The Economic Consequences of Drug Prohibition

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The Economic Consequences of Drug Prohibition

The drug trade is one of the most discussed issues both internationally and domestically. The term “drug trade” refers to every aspect of illicit drugs, from their cultivation to their consumption.  In Canada this issue, which is of great social concern, has sparked much debate among politicians, scholars and citizens over both the root causes of the drug trade and the policies that should be implemented to deal with the quandary.  However, the subjective nature of the debate often leaves the discussion without resolve. Considering this, the only way to move forward with a problem of such nature is to deal with objective facts. Assessing drug prohibition through an economic lens aids in clarifying the subjective nature of the debate and provides an explanation for the resultant patterns often observed with today’s prohibitionist policies. Nevertheless, in the end, it is the various citizens and officials who ultimately, influenced by their own subjective values, must make decisions regarding drug policies. However, one should be aware of all the consequences of prohibition before jumping to conclusions, therefore this article will shed light on the often overlooked negative consequences of drug prohibition and in doing so will provide arguments against prohibition[1].


Prohibition and Corruption

We often hear stories of corrupt Mexican and Columbian officials involved in the drug trade; this corruption however is prevalent in the USA and Canada as well though not to such a degree. Wherever drug prohibition policies are enacted, corruption is an inevitability.


Prohibition increases the profitability of illicit drugs, which in turn provides the means to corrupt.

 Prohibitionist policies allow those in the drug industry to earn large monetary profits every year and with this money drug producers gain both an incentive and the ability, to corrupt officials. To understand why prohibitionist policies lead to higher monetary profits for drug producers it is important to understand the risks undertaken by drug producers. Because governments have limited resources, it is far more effective for them to target large drug producers over smaller street dealers and drug users. By trying to incarcerate drug producers officials can stop the problem at its ‘root’. This is why sanctions for drug producers are much more stringent than sanctions for drug users. Furthermore, the drug producer is always at risk since he or she is constantly engaging in illegal activities such as drug production, bribing, smuggling etc., whereas drug users are only briefly involved in an illicit interaction (the purchase).  The heightened risk involved with drug production causes the supply of drugs to fall much more than the demand, which results in an increase in price[2]. The supply and demand chart below illustrates this phenomenon.

As shown above, without prohibition, the original market equilibrium (at S1 – D1) is $1 and at this price 1,000,000 grams are produced and supplied. With prohibition the quantity demanded decreases slightly but the quantity supplied decreases by a significant amount, which causes the new equilibrium price to become $100 and the supply to become 10,000 grams. This means that the demand for drugs is inelastic[3]. Although the total market value of the drugs has stayed the same ($1,000,000), the profit margin for the drug producers (revenue – expenses) has increased significantly[4]. Also, it is important to note that because the decrease in supply of the drug was due to increased risk and not monetary factors (such as a higher cost of production), the price markup will only benefit the drug producer and not the poorer labourers involved in the process such as the farmers. These high profit margins provide the key incentive for one to enter and remain in the business of illicit drug production. With this understanding it is valid to objectively conclude that prohibitionist drug policies indirectly inflate salaries earned by drug dealers and thus, make the business for illicit drugs more lucrative. With these profits, drug dealers gain the means to corrupt officials.


Drug Crimes are Victimless.

To understand why government corruption is so widespread with the drug trade, it is important understand the victimless nature of drugs. Although many supporters of prohibitionist policies often claim that drugs are not a ‘victimless crime’ because the family members and friends of drug users become the ‘victims’, they are still victimless in a definite sense. Drug trafficking and drug consumption are both voluntary transactions, unlike traditional crimes such as rape, murder etc. Both parties willingly participate in the transactions, hence these ‘drug crimes’ are less victimizing in their nature than traditional crimes. This is why governmental corruption is more likely to occur with drug related crimes rather than traditional crimes. Officials are more likely to “look the other way” in order to earn profits for themselves since ‘no one is getting hurt’.


Drug Prohibition and Violence

There has always been a relationship between drugs and violence, however the factors of causality are often misconstrued. The common misconception is that drugs cause violence, however by looking at both history and economic theory it becomes clear that it is the prohibition of drugs that causes the violence.


The story of Alcohol Prohibition.

