Underground Economy

September 8th, 2009 | economics -

Readers Question: How come the underground economy is not a major part of the discussion related to both macro and micro economics? My theory is it causes debt and recession

Definition of the underground economy. The underground economy involves economic transactions not measured by government statistics and ignoring government regulations and laws.

The underground economy is also referred to as: ‘black market’ ’shadow economy’, ‘parallel economy’.

The underground Economy includes:

Criminal activity e.g. selling of drugs on the street,
Labourers paid in cash and not declaring to the taxman
Borrowing from ‘loan sharks’ at extortionate interest rates
Prostitution
Buying untaxes cigarettes and alcohol.
illegal (unlicensed) taxi services

The size of the black market varies depending on the country. It is hard to measure, but estimates suggest the underground economy accounts for about 7-8% of the US and UK economies, but, in Russia it could be as high as 40-50%. (see: Size of black markets)

Does Underground Economy Cause Recession?

The underground economy does not contribute to significant economic downturns. Firstly, it is a relatively small % of economies. The fact people engage in illegal activities does not create the circumstances where there is a sudden sharp drop in consumer demand and fall in measured output. Recessions are typically caused by factors such as falling house prices, higher interest rates or a drop in confidence; these kind of factors will reduce spending in both the official and underground economy.

It is possible that if there was a sudden shift from the legal economy to underground economy, official GDP statistics would show a big fall. For example, after moves to a free market economy, Russia experienced dramatic falls in GDP. At least part of this was because of the great share of the underground economy, so official GDP statistics underestimated actual levels of GDP in Russia.

It is also possible that in a recession, the relative size of the underground economy rises as people take part time jobs and don’t declare their income or people seek to save money by buying cigarettes on the black market.

Underground Economy and Debt.

The problem with the underground economy is not so much that it encourages more debt, but, that it encourages people to take out the wrong kind of debt – extortionate loans from loan sharks which have ridiculously high interest rates.

People usually resort to loan sharks because they are ineligible for bank accounts or loans from normal institutions. This makes them vulnerable to the whims of loan sharks who can often charge interest payments far higher than the initial loan.

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