What Is the Black Economy?

The black economy is a segment of a country's economic activity that is derived from sources that fall outside of the country's rules and regulations regarding commerce. The activities can be either legal or illegal depending on what goods and/or services are involved. The black economy is related to the concept of the black market. In the same way that an economy is made up of many related markets considered as an integrated whole, the black economy is made up of the collection of various black markets in an economy.

Key Takeaways

  • The black economy is all economic activity in a given economy that occurs outside or in violation of the prevailing laws and regulations of society.
  • Where governments intervene, tax, or regulate markets sometimes people will break or ignore the rules imposed, which can produce net economic benefits or costs to society. 
  • Activity in the black economy is often illegal, usually untaxed, and rarely recorded by official economic statistics, and it may not consist of formal market transactions at all.

Understanding Black Economy

People operate in black economies in order to trade contraband, avoid taxes and regulations, or skirt price controls or rationing. Typically, black markets arise when a government restricts economic activity for particular goods and services, either by making the transaction illegal or by taxing the item so much that it becomes cost-prohibitive. A black market may arise to make illegal goods and services available or to make expensive items available for less money (such as pirated music or software).

As an example of a black economy, a construction worker who is paid under the table will neither have taxes withheld, nor will the employer pay taxes on his earnings. The construction work is legal; it is the nonpayment of taxes that classifies the event as part of the black economy. The illegal-weapons trade is also an example of illegal black-economy activity.

Because tax evasion or participation in a black market activity is illegal, those who engage in such behavior will often attempt to conceal their activities from governments or regulatory authorities. Black economy participants choose to transact their illegal transactions in cash, since cash usage does not leave a footprint. Different types of underground activities are distinguished according to the institutional rules that they violate. Typically, such activities are referred to with the definite article as a complement to the official economies (e.g., "the black market in bush meat").

The black economy consists of many decentralized clandestine markets. These underground economies exist everywhere—free market and communist countries alike, both developed or developing. Those engaged in underground economy activities circumvent, escape, or are excluded from the institutional system of rules, rights, regulations, and enforcement penalties that govern above-board parties engaged in production and exchange.

Costs and Benefits of the Black Economy

The net economic costs and benefits of activity in the black economy varies depending on the type of activity and the context. Often black market activities may benefit the direct participants but in ways that are harmful to others, such as the buying and selling of stolen property. Black market activities of certain types can create clear and unambiguous harm to society, such as murder-for-hire services. Other activities in the black market may not cause direct economic harm to anyone but can reduce the effectiveness of social institutions that benefit all of society, such the poaching of wildlife, illegal dumping of toxic waste, or the evasion of taxes used to pay for legitimate public goods.

Other times, the black economy can represent a clear net economic gain to society that circumvents or compensates for economic problems created by government policy. Smugglers and black marketeers can be the only source of food and medicine to starving people in war-torn regions. Illegal radio stations and newsletters can circumvent repressive regimes. Buyers and sellers who violate regulations such as price controls and quotas can undo some of the deadweight losses that can otherwise be tied to these types of policies. Banned private entrepreneurial and commercial activity in centrally planned or socialist economies can provide invaluable consumer goods and services that would be very scarce or nonexistent otherwise. Personal services such as home cooked meals and child rearing that occur within a household are typically beneficial to all involved and society at large, but they are part of the black economy because they occur entirely outside of any formal contract, regulation, or recorded market transaction.

Four Types of Black Economies

There are four major classifications of black economies: the illegal economy, the unreported economy, the unrecorded economy, and the informal economy. The illegal economy consists of the income produced by those economic activities pursued in violation of legal statutes defining the scope of legitimate forms of commerce. Extortion and drug dealing are part of the illegal economy. The unreported economy seeks to evade the institutionally established fiscal rules as codified in the tax code. Under-the-table employment and untaxed private transactions that are otherwise legal fall into this category. The unrecorded economy refers to economic activities that circumvent the institutional rules that define the reporting requirements of government statistical agencies. This can be due to deliberate concealment information for legitimate or illegitimate reasons or due to practical difficulties associated with data collection. The informal economy comprises those economic activities that circumvent the costs and are excluded from the benefits and rights incorporated in the laws and administrative rules covering property relationships, commercial licensing, labor contracts, torts, financial credit, and social security systems. Non-market activities, such as the production of household services or favors exchanged by friends and neighbors, fall into this category.