Civil Society / Economics / Policy

The market for drugs

A couple of weeks ago on Catallaxy Files a contributor going by the nom de plume ‘I Am Sparticus’ made a couple of posts about the market for drugs (here and here). As an economist and interested observer of such markets this is something of a pet topic for me. I’ve been lurking around the Silk Road—and its various reincarnations—since its inception in 2011. I remember reading the posts at the time and wondering just how something quite so could have sneaked its way onto The Cat. (Then I reminded myself it’s a conservative blog, not a libertarian one.) It’s taken a little while, but allow me to correct some of the author’s errors.

Silk Road

First thing first, economists have been falling over themselves to explain why prohibition is bad and does not work. In fact, “many of the harms typically attributed to drug use are instead due to drug prohibition.” This is just another chapter in The Economics of Prohibition: from alcohol, to narcotics, to marijuana, to tobacco, to whatever other vice. As the Journal of Economic Perspectives put it some 20 years ago: “The bottom line is that a relatively free market in drugs is likely to be vastly superior to the current policy of prohibition.”

All that notwithstanding, now let’s begin at the beginning. Sparticus admits that drugs are still readily available (and can be judged a failure on that metric), but claims that because

the price of drugs, whichever drugs, is higher than they would be without government intervention suggests that “prohibition” is working to some degree.

While it is true that the effect of drug prohibition on drug prices is to make them more expensive, the claim that this is good policy is certainty an interesting piece of mental gymnastics. By this logic, if drug markets were legalised and a 1% ‘prohibition tax’ was levied then the policy would be a success—because, well, the price is higher! All governments are therefore implementing extraordinarily successful prohibitory policies in all markets at all times. There you have it. Actually, the Australian evidence suggests that “rather than being a hinderance to the drugs black market, prohibition acts as an economic multiplier.” Unintended consequences 101.

The author then asks us to consider this purely as an economic issue and makes probably the most correct statement in the whole piece: “I am sure that amongst the Cats out there, are many many better economic thinkers than I.” (Reading the comments, many of which agree with the author, does cast doubt over this, however.) But this is where the real doozy comes in:

It could be argued that the free provision of drugs is a market failure. Let’s not debate this proposition; let’s just assume it for the purpose of this argument.

No. Just no. You don’t get to “just assume” faulty premises like these because they suit your argument. Start from first principles. First, the very existence of a market is not a market failure. This is true for drugs as it is elsewhere. Typically, externalities persist due to the non-existence of a market (or more accurately, because externality-resolving exchanges have been inhibited by transaction costs or outright prohibited by governments). Now consider the author’s claim about externalities:

The costs and benefits of drug consumption are borne not by just the users but by broader society – friends, families, communities.

Well, OK. Name me one kind of activity that does not externalise costs and benefits in this way. One of economists’ favourite examples of an uncompensated positive externality is ‘beautiful people’ (beautiful front yard gardens and privately-provided, publicly-displayed art are others). Being offended by an economist’s comparison of women to objects is another (negative) externality. Should beautiful people receive a subsidy for venturing out into public? Should economists be taxed for asking such questions? You see the game that gets played here: value is subjective and hence anyone can attribute a negative externality to any activity and propose some “scope for government intervention.” Here’s my reinterpretation of Sparticus:

Having to read inane posts on a nominally free market blog is a cost borne not just by the blogger but also by broader society. Government intervention is therefore warranted.

Remember, externalities are reciprocal. One person’s ‘reduction of a negative externality’ is another person’s ‘imposition of a negative externality.’ Stopping me from using drugs, or making it more costly, negatively impacts on me. There’s your externality. On the other hand, if the costs of my drug taking are paid by my friends and family then they always have the opportunity to compensate me for curtailing my use. It’s not that hard. And in fact, transaction costs are highest (or have a larger effect) when parties to a potential exchange are widely dispersed, anonymous, or at large social distance from each other. Think of bargaining between a factory owner and the many people living downstream from it; or think of a pseudonymous blogger and the many dispersed readers of the blog (actually, this isn’t the best example, but y’know, snark). It’s hard to arrange an externality-resolving exchange in these circumstances because of a collective action problem: the costs of the activity are dispersed and the benefits are concentrated.

