Sagar Agrawal John Locke Institute Essay Competition – Economics

What would be the consequences of legalising all drugs

in the United States of America?

This question has a very open dynamic, since it identifies all drugs in the United States of America.
There may be contrasting implications for a multitude of different kinds of drugs as a result of
legalisation. Ever since Nixon declared the ‘War on Drugs’ in 1971, costs to the US economy have
exceeded $1 trillion, a clear sign that we need to abandon current policies of prohibition. Currently, we
can look to Amsterdam’s model of legalising the production, consumption and sale of cannabis in
‘coffee shops’, which is truly unique. This provides a useful framework when assessing the likely
consequences of legalisation in the USA, albeit a different economy. Dutch drug policy is of a
libertarian persuasion, and views drug use as a public health matter, similar to obesity. This has been
inspired by the abysmal failure of the prohibition of alcohol US from 1919-1933. Statistical data finds
that for young people with a median age of 28, only 16% have reported the consumption of cannabis 1,
so legalisation has not caused visibly excessive consumption levels. Many people are tentative with
regards to legalising harder drugs such as cocaine, but in my view, there is no need to have
apprehensions. Through legalisation, all the perverse effects of prohibition can be avoided, whilst the
model promises substantial benefits in its own right, which outweigh potential drawbacks.

Legalisation would relax limits on supply caused by prohibition, so prices in legal drug markets will fall.
Although this would cause a substantial increase in the ‘casual’ consumption of drugs, there will be a
significant reduction in externalities associated with illicit markets. The disincentive effect of ‘high-
profit’ criminal activity on schooling and labour force participation would be eradicated, whilst
criminalisation of those who purchase drugs will fall to zero. Thus, negative external costs per unit of
drug will plummet post legalisation. Furthermore, commercialised drug markets will be far safer than
illegal markets, since commercial products have higher manufacturing standards, with less potency
and contamination; cocaine bought illegally has recently been found to contain rat poison 3. Cost-
benefit analysis (CBA) suggests that legalisation has a positive social effect 2. However, the case for
free-market marijuana, for instance, is clearer than that for cocaine or opiates since it does not appear
to have such significant health consequences, and is not believed to be highly addictive. Hence, due
to irrational consumers’ myopic behaviour, some view that lower prices in legalised markets can be
potentially detrimental depending on the drugs in question.

To analyse the economic consequences more closely, I will assume a single model of legalisation,
rather than distinguishing between drugs. Friedman (1972) qualitatively discerned benefits from drug
legalisation in terms of the social costs of prohibition foregone, magnified from a purely philosophical
standpoint by the value of liberty. Nadelmann (1989) describes the social costs of prohibition arising
precisely due to illegality, while Dennis (1990) suggests that a consequence of legalisation would be to
reduce strain on public finances. The elimination of government prosecution of the drug war (including
aggressive application of the domestic criminal justice system and combatting against Columbian drug
lords) massively reduces expenses. This is because government legislation needs compliance from
the governed, and this scenario takes the form of an iterated Prisoner’s Dilemma i. In order to establish
stable mutual cooperation between the government and governed on drug policy, the government
must establish a reputation of ‘toughness’, enforcing prosecution as a form of deterrence, even if costs
incurred are out of proportion to the situation. This enlarges the shadow of the future and increases
the discount parameter, so ‘defection’ for immediate gain (i.e. taking drugs) is rendered undesirable in
light of future retaliation by the government4. Legalisation would eliminate the costs of ‘toughness’. To
quantify this, drug-related crimes account for 50% of incarcerations in the USA, costing an extortionate
$40bn5.

