Economics of Illegal Drugs

1. Economics of Illegal Drugs Molly Burke, Usman Chaudhry, Peter Hathotuwa, Jackson Partin and Chris Voltz

2. 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%)

3. 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

4. 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

5. 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

6. Taxation Normal excise tax 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 • Assume tax as fraction of price= 30% • $2.4 billion in tax revenue • Possible reduction in revenue due to continued home production of marijuana

7. 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

8. 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)

9. 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

10. 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

11. 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

12. 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.

13. 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

14. 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

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

16. Arrests and Seizures

19. 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

20. 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

21. 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

22. Impact of Criminalization • law enforcement: $2.1 billion (2001) • imprisonment: around $960 million per year

23. 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

24. 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

25. Impact on Other Markets • Tobacco paraphernalia • Alcohol

26. 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?

27. 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?

28. 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.

29. 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.

30. 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.

31. 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