THE ECONOMICS OF DRUG PROHIBITION AND DRUG LEGALIZATION (Part 1)

I. Introduction

AROUND the world, the legal status of commodities such as marijuana,
cocaine, and heroin differs dramatically from that of nearly all other
goods. Most commodities are subject to substantial regulation and taxation,
but the production, distribution, sale, and possession of illegal drugs are
prohibited outright. Violation of these prohibitions is punishable by
lengthy jail terms, and many governments devote enormous resources to
enforcing these prohibition regimes.

The presumed justification for the special legal treatment of drugs is that
drug use causes substantial harm both to drug users and to society
generally. According to conventional wisdom, drug use diminishes the
productivity of the drug user, encourages violent and nonviolent crime,
contributes to moral degradation, damages the public purse, harms unborn
children, etc. The prohibition of drugs is assumed necessary to reduce the
consumption of drugs and thereby reduce the ills caused by drug consumption.

This paper explains that many of the harms typically attributed to drug use
are instead due to drug prohibition. This is not to deny that drugs can have
powerful effects on the user, nor to deny that drugs differ in some respects
from other commodities. But a wide range of outcomes typically thought to
result from drug use is far more accurately attributed to the current legal
treatment of drugs.

To make this case, the paper first presents an economic analysis of drug
prohibition and demonstrates how drug markets under prohibition compare to
drug markets under legalization. The analysis shows that many negative
outcomes typically attributed to drugs are the result of prohibition, and it
explains why these outcomes would be reduced or eliminated under
legalization. This analysis does not by itself imply that legalization is
preferable to prohibition; the analysis suggests that one effect of
prohibition is reduced consumption of drugs, and under some views this is a
desirable outcome. The analysis simply makes clear that some features of
drug markets and drug use are the result of drug prohibition-independent of
the physical or pharmacological properties of drugs-and it provides a
framework for thinking about the consequences of alternative policies.

The second part of the paper discusses the conditions under which drug
prohibition is likely to be the right public policy response to the negative
outcomes that can accompany drug use. Since most effects of prohibition are
undesirable, the main potential benefit of prohibition is any reduction in
drug consumption relative to what would occur under legalization. I discuss
different perspectives on drug consumption and how these relate to the
virtues, or not, of prohibition. The discussion explains that standard
arguments used to justify policies to reduce drug consumption are less
compelling than commonly asserted, even though drug use causes substantial
harm in some cases. The discussion also explains that, even if reducing drug
use is an appropriate public policy goal, other methods for reducing drug
consumption are available that potentially achieve a better balance between
the harms of drug use and the harms of drug policy.

The paper's third section discusses alternatives to prohibition and
legalization, such as sin taxation, subsidized treatment, medical provision
of drugs, needle exchanges, and public health campaigns. Many of these
policies can and do coexist with prohibition or legalization, but they are
distinct policies that require separate analysis. I show that each policy
has positive and negative aspects, and that evaluation of each depends on
views about drug consumption and on relevant evidence.

II. The Positive Analysis of Drug Prohibition

In this section I present what economists refer to as a "positive" analysis
of prohibition, meaning one that describes the effects of prohibition
without addressing whether those effects are good or bad. To conduct such an
analysis, one must compare prohibition to a particular alternative; here I
assume the alternative is the policy currently applied to most goods,
namely, legalization. Under legalization, drug markets would be subject to
standard tax and regulatory policies, but these would be no different than
those for coffee or ice cream. There are many alternatives to prohibition
besides legalization, such as sin taxation and subsidized treatment; I
abstract from these here for simplicity but discuss them explicitly in
section IV.

The Demand and Supply of Drugs under Prohibition and Legalization

The starting point for analyzing drug prohibition is the observation that
drugs continue to be supplied and demanded despite prohibition. This point
might seem obvious, but it bears repeating because so many policies,
statements by politicians, and even scientific analyses assume that what
happens under a law is whatever that law directs. Yet abundant evidence from
prohibitions of drugs, alcohol, gambling, prostitution, and other
commodities demonstrates that a sizeable fraction of the population
continues to supply and demand commodities that are prohibited. Thus, drug
prohibition creates a black market in drugs rather than eliminating drugs.

