It brings in over $500 billion a year, with a sophisticated international supply chain constantly churning out the most addictive products on the planet. That sentence could be about the smartphone market – but we’re here to talk drugs.
Yes, drugs. The illegal substance sector is easy to ignore – it exists in the shadows by design, after all. But the drugs industry’s size rivals that of many legitimate ones. An estimated $426 billion to $652 billion was spent on illegal drugs in 2017, although solid data is unsurprisingly difficult to come by. The recreational remedy racket’s real value could be much higher.
All that money has led to big business: a network of international criminal organizations that secretly produce and process drugs, smuggle them over oceans and across borders, and set up hyper-efficient delivery systems to ensure the anxiety-riddled hyper-consumers of 21st-century society can indulge in blissful oblivion – or at least a fit of the giggles.
All this is a world away from your stoner friend’s greenhouse: the drugs industry is dominated by big, slick, and ruthless organizations. Whether it’s the Mexican Sinaloa Cartel delivering Colombian cocaine to Wall Street bankers or the Sicilian Cosa Nostra shifting heroin around Europe, these gangs are basically multinational companies.
Why should I care? Any big industry affects your life – and drugs is no exception. Even if you don’t dabble yourself (and a pretty significant number of people do), your finances will to some extent be tied to the drug world. Your taxes fund drug prevention, rehabilitation, and punishment measures, and we all have to deal with the negative effects of drugs in our communities – whether increased crime rates or overburdened health services.
Economics, which is ultimately about how people make purchasing decisions, can tell us a lot about how to tackle drugs (as you’ll learn in this Pack, the current approach of most governments is not popular with economists). By understanding how the market works, as well as the case for legalization, you’ll have a better idea of what you think society should do about drugs. And as an added bonus, it’s a fascinating industry. We’ll make the economics so fun, your brain won’t be interested in a body high.
So let’s kick things off: how exactly does the drugs market work?
The takeaway: Economics can help tell us what to do about the $500 billion market for illegal drugs.
Give me a breakdown of the illegal drugs market.There are four main players. Cannabis is the biggest, with about 43% of total market value – probably because it’s seen as a safer drug. The next largest is cocaine (around $100 billion in annual sales), closely followed by non-prescription opiates, and then amphetamine-type stimulants (ATS) like ecstasy/MDMA and meth.
Where do they come from? Cannabis can be found basically anywhere: according to the UN, it’s grown in 159 countries around the world. And the chemicals used to manufacture synthetic drugs are equally widespread. Opiates, however, are more scarcely produced: only 50 countries cultivate opium poppies, with Afghanistan and Myanmar as the two biggest producers. Cocaine has the most concentrated production of all: the coca plant only flourishes at certain altitudes and in certain humidities. Three countries account for all coca cultivation – 70% comes from Colombia, 20% Peru, and 10% Bolivia.
What happens next?First up is processing: the plants (or chemicals) need to be turned into the actual drugs. Once transformed into pills, powder, or puff, these are packaged up and sold by the processors to cartels and mafias. They’ll ship the drugs around the world, smuggling them in vast quantities on boats, trucks, and planes. The gear is then sold on to smaller gangs in individual countries – and eventually, via street dealers, to end users.
As drugs make their way down the supply chain, their value shoots up. According to the London School of Economics, a standard 0.2g serving of Colombian cocaine (recommended daily consumption: 0g) costs around $0.54 to produce. The wholesale price of that same powder is $7.40. A street dealer will pay $14.20 – but the end user pays a whopping $35. That’s a markup of over 6,000% (compared with 635% for coffee, Colombia’s other prized export). And if you’re getting it cheaper, it’s probably cut with all sorts of nasties...
Why’s the markup so high? Because it can be. Illegal drugs are scarce – partly because they’re hard to produce, but mostly because they’re, well, illegal. The risk of being arrested for making or distributing drugs adds a “cost” to the trade, so not that many people do it. It’s hard for new organizations to start up too: the barriers to entry are even higher than in other industries. Building relationships with producers, establishing multinational distribution networks, and finding end users (beyond freeloading friends) isn’t easy. And even if a new kid does manage to get on the block, if they encroach on a drug cartel’s territory, they’ll probably get whacked.
Thanks to the globally high demand for drugs, suppliers enjoy an almost monopolistic position: they can charge massive prices because the buyers have nowhere else to go. To make matters worse, many of these users are addicted and will pay up no matter the cost. In economics jargon, we’d say addicts’ consumption is “price inelastic”: demand doesn’t vary much with price.
So are all drug dealers rich? Nope. The illegality adds actual costs to drug trafficking – a lot has to be spent on disguising products and bribing people to make sure the dope reaches the dopes. And according to some research, the market is competitive at street level: heroin users compare notes on which dealers have the best products, for example. Furthermore, at the very lowest rung of the drug-dealing pyramid, there’s a lot of available labor: kids may be dazzled by the glamor of top dealers’ lifestyles or the opportunity to pay for their own habits.
In Chicago, to take one example, the foot soldiers – the people that actually hang out by the bars and sell drugs – earn just $3.50 an hour. They put up with it because they want a shot at one day becoming the bosses, who do earn six-figure sums. Sound familiar?
How is the drugs market changing? The drugs market is facing similar changes to the rest of the economy: democratization and digital disruption are turning everything on its head.
Tastes are also changing. While production is increasing, heroin and cocaine’s market share is declining. Users are instead turning to synthetic drugs like fentanyl (the driver of the current US opioid epidemic) which offer similar but more reliably powerful highs. That’s already having an impact: demand for Myanmar’s opium has reduced because meth is more in vogue among Asian consumers.
