War on drugs – focus on supply or demand?

I have blogged on this before but find it very useful in teaching Price Elasticity of Demand (see also mindmap at end of post) with my class. Tom Wainwright’s book “Narconomics: How to Run a Drug Cartel”is a useful source for discussion and he also wrote an article for the Wall Street Journal on “How economists would wage the war on drugs”. Essentially, the war on drugs is being lost. Badly. As Wainwright notes:

The number of people using cannabis and cocaine has risen by half since 1998, while the number taking heroin and other opiates has tripled. Illegal drugs are now a $300 billion world-wide business, and the diplomats of the U.N. aren’t any closer to finding a way to stamp them out.

This failure has a simple reason: Governments continue to treat the drug problem as a battle to be fought, not a market to be tamed. The cartels that run the narcotics business are monstrous, but they face the same dilemmas as ordinary firms-and have the same weaknesses.

El Salvador – a leader of one of the country’s two gangs has a human resource issue with high turnover of employees.

Mexico – the Zetas cartel franchises its brand like McDonalds which in turn has led to arguments over territory.

Rich countries – street corner dealers are struggle to compete on price and quality with the ‘dark web’. It is a similar scenario with Amazon.

To combat the drug trade governments have focused on restricting the supply. Each year acres of coca plants and manufacturing activities are destroyed but the price has remains around $150-$200 per pure gram for the past 20 years. How have the cartels managed to keep this price?

However, supply of drugs might not even be appreciably reduced when drug crops are targeted. Wainwright points out that:

1. Drug cartels are a monopsony – they are a single buyer of Andean coca leaves, so they have market power over the price of leaves (i.e. the cartels have the ability to strongly influence the market price of coca leaves). So if some crops are wiped out, the price is unlikely to rise because of the cartels’ market power.
2. The price of cocaine is so much higher than the crop input costs that even a large increase in crop prices would have little effect on the market price of cocaine (i.e. even a big increase in the price of coca leaves would lead to only a small shift in the supply curve for cocaine).

Also because of its addictive nature demand for drugs is relatively inelastic – the decrease in quantity demanded is less than the percentage increase in price. Therefore reduced supply and a higher price doesn’t change demand that much.

Demand-Side interventions seem to be a better option and they are also a lot cheaper. Weighing up reducing supply by destroying coca crops in remote areas against drug education in schools and you find the latter is a much more plausible option. Tom Wainwright’s explain this below in his talk to the Cato Institute below:

A dollar spent on drug education in U.S. schools cuts cocaine consumption by twice as much as spending that dollar on reducing supply in South America

Bigger loses have be inflicted on cartels with some US states making marijuana legal.

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Mozambique’s monopsony market goes nuts

The primary sector is seen as integral to assisting developing countries grow and raise their standard of living. For the Mozambican economy the cashew industry is an example of this – more than 40% of Mozambican farmers grow and sell cashew, and the processing sector provides formal employment to more than 8,000 individuals. Mozambique is currently the second largest producer in East and Southern Africa and has links with premium export markets, including the United States and Europe.

In the 1960’s the cashew nut industry in Mozambique was in good shape supplying over 50% of global supply and processed most of these domestically and thereby adding employment. However, with a civil war and the instruction from the World Bank in the 1990’s to remove controls and cut taxes on the exports of raw nuts, trading firms shipped out cashews and processed them overseas with significant job losses. But an about turn by the government in 2001 has seen:

• an export tax of 18-22% for raw nuts
• a 0% tax for processed kernels.
• a ban on exports during the first few months of the harvest

16 factories employing 17,000 people, which process about half the cashews sold.

However by having less competition amongst processors – a little like a monopsony market – farmers selling raw cashew nuts are finding that the price of their crop is being reduced by the smaller number of processors. Most cashew nut farmers are smallholders and the government seems to be oblivious to the 1.3m families for the sake of protecting processing jobs.

Monopsony – one buyer many sellers – other examples include:
– large supermarkets, who can dictate terms to smaller suppliers.
– buyers of labour in the labour market.

There is a dilemma for developing countries as when a primary industry starts to expand into the secondary stage of processing, government protection can hurt nut-growers. Just like the coffee industry farmers are at the mercy of a small number of middlemen in this case the processors monopsony power.

Source: Mozambique’s nut factories have made a cracking comeback –
The Economist 12th September 2019