The Importance of Above Ground Economies
One of my brother’s best friends from his graduate school days at the University of Chicago is Sudhir Venkatesh. Sudhir was recently featured on NPR in a story about the underground economy in Manhattan:
Venkatesh says there are countless people like Sharelle in the inner city, scraping by on odd jobs. They make and sell box lunches at construction sites, or fix cars in an alleyway. Venkatesh admires the entrepreneurial drive of people like Sharelle.
“These are flexible entrepreneurs who have enormous skills, and will go where the market takes them,” he said.
But Venkatesh says there’s also a big downside to the underground economy. Because this kind of work is unregulated, people can’t go to the authorities for help when they need it. That means there’s no one to resolve disputes.
“There’s no government that’s enforcing contracts, so you have to simultaneously solve the disputes you have, to simultaneously create the norms and expectations for what’s fair and what’s right,” he said. “You may have to go out and punish people who don’t pay you or don’t deliver a good or service.”
As big as the underground economy is in the United States, it’s even bigger in other countries. The Peruvian economist Hernando de Soto has attracted the attention of policymakers across the worldwide political spectrum for his discussion of the problem. In his book The Mystery of Capital, written in 2000, de Soto wrote:
Since Deng Xiaoping’s economic reforms began in 1979, 100 million Chinese have left their official homes in search of extralegal jobs. Three million illegal migrants besieging Beijing have created a jumble of sweatshops on the outskirts of the city. Port-au-Prince has grown fifteen times larger; Guayaquil eleven times larger, and Cairo four times larger. The underground market now accounts for 50 percent of GDP in Russia and Ukraine and a whopping 62 percent in Georgia. The International Labor Organization reports that since 1990, 85 percent of all new jobs in Latin America and the Caribbean have been created in the extralegal sector. In Zambia, only 10 percent of the workforce is legally employed.
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The failure of the legal order to keep pace with this astonishing economic and social upheaval has forced the new migrants to invent extralegal substitutes for established law. Whereas all manner of anonymous business transactions are widespread in advanced countries, the migrants in the developing world can deal only with people they know and trust. Such informal, ad hoc business arrangements do not work very well. The wider the market, as Adam Smith pointed out, the more minute the division of labor can be. And, as labor grows more specialized, the economy grows more efficient, and wages and capital values rise. A legal failure that prevents enterprising people from negotiating with strangers defeats the division of labor and fastens would-be entrepreneurs to smaller circles of specialization and low productivity.
Whether in the United States or elsewhere in the world, this legal failure is a political problem. De Soto doggedly pursues a top-down political solution by persuading the elected heads of state in various countries to incorporate elements of his reform proposals in their own countries. I have tried to convince de Soto (and others) that the better approach would be going bottom-up - selling voters on the value of this kind of legal reform.
If a candidate for president in one of these countries runs on a legal reform platform and wins, my pitch goes, than he or she will have a mandate to actually implement the program. I even have a shorthand name for the program - “A deed for every shanty and a computer for every shantytown.” (The technology piece of the program is based on C.K. Prahalad and his description of the use of technology both to reduce corruption in interactions with government and to give extralegal consumers and producers access to the same information as the big boys - a post for another day.) Not every electorate will have enough trust that government will do better for them than their ad hoc arrangements. Still, back in the nineteenth century, it took Americans a while to take that chance, too.
The NPR story on Sudhir finishes as follows:
People who work off the books for long periods can end up afraid to leave that world and isolated from the broader economy — which limits how much money they can make. He says that’s an issue that society will have to address if it ever wants to bring real growth to the inner city.
Sudhir’s last book made a terrific contribution to the public good but I think The Underground Economy has the potential to be a key spark in a very important public debate. As American political thinkers consider both the consequences and the upside of addressing this problem at home, I hope at least a few also ponder the problem abroad. After all, the fact that the urban poor in other countries have such high barriers of entry into the formal economy has a direct impact on us here in the United States. Some of those urban poor emigrate from their countries and arrive here. Some become terrorists. If they were making a good enough living at home, neither would happen with the frequency they do now.
