Economics of Drug Prohibition

1. Economics of Drug Prohibition Econ 3670 Applications of Choice Theory Roberto Martinez-Espiñeira

2. 1 Introduction • According to conventional wisdom, illicit drugs may be responsible for a broad range of social and personal ills, including • Crime • Diminished health • Reduced productivity

3. 1 Introduction • Popular thinking attributes these ills mainly to the characteristics of drugs themselves • e.g. the psycho-pharmacological effects of drugs make users commit violent and other crimes • the mind-altering and addictive properties of drugs cause users to suffer poor health or diminished productivity

4. 2 Introduction • The libertarian economist argues that the social and personal ills typically associated with illicit drugs have little to do with drugs themselves; instead, they result from the economic incentives created by drug prohibition • Libertarian economists include Milton Friedman, James Buchanan, and Friedrich von Hayek (all Nobel Laureates) as well as Thomas Sowell and Robert Barro

5. 3 Introduction • This lecture details the thinking of a libertarian economist towards the issue of drug prohibition • You may not agree with many of the views which follow, but they will challenge you to think more deeply about the issue

6. 4 Prohibition and the demand for drugs: theory • Prohibition potentially reduces demand for drugs via several mechanisms • Fosters a social norm that drug use is wrong, thereby discouraging use • This effect is hard to quantify since norms are difficult to measure • Further, prohibition might increase demand by glamorizing drugs or creating a forbidden fruit

7. 5 Prohibition and the demand for drugs: theory • Prohibition can also reduce demand by those who exhibit ‘respect for the law’ even if such persons do not believe drug use is wrong • Little direct evidence on this effect • Violation of certain other laws is common (speeding laws, tax laws) • Degree of non-compliance suggests caution in assuming that respect for the law, per se, substantially reduces the demand for drugs

8. 6 Prohibition and the demand for drugs: theory • Prohibition can reduce the demand for drugs by sanctioning the purchase or possession of drugs (heavy fines, jail terms etc.) but the impact of these sanctions on demand is probably modest • Actual penalties for possession usually far below maximum • There are many arrests for drug possession, but there are also many drug users, and the number of purchases or ‘possessions’ is far larger than the number of users • Many of the arrests that do occur are incidental to the commission of other crimes (prostitution, theft, etc). • So, persons who are otherwise law-abiding face minimal chances of arrest for drug possession

9. 7 Prohibition and the supply of drugs: theory • Prohibition can also affect the supply of drugs via several mechanisms • Reduces supply by imposing costs that would not be borne by legal suppliers • Produce, transport, distribute drugs secretly or bribe law enforcement officials to look the other way • However, black market suppliers face low marginal costs of evading tax and regulatory policies that ordinarily add costs for legal suppliers • Income taxes, excise taxes, environmental regulation, safety and health regulation, child labor laws, minimum wage laws etc.

10. 7 Prohibition and the supply of drugs: theory • Prohibition can also affect the supply of drugs via several mechanisms • It is conventional wisdom that banning drug sales will in increase the price because of increased costs • Economists suggest that the increase may be less than suggested and that it is an empirical question • This is because prohibition increases some costs but reduces other costs

11. 8 Prohibition and the supply of drugs: theory • The impact of prohibition on market power • Prohibition facilitates evasion of anti-trust laws, thereby increasing market power, or lowers the marginal costs of extreme punishments (violence), thereby enhancing the potential for collusive agreements • Alternatively, the arrest and incarceration of a dominant supplier can encourage price wars among the remaining suppliers as they compete for the arrested supplier’s market share • Thus, the net effect of prohibition on market power is ambiguous and depends on both the level and kind of enforcement

12. 9 Prohibition and the supply of drugs: theory • Overall, the evidence suggests that prohibition has raised costs relative to what would occur in a legal cost, but by far less than asserted in many accounts • Miron (2003) estimates that cocaine is currently 2-4 times, and heroin 6-19 times, its price in a legal market • Prior research has suggested that cocaine is 10 to 40 times and heroin hundreds of times, its legal price • MacCoun and Reuter (1997) note that the price of marijuana in the Netherlands which has de facto legalized marijuana, is little different from the price in the USA

