Lemons in the Illicit Drug Market
This study analyzes why increasing public opposition to illicit drug use, along with the prevalence of drug demand reduction policies (such as those used by large companies to deter employees from using drugs) has not altered the rates of heroine and cocaine use and has actually led to a decrease in price of retail drugs in Europe and the U.S.
The illegal drug market can be classified as a monopolistic competitive market, meaning that there are a large number of suppliers at mostly local levels, no barriers blocking entry to the market, and usually a lack of perfect knowledge about the product on both sides. Upper-level dealers who have established trust with their clients can get away with selling products at higher prices because the buyers trust that they will be of good quality–but these high profits will attract newcomer suppliers to the market, lowering the prices over time. Although risk factors such as the threat of law enforcement and incarceration should technically increase the price, the ample amount of cheap workers willing to ingest drugs and carry them across borders for money has decreased the risk premium of the products and the intermediation margin of the market. Globalization has led to increased air and maritime travel efficiency, causing an increasing prevalence of cheap air and maritime traffickers, often transporting from poor/rural countries (the study uses a cocaine trade route from West Africa into Europe as an example). All of these factors–mostly decreasing the price of the import/export business–have contributed to a decrease in price of the product and have allowed a steady flow of drugs to remain.
The study also brings up the concept of the “market for lemons” that we discussed in class. While the drug trade is an example of a monopolistic competitive market, so is the market for health insurance or the market for used cars. Asymmetry of information is a common characteristic for buyers and sellers in these types of markets–for example, a drug supplier often knows the quality of the drug better than the buyer, and even though this knowledge can be imperfect, it still precedes the buyer’s knowledge. Interestingly enough, sometimes this lemon problem can lead to market failure. Akerlof, the developer of the “market for lemons” theory, states that in a market with products of vastly varying qualities “it is … possible to have the bad driving out the not-so-bad driving out the medium driving out the not-so-good driving out the good in such a sequence of events that no market exists at all” [9]. The study states that this does occur in drug markets, where the high-quality drugs tend to be driven out, with only the low quality drugs or “lemons” left over. This is why trust is a such key factor in illicit drug trade, because it allows the buyer a chance to establish themselves as high-quality supplier and thus charge a “quality premium.” This higher price can be an example of a “signal quality,” as it is more than providers of low-quality charge and serves as a signal to potential buyers.
Sources:
http://www.sciencedirect.com/science/article/pii/S0955395909000462
http://www.cs.cornell.edu/home/kleinber/networks-book/networks-book-ch22.pdf