Wednesday, 1 July 2009

More from Kevin Murphy

More from the interview of Kevin Murphy in the The Federal Reserve Bank of Minneapolis's magazine, The Region, June 2009.


Region: What are the implications of rational addiction theory for public policy on currently illegal drugs—that is, enforcing prohibition versus legalization and taxation?

Murphy: There we started out from the point of view of how does an economist think about a prohibition? The way I think about prohibition, why does prohibition on drugs curtail drug consumption? Well, the primary way is it makes drugs more expensive. It raises the street price of drugs from what they would be if people could freely bring them into the country and freely distribute them. It raises the price by making them less available. If I want to get drugs, I can’t just go down to the supermarket or the drugstore and buy my drugs. I’ve got to go to a neighborhood, maybe it’s dangerous. I also have to worry about the strength and quality of the drugs. Am I going to get drugs that are tainted?

All those things make drugs more expensive than they would otherwise be. And what do we know about demand for any commodity, whether it’s drugs or haircuts or strawberries? You make them more expensive, people consume less. So our view of the world is that, basically the way drug policy works in the United States at least, is it tries to make drugs more expensive, less attractive, and cause people to consume less. In economic terms, it pushes us back up the demand curve. And rough estimates say we’ve quadrupled the cost of drugs relative to what they would be in a world without this interdiction.

If you quadruple the price of something, people are going to buy less of it. But, unfortunately, the way we bring about that quadrupling of price is by increasing the cost of supplying drugs. The amount of money people are spending on drugs is actually higher than it would be if the price were lower, because the demand for drugs is not very elastic.

Region: You’ve shifted the supply curve, and moved up the demand curve.

Murphy: Exactly. So think about a simple world where the elasticity of demand is about a half. You quadruple the price of drugs, and the quantity of drugs is cut in half. So you’ve got four times the price, half the quantity. You’ve doubled expenditures. People are spending twice as much and consuming half as much.

Well, where did that added expenditure go? It goes to the drug dealers. It doesn’t go to the government; it doesn’t stay with the consumers. It goes to drug dealers. And that revenue actually finances the supply of drugs and finances the drug lords who supply drugs to the United States. So what we’ve really done in this case is financed the people who are on the other side of the War on Drugs. So, the War on Drugs, in our view, has been kind of doomed by its basic economics. That is, the harder you fight the war, the higher you push up the price. The higher the price, the higher the revenue of suppliers; the higher the price, the greater the incentive to supply drugs to the United States.

Now, what are the costs to the suppliers? Well, they have to avoid detection. They fight over turf for drug territories. They pay people off. They may go to prison. All those costs are pretty much bad things. They use violence to enforce their contracts and the like. Not a good outcome.

But when you put people in prison, you have to consider not only does it cost society in the form of people in prison who could otherwise be gainfully employed, but it also costs us money to put them there. So for every dollar of cost we impose on the drug suppliers, we spend at least a dollar of our own money on top of it to keep them there. If we normalize what we would have spent in a free market on drugs at $100, consumers are now spending $200 on half the quantity of drugs and then spending another $100 on top of that to put all those people in jail. So we’re paying three times as much for half as much output. From an economic point of view, that’s more than a little bit counterproductive.

Usually you think, if I’m going to produce less output at least it should cost me less.

Region: So, rational addiction but irrational ...

Murphy: Irrational policy, right. So, what’s the answer? If you want to reduce consumption, raise the price. What’s the natural way to raise the price of something? Tax it.

Region: That is, something you want to discourage.

Murphy: Something you want to discourage, exactly. We want to discourage smoking, so we tax cigarettes. If we want to discourage greenhouse gases, we’ll tax carbon emissions. Whatever it is, if you want to discourage it, tax it. The advantage of that is, you get the same reduction in output; the cost of production rather than going up, goes down. It costs less to produce half as much output as it does to produce the full amount of output. And the extra money that would have been wasted is now going to the government in the form of tax revenues, which would allow us to reduce other taxes, or do other things.

So, a system where we make drugs legal and tax them makes a lot of economic sense relative to the current system. People say, wait a minute, we can’t make drugs legal. Don’t drugs cause all these horrible problems?

The problem is, most of the things that people point to when they talk about the horrible things generated by drugs are actually the horrible things generated by the War on Drugs. The violence and the corruption we have, and the corruption in foreign governments—that’s because drugs are illegal. If drugs were legal, we wouldn’t have a violence problem. We wouldn’t have tons of people in prison. Those people are there not because drugs did anything but because we made these things illegal. People still wanted them, and when people still want something that’s illegal, we have a black market. And if we imprison people who engage in a black market, we’re going to increase the size of the prison population and make all the associated expenditures.

We see that in the recent War on Drugs. We saw that with prohibition in the 1920s. It’s an old phenomenon. You may enact a prohibition, but it doesn’t get rid of demand. People still want the commodity. You’ve just forced production to occur in the black market, and when demand is inelastic—and that’s what’s key—when people are going to still demand it even as you push the price up, the black market is very inefficient, because you’re raising costs and expenditure at the same time.
The important point from this?
So, the War on Drugs, in our view, has been kind of doomed by its basic economics. That is, the harder you fight the war, the higher you push up the price. The higher the price, the higher the revenue of suppliers; the higher the price, the greater the incentive to supply drugs to the United States.
Now if we could only get those in government and law enforcement to understand this bit of basic economics.

1 comment:

matt b said...

The bit I love in this article is where he points out that inelasticity is key. For me that tied the whole concept together.