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The underground economy or black market is a market where all commerce is conducted without regard to taxation, law or regulations of trade. The term is also often known as the underdog, shadow economy, black economy, parallel economy or phantom trades.

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.

Pricing

Goods acquired illegally take one of two price levels:
  • They may be cheaper than legal market prices. The supplier does not have to pay for production costs or taxes. This is usually the case in the underground market for stolen goods. Criminals steal goods and sell them below the legal market price, but there is no receipt, guarantee, and so forth.
  • They may be more expensive than legal market prices. The product is difficult to acquire or produce, dangerous to handle or not easily available legally, if at all. If goods are illegal, such as some drugs, their prices can be vastly inflated over the costs of production.


Black markets can form part of border trade near the borders of neighboring jurisdictions with little or no border control if there are substantially different tax rates, or where goods are legal on one side of the border but not on the other. Products that are commonly smuggled like this include alcohol and tobacco. However, not all border trade is illegal.

Consumer issues

Even when the underground market offers lower prices, most consumers still buy on the legal market when possible, because:
  • They may prefer legal suppliers, as they are easier to contact and can be held accountable for faults
  • In some jurisdictions, customers may be charged with a criminal offence if they knowingly participate in the black economy, even as a consumer.
  • They may feel in danger of being hurt while making the deal
  • They may have a moral dislike of black marketing
  • In some jurisdictions (such as Englandmarker and Walesmarker), consumers in possession of stolen goods will have them taken away if they are traced, even if they did not know they were stolen. Though they themselves commit no offence, they are still left with no goods and no money back. This risk makes some averse to buying goods that they think may be from the underground market, even if in fact they are legitimate (for example, items sold at a car boot sale).


But some actively prefer the underground market, particularly when government regulations hinder what would otherwise be a legitimate service. For example:
  • Unlicensed taxicabs. In Baltimoremarker, it has been reported that many consumers actively prefer illegal taxis, citing that they are more available, convenient, and priced fairly.


Traded goods and services

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

Transportation providers

Where taxicabs, buses, and other transportation providers are strictly regulated or monopolised by government, a black market typically flourishes to provide transportation to poorly served or overpriced communities. In the United States, some cities restrict entry to the taxicab market with a medallion system— that is, taxicabs must get a special license and display it on a medallion in the vehicle. This has led to a market in Carpooling/illegal taxicab operation.

Illegal drugs

From the late 19th and early 20th centuries, many countries began to ban the keeping or using of some recreational drugs, such as the United States' war on drugs. Many people nonetheless continue to use illegal drugs, and a black market exists to supply them. Despite law enforcement efforts to intercept them, demand remains high, providing a large profit motive for organized criminal groups to keep drugs supplied. The United Nations has reported that the retail market value of illegal drugs is $321.6 billion USD.

Although law enforcement officers do capture a small proportion of the illegal drugs, the high and very stable 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. Many drug legalisation activists draw parallels between the illegal drug trade and the Prohibition of alcohol in the United States in the 1920s.

In the United Kingdom, it is not illegal to take drugs, but it is illegal to possess them. This can lead to the unintended consequence that those in possession may swallow the evidence; once in the body they are committing no crime.

Prostitution

Prostitution is illegal or highly regulated in most countries across the world. These places form a classic study of the underground economy, because of consistent high demand from customers, relatively high pay, but labor intensive and low skilled work, which attracts a continual supply of workers. While prostitution exists in almost every country, studies show that it tends to flourish more in poorer countries, and in areas with large numbers of unattached men, such as around military bases.

Prostitutes in the black market generally operate with some degree of secrecy, sometimes negotiating prices and activities through codewords and subtle gestures. In countries such as the Netherlandsmarker, where prostitution is legal but regulated, illegal prostitutes exist whose services are offered cheaper without regard for the legal requirements or procedures— health checks, standards of accommodation, and so on.

