, media studio’s and poor poor youtubers, ehem…
But in all seriousness though, design and cutting edge research can be a major component of entire
national economies, and by not fully supporting the profit motive involved in innovation,
we may not benefit from the next breakthrough that will change our lives for the better.
Now all of this goes to show that the black market is there to fill in the gaps
caused by governments or regulatory bodies saying,
no you can’t buy this or you can buy this but it has to be from this company.
But the shadow economy leakes in and takes advantage of all market inefficiencies,
even when they are not there to control the product, but they are there to
Control the price
Passionate advocates for legalizing certain markets will always argue
that something should be legalized and taxed.
This will more often than not alleviate a lot of social issues that can come along with
these markets but it doesn’t mean that it will get rid of them entirely.
Tobacco is one of the most notable examples of this.
Smoking is very bad for you, despite this it remains legal
in every country in the world, apart from Bhutan.
But because of its negative side effects, governments will often levy a tax on tobacco
products to try and artificially make them less desirable purchases.
In Australia for example, a packet of cigarettes that costs a dollar to produce and import
can easily sell over the counter for $40, once government taxes are considered.
This kind of static price increase means that there is huge opportunities
for people to sell cigarettes that are imported directly into the black market.
The buyers are getting exactly the same product,
probably produced in the same factory at a significantly reduced price.
The sellers get to pocket the difference between the price in international markets
and the price in the domestic market, all while dealing in a product that is
significantly less frowned upon than hard drugs or weapons or kidneys.
This price intervention also goes the other way
when governments say that something can’t cost more than a certain amount.
Take oil for example, when you fill-up the price you pay is mostly determined
by the price of crude oil, government taxes on oil, and the markup of the oil retailer.
Lets say for simplicity this is around
$1 per litre or, $3.80 per gallon for our american friends.
At this price the demand for oil, perfectly matches the supply of oil,
and the market is said to be in equilibrium.
But if a government were to turn around and say that expensive oil is hurting our auto industry,
and trucking companies can’t turn a profit with these high oil prices,
they might introduce what is called a price ceiling.
A price ceiling means that the price of whatever product, in this case oil, cant go above lets say,
50 cents per litre, half the price it was originally trading at.
If we go back to our demand and supply graph, that would look like this.
Nobody can but or sell oil for more than 50 cents per litre.
The problem this causes is that almost everybody will want to fill up their cars at 50cents per
litre, they will load up jerry cans, and go on road trips and in all just consume more petrol.
But retailers would not want to sell it at this price. At 50 cents per litre they might not even
be breaking even on production, unless they are drilling from nothing but the easiest oil wells,
so definitely not fracking, and definitely no shale oil.
What this means is that there will be lots and lots of people that go
without petrol shown by this quantity shortfall here.
So what are people to do? They still need petrol to get to work or pick up the kids, so
it not always a luxury that they can just go without. So, they buy it from people
with less of an attachment to those pesky regulations.
Those people filling up their jerrycans might be a little bit enterprising and
agree to sell this fuel back to the general public, at a significant markup of course.
We can chart this out on our graph. No matter what, oil producers are only
going to make this much oil available at 50c per litre, but this much is demanded.
This will form a black market price at this level up here say at $2.
A not so fun fact is that this area here represents a deadweight loss.
That s the cost created to society born out of market inefficiencies.
In an attempt to make oil prices more affordable,
this intervention has made it more expensive for regular consumers.
Oil is an easy example of this but we see these types of price
ceilings creating black markets all the time.
Resale supreme bricks, concert ticket scalpers, toilet paper resellers,
all take advantage of lower mandated prices that what the true market price is.
So now the different ways that black markets form are understood,
how is it that we study them, and why are the so important?
Why so important?
Black markets have the impression of just been made up of hardened criminals peddling
very illegal goods.
But as we have seen these markets exist wherever there is inefficient market stipulations.
The logical extent of this is something like a child’s lemonade stand.
Chances are this stand is an unlicensed restaurant,
utilizing child labor, in a residential zone, so it’s part of the underground economy.
The black market often includes things that people thing are really benign,
but all of this can add up to a significant difference in the economy.
Things like unregistered work for cash in hand, or
goods sold on the side of the road are more often than not, unreported to taxation agencies.
These industries can also have significant impacts on labor statistics and unemployment rates.
If governments are trying to conduct robust fiscal and monetary policy then they
are going to need to know things like the true unemployment rate.
In reality, good economists will actually account for the
underground economy in their macroeconomic models.
Now actually quantifying the size of this black market is the hard part.
If you interview your local kidney dealer, or lemon beverage proprietor they are going
to be less than forthcoming with their financial figures.
Either because they don’t know or because that information would expose criminal activities.
To get around this unco-operative accounting economists use a range of measures from forensic
finance to aerial photography and even monitoring the types of consumer goods purchased in an area.
If a supposedly poor neighborhood is loading up on new cars, tv’s,
and jetskii’s its pretty safe to assume that there are black market operations going on.
One of the most inspired ways economists measure the size of the shadow economy is detailed in this
article written by Friedrich Sneider and Dominik enste for the journal of economic literature.
they look at energy output and compare it to GDP figures.
In reality there is an incredibly strong correlation between GDP and energy output.
we have actually explored this phenomenon before when we were looking at the economy
of the star wars galaxy and where it sat on the kardisheve scale.
Back on earth, if a country or area is using a disproportionate amount
of electricity compared with its genuine economic output,
its an indication that there is some funny business going on.
Now the reason this is all so important to economists despite making good models, and
you know the law and stuff, is that these industries can have major economic impacts.
Illegal labour is one of the most severe examples of this.
Just like our friendly neigborhood drug dealer from earlier,
if people are working illegally they dont have any… well… legal recourse if something goes wrong.
Having a market filled with workers that are happy to work below minimum wage in adverse conditions
puts downward pressure on the pay and working conditions of all workers.
Steven Colbert of all people probably said it best in a statement to a congressional hearing,
“if your coworker can’t be exploited, then its less likely that you will be exploited yourself”
How to profit?
Ok so you have seen the doom and gloom, human suffering and worst of all broken
economic models that can come out of the underground economy
but you are still keen to dive in and carve out your own little slice of that black market pie.
Now you know how... don’t go for the obvious stuff, these markets are overcrowded,
over targeted by authorities and filled to the brim with nasty gangsters.
Go and find some market altering piece of government bureaucracy and work around it.
You will be rewarded for facilitating a free market, where supply meets demand,
taxes are an afterthought and you won’t even need to get your hands dirty
dealing with stuff that grandma would disapprove of.
The market for the hearts and minds of politicians is a good one. A little bit
of money invested here is likely to net you significant returns in the form of
government contracts or accommodating regulations.
However, you do it you are going to want to know how to launder that money and once again
economics explained has you covered, so go watch our video on money laundering in the modern-day.
Final thoughts
The black market, the shadow economy, or the financial underground,
whatever you want to call it, the collective transactions that fall
outside the letter of the law are as important as they are diverse.
Alot of regular people, and economists for that matter fall for the assumption that
the black market is just some fringe reality filled with Heisenberg’s.
Just as many will fall for the assumption that this is not an
important factor to consider when looking at the economic impacts of well, anything.
The black market by it’s by it’s nature a non exact science but by accepting it’s size and
influence we can better steer our legitimate economies, tailor market altering policies,
and if nothing else, pocket a bit of cash off those pesky market failures.
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