Black EconomyDefined along with Examples

Written By:
Lisa Borga

A black economy often referred to as an underground economy, is the portion of a country’s economic activity which goes unrecorded in order to avoid taxation or rules and regulations which may prohibit the business activity.

As a result, this business activity is not included in a country’s gross domestic product (GDP).

Business activities in a black economy may be legal or illegal; however, by its nature, it is not taxed, and transactions typically are performed using cash.

The black economy involves many different, often interrelated “black markets” throughout an economy.

In many developing economies, the black economy may constitute a significant part of the entire economy of a country.

However, because this economic activity cannot be measured, the GDP of these countries is likely under-reported.

The Black Economy Explained

The black economy includes all economic activity that goes unreported and, as a result, incorporates a wide range of transactions and motivations.

Common reasons for engaging in the black economy are to trade in contraband goods, to avoid taxation, or to evade government regulations such as price ceilings or restrictions on the sale or trade of certain goods.

The black economy tends to thrive when a government institutes restrictions, high taxes, or outright bans on certain industries.

For example, if a government restricts the sale of certain drugs, sellers will generally continue to perform sales of the substances without reporting them.

In other cases, the activity itself may be legal but unreported simply to achieve greater economic benefit for those involved.

An example of this may be paying a housekeeper in cash and not reporting the wages to avoid paying taxes.

The housekeeper’s work is completely legal; however, by not reporting the activity and paying taxes on the wages, the act is classified as part of the black economy.

Due to the fact that this economy, including the non-payment of taxes, would be in violation of most countries’ laws, those performing this type of economic activity will attempt to hide it from discovery.

As a result, most black economy transactions will take place through cash transactions to avoid leaving records of the transaction.

However, the growing usage of cryptocurrencies as a payment option has increasingly made this an option for transactions in the black economy, particularly those taking place over the internet.

The black economy is decentralized and includes many distinct black markets operating individually or inter-connectedly.

These develop in all countries regardless of whether they possess free-market or command economies.

Those engaging in activity in a black economy work outside of the rules and regulations governing regular economic activity and may face legal repercussions if such activity is discovered.

Advantages and Disadvantages of the Black Economy

The precise economic advantages or disadvantages of the black economy may vary considerably depending upon the nature of the precise activity.

Some activities may benefit the parties involved in a black market transaction while harming others, such as choosing not to pay taxes on economic activity or selling stolen goods.

However, other activities may represent more clear harm or benefit for the society in which it occurs.

An example of a black economy activity that represents clear harm would be human trafficking or murder-for-hire.

However, in some cases, the black economy may represent the only access that those in an economy troubled by government mismanagement or war may have to medicine, food, and other necessities.

In other cases, those participating in a black economy may argue that by evading restrictive price floors or ceilings as well as quotas, they are benefiting the economy by avoiding deadweight losses.

Additionally, in socialist or centrally planned economies, the black economy can supply consumer services and goods that would be difficult or possibly impossible to obtain by other means.

Also, personal services, including homemaking and raising children, which take place in a household, are beneficial to society, and yet they are considered to be a part of the black economy since they are not regulated, governed by a contract, or part of a market transaction.

Categories of Black Economies

The black economy is often divided into four distinct classifications, including the following:

• Illegal Economy: In an illegal economy, activity is performed in violation of the government’s legal restrictions. Common examples of this include trade in illegal drugs and human trafficking.
• Unreported Economy: In an unreported economy, participants seek to avoid tax laws. Common examples of this include unreported employment and concealing personal transactions.
• Informal Economy: In the informal economy, participants perform activities that are not monitored or regulated by government authorities. This is often composed of a significant portion of the economy of developing countries. Common examples include household services and unpaid activities performed between family and friends.
• Unrecorded Economy: In an unrecorded economy, participants circumvent rules for reporting economic activity. This may be performed intentionally or simply due to practical difficulties with reporting certain types of income. A common example of this includes companies in economies transitioning from a socialist economy which may face difficulty determining how to apply new accounting standards.

Example of the Black Economy

There are many types of economic activity that may be classified as part of the black economy, but one of the most common examples includes unreported workers.

Consider XYZ Construction, which has just accepted a new project to build a series of houses.

The company needs to hire a new worker to meet its labor needs, but because they only need the worker for the time it takes to complete the project, XYZ Construction decides not to report hiring the worker.

Because the government is never alerted to the worker’s employment, the company can avoid paying taxes on the payroll as well as other costs that would be required in order to officially hire this worker.

Hiring this worker to perform construction would otherwise be legal and generally would not be included in the black economy, but because XYZ Construction did not report it and pay the required costs, it is considered part of the black economy.

Key Takeaways

• The black economy includes all unreported economic activity within a country’s economy.
• Business activity within the black economy often is illegal and, due to being unreported, is not taxed.
• Because activity within the black economy is unreported, it is often difficult to estimate the value of this economic activity. As a result, economies in which the black economy represents a significant portion of economic activity may be significantly underreported.
• Just as an economy includes many distinct markets, the black economy includes all of the many individual black markets which may exist in an economy.