Definition of the underground economy

What is the underground economy?

The underground economy refers to economic transactions deemed illegal, either because the goods or services exchanged are illegal in nature or because the transactions do not meet government reporting requirements. The underground economy is called the parallel economy, the black market or the informal economy.

Key points to remember

  • Although estimates vary, some estimate that the underground economy accounts for 11-12% of US gross domestic product (GDP), or about $2.25-2.5 trillion.
  • The elements of the underground economy vary from country to country, state to state and, in some cases, municipality to municipality.
  • Alternative names for the underground economy include underground economy, black market, and informal economy.
  • Illegal drug trafficking, human trafficking, endangered species, human organs, antiques and stolen goods are examples of underground economy activities.

Understanding the underground economy

It is difficult to accurately assess the size of underground economies because, by nature, they are not subject to government oversight; therefore, the economic activity does not generate tax declarations or appear in official statistical reports; however, tracking outgoing expenses, even if the transactions are hidden, can give insight into the statistics. In other words, the money spent – ​​which is not counted in recorded transactions – theoretically represents the extent of black market activity.

The US underground economy is estimated to have reached $1 trillion in 2009, which represents approximately 8% of US gross domestic product (GDP); however, in 2013, largely due to the long-term effects of the 2008 financial crisis and the resulting contraction of the formal economy, underground economic spending reached approximately $2 trillion. Estimates vary, but studies show that the underground economy in the United States accounts for 11% to 12% of GDP, bringing the underground economy to around $2.5 trillion in 2021.

Global underground economies

Compared to most other nations, the U.S. underground economy has remained relatively stable, according to findings released by a 2018 International Monetary Fund study, which explored the parallel economic activity of 158 countries between 1991 and 2015. Some of the main findings of the report are as follows: follows:

  1. The average value of the size of the underground economy in all countries was 31.9%.
  2. The countries with the three largest underground economies were Zimbabwe (60.6%), Bolivia (62.3%) and Georgia (64.9%).
  3. The three smallest parallel economies were Austria (8.9%), the United States (8.3%) and Switzerland (7.2%).

Depending on the context, the impact of underground economies can range from harmful to helpful. For example, in developing countries with large underground economies, uncollected tax revenues can slow economic growth and hamper the creation of public programs; however, in other cases, participants in underground economies who retain income that would ordinarily go to taxes can stimulate overall economic activity and stimulate demand.

This is particularly true in countries where withheld tax revenues have allegedly been siphoned off by corrupt officials.

What is considered “underground”?

The list of activities considered clandestine economic transactions varies according to the laws of a given jurisdiction. For example, in some countries alcohol is prohibited, while other countries encourage legal brewing, distilling and distribution activities. Likewise, while drugs are illegal in most countries, some countries, as well as a growing number of US states, have legalized the sale and consumption of cannabis.

In the early 1900s, Mexican immigrants introduced the recreational use of marijuana to the United States. During the Great Depression, high unemployment rates raised fears about marijuana use, which (coupled with racist sentiments at the time) led to research linking marijuana to violent crime.

Therefore, in 1931, 29 US states banned the drug. Nevertheless, many people deemed the plant harmless and continued to buy and sell it illegally. Later studies refuted the idea that marijuana was linked to crime while stating that the drug was neither addictive nor a gateway to other drugs. Instead, proponents argue that marijuana has been shown to be therapeutically useful in treating diseases such as cancer and AIDS.

As of 2022, 37 states and the District of Columbia have legalized the herb for medicinal use, which is now found in abundance in some food products, as well as many topical and oral medications. In 2022, 18 states and DC allow regulated non-medical cannabis.

The IRS considers money earned from child care as taxable self-employment income and, when the amount is more than $400 for the year (as of 2022), must be reported when the individual files his income tax return.

Meanwhile, approximately 53.2% of cigarette sales in New York State in 2018 (latest figures) were facilitated by clandestine economic transactions. Although tobacco is legal in New York, the product is subject to an exorbitant sin tax, and many sales are undeclared or “under the table.”

All of these clandestine transactions, in which participants fail to report their income to the IRS or the state, are technically considered clandestine economic activities. This status may even apply to babysitters who do not declare the money they pocket after watching a neighbor’s child on the street.

Other prime examples of underground economic activity include the untaxed sale of physical goods and the smuggling of goods into a country to avoid paying border duties. Human trafficking operations also include the underground economy, as do markets for copyrighted materials, endangered animal species, antiquities, and illegally harvested human organs.

Which country has the largest underground economy?

Zimbabwe has the largest underground economy with around 60.6% of its economy made up of underground activities. Switzerland has the smallest underground economy, accounting for 7.2% of its economy.

What are the characteristics of an underground economy?

Underground economies do not only include illegal activities, such as the buying and selling of prohibited drugs or the illegal sale of weapons. This also includes any undeclared income, such as payment for under-the-table restaurant workers or jobs such as childcare that are not declared. Similarly, any barter that does not involve the exchange of cash and that is not declared is considered part of the underground economy.

Why do people engage in the underground economy?

There are a variety of reasons people engage in the underground economy. These reasons can be as simple as obtaining items they cannot legally purchase, such as prohibited drugs and weapons. It can also include avoiding taxes, labor laws and red tape.

Bonny J. Streater