Under the 18th Amendment to the Constitution, the production, sale and transportation of alcohol (for purposes of consumption) were made illegal in the U.S. This ban lasted from 1920-1933 and inevitably gave rise to bootleggers who illegally produced and distributed alcohol in the black market. Prohibition far from eliminated the consumption of alcohol; it just transferred the industry from legitimate control to the hands of organized crime. During this time, underground gangsters such as Al Capone earned staggering revenues from the illicit alcohol trade, which were used to fund other criminal activities, such as suborning officials. An unintended but obvious consequence of the prohibition was violence. The most notable example of this was the St. Valentine’s Day Massacre (1929) where Capone had organized for the assassination of several individuals working for Bugs Moran (Capone’s rival in the illicit alcohol trade). Had the ban on alcohol remained till this day, the alcohol trade would be just as violent as the heroine and cocaine trade are. Now that alcohol is legal, the alcohol trade is in the hands of legitimate business owners who gain market share by either cutting prices or improving the quality of their products, both of which benefit the consumer. No organization in the alcohol trade would ever think of using violence to gain customers.

The only types of businesses that exhibit this kind of violence are those that are legislatively prohibited such as prostitution, gambling and of course the drug trade. The prohibition of alcohol provides a great historical example of how prohibitionist policies inevitably lead to violence, not the product itself.


Prohibition increases the Marginal Benefits of Violence[5].

In a market absent of prohibition, competition leads to lower prices and increased quality, however this market mechanism doesn’t occur efficiently or in most cases even at all under unsanctioned markets. For example, in the electronics industry if Samsung loses/gains a customer to/from Sony, it’s not that big of a deal. This one customer or even a hundred customers aren’t too significant to the company’s bottom line. However if a drug dealer gains or loses a customer it is a big deal. One customer can mean a significant amount of revenues, which is magnified by the fact that most drug users are repeat customers and that drug dealers have relatively low variable costs. Therefore, using violence to hinder or even kill rivals to gain market share has a much higher benefit then it otherwise would if prohibitionist measures were not in effect, thus we can say that the marginal benefit of using violence is increased.


Prohibition decreases the Marginal Cost of Violence[6].

Following up on the Samsung and Sony example, a Samsung executive would never use violence to threaten Sony because as mentioned before it isn’t worth it (the profit from gaining couple of customers just isn’t high enough) and secondly, the cost to do such a thing is very high. The Samsung executive most likely has a family that he cares for, has friends in respectable social groups, lives a legitimate life, pays his taxes and so on. Using violence greatly threatens his way of life; if he goes to jail he loses all the things he once had and cherished, therefore making the use violence very costly to someone who operates a legitimate business. However, in the illegitimacy of the drug trade, the riskiness of using violence bears less weight taking into account the fact that the drug dealer has already engaged in a number of crimes that could have him or her put away for the rest of their lives! We can also postulate that it is much easier to use violence as means to an end since an individual engaged in illicit activities would have most likely developed a network of criminals whereas a legitimate business owner would have no such connection (presumably). Thus, we can say, that the marginal cost of using violence is lower than it otherwise would be in an industry absent of prohibition. If prohibition were to be lifted, legitimate drug dispensing businesses could operate even in the shadiest streets and neighbourhoods just as liquor stores operate using safety measures like bulletproof glass.


Prohibition fosters subcultures of violence.

A good question to ask is whether or not the individuals who deal drugs in an illicit market would still continue to do so if the market was legitimized.  By turning the market of drugs illicit, prohibition inadvertently drives away legitimate businessmen into other businesses. This creates an opportunity for profit seekers to enter the market, and the individuals attracted to this opportunity may not be businessmen in the conventional sense. They might not have the skills to compete with legitimate entrepreneurs in a sanctioned market but in an illicit market they may posses the necessary ‘criminal skills’ to succeed.  So it’s no wonder that individuals who are more likely to use coercion and corruption as business tactics are more likely to enter this market. If prohibition were to be removed, legitimate businessmen enter the market and through the mechanism of competition drive out all of their miscreant competitors.


Prohibition encourages Consumer Violence.

Considering that the demand for drugs is inelastic the increase in price resulting from prohibition will largely leave its consumer demand unscathed. Addicts of any sort can and will utilize any means to get their ‘fix’, and if they don’t have the monetary resources to finance their addiction there is the very probable chance that they will resort more delinquent means such as violence and robbery. Thus, prohibition not only increases violence from the producer but from the consumer as well.


