Written by Nicolai Heering

A black-market economy, an underground economy, or a shadow economy are terms for economic activities that bypass any type of legislative restriction, including taxation. Invariably, the knee-jerk reaction of most people is to say that is a bad thing. But is that always true?

Consider the case of Italy. Italy is notorious for red tape, ludicrous bureaucracy, and rather inefficient government. Yet, the Italian economy somehow continues to defy such obstacles. In 2023, the economy grew by 0.9 per cent compared to 0.1 per cent in the UK. So, although not impressive, 0.9 per cent is still substantially more than the presumably better organised economy of the UK. Although statistics on the size of the black-market economy are, by their very nature, hard to come by, anyone who knows Italy fairly well will know that its size is substantial. Arguably, that is what keeps the Italian economy afloat since money can flow where it is needed without much let or hindrance, and trade that would otherwise be impeded by government red tape can proceed.

Italy is but one example of an economy where the black market is a force to be reckoned with due to overregulation. Looking outside of Europe, Brazil is another. Although heavily overregulated – the country was most recently ranked 124^th in the world for ease of doing business – Brazil most likely survives because of the “jeitinho brasileiro.” Literally, ‘the little Brazilian way’, meaning an informal way of overcoming formal obstacles. In 2023, the Brazilian economy thus grew by 2.9 per cent – much more than the 0.1 per cent growth rate of the British economy, which was ranked 8^th for ease of doing business in the same survey that ranked Brazil 124^th. Again, the probable explanation is the size of the black-market economy. A large one in Brazil and a much smaller one in the UK.

Of course, the downside of having a large black-market economy is that it facilitates crime, which – apart from all the personal tragedies and injustices that it causes – also impacts the economy negatively. Witness the existence of the powerful mafia in Italy and the dangerous gangs in Brazil. Therefore, in the interests of reducing the size of the black-market economy and thus the crime that relies on it, it needs to be more attractive for people and businesses to act within the law. For that to happen, a major cull of unnecessary and obstructive legislation is obviously required. But that is not all. Strict and impartial enforcement of the remaining legislation is also required as businesses and individuals need to be able to rely on equitable law that enforces contracts and creates a level playing field. Otherwise, they will have little incentive to act within the formal economy rather than the informal one.

Looking at the economies of the world, it would seem that they can be largely grouped as follows:

1. Countries with overregulation and strict law enforcement. The overregulation stifles the economy, and the strict enforcement of unjust laws prevent the black market from compensating for the overregulation. Some examples are Venezuela, Cuba, and North Korea. The only people preferring this Group are likely to be mid-level and senior members of government who are able to maintain an acceptable standard living at the expense of their fellow countrymen.
2. Countries with overregulation where lax law enforcement allows the black market to at least partially compensate for the overregulation. E.g. Italy, Brazil, and Indonesia. Some people may prefer Group 2 given the flexibility and, perhaps, cheaper and more relaxed way of life available in those countries.
3. Countries with comparatively light regulation but strict and impartial law enforcement. This Group includes countries such as Singapore, Switzerland, and certain parts of the United States such as Texas and Florida. Group 3 is arguably the most attractive of the three given the strength of the economies of the countries in that category and how desirable they are to live in.

So how do countries in Group 3 ensure that they remain in that Group, and how can countries in the other Groups aspire to membership of it? The answer seems self-evident: Don’t overregulate, don’t overtax, and treat people equally before the law. 

People turn to the black market when they have few other attractive options. They may have been regulated out of a job that should not have been regulated or have been faced with the prospect of punitive taxes that should not have been punitive. If politicians wish to reduce the black-market economy, only a significantly leaner and equitable regulatory regime combined with efficient and impartial enforcement is likely to wilt the black-market economy and bring economic activity back into the safer formal economy.

Nicolai Heering is the Financial Freedom Fellow at the Consumer Choice Center and is a passionate advocate for smarter financial regulations to improve consumers’ lives.