Economics of the Drug War

So last night I gave my first lecture at la Universidad Nacional de Colombia. I presented a great paper by some of the best economists around, Gary Becker, Kevin Murphy, and Michael Grossman. The paper, The Market for Illegal Goods: The Case of Drugs, is a hell of a paper to talk about in Colombia. I think it basically begins to explain two thirds of the problems in this country. (On the note of problems, it’s been raining a lot and there was a serious thunderstorm two days ago. When there is unexpectedly loud thunder, people duck out of habit.)

Here is the paper´s abstract: This paper considers the costs of reducing consumption of a good by making its production illegal and punishing apprehended illegal producers. We use illegal drugs as a prominent example. We show that the more inelastic is either demand or supply for a good, the greater is the increase in social cost from further reducing its production by greater enforcement efforts. So optimal public expenditures on apprehension and conviction of illegal suppliers depend not only on the difference between the social and private values from consumption, but also on these elasticities. When demand and supply are not too elastic, it does not pay to enforce any prohibition unless the social value is negative. We also show that a monetary tax could cause a greater reduction in output and increase in price than would optimal enforcement against the same good if it is illegal, even though some producers may go underground to avoid a monetary tax. When enforcement is costly, excise taxes and quantity restrictions are not equivalent.

It´s strange to read about coca production and the destruction of coca fields on the front page of the paper every day. On any given day El Tiempo has two articles about Coca on the front page and another three inside. One thing I´ve learned is that it’s really easy to make cocaine. Coffee, difficult; bananas, difficult; exotic Amazonian fruits and nuts, very difficult. Coca and cocaine, easy. it’s a leaf treated with some chemicals. The plant grows like a weed, unlike coffee or bananas, which you have to irrigate and tend to aggressively. And there is a virtually endless supply of farmers in the mountains willing to grow it at any price, because it’s much easier to grow that their alternatives.

In the context of the paper I presented, the supply of cocaine is extremely inelastic. The price could fall drastically or raise drastically and you would see a similar number of farmers growing coca. 145 k hectares in Colombia are dedicated to growing coca (about 2% of the land in the country). That number could not be much larger if it were legal.

The idea from which the paper procedes is this: the way a regime of criminalization reduces the quantity of cocaine is by raising the price paid by those who demand it. There are two kinds of prices: pecuniary prices, which the law increases by making drugs cost more money, and non-pecuniary risks, which is how you think about the chance that you might get shot when you buy drugs, or that they might be poisonous. The government raises the price by making it hard to get drugs from point A (let´s call it Colombia), to point B (Chicago). Because cocaine is illegal everywhere in between, you have to take serious risks to traffic cocaine into the US. For smugglers, narcos and drug mules to do this work, they must be paid more than the simple compensation for transporting from one point to another (more than say, someone shipping coffee), they have to be compensated for both their efforts to avoid detection and the risk of being caught. The stronger the penalty or the more likely detection the greater the risk and thus the compensation which results in a higher price of the final product. More police or more jail time raises the price of drugs. This is the reason a kilo of Cocaine in Chicago costs more than a Kilo of Coffee. In Bogotá, it doesn’t.

The conclusion of the paper shows that, because Cocaine is so easy to produce, and producers of coca and cocaine respond minimally to changes in price (even if the price fell considerably, it would remain the most lucrative crop considering the small amount of work involved) its demand is inelastic. If you increase or decrease the price of Cocaine by 10%, you won’t change the quantity of cocaine much at all--so people will try to break the law even if it is harsh, and the harsher the law the greater the social cost incurred by those who break it.

One social cost in this situation is any wasted effort or unnecessary risk. For instance, balloons hidden in the orifices of a smugglers is, among other things, inefficient. A bad way to transport anything anywhere. If we transported Coffee from Colombia in this way it would be extremely expensive.

More important social costs are the cost of enforcement: Colombia spends some 5% of it’s GDP fighting narcos and rebels, The US poisons the countryside to kill crops (not just coca), millions of people die in the war with drug dealers, millions more are put in prisons thought the Americas at no small cost where they can neither work nor raise children, and there are millions of people who do not have access to civil services because they must remain outside the bounds of the law.

