Ducking Government Regulation the Old Fashioned Way: A Look at the Black Market

Sometimes being a publicly traded company may not seem like it’s worth the hassle. Quarterly earnings reports, disclosure of stock sales by insiders, a raft of government regulations, it’s all a lot of rules dictating how one does business. And, whether public or not, there’s any number of government regulations to follow at the local, state, and federal level. Not to mention local, state, and federal taxes.

It’s enough to make one seriously consider taking it all underground. What would it be like? To operate a company without any concerns other than profit and your employees? To keep all of your profits without any consideration of taxes? Must be nice. Or not. With that freedom comes a whole range of new issues, not the least of which being “people with guns may come take our stuff and we can’t call the police” or “I could go to prison.” Those two alone tend to keep most businesses operating in the daylight.

However, for a great many people, the high risks and tremendous freedom of a black market economy remain appealing. For as long as there have been governments and laws, there have been people trying to skirt them, buying and selling goods and services on their own terms. And that tradition continues with fervor even today. Estimates by some economists place the size of shadow economies at over 20 percent of global GDP. Those are, of course, just estimates as no cartel is releasing an earnings report (that would be a touch bold, even for the most powerful figures of organized crime). But they do speak to a simple fact: no matter what the legal economies do, there’s always a large market out there for goods that exist outside the law.

Different Types of Shadow Markets

Economies that function outside of the law can take on a variety of different forms, but they tend to divide into two distinct camps based on pricing: goods and services that are available at a discount because they are illegal, and goods and services that charge a premium because they are illegal. Unlicensed moonshine or cigarettes in the United States, for instance, are sold illegally because, by operating outside of legal authority, vendors can avoid paying taxes and fees and offer the same goods at a discount. On the flip side of that coin is the sale of illicit drugs. Cocaine, for instance, is illegal and can only be obtained outside of legal authority. This allows the people distributing it to charge a considerable premium over what one would normally expect to pay in a legal economy based on its production costs.

Risk Premiums Drive Massive Margins

Illegal goods and services tend to survive, and even thrive, based on these unusually high margins. A brick of cocaine that sells for $2,000 in Peru, where’s it’s grown and processed, is worth $10,000 by the time it gets to Mexico. It’s then another $30,000 wholesale, and $100,000 by the time it’s sold by the gram at the street level. At a base level, this is a basic example of a risk premium. Each time the product crosses a border, there’s a chance it gets stopped by customs or government officials. Any person involved in moving it is taking a legal risk, and the compensation they receive has to be enough to make it worthwhile for them. And at the street level, dealers take major risks to sell products, resulting in the price jumping even further. On the whole, the profit margin for a complete end-to-end lifespan is 5,000 percent, but this sort of mark-up is necessary to make it appeal enough for people to accept the risk of incarceration of violent death associated with the industry.

For legal products being sold outside the normal market, the margins clearly remain higher than they would be working inside the law. Otherwise, the risks associated with operating an illegal business wouldn’t be worth taking. However, the legal availability of the same goods drastically reduces these margins. There needs to be a significant enough price advantage that your potential consumers will accept their own risk premium when they select your product over the legal alternative. In the case of entirely illegal substances, no such price controls exist.

No Anti-Trust Laws

Another benefit (and liability) for moving illegal goods is the absence of any sort of anti-trust laws or government regulations. Is your product unsafe? That could injure customers, potentially hurt your business by damaging your reputation. But you won’t have to worry about facing fines or legal ramifications. What’s more, monopolies, which allowed some of the richest men in history to accumulate vast fortunes when they were still legal, are fair play. And anyone’s who watched an episode of The Wire can tell you that said monopolies can be violently enforced, at times, allowing one to completely control a market place. What if, in the late 1990s, Bill Gates and Microsoft (MSFT) didn't have to limit their business because of anti-trust laws? What if Bill Gates could have just gotten a gun and FORCED everyone to use windows? And what if those people couldn't call on the police to protect them? Kind of makes it a whole new ballgame.

On the whole, illegal goods enjoy a number of advantages purchased by their considerable risk premium, including elastic demand, an absence of traditional marketplace competition, and no regulatory body limiting the way one does business.

A Massive Economy by Any Measure

So what does this all mean? It means that the size of the underground economy is considerable. Estimates of just how much money is trading hands for prostitutes, illicit drugs, and/or stolen artwork are inherently shoddy. Given that these economies need to stay hidden from any official measure as a matter of survival, attempts to measure them defy traditional efforts to collect data.

However, the estimates of its size are considerable, to say the least. If Elgin and Oztunali’s estimates, where one fifth of the global economy takes place outside of legal regulation, are accurate, it means that shadow industries are easily among the most active in the world. And author Robert Neuwirth asserts that it’s even higher, estimating the size at $10 trillion a year, which would be over one fourth of global GDP. What’s more, Neuwirth says the black market, if legally recognized "would be an economic superpower, the second-largest economy in the world…" He also estimates that it involves 1.8 billion people, nearly half the world’s workforce. Add to this recent estimates from the public safety secretary in Mexico put the cartel’s annual revenue from sales to American buyers at almost $65 billion and a dark picture of the global economy starts to emerge.