The Economics Behind the U.S. Government’s Unwinnable War on Drugs

The late Nobel Laureate James Buchanan was known to say, “Economics puts limits on people’s utopias.” Unfortunately, the advocates of the U.S. government’s war on drugs have failed to appreciate the economics underlying the drug war that makes their utopian vision impossible to achieve through drug prohibition.

Although the Obama administration has softened the rhetoric of prior administrations by talking about treatment rather than an “enforcement-centric ‘war on drugs’ approach,”[1] enforcement budgets remain large and penalties for distribution severe. As for legalization, the administration claims that “drug legalization also runs counter to a public health and safety approach to drug policy. The more Americans use drugs, the higher the health, safety, productivity, and criminal justice costs we all have to bear.”[2]

Regarding violence, in a recent speech in Mexico, President Obama stated, “Much of the root cause of violence that’s been happening here in Mexico… is the demand for illegal drugs in the United States.”[3] However, Mr. Obama failed to specify whether the cause of the violence is drugs per se or the fact that drugs are illegal.

Economics is a science of means and ends. Thus, the question for economics is whether the means—drug prohibition—is effective in promoting the ends of greater health, safety, and productivity, as well as lower violence and criminal justice costs

The Economics of a Supply-Side War

Both the possession and distribution of illegal narcotics are criminally punishable. However, the penalties for distribution, whether street-level dealing or international smuggling, have always been much harsher than the punishments for possession. Possession—at least for marijuana—is becoming decriminalized in some states. Meanwhile, enforcement devoted to interdiction of imports and the breaking up of dealer networks continues. In short, while there are demand-side penalties, the U.S. government’s war on drugs is primarily a supply-side war.

At its core, a supply-side drug war acts essentially like a tax placed on drug suppliers.[4] It increases their cost of bringing drugs to market and, thus, decreases their willingness to supply drugs. The result, as in virtually any other market, will be higher prices and a smaller quantity supplied. The key question for whether a supply-side drug war can be won is whether the main effect is an increase in price or a decrease in quantity. If the drug war is to be effective, its main effect must be to decrease quantity rather than to increase price.

The amount of illegal drugs that people use is not very sensitive to price. Many addicts likely continue to consume close to the same quantity even in the face of large price increases. The demand for illegal drugs is what economists call “price inelastic.”[5] Figure 1 illustrates the effect of a supply-side drug war on an inelastic demand.

Figure 1. Effect of a supply-side drug war on an inelastic demand

The war on drugs shifts the supply of drugs from Supply (No Drug War) to Supply (Drug War) because of the increased difficulty of getting the drugs into the United States and then distributed to users. As a result, the benefit, in the eyes of the drug prohibitionists, is the decrease in consumption from Q1 to Q2.

The main effect of a supply-side drug war is a large increase in the price of drugs. Revenues of drug dealers equal the price of the drugs times the quantity sold. Because the drug war increases price more than it decreases quantity, the remaining drug dealers have more revenue as a result of the drug war. In the above figure, the drug war costs suppliers the revenue in the blue box, but suppliers gain the revenue in the larger red box. They can use this increased revenue to buy better technology to smuggle drugs into the United States, to buy more and better weapons to fight law enforcement, or to corrupt more judges and police officers.

Because the demand for drugs is not price-sensitive, each “victory” in the war on drugs enhances drug dealers’ revenue, making future decreases in supply all the harder to achieve. It is no accident that the number of annual drug-related deaths in Mexico almost quintupled from 2,300 in 2007 to 11,000 in 2010. This increase was a result of the Mexican government’s stepped-up enforcement efforts.[6] The drug suppliers used their enhanced revenue to fight back more violently.

If this were the end of the story, some people might say, “Even if a supply-side war is impossible to completely win, at least it is a step in the right direction. After all, it does decrease the quantity of drugs used.” Unfortunately, this decrease in drug use comes with great costs that undermine the very goals of the war.

Costs of Drug Prohibition

Drug prohibitionists want drugs to be illegal in order to minimize the damage drug use does both to users and to the society around them. Unfortunately, prohibition, while decreasing consumption, greatly increases the harm done to the remaining users and to society.

