Economics of Illegal Drugs

Molly Burke, Usman Chaudhry, Peter Hathotuwa, Jackson Partin and Chris Voltz

Some Negative Effects of Drug Prohibition in the USA

• Government expenditures on active prohibition law enforcement total an estimated $7.7 billion annually ($5.1 billion accrued to state and local government; $2.6 billion at the federal level.

• Inability to capitalize on potential tax revenue of $2.9 billion annually with a corporate tax rate of 2.1% ($6.1 billion with a sin tax rate of 5.4%)

Government Expenditure on Marijuana Prohibition (2000 est.)

• Prohibiting marijuana use incurs a twofold economic burden on the government:– Combined costs of arresting suspected drug

offenders, prosecuting them in court, and incarcerating them once convicted

– Inability to tax drugs due to prohibition• If marijuana were legalized, expenditure on law

enforcement would diminish and the gov’t could generate revenue through taxation

• Total Federal expenditure--$2.6 billion

Government expenditure on Marijuana Prohibition (2000 est.)

• State and local government expenditure occurs via three major branches:– Police Budget: Arrests for possession and

sale/manufacture--$1.71 billion– Judicial and Legal Budget: Prosecutions--$2.94

billion– Corrections Budget: Incarceration of marijuana

prisoners--$484 million

• Total State and Local expenditure : $5.1 billion

Taxation• The government could legalize drugs and institute taxation

like those on alcohol and tobacco• The current estimated US expenditure on illegal marijuana

is around $10.5 billion annually• Assuming relatively inelastic demand for marijuana and a

minimal price decline (25%) after legalization, we can assume an expenditure of around $7.9 billion annually

• Taxation of this expenditure could generate between $2.4-$9.5 billion annually

• A sin tax, like those placed on alcohol and tobacco sales, could have economic and moral benefit:– Generate massive revenue, while– Keeping consumption lower than it would be without a tax

Taxation

Normal excise tax• Assume tax as fraction of

price= 30%• $2.4 billion in tax revenue• Possible reduction in

revenue due to continued home production of marijuana

Sin tax• Assume tax as fraction of

price =80%• $9.5 billion in tax revenue• Possible reduction in

revenue due to elastic demand (decline in consumption); underground market activity to avoid high tax

Prohibition vs. Monopolistic Competition

• Marijuana is currently a demerit good• Due to illegality of manufacture, sale, and

consumption, suppliers face high risks, including arrest and imprisonment. This affects supply and demand: Price of the drug increases. Many consumers are

willing to pay a higher price to cover the “risk premium” of getting caught buying or receiving subpar goods.

Quantity demanded decreases (by the Law of Demand). Some would-be consumers of the drug choose not to enter the market due to fear of prosecution or the high cost of the drug due to the risk premium

Upward shift in supply (supply decreases) Consumer surplus and producer surplus decrease

In Monopolistic Competition

• With legalization, the drug market could satisfy a monopolistically competitive model

• Monopolistic competition means:– Many sellers (more sellers willing to enter the market

once fear of prosecution is eliminated)– Differentiated products (not all weed is created equal)– Multiple dimensions of competition (sellers can now

advertise)– No significant barriers to entry (no longer illegal)

Counterintuitive Aspects• The drug market and its supply and demand curves

differ from those of most other products• Traditionally, the magnitude of changes is

acknowledged to depend on the elasticity of demand or supply– However: their direction is not questioned except that the

extreme case of perfectly inelastic demand is sometimes considered on the ground that drugs are addictive

• Many atypical responses possible with each externality• Focus:– Demand-control interventions (prevention & treatment)– Atypical relationship of price to supply for producers

Demand-control Interventions

• Ineffective rehabilitation programs perceived as demand-limiting factor– Due to labeling of participants as heavy users, can

lead to more intensive drug use– Counterintuitive because rehab can result in

greater consumption after course of treatment.• The fault lies with individual programs, not the

concept, but treatment does not always result in decreased demand

Demand-control Interventions• Immunotherapy– Antibodies created by immunotherapy are too large to cross

the blood-brain barrier. Instead they bind with the drug molecule in the blood stream. • This prevents bound molecules of the drug from reaching the brain.

– Difficult to quantify, but ingesting a given amount of the drug after immunotherapy produces a “smaller” psychic effect since less reaches the user’s brain. Conversely, users would have to spend more to achieve the “same” effect as before. • Some patients who try cocaine after immunotherapy vaccine

describe not getting the rush but still experiencing similar effects on their heart.

– Can increase drug consumption rather than decrease, depending on user attitude. (Cost vs. Benefit changes)• Less harm to individual, but less overall welfare since demand

increases. More supply = larger drug organization = more crime

Atypical relationship of price to supply

• In countries like Afghanistan, there is a lack of infrastructure.– No banks to serve opium farmers. Credit is therefore very

expensive, and saving must occur in other ways.• As a result, holding opium (relatively compact and non-

perishable) is a common method of saving from season to season.– In good times, opium farmers may hold back some of a

year’s production from the market to save for a rainy day (aka drought).

• When prices rise above a certain level, therefore, gradient of the supply curve changes significantly.– Supply ceases to increase with price, defying traditional

economic model.

