Black Economy

What Is the Black Economy?

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The Black Economy is a significant but difficult to measure part of almost every economy in the world. Depending on the source, “black economy” is taken to mean that part of the economy that involves illegal and criminal activity, such as the trade in drugs or smuggled goods. However, the term is also used interchangeably with terms such as shadow economy, informal economy, or underground economy. Whether it involves illicit activity or not, the black economy has four key characteristics:

  • It is a cash-based economy and is isolated from the banking system.
  • It may feature its own sophisticated system of credit.
  • It exists outside a country’s business regulation framework.
  • It is usually difficult if not impossible for the government to track, and therefore is untaxable.
  • It is not reflected in the country’s GDP or GNI statistics, though it may be a very large part of the economy.

How large is the black economy? For years, the International Monetary Fund has estimated that around 30% of the global economy is “informal”; the figure is higher in poor and developing countries, and lower – but still exists at a significant level – in first-world countries. More recent studies, in particular, one done by a researcher at Bogazici University (Turkey) in 2012 using several sophisticated statistical models, give slightly lower estimates of about 22%. The black economy is largest in Sub-Saharan Africa and Latin America, accounting for between 38 and 40 percent of those economies, and smallest in the OECD countries at slightly less than 18%. The black economy is also said to be counter-cyclical, that is, growing when the formal economy shrinks; since 1960 the size of the black economy gradually declined in most of the world but began to grow rapidly again from 2008, after the onset of the global financial crisis.

The Link Between the Black Economy and Poverty

The black economy is obviously larger in poorer, less-developed countries, and the link between poverty and the “informal” economy was established in two important reports published by the International Labour Organisation in 1972-1973, which characterized the development of a black economy as an outcome of survival strategies by impoverished people, most often those migrating into cities in search of economic opportunities. The ILO drew the significant (for that time) conclusion that the black economy should be considered an integral rather than complementary or marginal part of the economy but considered the existence of a large black economy as still being evidence of poverty.

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The reasoning behind this assertion is that while a black economy can grow and actually provide fairly stable livelihoods for a lot of people, its extralegal nature prevents small entrepreneurs from growing beyond a certain point, and keeps individual workers from entering the formal job market and financial system. The ILO prescription for correcting the problem of the black economy growing in countries where unemployment and low economic output persisted was to address what the organization saw as its root causes: Excess labor supply, undercapitalization of the business sector, and a lack of skills and accessible technology. By providing educational, financial, and technical resources, it was thought, much of the black economy could be transferred to the formal economy.

That was a nice idea, but in most countries, it did not work. In his 2000 book The Mystery of Capital, author Hernando de Soto explains that the ILO misread the real problems that led to the growth of a black economy. In most countries, according to de Soto’s research, the informal economic sector actually has a great amount of technical, financial, and skill resources, and the evidence of it should be instantly recognizable. After all, the full spectrum of economic activity, even if only in rough forms, is represented in the black economy, which would not be possible without the existence of the very resources the ILO believed were lacking. In de Soto’s view, simply providing more resources through training programs, housing assistance, conditional cash transfer programs, health care, and similar initiatives simply adds wealth to the black economy system and allows it to flourish, making it even harder to ‘correct’. The real solution, de Soto asserts, is not to provide resources but to correct institutional and regulatory structures that keep black economy resources isolated from the mainstream economy by introducing legal reforms that encourage contract enforcement, statutory and tax legalization of businesses, and strong protections of property rights.

To some degree, this direction is already being followed in many parts of the world. The growth of microfinance programs, particularly in South Asia and Latin America, have in the past couple decades given more people access to the mainstream financial system by providing credit and savings. Microfinance programs also have an added advantage for governments, in that they permit at least some of the people in the black economy to be tracked, accounted for in economic calculations, and taxed. Another initiative that has grown in some parts of the black economy, particularly among agricultural workers and their families, is the growth of cooperatives. While an individual small farmer or sharecropper might only produce barely above a subsistence level of output and find himself marginalized from opportunities to formalize his business, gathering many of these people together into a cooperative gives them access to a formal business structure, and as a result, credit and other resources to help them expand their economic activity.

Despite progress in some areas, however, as the growth of the world’s black economy after 2008 showed, it is still a persistent and widespread part of global society, one which is highly sensitive to changes in economic conditions. Part of its longevity can be attributed to its attractiveness; living and working under circumstances where one is not troubled by pesky laws or taxes is not an unappealing concept. So while governments will continue to strive to reduce the black economy, it is unlikely it will ever disappear entirely.

Read more about it: Hernando De Soto, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else. New York: Basic Books, 2000.



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