Simple Economics of the Social Costs and Benefits of the War on Drugs

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Project Summary:

The objectives of this project are to evaluate two approaches to the regulation of such harmful addictive substances as cocaine, heroin, and marijuana (hereafter termed drugs). The first approach is characterized by a regime in which the production and consumption of these substances are illegal and discouraged by government efforts aimed at destroying supplies and apprehending and punishing producers and consumers of these goods. These efforts raise price above the competitive or free market level. The second approach is a regime in which production and consumption of drugs are legal but subject to excise taxation. In addition, the government allocates resources to preventing the development of an illegal market. Put differently, it imposes a non-monetary tax in the illegal sector whose expected value exceeds the monetary tax in the legal sector. We will examine a number of properties of a model in which social welfare is maximized with regard to drug consumption and prices in the two regimes. This analysis yields analytical expressions for the optimal level of enforcement under each one and the optimal tax in the regime in which consumption is legal. An important component of our analysis is that we show the optimal price in a regime in which drug production and consumption are illegal or prohibited by law. Hence consumption can actually be smaller in the former case. We will conduct a full cost-benefit analysis of both regimes. For the drug war, this requires information on the difference between the social and the private value of consumption, the total costs of producing drugs, the costs incurred by the government in fighting the war including the costs of apprehending, convicting, and imprisoning offenders, and the effect of the war on price and consumption. Much of this information also is required in evaluating legalization and taxation. As part of this investigation, we will consider government incentives to enforce the war in a differential manner against consumers as opposed to producers and against producers of different sizes. We also will consider the effects of the war on the formation of cartels. If the price elasticity of demand for drugs is less than one in absolute value, the legalization regime is likely to be more effective than the drug war. Given inelastic demand, the combination of tax and enforcement result in a higher optimal price and less consumption than the drug war because the costs of the war are inversely related to the price elasticity. Since the price elasticity plays a key role in our analysis, we will estimate it for cocaine, heroin, and marijuana. We will use as outcomes the percentage of arrestees testing positive for each substance, the rate of hospital emergency room episodes associated with each substance, and the rate of patients receiving treatment for each substance in substance abuse treatment facilities. The data pertain to time series of city cross sections. As part of this research, we will investigate whether the substances at issue are substitutes or complements. In the former case, a reduction in the price of marijuana, for example, leads to a reduction in the consumption of cocaine and heroin. In the latter case, consumption of all three substances rise when the price of marijuana falls. The signs and magnitudes of these “cross price” effects are useful in studying a case in which marijuana but not other drugs is legalized.