Black markets provide an important signal that there may be something wrong with government regulation or taxation, but they also pose problems for consumers, legitimate traders and law enforcement.
Two weeks ago, I wrote a column in praise of smugglers. I pointed out that they help consumers circumvent irrational prohibitions and excessive taxation. By doing so, I argued, they serve a great moral purpose, which is to keep in check the abuse of government power to direct production, restrict trade and impose unjust taxes.
I concluded not by suggesting that black markets are an ideal expression of free market ideology, but that an honest, fair and efficient government should order affairs in such a manner that there is minimal incentive for smugglers to operate outside the formal economy.
If you’re of the view that black markets are super-bad, however, you’d be forced to the same conclusions.
Smugglers did consumers a solid favour during lockdown, especially by selling cigarettes to smokers who were cruelly deprived, without good reason, of their psychological crutch.
The market share of the largest legitimate tobacco company, British American Tobacco South Africa (BATSA) plummeted from 48% to 8.7% in the first three months of lockdown, while brands produced by smaller local manufacturers or in neighbouring countries made significant gains on the black market.
Although Covid-19 lockdowns have blunted the ability of illicit traders to manufacture and distribute their products in other countries, this has not been true for Africa. The ban on tobacco in South Africa has had the exact opposite effect, greatly stimulating the illicit market.
Although black market profits have collapsed since the tobacco ban was lifted, there are fears that the smuggling networks may be here to stay. Even before the lockdown, South Africa had one of the biggest illegal trades in tobacco in the world, with a third of the market supplied by illicit operators. That figure now probably stands well north of half of the total tobacco trade.
Sympathies, or not
This has massive tax implications, running to billions, although it is hard to feel sympathetic towards a rapacious, corrupt government with socialist ambitions.
It is also hard to feel sympathetic towards the legal tobacco industry, although it is understandable that it, and the government, would make common cause against the illicit tobacco trade.
Black market trade also puts consumers at risk of getting lower-quality or contaminated products, and gives them no legal recourse against illicit producers. Again, most people will find it hard to sympathise with smokers who buy cheap, untaxed cigarettes, but these people are citizens and voters too, and ought to be equal before the law. They are also fathers, mothers, brothers, sisters, sons and daughters, and merit more sympathy than those of a judgmental mind might imagine.
Besides the obvious impacts on government, legal tobacco firms, and smokers, there are more general principles at stake here, though.
Tobacco companies supply a product that their customers want. Sure, those products involve significant health risks, but so do fast motorcycles, ordinary cars, mountain-climbing gear, sugary sweets, and even media. One might advise healthier lifestyles, but it surely is up to the consumer to decide what level of risk they’re willing to take with their own health.
Another principle is that those who trade in full compliance with the laws, regulations and taxes imposed upon them ought not to be undermined by competitors who do not comply with the law.
Government powerless against smugglers
The solution to this problem is not simply law enforcement, however. As the debacle over the Beitbridge border fence demonstrated, the government is pretty powerless in the face of determined smugglers, whether they bring cigarettes or Covid-19 into the country.
Attempts to track and trace every single cigarette that is legally manufactured would place a heavy burden upon producers and many thousands of retailers, raising the prices of legal cigarettes and providing yet more incentive for black market operators to continue their illicit trade.
The better solution would be to make it easy and inexpensive to trade legitimately. Laws should not limit competition, regulations should not be overly burdensome, and taxation should be low. That would make it far less lucrative to circumvent the law.
Light-touch regulation would have the happy side-effect of stimulating economic activity and, thereby, job creation. Conversely, expect more actions like the closure by Japan Tobacco International (JTI) of its South African factory, which its communications director, Bongani Mshibe, told the Associated Press was due to the scale of the illicit market.
JTI recently launched a report warning of a ‘gathering storm’ in illicit tobacco trade worldwide, especially as disposable income dries up in the wake of the economic devastation wrought by harsh pandemic lockdowns.
‘Exploring fiscal measures’
It finds that while better law enforcement is important in combating the illicit trade, consumers under economic pressure are far more likely to care about price, so to reduce the demand for illicit product will require ‘exploring fiscal measures that will allow consumer confidence to grow and avoid the temptation to spend on illicit products’.
That is, slashing sin taxes will make a big difference in the fight against the illicit tobacco trade. It should be obvious that this is true, even if government pretends that its actions could not possibly be to blame for black markets.
The report points to increasingly resourceful smugglers developing new supply chains to circumvent those shut down by lockdowns. The internet, in particular, has proven to be an effective channel for communication between illicit traders and their customers. This makes it even harder for law enforcement to crack down on the black market, which in turn makes the case for fiscal counter-measures – that is, lower taxes – stronger.
Another risk of driving the tobacco trade into the hands of black marketeers is that illicit traders don’t have a particular loyalty to any given product. They will seek out profitable trade of any kind, and illicit trade in prohibited, highly taxed or highly regulated products is generally the most profitable of all.
Illicit cigarettes have been smuggled under the cover of personal protective equipment (PPE), or alongside counterfeit PPE, for example. Illicit tobacco sales channels often overlap with those of smuggled or counterfeit branded goods.
Branching out
Ultimately, the illicit tobacco trade will become increasingly integrated with the activities of organised criminal gangs, alongside illicit drugs, guns, gambling, wildlife, protection rackets, fraud and prostitution.
Together, these gangs account for between 8% and 15% of global GDP. If organised crime were a country, it would have the third-largest GDP in the world, behind the US and China.
The answer to many of those crimes also lies in easing the legal burden, of course, and reducing the profit incentive for black marketeers to operate. Decriminalising drug use and prostitution can go a long way towards protecting people caught up in these businesses, for example. Legal, regulated gambling, gun sales and wildlife trade can all squeeze the profit margins of illegal trade, pushing shady operators out of the market.
Examining the dangers and risks associated with black markets leads us to the same conclusion as before: public policy should be such that the incentives for illicit trade are minimised. That means light-touch regulation and low and reasonable levels of taxation.
Lightening the heavy hand of government not only minimises the scale of the illicit trade problem, but at the same time, it stimulates legal economic activity and maximises prosperity and job creation. That’s a win-win, in anybody’s books.
The views of the writer are not necessarily the views of the Daily Friend or the IRR
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