What’s the underground economy?

Photo: Melony Candia. Source: Morguefile

The informal economy is the cash economy. It’s the economy of under-the-table transactions, of digital currencies and returning favors. Sometimes it’s unsavory, sometimes not.

If you read a new book that you like and loan it to a friend, that’s informal activity. No money changes hands. This is perfectly legitimate. But sometimes informal activity is sleazy: cash payments for goods or services so sellers can avoid reporting what they do – to avoid paying taxes, or because their activities are criminal, or something even darker.

The more advanced a society is, the smaller the portion of its economy is underground. In the US the informal economy is less than 9% of total GDP; in some countries in South Asia it can be over 80%. This is a problem for the developing world, because jobs in the black market can trap people in cycles of poverty and exploitation. There isn’t enough capital available for successful businesses to get off the ground.

Source: Tes Teach

The simplest way to move people out of the economic shadows and into the light is to ease regulatory and tax burdens and make it simpler for small businesses to compete. People work for cash because the formal alternative costs too much – in time, money, energy, or other resources. Also, property rights need to be protected. Settled property rights give people incentives to invest, innovate, and pool their resources with others for everyone’s benefit.

If governments make formal work more attractive, they’ll get more of it.

Douglas R. Tengdin, CFA