The Secrets of 'System D': As Global Economy Falls, Black Market Rises

Perhaps one of the most overlooked consequences of the global financial crisis is the explosion of growth economists have seen in the black markets. Everyone knows about the underhand sale of goods, but few understand just how much covert street vendors and back alley dealers affect the world economy.

The rule is this: wherever there are strict – and usually unreasonable -- government controls, there will be black markets. People will get around those controls. And although most people tend to view these market "agreements" as a “negative,” because they involve disobeying civil laws, some noted economists see the black market as a morally neutral (or even “positive”) market force.

“Well, the black market was a way of getting around government controls. It was a way of enabling the free market to work,” said famed economist Milton Friedman. “It was a way of opening up, enabling people. You want to trade with me, and the law won't let you. But that trade will be mutually beneficial to both of us.”

Friedman explains:

The most important single central fact about a free market is that no exchange takes place unless both parties benefit. The big difference between government coercion and private markets is that government can use coercion to make an exchange in which A benefits and B loses. But in the market, if A and B come to a voluntary agreement, it's because both of them are better off. And that's what the black market does, is to get around these artificial government restrictions.

Now, obviously you'd like a world in which you obey the law. The fact that the black market involves breaking the law is something against it. It's an undesirable feature. But this only exists when there are bad laws. And nobody, nobody believes that obeying every law is an ultimate moral principle. There comes a point, if you look back at the history of law obedience -- think of conscientious objection during wars -- I think you will see that everybody agrees that there is a point at which there is a higher law than the legislative law.

Therefore, with Friedman’s understanding of black markets, and considering the rapid expansion of government controls compounded with the global economic crisis -- is it any wonder that these illicit markets have swollen to such enormous sizes?

Wait a minute -- just how big have the black markets become?

Small, illegal, off-the-books businesses collectively account for trillions of dollars in commerce and employ fully half the world’s workers, says Robert Neuwirth, author of “Stealth of Nations: The Global Rise of the Informal Economy,” according to a recent Wired report. And more than just being generators of cash, Neuwirth claims these enterprises are “critical sources of entrepreneurialism, innovation, and self-reliance.”

As these illicit markets have grown during the recession, they’ve added jobs, increased sales, and (believe it or not) improved the lives of hundreds of millions, Neuwirth’s book claims.

Shadow Markets of the World

"If all the world’s informal markets were formed into a single independent nation, its $10 trillion economy would be the second-largest on the planet (behind only the US)," writes Robert Capps of Wired. "These markets thrive in places where taxes are low, poverty is high, and resources are scarce. The colors on this map indicate the size of each country’s underground economy, as a percentage of its GDP."

Source: Friedrich Schneider et al., “New Estimates for the Shadow Economies All Over the World,” International Economic Journal, 2010 (image courtesy: Wired)

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“It’s time,” Neuwirth says, “for the developed world to wake up to what those who are working in the shadows of globalization have to offer.”

Wired had a chance to sit down with Neuwirth and ask him about black market growth and its overall impact on the world economy. Below is an excerpt from that exchange:

Wired: You refer to the untaxed, unlicensed, and unregulated economies of the world as System D. What does that mean?

Robert Neuwirth: There’s a French word for someone who’s self-reliant or ingenious: débrouillard…I decided to use this term myself—shortening it to System D—because it’s a less pejorative way of referring to what has traditionally been called the informal economy or black market or even underground economy. I’m basically using the term to refer to all the economic activity that flies under the radar of government. So, unregistered, unregulated, untaxed, but not outright criminal—I don’t include gun-running, drugs, human trafficking, or things like that.

“There are the guys who sneak stuff out of the port. The guys who get it across the border. The truck loaders and unloaders. All working under the table.”

Wired: Certainly the people who make their living from illegal street stalls don’t see themselves as criminals.

Neuwirth: Not at all. They see themselves as supporting their family, hiring people, and putting their relatives through school—all without any help from the government or aid networks.

Wired: The sheer scale of System D is mind-blowing.

Neuwirth: Yeah. If you think of System D as having a collective GDP, it would be on the order of $10 trillion a year. That’s a very rough calculation, which is almost certainly on the low side. If System D were a country, it would have the second-largest economy on earth, after the United States.

Wired: And it’s growing?

Neuwirth: Absolutely. In most developing countries, it’s the only part of the economy that is growing. It has been growing every year for the past two decades while the legal economy has kind of stagnated.

Wired: Why?

Neuwirth: Because it’s based purely on unfettered entrepreneurialism. Law-abiding companies in the developing world often have to work through all sorts of red tape and corruption. The System D enterprises avoid all that. It’s also an economy based on providing things that the mass of people can afford—not on high prices and large profit margins. It grows simply because people have to keep consuming—they have to keep eating, they have to keep clothing themselves. And that’s unaffected by global downturns and upturns.

Wired: Why should we care?

Neuwirth: Half the workers of the world are part of System D. By 2020, that will be up to two-thirds. So, we’re talking about the majority of the people on the planet. In simple pragmatic terms, we’ve got to care about that.

Click here to read the full interview.