Thinking outside the box: the unexpected ways black markets can contribute to the economy

Black markets are also known as shadow markets, underground markets, hidden economies, or undeclared markets. While it is difficult to estimate the actual size of a particular black market, it still makes up a large part of an economy's GDP. For developing economies, this part can be up to 36% of their GDP, and for developed countries, it can be up to 13% of their GDP.

To make effective gains from monetary and fiscal policy, it is necessary to determine the size of this economy. Economists used a variety of intermediate variables to arrive at the estimated size of the black economy. Moreover, there is no formal definition of black money in the literature or in economic theories.

Black markets do not necessarily refer to illegal goods:

When we hear the term black market, we often think of illegal goods and services that are traded in the market. Examples include counterfeit goods (counterfeit by designers), drugs, weapons, human organs or prostitution, and the rare wildlife trade; all of these objects are smuggled across the geographical borders of countries and become part of the black economy trade. But this term also refers to how agreements are concluded for any good or service.

A good example of this is buying a burger from a street vendor, rather than Wendy's. If the local seller will accept cash payment and pay little or no taxes. Such exchanges also fall within the scope of the black market.

Therefore, black markets do not necessarily refer to the illegal goods and services that are transacted, but rather more broadly, as they relate to how the agreement on exchange is concluded. Thus, a statutory good or service can also become part of the black market if the income holder does not file a declaration or comply with responsible tax laws in the public treasury.

If black markets could include legal goods, it was appropriate to understand how the black market evolved, because any commodity today could become part of the black market tomorrow.

How are black markets created?

Black money is generated from various sources. Moreover, the prevalence of this generation varies from sector to sector. Some sectors are more vulnerable than others. For example, real estate, luxury goods, bullion, and jewelry markets, to name a few, often attract black money more easily than others. In all these examples, black money is prevalent because of the large amounts of money involved, the potential for cash exchanges by reporting undervalue; and money laundering methods are widespread.

Another route is forgery. The amount of counterfeit goods sold around the world makes it the tenth largest economy on the planet. Since these are copies of the original, they are sold through unofficial channels, facilitating tax evasion. Since they are sold through informal channels, they do not have to comply with any standards or comply with any taxes. This leads to the generation of black money.

Apart from these two sources, government intervention can also lead to the creation of black markets. We often think of laws as a panacea for price fluctuations, especially in the case of necessities. However, price caps imposed by governments during periods of inflation often lead to sellers hoarding goods. Hoarding leads to an artificial scarcity in the market, which leads to a further rise in prices.

Black Economy:

Because there is a steady demand for necessities, sellers direct these goods to black markets, where they charge prices above government-imposed caps. The income gained from this approach is not recorded in official accounts, and it becomes part of the black economy.

The example above highlights that black money can be created from completely legal goods! Crime, smuggling, forgery, leakage from government spending programs, and crimes like bribery and kidnapping are certainly not the only sources of black money. As long as demand exists, markets can be deliberately distorted by cutting off the supply of goods to cause a significant rise in prices, or the current price decline can be distorted by creating supply shortages.

Governments therefore play a very crucial role in controlling prices in the economy. A bona fide intervention can be catastrophic if all its effects are not foreseen in their entirety. In addition, manipulation of tax calculations is widespread among taxpayers to reduce their personal tax burden.

Governments must also ensure that incentives for compliance are not counterproductively distorted.

Despite all the measures mentioned, generating money from these channels is generally attractive, as it reduces overall costs, and allows for faster turnover of money, due to strong informal distribution channels.

What is the impact of the black economy?

Since there is no uniform definition of black money in the economic literature, many researchers arrive at their estimates by a variety of methods. Each method leads to a different result, and none of these estimates arrive at the same answer. In other words, there is no standardized way to measure the black economy. Hence the effect can only be an estimate reached using intermediate variables. For example, one study investigates this effect by studying electricity consumption patterns.

Income generated in the black economy leads to significant losses in the public treasury due to losses of tax revenue. This is exacerbated by ineffective macroeconomic policies and a decline in the quality of public goods, with the tax burden falling on fewer people to maintain the economy.

Since the size of a black 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 measures they lack. This leads to a deterioration in the quality of government interventions. Over time, this can lead to devastating results, as poor quality intervention will exacerbate socio-economic indicators, forcing people to participate in informal markets.

While on the one hand, the black economy seems to be intruding and subsisting on the formal economy, it also has its share of benefits. The black economy doesn't just include criminals. It also includes people who work in informal or informal sectors of the economy.

While the income they earn is not publicly reported or publicized, it does allow them to survive and, in a way, reduce the burden of social transfers that might otherwise be required. It serves as a safety net for individuals to earn a living. For low-income consumers, it offers cheaper alternatives due to the absence of taxes.

This allows them to rely on their incomes, rather than relying on handouts or subsidies provided by governments. For example, for someone to become a licensed plumber in the USA, there are significant costs associated with licensing. If there were no black markets for this business, these individuals would have to live on food stamps. But, through informal markets, they can still do plumbing and thus earn a living.