The Economics of Illicit Drug Trafficking

In 1971, President Richard Nixon formally declared a war on drugs. Since that time, the United States has spent well over $1 trillion on drug prevention and incarceration. In 2014, the White House estimated that American drug users spent approximately $100 billion on illicit drugs over the preceding decade and that taxpayers lost $193 billion in "lost productivity, health care and criminal justice costs" in 2007 alone. By comparison, the United States government spent $39.1 billion on energy and the environment in 2015, and just $29.7 billion on science.

Viewed through a cultural or moral lens, there may be a reasonable argument for the prohibition of potentially dangerous drugs. When viewed through an economic lens, however, the war on illegal drugs is less convincing. Basic economic analysis can show why most prohibitions fail to realize their intended goals and why making drugs illegal may actually benefit drug producers and suppliers at the expense of everyone else.

The economic patterns of illicit drug trafficking follow the same principles of any illegal good or service with a reasonable real demand. After all, there is nothing special about the production or distribution of today's major illegal drugs: heroin, LSD, cocaine, ecstasy, amphetamines, meth and cannabis (marijuana). This puts illegal drugs in the same category as illegal immigrant labor, prostitution, the market for used body parts (such as kidneys,) firearms inside gun-free jurisdictions or even alcohol during prohibition. Put together, these goods and services constitute the black market.

Black markets do not operate like normal markets. A black market naturally exhibits several tendencies of monopolistic markets or markets with uncertain contract protections. This includes high barriers to entry, lack of recognizable contract law and uncertain property rights. In black markets, powerful producers can experience supernormal profits by limiting competition and restricting output.

Another disadvantage that is a feature of black markets, especially in the illegal drug market, is that consumers tend to be captives of the underground economy without legal or medical recourse. Addicts who use heroin cannot simply seek treatment for their addiction without fear of significant consequences. Thanks to a lack of marketing and restrictions on competition, the addict does not know if there are alternative products that might be safer or less expensive. Moreover, the addict can rarely challenge a producer who cheats, causes harm or commits fraud. All of those features encourage overreliance on a single substance or producer.

In 2014, the London School of Economics (LSE) Expert Group on the Economics of Drug Policy released a report entitled "Ending the Drug Wars." The report used standard economic analysis to show how the global strategy of drug prohibition had "produced enormous negative outcomes and collateral damage," including "mass incarceration in the U.S., highly repressive policies in Asia, vast corruption and political destabilization in Afghanistan and West Africa, immense violence in Latin America, an HIV epidemic in Russia, and an acute global shortage of pain medication," among other "systematic human right abuses around the world."

The report included signatures and contributions from dozens of leading economists and political figures, including five Nobel Prize winners; Professor Jeffrey Sachs of Columbia University; Nick Clegg, the then-deputy prime minister of the United Kingdom; and Aleksander Kwasniewski, the former president of Poland. They seemed to agree that the losers of the illegal drug market included virtually everybody who was not involved in producing illegal drugs.

This makes sense, at least from an economic perspective, because the only net winners in an anti-competitive or monopolistic market are those who have the privilege of producing the anti-competitive good. Illegal drugs receive an incredible markup compared to legal goods precisely because they are illegal. The LSE estimates that cocaine and heroin receive a markup of nearly 1,300% and 2,300%, respectively, when exported. This compares to a 69% markup for coffee or 5% markup for silver.

Not only do those extraordinary markups create supernormal profits for producers and suppliers, but they also decrease spending everywhere else in the economy. Someone who has to pay 2,000% markups to buy their drug of choice is forced to decrease spending on other goods and services, and probably suffer a loss in productivity and income potential as well. The truly catastrophic opportunity costs, however, are reserved for the governments waging war on illegal drugs and their taxpayers.

In fiscal year 2017, a total of $31.1 billion is scheduled to be spent on the National Drug Control Strategy, which aims to prevent drug use and ameliorate its consequences in the United States. This represents a nearly 100% increase in anti-drug spending in the United States since 2003 and a nearly $10 billion annual increase since 2008. In a paper entitled "The Budgetary Impact of Ending Drug Prohibition," scholars Jeffrey Miron and Katherine Waldock estimated that the United States could save roughly $41.3 billion per year by legalizing drugs.