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THE UNDERGROUND Adam Smith believed in a God that was kind and wise and all-powerful. The great theorist of the free market believed in Providence. “The happiness of mankind,” Smith wrote, “seems to have been the original purpose intended by the Author of nature.” The workings of the Lord could be found not in the pages of a holy book, nor in miracles, but in the daily, mundane buying-and-selling of the marketplace. Each purchase might be driven by an individual desire, but behind them all lay “the invisible hand” of the Divine. This invisible hand set prices and wages. It determined supply and demand. It represented the sum of all human wishes. Without relying on any conscious intervention by man, the free market improved agriculture and industry, created surplus wealth, and made sure that the things being produced were the things people wanted to buy. Human beings lacked the wisdom, Smith felt, to improve society deliberately or to achieve Progress through some elaborate plan. But if every man pursued his own self-interest and obeyed only his “passions,” the invisible hand would guarantee that everybody else benefited, too.
Published in 1776, The Wealth of Nations later had a profound effect upon the nation born that year. The idea that “life, liberty, and the pursuit of happiness” were unalienable rights, endowed by a Creator, fit perfectly with the economic theories of Adam Smith. “Life, liberty and estate” was the well-known phrase that Thomas Jefferson amended slightly for the Declaration of Independence. The United States was the first country to discard feudal and aristocratic traditions and replace them with a republican devotion to marketplace ideals. More than two centuries later, America’s leading companies—General Motors, General Electric, ExxonMobil, Microsoft, Wal-Mart, Boeing, et al.—have annual revenues larger than those of many sovereign states. No currency is more powerful than the U.S. dollar, and the closing prices on Wall Street guide the financial markets of Tokyo, London, Paris, and Frankfurt. The unsurpassed wealth of the United States has enabled it to build a military without rival. And yet there is more to the U.S. economy, much more, than meets the eye. In addition to America’s famous corporations and brands, the invisible hand has also produced a largely invisible economy, secretive and well hidden, with its own labor demand, price structure, and set of commodities.
“Black,” “shadow,” “irregular,” “informal,” “illegal,” “subterranean,” “underground”—a variety of adjectives have been used to describe this other economy. Although defined in numerous ways, at its simplest the American underground is where economic activities remain off the books, where they are unrecorded, unreported, and in violation of the law. These activities range from the commonplace (an electrician demanding payment in cash and failing to declare the payment as income) to the criminal (a gang member selling methamphetamine). They include moonlighting, check kiting, and fencing stolen goods; street vending and tax evading; employing day laborers and child laborers; running sweatshops and chop shops; smuggling cigarettes, guns, and illegal immigrants; selling fake Rolexes, pirating CDs. Economists disagree about the actual size of the underground economy and how to measure it. Some studies look at the discrepancy between the amount of personal income declared on tax returns and the amount of money that is actually spent. Other studies examine changes in currency supply, the velocity of money, levels of electricity usage. Each of these methodologies has its merits. All have produced conclusions that are debatable. There is general agreement, however, on two points: America’s underground economy is vast—and most of its growth occurred in the past thirty years.
Any estimate of illegal economic activity is bound to lack precision, since it attempts to quantify things that people have carefully tried to hide. Nevertheless, the best estimates convey a sense of scale and proportion. In 1997 the Austrian economist Friedrich Schneider calculated the rise of America’s “shadow economy” by tracing changes in the demand for currency. According to Schneider, in 1970 the size of the underground was between 2.6 and 4.6 percent of America’s gross domestic product (GDP). By 1994 it had reached 9.4 percent of the GDP—about $650 billion. Using a different methodology in 1998, Charles Rossotti, the commissioner of the Internal Revenue Service, told Congress that during the previous year Americans had failed to pay about $200 billion of federal taxes that were owed, an amount larger than the government’s annual spending on Medicare. Assuming an average federal tax ratee of 14 percent, that means Americans somehow neglected to report almost $1.5 trillion in personal income. The IRS estimate did nottttt include undeclared earnings from criminal activity.
