Front Page Titles (by Subject) Black Markets vs. Regulation - Literature of Liberty, October/December 1978, vol. 1, No. 4
The Online Library of Liberty
A project of Liberty Fund, Inc.
Search this Title:
Also in the Library:
Black Markets vs. Regulation - Leonard P. Liggio, Literature of Liberty, October/December 1978, vol. 1, No. 4 
Literature of Liberty: A Review of Contemporary Liberal Thought was published first by the Cato Institute (1978-1979) and later by the Institute for Humane Studies (1980-1982) under the editorial direction of Leonard P. Liggio.
About Liberty Fund:
This work is copyrighted by the Institute for Humane Studies, George Mason University, Fairfax, Virginia, and is put online with their permission.
Fair use statement:
Black Markets vs. Regulation
“The Subterranean Economy.” Financial Analysts Journal (Nov/Dec 1977): 26–27, 34.
This study is the first systematic attempt to measure the size of the subterranean, extra-legal economy that has prospered as Americans have increasingly sought to evade both taxation and regulation of their business activities. The government's disregard for the existence of this subterranean economy has meant understating the country's actual GNP statistics, as well as overstating the extent of unemployment (since many who are officially unemployed are in fact employed in this unacknowledged economy).
The natural reluctance of participants in the subterranean economy to report their activities to the government has always been a major stumbling block in measuring its size and growth. Gutmann has succeeded in estimating the size of the subterranean economy by devising an imaginative methodology which involves comparing the relationship over time between the two components of the nation's stock of money (M1): currency and demand deposits (checking accounts). Gutmann hypothesizes that, as an economy develops, more transactions are typically carried out with checking accounts. Demand deposits, therefore, should grow more rapidly than currency. However, currency (cash) is the essential medium of exchange for the subterranean extra-legal economy since it permits transactions to occur without leaving any record. Thus, an increase in the amount of currency in relation to the amount of demand deposits may signal growth in the subterranean economy in relation to the “official” economy.
Using this methodology, Gutmann reviews the period 1892 to the present and discovers that between 1892 and 1941, as one would ordinarily expect, demand deposits did grow more rapidly than currency. However, in the period 1941 to 1945 this trend reversed itself, and cash grew more rapidly than demand deposits, a result which Gutmann attributes to the prevalence of black markets and tax avoidance during World War II. Between 1945 and 1961 the earlier growth of demand deposits revived once again but, beginning in 1961 and continuing until today, cash once more grew more rapidly than demand deposits. Gutmann concludes that, by 1976, the subterranean economy had an “illegal GNP” of $176 billion and that rising tax rates and the increasing burden of government regulations will continue to drive more and more of the total U.S. economy underground.
“The subterranean economy, like black markets throughout the world, was created by government rules and restrictions. It is a creature of the income tax, of other taxes, of limitations on the legal employment of certain groups, and of prohibitions on certain activities. It exists because it provides goods and services that are unavailable elsewhere or obtainable only at higher prices. It also provides employment for those unemployable in the legal economy; employment for those...whose freedom to work is restricted; and incentive to do additional work for those who would not do so if they were taxed.”