The Encyclopedia of Libertarianism

Black Markets

The black market is a complex and multifaceted phenomenon known and discussed under many different names: the informal, unofficial, irregular, parallel, second, underground, subterranean, hidden, invisible, unrecorded, and shadow economy. Its underlying feature is a set of activities that evade the regulatory and administrative standards of the formal or official economy, are not reported to the government, are unrecorded by the system of national income accounting, avoid the taxation system, and, in some cases, involve straightforward criminal products and services. The black market economy, when trading decisions are not the result of coercion, is a free market because, by definition, it lacks government intervention.

Libertarians interpret the emergence of the black market sector in two coextensive ways. First, they view this sector as a natural outcome of the fact that “the market embodies the sum of all human wishes,” irrespective of how the general public or the government judges some of those wishes. Thus, black markets exist in certain goods and services that remain strongly in demand despite the fact that governments may prohibit them entirely (i.e., narcotics, pornography, and prostitution). Second, libertarians view such markets as an indicator of an unhealthy government policy that forces its citizens to take their activities underground. Among those policies are government price controls, rationing schemes, discriminatory taxation, governmental attempts to monopolize products, and extreme rates of taxation on otherwise perfectly legitimate wages, salaries, and small business profits. In addition to that, black markets also emerge in temporary service and low-capital occupations, where government detection and enforcement is unlikely (freelance handymen, household servants, temporary day laborers, etc.).

The Prohibition Era of the 1920s is a classic example of black market activity. Yet given that the size of the black market economy grows with the size of the governmental intervention, the ultraregulated socialist economies, such as those of Nazi Germany, Soviet Russia, and Eastern Europe, offer the most striking example of this phenomenon. There, massive regulatory and police establishments, and even the frequent imposition of the death penalty aimed at containing economic crimes, coexisted with a thriving underground economic sector. Nowadays, it can be argued that the “war on drugs” waged in many countries has created a situation similar to the one during the Prohibition period.

The diversity of facets and nuances of a black market economy complicates its discussion or analysis. For instance, underground activities and tax evasion are related, but not identical. No taxes are paid on underground activities, yet above-ground activities also are subject to tax-avoidance schemes. Nor should the underground economy be identified with criminal activity. Some activities are perfectly legal, but escape measurement in official statistics or taxation. In this context, some authors make a distinction between the black and the underground economy. The underground economy consists of all trade that occurs without detection by government and thus is not taxed, whereas the term black market is used to refer to trade in stolen goods or other theft-related activities. Part of the same family of concepts that mirror aspects of the black market is the informal economy, which has reference to local systems of exchange that fall outside state-controlled or money-based economic activities. These systems of exchange consist of barter, mutual self-help, odd jobs, allotment farming, street trading, and other similar activities. Finally, it is important to clarify the notion of the gray market—the circulation of goods through distribution channels other than those authorized by the manufacturer or producer. Gray market goods are not illegal. Instead, the process by which they are brought to market avoids the legal or standard distribution channels. Frequently this process occurs when the price of an item is significantly higher in one country than another. Hence, the existence of the gray market is an example of economic arbitrage.

The efforts to measure the size of the black market economy seek to relate the underground activity to officially measured national income and to determine its size relative to it. The most common method is the indirect or discrepancy approach. The assumption is that the effects of the underground economy are reflected in traces visible in the labor, money, and product markets. For instance, if spending in individual households and aggregate national accounts is higher than is officially recorded income, this result indicates black market activity. The size of black markets varies from one country to another and from one historical period to another. In general, the degree of government intervention and regulation is a good predictor of black markets’ size. In many Third World countries, black market activity is believed to produce well over half of the gross national product. Informed estimates put the size of black markets at nearly 10% of the Gross Domestic Product for countries like the United States.

Both the general perception and much scholarly research regard the underground economy and its effects on the official economy mostly in negative terms that call for counteractive measures. But libertarians tend to look at the positive side of the black market economy: The black market economy is a spontaneous response to the demand for services and goods; it is a reservoir of innovative spirit and entrepreneurial talent. Further, it increases the competition and efficiency of the economy, challenges the authority and boundaries of government activities, contributes to the creation of markets, ensures financial resources for the poorest of the poor, and imposes beneficial changes on legal, social, and economic institutions. The choice between deterrence as a method of dealing with it (more regular and intensive controls, higher fines and prison sentences) as opposed to the positive approach (reducing regulation, reducing the tax burden, decriminalizing certain activities) is sometimes a difficult policy decision. Yet it is no surprise that libertarians consistently favor the second.


Further Readings

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

———. The Other Path: The Invisible Revolution in the Third World. London: Tauris, 1989.

Lippert, Owen, and Michael Walker, eds. The Underground Economy: Global Evidence of Its Size and Impact. Vancouver, BC, Canada: The Fraser Institute, 1997.

Originally published .