Spatial Economics and Drugs• Vertical– Quality of drug, how product is cut• New drug dealer vs. Established• Price tends to be less variable - variable is quality of drug

experience

• Horizontal– Dealer territories, networks of sellers• Complex, multilayered networks so that raids do not lead

back to organizer/importer/producer• Standard aspects of spatial economics do apply in terms of

distribution of territory among competitors, since dealers want to maximize sales

Drug Enforcement Administration

• Goal: To enforce controlled substance laws, bring civil and criminal justice to those manufacturing and/or distributing controlled substance, and work to reduce the availability of illicit substances in the United States and abroad.

• Budget for FY 2011 was $2.02 Billion• Between 2005-2011 the DEA took $17.7

Billion for drug trafficking organizations

Agents

• 10,000 Men and Women• 5,000 Special Agents • 500 Diversion Investigators• 800 Intelligence Research Specialists• 300 Chemists

Arrests and SeizuresYear Number of DEA Arrests

2010 30,922

2009 31,701

2008 28,555

2007 29,933

2006 30,690

Year Cocaine Heroin Marijuana Meth. Hallucinogens

2010 29,179 690 722,476 2,067 2,578,935

2009 50,825 619 671,557 2,010 3,425,496

2008 50,474 606 662,143 1,519 9,325,294

2007 98,299 625 360,728 1,113 5,690,324

Unit=kgs

Prevention

• Federal and State governments: $373.9 Billion– 95.6% was spent to deal with the consequences

and aftermath of drug abuse and addiction– 1.9% spent on prevention and treatment– 1.4% on taxes and regulations– $1.7 Billion has been requested for 2012 to be

used in outreach and education programs

Treatment

– SAMHSA found the average cost for addiction rehab in 2002 was about $1,500 per course of treatment

– The same study found that 23 million people needed treatment but only about 2.3 million people actually get treated• The cost is raised substantial depending on the drug

and treatment facilities

Marijuana Use Nationally

• 28.5 million Americans age 12 and older say they used marijuana in 2009 (National Survey on Drug use and Health

• value of US-grown marijuana industry: $20-$50 billion• value of US corn industry: $15-$30 billion

Impact of Criminalization

• law enforcement: $2.1 billion (2001)• imprisonment: around $960 million per year

Current Decriminalization

• California: average price of an ounce of marijuana is $322

• in states where marijuana is not decriminalized average cost of an ounce is over $400

Impact on Producers/Consumers

• average cost of 0.5 gram of marijuana sold on street is around $9

• cost of producing same amount is only $2

Impact on Other Markets

• Tobacco paraphernalia• Alcohol

Interview • Have you ever taken an Economics course? • What is your average monthly demand?• What is your selling price? Is that the market price?• What is your average monthly cost?• What is your average monthly profit?• What do you do if your demand exceeds your supply?• What do you do if your supply exceeds your demand?• What is the opportunity cost of your business?• Do you think there is competition? What do you think would

happen if there is competition? • Does the price changes with quality?

Interview• How does the price structure work?• What are the variables in your business?• What do you think is the social cost of your business?• Do you sell the same type or different types?• How do you reach out to customers?• What is the impact of joining a fraternity on your business?• Have you considered diversification? Aderall, Molly, Cocaine?• Are there any chances of loss in your business? What are

these chances?• What do you think is the impact of all the ‘middlemen’ in drug

dealing?

Facts about Drug-Dealing• The average estimated earnings of the drug gang leaders

are between $50,000 to $130,000 annually. • The estimated earnings of the second level members of

these gangs are about $12,000 annually. • The average estimated earnings of the street level

dealers are less than $2,500 annually despite the fact that they work 20 hours per week.

• Drug dealing is done on part-time basis. Survey of drug dealers in Washington DC shows that about 25% of the study group sold drugs no more than once a week and earned about $50 per month from this.

Facts about Drug Dealing

• Three-eighths of the study group sold drugs on daily basis and reported a median net income of $2,000 per month.

• Drug dealing is a “transitory enterprise”. About 75% to 80% of the street level drug dealers held low paying jobs in the legitimate sector.

• Arrest data of Washington DC shows that 74% of the people arrested for the possession of drugs were employed and about 67% of people charged with drug dealing were employed.

Facts about Drug Dealing

• Most of the street level drug dealers engage in this business to supplement their income from the low paying jobs.

• The authors of the Washington DC study have concluded that most members of these gangs are not engaged in violence. Only a quarter of these members have been arrested for violent crimes and about one-sixth have been convicted of violent crimes.

• Violence causes disruption and businesses (legal or illegal) do not like disruptions.

Bibliography• All the graphs and the tables are taken from the ‘World Drug Report 2011’ of the

United Nations Office on Drugs and Crime.• http://cwhitaker.hubpages.com/hub/The-Economic-Effects-of-Legalizing-

Marijuana• http://www.epa.gov/agriculture/ag101/cropmajor.html• http://www.pbs.org/wgbh/pages/frontline/the-pot-republic/marijuana-

economics/• http://www.aclu-wa.org/library_files/BeckettandHerbert.pdf• http://www.drugscience.org/Archive/bcr4/6Fiscal.html• http://www.justice.gov/dea/agency/mission.htm• http://articles.cnn.com/2009-05-28/health/addiction.costs_1_substance-abuse-• addiction-federal-budget?_s=PM:HEALTH• http://www.drug-rehabs.com/addiction-treatment-cost.htm• http://www.heinz.cmu.edu/research/261full.pdf