In other countries such as Nicaraguamarker where legal prostitution is regulated, hotels may require both parties to identify themselves, to prevent the rise of child prostitution.

Weaponry

The legislatures of many countries forbid or restrict the personal ownership of weapons. These restrictions can range from small knives to firearms, either altogether or by classification (e.g. caliber, automation, etc), to explosives. The black market supplies the demands for weaponry that can not be obtained legally, or may only be obtained legally after obtaining permits and paying fees. This may be by smuggling the arms from countries where they were bought legally or stolen, or by stealing from arms manufacturers within the country itself, using insiders. In cases where the underground economy is unable to smuggle firearms, they can also satisfy requests by gunsmithing their own firearms. Those who may buy this way include criminals, those who wish to use them for illegal activities, and collectors.

In England and Wales some kinds of arms designed for shooting animals may be kept at home but must be registered with the local police force and kept in a locked cabinet. Some people buy on the black market if they would not meet the conditions for registration— for example if they have a record of committing a criminal offense, however minor.

In some jurisdictions, collectors may legally keep antique weapons. Sometimes they must be disarmed (incapable of being fired); but sometimes they are so ineffective by modern standards that they are allowed to be kept intact. For example a blunderbuss or cannon is hardly likely to be used for a drive-by shooting.

Alcohol and tobacco

It has been reported that smuggling one truckload of cigarettes from a low-tax US state to a high-tax state can lead to a profit of up to $2 million. The low-tax states are generally the major tobacco producers, and have come under enormous criticism for their reluctance to increase taxes. North Carolinamarker eventually agreed to raise its taxes from 5 cents to 35 cents per pack of 20 cigarettes, although this remains far below the national average. But South Carolinamarker has so far refused to follow suit and raise taxes from seven cents per pack (the lowest in the USA).

In the UK it has been reported that "27% ofcigarettes and 68% of roll your own tobacco [is] purchased on the black market".

Booze Cruise

In the UK, the Booze Cruise— a day-trip ferry to continental Europe simply to get alcohol and tobacco at lower tax rates— is still very popular. Its popularity varies on the Euro to Sterling exchange rate, and the relative tax rates between the different countries. Some people do not even bother to get off the boat, they buy their stock on board and sail straight back. Ferry companies offer extremely low fares, in the expectation that they will make the money up in sales on the boat. The same system exists for boats between Liverpoolmarker and Dublinmarker, Irelandmarker.

This is entirely legal, providing the goods are for personal consumption, because there is no customs restrictions between EU countries. So is not strictly a black market, more a grey market. It would be naive to expect that every sale is for personal consumption, but officials use their judgement on whether someone is going too far. It has been known for them to arrest people hundreds of miles away from the port if they have imported a lot , and even turn up at events such as weddings if they are given as the reason for the unusually large amount.

The UK and Ireland are both EU members, as well as being in a Common Travel Area which results in there being neither customs nor passport checks between the two countries. This leads to many anomalies.

Copyrighted media

Street vendors in countries where there is scant enforcement of copyright law, particularly in Asia, often sell deeply discounted copies of films, music CDs, and computer software such as video games, sometimes even before the official release of the title. Anyone with a few hundred dollars can make copies that are digitally identical to an original and suffer no loss in quality; innovations in consumer DVD and CD writers and the widespread availability of cracks on the Internet for most forms of copy protection technology make this cheap and easy to do.

This has proved very difficult for copyright holders to combat through the law courts, because the operations are distributed and widespread— there is no "Mr. Big". The issue is compounded by widespread indifference to enforcing copyright law, both with governments and the public at large. To steal a car is seen as a crime in most people's eyes, but to obtain illicit copies of music or a game is not. (see comparison of copyright infringement to theft)

Currency

Money itself is traded on the black market. This may happen for one or more of several reasons:

  • The government sets ("pegs") the local currency at some arbitrary level to another currency that does not reflect its true market value.
  • A government makes it difficult or illegal for its citizens to own much or any foreign currency.
  • The government taxes exchanging the local currency with other currencies, either in one direction or both (e.g. foreigners are taxed to buy local currency, or residents are taxed to buy foreign currency)
  • The currency is counterfeit.
  • The currency has been acquired illegally and need to be laundered before the money can be used.


