The Underground Economy Running head: The Underground Economy and the Effect on the GDP.

The Underground Economy and the Effect on the GDP. Diane Doak-Fisher Rochester College

The Underground Economy

The Underground Economy and the Effect on the GDP The market is defined as a group of buyers and sellers of a good or service and the way in which they come together to trade (O'Brien, 2009). Market economies work on the assumption that market forces, like supply and demand, are the best way of what is right for a nation's wellbeing. Economists measure total production by Gross Domestic Product (GDP). GDP is the market value of all final goods and services produced in a country during a period of time, which is typically one year (O'Brien, 2009). The GDP is measured using Market Values, in terms of dollars, of all the goods and services produced. A final good or service is one that is purchased by its final user and is not used in the production of goods and services. The GDP only includes new goods and services that are produced during the specified period of time. It does not include used items. The gross domestic product (GDP) is one the primary indicators used to gauge the health of a country's economy. A countries economic production and growth, what GDP represents, has a large impact on nearly everyone within that economy. When the economy is healthy, you will typically see low unemployment and wage increases as businesses demand labor to meet the growing economy. A significant change in GDP, whether up or down, usually has a significant effect on the stock market.

There is another, busy and hidden market where jobs, services, and business transactions are conducted by word of mouth, via the internet, or in advertisements in newspapers personal sections and are generally paid for in cash to avoid scrutiny by the government. It is called the underground economy or market. This market is also referred to as the Gray Market. Sales via the underground market are not authorized by the manufacturer or producer. The

The Underground Economy underground market or gray market is not the same as the black market, as the goods are not illegal. They are sold outside of the normal channel of distribution by companies, in ways that are unofficial, unauthorized, or unintended by the original manufacturer. There is no way to

accurately know how important this activity is to the economy because it is unreported. When a server takes tips that they do not report, or a contractor offers to work for less if paid in cash rather than by check, or a farmer who sells vegetables at a roadside stand understates his revenues to the IRS, are all part of the underground economy and not included in the GDP. The best way to understand the U.S. economy is by looking at Gross Domestic Product. The underground markets effect on the economy is seen by its exclusion from the GDP. If the GDP is slowing down, or is negative business revenues will drop, and unemployment will rise. The GDP is important for three reasons:

1. It is used to determine if the U.S. economy is growing more quickly or more slowly than the quarter before, or the same quarter the year before. 2. It is also used to compare the size of economies throughout the world. 3. It is to compare the relative growth rate of economies throughout the world.

There are different types of activity in the underground market, imported manufactured goods that would normally be unavailable or more expensive in a certain country, unreported wages, unreported sales and unissued securities that are not yet traded in official markets. Individuals and firms will sometimes hide the buying and selling of goods and services and as a consequence their production is not included in the Gross Domestic Production (O'Brien, 2009). In The World is Flat by Thomas Friedman the economy is characterized by a flat world in which globalization, technology, and the Internet have each contributed to a level playing field

The Underground Economy (Friedman, 2005). For companies that manufacture and sell their products internationally, the world is not flat. Products that were manufactured to be sold in other countries are finding their

way back to the United States where they are sold through unauthorized and illegal channels, like street vendors, pawn shops, internet sites or the back of a van. When these new items are sold via the underground economy their production isnt included in the GDP. Illegal immigrants are another source fueling the underground economy. Millions of nannies, construction workers, lawn maintenance employees and others are paid off-the-books, their incomes largely untaxed. The best guess as to the size of the output of this shadow economy is about $970 billion, or nearly 9% that of the real economy ( (Mctague, 205). The underground economy is undermining the effectiveness of the Internal Revenue Service, which is dependent on employees' withholding taxes. If the IRS could collect all the taxes it says that it is owed from the underground economy in a given year, then the current budget deficit would be greatly reduced. Front page magazine also reports that the poor performance overall of the legitimate economy is fueling the underground market. Corporate downsizing has forced many people into contract labor. As a contractor you must report your income as a business and pay your own taxes. People are often confused by the complexity of estimating their taxes and making quarterly payments, which leads to mistakes and under reporting or out-and-out avoidance. The growth of online commerce also contributes to the growth of the underground market. There was approximately $50 million in Gross Merchandise Volume sold on eBay on November 27, 2008, Thanksgiving Day (steiner). The sellers are responsible for paying taxes. Some of them set up a business and get a taxpayer ID number; others don't. There are dozens of Internet marketplaces where you can set up shop and sell online, Craigs list, Amazon, Yahoo shopping, and caf press are just a few.

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Some companies are taking steps to combat the revenue loss from goods sold in the underground market. They do not honor the product warranties for serial numbers that were to be sold out the country. Some IT companies, including 3Com, Apple and HE established a so-called 'Anti-Gray Market Alliance' in order to lobby against the importation of gray market goods in September 2001. The Alliance for Gray Market and Counterfeit Abatement is a strategic initiative composed of leading high technology companies committed to addressing the global impact of the gray market and counterfeiting of goods on the technology industry (AGMA).

Recently, Levi's retailers went to court to restrain the largest retailing store Tesco from selling Levi's jeans, because Tesco imports the jeans from other markets and sells them lower price. In order to compete with the underground market, Levi's announced in late April of 2003 that its Signature Series was to be sold in some discount stores such as Wal-Mart. (Voyle 2003). Information technology manufacturers are losing up to US$10 billion in profits annually to the underground market, with as much as $58 billion of technology products passing through the underground market each year, according to the results of a new study by audit, tax and advisory firm KPMG LLP and the Alliance for Gray Market and Counterfeit Abatement (AGMA). According to KPMGs latest estimates, the projected underground market for IT products has increased by $18 billion over the Firms 2002 projection of $40 billion. These estimates place the size of the gray market at about eight percent of total global IT sales.

The Underground Economy References

(n.d.). Retrieved 02 09, 2010, from AGMA: http://www.agmaglobal.org/# Friedman, T. (2005). The World is Flat. In T. Friedman, The World is Flat (pp. 27-45). Farrar, Straus and Giroux. Mctague, J. (205). Americas shadow economy. front page magazine . O'Brien, R. G. (2009). In R. G. O'Brien, Essentials of Economics (p. 349). new Jersey: Prentice Hall. steiner, i. (n.d.). Auction Bytes. Retrieved 02 07, 2010, from http://blog.auctionbytes.com/cgibin/blog/blog.pl?/pl/2009/11/1259511616.html Voyle, S. (2003). Levis leaps into mass market. Financial Times , 12.