Prohibition and Drug Safety

Seeing as how prohibition limits the supply of drugs and increases the risk faced by both the dealers and consumers, there is a tendency for illicit drugs to become more dangerous during times of prohibition. The increased risks lead drugs to become more and more potent over time, as this allows for fewer transactions to be made and ‘more bang for your buck’. For example, alcohol during prohibition was much stronger than alcohol before prohibition; in some cases a given volume of bootleg alcohol had up to a ten times higher alcohol concentration than legitimate alcohol before the ban. This phenomenon was coined the “Iron Law of Prohibition” by economist and activist Richard Cowan. Furthermore, since illicit drugs aren’t produced by any reputable firms, aren’t held up to any regulatory standards and are usually produced by individuals in unsanitary conditions, the purity of these drugs are often lacking. This could be why after alcohol prohibition came into effects; deaths due to alcohol consumption initially decreased by 10-20% but then rose sharply over 50% according to some estimates[7].


Cost of Prohibition

The cost of enforcing prohibitionist drug policies is staggering. In Canada alone drug enforcement policies cost taxpayers $5.4 Billion in 2002 and this number has been increasing. Furthermore, the amount of individuals incarcerated for drug related crimes would decrease thus lessening the costs of prison related expenditures. If we abrogate prohibitionist policies, the funds that were initially allocated to drug enforcement will be available for more worthwhile causes such as tax breaks for the public and protection of private property.


Things to remember…

  • There is a distinction between acts that are illegal and acts that are immoral. Therefore it is perfectly acceptable to support drug legalization yet rebuke the use of illicit drugs (just as one could chastise cursing but be against legally punishing those who curse).
  • Prohibitionist policies tend to raise the prices of drugs, the revenues earned from the drug trade combined with the ‘victimless’ nature of drugs leads to corruption of officials
  • Prohibitionist policies cause the marginal cost of using violence to decrease while increasing its marginal benefit and lower the safety of the product as well

As Will Rogers once wittingly stated, “Instead of giving money to fund colleges to promote learning, why don’t they pass a constitutional amendment prohibiting anybody from learning anything? If it works as good as the Prohibition one did, why, in five years we would have the smartest race of people on earth.” The prohibitions of voluntary-mutually beneficial activities are destined to fail.

Written by Gaurav Mehra, Twitter:@g__mehra Email:

For a more details on the arguments provided in this article please see Lessons for the Young Economist (CH.20) by Robert P. Murphy and Making an Economic Case for Legalizing Drugs by Jeffery A. Miron and Katherine Waldock.


[1] Many of the arguments presented in this article summarize those presented by Robert Murphy in his book Lessons for the Young Economist. Note* The word drug refers only to illicit drugs and the term officials refers to anyone with legitimate power affecting the drugs trade such as government employees, politicians and law enforcement agents.

[2]  The Law of Supply and Demand is at the base of economics. In graphical representations, the supply line represents the quantity of a product that is produced or supplied at a given price. Similarly, the demand line represents the quantity demanded of a product at a given price. The point of intersection of these two lines represents the market equilibrium, where the price and quantity produced of the product is at its most efficient point, where demand meets supply (no surplus or shortage). There is movement along the demand/supply curves if there is a change in price. There is a shift in the demand/supply curve if factors other than price affect the supply or demand of product.

[3] Inelastic demand simply means that when the price of a good increases or decreases, the demand for the good stays relatively the same. Ex. A diabetic would purchase the almost the same amount of insulin regardless of if it cost $1 or $50.

[4] Although these numbers are hypothetical they are representative of actual price, quantity and demand changes.

[5] Marginal Benefit: Increase or decrease in an activity’s overall benefit caused by a unit increase or decrease in the level of that activity, all other factors remaining constant.

[6] Marginal Cost: Increase or decrease in an activity’s cost whether quantitative or qualitative caused by a unit increase or decrease in the level of that activity, all other factors remaining constant.

[7] The American Economic Review, Vol. 81, No. 2, pp. 242-247, (May 1991).

Twitter: @g__mehra

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One Response to “The Economic Consequences of Drug Prohibition”

  1. For those fluent in Spanish, a great discussion on the topic, by Prof. Jesús Huerta de Soto:

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