A government may officially set the rate of exchange of its currency with that of other currencies— typically the US dollar. When it does, it is often pegged at an exchange rate that is artificially low— that is, below what would be the market value if it were a floating currency. Others in possession of the foreign currency, for example expatriate workers, will sell the foreign currency to buy local currency at higher exchange rates than they can get officially.

More rarely, a government may peg its currency too high. This tends to make the foreign currency become a de facto currency for the country, since it is easier for everyone to deal in the tradable foreign currency than the local one. Tourists and occasional visitors tend to deal solely in a major hard currency instead of the local currency. The whole country is essentially then trading on the black market. Some countries, such as Ecuadormarker, abandoned their local currency and now use US dollars, essentially for this reason, a process known as dollarization. See also the example of the Ghanaian cedi from the 1970s and 1980's.

The Cuban convertible peso and US Continental dollar both have had black market rates significantly different from their face value.

If foreign currency is difficult or illegal for local citizens to acquire, they will pay a premium to acquire it. Taxation is generally less important but, if it is high enough, can still encourage a black market simply for tax avoidance even if currency trading is generally legal.

Fuel

In the EU it is not illegal for a person or business to buy fuel in one EU state for their own use in another, but as with other goods the tax will generally be payable by the final customer at the physical place of making the purchase.

Between the Republic of Irelandmarker and Northern Irelandmarker there has often been a black market in petrol and diesel.The direction of smuggling can change depending on the variation of the taxes and the exchange rate between the Euro and Pound Sterling; indeed sometimes diesel will be being smuggled in one direction and petrol the other.

In some countries diesel fuel for agricultural vehicles or domestic use is taxed at a much lower rate than that for other vehicles. This is known as red diesel, because a red dye is added so it can be detected if used in other vehicles. Nevertheless, the saving is attractive enough to make a black market in red diesel. In 2007 it was estimated that £350 million was lost in revenue this way.

Appearance and disappearance

If an economic good is illegal but not seen by many in society as particularly harmful, such as alcohol under prohibition in the United States, the black market prospers. Black marketeers can reinvest profits in diverse legal or illegal activities, well beyond the original source of profit.

Some, for example in the marijuana-trade debate, argue for removing the underground markets by making illegal products legal. This would, in their view:

  • decrease the illegal cashflow, thus making the performance of other, potentially more harmful, activities financially harder
  • allow quality and safety controls on the traded goods, thus reducing harm to consumers
  • let the goods be taxed, providing a source of revenue
  • free up court time and prison space and save taxpayer money.


Modern examples

Wars

Black markets flourish in most countries during wartime. States that are engaged in total war or other large-scale, extended wars must necessarily impose restrictions on home use of critical resources that 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 Military Payment Certificates on maid service and sexual entertainment, thus supporting their partners and their families. If the Vietnamese civilian wanted something that was hard to get, he would purchase it at double the price from one of the soldiers, who had a monthly ration card and thus had access to the military stores. 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 marketeers were prosecuted by the military.

Prohibition in the United States

Alcohol

A classic example of creating a black market is the Prohibition of alcohol during the 1920s in the United States. Many organized crime syndicates took advantage of the lucrative opportunities in the resulting black market in banned alcohol production and sale. Most people did not think drinking alcohol was particularly harmful nor that its buyers and sellers should be treated like common criminals. So illegal speakeasies prospered, and organizations such as the Mafia grew tremendously more powerful through their black market activities distributing alcohol. This lasted until repeal of Prohibition.