13. 10 Price and quantity of drugs under prohibition: evidence • So, theory implies that prohibition reduces drug consumption but also suggests that this reduction is potentially modest • Evidence on this issue is incomplete due to lack of good data but existing research suggests some broad conclusions

14. 11 Price and quantity of drugs under prohibition: evidence • The amount of drug use that occurs under prohibition suggests by itself that prohibition’s impact on drug consumption is moderate

15. 14Price and quantity of drugs under prohibition: evidence • Over the past 25 years, enforcement of drug prohibition has expanded dramatically • e.g. the real, per capita budget of the Drug Enforcement Administration (DEA) has increased by a factor of more than three and the drug arrest rate has increased by a factor of roughly two • Over the same period, however, heavy drug consumption has increased and the real purity-adjusted prices of cocaine and heroin in the US have more than halved

16. 15 Real DEA Budget and Total Drug Arrests Per 1000 Population in USA (1975-2002)

17. 16 Median Prices Per Pure Gram of Cocaine and Heroin in USA (1974-2000)

18. 17 Price and quantity of drugs under prohibition: evidence • This evidence does not prove that increased enforcement had no effect; prices might otherwise have fallen further and drug consumption increased • But absent an explanation for why this should have occurred, this evidence constitutes a puzzle for the view that enforcement reduces consumption and increases price

19. 18 Drugs, prohibition, and crime • The impact of prohibition on crime • Participants in illicit markets cannot resolve disputes via standard, non-violent mechanisms • Existing evidence shows that the net effect of prohibition is to increase violence

20. 19 Murder Rate in USA Per 100 000 Population (1900-2001)

21. 20 Drugs, prohibition, and crime • The murder rate rose rapidly after 1910, when many states adopted drug and alcohol prohibition laws • The rate also rose through World War One, when alcohol and drugs were first prohibited nationally, and it continued to rise during the 1920s as efforts to enforce alcohol prohibition increased • The rate then fell dramatically after alcohol’s repeal in 1934 and (except for wartime) remained at modest levels for several decades • In the late 1960s, the rate increased dramatically again and stayed at historically high levels through the 1970s and 1980s, coinciding with a drastic increase in drug law enforcement

22. 21 Drugs, prohibition, and crime • The impact of prohibition on crime • Comparisons across cities and countries also indicate a positive relationship between prohibition enforcement and violence • These results must be interpreted with caution because they document correlations that might not be causal

23. 22 Drugs, prohibition, and crime • The impact of prohibition on crime • Micro evidence suggests even more clearly that prohibition increases violence • Goldstein et al. (1989, 1997) find in a sample of New York City precincts during 1988 that almost three-quarters of ‘drug-related’ homicides were due to disputes over drug territory, drug debts and other drug-related issues rather than to the psycho-pharmacological effects of drugs

24. 23 Drugs, prohibition, and crime • The impact of prohibition on crime • A body of evidence suggests that violence is commonly used in a range of prohibited activities, independent of the characteristics of the good • Violence committed by pimps or johns against prostitutes is well-documented • Violence was an important feature of the gambling industry during its early years in the USA when entry was limited; the incidence has decreased as legal gambling has mushroomed • Violence is commonly used to resolve disputes in countries like Russia where the official dispute resolution system is ineffective

25. 24 Drugs, prohibition, and crime • The effect of drug use on crime • There is little evidence of a causal role for drug use in relation to crime • To the extent that it exists, it is stronger for alcohol • The evidence usually offered as showing an effect of drug use on crime does not stand up to careful scrutiny • This evidence consists of statistics that document a high frequency of drug use among arrestees • This suggests that many criminals use drugs but it does not demonstrate that drug use causes criminal behavior

26. 25 Drugs, prohibition, and crime • The effect of drug use on crime • The correlation between drug use and crime is contaminated by the fact that many arrests are for possession; the sense in which this shows that drug use ‘causes’ crime is purely tautological • These data provide no evidence that drug users were under the influence of drugs when they committed their crimes or any evidence that the influence was to make the user criminogenic • The set of arrestees is not a random sample of the population • Data on the behavior of arrestees do not indicate how many people consumed drugs without engaging in criminal behavior and thus say nothing about the tendency of drug use to cause such behavior

