Black market

A black market is a market that operates outside the law, and its existence is evidence that the legal price is not one people will trade at. It is also called the underground, informal, shadow or extralegal economy, and the choice of term usually signals what the speaker thinks of it. The Austrian treatment is that a black market is not a pathology but a market doing what markets do under a constraint, and that the interesting questions are about what the constraint costs.

Price controls produce it

A maximum price set below the level that clears the market does not make the good cheaper. It makes the quantity supplied fall short of the quantity demanded, and the resulting shortage has to be resolved by something other than price: queueing, rationing, favouritism, or a trade at the market price conducted illegally.

Ludwig von Mises's point about this is that the black market is what keeps a controlled economy functioning, and is then blamed for its difficulties. The controls create the shortage; the illegal trade relieves it; the illegal trade is prosecuted; the shortage returns. A government that will not abandon the control has to extend it, first to the inputs of the controlled good and then to the inputs of those, which is the sequence by which piecemeal intervention arrives at comprehensive planning.

The same analysis covers rent control and the informal rental sector that appears wherever it is imposed, and the minimum wage and off-the-books employment.

Prohibition produces it differently

Where the good is banned rather than price-capped, the legal supply is zero and the whole market is black. Three effects follow that a simple "the trade continues anyway" summary misses.

The price carries a risk premium. Suppliers must be compensated for the probability of prosecution, seizure and violence, so enforcement raises the price rather than lowering the quantity as much as intended, and the revenue that premium generates funds the organisations enforcement is meant to suppress.

Contract enforcement disappears. An illegal seller who is cheated cannot sue. Disputes are settled by violence because there is no other mechanism, and the resulting violence is then cited as evidence of how dangerous the trade is, when it is evidence of how dangerous illegality is. Legal alcohol producers do not shoot each other over territory.

Product quality falls and potency rises. Because the risk of interdiction attaches to volume rather than to value, suppliers economise on volume by shifting to more concentrated forms, and because quality cannot be advertised, warranted or sued over, there is nothing holding it up. This is the pattern Richard Cowan named the iron law of prohibition and that Mark Thornton gave the economic analysis of in The Economics of Prohibition: beer gives way to spirits, opium to morphine and morphine to heroin, and the deaths that follow are attributed to the substance rather than to the law.

See drug prohibition and victimless crime.

The cost of entering the law

A third source of black markets has nothing to do with price controls or bans. It is that becoming legal can cost more than the legality is worth.

Hernando de Soto's teams measured the procedure in several countries. Registering a small one-employee workshop in Lima took 289 days and about $1,231, roughly thirty times the monthly minimum wage. Obtaining permission to build a house on state land in Peru took 207 administrative steps across 52 offices and just under seven years, with a further 728 steps to obtain title. Legalising an informal property development in the Philippines took 168 steps and 53 agencies over 13 to 25 years, and buying land in Haiti took 111 steps over 19 years. Staying legal turned out to be nearly as difficult as becoming legal.

Where those are the terms, operating extralegally is not defiance but arithmetic, and the consequence de Soto emphasised is that the resulting assets are dead capital: real, valuable, and unusable as collateral, because the holder has possession without a title anyone will lend against.

How large

The informal sector is not a fringe. A 2009 OECD study found that on a worldwide average more than half of all non-agricultural jobs are informal, reaching at least 80 percent in sub-Saharan Africa and South Asia, and concluded that informality is increasingly becoming normal, not least in middle and even high-income countries.

Robert Neuwirth's survey of what he calls System D reports that about one in six people on the planet is a squatter, that roughly three-quarters of the Philippine workforce and more than two-thirds of Bolivian jobholders work informally, and that unrecorded activity accounts for at least a quarter of the economy in southern Italy and Sicily. He puts the United States, by absolute value, at the largest unregistered economy in the world.

The direction of travel matters as much as the level. In Venezuela the share of employees in legal businesses fell from two-thirds in 1976 to under half by 2000. In Brazil more than two-thirds of housing built in the 1970s was intended for rent, against about 3 percent of new construction officially listed as rental by 2000, the difference having migrated to the favelas, where rents are paid in dollars and non-payers are evicted quickly because no rent control applies.

Officials as suppliers

Where a black market could be suppressed at moderate cost and is not, the officials charged with suppressing it hold something valuable: the ability to permit some operators and exclude others. Bruce Benson's analysis is that this converts enforcement discretion into a saleable property right, and that the result is not an unpoliced market but a policed one whose entry is controlled by officials rather than by consumers. Every entrant is illegal, and the right to be the illegal incumbent is sold.

This is why corruption is systematically worse in the public sector than in the private one, and the reason is structural rather than moral. A private firm's owner is vigilant about payments that divert his own money, and a private supplier who takes them loses reputation to competitors. A licensing official faces no competitor and spends nobody's money in particular, so the discipline that limits the practice elsewhere is absent.

See also

• Price controls
• Rent control
• Drug prohibition
• Victimless crime
• Crime
• Market
• Property rights
• Regulatory capture

Links

• The Economics of Prohibition (pdf) by Mark Thornton
• The Underground Economy (pdf) by Hans F. Sennholz, 1984
• The Underground Economy in One Page by Danny G. LeRoy, May 2010
• Can the Underground Economy Save Europe? by David Howden, November 2011
• The Nonviolent Black Market in Information by Manuel Lora and Daniel Coleman, July 2010
• The Ethics of Bribery by Murray N. Rothbard, June 2007
• In Defense of Bribery by Pierre Lemieux, August 2005
• Dimensions of the Shadow Economy (pdf) by Friedrich Schneider, 2000
• Black market and Informal sector on Wikipedia