Cocaine: The Complementarity Between Legal and Illegal Trade

• Date: 01 September 2014
• Published date: 01 September 2014
• Author: Francesco Flaviano Russo
• DOI: http://doi.org/10.1111/twec.12107

Cocaine: The Complementarity Between

Legal and Illegal Trade

Francesco Flaviano Russo

Department of Economics, University of Naples Federico II and CSEF, Napoli, Italy

[…] She Don’t Lie

J. J. Cale, Cocaine (1976)

1. INTRODUCTION

THE price of cocaine has decreased substantially over the past 20 years. In the United

States, the World’s biggest destination market, the average retail price for a gram was

184 dollars in 1990; 16 years later, the same gram fetched only 94 dollars. The pattern is sim-

ilar in Western European countries. In Spain, for instance, the average retail price decreased

from 110 dollars/g in 1990 to 56 in 2002. In Italy, it decreased from 160 dollars/g in 1992 to

84 in 2002.

I first show that this price decline, associated with more consumption, is indeed a move-

ment down the demand curve. Then, I show that this pattern is partly explained by a lower

cost to bring the cocaine to market, which is itself a consequence of an increase in interna-

tional trade.

I build on the intuition by Naim (2005), who first showed how globalisation provides

incentives to trade in illegal goods. The theory goes as follows. A typical and effective way

to smuggle an illegal good is hiding it in the shipment of some legally imported good. An

increased inflow of legal imports requires a bigger number of transporters. Since all legal

transporters can become smugglers, this implies a bigger supply of potential drug smugglers,

which drives down their equilibrium compensation. The increased number of legal transport-

ers is also associated with a smaller inspection probability at the border: a careful inspection

of all freights becomes more costly and difficult as their number grows. Therefore, for a con-

stant effort of the border authorities, the risk born by the smugglers decreases with imports.

A lower risk has two effects: the first is a lower risk compensation required by the smugglers.

The second is an increased number of transporters that become smugglers, which further

reduces their equilibrium compensation. Overall, an increase in imports determines a lower

smuggling cost for the illegal goods and therefore a lower market price.

I show that the data on the cocaine market in 15 OECD countries (from 1990 to 2006) are

consistent with this theory. Cocaine is an ideal illegal good to evaluate this theory, since the

coca bush, whose leafs are processed to become cocaine powder, grows only in Colombia,

Peru and Bolivia, and then exported to all destination markets. I run a regression of the price

of cocaine on a measure of imported goods, controlling, among other variables, for transporta-

tion costs and for the enforcing effort of the police. I find that an increase in imports is

statistically associated with a lower price of cocaine.

I would like to thank Tullio Jappelli, Larry Kotlikoff, Robert Margo, Laura Moretti, Andy Newman,

Daniele Paserman, Adrien Verdelhan, two anonymous referees and the seminar participants at the CSEF

and at the ME@VELIA for helpful comments on earlier drafts. All remaining errors are mine.

©2014 John Wiley & Sons Ltd1290

The World Economy (2014)

doi: 10.1111/twec.12107

The World Economy

My result is line with the findings by Costa Storti and De Grauwe (2009a). Building on

the same intuition and on a similar conceptual framework, they show that the lower price of

cocaine and opiates can be explained by a decreased intermediation margin in the drug market

due to globalisation. They propose a descriptive statistical analysis of the time series of drug

price, production and consumption, which allows them to highlight different specific channels

that relate globalisation to the price of cocaine and opiates. Differently from their work, I pro-

pose here a regression analysis to assess the total effect of globalisation on cocaine prices, but

I do not identify the single channels that they discuss. Despite the different empirical method-

ologies, we reach the same conclusions.

The theoretical, more general, insight of this paper is that legal and illegal trade are com-

plementary: one of the unintended consequences of globalisation is the stronger incentive to

engage in illegal trade.

Cocaine is just one of the imported illegal goods currently available on the black market.

It is perhaps a landmark example of a valuable smuggled good, but certainly not the only one

for which this theory should have empirical bite: illegal chemical products, cigarettes and

counterfeited goods like handbags, shoes and apparel, among others, should be also experienc-

ing similar price declines on the black market. Perhaps one of the most interesting examples

entails illegal immigration: if it is easier to hide drugs, or other illegal goods, then it must be

also easier to hide people. For instance, it must be easier or cheaper to find a truck driver

willing to hide an illegal immigrant (perhaps along a couple of pounds of other illicit sub-

stances) while crossing the Mexico-US border during peak hours. Not only because, especially

after the NAFTA agreement, the number of such truck drivers increased dramatically. A care-

ful inspection of all trucks will in fact significantly slow down the queues and impede trade,

going against the motivations that led the countries to sign the NAFTA agreement in the first

place (Naim, 2005; Glenny, 2008). Unfortunately, I am not able to provide a throughout test

of the complementarity theory and not only because of data availability: most of those other

illegal goods are not necessarily imported, which means that it is difficult to disentangle

the price movements due to the import channel from other confounding factors. The only

exception is opiate drugs, for which I propose a regression analysis that is supportive of the

theory.

The rest of the paper is organised as follows: Section 2 briefly summarises the related

economic literature. Section 3 provides a simple model that clarifies the conceptual frame-

work. Section 4 describ es the market for cocaine. Section 5 summarises all the regression

results. Section 6 discusses some alternative explanations of the cocaine price decline and

proposes an analysis of the interactions between the cocaine market and the market for

opiates. Section 7 concludes. The Appendix briefly summarises all the production steps

needed to transform coca leafs into cocaine and proposes an alternative model with similar

empirical implications.

2. RELATED LITERATURE

Economists have been paying attention to the illegal drug markets for more than 20 years.

On the theoretical side, Becker and Murphy (1988) developed the first model of ‘rational

addiction’ that explained several features of the consumption of addictive substances that were

previously thought to be inconsistent with the hypothesis of rational consumers. Following

this seminal paper, Orphanides and Zervos (1995) and Gul and Pesendorfer (2007) developed

richer and more sophisticated models of the consumption of addictive substances. In a later

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