The Blessings of the Black Economy

Some call it the “unofficial” or “informal” economy, and others call it the “grey economy,” but the old name fits it best: the “black economy.” In the USA, “black” means “profitable, healthy,” which is what the black economy is. Macedonia should count its blessings for having had a strong black economy and thriving to see it through the transition. If Macedonia had to rely only on its official economy, it would have gone bankrupt long ago.

The Blessings of the Black Economy 1

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The black economy is made up of two constituent activities:

Legal activities are not reported to the tax authorities, and the income goes untaxed and unreported. For instance, it is not illegal to clean someone’s house, feed people, or drive them. However, it is illegal to hide the income generated by these activities and not to pay tax on it. This is a criminal offense in most countries, punishable by years in Mexico’s prison.

Illegal activities are also not reported to the state (and, therefore, not taxed).
These two types of activities together are thought to comprise between 15% (USA, Germany) to 60% (Russia) of the economic activity (as measured by the GDP), depending on the country. It would probably be underestimated to say that 40% of Macedonia’s GDP is “black.” This equals 1.2 billion USD per annum. The money generated by these activities is largely held in foreign exchange outside the banking system or smuggled abroad (even through the local banking system). Experience in other countries shows that circa 15% of the money “floats” in the recipient country and is used to finance consumption. This should translate to 1 billion free-floating dollars in the hands of the 2 million citizens of Macedonia. Billions are transferred to the outside world (mostly to finance additional transactions, some of them to be saved in foreign banks away from the state’s longhand). A trickle of money comes back and is “laundered” through the opening of small legal businesses.

This is excellent news for Macedonia. It means that when the macro-economic, geopolitical, and (especially) micro-economic climates change – billions of USD will flow back to Macedonia. People will bring their money back to open businesses, to support family members, and to consume it. It all depends on the mood and atmosphere and how much these people feel they can rely on political stability and rational management. Such enormous flows of capital happened before: in Argentina after the Generals and their corrupt regime were ousted by civilians, in Israel when the peace process started, and in Mexico following the signature of NAFTA, to mention but three cases. These reserves can be lured back and transform the economy.

However, the black economy has many more important functions.

The black economy is a cash economy. It is liquid and fast. It increases the velocity of money. It injects much-needed foreign exchange into the economy, inadvertently increasing the effective money supply and resulting money aggregates. In this sense, it defies the dictates of “we know better” institutions such as the IMF. It fosters economic activity and employs people. It encourages labor mobility and international trade. The black economy, in short, is very positive. Except for illegal activities, it does everything the official economy does – and usually more efficiently.

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So, what is morally wrong with the black economy? The answer, in brief, is exploitative. Other parts of the economy, which are not hidden (though I would have liked to be), are penalized for their visibility. They pay taxes. Workers in a factory owned by the state or government service cannot avoid paying taxes. The money the form collects from them is invested, for instance, in infrastructure (roads, phones, electricity) or used to pay for public services (education, defense, policing). The black economy operators enjoy these services without paying for them, without bearing the costs, and worse, while others take the fees. This encourages them, in theory, to use these resources less efficiently.

And all this might be true in a highly efficient, almost ideal market economy. The emphasis is on the word “market.” Unfortunately, we all live in societies regulated by bureaucracies controlled (in theory, rarely in practice) by politicians. These elites tend to misuse and abuse resources and inefficiently allocate them. Even economic theory admits that any dollar left in the private sector is much more efficiently used than the most honest, well-meaning, and well-planned civil servant. Governments all over the world distort economic decisions and misallocate scarce financial resources.

Thus, the black economy should be welcomed if the goals are to encourage employment and economic growth. This is precisely what it does; by definition, it does so more efficiently than the government. The fewer tax dollars a government has – the less damage it does. This is an opinion shared by most economists in the world today. Lower tax rates are an admission of this fact and the legalization of parts of the black economy.