The Effects of Illicit Drug Trafficking on Economic Growth in America

Term Paper, 2020

13 Pages



Drug crime is a serious problem worldwide. The use, but also the abuse of legal and illegal psychoactive substances, is an integral part of our societies. Correspondingly lucrative, but also damaging, is the business that is done with legal and illegal drugs. In this essay, I will address the effects of illicit drug trafficking on economic performance. Since a global view would go far beyond the scope of this work, I will limit myself to the American continent, especially on Mexico's drug trafficking with the USA. Furthermore, I will mainly focus on the cocaine trade, as this drug has the greatest economic, evidence-based effects for the individual countries studied. First of all I will briefly explain the reasons why drug crime, but also drug prohibition in general, is an economic problem. In the second part of this essay, I will introduce the US demand market and the associated supply markets (Mexico and other Central and South American countries). In this context I will use the analysis of two papers (one written by Robles et al. and one written by Holst et al.) to explain to what extent the activities of drug cartels have an effect on economic growth in Mexico. Finally, I will counter-examine the findings of these two studies and formulate my own conclusion from the results obtained.

1. Drug Prohibition and Drug Crime as a General Economic Problem

First of all, it is important to understand that drug users are not a fringe group. Almost every adult citizen regularly uses legal drugs and 26.5% of all German citizens aged 18-64 have already tried an illegal drug (see Retzmann et al., 2014, p.257) and the trend is still rising (see Ludwig, 2019). The basic idea behind a repressive drug policy is that the prohibition would also eliminate the problems behind it. Unfortunately, this neglects an important economic principle: supply and demand. The trade and consumption of a good can never be completely prevented, since the costs for these measures would be astronomical. However, the quantities offered can be reduced. On the drug market, the reduced supply then meets a price-inelastic demand, which allows to set prices (see Retzmann et al., 2014, p.269). The demand is therefore inelastic because drug bans will only free very few addicts from their addiction. As a result of prohibition, drug prices rise proportionally more than demand falls (see Mankiw et al., 2012, p.132-133). For cocaine and cannabis, for example, a 1% increase in price leads to a 0.5% drop in demand (see Insulza, 2013, p.14). As a result, the prices of illegal drugs such as cocaine are significantly higher than those of legal goods and the dealers receive the vast majority of market sales as a scarcity bonus. This enormous profit margin, unwanted by the state, but nevertheless brought about, attracts internationally operating criminal organizations, the DTOs (Drug Trafficking Organizations). Like legally operating companies, profit maximization is the main goal of DTOs (see Retzmann et al., 2014, p.269). In contrast to legal markets, illegal markets are not subject to any legal framework (see Retzmann et al., 2014, p.257). Therefore, drug cartels do not compete by price policies and laws, but directly and often with the help of violence against each other in order to monopolize their dominance for the demand market (see Robles et al., 2015, p.27). In addition, many of the profits generated by drug trafficking are invested to finance and expand further illegal activities. This leads to the effect that in countries with high cartel activity the whole economy starts to build on corruption and such organizations (see UNODC, 2017, p.29). What is also important to mention is that large drug seizures are usually made at the beginning of the value chain, where the value of the drugs is comparatively on a low level. For example, lkg of cocaine can be produced in Colombia for $ 800 and has a sales value of $ 122,000 in the US (see Wainwright, 2016, p.58). From an economical perspective, it would therefore make sense to carry out these seizures only at the end of the value chain. Unfortunately, at this point the drugs are divided into very many, small quantities leading to astronomical cost rises of confiscation (see Insulza, 2013, p.23). The state's policy of repression thus unintentionally becomes the real engine of the drug market, because the more strictly prohibition is enforced, the more the price rises. The higher the drug price, the higher the profit and the greater the interest of the DTOs in making further investments in this milieu, which in turn leads to an increase of the repression costs for the state (see Retzmann et al., 2014, p.269).

2. Demand Market USA & Supply Market Central- and South America

Below I will give an overview of the two countries that are the main subject of my essay. On the one hand we have the USA as a drug demand country and on the other side Mexico as a drug supply and transit country. According to the United Nations World Drug Report, the 2010 US illicit drug market was worth approximately $ 109 billion, or 0.74% of the total GDP (see Insulza, 2013, p.9). More recent reports suggest that the value has increased even further in recent years (see Kilmer, 2019). Comparisons with other countries also suggest that the USA is the largest drug market in the world (see UNODC, 2017, p.23). Between 80% and 90% of the cocaine consumed in the US is smuggled through Mexico today (see UNODC, 2010). Mexico is an export country with $ 461 billion in exports in 2019 (see Statista, 2020). The most important commercial goods are manufactured products, silver, vegetables, coffee, cotton and oil (see Pariona, 2017). Because of its proximity to the United States, drug trafficking is extremely lucrative for DTOs here. Mexico acts as a key country as it is also close to cocaine producing countries such as Bolivia or Colombia. It is a multi-billion dollar industry that shapes the country in many ways (see Hartmeier, 2018, p.3). Even if it is difficult to determine exact numbers due to the illegality, the UNOCD estimated the value of the globally traded cocaine of approximately 85 billion USD in 2009. Thereof, $ 40 billion or 47% went to the USA (see Insulza, 2013, p.12). From more recent reports by the UNODC it can be concluded that the value of cocaine trafficked has increased significantly since 2009 until today (see UNODC, 2018, p.28-29). The coca leaf producers concentrate on countries around the Andea region, such as Bolivia, Argentina and Colombia. The synthesis to raw cocaine often takes place near the cultivation areas. This requires a considerable amount of fixed capital and the production is often accompanied by armed troops, such as the FARC (Fuerzas Armadas Revolucionarias de Colombia) in Colombia. Internationally active smuggling organizations, which cooperate with the main drug traffickers form the next phase in the value chain and smuggle the drugs into the United States (see Insulza, 2013, p.17). Approx. 70% of the produced cocaine leaves Colombia via the Pacific, 20% via the Atlantic and 10% via Guatemala (see UNODC, 2010).

