What are the negative effects of a Black Market?

What actually comes to mind when we talk about a black market, or using an economist’s words, an underground economy? You’re probably thinking of the illegal drug lord, or selling kidney stuff. But it actually refers to all the trading work that happens ‘off the books’, essentially avoiding government interference and taxes. A lot of these activities are actually completely mundane. For example, all the money you make babysitting or selling food at your school bake sale can be considered part of this underground, informal economy. As you can imagine, it’s hard to measure exactly how far and wide this underground economy reaches. It’s not like tax evaders, animal smugglers and drug dealers want to give a completely honest account of their finances.

One reason why these black markets can exist is because people don’t want to pay tax on their transaction for a perfectly legal good be as it’s an opportunity cost for them (spending more money means they have less for themselves). Another reason is that people with the product/good know they can sell it for a higher price due to excess demand and make a profit. The way this works is that there are actually many who are willing to pay a much higher price than the actual market price, but just didn’t manage to get the product themselves. This creates an excess demand where demand is still present as it was unluckily not satisfied. Those in possession of this good see it as a chance to make profit from selling the good for this much higher price to those who are willing to pay it. Off the books of course.

There are various downsides to this informal economy, one being it doesn’t provide enough safety for those in it. For example the labourers in a black market, compared to those in a regulated job, might not get sick days, overtime pay or even get paid at all. It only means poor working conditions and poor pay which only really increases the divide between the poor and the rich. This creates an issue for important economic statistics too, for say unemployment, which may only encourage misguided policies as a reaction, further taking toll on the economy.

For the government, this sets off a negative cycle as tax revenue falls because people drop out of the official economy due to the growth of this underground economy. The government then has only two options. It can then respond with cuts in spending or with a tax increase. However this only starts the cycle off again as more people start to enter the black market due to those high taxes.

Sources:

https://www.youtube.com/watch?v=joG6-QZc-fw