27. 26 Drugs, prohibition, and the welfare of drug users • Prohibition reduces quality control in the market for drugs • Prohibition harms drug users by raising drug prices • An indirect effect of this is to encourage users to employ risky consumption methods that give the ‘biggest bang for the buck’ • Prohibition discourages medical use of drugs

28. 27 Drugs, prohibition, and the welfare of drug users • Addiction revisited • Drugs are far less addictive than commonly portrayed • Continued use rates for alcohol and tobacco are even higher than those for illicit drugs, and casual observation suggests continued use rates for other legal goods are higher still (e.g. chocolate, caffeine) • Stereotypical depictions of addiction suggest that experimentation progresses inevitably into regular use and that irregular use occurs rarely • In fact, a sizeable percentage of heroin users consume only occasionally (Zinberg, 1979) and measurable withdrawal symptoms from opiods rarely occur until after several weeks of regular administration (Jaffee, 1991)

29. 28 Drugs, prohibition, and the welfare of drug users • Health consequences • The negative health consequences of drug use are often overstated • The Merck Manual, a standard reference book on diagnosis and treatment of diseases states that, ‘people who have developed tolerance [to heroin] may show few signs of drug use and function normally in their usual activities…Many but not all complications of heroin addiction are related to unsanitary administration of the drug’ • It also writes that, ‘there is still little evidence of biologic damage [from marijuana) even among relatively heavy users’ • Concerning cocaine, the manual does not mention effects of long-term use but emphasizes that all effects, including those that promote aggression, are short-lived • Many of the health risks discussed for all drugs result from overdoses or adulterated doses, not moderate or even heavy levels of use

30. 29 Drugs, prohibition, and the welfare of drug users • Health consequences • Problem with standard depictions of health consequences of drug use is that they rely upon data sources that are biased towards those suffer the worst consequences from drug use (data from clients of drug treatment programs) • Even a robust correlation between drug use and poor health does not indicate the effect of drug use on health, since drug use is often associated with a range of behaviors and characteristics that might be detrimental to health

31. 30 Drug Use and Labor Market Outcomes • According to the conventional view, drug use inhibits concentration, co-ordination, motivation, and other factors that contribute to successful job market experience • widely-cited estimates of drug abuse suggest that drug use reduces productivity in the US by tens of billions of dollars each year (Harwood, Fountain, and Livermore, 1998)

32. 31 Drug Use and Labor Market Outcomes • In fact, the existing evidence on relationship between drug use and labor market outcomes faces severe methodological difficulties • These studies use data on the wages and drug use of individuals, along with ancillary information on demographic and economic characteristics such as age, education, or experience • The basic analysis regresses wages on drug use plus measured individual characteristics • The problem is that drug use and wages are both plausibly correlated with unmeasured characteristics such as optimism, motivation, sociability, creativity or risk aversion • So, a finding that drug use and wages are correlated can reflect the influence of these omitted individual characteristics

33. 32 Drug Use and Labor Market Outcomes • The results of existing studies of drug use and wages are therefore difficult to interpret at best • Further, the results do not support the conclusion that drug use is associated with lower wages • A persistent puzzle in this literature is that the estimated relation between drug use and wages is often positive! • The estimated relation between drug use and certain other labor market outcomes such as employment status or hours worked, is more frequently negative, but even for these outcomes there are many ‘paradoxical’ results in the literature • Given the methodological problems, the right conclusion is that there is no evidence in either direction

34. 33 Concluding Thoughts • In summary, the libertarian economist emphasizes that the unusual characteristics of illicit drugs markets result from the legal status of drugs rather than from the characteristics of drugs themselves • A normative analysis of prohibition must distinguish between the effects of prohibition and the effects of drugs themselves • An obvious question raised by the libertarian economist’s analysis is whether prohibition is the best policy towards illicit drugs