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Economics of the Underground Economy

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brutus b

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Feb 10, 2009
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I'm in a class called "The Economics of the Underground Economy" and the professor wants us to write an 8-10 page paper concerning some aspect of the underground economy. A lot of people are writing boring papers strictly about the history of a drug etc. I'd like to write a little more in-depth paper that actually uses economics. However, my creativity seems to have left me and I'm drawing a blank.

The only ideas I have so far are:
(1) The media keeps talking about RCs as substitutes and replacements. However, given the way extra competition should work, they are not in fact substitutes/replacements because they have not lowered the price of the "original" drugs.

(2) The cost of the war on drugs is very high (enforcement, trials, incarceration, etc). Drug dealers are rational; they begin dealing drugs because it is often the best option available to them. Would it be cheaper for the government to give out one time transfer payments (or a monthly stipend) to those at risk, and in exchange they enter into a binding contract that would punish them severely if they were caught with drugs (the thinking being that the transfer payment replaces the need to deal drugs for income, and giving a person $20,000 is cheaper than paying for the police to arrest him, trial to convict him, and jail to incarcerate him).


Anyone have any ideas? Hopefully I can get a discussion going and some interesting ideas will pop up.
 
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I like your ideas regarding the war on drugs, but I would not take the route of 'bribing' dealers.

Perhaps you could focus on the costs for society, which result from the finding, prosecuting and incarcerating of drug users, which in no way have harmed others by their actions?
There are the costs of law enforcement, property damage, incarceration but also there is a tremendous amount of potential labor wasting away in prison.
It would be nice if you could add this all up and compare it with the actual costs of drug use.
You could include all South-American countries affiliated with the cocaine business too.
 
I agree with your second statement, drug dealers are in business, it just happens to be an illegal business, which is part of why they make so much money.

The RC's will be illegal soon enough, and will either disappear or just be another illegal drug for drug dealers to sell with their other products. Nothing will really change.

People will continue to use drugs no matter if they are legal or illegal. Lawmakers are ignorant to this fact. If this whole RC scene has shown the drug community anything it's that. People like to take drugs, it's a fact.

Drug dealers are simply capitalizing on this, in fact, the underground/black/illicit/whateveryouwannacallit drug market is probably the best example of "free market" economy you can find.
 
First, 8-10 pages isn't that much so you should probably keep your research question really tight or stick to a small literature review of a particular aspect of the underground economy.

Second, Your ideas seem more like policy papers about how to bring the underground economy into the formal economy rather than an analysis of an aspect of the underground economy.

Research questions/topics I think you would be interested in that you can do in 8-10 pages

1) Are drug dealers rational? (lots of work on this)
2) How are business deals done within the illegal economy?/"Is there honor amongst criminals?"

I know some of the sociological/anthropological literature on this topic so if you want some recommendations on books/articles, send me a PM and I will be happy to send you some citations.
 
I think 8-10 pages is quite a bit, actually. I would expect a paper of that magnitude to be worth 25% or more of my final mark.
 
Thanks a lot guys, you put forth some really great ideas. I know my topics are a little too normative; I can't decide if I want to write a policy paper or just a strict analysis.

I especially loved "Are drug dealers rational", it reminded me of the Freakonomics chapter about drug dealers.

8-10 pages is normal to me; I've certainly written more but it isn't the shortest assignment I've ever had (it's worth 20% of the final grade).

I think I'm going to proceed with my 2nd topic despite it being a bit broad. I'm just interested in that area, and hopefully through research, analysis, and writing I'll find a fascinating nugget to concentrate on. I think I'll start this weekend unless someone else puts up another great idea.
 
I loved reading "Freakonomics". "Super Freakonomics" is quite good too, if you haven't had the chance to read it already.

There are many, many parallels between the "legit" and "underground" business worlds, and, as others have said and as I'm sure you'll come across in your research, the legit markets, the gray market and the black market intermingle with one another on nearly every level of scale and actually depend on one another, at least partially, to exist.
 
Say you buy a qp of bud for 1200$
You sell ounces for 360$ so off each oz, you make 60$

Your friend buys 500 tabs for 2000$ dollars
he sells 30 tabs for 240$ so he profits 120$

Since youre in the middle of no where, tabs can sell for 15$ each

Your friend will trade you 30 tabs for an oz.
You sell the tabs all seperately for 15$ making 450$

Since you payed 300$ for the oz you traded for, you are now profiting 150$ instead of 60$ and your friend saved 120$ because he now paid 240$ for the oz instead of 360$

comparative advantage.
 
i think the economic system within prison and the formation of gangs for protection of assets/self would make a badass paper.

their incentives are really extreme and could actually make a good model.
 
A few interesting things about the economics of the drug trade:

How does the regular economy benefit from the illegal economy? (some have said the the recent banking crisis was averted only by liquidity provided by the drug trade)

Who is dependant on the drug economy in the real economy?

Is the illict market (drugs, esp) a true free market?

Where does all the money go?
 
talk about how all the bud is being bought from dispenceries and shipped to states without dispenceries which results in the unbalance of cash as money is being traded for uncounted goods and services.

and then the money is eventually invested into commercial banks. which could create major inflation in such areas.
 
One aspect of the black market I've always been curious about is the economics of black market currency. This would be more a subset of financial economics, but I think there are really a lot of things to consider about ill-gotten gains. For one thing, money obtained through illegal activity is worth significantly less than legitimate income. You couldn't reasonably sell $1M worth of coke and then turn around and buy a flash house and a bunch of cars without drawing negative attention to yourself. Unless it's been cleaned somehow, it's basically no good besides small day-to-day expenses; can't be spent on big ticket items, can't be invested, etc. These obstacles account for some (perhaps a lot) of the markup in drug prices, obviously along with the risk aspect in general. You could do a quantitative analysis of these issues style on this and figure out some figures for how highly the rewards must be to cover the cost of the risks (calculating the opportunity cost per year in prison, etc).
 
Many drug dealers do it for other reasons than the money. There is a lot of power in regard to having control over distribution to an addictive substance. I've known some who do it just to act big. Some make very irrational financial decisions in order to "sell' more. It can be a highly social thing where users gravitate around their source. The dealer can also get away with much more socially because of their power of distribution. The social life and self-esteem of a dealer gets affected severely even if they continue to be financially well off.
So there is a lot of politics involved here and it may overtake any principles of rational economics, just as it can in the 'above-ground' economies.
 
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