The Underground Economy in One Page
What is the underground economy?
It is not something subterranean. It is neither a physical structure nor a place. The pejorative term "underground economy" is used to describe the activities of buying and selling that occur beyond the purview of authorities. Typically the goods or services that are exchanged include, among others, drugs, sex, electronics, software, movies, music, and building-construction services.
Markets are processes involving the interplay of buyers and sellers. When the role of government is restricted to protecting persons and private property against aggression and theft, market processes transpire without impediment. Consumption opportunities are maximized as entrepreneurs deploy resources to produce goods and services in view of profitably satisfying the myriad wants of consumers.
When governments interfere with market processes by way of taxes, regulations, and prohibitions, they go beyond protecting individuals and private property from aggression and theft. Government-granted monopoly privilege in the form of compulsory producer cartels or patents do not protect property rights; they invade them. The aim of government interventionism is to control the productive and consumptive behavior of individuals. In other words, central authorities want to influence what you do with your body and the things that you own, ostensibly for your own good.
This puts those enforcing government interventionism in a difficult position, particularly with respect to the prohibition of marijuana, hash, or cocaine and services like sexual gratification. By making the production, marketing, and consumption of these goods and services illegal, enforcement agencies are required to divert resources from the protection of person and property toward surveying, capturing, fining, or arresting willing consumers, purveyors, or marketers. They are trying to halt market processes — the interplay of willing buyers and sellers. Not only is this enforcement activity very costly; it is also not very effective. In fact, evidence suggests that prohibiting drugs and prostitution is counterproductive.
When something becomes illegal, consumer demand does not vanish. Instead, consumers seek alternative, more costly and risky, means of satisfying their wants. Prices are higher than they would be otherwise, and product diversity, quality, and quantity demanded are lower. In view of suppressed demand and the potential to earn large profits, individuals with a knack for averting authorities direct their energy and resources to satisfy this demand. The illegality of the activity enables the intermediaries to ask higher prices of consumers and to bid down prices paid to growers of hemp, coca, and opium poppies. It gives rise to drug cartels, prostitution rings, and violence associated with the protection of "their" territories.
The government's "war on drugs" has been both a tremendous triumph and an abysmal failure. Drug warriors have been very successful. We have all seen media images of police stings involving massive amounts of money, drugs, and firearms. However, this has had no impact in local markets. Illegal drugs are available just about everywhere and at prices that have fallen in real terms over time. The amount of pot that could be bought for $10 at a local high school in 1980, for example, is likely the same quantity that could be obtained for $10 today.
Prohibition advocates can point to some positive effects. The quantity demanded of soft drugs such as marijuana and hash is likely lower than it would be otherwise. The same can be said of prostitution. But it is hard to believe that the desired effects are anywhere large enough to justify the human cost of their prohibition in terms of lives lost and lives destroyed.