A consumer of drugs and those apparently affected by it—friends, families, communities—is not like this. Those most affected by the consumption of drugs are those closest to the consumer, and are therefore in prime position to strike a bargain to remove any perceived external effects. There is no collective action problem among friends and family, or at least it is surely severely reduced.

Moreover, most of the negative externality is psychological: not wanting to be associated with a drug-consumer because it’s icky. Other associated external effects such as physical injury from (say) assault or crime are not externalities of drug use per se but of those actions themselves and can be dealt with legal liability and tort law. Family adversity, environmental damage, drug wars? All private costs or social cost of some other action, not drug use itself. Second-hand smoke? Leave the vicinity; enforcement of property rights will suffice. Increased burden on the public health system? It’s the publicness of the health system (i.e., the fiscal commons) that transmits the externality, not the act itself. But what about the economic cost of (lazy stoners’) lost productivity? You don’t own other peoples’ labour, sorry.

As I say, the only real external effect here is feeling icky because your friend or child or in-group member is doing something you disprove of. And that is entirely legitimate, of course, but it means the burden is on you to propose a mutually-beneficial exchange to reduce their drug consumption and relieve yourself of your ickyness. (By the way, this is the Misean-Kirznerian impulse to remove uneasiness and make yourself better off through the entrepreneurial process.)

We only identify externalities by the attempts of individuals to resolve them. So in this way, the “free provision of drugs” is not a market failure. The failure is the absence of the market for mitigating drug consumption. Put another way, external effects persist because there’s no mechanism for parties to transact over the amount of drugs to be consumed. There’s no cap-and-trade, there’s no ‘drug consumption trading scheme’ (DCTS). We don’t need a national scheme for this, we just need people to put their money where their mouth is and act on their purported grievances. Again, this shouldn’t be too hard if it’s your best friend or brother on the other side of the bargain.

The deeper point is that we do not get to stand outside an exchange relation and make pronouncements about externalites, like an omniscient social planner. This is the great shortcoming of both the Coasean and Pigouvian programs, as Roy Cordato puts it:

Both approaches assume static states of the world where all social opportunity costs, and therefore benefits, are objectively knowable. If these assumptions are removed, the implications of dynamic markets and the subjective nature of value are highlighted. As a result, the extent to which either approach is operational as a real-world policy tool is called into question. In order to secure efficiency harmful external effects should be internalized, but only through clearly defining and enforcing property rights.

James Buchanan, too, knew that lazy externality-begging is tied to the fallacy that an optimum allocation of rights can be ex ante identified: “It is unfortunate that Coase presented his argument largely in terms of presumably-objectively measurable and independently-determined harm and benefit relationships.” Conversely, according to Buchanan, no external observer can determine an efficient outcome, or whether a particular trade falls short of some theoretical optimum.

And the same applies here: the Sparticuses of the world cannot presume to know all social opportunity costs, and harms and benefits. Only the parties to an activity can subjectively evaluate them, and following this, strike a bargain. If transaction costs stand in the way, then shift your effort to the institutional level and seek to reduce them. Don’t succumb to lazy externality-begging. As usual, the challenge to wannabe social planners such as this: come back when you’ve quantified the supposed externality, and don’t forget to show your working. (I won’t be holding my breathe.)

Finally, let’s return to the reciprocity of externality. I made the claim earlier that the imposition of anti-drug policies is actually a negative externality borne by drug consumers. But what of the subjectivity of externality? How can I make such a pronouncement? Surely if the externality exists—and anti-drug policies are inefficient—then drug consumers will themselves find it advantageous to contract to remove them? True enough. But we need to pay attention to the relative imposition of costs here. The argument could be made that because the current policy setting is ‘illegal’ and carries a penalty (as well as some measure of social ostracism), then the transaction costs for drug consumers are higher than for anti-drug commandos.

Again, well may this be the case: all we can really say is that given these constraints the appropriate outcome is the status quo. No externalities either way, right? The upshot is that as the subjective evaluations made by drug consumers (and non-consumers alike) of the costs of anti-drug policy-change—both the costs of putting up with them and of sticking your neck out to change them—then so too will the calculus over anti-drug policy-change, change. That is to say, yes the current policy may be efficient, but as costs and benefits change, the efficient policy changes: from illegal to legal. We only identify externalities by the attempts of individuals to resolve them. Let’s see the efficient outcome reveal itself.


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