New Zealand Law Society - The rise of the internet shadow economy

The rise of the internet shadow economy

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Hammer shadow coming down on a piggy bank

When I was a kid we knew the shadow economy as the black market. It primarily comprised the illegal trade of goods and services, all under the table, within relatively small communities.

In my neighbourhood we had a guy who printed his own T-shirts and sold them under the table. There was a guy who stole retail products almost to order and sold them to friends and family at a five-finger discount. There was even a mate’s dad who would fill his garage with crates of beer on Friday so he could sell them at inflated prices to neighbours over the weekend (back when weekend alcohol sales were still illegal).

And then, of course, there were the tinny houses. Needless to say it wasn’t the most salubrious of neighbourhoods.

The ‘black market’ of the pre-internet era was decentralised and location-specific. Vendors had to be intimate enough with their community to be known to their potential customers, while remaining small enough to be invisible to the taxman and to law enforcement.

All that has changed and, like so many other aspects of our lives, the black market/shadow economy is being totally disrupted by the internet and the technologies that it has enabled.

Welcome to the age of the internet shadow economy, where you can buy just about anything from just about anywhere in the world via your smartphone or web browser. And your neighbours no longer have to know what you’re up to.

The Wall Street Journal defines a shadow economy as being “described by those operating in it: work done for cash, where taxes aren’t paid, and regulations aren’t strictly followed”. Although it is relatively small here, Forbes estimate that the shadow economy makes up 9% of Australia’s GDP and 20% of Italy’s.

I define the internet shadow economy as being where this shadow trade is conducted anonymously online. As well as the anonymity that the web affords, the internet shadow economy is facilitated by encryption tools, trading platforms (such as those commonly found on the dark web), online clearing houses and even digital currencies. When combined these components provide a platform for international commerce (legal or otherwise) that can be completely anonymous and untraceable using conventional means.

However you define it, the internet shadow economy is huge. As has always been the case with the internet, pornography and illicit activity are leading the way (pornography revenues in the US alone exceed the combined revenues of ABC, CBS and NBC television networks), although the volume of more legitimate forms of commerce is increasing at a considerable rate.

Although the size of the ‘traditional’ shadow economy (the black market) continues to decline (see Medina and Schneider, 2017) the internet shadow economy is growing rapidly and it has an outsized (and increasing) impact on society as a whole.

Drugs and other illicit products and services

The dark web is disrupting criminal enterprise. Anyone with an internet connection can now compete, completely anonymously, with organised criminals in the importation and distribution of illicit substances. It’s infinitely safer and more efficient to buy and sell illicit substances via the dark web than via the traditional black market, as neither vendor nor customer need ever be known to each other. Cryptocurrencies such as bitcoin not only support this anonymity, they also make the transactions almost impossible to trace.

This is likely to result in increased illicit drug use over time within our communities. It is, after all, natural to expect consumption to increase as the cost of illegal drugs decreases and many of the barriers to buying and consuming them (eg, fear of prosecution, variable product quality, procurement difficulties, etc) decrease.

Regardless of your views on drugs, it’s clear that the criminalisation of them hasn’t worked. Hundreds of thousands of New Zealanders sell or consume illegal drugs every week.

What will happen if we experience an unprecedented increased in drug use? Will this force us to rethink our approach to the criminalisation of drugs?

Professional services

As I write this I’m considering hiring a new junior administrator for my business. I could pursue the traditional option of hiring someone on the local labour market, or I could hire someone like ‘Andrea’, who lives in Ukraine, has her masters degree in commerce (and over 10 years commercial experience) and who will work for less than our minimum wage.

Not only that, but Andrea will also work unsociable hours, night after night, six or seven days per week so that her working hours are compatible with ours here.

Is this legal? I’m not entirely sure. Is it ethical? That’s debatable, but it certainly would feel exploitative to me.

Broken piggy bank with cash and coins

What is clear is that it is possible. I could hire Andrea, or one of millions of other qualified professionals from around the world, within minutes using one of thousands of ‘freelancer’ websites that cater to almost any professional services requirement. I could also terminate such an arrangement at any time or otherwise treat her unfairly in a variety of ways that are, quite rightly, illegal here.

This type of service has already disrupted many creative industries, where entire creative teams can be replaced by highly skilled, unseen workers who will gladly work longer for less.

This ‘peer to peer’ outsourcing of services isn’t without risk, but it is often fast, effective and, most important, inexpensive.

Ongoing technology and communications improvements allow these remote workers to become increasingly productive. I already have no doubt that Andrea would be considerably more productive than a less-qualified local costing more than twice as much per hour.

Will we see a big increase in such micro-outsourcing (ie, on the scale of an individual person or role) as the barriers to it decrease? If so, how will this affect our taxation and labour laws? Will we seek to tax the use of overseas employees in the same way we add GST to products purchased overseas? Will we try and implement minimum employment standards for such remote employees?

Even if we could implement such controls would they help or harm people like Andrea, who would still be earning more than the local average wage if she got the job?

Financial services

Although their prices are still highly volatile, the emergence of cryptographic currencies (‘cryptocurrencies’ such as Bitcoin, Ethereum and dozens of others) has given birth to an entire financial services industry that exists entirely within the internet shadow economy.

Here I can buy and sell currencies, invest in a range of securities and even offer or buy various types of insurance.

This industry is in its infancy, but it is superior in many ways to the traditional financial services industry:

  • It is truly global, allowing customers to connect with service providers from all over the world.
  • Regulation is sparse or non-existent.
  • Consumer protections are often built into algorithms and blockchains.
  • Markets are extremely efficient, lowering friction and cost for all participants.
  • Although fraud is rife (fools and their money are being parted on a daily basis), the cryptographic tools exist to offer vastly more security and protection (for all parties) than with our banking-centric economies.
  • Parties and transactions can remain anonymous. It’s entirely possible to become wildly rich (or to lose everything) without anyone else knowing about it.

How will government, private enterprise and society as a whole respond to larger and larger amounts of capital moving to the internet shadow economy, where it can become completely untraceable/un-taxable? What impact will this have on our taxation system, on banks and on the average consumer?

Regulation difficulties

The internet shadow economy makes it easy to maintain complete anonymity and to hide our activities online. This raises obvious questions about what visibility and control regulators will have over it going forward.

There are already ‘businesses’ within New Zealand that operate 100% within the internet shadow economy, completely out of view of regulators. I suspect that most of these businesses are drug dealers and other vice merchants, but there is a significant (and growing) number of businesses that sell legal products and services, but choose to do so in the shadows.

These shadow businesses are typically very small, as any enterprise with more than one or two people becomes hard to hide, although their combined effect can be huge. There are Bitcoin millionaires in New Zealand, as well as freelancers providing everything from clerical to pornographic services from the safety of their bedrooms. It’s impossible to know how much of this commerce is being conducted under the table, but I doubt that much of the income is being declared.

Consider the example of the pornographic webcam industry in Romania, where tens of thousands of ‘camboys’ and ‘camgirls’ generate hundreds of millions of dollars per annum, much of which is untaxed. This has a material effect on the Romanian economy, yet this activity is almost impossible to regulate.

No one really knows how big the internet shadow economy is in New Zealand and, while it’s relatively small, no one cares very much.

What will we do as it grows big enough to have a material impact on our economy? How can we tax and regulate something that we can’t see?

Damian Funnell is a technologist and founder of Choice Technology, an IT services company and, a cloud software company.

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