3. Economic Impacts of Drug Cartels in Mexico

In his paper from 2018, Peter Hartmaier set up a very concise definition for the term drug cartel: "A drug cartel is an organization operating in the illicit market of drug production, trafficking and sales. The goal of cartels is to reduce competition and acquire large shares of market acting in a monopolistic way" (Hartmeier, 2018, p.7). According to the US Justice Department, Mexican and Colombian drug cartels are responsible for drug sales in the US valued at $ 18 billion to $ 39 billion annually (see Keefe, 2012). This profit also results from the enormous profit margin from illegally traded cocaine, which, as already mentioned, can be bought in Colombia for 800$ per kilogram and sold in the USA for $ 122,000 (see Wainwright, 2016, p.58). This dynamic originated in the last two decades of the 20th century, when the number of DTOs in Mexico increased significantly due to increasing fragmentation into smaller cartels, increasing political competition and anti-corruption reforms. As a result, the government's position has been weakened and drug lords have gained more and more economic and political power in the country (see Snyder and Duran-Martinez, 2009, p.270). With the handover to the new President Felipe Calderon in 2006, a strong tightening of the laws against drug cartels was initiated in order to get the problem of drug crime under control (see Holst et al., 2016, p.9). This highly repressive prohibition policy is also known as the "War on Drugs" and costs a large number of cartel members, law enforcement officers but also civilians their lives every year (see Hartmeier, 2018, P-7).

At the beginning of 2007, shortly before the implementation of the government plan "War on Drugs", Mexico had a historic low in the homicide rate of 8.1 per 100,000 inhabitants (for comparison: the homicide rate in the USA is 5 per 100,000 inhabitants). During Calderon's regency (2007-2012), however, the homicide rate rose massively from 8.1 to 23 homicides per 100,000 inhabitants (see Holst et al., 2016, p.l). Besides the competition between the DTOs to expand their drug business (see Holst et al., 2016, p.5), according to Robles et al. there are three main factors for the increase of the homicide rate: First, in the late 1990s and early 2000s, crackdowns on the drug business in Colombia became increasingly successful, leading to significant slumps on the supply side while demand remained high and inelastic. Second, an increase in the incarceration of drug lords had led to an increased fragmentation of DTOs (Drug Trafficking Organizations) into smaller, "wilder" and more disorganized groups, and last but not least the increased use of police and military violence against the drug business from 2007 (see Robles et al., 2015, p.3). This high and increasingly arbitrary level of violence has in many ways negative effects on the country's economy.

There are around 4 million small and medium-sized enterprises in Mexico, comprising around 72% of the workforce and 52% of GDP. So they have an important role in the economic system (see Carriedo, 2017). According to a study by the Bank of Mexico, 60% of all companies are influenced by the criminal atmosphere that DTOs generate, such as violence, extortion and kidnapping if the companies do not want to cooperate (see Krzeski, 2013). Many companies, but also private individuals, therefore feel compelled to flee from the cartels to safer areas (see Holst et al., 2016, p.2). In addition, entrepreneurs are prevented from investing into new businesses in these regions (see Kim, 2014). According to Ashby et al., DTOs deter foreign investors from doing foreign direct investments in the service, trade and agriculture sector in Mexico (see Ashby, 2013). Another economic sector that is strongly influenced by drug cartels is the tourism branch. A good example for this is the city of Acapulco. The city was still a very popular tourist destination in the 1950s, but the increasing crime and violence rates in recent years have made Acapulco the most dangerous city in Mexico. Of course, this has a strong impact on the tourism branch, which in turn damages the local economy, depending on up to 80% from tourism (see Flannery, 2016). One part of the profits made by the drug lords are used to cover the costs of the drug trafficking, such as production costs, bribes, weapon costs and salaries for cartel workers. The other part is often invested in luxury goods, but also in legal businesses. In order to gain social prestige and strengthen their position, DTOs are known to invest their profits in society. Pablo Escobar, one of the greatest drug lords of all time, built hundreds of houses for the poorest citizens of the city of Mendelin (see Green, 2015). This shows that DTO activities can also have positive effects on the infrastructure and thus on the economy of the country, even if these actions take place for selfish reasons.


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The Effects of Illicit Drug Trafficking on Economic Growth in America
Carl von Ossietzky University of Oldenburg
Economic Growth
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effects, illicit, drug, trafficking, economic, growth, america
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Johannes Grunwald (Author), 2020, The Effects of Illicit Drug Trafficking on Economic Growth in America, Munich, GRIN Verlag,


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