Other social costs include drug-related healthcare expenses and productivity damages. In 1994, it was
found that 25% of Medicare expenses on inpatient hospital care was attributable to substance abuse,
totalling $20bn6. Furthermore, research in 1992 concluded that the cost of productivity losses due to
alcohol and drug abuse amounted to $176bn 7. This includes factors such as mental impairment,
illness and premature deaths. The commercialisation of the illicit drug market would enable quality
control, and also removes disincentives to request medical care for drug-related problems, thus
reducing health risks. De facto decriminalisation of all drugs in Portugal provides a useful illustration ii.
Within 5 years, deaths from drug overdoses fell from 400 to 290 annually, whilst new HIV cases
caused by unsterilised equipment used to inject illegal substances plummeted from 1400 in 2000 to
400 in 20068. Principally, this is because decriminalisation resulted in earlier intervention and more
targeted treatment towards drug-related health problems. However, Clark (2003) argues in a key
proposition that legalisation never lowers the quantity of drugs traded 9, and so the balance between
augmented market equilibrium quantity (due to lower price attracting demand) and lower external
costs per unit of drug is vital in determining the impact on social welfare. Government policy plays an
intricate role in affecting the delicately-poised balance between these two variables. It should be noted
that the CBA framework dubious, since there are many unquantifiable obscurities to account for in
analysing net social benefit, such as the value of freedom; Dennis concludes that legalisation would
be desirable as long as drug consumption does not increase by 100%. The corresponding figure in
Ostrowski’s calculations is 1200%.

The USA might adopt various policies post-legalisation. The government can directly set prices by
centralising drug sale. Alternatively, legal prices can be determined indirectly via taxation and free
market interactions. Proponents for legalisation often cite the benefit of taxation, claiming that the
government budget would be $48.7bn better off annually 10. This is due to the elimination of
prosecution costs post-legalisation, as well as taxation of drug sales on the legal market. However,
forecasts such as these are naturally spurious, due to the unpredictability of future markets. Budgetary
implications would depend on numerous elements, such as the level and nature of taxation (i.e. ad
valorem or specific tax), position on the business cycle, and also the time period in which we analyse
legalisation - culture and preferences may change over time. This causes demand for drugs to
become more price elastic through time, thus not generating the same tax revenues as in the past.
Moreover, bureaucrats in the US Congress might easily get carried away with taxation, so as to direct
consumption to illicit markets and facing the same issues as under prohibition. Politicians have
recently adhered to the concept of a ‘sin tax’, aimed against ‘socially harmful’ goods such as tobacco
and alcohol. Assuming that legal and competitive illegal markets co-exist, it is welfare maximising for
the legal price to be reduced until the illegal market is eliminated. The legal market should not be
taxed so much that the illegal market remains competitive. Conversely, exorbitant legal prices force
users to support consumption by resorting to street crime or falling into poverty, due to the regressive
nature of drug taxes11.
Experience with the alcohol and tobacco industry can answer two key questions. Firstly, how
accessible are these legal drugs to the American youth? Secondly, how have price controls affected
the market?

In answer to the first question, this table reveals the difference between rural and urban areas in the
perceived ease of access of alcohol and tobacco Southern US students 12 . Geographical location does
not seem to alter the availability of commercial drugs, although access is predictably higher amongst
high school students than middle school students. For high school students, a mean of 60.9% report
that alcohol is easily accessible, whilst a mean of 59.3% find the purchase of tobacco straightforward.
In comparison, just over 55% of high school students say that cannabis is easily attainable, which is
lower than the previous two figures, despite the fact that 10 US States have already legalised
cannabis consumption13 (it remains illegal elsewhere). This is consistent with the hypothesis that
quantity consumed will increase post-legalisation due to increased availability.
The second question is more difficult, since price control is not the only factor affecting consumption;
there is an element of personal choice and changing information, hence causes are harder to pinpoint.
Consumption of tobacco has been decreasing since 1963, when consumption was at a record high of
4,345 cigarettes per capita, compared to 2006 when consumption was at 1,691 per capita. However,
real expenditures on tobacco increased to approximately $88.9bn, just under 1% of disposable
income. This was double that of 1989 spending 14, partly attributable to increasing tax rates (reaching
$2 per pack in 2008). Here, it is clear that the law of demand is upheld, and government price controls
have had some effect in reducing consumption, although increasing awareness of the dangers of
cigarettes has surely had a role to play in deterring new consumers.
Applying these answers to the legalisation of all drugs, it is clear that we risk attracting new consumers
to the market since ease of access would increase. Price controls can have stabilising effects to an
extent, so long as we contain illegal markets.

