The underground economy encompasses economic transactions considered illegal, either because the goods or services traded are unlawful or because transactions fail to comply with governmental reporting requirements. This economy is also known as the shadow economy, the black market, or the informal economy.
Key Takeaways
- Estimates suggest that the underground economy constitutes about 11% to 12% of the U.S. gross domestic product (GDP), equating to roughly $2.25 trillion to $2.5 trillion.
- The elements of the underground economy can differ significantly from nation to nation, state to state, and even municipality to municipality.
- The underground economy has various aliases, including the shadow economy, black market, and informal economy.
- Activities in the underground economy range from dealing in illegal drugs, human trafficking, and the sale of endangered species to the trade of human organs, antiquities, and stolen goods.
Understanding the Underground Economy
It is challenging to accurately gauge the size of underground economies because they elude governmental oversight, resulting in economic activity that does not generate tax returns or appear in official statistical reports. Tracking outgoing expenditures—which remain cloaked—can provide some statistics. Simply put, money spent that isn’t accounted for in recorded transactions theoretically represents the breadth of black market activity.
The American underground economy was estimated at $1 trillion in 2009, making up approximately 8% of the U.S. GDP. By 2013, the figure had reached $2 trillion due to the long-term effects of the 2008 financial crisis and the resulting contraction of the formal economy. By 2021, the underground economy constituted about 11% to 12% of GDP, or approximately $2.5 trillion.
Global Underground Economies
According to a 2018 International Monetary Fund study of shadow economic activity in 158 countries from 1991 to 2015:
- The mean size of the shadow economy across all nations was 31.9%.
- The largest shadow economies were found in Zimbabwe (60.6%), Bolivia (62.3%), and Georgia (64.9%).
- The smallest shadow economies were observed in Austria (8.9%), the United States (8.3%), and Switzerland (7.2%).
The impact of underground economies can range from harmful to beneficial, depending on the context. In developing nations, large shadow economies can impede economic growth and the creation of public programs through uncollected tax revenue. Conversely, in some scenarios, uncollected tax revenues in corrupt government-run nations may result in diverted funds being spent in the local underground economy, increasing overall economic activity and stimulating demand.
What Is Considered “Underground”?
The activities deemed as underground economic transactions vary by jurisdiction. For instance, alcohol is banned in some countries, while legal in others. Similarly, while drugs are illegal worldwide, an increasing number of U.S. states have legalized cannabis for both medical and non-medical purposes.
In the early 1900s, Mexican immigrants introduced recreational marijuana use in the United States. The Great Depression and high unemployment rates led to fears of marijuana consumption, resulting in its criminalization by 29 U.S. states by 1931. Subsequent studies debunked marijuana’s association with crime and highlighted its therapeutic benefits.
As of 2022, 37 states and the District of Columbia have legalized marijuana for medical use, while 18 states plus D.C. have legalized it for non-medical use. The IRS recognizes money earned from activities such as babysitting as taxable self-employment income that must be reported if it exceeds $400 annually.
Meanwhile, about 53.2% of cigarette sales in New York state in 2018 were estimated to occur through underground economic transactions, largely due to high sin taxes. Unreported or under-the-table transactions, even for activities as small as babysitting, are considered underground economic activities. This includes the untaxed sale and smuggling of goods and human trafficking.
Which Country Has the Largest Underground Economy?
Zimbabwe boasts the largest underground economy, with about 60.6% of its economy consisting of underground activities. In contrast, Switzerland has the smallest, at 7.2%.
What Are the Characteristics of an Underground Economy?
Underground economies encompass more than just illegal activities like drug trade or weapon sales. They include any unreported income, such as under-the-table payments for restaurant work or babysitting, and unreported bartering transactions.
Why Do People Engage in the Underground Economy?
People engage in the underground economy for various reasons, such as acquiring items they cannot legally buy (e.g., outlawed drugs, weapons) or avoiding taxes, labor laws, and administrative hurdles.
Related Terms: black market, shadow economy, informal economy, tax evasion, illegal trade.
References
- Dickinson. “Understanding the Shadow Economy”.
- CNBC. "$2 Trillion Underground Economy May Be Recovery’s Savior".
- The Christian Science Monitor. “America’s ‘Shadow’ Economy Is Bigger Than You Think - and Growing”.
- International Monetary Fund. “Shadow Economies Around the World. What Did We Learn Over the Last 20 Years?” Download. Page 2.
- PBS. “Frontline. Marijuana Timeline”.
- University of Georgia. “Survey of Marijuana Law in the United States: History of Marijuana Regulation in the United States”.
- National Conference of State Legislatures. “State Medical Cannabis Laws”.
- Turbotax. “Do Babysitters Have to Report Their Income on Taxes?”
- Tax Foundation. “Cigarette Taxes and Cigarette Smuggling by State, 2018”.
