US Interstate Underground Trade Flow: A Gravity Model Approach

Abstract

In this paper we model interstate trade in US shadow economies using a traditional gravity model, updated to control for factors that encourage (discourage) underground exchange among formal sector trading partners. Using data on interstate trade flow from the US Census Bureau, and state-level shadow economy size estimates from Wiseman (2013), we develop a first-ever estimate of interstate underground trade flow (UTF) for the US. Using a UTF ratio, measured as the portion of state i’s aggregate value of underground exports flowing into state j, we investigate the relationship between UTF and policy governing marijuana consumption in each state. Results suggest a negative (positive) relationship between the UTF ratio and marijuana decriminalization when state i (state j) is the only state among trading partners to relax its regulation. Additionally, when both trading partners decriminalize marijuana consumption, this relationship is positive. This may suggest that states recognize an increased cost to exporting underground goods to states where the good is prohibited; when the rules make it quasi-legal to produce and sell at home. Alternatively, states that decriminalized marijuana appear to increase their consumption of underground imports (or at least the value of those imports) all around.