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
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 …