The Blessings of the Black Economy

By: Dr. Sam Vaknin

Also published by "The Guradian"

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Some call it the “unofficial” or "informal" economy, others call it the “grey economy” but the old name fits it best : the “black economy”.  In the USA “black” means “profitable, healthy” and this is what the black economy is.  Macedonia should count its blessings for having had a black economy so strong 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 black economy is made up of two constituent activities :
 

  1. Legal activities that are not reported to the tax authorities and the income from which goes untaxed and unreported.  For instance : it is not illegal to clean someone's house, to feed people or to drive them.  It is, however, illegal to hide the income generated by these activities and not to pay tax on it.  In most countries of the world, this is a criminal offence, punishable by years in prison.
  2. Illegal activities which, needless to say, 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 an underestimate to say that 40% of the GDP in Macedonia 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 it to be saved in foreign banks away from the long hand of the state).  A trickle of money comes back and is “laundered” through the opening of small legal businesses.

These are excellent news for Macedonia.  It means that when the macro-economic, geopolitical and (especially) the micro-economic climates will change – billions of USD will flow back to Macedonia.  People will bring their money back to open businesses, to support family members and just to consume it.  It all depends on the mood and on the atmosphere and on how much these people feel that they can rely on the 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.

But 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 to the economy and inadvertently increases the effective money supply and the 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 labour mobility and international trade.  Black economy, in short, is very positive.  With the exception of illegal activities, it does everything that the official economy does – and, usually, more efficiently.

So, what is morally wrong with the black economy ?  The answer, in brief : it is exploitative.  Other parts of the economy, which are not hidden (though would have liked to be), are penalized for their visibility.  They pay taxes.  Workers in a factory owned by the state or in the government service cannot avoid paying taxes.  The money that the state collects from them is invested, for instance, in infrastructure (roads, phones, electricity) or used to pay for public services (education, defence, policing).  The operators of the black economy enjoy these services without paying for them, without bearing the costs and worse : while others bear the costs.  These 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 which are regulated by bureaucracies which are controlled (in theory, rarely in practice) by politicians.  These elites have a tendency to misuse and to abuse resources and to allocate them in an inefficient manner.  Even economic theory admits that any dollar left in the hands of the private sector is much more efficiently used than the same dollar in the hands of the most honest and well meaning and well planning civil servant.  Governments all over the world distort economic decisions and misallocate scarce economic resources.

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

The black economy is especially important in times of economic hardships.  Countries in transition are a private case of emerging economies which are a private case of developing countries which used to be called (in less politically correct times) “Third World Countries”.  They suffer from all manner of acute economic illnesses.  They lost their export markets, they are technologically backward, their unemployment skyrockets, their plant and machinery are dilapidated, their infrastructure decrepit and dysfunctional, they are lethally illiquid, they become immoral societies (obligations not honoured, crime flourishes), their trade deficits and budget deficits balloon and they are conditioned to be dependent on handouts and dictates from various international financial institutions and donor countries.

Read this list again : isn’t the black economy a perfect solution until the dust settles ?

It enhances exports (and competitiveness through imports), it encourages technology transfers, it employs people, it invests in legitimate businesses (or is practised by them), it adds to the wealth of the nation (black marketeers are big spenders, good consumers and build real estate), it injects liquidity to an otherwise dehydrated market.  Mercifully, the black economy is out of the reach of zealous missionaries such as the IMF.  It goes its own way, unnoticed, unreported, unbeknownst, untamed.  It doesn’t pay attention to money supply targets (it is much bigger than the official money supply figure), or to macroeconomic stability goals.  It plods on : doing business and helping the country to survive the double scourges of transition and Western piousness and patronizing.  As long as it is there, Macedonia has a real safety net.  The government is advised to turn a blind eye to it for it is a blessing in disguise.

There is one sure medicine : eliminate the population and both unemployment and inflation will be eliminated.  Without the black economy, the population of Macedonia would not have survived.  This lesson must be remembered as the government prepares to crack down on the only sector of the economy which is still alive and kicking.
 
 

Operational Recommendations

The implementation of these recommendations and reforms should be obliged to be GRADUAL.  The informal economy is an important pressure valve for the release of social pressures, it ameliorates the social costs inherent to the period of transition and it constitutes an important part of the private sector.

As we said in the body of our report, these are the reasons for the existence of an informal economy and they should be obliged to all be tackled:


Reporting Requirements and Transparency


Reduction of Cash Transactions


Government Tenders


Databases and Information Gathering


Law Enforcement


Reforms and Amnesty


The Tax Code


Legal Issues


Customs and Duties


Public Campaign