Drug legalisation would drastically reduce crime in the US. From a psychological viewpoint,
legalisation would eliminate the ‘reactance’ effect from prohibition. Psychological reactance occurs in
response to threats to perceived behavioural freedoms, and can strongly motivate people to
deliberately rebel against governing authorities, regardless of the utility derived from the act itself. This
can partly explain how illicit markets emerge in the first place, as well as the keen eye from producers
to make super-normal profits from illegal activity. Moreover, Goldstein (1985) made a distinction
between three kinds of drug-related crime in illicit markets. ‘Economic-compulsive’ crime arises from a
need to gain additional income to fund consumption due to addiction, usually resulting in theft.
‘Psychopharmacological’ crime is generated by the action of drugs on the brain, impairing self-control
and decision-making capacity. Lastly, ‘Systematic’ violence is an underlying feature of illicit markets,
where legal enforcement of contractual obligations is impossible 15. In Australia, it was found that crime
was responsible for 56% of tangible costs arising from illicit drugs in 2004/5, and the figure is similar
for the US16. Legalisation would greatly limit the first two kinds of crime, due to lower prices and safer
products in the legal market, whilst erasing ‘systematic’ violence and ‘reactance’.

The detrimental effects of drugs on living standards are plain to see. Productivity damages left US
employers $120bn worse off in 2011 (0.9% of GDP 17). Drug abuse has enormous implications for 3 rd
parties due to crime, environmental damage from disposal, and premature deaths to name but a few.
The dramatic inefficacy of prohibition has encouraged many proponents of legalisation. However, it
remains conventional to lobby only for the legalisation of cannabis, not hard ‘class A’ opioids where
the line is generally drawn. Hard drugs are deemed to be simply too addictive, harmful and ‘socially
unacceptable’ to be legalised and sold commercially. I argue exactly to the contrary. Empirically, 80
years prohibition has simply created illicit markets which have spiralled out of control, and the global
drug trade has continued to thrive. Legalisation changes the equation. Not only can we ensure that
commercial drugs will incur less health risks, we can regulate markets. Revenues generated from
‘sensible’ tax rates allow for hypothecation and fiscal headroom. However, Congress should avoid
engaging in catastrophic policy such as minimum pricing, which would distort all market signals and
create further illicit markets. ‘Libertarian Paternalism’ could prove to be a powerful tool through which
the government may employ choice architecture to ‘nudge’ people not to consume drugs whilst
upholding the value of choice18. An example would be placing drugs in inconspicuous locations. The
importance of regulation leads me to emphasise the inherent uncertainty with which we make
predictions; who can determine the rationality of officials, under whom legalisation takes place? In this
‘War on Drugs’, we can only hope for competent regulation, in which case the USA is likely to emerge
victorious.

Main body word count: 1999

References:

Grant, T. (2017). Amsterdam’s Relationship With Cannabis Legalisation. Available at:

