Saving Mexico

To Weaken The Cartels, Some Argue The U.S. Should Legalize Marijuana, Let
Cocaine Pass Through The Caribbean And Take The Profit Motive Out Of The
Drug Trade

In the 40 years since U.S. President Richard Nixon declared a "war on
drugs," the supply and use of drugs has not changed in any fundamental
way. The only difference: a taxpayer bill of more than $1 trillion.

A senior Mexican official who has spent more than two decades helping fight
the government's war on drugs summed up recently what he's learned from his
long career: "This war is not winnable."

Just last week, Mexican Navy Special Forces swarmed a luxury apartment
tower in a central city and gunned down Arturo Beltran Leyva, a drug
trafficker whose organization helped smuggle several billion dollars worth
of cocaine and marijuana into the U.S. during the past decade, according
to the Drug Enforcement Administration.

Within days of Mr. Beltran Leyva's death, Mexican officials were already
trying to guess which of his lieutenants would take his place. Almost no
one expected the death of Mr. Beltran Leyva to slow down the business of
drug trafficking or the horrific drug-related violence in Mexico that has
claimed around 15,000 lives in the past three years. On Monday, hit men
gunned down several family members of a Mexican naval officer who had been
killed in the Beltran Leyva raid. Four people have been arrested in
connection with the killing, though Mexican authorities say the hit men are
still at large.

Growing numbers of Mexican and U.S. officials say--at least
privately--that the biggest step in hurting the business operations of
Mexican cartels would be simply to legalize their main product:
marijuana. Long the world's most popular illegal drug, marijuana accounts
for more than half the revenues of Mexican cartels.

"Economically, there is no argument or solution other than legalization, at
least of marijuana," said the top Mexican official matter-of-factly. The
official said such a move would likely shift marijuana production entirely
to places like California, where the drug can be grown more efficiently and
closer to consumers. "Mexico's objective should be to make the
U.S. self-sufficient in marijuana," he added with a grin.

He is not alone in his views. Earlier this year, three former Latin
American presidents known for their free-market and conservative
credentials--Ernesto Zedillo of Mexico, Cesar Gaviria of Colombia and
Fernando Henrique Cardoso of Brazil--said governments should seriously
consider legalizing marijuana as an effective tool against murderous drug
gangs.

If the war on drugs has failed, analysts say it is partly because it has
been waged almost entirely as a la w-and-order issue, without understanding
of how cartels work as a business.

For instance, U.S. anti-drug policy inadvertently helped Mexican gangs
gain power. In the late 1980s and early 1990s, the U.S. government
cracked down on the transport of cocaine from Colombia to U.S. shores
through the Caribbean, the lowest-cost supply route. But that simply
diverted the flow to the next lowest-cost route: through Mexico. In 1991,
50% of the U.S.-bound cocaine came through Mexico. By 2004, 90%
did. Mexico became the FedEx of the cocaine business.

That change in the supply chain came as Colombia waged a successful war to
break up the country's Cali and Medellin cartels into dozens of smaller
suppliers. Both moves helped the Mexican gangs, who gained pricing power
in the market. Before, the Colombian cartels told Mexicans what price they
would pay for wholesale cocaine. Now, Mexican gangs play smaller Colombian
suppliers off of each other to get the best price. Mexican gangs are
"price setters" instead of "price takers."

Some Mexican officials say privately that the U.S. should seriously
consider allowing cocaine to pass more easily through the Caribbean again
in order to squeeze Mexican gangs. "Would you rather destabilize small
countries in the Caribbean or Mexico, which shares a 2,000-mile border with
the U.S., is your third-biggest trading partner and has 100 million
people?" one official said.

Today, the world's most successful drug trafficking organizations are found
in Mexico. Unlike Colombian drug gangs in the 1980s, who relied almost
entirely on cocaine, Mexican drug gangs are a one-stop shop for four
big-time illicit drugs: marijuana, cocaine, methamphetamines and
heroin. Mexico is the world's second biggest producer of marijuana ( the
U.S. is No. 1 ), the major supplier of methamphetamines to the U.S., the
key transit point for U.S.-bound cocaine from South America and the
hemisphere's biggest producer of heroin.

This diversification helps them absorb shocks from the business. Sales of
cocaine in the U.S., for instance, slipped slightly from 2006 to 2008. But
that decline was more than made up for by growing sales of methamphetamines.

In many ways, illegal drugs are the most successful Mexican multinational
enterprise, employing some 450,000 Mexicans and generating about $20
billion in sales, second only behind the country's oil industry and
automotive industry exports. This year, Forbes magazine put Mexican drug
lord Joaquin "Shorty" Guzman as No. 401 on the world's list of billionaires.

Unlike their rough-hewn parents and uncles, today's young traffickers wear
Armani suits, carry BlackBerrys and hit the gym for exercise. One drug
lord's accountant who was arrested in 2006 had a mid-level job at Mexico's
central bank for 15 years.

Recently, Mexico's deputy agriculture minister, Jeffrey Jones, told some of
the country's leading farmers that they could learn a thing or two from
Mexican drug traffickers. "It's a sector that has learned to identify
markets and create the logistics to reach them," he said. Days later,
Mr. Jones was forced to resign. "He may be right," one top Mexican
official confided, "but you can't say things like that publicly."