Two other periods in modern American history were marked by thriving underground economies. From 1920 to 1933, the prohibition of alcohol led to widespread trafficking and the rise of organized crime. At the height of Prohibition, Americans spent about $5 billion a year on alcohol (roughly $54 billion in today’s dollars). This black market constituted about 5 percent of the U.S. gross national product at the time. When Prohibition ended, some bootleggers became well-respected businessmen. During the Second World War, the imposition of rationing and price controls created even larger black markets. A system designed to distribute scarce commodities fairly had some unanticipated effects: a burgeoning trade in ration books and a hidden cash economy. Perhaps 5 percent of the nation’s gasoline and 20 percent of its meat were soon bought and sold illegally. According to one estimate, by the end of the war Americans were failing to report as much as 15 percent of their personal income. The underground subsided amid the prosperity of the Eisenhower era. Wages increased, tax evasion decreased, and no illegal commodity generated the sort of profits once supplied by bootleg alcohol. And then at some point in the mid- to late 1960s the underground economy began to grow. Conservative economists point to high income tax rates and excessive government regulation as the fundamental causes. Liberals contend that declining wages, unemployment, union busting, and the business deregulation of the Reagan years were much more responsible for shifting economic activity underground. The explanations offered by the left and the right are not mutually exclusive. A stagnant economy prompted Americans of every background to work off the books. The hippie counterculture of the 1960s and the anti-tax movement of the late 1970s shared common ground in their dislike of government, encouraging defiance of the IRS. A new drug culture provided new opportunities for organized crime. The expansion of America’s underground economy over the last thirty years stemmed not only from economic hardship and a desire for illegal profits, but also from a growing sense of alienation, anger at authority, and disrespect for the law.
During roughly the same period similar phenomena occurred throughout the western industrialized world. The underground economy of the European Union may now be larger than that of the United States. Years of high unemployment, high tax rates, illegal immigration, and widespread disillusion with government have created enormous undergrounds. According to Friedrich Schneider’s estimates, these shadow economies range in size from an estimated 12.5 percent of GDP in Great Britain to an estimated 27 percent of GDP in Italy. Countries that were once part of the Soviet Union have even larger black markets. In Estonia the underground is now responsible for an estimated 39 percent of GDP; in Russia, for an estimated 45 percent; in Ukraine, for an estimated 51 percent. The underground is sometimes the most vibrant sector of these transition economies, the place where free enterprise has finally bloomed. But in many ways the growth of black markets in the developed world represents a step backward. An expanding underground economy is often associated with increased corruption and a greater disparity in wealth. For years government officials and members of the Communist Party secretly profited from the Soviet Union’s “second economy,” offering services and commodities unavailable through the mainstream. The largest undergrounds are now found in the developing world, where governments are corrupt and laws are routinely ignored. In Bolivia the underground economy is responsible for an estimated 65 percent of GDP. In Nigeria it accounts for perhaps 76 percent.
The U.S. dollar now serves as the unofficial currency of this new global underground. During the late 1960s and early 1970s American economists began to notice that the amount of currency in circulation had grown much larger than the amount ordinary citizens were likely to use in their everyday transactions. The discovery led to the first inklings that an underground economy was emerging in the United States. While business publications heralded the advent of a cashless, credit-based economy, the use of banknotes quietly soared. The $100 bill soon became the underground favorite, not just in the United States, but overseas as well, thanks to its high face value and the relative stability of the dollar. During the late 1970s the outflow of currency from the United States averaged about $2 billion a year. By the 1990s, about $20 billion in U.S. currency was being shipped to foreign countries every year. Today approximately three-quarters of all $100 bills circulate outside the United States.
The supremacy of the dollar in the global underground has proven a boon to the American economy. The outflow of U.S. currency now serves, in essence, as a gigantic interest-free loan. Every time the U.S. Treasury issues new banknotes, it purchases an equal value of interest-bearing securities. Those securities are liquidated only when the currency is taken out of circulation and put into a bank. In 2000 the U.S. Treasury earned an estimated $32.7 billion in interest from its banknotes circulating overseas. The 1996 redesign of the $100 bill was partly motivated by fears that Middle Eastern counterfeiters had created a convincingly real $100 bill, a “supernote” that might threaten the role of U.S. currency in unofficial transactions. The latest threat to the $100 bill comes not from organized crime figures, but from the central bank of the European Union. The new 500- euro note is perfect for black market activity. It has roughly five times the value of a $100 bill, allowing drug dealers and smugglers to lighten their suitcases. Portugal has banned the 500-euro note for those reasons, and its acceptance in other foreign undergrounds is not yet certain.
