The United States has spent more than $1 trillion since President Richard Nixon formally declared the war on drugs in 1971. Yet Americans continue to spend heavily on illicit substances, buying $150 billion worth of cocaine, heroin, marijuana and meth annually. For 2020, the federal government requested $35.1 billion for the National Drug Control Budget. It's worth asking: is this money well spent?
Viewed through a cultural or moral lens, there may be a reasonable argument for the prohibition of dangerous drugs. When viewed through an economic lens, the war on illegal drugs is less convincing. Basic economic analysis can show why most prohibitions fail to realize their intended goals and why making drugs illegal may actually benefit drug producers and suppliers at the expense of everyone else.
Economics of Black Markets
The economic patterns of illicit drugs follow the same principles of any illegal good or service with a reasonable real demand. There is nothing special about the production or distribution of popular illegal drugs: heroin, LSD, cocaine, ecstasy, amphetamines, meth and marijuana. This puts illegal drugs in the same category as undocumented immigrant labor, prostitution, the market for body parts (such as kidneys,) firearms inside gun-free jurisdictions or even alcohol during prohibition. Put together, these goods and services constitute the black market.
Black markets work differently from normal markets. A black market naturally exhibits several tendencies of monopolistic markets or markets with uncertain contract protections. This includes high barriers to entry, lack of recognizable contract law and uncertain property rights. In black markets, powerful producers can experience super-normal profits by limiting competition and restricting output.
Another disadvantage that is a feature of black markets, especially in the illegal drug market, is that consumers tend to be captives of the underground economy without legal or medical recourse. Addicts who use heroin cannot simply seek treatment for their addiction without fear of significant consequences. Thanks to a lack of marketing and restrictions on competition, the addict does not know if there are alternative products that might be safer or less expensive. Moreover, the addict can rarely challenge a producer who cheats, causes harm or commits fraud. All of those features encourage over reliance on a single substance or producer.
Winners and Losers
In 2014, the London School of Economics released a report entitled "Ending the Drug Wars." The report used standard economic analysis to show how the global strategy of drug prohibition had "produced enormous negative outcomes and collateral damage," including "mass incarceration in the U.S., highly repressive policies in Asia, vast corruption and political destabilization in Afghanistan and West Africa, immense violence in Latin America, an HIV epidemic in Russia, and an acute global shortage of pain medication," among other "systematic human right abuses around the world."
The report included signatures and contributions from dozens of leading economists and political figures, including five Nobel Prize winners; Professor Jeffrey Sachs of Columbia University; Nick Clegg, the then-deputy prime minister of the United Kingdom; and Aleksander Kwasniewski, the former president of Poland. They seemed to agree that the losers of the illegal drug market included virtually everybody who was not involved in producing illegal drugs.
This makes sense, at least from an economic perspective, because the only net winners in an anti-competitive or monopolistic market are those who have the privilege of producing the anti-competitive good. Illegal drugs receive an incredible markup compared to legal goods precisely because they are illegal. The London School of Economics estimates that cocaine and heroin receive a markup of nearly 1,300% and 2,300%, respectively, when exported. This compares to a 69% markup for coffee or 5% markup for silver.
Not only do those extraordinary markups create super-normal profits for producers and suppliers, but they also decrease spending everywhere else in the economy. Someone who has to pay 2,000% markups to buy their drug of choice is forced to decrease spending on other goods and services, and probably suffer a loss in productivity and income potential as well. The truly catastrophic opportunity costs, however, are reserved for the governments waging war on illegal drugs and their taxpayers.
Impact on Taxes and Spending
For fiscal year 2020, the federal government requested $35.1 billion for the National Drug Control Budget, which aims to prevent drug use and ameliorate its consequences in the U.S. However, this money could be saved, and billions in new tax revenue could be generated by legalizing drugs. Scholars Jeffrey Miron and Katherine Waldock, in their paper "The Budgetary Impact of Ending Drug Prohibition," estimated that legalization would save federal and state governments $41.3 billion per year, while generating $46.7 billion annually in tax revenue.