As that trend plays out across the globe, it could dramatically reshape crime networks. As we saw last session, geography is a major barrier to entry for would-be peddlers. But synthetic drugs can be produced anywhere. That might spell disaster for the big international cartels, who – like department stores – face becoming middlemen cut out by a more “direct-to-consumer” model.
Are there any other threats to traditional drug dealers? The internet and cryptocurrencies could lead to some massive changes. Despite the demise of the infamous Silk Road, the “dark web” – which includes illegal marketplaces only accessible through special web browsers – accounts for $170 million to $300 million in sales a year.
These sites are (we’re told) almost identical to Amazon and eBay: you can see various sellers for any given product, filter by price and location, and leave reviews once you’ve got your fix. Prices are even quoted in dollars, although you typically have to pay with cryptocurrencies like bitcoin. As adoption of digital currencies grows and it becomes easier to use such platforms, sales may well rise further.
Buying drugs online offers a bunch of advantages. Buyers can more easily evade law enforcement, reviews from fellow users mean they know what they’re getting, and greater scrutiny has led to higher drug quality – a Spanish think tank found cocaine purity was 50% higher when bought online. And for dealers, it’s much safer to sell anonymously online rather than put yourself in the (literal) firing line of a competitor.
So just like Amazon, dark web marketplaces have become pretty popular. But unlike Amazon, their prices aren't lower than those of sellers on the street. There’s a mix of reasons for that: increased drug quality is the main one, as users are willing to pay more for a better high.
But selling online also comes with higher costs. Shipping is expensive and time-consuming: dealers can’t benefit from economies of scale, because they have to send each package from a different location to evade suspicion. Seeing as most street dealers don’t rent storefronts, online selling might actually be more expensive than traditional retail – the exact opposite of legitimate commerce.
That might be why many of the big drug cartels are yet to embrace the dark web, instead clinging to their traditional distribution channels like plastic wrap to some dodgy dust. But all this might change, with the move towards synthetic drugs disrupting the industry further: if anyone can synthesize LSD in their basement and sell it online, new entrants might flood the market. And the reduced violence involved in online dealing means it’s less likely to attract law enforcement. Some suspect that the cartels could be like bookstores in the early 2000s, completely oblivious to the existential threat on the horizon. And we haven’t even started on legalization yet...
The takeaway: As synthetic drugs and the dark web become more popular, cartels’ hold on the market might loosen.
What’s economics got to do with drug laws? Plenty. Economics allows us to model the effects of different government policies on markets: it’s why, for example, we use economic analysis to figure out what the minimum wage should be (more on that in a future Pack). And while drug policies have to weigh up moral and health considerations, they also fall within the pecuniary purview.
The aim of most anti-drug laws is to reduce drug consumption, but those laws are often counterproductive. Take one example from the UK. Since 2015, the law has punished people supplying “cutting agents” – other chemicals used to dilute drugs – with up to 20 years in prison. The law did change dealers’ behavior: they no longer dilute their drugs, because it’s not worth the cost of getting caught. Cocaine purity has soared in the UK, and some are concerned that a higher-strength product is creating more addicts – and more usage.
Other policies may have contributed to an increase in purity too. If more police are on the streets trying to intercept transactions, buyers are less likely to shop around and more likely to stick with the same dealer. But when customers are loyal, product quality goes up – a dealer isn’t going to risk ripping off a regular, after all. So more police = more potent drugs, oddly.
*How****can governments reduce drug consumption, then?*** Economics tells us there are two ways to reduce consumption of everything from milk to Mary Jane: either reduce the supply or reduce the demand. The “war on drugs” has tended to focus on the former by going after gangs. But this graph shows you why that doesn’t work:
As mentioned previously, drug demand (shown by the blue line) is relatively “inelastic”. So when the quantity of available drugs is reduced (shown by the red line), consumption only slightly decreases. And prices, crucially, rise more than quantity decreases: so the money dealers rake in (shown by the orange shaded area) actually increases.
That has knock-on effects: more cash for dealers leads more people to want to get into the market, which might then increase supply again. And according to one researcher, higher revenues may even spark more violence as dealers fight over drug money.
Traditional economics suggests that a less harmful way of tackling drugs would be to reduce demand – by effectively treating addiction and improving education about the dangers. That would likely have a bigger impact than trying to squeeze supply, and by decreasing dealers’ revenues, it should hopefully reduce violence too. It’s also a more efficient way of spending: it’s estimated that each dollar spent on treating addicts saves the US $7 that would have otherwise been spent in the justice system.
Does legalization work? From an economic point of view, it could reduce organized crime. Complete legalization would flood the market with suppliers, driving down prices and cutting off a key source of income for cartels and mafias. But those lower prices could also lead to increased consumption. This is all theoretical: there’s very little data on what actually happens when drugs are legalized. We know that cannabis legalization in Colorado and Washington led to reduced prices, and in Canada consumption increased – but no market has had legal weed (or anything else) for long enough to draw proper conclusions at present.
There’s more evidence about drug decriminalization. In 2001, Portugal decided that possession of small amounts of drugs for personal use would no longer be a crime (though dealing remained illegal). That seems to have worked: the number of drug-related deaths decreased from 80 in 2001 to 16 in 2012. The criminal justice burden was significantly reduced, while rates of drug use didn’t increase.
To conclude, drug addiction is every bit as complicated as the processes that get those drugs to users – but economics can help us understand what’s going on in the market, and how that might change in the future. If only more politicians subscribed to Finimize, eh?
The takeaway: Tackling drug demand is probably more effective than reducing drug supply.
🔹The international market for illegal drugs is estimated at around $500 billion
🔹Prohibition has led to high drug prices, and a market dominated by cartels
🔹But the internet and an increased preference for synthetic drugs might be about to change that
🔹Economics suggests that the best way to deal with drugs is to treat addicts, not pursue suppliers
Now that you’re a drugs expert, take our quiz!
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.