The bright side of the black market

Menno writes*

The black market is not as bad as many policymakers believe. It provides a lot of otherwise unemployed individuals with labor and income. Formalization of the economy is vital since it allows for more development through taxation, which is especially the case in countries with a huge informal market such as Bangladesh. However, this does not mean the informal economy is only bad news.

Informal businesses collectively employ fully half the world’s workers. Often, the black market is considered to be harmful to a country’s development. However, small, illegal, off-the-books businesses collectively account for trillions of dollars in commerce. These enterprises are essential for entrepreneurialism, innovation, and self-reliance. Furthermore, black markets have grown during the international recession, adding jobs, increasing sales, and improving the lives of hundreds of millions. Thus, black markets offer more than meets the eye.

The reason the informal market troubles a lot of policymakers is because it is associated with low productivity and poverty. It is generally believed that the primary solution to a large informal economy is economic growth. More formal employment leads to more taxation, which can then lead to better education, which can help people transfer from informal to formal labor. The figure below shows that an increase in GDP is associated with a lower share of informal employment. However, this trend does not occur in all countries.

In Bangladesh, specifically, the informal economy has grown to a vast size. It currently accounts for 89% of the total labor force, constituting 64% of the country’s GDP. The informal market has grown despite a steady rate of economic growth for the last three decades. The increase of the informal market is driven by the large population, the dominance of young age groups, and an increase in female participation in the labor market. Furthermore, Bangladesh’s economy is witnessing a significant growth of service sector jobs ahead of manufacturing jobs, forcing a lot of people to work in the black market.

Institutional restrictions, harassment, illegal extractions by local touts, and general hostility in society significantly limit the full potential of the black market in Bangladesh. Furthermore, informal businesses enjoy less institutional support than their formal competition. Often, informal employees work under challenging conditions, with more harassment and less job security.

Since economic growth decreased the size of the informal economy, Bangladesh requires a different approach. First of all, I believe, since the informal economy plays such a significant role, Bangladesh should focus on improving productivity within the sector instead of threatening it. Policymakers should remember that, even though the formal economy is more efficient, the informal economy still provides a large number of jobs and contributes to economic growth. Thus, instead of attempting to lower the size of the informal market through institutional restrictions, I believe it should be incorporated into the formal economy by providing job security and benefits.

Second, policymakers need to shift from promoting service sector jobs to providing industrial employment and investing in education. Often people are informally employed, not because they want to but because they have to. By providing these individuals with jobs and education, they could transfer into the formal market, where there can work under better conditions for a better wage.

Bottom Line: Productive work is helpful, formal or not.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Author: David Zetland

I'm a political-economist from California who now lives in Amsterdam.

3 thoughts on “The bright side of the black market”

  1. Hey Menno, interesting topic! I agree with you that productive work is helpful, formal, or not. The idea of incorporating the informal sector into the formal one is good in theory. However, I am wondering how, and if, this will work, practically speaking. Correct me if I am wrong, but is it not the case that many jobs in the informal sector also perform illegal business (in the sense of performing illegal actions, not being illegal as a business)? Would you also want these jobs to be included in the formal sector? And if so, what would this look like?

  2. Hey Menno,

    That was an interesting read, and I fully agree with you. And it perfectly makes sense for people to work in the informal sector if they can’t find work elsewhere.

    I think one aspect that could play a part in governments wanting to reduce their informal sector is lobbying. (I’m just hypothesising here.) The formal sector experiences competition from the informal sector. The informal sector, however, does not pay taxes, while the formal sector does.

    Therefore, it is rational for formal companies to lobby the government to limit competition from the informal sector. The formal sector also likely has much better lobbying access than the informal sector.

  3. Hi Menno,
    Interesting topic! I do agree that it is counter-productive to stigmatize and attempt to crush the informal economy, at least in developing countries. The informal economy, until better governance comes about, is critical in developing a working market economy.

    “More formal employment leads to more taxation, which can then lead to better education, which can help people transfer from informal to formal labor.” Indeed the government would increase revenue from formalising the economy. But the assumption that greater taxation leads to better education, regulation, investment in infrastructure etc. is premised upon good governance, and that government is incentivised to create institutions that foster private competition and economic growth. As this is often not the case, and formalisation, higher taxation and regulation simply means more rents for the corrupt government elite, the black market serves as perhaps the main and vital mechanism (if one could call it that) to create growth and wealth.

Leave a Reply

Your email address will not be published. Required fields are marked *