The last one is important. It’s why drug dealers are violent and Starbucks is not. Starbucks might be able to make a good thing out of taking up arms against Duncan Doughnuts, but they don’t for the obvious reason that it’s illegal. Duncan Doughnuts is protected by laws. Drug dealers aren’t. Gangs fight for turf and clientele and monopoly power just as Starbucks and Duncan Doughnuts do but since they have no legal recourse, their competition is a very violent one. Drug dealers get killed a mugged often because they carry cash and can’t call the cops. Lots of people die. More are killed on both sides in a war between police and drug dealers, gangs, and cartels.

The final topic, and the students in lecture really objected to this one, is the role of the drug trade and legislation in corrupting the government. Laws against a popular, easily produced crop in high demand can do a lot to explain Latin America´s problems with corruption (and I don’t mean to absolve the US (see: Noriega)). When you make a large portion of the population criminal, and you have to dedicate another large portion of the population to enforcing the laws against them, there are plenty of mutually beneficial transactions that are possible, from the police officer who finds drugs in a car to the president whose government spends an enormous amount of resources fighting a cartel that exports something very profitable. Criminalization makes drugs so profitable that drug traffickers have, in the past, offered to pay enormous sums of money to the government if they would stop enforcing their laws.

In Colombia, a cartel offered to pay off the country’s 3 billion dollar national debt if they would cease their war. After a long national debate, the government rejected to idea and entered the most brutal phase of violence in recent history. This was in 1988. Another former president was revealed, in a scandal compared to Watergate, for having taken some 6 million dollars from the leader of the Calí drug cartel to finance his campaign. Pablo Escobar, of the Medilliean cartel, donated several million to the poor of Colombia’s second largest city, building ten thousand new houses, new schools, and providing running water where it was previously unavailable. His two billion dollar drug-fortune financed it. This was another attempt to buy legaslative change.

Drug dealers pay so much to corrupt the government at the highest levels because of the profit in the trade, which only exists in a state of criminalization. If drugs were legalized, there would not be the opportunity for profits. You would expect fair compensation. If a trade, like coffee production, compensated people excessively they would enter the trade. In class a student objected to this assessment. I asked him, I thought cleverly, why he didn’t enter the coffee industry if he thought it was so profitable. He told me his family owns many hectares of coffee plantations. I was the ass. But the point remains. Anyone can grow coffee so there is no “real” profit if the market is efficient. He conceded his family would make more if they grew coca on the same farm.

The other reason the social cost of criminalization is so high is because demand is inelastic. Americans will pay a whole lot for coke. This was pointed out to me at a Bogotá club two days ago. I was talking to some people and a guy came to our table, pulled out a bag of Cocaine, and asked if we wanted to buy some. He saw that I was both (1) surprised and thus (2) an American, tossed the (large) bag toward me and said, nicely, "yeah, it’s cocaine. people use it. no big deal. the only reason it’s a problem is because you people pay so much for it." He understood the problem better than any of the econ students at Uni. Nacional.

The real lesson of the paper is that since the laws reduce the quantity of drugs by raising the price, we could achieve the same result through taxation. That is not to say that if the completive market price of cocaine is 10 dollars a kilo and the street price in Chicago is 1000 that we need to tax cocaine to cost 1000 dollars a kilo and should expect the same results. That is clearly not true. If legal markets provide consistent quality and a safe transaction, the price would have to be greater than $1000/kilo. The current quantity of drugs in Chicago reflects the pecuniary price, but also the risks involved. Legal markets can get rid of those risks by taking the violence out of the industry. The point is, sending people to prison for producing something is expensive, inefficient, and unjust.

We would be better off taxing people. you can read the paper here: http://gsbwww.uchicago.edu/fac/kevin.murphy/teaching/Market%20for%20Illegal%20Goods-JPE.pdf