Cutting Costs and Killing Consumers: A Look at the Cocaine Industry

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John Belushi, a brilliant actor known for his work in SNL, Animal House, and the Blues Brothers. He died at age 33 partially due to cocaine overdose. Content Source. Image Source.

A few weeks ago, our class talked about the usage of drugs and the market for illegal substances from the post, “Drugs Are Bad, M’kay?” This post brought up questions about the efficiency of drug regulation and the costs of incarceration. The post argued:

From a purely moral perspective, punishing the sale of plant material more harshly than we do most instances of manslaughter (and even some cases of murder) seems reprehensible.  Such a law makes equally less sense from an economic point of view.

Additionally, another post “Methonomics” commented on the usage of meth and the large return workers in the illegal drug industry make in exchange for a relatively short amount of time working. The author commented:

When comparing the amount of money made by a cartel member in a shipment, and the amount of money the average American makes in a given week, (around $1,000) the numbers are not even close. We can see that a cartel member even on the bottom of the food chain makes what an average American makes in months of work, all in one shipment in a matter of days.

From the consumer incarceration rates to the supplier profits and price-controlling power, it is clear that the illegal market for drugs seems to defy some of our basic economic foundations and produces economic anomalies. This post will therefore aim to explore some of the broader trends in the illegal market for drugs, most specifically, cocaine.

1. The Basic Supply & Demand for Drugs:

The United Nations Office on Drugs and Crime (UNODC) often publishes a World Drug Report analyzing the data compiled about drugs. Chapter 2 of the 2012 version, The Contemporary Drug Problem: Characteristics, Patterns, and Driving Factors (p.68), aims to discover trends in consumptions by analyzing data such as the prevalence of drugs, the age and gender of drug users, and the fluctuating prices of various drugs. Fig.9 represented below from the report shows the drug market via the supply and demand curves we have been using in class.

Screen Shot 2014-11-08 at 9.46.17 AM

The chapter noticed how dependent consumers would be more willing to purchase drugs  despite wide fluctuations in prices:

The behaviour of depend- ent users influences the demand curve by making it less price-elastic. Contrary to normal consumer behaviour, where price heavily influences demand (higher prices lead to lower consumption), in the short term, persons who are dependent on illicit drugs are usually not deterred by price increases. In the longer term, however, overall consump- tion will eventually decline if prices rise markedly as dependent users face increasing difficulties to finance their habit. Conversely, dependent users may increase their con- sumption once prices fall.

2. Economies of Scale & Cocaine

A 2012 article from Slate, “More Blow for Your Dough” examines reasons why cocaine production has gotten cheaper since the 1980s. The author used the argument for economies of scale, saying that the larger production scale of cocaine, with kingpins (crime bosses) investing in capital and technology has helped to lower the average total cost while increasing the quantity of cocaine produced.

Another report from Strategic Forecasting, Inc. (Stratfor), a global intelligence company, titled “Mexico’s Cartels and the Economics of Cocaine” aimed to understand the profit chain for cocaine as it passes from supplier countries into the United States. The image below from the article shows the inflation of price as cocaine travels across the continents.

The combination of lowering production costs with a strong control on prices can make the cocaine industry incredibly lucrative. The article commented:

Cocaine is a product that has a very limited and specific growing area. Consequently, that distinct coca growing area and the transportation corridors stretching between the growing area and the end markets are critically important. With a business model of selling cocaine at over 10 times the cost of acquisition — and even greater over the cost of production — it is not surprising that the competition among the various Mexican cartels for the smuggling corridors through Mexico to the United States has become quite aggressive.

3. Lower Prices & Market Trends for Cocaine

The World Drug Report 2012 (p.37) analyzed worldwide market trends for cocaine. Interestingly, due to a decline in cocaine manufacturing in Colombia (historically a main importer of cocaine for the United States), cocaine use is on the decline in the United States. Or, at least the report makes the connection that the falling level of seizures of cocaine indicates a decrease in usage (this data however, assumes that the ratio of seizures to actual consumption and production must stay the same).

Screen Shot 2014-11-08 at 9.48.29 AMOn the other hand, this research argues that cocaine usage in European countries has not fallen. One reason might be that European cocaine is mostly supplied by countries other than Colombia. But, the stronger argument is that suppliers in Europe are cutting the cocaine with weaker substances. A report in the Economist, “All cut up” summarized this finding and its effect on cocaine users. Suppliers are managing to keep the prices the same while decreasing the quality of their product. As this graph below from the same World Drug Report 2012 shows, the face-value price of cocaine in Western and Central Europe is incredibly stable, while the purity-adjusted price rises.

Screen Shot 2014-11-08 at 10.58.24 AMWhat does this mean for consumers? The Economist article argued that some cocaine users are merely learning how to purify their own cocaine, or asking for “Bolivian” or “Peruvian” cocaine in hopes that it will be more pure. Other cocaine users are merely switching to different and newer drugs on the market.

4. Conclusion

It shouldn’t come as a surprise that there is no clear answer to any of the questions brought up. The illegal drug market is as much social and political as it is economic. Interestingly, The National Bureau of Economic Research (NBER) has a piece titled, “Rethinking America’s Drug Policy.” This is an informative piece which might provide some great insight towards the next steps we should take when we consider the regulation and production of drugs.

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