Mr. Jones says he stands by his comments.

Because governments make drugs illegal, the risk associated with
transporting them translates to high rewards for those willing to take that
risk. The wholesale price of a single kilo of cocaine, for instance, costs
$1,200 in Colombia, $2,300 in Panama, $8,300 in Mexico, and between $15,000
and $25,000 in the U.S., depending on how close you are to the Mexican
border. At a retail level on the streets of New York, it can run close to
$80,000. With markups like that, the business is bound to keep attracting
new entrants, no matter what governments do to stop it.

Governments also have a hard time stopping the drugs trade because, like
any good business, trafficking organizations innovate and adapt. Mexican
customs has stumbled upon a long list of ingenious methods to transport
cocaine, including one shipment of liquefied cocaine smuggled in red wine
bottles. Another recent bust yielded 800 kilos of cocaine--worth an
estimated $40 million--stuffed inside a batch of frozen sharks.

After Mexico restricted the importation of pseudoephedrine to slow the
manufacture of methamphetamines, drug gangs found another way to make the
drug using different, unrestricted chemicals widely used in the perfume
industry. "I've always thought these guys had a good research and
development arm," says one exasperated Mexican official.

Advocates for drug legalization say making marijuana legal would cut the
economic clout of Mexican cartels by half. Marijuana accounts for anywhere
between 50% to 65% of Mexican cartel revenues, say Mexican and
U.S. officials. While cocaine has higher profit margins, marijuana is a
steady source of income that allows cartels to meet payroll and fund other
activities.

Marijuana is also less risky to a drug gang's balance sheet. If a cocaine
shipment is seized, the Mexican gang has to write off the expected profits
from the shipment and the cost of paying Colombian suppliers, meaning they
lose twice. But because gangs here grow their own marijuana, it's easier
to absorb the losses from a seizure. Cartels also own the land where the
marijuana is grown, meaning they can cheaply grow more supply rather than
have to fork over more money to the Colombians for the next shipment of
cocaine.

Several U.S. states like California and Oregon have decriminalized
marijuana, making possession of small quantities a misdemeanor, like a
parking ticket. Decriminalization falls short of legalization because the
sale and distribution remain a serious felony. One of the big reasons for
the move is to reduce the problem of overcrowded and costly prisons.

While this strategy may make sense domestically for the U.S., Mexican
officials say it is the worst possible outcome for Mexico, because it
guarantees demand for the drug by eliminating the risk that if you buy you
go to jail. But it keeps the supply chain illegal, ensuring that organized
crime will be the drug's supplier.

Making pot legal might actually increase violence south of the border even
more in the short term, with drug gangs fighting over a smaller economic
pie of the remaining illegal drugs. But it would eventually reduce the
overall financial clout of cartels.

If more radical options like legalizing prove impossible, then some
analysts say Washington and Mexico City should at least refocus the battle
against drugs along economic lines.

Until recently, Mexican police almost never looked at a cartel's
finances. During a 2006 raid of a drug traffickers Mexico City home,
police found a hand-written ledger describing the cartel's cocaine business
for a single month: the price paid to Colombian suppliers ( $3,500 per kilo
), the sale price here in Mexico ( $8,200 per kilo ) and the cartel's net
profit of $18 million. Police didn't bother to keep the piece of paper,
according to people who participated in the raid.

"We've been attacking the players rather than attacking the industry. We
need to focus on shrinking their markets and raising their operating
costs," said Alberto Islas, a 40-year-old with an economics degree from MIT
who runs a private security consulting company in Mexico City.

For the first time, Mexico's government is paying more attention to drugs
as a business. A new 2% tax on cash deposits greater than $1,250 in bank
accounts gives tax authorities a better picture of Mexico's cash
economy--the currency of the drugs trade. Just this year, authorities
found five people with unexplained cash deposits of more than $4 million,
including one from a man who doesn't even have a formal job.

Mexican customs is also trying--for the first time--to disrupt the flow of
guns and money that return from the U.S. to Mexico in exchange for the
drugs. Disrupting that flow is crucial to cartel finances: Mexican gangs
send drugs north, and get cash and guns in return.

For decades, people crossing into the U.S. from Mexico have been subjected
to rigorous checks, but Mexico never bothered to check people coming back
from the other direction. Now, cars coming from the U.S. will be blocked
by a mechanical arm. License-plate photographs will be run against a
criminal database in Mexico City, while a scale and vehicle-scanning system
will determine if the car may be overloaded with contraband. Dogs trained
to locate weapons and money will roam the area.

"Cash is king. Every bit of money we seize hits the cartels directly on
the bottom line," says Alfredo Gutierrez Ortiz, the head of Mexico's tax
authority.

But Mr. Gutierrez has also been around long enough to know Mexico is not
going to stamp out the drugs trade here entirely.

"We must raise the transaction cost, make it too expensive for them to use
Mexico as an export platform relative to other countries," he said. "But
the demand itself--well, that's not going to go away."