At another event in a couple of weeks, I’ll be doing a presentation on the economics of prohibition. Researching the topic has caused me to doubt one of the traditional arguments for legalization, at least as it’s usually presented. (Just to be clear, I don’t doubt the wisdom of legalization in general. I have doubts about one specific argument.)
Stossel and others often make the following claim: drug prohibition restricts supply, drives up profits in the drug industry, and there high profits encourage violence. Now, a restriction in supply should drive up prices, but it doesn’t follow that profits will also rise. The supply curve represents costs of production, including costs associated with the risk of legal punishment and eradication of one’s product. To the extent that prohibition reduces supply, the reduction occurs because of a rise in (expected) costs, which means profits need not rise at all.
Indeed, if there are low barriers to entry into the drug industry – as appears to be the case – producers should continue to enter until they drive (expected) profits down to near-zero.
I suspect the reality is that ex ante profits in the drug industry are not very high. But many of the costs are actually expected costs, which result from the risk of punishment or product eradication. As a result, ex post profits exhibit high variance. The luckier, or perhaps cleverer, producers reap large profits because they haven’t gotten caught (much). The unluckier producers actually make losses, especially once you factor in lost life and liberty. Overall, the industry is not high profit, but high-risk high-return.
The connection to violence is also tenuous. Even if you buy the argument that prohibition inflates profits, high profits don’t generally breed violence in other markets. To explain the violence of drug markets, we must appeal to a different (and much stronger) pro-legalization argument: that illicit markets have to provide their own contract enforcement because they cannot rely on courts of law. Or, to put it simply, they have to hire thugs to beat up people who break their promises or fail to pay their bills.