Even though prohibition does not eliminate drugs, it is likely to have
important effects on the operation of the market. In particular, prohibition
might affect the demand for drugs as well as the supply. I address each of
these in turn.

Prohibition potentially affects the demand for drugs through one of several
mechanisms. First, the mere existence of prohibition might reduce demand if
some consumers exhibit respect for the law. This mechanism does not appear
to be quantitatively important since abundant evidence suggests that many
people disregard laws that are weakly enforced. Second, prohibition might
encourage demand for the good through a "forbidden fruit" effect. There is
little concrete evidence to support this effect, although anecdotally it
appears plausible for some groups (for example, teenagers). Third,
prohibition might reduce demand directly by punishing purchase or possession
of the good.

The degree to which drug prohibition imposes penalties for purchase and
possession is arguably lax. Although more than 1 million arrests are
recorded each year for possession of drugs, there are more than 20 million
drug users, and most of these users have purchased drugs on many occasions.
Thus, the most obvious calculation-the number of arrests divided by the
number of drug purchases-suggests very low probabilities of being arrested
for mere purchase or possession. Moreover, many of the arrests for
possession occur because the arrestee violated some other law-against
prostitution, theft, speeding, loitering, disorderly conduct, and so on-and
was also found to possess drugs. The arrest was recorded as possession
partly because of FBI datakeeping practices (which suggest recording each
incident under the most serious category) and partly because possession is
easy to prove. Thus, otherwise law-abiding citizens who wish to purchase and
consume drugs face minimal risks of arrest or other sanction.

In addition to possibly affecting the demand for drugs, prohibition is
likely to have an effect on the supply. Prohibition increases the costs of
manufacturing, transporting, and distributing drugs, since suppliers must
take steps to avoid detection by law enforcement authorities. There is also
an indirect effect of prohibition on costs; conditional on operating in
secret, black market suppliers face low marginal costs of evading tax laws
and regulatory policies, and this gives them a cost-advantage relative to
legal suppliers. This provides a partial offset to the direct effects of
prohibition on costs; moreover, other mechanisms (such as differences in
advertising incentives, differences in enforcement, differences in market
power) might also offset the direct effects of prohibition. The existing
evidence suggests that net costs for drugs are higher under prohibition -
substantially higher in some cases (Miron, 2000).

The net implication of this analysis for the effect of prohibition on drug
use is therefore more nuanced than usually assumed. The presumption is
probably that prohibition reduces the quantity consumed, since the direct
effects on supply and demand go in this direction. But these are not
necessarily large, and there are indirect effects that go in the other
direction.

The evidence on whether drug prohibition significantly reduces drug
consumption is incomplete. There is no question that many people continue to
consume drugs under prohibition, but this fact alone does not determine
whether the quantity is different from what it would be under legalization.
A substantial social science literature exists that attempts to estimate
this effect, in some cases using evidence on prohibitions of other
commodities such as alcohol (for example, Dills and Miron, 2001). Overall,
this literature suggests that drug prohibition has modest but not dramatic
negative effects on consumption (see Miron, 1998).

The first-order effects of prohibition are therefore as follows: prohibition
probably raises the costs of supplying drugs, which implies higher prices
and lower consumption; and prohibition may reduce the demand for drugs,
implying lower prices and reduced consumption. Whether these effects are
large or small is not yet resolved.

Prohibitions and Crime

In addition to affecting the supply of and possibly the demand for drugs,
prohibition has numerous other effects. Probably the most important of these
is increased crime.

Prohibition increases violent crime by preventing drug market participants
from resolving their differences through standard nonviolent mechanisms. In
all markets, disputes arise between buyer and seller, supplier and
purchaser, employer and employee. In a legal market participants use courts
and related nonviolent mechanisms to resolve these disputes. In a black
market participants do not have this option because they would reveal their
identity and illegal activities to the authorities by using the courts, and
courts do not enforce contracts involving illegal goods. Suppliers in legal
markets can also use advertising to compete with rivals; this is difficult
in a black market, where violent turf battles are one possible substitute.

