Black markets
When price controls are imposed, exchanges at prices outside of the range set by the government are illegal. Governments may also make it entirely illegal to buy and sell certain products. This is the case with drugs like marijuana and cocaine in the United States. Similarly, prostitution is illegal in all states except Nevada. However, controlling prices and making a good or service illegal doesn’t eliminate market forces. When demand is strong and gains from trade can be had, markets will develop and exchanges will occur in spite of the restrictions. People will also engage in illegal exchanges in order to evade taxes. For example, the $3.39 per-pack cigarette tax in New York City has made cigarette smuggling in that city a thriving business.
Markets that operate outside the legal system are called black markets. How do black markets work? Can markets function without the protection of the law? As in other markets, supply and demand will determine prices in black markets, too. However, because black markets operate outside the official legal structure, enforcement of contracts and the dependability of quality will be less certain. Furthermore, participation in black markets involves greater risk, particularly for suppliers. Prices in these markets will have to be higher than they otherwise would be to compensate suppliers for the risks they are taking – the threat of arrest, possibility of a fine or prison sentence, and so on. Perhaps most important, in black markets there are no legal channels for the peaceful settlement of disputes. When a buyer or seller fails to deliver, it is the other party who must try to enforce the agreement, usually through the use or threat of physical force.
Compared to normal markets, black markets are characterized by a higher incidence of defective products, higher profit rates C for those who do not get caught), and more violence. The incidence of phony tickets purchased from street dealers selling them at illegal prices, and deaths caused by toxic, illicit drugs, are a reflection of the high presence of defective goods in these markets. Certainly the expensive clothes and automobiles of many drug dealers suggest that monetary profits are high in black-markets. Evidence of violence as a means of settling disputes arising from black market transactions is widespread. Crime statistics in urban areas show that a high percentage of the violent crimes, including murder, are associated with illegal trades gone bad and competition among dealers in the illegal drug market.
The prohibition of alcohol in the United States from 1920 to 1933 vividly illustrates how violence, deception, and fraud plague markets that operate outside the law. When the production and sale of alcohol was illegal during the Prohibition era, gangsters dominated the alcohol trade, and the murder rate soared to record highs. There were also problems with product quality (tainted or highly toxic mixtures, for example) similar to the ones present in modern-day illegal-drug markets. When Prohibition was repealed and the market for alcoholic beverages began operating once again within the legal framework, these harmful secondary effects disappeared.
The operation of black markets highlights a point often taken for granted: a legal system that provides for secure private-property rights, contract enforcement, and access to an unbiased court system for settling disputes is vitally important for the smooth operation of markets. Markets will exist in any environment, but they can be counted on to function efficiently only when property rights are secure and contracts are enforced in an evenhanded manner.
The analysis of black markets also provides insights into the economies of Russia, Ukraine, and other parts of the former Soviet Union. Following the collapse of communism, the legal systems in these areas reflected the prior socialist nature of these economies. Both the protection of private property and the enforcement of contracts between private parties were highly uncertain. People with political connections were of- ten able to escape their contractual responsibilities and obtain favorable rulings from legal and regulatory authorities. As a result, markets in these countries operated much like black markets. Fraud and deception were commonplace, and the incidence of violence related to business dealings was widespread. A market economy – like any other – does not work well in such an environment. Many foreign businesspeople who were initially attracted to markets in these countries soon began packing their bags and returning home. Financial capital fled, investment shrank, and these economies performed poorly. During the last few years, there has been some improvement in the legal environment, but the enforcement of contracts and conduct of business activities in the former Soviet Union still involve considerable risk. Without sound legal systems, these countries will be unable to reap the full benefits of a market economy.
Tags: Black markets, Crisis, economy, financial markets
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