Although Prohibition ended in 1933, there are still some parallels today with evasion of the drinking age of 21 in the United States, which is high compared to other industrialized countries and three years above the age of majority in nearly all states. Like Prohibition, this law is widely (but more covertly) disobeyed as well. Though social sources of supply predominate for underage drinkers, some bars and stores knowingly serve and sell to those who are underage, and some may even make deals with local police. Many college towns especially have a vast network of fraternities and sororities (and others) that run what can be considered modern-day speakeasies in their houses, in which age is irrelevant. Since the substance in question, alcohol, is legal for those over 21, it can be considered more of a gray market than a black market.

Smoking

This effect is seen similarly today, when jurisdictions pass bans on smoking in bars and restaurants. In these jurisdictions, smokeasies arise which allow smoking despite the legal prohibition. In a sense the owner is not a black marketeer since he is not necessarily selling tobacco, but he profits by the sale of other goods on his premises (typically alcohol).

This phenomenon is very prevalent in many US state jurisdictions with smoking bans, including Californiamarker, Philadelphiamarker, Utahmarker, Seattlemarker, Ohiomarker, and Washington, D.C.marker.

Comparison with regular economy

Country Size of shadow economy in percent of GDP, average over 1990-93
Developing economies
Africa
Nigeria and Egypt 68-76%
Tunisia and Morocco 39-45%
Central and South America
Guatemala, Mexico, Peru and Panama 40-60%
Chile, Costa Rica, Venezuela, Brazil, Paraguay and Colombia 25-35%
Asia
Thailand 70%
Philippines, Sri Lanka, Malaysia and South Korea 38-50%
Hong Kong and Singapore 13%
Transition economies
Central Europe
Hungary, Bulgaria and Poland 20-28%
Romania, Slovakia and Czech Republic 7-16%
Former Soviet Union
Georgia, Azerbaijan, Ukraine and Belarus 28-43%
Russia, Lithuania, Latvia and Estonia 20-27%
Developed economies
Greece, Italy, Spain, Portugal and Belgium 24-30%
Sweden, Norway, Denmark, Ireland, France, The Netherlands, Germany and Great Britain 13-23%
Japan, United States, Austria and Switzerland 8-10%


Market economy

Agorists and some other proponents of the free market argue that the black market is the most free market. Other regulated markets, they claim, suffer one way or another from undue interference in the general working of a free market.

Others argue that black markets are often controlled by other parties — such as a gang that aggressively regulates the drug trade in its territory — in a similar fashion to the government control of white markets, and are therefore not truly free markets. Agorists, however, use the term "red market" to distinguish between black markets in general and those based on violence and theft.

See also



References

  1. Journal of Political Economy, "A Theory of Prostitution" February 16, 2001
  2. North Carolina's Cigarette Tax Increase Is A Small Step In The Right Direction But Kids and Taxpayers Will Miss Benefits of Greater Increase (Campaign for Tobacco-Free Kids)
  3. The Tax Foundation— State Sales, Gasoline, Cigarette, and Alcohol Tax Rates by State, 2000-2008
  4. "California's Ban to Clear Smoke Inside Most Bars," The New York Times, December 31, 1997
  5. "The Land of Smoke-Easies, $500 Barfs," The San Francisco Chronicle, May 15, 1998
  6. "'Smoke-easys' ignore the tobacco ban", Philadelphia Inquirer, March 27, 2007
  7. "Smoke-easies", Fort Wayne News-Sentinel, March 28, 2007
  8. "Everyone Head for the Smoke-Easy," Utah Statesman, December 12, 2006
  9. "Smokers find refuge in secret nicotine dens", Seattlepi.com, May 31, 2006
  10. "smoke-easies, altoid tins, blue moon, janis joplin and vivid imaginations" Yellow Is The Color Blog
  11. "Smoke-easies offer cover from puff police; Aficionados just want a place to light up, relax," The Washington Times, November 20, 2003
  12. Matthew H. Fleming, John Roman, and Graham Farrel. The shadow economy. [1]
  13. Konkin, Samuel Edward. New Libertarian Manifesto


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