Underground Economy - Definition

Updated at December 19th, 2020

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Underground Economy Definition

An underground economy describes economic transactions that are undertaken as a black market. Illegal transactions void of adequate monitoring by oversight boards largely form the underground economy. Goods and services that are not recorded or taxed by government agencies are underground economy.

A Little More on What is the Underground Economy

Any informal economic transaction is described as an underground economy, in this situation, the transactions occur illegal and not registered with the government. Illicit trades, drug trades, illegal procurement of arms, human trafficking, exchange of stolen items, illegal prostitution and others are underground economy. Here are the major points to know about the underground economy;

Illicit trade transactions, illegal markets, black markets all form the underground economy.
The underground economy is one in which transactions are carried out without the involvement of the government.
Trades in this market are untaxed and unregistered.
An informal economy is also the underground economy, this type of economy accounted for almost $2 trillion of the United States economy in 2013.

Measuring the Underground Economy

Measuring the underground economy is a daunting task, largely because trades and transactions in this economy are not registered with the government neither are they taxed. Since they are not regulated by the government, keeping an eye on the size of the economy becomes a challenge. The underground economy is not included in the annual statistical reports of GDP reports of a countrys economy, there is no record of them. However, the one way to have an idea about the size of the underground economy is the amount of money spent that is not accounted for in the economy. In 2009, as reported in a financial report, underground economy in the U.S hit $1 trillion and grew to $2 trillion in 2013. The impacts of underground economy is also seen on the GDP of a country. Other terms used to underground economy are shadow economy or informal economy. In a report released by the International Monetary Fund (IMF) in 2018, underground economy was examined in 158 countries. The reports included in this study were;

The size of the shadow economy across all nations measured up to 31.9%.
Georgia, Bolivia and Zimbabwe are the three nations where underground economies are most prevalent.
Switzerland, United States and Austria are nations that have underground economies.

Effects of the Underground Economy

There are different levels in which the underground economy affect the economy, depending on the size of the economy and its effects. The underground economy can either have a positive or negative effect on the economy. Emerging countries feel the harmful effects of the shadow economy unlike developed economies. While shadow economy can shrink the growth of a nation, especially a developing nation, it can also boost the growth of a nation in another context.

Activities and Participants in the Underground Economy

Generally, the following transactions form the activities in the underground economy; sales of untaxed products, smuggling of goods, illegal prostitutes, sales of banned drugs, trade if hard drugs, illegal purchase of harmful substances, human trafficking and others. However, it is important to state that what is regarded as underground economic transaction in a country might not be so in another country. For example, drugs are illegal in most countries while few countries legalized the use of drugs such as cannabis. So also alcohol and tobacco, while some countries have legalized its use, other countries regard such transactions as a shadow economic transaction.

Real World Example of the Underground Economy

Many countries experience diverse rates of underground economy. In the early days, the United States experienced an influx of underground economy where marijuaba was illegal traded in the black market. This was introduced by immigrants from Mexico in the 1900s. Despite that the drug has been forbidden in the United States as far back as 1931, there are few people that still engage in the illegal trade of marijuana up till this moment, they do so using the underground economy.

References for Underground Economy

Academic research for Underground Economy

Taxes and the Canadian underground economy, Tedds, L. M., & Giles, D. E. (2002). Taxes and the Canadian underground economy. Taxes and the Canadian underground economy, Toronto: Canadian Tax Foundation. Uses and abuses of estimates of the underground economy, Tanzi, V. (1999). Uses and abuses of estimates of the underground economy. The Economic Journal, 109(456), 338-347. The underground economy and the currency enigma, Feige, E. L. (1994). The underground economy and the currency enigma. Public Finance= Finances publiques, 49(Supplement), 119-136. The effect of taxes on labor supply in the underground economy, Lemieux, T., Fortin, B., & Frechette, P. (1994). The effect of taxes on labor supply in the underground economy. The American economic review, 231-254. [PDF] Assessing the size of the underground economy: The statistics Canada perspective, Smith, P. M. (1997). Assessing the size of the underground economy: The statistics Canada perspective. The underground economy: Global evidence of its size and impact, 11-37. [PDF] Estimating the underground economy using MIMIC models, Breusch, T. (2005). Estimating the underground economy using MIMIC models. Working Paper, National University of Australia, Canberra, Australia. Informal and underground economy, Frey, B. S., & Schneider, F. (2000). Informal and underground economy (No. 0004). Working Paper, Department of Economics, Johannes Kepler University of Linz. Labor market institutions, taxation and the underground economy, Fugazza, M., & Jacques, J. F. (2004). Labor market institutions, taxation and the underground economy. Journal of Public Economics, 88(1-2), 395-418.

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