When drugs are illegal, they become more potent. In order to minimize the risk of detection per amount of narcotic supplied, suppliers make drugs as small and light as possible. This means higher potency. Economist Mark Thornton has found that increased federal expenditures on interdiction explain 93 percent of the increase in marijuana’s potency.[7]

Drug prohibition also shrinks the price differential between more-potent and less-potent drugs since the fixed cost of evading law enforcement is similar regardless of potency. As a result, prohibition also encourages users to demand the more-potent drugs because the relative price difference between more- and less-potent drugs is lower.[8]

These same effects were observed during alcohol prohibition. The relative price of hard liquor to beer decreased, leading to increased consumption of higher potency drinks like moonshine and gin.[9]

Illegality also makes product quality more variable. When drugs are sold on the black market, there can be no name brand attached to them. Thus, when a dealer sells a bad dose, he does not damage the reputation of a supply chain nearly as much as when, say, Tylenol sells a bad dose.[10] Moreover, consumers cannot sue drug suppliers for producing dangerous products. In a legal market, drug suppliers would be pressured to supply quality products and would face economic and legal consequences if they did not.

The net effect of prohibition on drug users is, at best, to decrease consumption while making the consumption of the remaining drug users much more dangerous because their purchases are more potent and less predictable. This is borne out in the data on deaths from drug overdoses. From 1971—two years before the creation of the federal government’s Drug Enforcement Administration and Nixon’s declaration of the war on drugs—to 2007, the rate of death from a drug overdose per 100,000 total deaths increased by a factor of ten.[11]

Prohibition also creates more problems for non-users. Because it increases the cost for addicts to support their habit, many resort to stealing in order to get their needed high. In a study of the U.S. drug war on Latin America, economist David R. Henderson estimated that if the same mark-ups applied to cocaine as to coffee, which would be roughly accurate with cocaine legalization, then cocaine’s price in the United States would fall by about 97%.[12] If cocaine and other narcotics lost the price premium caused by the drug war, few, if any, addicts would need to resort to crime to afford their habit.

On the supply side of the market, the drug business is violent precisely because it is illegal. Illegal businesses can’t settle disputes in court, so they do so through violence. If drugs were legalized, drug suppliers could settle disputes by turning to courts and arbitrators. One reason that large dealer networks and organized crime outcompete smaller dealers is that they can partially provide their own internal dispute resolution.

When alcohol was prohibited in the early twentieth century, violent criminal gangs catered to the nation’s thirst for alcohol. When Prohibition ended, normal businesses returned to the market and violence subsided.

Economist Jeffery Miron found that both alcohol prohibition and drug prohibition enforcement efforts have increased the homicide rate in the United States. He estimates that the homicide rate is 25-75 percent higher due to prohibition.[13] In short, the violence associated with drugs, both by users to support their habit and by gangs supplying the drugs, is a product of prohibition rather than a rationale for prohibition.

These costs, taken together with the above supply and demand analysis, indicate that the very concerns that animate drug prohibitionists—the harm to users and the violence in society—should cause them to oppose drug prohibition.

External Costs of the Drug War

In addition to the costs that fall within a means-ends calculation for prohibitionists, there are other costs of the drug war that many people care about, most notably the loss of liberty.

The drug war must be financed by tax dollars. Taxes restrict individual liberty by taking away peoples’ freedom to spend their money on goods and services. Currently the government spends $51 billion annually on the war on drugs.[14] This does not count potential tax revenue that could be raised if drugs were legalized (because that revenue represents a transfer, not a net cost or benefit).

More than half a million people are incarcerated in the United States as a result of drug convictions.[15] Any cost-benefit analysis of the drug war must count their lost liberty as a cost. Furthermore, not only does the rest of society pay for their incarceration through taxes, but we also lose out on whatever goods and services they might produce for us were they not in prison.

Other lost liberties arise from the nature of drug transactions. Normal crimes, such as theft, have a victim who has an incentive to report the crime. But normal detection and enforcement methods will not work in the drug war. Why? Because regardless of what the rest of society thinks about drug use, neither drug users nor drug dealers consider themselves victims. To enforce drug prohibition, police must assume powers and pursue practices that are unnecessary for enforcing laws against other crimes. These tactics include searches of people and property suspected of holding drugs, wiretapping and other surveillance, and violent raids of suspects’ homes.

Sometimes these tactics have tragic results. Police mistakes often result in “no-knock” raids of the wrong homes. Since 1985, innocent people’s homes have been mistakenly raided around 200 times and, in approximately 50 instances, police killed innocent civilians.[16]

Moreover, police routinely confiscate personal property if it is suspected of being involved in the drug trade. The police are not even required to file charges in order to confiscate property, and police departments supplement their budgets with these confiscations. In the 20 years ending in 2009, the authorities seized approximately $11 billion in private assets in this manner, and the seizure rate has been growing at nearly 20 percent per year.[17]

This is not an exhaustive list of the costs. These and others are important costs to consider when evaluating the war on drugs.

