Why Illegal Drug Money Doesn’t Promote Economic Development

Sandra Avila Beltran, the woman he reached the pinnacle of the Colombian-Mexican drug cartel as the “Queen of the Pacific,” has been extradited back to Mexico. Her tale is a complicated one, and is a fascinating allegory for the travails of the modern drug war. She essentially married and murdered her way to the top of the cartel before finally being arrested and convicted for various drug-related crimes, most of which have to do with trafficking and not the violence that accompanies the illegal drug trade. Hardly a newbie, she was a third generation drug trafficker, so she knew the system and figured out how to use it effectively. As interesting as this is, however, I found the following snippet from the Miami Herald’s (August 21, 2013) reporting most interesting and relevant for this blog: “With her wealth, Avila ran a string of tanning salons and a real estate company with investments throughout Sonora state.”

It’s a small detail, but an important one in terms of understanding wealth creation and economic development.

At first glance, the fact Beltran used her “wealth” to open up a string of businesses and invest in wealth seems to support the views of many, including some economists, who point to the unintended if very real positive benefits of economic crimes like drug trafficking. In this case, Beltan generated a lot of revenue, employed a lot of people, and then “laundered” her earnings by opening up legitimate (and legal) businesses. If all the drug money is being redirected to productive enterprises, doesn’t this suggest that the economic effects of the drug trade are really benign?

Not necessarily. The billions of dollars of money siphoned out of the productive economy still represents a massive misallocation of resources, and this has dire consequences for wealth creation and economic development, particularly in cities. I developed an extensive analysis of the illegal drug trade in my first book, Drug Policy and the Decline of American Cities (winner of the Antony Fisher Memorial Award), but many others have provided similar analyses (see for example Mark Thornton’s excellent book The Economics of Prohibition and Steven D Levitt’s insightful chapter on drug organizations in his book Freakonomics).  Still, most analyses focus on the effectiveness of the War on Drugs, not its implications for economic development. And the drug trade has a huge impact on cities and economic development, particularly Latin American Favelas and U.S. inner city neighborhoods.

Even though drug trafficking is largely a voluntary enterprise, prices are much higher because of drug law enforcement. And even while the transaction itself is voluntary (and usually peaceful), the economic context in which the transaction takes place is skewed by violence. Since these transactions take place outside the legal system, contracts are enforced through violence. Similarly, rather than competing peacefully for customers like Wal-Mart, Publix, Winn-Dixie or Kroger based on quality, price and brand, drug gangs attempt to forcibly seize territory through intimidation, murder, and other forms of brutality. This activity stifles normal entrepreneurial activity because risk premiums drive many productive entrepreneurs and innovators out of the market while policy induced price premiums rob financial markets of the capital needed to seed new enterprises. This happens by limiting the range of investment choices within the industry to those enterprises that can physically survive, but more important direct money away from businesses providing goods and services in the legal market.

Beltran was an entrepreneur only in the most abstract form of the word–a ruthless businesswomen who used any means necessary to expand her own enterprise–but her strategies and investments undermined the long-term growth of the economy. Economies don’t grow simply by redistributing revenues to existing players. Economies grow when capital is invested in long-term enterprises that provide goods and services that consumers value. The most efficient investments are made in environments with secure property rights, transparent contracts, and players recognize the win-win benefits of long-term relationships. All these characteristics are missing from the illegal drug trade.

The give and take of market competition ensures that enterprises that fail their consumer go out of business while those that provide value to consumers thrive. Beltran’s success was based on her ability to use force to secure her position in the cartel hierarchy, not serve the interests of her customers. Moreover, her investments in the legal economy reflected the distorted incentives of the illegal drug market, including directing her wealth into investments chosen more for their ability to hide its source than serve the long-term interests of the consumer. Her investments were chosen to preserve her personal wealth, not build wealth through real economic development and wealth creation.

So, in the end, Beltran’s ascension to the pinnacle of the illegal drug trade, and ultimately her fall, holds important lessons for economic development. While she was a hard driving business person, she was not the kind of entrepreneur that builds an economy or contributes to long-term growth and development. Her “business” is also a product of the distorted environment in which it operates, a product of public policy, not the desires of consumers and suppliers trading freely and transparently in a well functioning market economy.