Black economy definition

What is a Black Economy?

A black economy is that portion of a country's economy that is undocumented. Individuals prefer to operate within the black economy so that they can avoid making tax payments to the government, or to avoid price controls or rationing. The black economy operates by using cash payments or barter to settle transactions. The transactions occurring within the black economy are not included in a country's gross domestic product (GDP) calculation, since there is no way to measure it.

The black economy constitutes a large part of the total economy of a country in the developing world, because these nations have a large proportion of low-income citizens who cannot afford to pay taxes. Consequently, the GDP figures for many developing nations are probably severely under-reported.

There also tends to be a thriving black economy when a government imposes excessively high taxes, or when the government restricts certain types of activities, such as the sale of drugs or weapons. A black economy is also present when the government imposes an excessive amount of regulation. Examples of black economy transactions are:

  • The sale of illegal drugs

  • The provision of unauthorized transportation services

  • Smuggling heavily-taxed goods over the border for sale within the country

  • Paying cash to a housekeeper

  • Unauthorized currency conversions

Types of Black Economies

There are several types of black economies, including the unrecorded economy and the informal economy. They are described below:

  • The unrecorded economy. The unrecorded economy includes all activities that are not recorded by a government’s statistical agency. These activities may not be recorded through data collection errors or inadequacies, or because the activities in question are actively trying to avoid coming to the attention of the government.

  • The informal economy. The informal economy includes those activities that circumvent the normal business and legal structure of a country. This means that informal activities are not licensed by the government, have little or no legal recourse, and have an extremely difficult time obtaining financing from formal lenders. Informal economies tend to comprise a large part of the total economy in countries where it is difficult to obtain a business license, usually due to bureaucratic difficulties and the need to pay bribes to government employees.

Disadvantages of a Black Economy

Here are some of the main disadvantages of a black economy:

  • Loss of tax revenue. Transactions in the black economy are often unreported, leading to significant tax evasion. This reduces government revenue, which in turn limits funding for essential services like healthcare, education, infrastructure, and social welfare programs.

  • Unfair competition. Businesses that operate in the formal sector are subject to regulations, taxes, and compliance costs, while those in the black economy are not. This creates an uneven playing field, putting legal businesses at a competitive disadvantage and discouraging fair business practices.

  • Increased corruption. A black economy is often associated with corruption and crime, as people involved in illicit activities may bribe officials to avoid detection. Additionally, illegal activities like drug trafficking, human trafficking, and smuggling can flourish within the black economy, leading to broader social and security issues.

  • Weak labor protections. Jobs in the black economy typically lack formal contracts, benefits, and labor protections. Workers are often paid low wages, and they do not receive healthcare, retirement benefits, or protection against unfair dismissal. This can lead to exploitation and poor working conditions.

  • Distortion of economic indicators. Black market transactions are not recorded in official statistics, making it difficult to accurately measure a country’s GDP, employment rates, and other economic indicators. This can lead to inaccurate policy decisions, as governments rely on these indicators to make informed choices about economic policy.

  • Reduced access to financial services. Businesses and individuals in the black economy cannot freely access legal protections, financial services, or government support. They may be vulnerable to exploitation by lenders or suppliers, and they often operate with cash-only transactions, which limits their ability to grow or access loans for investment.

  • Increasing levels of inequality. The informal economy can contribute to widening income inequality. People involved in the black economy may have unstable incomes and no social safety nets, which can lead to greater financial vulnerability and increase the wealth gap within society.

  • Higher prices. Black market activities, particularly smuggling or illicit trade, can distort prices for certain goods. For example, counterfeit goods might be sold at lower prices than genuine ones, which harms legitimate businesses. Alternatively, restricted goods like narcotics may command high black-market prices, affecting consumer behavior and causing inflationary pressures in certain markets.

In short, while the black economy can provide short-term economic opportunities for individuals and small businesses, it generally creates long-term disadvantages for the economy as a whole, hampers fair business competition, and undermines the quality of life for workers and society.

Similar Terms

The black economy is also known as the underground economy or shadow economy.

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