Conclusion

The U.S. government’s policy of drug prohibition, like alcohol prohibition before it, is a failure—and not one that can be corrected by a mere tweaking of current policy. The economic analysis of fighting a supply-side drug war predicts that the war will enhance drug suppliers’ revenues, enabling them to continuously ratchet up their efforts to supply drugs in response to greater enforcement. The result is a drug war that escalates in cost and violence.

Furthermore, the secondary consequences of prohibition are perverse. The drug war causes drugs to be more potent and their quality less predictable than if drugs were legal, leaving the remaining users at greater risk and, in the face of higher prices, more likely to commit crimes to support their habit.

In short, the means—drug prohibition—is incompatible with the ends of improving health and decreasing violence. There are two paths forward: a demand-side drug war or legalization.

A demand-side drug war that places draconian penalties on usage or possession does not necessarily fail a means-ends test. If the goal is simply to end drug usage, implementing a swift death penalty for anyone convicted of possession or use would do the trick. Of course, it would not improve those people’s health. Most people, including myself, would consider such a policy even more unjust than the current drug policy.

The alternative, legalization, is a better path forward. It passes a means-ends test while better respecting individual liberty. Consumption may increase but the drugs that are consumed would be safer; and violence would decrease. To the extent that decreasing drug consumption is desirable, moral suasion and education would be more effective—without the nasty side effects—than the current policy of prohibition.

Footnotes

[1] Kay Steiger, “Obama administration signals change from prison to treatment in drug war,” The Raw Story, April 25, 2013.

[2] “A Drug Policy for the 21st Century”

[3] Marijuana: Barack Obama says no to legalizing drugs—but what’s that mean for Colorado?

[4] See Miron, Jeffrey and Jeffrey Zwiebel, “The Economic Case Against Drug Prohibition.” Journal of Economic Perspectives. Fall 1995.Vol 9, No. 4: 175-192.

[5] Tyler Cowen and Alex Tabarrok suggest an elasticity in the range of 0.5 based on the existing literature. Modern Principles: Microeconomics (2009), Worth Publishers. Chap 4.

[6] “Time to end our unwinnable drug war”.

[7] Thornton, Mark (1991) The Economics of Prohibition. The University of Utah Press: Salt Lake City. p. 107.

[8] Armen A. Alchian and William R. Allen were the first economists to point out this effect, although they did it in a different context. They noted that the cost of shipping oranges from California to New York was the same whether the oranges were high-quality or low-quality. This fixed transport cost, added to the price, narrowed the relative price difference between “good” and “bad” oranges. Therefore the ratio of the price of good oranges in New York to the price of bad oranges in New York is lower than the same price ratio in California. That, they explained, is why the good oranges tend to shipped out to more-distant places. We can apply their insight to illegal drugs, where the fixed cost is the risk. See Armen A. Alchian and Willam R. Allen, University Economics, 3rded., Belmont, California: Wadsworth, 1972, p. 70-71.

[9] Thornton, Mark (1991) The Economics of Prohibition. The University of Utah Press: Salt Lake City. p. 105.

[10]Benjamin Klein writes, “Even in cases where the problem is not strictly the company’s ‘fault,’ such as the 1982 Tylenol tampering cases that led to seven poisoning deaths, the $2 billion (or more than 20 percent) decline in stock-market value borne by the producer, Johnson and Johnson, was almost ten times as great as the company’s direct recall and litigation costs. See Benjamin Klein, “Brand Names,” in David R. Henderson, ed., The Concise Encyclopedia of Economics, 2nd ed., 2008.

[11] Boettke, Peter, Christopher Coyne, and Abigail Hall (2013) “Keep Off the Grass: The Economics of Prohibition and U.S. Drug Policy.” Oregon Law Review Vol. 91: 1079.

[12] Henderson, David R. (1997) “The U.S. Drug War on Latin America,” Unpublished Manuscript.

[13] Miron, Jeffery (1999) “Violence and the U.S. Prohibition of Drugs and Alcohol.” NBER Working Paper No. 6950. PDF file.

[14] Drug War Statistics

[15] Derived from Boettke et al. p. 1071 and Drug War Statistics.

[16] Botched Paramilitary Police Raids. Cato.org.

[17] Boettke et al: 1069.