The ambiguous moral foundations of the underground economy.

• Author: Priest, George L.
• Position: Symposium: The Informal Economy

George Priest critically examines moral judgments about the underground economy and shows that the broader condemnation of underground activity now conventional in modem discussion is highly problematic and cannot be defended. He compares the relative moral position of market-based to state-controlled regulatory activities and shows, through the example of the underground economy, how the market achieves with greater systematic success many democratic values often asserted as justifications for broader governmental regulation.

Most treatments of the underground economy presuppose that underground economies cannot be morally justified. This moral condemnation is suggested by the conventional taxonomy of activities comprising the underground economy itself: illegal, unreported, unrecorded, and informal. A recent U.S. Department of Labor publication, for example, defines the illegal sector of the underground economy as "economic activities pursued in violation of legal statutes defining the scope of legitimate forms of commerce," presenting examples such as prostitution or the trade in drugs. The same publication defines the "unreported economy" as comprising "those economic activities that circumvent or evade . . . the tax code"; "the unrecorded economy" as those "that circumvent the institutional rules that define the reporting requirements of government statistical agencies"; and "the informal economy" as "those economic activities that circumvent the costs of ... the laws and administrative rules covering property relationships, commercial licensing," or other governmental regulations.(1)

These various activities are obviously similar in their circumvention of rules or regulations, but they are similar in a deeper sense because their existence is presumed to directly impede legitimate government actions, as well as broader values of the citizenry. For example, in a recent essay, Professor Feige, the most prominent scholar of the underground economy, explains the "conceptual linkage among underground economies" as comprising two elements: concealment and immorality. The intentional concealment of this set of economic activities from government and policymakers biases and distorts economic data--data which the government relies upon to control the economy.

To the extent that national accounting systems are based on data

sources primarily collected from the formal sector, a large and

growing informal economy will play havoc with perceptions of

development based on official statistics, and consequently with policy

decisions based exclusively on information provided by official

sources.(2)

In addition, and more importantly, the underground economy represents a moral challenge to the most basic legal and political institutions of a society. Thus, according to Professor Feige, the "most serious consequence" of illegal activities "is to undermine the stability and responsibility of political, legal and economic institutions that might otherwise serve to facilitate the [economic] development process."(3) He condemns the unreported economy on similar moral grounds: "Tax noncompliance shifts the burden from the dishonest to the honest, increasing the costs of adherence to any system of rules and regulations."(4) And finally, Professor Feige regards the impact of informal economic activities as even more harmful: "An often overlooked consequence of growing informality is the unraveling of the social and political fabric."(5) Most other treatments in the academic literature share this moral perspective.(6)

This Essay critically examines such moral judgments. It is inspired by two developments of recent times. First, the collapse of the socialist economies of the Soviet Union and Eastern Europe suggests that we must reevaluate our presumptions about the comparative virtue of economic organization by the state versus organization by the market. The debate during the 1930's and 1940's between Lerner and Lange, who demonstrated the theoretical possibility of optimizing societal resources through government planning, and the Austrians, who maintained that only the market could achieve this result, was never closed. Given the subsequent appearance after World War II of a sustained and surviving rivalry between Eastern and Western economies, students of political economy have been required at least to entertain the proposition that government planning might be more successful than a competitive marketplace in attaining such widely held societal goals as the efficient allocation of resources and the equitable distribution of income. The recent abject failure of Eastern-controlled economies in terms of both efficiency and growth (and of even more basic humanistic, environmental, and democratic objectives) compels a reconsideration of that position. In an age in which all of the world's great socialist economies have fallen and are moving toward capitalism (however falteringly), it is less clear than before whether the broader public interest is better served by that form of planning that the underground economies evade or by the productive activities of the underground economies themselves.

Second, modern studies of Eastern economies have been supplemented by similar evidence from the Third World and developing economies suggesting that capitalistic energies have succeeded in aiding the poor to a greater extent than have the most ardent efforts of socialist politics. This evidence, too, compels a reevaluation of the role of underground economies in otherwise broadly capitalistic societies.

Although this Essay describes some of the social and political contributions of underground economic activity, it does not claim that all features of underground economies are socially beneficial or congruent with democratic values. The goal of the Essay is more modest: to reorient the dialogue--especially the moral dialogue--concerning underground economies. By necessity, it must also address the broader moral defensibility of capitalism itself

Part I begins the discussion by presenting illustrations taken from studies of the underground economy in a pre-1989 socialist state and, separately, in a modern developing nation. These examples show how underground economic activities--however violative of established legal norms--represent private efforts to achieve ends widely valued in most societies, such as increasing the wealth of a country and aiding its poor. Part II generalizes this proposition by comparing the relative moral positions of market-based and state-controlled regulatory activities. Over the past century, most defenders of the market have emphasized values such as personal liberty and wealth creation, which most agree are important,(7) but which many are willing to sacrifice toward the achievement of broader societal goals. Part II defends the market--and, through that defense, underground economic activity--on additional grounds. This defense shows through the example of the underground economy how the market achieves many democratic values often asserted as justifications for broader governmental regulation. Part III extends the analysis to underground economic activity in the United States. Again, it cannot be claimed that all underground activities are morally justifiable and, no doubt, many will dispute the morality of particular types of underground activities, but the Essay will attempt to show that the broader condemnation of underground economies, however conventional, is highly problematic and cannot be defended.

1. TWO EXAMPLES OF UNDERGROUND ECONOMIES AT WORK

   This Part describes the operation of underground economies in a centrally planned socialist state, the former Soviet Union, and in a Third World developing nation, Peru. The descriptions are not exhaustive and are meant only to illustrate major forms of underground economic activity. Examples were chosen from these countries because, given the nature of their respective governments, Western readers are less likely to condemn automatically the widespread contravention of the law that these underground activities display.(8) Section A reviews the underground economy of the former Soviet Union, and Section B reviews that of Peru. Section C discusses similarities across these two very different economic cultures.

   1. The Underground Economy in a Centrally Planned State

      Prior to its fall in 1991, the Soviet Union (and, to a greater or lesser extent, its satellite countries) possessed a formal economy in which the state owned and controlled the means of production; made all resource allocation decisions; and prohibited a wide range of private economic activities, including the ownership of property and, in particular, private speculation. Notwithstanding these prohibitions, it was widely acknowledged that a substantial underground economy provided a broad range of goods and services to the Soviet citizenry.

      1. Agriculture

         The formal agricultural economy in the Soviet Union consisted of state farms and collective farms whose production decisions were largely subject to central control. State and collective farms were allocated all resources necessary for production, including land, machinery, seeds, fertilizer, and the like. In addition to this formal production, however, there existed a second agricultural economy, based upon private production entirely from small plots of land--adjoining or near to individual houses--that the state allocated to collective farm workers for their own production. These private plots were each quite small (on average, three-fourths of an acre),(9) and they were farmed with the crudest of implements.(10) In 1985, these private plots constituted only 1.4% of arable land in the Soviet Union,(11) yet they accounted for extraordinary proportions of total Soviet agricultural production: 60% of potatoes; 29% of vegetables; 28% of meat; 29% of milk; 28% of eggs; and 26% percent of wool.(12) Private production was virtually the only...