Why does the existence of black markets not necessarily have to be harmful to an economy? » Science ABC

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The existence of black markets is not necessarily harmful to an economy, as they can serve as safety valves during economic crises, provide access to goods and services in restrictive environments, and promote innovation. Governments in many countries are considering ways to formalize these sectors.

Black markets are also referred to as shadow or underground markets, hidden economies and unreported markets. Although it is difficult to estimate the actual size of a given black market, they still represent a significant portion of an economy’s GDP. For developing countries, it can be up to 36% of their GDP, and for developed countries it can be about 13% of their GDP, according to the St. Louis Federal Department’s 2015 estimates.

For effective gains from monetary and fiscal policy, it is important to capture the size of this economy. Economists have used various proxy variables to determine the estimated size of the shadow economy. Furthermore, there is no formal definition of black money either in the literature or in economic theory.

When we hear the term black markets, we often think of illegal goods and services traded on a market. Examples include counterfeit goods (designer imitations), drugs, weapons, human organs or prostitution, and the trade in exotic wildlife; All of this is smuggled across geographical borders and becomes part of the black market. However, this term also refers to the way in which billing is made for a good or service.

A good example is buying a burger from a street vendor rather than Wendy’s. The local seller accepts cash payments and pays little to no taxes. This transaction would also fall into the realm of black markets.

Most informal market structures are part of the shadow economy. These can be companies with different incomes, which do not necessarily involve low earners. (Source: AJP/Shutterstock)

Therefore, black markets do not necessarily refer to the trade in illegal goods and services, but more broadly to the way in which a transaction is carried out. Therefore, a legal good or service can also become part of the black market if the income recipient does not file a declaration and/or does not comply with the taxable laws of the treasury.

If black markets can include legal goods, it is important to understand how a black market develops, as any good today can become part of the black market tomorrow.

How do black markets arise?

Black money is generated from various sources. Furthermore, the extent of this generation also varies from sector to sector. Some sectors are more vulnerable than others. For example, markets for real estate, luxury goods, gold bullion and jewelry, to name a few, often attract black money more easily than others. In all of these examples, black money is prevalent because large sums of money are involved and there is a possibility of underreporting of cash transactions. There are extensive opportunities for money laundering.

Another way is forgery; The volume of counterfeit goods sold worldwide makes counterfeiting the world’s 10th largest economy. Because they are copies of an original, they are sold through informal channels, making tax evasion easier. Because they are sold through informal channels, they do not have to comply with standards or pay taxes. This leads to generation of black money.

Apart from these two sources, government intervention can also lead to the emergence of black markets. We often think of laws as a panacea for price fluctuations, especially for consumer goods. However, price caps imposed by governments during times of inflation often lead to sellers hoarding goods. Hoarding creates artificial shortages in the market, thereby driving up prices even further.

Since there is a constant demand for everyday goods, sellers funnel these goods to black markets where they charge prices above government-imposed limits. The income generated by this approach is also not recorded in the official accounts and flows into the shadow economy.

Recycling as an industry thrives on the informal economy in developing countries, as informal workers sell recyclable goods to traders and industries operating in the formal private sector. (Source: AJP/Shutterstock)

The example above shows that black money can be generated with completely legal goods! Crime, smuggling, counterfeiting, the expiry of government spending programs and crimes such as bribery and kidnapping are certainly not the only sources of black money. As long as demand exists, markets can be intentionally distorted by disrupting the supply of goods to cause a price increase, or an existing price decrease can be distorted by creating supply constraints.

Governments therefore play an extremely important role in monitoring prices in the economy. A well-intentioned intervention can be disastrous if all of its effects are not fully anticipated. In addition, tax account manipulation is widespread among taxpayers to reduce their personal tax burden.

Governments must also ensure that incentives for compliance are not distorted in self-defeating ways. Despite all the measures mentioned, generating money through these channels is generally attractive as it reduces overall costs and enables faster sales due to robust informal distribution channels.

Also Read: Why Can’t We Just Print More Money to Solve Our Financial Problems?

What effects does the black economy have?

Since there is no uniform definition of black money in the economic literature, different scholars’ estimates are determined in different ways. Each method produces a different result and none of these estimates produce the same result. In other words, there is no standard way to measure the shadow economy. The impact can therefore only be an estimate determined using proxy variables. One study examines these effects, for example, by examining electricity consumption patterns.

The income generated in the shadow economy leads to significant losses for the state treasury due to tax losses. This leads to ineffective macroeconomic policies and lower quality of public goods as the tax burden of maintaining the economy falls on a smaller population.

Since the size of the shadow economy also varies from country to country, it becomes difficult for governments to collect accurate data on unemployment, social transfers and per capita income, among other missing metrics. This deteriorates the quality of government interventions. Over time, this can prove self-defeating, as poor quality interventions further deteriorate socio-economic indicators and further force people to participate in informal markets.

Informal retail is dominated by small shops selling branded household items. The sector is very complex and most of these retailers track sales and inventory manually. Over the last decade, the rise of online payment aggregators has begun to transform this economy. (Source: Rembolle/Shutterstock)

While on the one hand it seems as if the shadow economy puts the organized economy at a disadvantage, it also brings with it some advantages. The shadow economy doesn’t just include criminals. This includes people working in informal or unorganized sectors of the economy.

Although the income they earn is not publicly reported or declared, it allows them to stay afloat and also, in some ways, reduces the burden of social transfers that would otherwise be required. It acts as a safety net for individuals to earn a living. For consumers in lower income brackets, it offers cheaper alternatives due to the lack of taxation.

This means they can rely on their income and are not dependent on handouts or social assistance from the government. For example, to obtain a license as a plumber in the United States, there are significant costs associated with licensing. If there had been no black markets for this work, these people might have had to live on food stamps. Through informal markets, they are still able to do plumbing work and earn a living.

Although an unlicensed plumber is economically the same as a seller of counterfeit goods since neither pays taxes or declares their income, it is important to recognize the different impacts of their activities on the economy. Their effects are not the same. Although black markets have costs for any economy, their benefits cannot be overlooked.

Also Read: Is the health of the stock market a sufficient indicator to predict the health of an economy?

The benefits of black markets have also been recognized over time, considering how long it takes to implement strict income control laws in the economy, especially in the context of developing countries.

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Review Quiz References (click to enlarge)

1. C Gu. Prohibited Transactions and Black Markets – web.stanford.edu.
2. Measuring the underground economy is difficult.
3. The global impact of counterfeiting and solutions to stop it – www.forbes.com
4. EFMA.

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