Thursday, October 6, 2016

Excellent Paper on the Economics of Drug Prohibition by Gary Becker

So I wrote a few pieces a few months ago about the economics of deterring drug use. I found that essentially all of my arguments are covered in this paper by Gary Becker, Kevin Murphy, and Paul Grossman. The title is "The Economic Theory of Illegal Goods: The Case of Drugs." It's a basic microeconomic treatment of illegal drugs by the best micro guys in the world. I nearly titled this post "Gary Becker Got There First" but I thought that was a little obscure for some of my readers. It is very readable, in my opinion, even if you don't have much of an economics background. So please read for yourself if you find any of the claims in this post implausible or surprising. I was happy to see that a full, ungated pdf of the paper is freely available in the above link.

From the abstract:

Optimal public expenditures on apprehension and conviction of illegal suppliers obviously depend on the extent of the difference between the social and private value of consumption of illegal goods, but they also depend crucially on the elasticity of demand for these goods. In particular, when demand is inelastic, it does not pay to enforce any prohibition unless the social value is negative and not merely less than the private value.

He’s saying that it makes no sense to use criminal penalties to deter drug use, especially when demand is inelastic. “Inelastic demand” means that users aren’t very responsive to price changes, which is probably a pretty accurate description of most drug users. The condition at the end, the social value needing to be negative for prohibition to make sense, is essentially saying that external costs have to be so bad that they more than cancel the benefits to the user. Imagine that every time someone snorts cocaine, for every “unit of joy” enjoyed by the user some random victim feels two units of agony. This is a grossly unrealistic estimate (if it is anyone’s estimate) for the social harms caused by drug use, so it probably doesn’t make sense to ban any class of drugs. He’s not exactly saying the same thing as me, but I point out here that trying to ban or even deter a substance with inelastic demand is a losing game, at least from the viewpoint of the drug users. We aren’t helping them. For every one we deter, we make the remaining ones so much worse off that it’s not worth it.

More from the abstract:

We show that a monetary tax on a legal good could cause a greater reduction in output and increase in price than would optimal enforcement, even recognizing that producers may want to go underground to try to avoid a monetary tax. This means that fighting a war on drugs by legalizing drug use and taxing consumption may be more effective than continuing to prohibit the legal use of drugs.

I argue as much in previous posts (see here and here). The basic intuition here is that it’s better to deter drug users with a tax, which transfers value from one person to another, than with a penalty, which destroys value. These are two ways to hurt drug users, and only in the “tax” case does society at large collect the value of the harm done to users and dealers. A penalty is akin to taxing the drugs and then throwing away the revenue.

…when demand for drugs is inelastic, total resources spent by drug traffickers will increase as the war increases in severity, and consumption falls. With inelastic demand, resources are actually drawn into the drug business as enforcement reduces drug consumption.

It’s worth pondering this for a moment. Basic economics explains why drug cartels are so powerful and well-funded. Hammering the suppliers harder will mildly increase the market price of drugs, but will draw more resources into drug production and redistribution. (For a very clear explanation of this point, see this great post by Benjamin Powell on Econlib. See the graph and accompanying explanation.) In human terms, this means more young people getting recruited into drug dealing and smuggling, with all the associated violence and all the drug mules dying with exploding balloons of cocaine in their bodies.  Also, perhaps less compellingly but still costly, resources are devoted to building clandestine labs for producing drugs along with ingenious contraptions, vehicles and even tunnels for smuggling. (This story came across my news feed just today.) We could just manufacture the drugs in a single, legal, auditable, regulateable factory and ship them in bulk legally on trucks. The added cost of doing these things clandestinely is a social loss that shouldn’t be overlooked.

After a thorough mathematical treatment, one section of the paper concludes:

The conclusion that with positive marginal social willingness to pay-no matter how small-inelastic demand, and punishment to traffickers, the optimal social decision would be to leave the free market output unchanged does not assume the government is inefficient, or that enforcement of these taxes is costly. Indeed, the conclusion holds in the case we just discussed where governments are assumed to catch violators easily and with no cost to themselves, but costs to traffickers…The optimal social decision is clearly then to do nothing, even if consumption imposes significant external costs on others.

This is kind of stunning. Without even stacking the deck in favor of legalization by making some “weird” libertarian assumption about government inefficiency, their argument implies that the optimal amount of drug enforcement is zero. We should leave drug dealers alone. The argument they are making specifically applies to enforcing legal penalties; in the next paragraph they contrast this with the case of setting an optimal tax.

The authors then show that their conclusion basically holds even if they relax their assumptions. (This is a very important step to any argument, by the way. There is always a thoughtless critic ready to point out that your assumptions don’t hold 100% (duh!), but they never then bother to show you what changes when you relax those assumptions. Best to preempt them.)

Even if demand is elastic, it may not be socially optimal to reduced output if consumption of the good has positive marginal social value…[some technical details, elasticity conditions, etc.]… It takes very low social values of consumption, or very high demand elasticities, to justify intervention, even with negligible enforcement costs.

Even if you significantly relax the assumptions, the conclusion that you should not enforce drug laws at all *still holds.*

The section concludes by reiterating:

…when demand is inelastic, total production costs rise as consumption falls, and enforcement costs rise more rapidly. With inelastic demand, a war to reduce consumption would be justified only when marginal social value is very negative. Even then, such a war will absorb a lot of resources.

The next section gives a treatment of trying to deter drug use (production actually, although deterring use is the ultimate goal) with taxes rather than penalties.

Our analysis shows, moreover, that using a monetary tax to discourage legal drug production could reduce drug consumption by more than even an efficient war on drugs. The market price of legal drugs with a monetary excise tax could be greater than the price induced by an optimal war on drugs, even when producers could ignore the monetary tax and consider producing in the underground economy…With these assumptions, the level of consumption that maximizes social welfare would be smaller if drugs were legalized and taxed optimally instead of the present policy of trying to enforce a ban on drugs.

In other words, a tax is far more efficient than a ban for achieving the goal of drug deterrence. You get less overall drug use, and society pays a lower price to achieve this goal.

The paper has much more to it. There  is some discussion of what types of firms are likely to exist in a legal vs illegal market; the authors note that under alcohol prohibition the firms that produced alcohol were very different from the ones that existed before and after. It wasn’t just the same companies operating in different kinds of markets. There is a somewhat throw-away section on peer pressure, which attempts to illuminate the reasons why young people might want to try drugs and why parents might want to stop them. This is Gary Becker, after all, who became a heretic in his field by applying economic analysis to the sacred realm of the family. Another section discusses the desirability of ad campaigns aimed at dissuading drug use. And a final section gives something of a public choice explanation of why we have sub-optimal drug policy. Read the whole thing. It’s very much worth pondering. Reading this reinforces my belief that legalization is a real no-brainer. I’m also pleased to see that some of my arguments were made more convincingly by someone else. It tells me I must have been on the right track.

The all-caveats-aside takeaway: A tax on drugs is strictly superior to a ban on drugs. The attempt to deter drugs with legal penalties is like taxing drugs at some high rate, then throwing away the tax revenue. The inelastic demand for drugs makes prohibition a strictly losing game. You can make these results go away by appealing to extreme, implausible assumptions, but that's grasping at straws. 

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