This is “Barriers to Trade and the Underground Economy”, chapter 11 from the book Theory and Applications of Microeconomics (v. 1.0).
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You come downstairs one morning and find a note on the table.
Please go to the store today and buy the following:
So far there is nothing unusual about this. You plan to go to the grocery store on your way home that evening. Then you read on.
These are a bit trickier. If you are like many readers of this book, you may not be allowed to purchase alcohol or possibly even cigarettes. In the United States, you must be 21 or over to buy alcohol and over 18 (or 19 in some states) to purchase cigarettes. Depending on where you live, it may also be quite inconvenient to purchase alcohol. In some places, by law, alcohol is sold only at certain times of day. In some places—certain states in the United States and certain countries in Europe, for example—it is sold only in government-run stores.
Many goods, like alcohol, are restricted in terms of who can buy them, when they can be purchased, and where they can be purchased. Alcohol laws differ from country to country. In most European countries, for example, you can buy alcohol at the age of 18. The laws also change over time. Thirty years ago, 18-year-olds could buy alcohol in the United States as well. Ninety years ago, it was illegal for anyone to buy alcohol in the United States.
Next on the list is the following.
This may also be difficult. You know that you can probably find someone who has tickets and is willing to sell them, but you know that local laws say that this, too, is illegal. So-called scalping of tickets is forbidden. Still, if you go to eBay, you’ll probably be able to find some tickets for sale.
Then the list gets stranger:
At this point (at least if you are living in the United States), you begin to seriously worry. You search the Internet for “Cohiba” and discover that these cigars are manufactured in Cuba, but you vaguely remember that it is illegal to import goods from Cuba to the United States. You know that camembert is a French cheese, but “raw milk” sounds strange. More online investigation informs you that it is also illegal to import cheeses into the United States unless they are made from pasteurized milk. Apparently, raw milk cheeses may carry dangerous bacteria. As for marijuana, you already know that it is illegal in the United States.
You read on.
This is another transaction that you know is illegal. That said, you know that there are many illegal immigrants working in your town. It would be easy to find someone to hire if you were willing to break the law. With some foreboding, you turn the list over and read the other side.
Most of the things that were on the list up to this point were goods or services that you would probably be able to find if you had to. Even though some of them could not be purchased legally, it would not be too hard to find out where to purchase most of them. (Oddly, it would probably be easier to get the marijuana than the cheese.) A human kidney is a different proposition, however. You’re pretty sure, even without research, that buying and selling human organs is illegal, and you would have no idea where to go to buy a kidney even if you were willing to break the law.
We know that the market interaction of buyers and sellers creates value in an economy.We discuss this in detail in Chapter 5 "eBay and craigslist", and Chapter 7 "Why Do Prices Change?". In a market, sellers supply a good or a service, and buyers demand that good or service. Because each transaction is voluntary, the value that the buyer places on the good is always greater than its value to the seller. This means that each trade creates some value. In addition, if the market is competitive, all value-creating trades occur in the market; there are no disappointed buyers or sellers.
This logic suggests that governments should be doing everything in their power to encourage and facilitate trade. Yet, in practice, there are several ways in which governments do the opposite: they actively intervene to restrict trade. We have just listed a large number of examples, and you can surely think of many more. We would like to understand all the restrictions that are deliberately put in place to impede trade.
Our main aim here is not to analyze the rationales behind these restrictions, although we do briefly explain some of them. In other chapters, we provide more insight into precisely why governments impose these and other limitations on our ability to transact with one another.See in particular Chapter 12 "Superstars", and Chapter 14 "Busting Up Monopolies". Our goal in this chapter is to explore what happens when governments interfere with trade in different ways.
One message of this chapter is a reiteration of the gains from trade, together with the recognition that they provide a powerful incentive for people to get together and transact with one another. It seems that whenever the government steps in to try to prevent them from trading, people still try to find a way around these restrictions. The gains from trade are a powerful motivator. Indeed, people continue to trade even when this is an illegal act that carries a significant risk of fines or imprisonment. We use the term underground economy to describe where these trades occur. The question we want to answer in this chapter is as follows:
What are the consequences of government restrictions on trade?
In this chapter, we will see many different ways in which governments intervene. For most of our analysis, we use the supply-and-demand framework. We analyze different kinds of government policy and examine the following questions:
We organize our discussion by looking at different categories of restrictions on trade. First, we look at the sale of goods and services in domestic markets. Then we turn to restrictions in international markets for goods and services. Finally, we turn to restrictions not on goods and services but on labor, both within and across countries.