The three essays in this book shed light on different aspects of the American underground—and on the ways it has changed society, for better or worse. “Reefer Madness” looks at the legal and economic consequences of marijuana use in the United States. Pot has become a hugely popular black market commodity, more widely used throughout the world than any other illegal drug. The enforcement of state and federal laws regarding marijuana guides its production, sets the punishments for its users, and suggests the arbitrary nature of many cultural taboos. Americans not only smoke more marijuana but also imprison more people for marijuana than any other western industrialized nation.
“In the Strawberry Fields” examines the plight of migrant workers in California agriculture, who are mainly illegal immigrants. The state’s recruitment of illegals from Mexico started a trend that has lately spread throughout the United States. Many employers now prefer to use black market labor. Although immigrant smuggling looms as a multi-billion-dollar business in its own right, the growing reliance on illegals has far-reaching implications beyond the underground, affecting wages, working conditions, and even the practice of democracy in the rest of society.
“An Empire of the Obscene” traces the history of the pornography industry through the career of an obscure businessman and his successors. It describes how a commodity once traded only on the black market recently entered the mainstream, turning behavior long thought deviant into popular entertainment. Profits from the sale of pornography that used to be earned by organized crime figures are now being made by some of America’s largest corporations. The current demand for marijuana and pornography is deeply revealing. Here are two commodities that Americans publicly abhor, privately adore, and buy in astonishing amounts.
Linking all three essays is a belief that the underground is inextricably linked to the mainstream. The lines separating them are fluid, not permanently fixed. One cannot be fully understood without regard to the other. The vastness and complexity of the underground challenge the mathematical certainties of conventional economic thinking. Hard numbers suddenly appear illusory. Prices on Wall Street rise or fall based on minuscule changes in the rate of inflation, the unemployment rate, the latest predictions about the GNP. Billions of dollars may change hands because an economic measurement shifts by one-tenth of a percent. But what do those statistics really mean, if 20 percent, 10 percent, or even 5 percent of a nation’s economy somehow cannot be accounted for? America’s great economic successes of the past two decades—in software, telecommunications, aerospace, computing—are only part of the story. Marlboro, Camel, and Philip Morris are familiar names, and the tobacco industry is one of the most powerful lobbies in Washington, D.C. But Americans now spend more money on illegal drugs than on cigarettes.
The proper role of the state and the proper limits on the free market are central themes of this book. The political system of the United States and the economic system proposed by Adam Smith are ostensibly dedicated to freedom. Since 1776 Americans have been willing to fight and to die for freedom. You will search long and hard to find an American who thinks freedom is a bad thing. The question that has been much more difficult to answer is: Freedom for whom? Should the government be protecting the freedom of workers or employers? Of consumers, or manufacturers? Of the majority who live one way, or the minority who choose to live differently? In the abstract, freedom is always easy to celebrate. But adherence to that lofty ideal seems impossible to achieve. Despite the best of libertarian intentions, giving unchecked freedom to one group usually means denying it to another.
What happens in the underground economy is worth examining because of how fortunes are made there, how lives are often ruined there, how the vicissitudes of the law can deem one man a gangster or a chief executive (or both). If you truly want to know a person, you need to look beyond the public face, the jobs on the résumé, the books on the shelves, the family pictures on the desk. You may learn more from what’s hidden in a drawer. There is always more to us than what we will admit. If the market does indeed embody the sum of all human wishes, then the secret ones are just as important as the ones that are openly displayed. Like the yin and yang, the mainstream and the underground are ultimately two sides of the same thing. To know a country you must see it whole.

Copyright © 2003 by Eric Schlosser. Reprinted by permission of Houghton Mifflin Company.