This simple prediction of economic reasoning is consistent with a
substantial body of evidence. The use of violence to resolve disputes is
common in drug markets and prostitution markets, and it was common in
gambling markets before the introduction of state lotteries and expanded
legal gambling combined to eliminate the black market. Similarly, the use of
violence to resolve commercial disputes in the alcohol trade was widespread
during Alcohol Prohibition (1920-1933), but rare both before and after
(Friedman, 1991). And the overall incidence of violence has increased and
decreased systematically over the past 100 years with enforcement of drug
and alcohol prohibition (Miron, 1999).

Prohibitions also encourage crime through several other mechanisms. By
raising the price of drugs, prohibition encourages income-generating crime
such as theft or prostitution, since users need additional income to
purchase drugs. And enforcement of prohibition diverts criminal justice
resources from deterrence of all kinds of crime (Benson and Rasmussen, 1991;
Benson et al., 1992).

The conclusion that prohibition causes crime contrasts starkly with the
usual claim that drug use itself causes crime. There is little evidence,
however, that drug use per se promotes violence or other criminal behavior
(Duke and Gross, 1993; U.S. Department of Justice, 1992). Considerable
evidence that purports to show such an effect merely indicates a correlation
between drug use and crime; the same methodology would suggest that wearing
blue jeans or eating fast food is criminogenic.

Other Effects of Prohibitions

Product Quality: A different effect of prohibition is decreased product
quality. In a legal market, consumers who purchase faulty goods can attempt
to punish suppliers with liability claims, by causing bad publicity, by
avoiding repeat purchases, or by reporting such events to private or
government groups. In a black market, most of these mechanisms are
unavailable, and the remaining ones (such as avoiding repeat purchases) are
likely to work less effectively. United States experience with alcohol
prohibition provides a classic example of this effect; deaths from
adulterated alcohol soared (Miron and Zwiebel, 1991; Morgan, 1982). In drug
markets, this effect potentially explains many accidental overdoses and
poisonings.

Corruption: In legal markets participants have little incentive to bribe the
police, and they have legal mechanisms such as lobbying or campaign
contributions by which to influence politicians. In black markets
participants must either evade law enforcement authorities or pay them to
look the other way, so the scope for corruption is substantial. Similarly,
standard lobbying techniques are more difficult for a black market supplier,
and campaign contributions are automatically illegal bribes. Thus,
prohibition increases corruption of law enforcement authorities and
politicians.

Redistributions to Criminals: In a legal market the income generated by
production and sale of drugs is subject to taxation, and these tax revenues
accrue to the government. In a black market, suppliers capture these
revenues as profits. Thus prohibition enriches the segment of society
willing to evade the law. The revenue involved is substantial; estimates
suggest the black market has revenues of tens of billions of dollars, so at
standard tax rates the government would collect at least several billion
dollars in additional revenues.

Complications of Policymaking in Other Areas: Because drug crimes involve
voluntary exchange, enforcement relies on asset seizures, aggressive search
tactics, and racial profiling, tactics that strain accepted notions of civil
liberty (see, for example, Schlosser, 1994a, 1994b). Because of prohibition,
many states prohibit the sale of syringes, which increases sharing of dirty
needles and thus promotes the spread of HIV. Because of prohibition,
marijuana is even more tightly controlled than morphine or cocaine and
cannot be used for medical purposes (Grinspoon and Bakalar, 1993). Because
of prohibition, foreign policy decisions and free trade negotiations are
intertwined with decisions about drug policy (see, for example, Barro,
1992).

Respect for the Law: All experience to date indicates that, even with
draconian enforcement, prohibitions fail to deter a great many people from
supplying and consuming drugs. This fact signals users and nonusers that
laws are for suckers; it undermines a spirit of voluntary compliance
essential to law enforcement in a free society.

Direct Costs of Enforcement: Expenditure across all levels of government for
enforcement of drug prohibition is currently at least $20 billion per year
and plausibly in excess of $30 billion (Miron, 2001a). This estimate
includes only those expenditures directly attributable to drug policy, not
auxiliary expenditures related to prohibition-induced crime.

Summary

Drug prohibition probably reduces drug consumption relative to what would
occur under legalization, but existing evidence suggests this reduction is
modest. But whether the effect is large or small, prohibition has many other
effects compared to legalization.