https://www.directcannabisnetwork.com/amsterdams-relationship-cannabis-legalization/
2
Miron, J. & Zwiebel, J. (1995). The Economic Case Against Drug Prohibition. Available at:
https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.9.4.175
3
Glenny, M. (2010). The War on Drugs: an upper or downer for development. Available at:
http://www.lse.ac.uk/website-
archive/newsAndMedia/videoAndAudio/channels/publicLecturesAndEvents/player.aspx?
id=534&from_serp=1
4
Axelrod, R. (1990). The Evolution of Co-operation. pp.155
5
Elevationshealth. (2016). The Annual Cost of The War on Drugs. Available at:
https://elevationshealth.com/annual-cost-war-on-drugs/
6
Merrill, J. et al. (1994). The Cost of Substance Abuse to America’s Healthcare System. Available at:
https://www.centeronaddiction.org/addiction-research/reports/cost-substance-abuse-america
%E2%80%99s-health-care-system-report-2-medicare
7
Harwood, H., Fountain, D. & Livermore, G. Economic Costs of Alcohol and Drug Abuse in the United
States, 1992. Available at:
https://www.ncjrs.gov/App/Publications/abstract.aspx?ID=182086
8
Greenwald, G. (2009). Drug Decriminalisation in Portugal. Available at:
https://object.cato.org/sites/cato.org/files/pubs/pdf/greenwald_whitepaper.pdf
9
Clark, A. (2003). The Economics of Drug Legalisation. Available at:
http://www.parisschoolofeconomics.com/clark-andrew/ecleg.pdf
10
Miron, J. (2010). The Budgetary Implications of Drug Prohibition. Available at:
https://scholar.harvard.edu/files/miron/files/budget_2010_final_0.pdf
11
Wilkims, C. & Scrimgeour, F. (2000). Economics and the Legalisation of Drugs. Available at:
http://press-files.anu.edu.au/downloads/press/p92721/pdf/article04.pdf
12
Warren, J., Bryant Smalley, K. & Nikki Barefoot, K. (2015). Perceived Ease of Access to Alcohol,
Tobacco, and Other Substances in Rural and Urban US Students. Available at:
https://www.ncbi.nlm.nih.gov/pmc/articles/PMC4727394/
13
Robinson, M. & Berke, J. (2018). Here's where you can legally consume marijuana in the US in
2018. Available at:
http://uk.businessinsider.com/where-can-you-can-legally-smoke-weed-2018-1?r=US&IR=T/#alaska-1

14
Encyclopedia.com. (2008). How Alcohol, Tobacco, And Drug Use Affect Economics And
Government. Available at:
https://www.encyclopedia.com/law/legal-and-political-magazines/how-alcohol-tobacco-and-drug-use-
affect-economics-and-government

15
Goldstein, P. (1985). The Drugs/Violence Nexus: A Tripartite conceptual framework. Available at:
https://doi.org/10.1177%2F002204268501500406

16
Bryan, M., Del Bono, E. & Pudney, S. (2013). Drug-related crime. Available at:
https://www.iser.essex.ac.uk/research/publications/working-papers/iser/2013-08.pdf
17
INCB. (2013). Economic consequences of drug abuse. Available at:
https://www.incb.org/documents/Publications/AnnualReports/Thematic_chapters/English/AR_2013_E_
Chapter_I.pdf
18
Thaler, R. & Sunstein, C. (2009). Nudge: improving decisions about health, wealth, and happiness.

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i
Let the discount parameter (w) be sufficiently high e.g. w=0.9 (reasonable assumption since government and
governed are likely to have ongoing interactions) and assuming government employs strategy of cooperation (no
prosecution) until defection by governed, thereafter employing strategy of ALL D (prosecution). Note: Government
does not defect first.
Defining payoffs:
Temptation payoff (T) for unreciprocated defection = 5
Reward payoff (R) for mutual cooperation = 3
Punishment payoff (P) for mutual defection = 1.
Sucker’s payoff (S) for unreciprocated cooperation = 0
R
 Total payoff for mutual cooperation (compliance of governed): S∞ = =30
1−0.9
P
 Total payoff for player who defects first: S∞ = −1+5=14 , hence incentive for player to cooperate
1−0.9
and receive higher total payoff.
Player first to defect has no incentive to co-operate in the future, provided the government’s reputation for toughness
is well-established and they are aware that the government employs a strategy of ALL D after initial defection.
*Player gets T on first move instead of P, hence 4 is added to the payoff of mutual defection.

ii
Though not to be confused with legalisation, useful lessons can be learned from the effects of decriminalisation,
since they would hold under the more comprehensive legalisation policy.