THE DRUG TRADE

The drug trafficking industry has modernized amid the drug wars of the 1980s and 1990s. All thanks to the peculiar economics of an illegal trade.

Editors' note: We chose to reprint this article fronz the respected British journalThe Economist for two main reasons. First, the authors describe in detail how the Latin American drug trade has solidified even as law enforcement has been stepped up over the last decade. This point casts doubt on all "source country" strategies, including the Drug Enforcement Administration's "kingpin strategy" targeting upper-echelon traffickers, as well as the Clinton administration's efforts to engage the military government of Burma in joint anti-heroin operations.

Second, the article gives perspective at a time when the United States has become more tense than ever in its relations with Colombia, which stands accused ofinsufficient efforts against drug trafficking. Clearly, the frustration of U.S. officials is traceable both to the actions of the Colombian government and to America's dogged persistence with drug prohibition.

Reprinted with permission from the December 24, 1994-January 6, 1995 edition of The Economist. Copyright 1995 by The Economist (the journal does not use bylines). Drug Abuse & Addiction, Detoxification, Treatment, Opiate Withdrawal. Substance Abuse: Heroin, Cocaine, Marijuana, Crystal meth, Vicodin, OxyContin, Amphetamines, Percocet and others.
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IT IS MORE THAN FIVE YEARS since President Bush declaredwar on Latin America' s illegal cocaine industry. By increasing America's anti-drug budget, involving its armed forces in repression of the drug trade, and by offering hundreds of millions of dollars in aid to the governments and security forces of the Andean cocaine-producing countries, Mr. Bush planned to reduce the amount of cocaine reaching the United States from Latin America by 10 percent within two years, and by 50 percent in 10 years. Halfway through that decade — and after the United States has spent more than $50 billion on its anti-drug fight — Latin America's illegal drug industry is still booming.

Although the issue of illegal drugs is becoming more prominent in many European countries, it no longer commands headlines or the top slot on the political agenda in America. As Europe's politicians may quickly discover, this is mainly because their counterparts in America found that there were few electoral rewards in engaging with such an intractable problem.

Firm figures are few and far between but, such as they are, they give little comfort to anti-drug policemen anywhere. True, Arnerican officials reckon that production of cocaine may have fallen recently. (The National Narcotics Intelligence Consumers Committee estimated Latin America's "potential" output of cocaine at 770-805 metric tons in 1993, down from 955-1,000 tons in 1992.) But, as the officials admit, the cause has more to do with a fungus that attacked Peru' s coca crop than with successful law enforcement. Other analysts believe the committee may have underestimated yields. Though much more cocaine is intercepted by the authorities around the world than a decade ago, that positive trend has stopped: Total seizures lately seem to have stabilized atbetween 275 and 350 metric tons a year. In any case, the earlier increase in seizures may reflect higher production as much as tighter prohibition.

The United States remains much the largest market for cocaine. Despite the efforts of a dozen government agencies and all those Bush dollars, repression has not threatened supply. The drug's price is low and stable. For the past five years, wholesale prices have fluctuated around an average of $16,000 to $20,000 a kilo (down from $50,000 to $60,000 in the early 1980s). Meanwhile, new markets for cocaine have opened up across the world, especially in Europe. America's State Department notes that all major European capitals have reported a growing influx of cocaine. Last year Russian police seized more than a ton of Colombian cocaine in St. Petersburg.

On the demand side, use of cocaine and crack has spread to Europe's inner cities. In America, government figures suggest that the casual use of cocaine declined sharply after 1985, but is now increasing again. Some analysts doubt the value of this figure: It relies on consumers telling the truth. The figures also show that consumption by regular users is going up. Hospital emergencies involving cocaine — probably the most reliable indicator of consumption — have increased by 25 percent since 1991. In addition, the use of heroin is rising sharply in America.

This bleak picture is not due to lack of effort by the drug fighters. Indeed, they have some notable successes to their credit, thanks partly to unprecedented cross-border cooperation. One such success was "Green Ice," an international operation in 1992 against the money-laundering system of traffickers from Cali, Colombia. Coordinated by America's Drug Enforcement Administration (DEA) , it led to 200 arrests in seven countries and the seizure of $40 million in cash.

In December 1993 security forces finally caught and killed Pablo Escobar, Colombia's most notorious and most violent drug gangster. The chase, assisted byAmerica's most sophisticated intelligence technology, had taken 17 months. Escobar's death completed the dismantling of the "Medellin cartel," which American officials claimed had been responsible for 80 percent of the cocaine reaching the United States during the 1980s. Escobar and his cronies were also behind a bloody campaign of bombings, including the blowing up of a civil airliner in mid-flightwith more than 100 passengers aboard, as well as the murder of some of Colombia's leading politicians, judges and journalists.

Yet neither operation had a discernible impact on the flow of cocaine. Individual traffickers have come and gone, but taken as a whole the Andean drug industry, whose center of operations has long been in Colombia, appears stronger than ever. Colombia has also emerged as an important producer of heroin — perhaps the second largest after Myanmar (formerly Burma) . The Colombian trafficking businesses appear to have stepped up both the repatriation of drug profits and their investment in legal businesses. Less than two decades after large-scale exports of cocaine from Colombia began, the country's drug business now seems too big, too diversified and too clever for law enforcement efforts to have more than a marginal effect on its viability.

WHY HAS THIS HAPPENED? The answer starts with the peculiar economics of an illegal trade. Prices at each stage in the long chain that turns a coca leaf on an Andean hillside into a gram of cocaine on the streets of the Bronx are determined principally by the
risks that stem from the trade's illegal status. That is why the price of a kilo of pure cocaine (measured in relation to its equivalent in coca leaf) rises by a factor of roughly 200 times between the coca farm and the street. Most of that increase occurs once the drug has entered the United States — because law enforcement is tighter in most of American's cities than in, say, the wilder parts of Peru's Amazon basin.

Peter Reuter, an economist at the University of Maryland who has made a detailed study of cocaine economics, argues that even much tougher enforcement in the producer countries would fail to eliminate the supply of cocaine. There are just too many coca farmers, processors, exporters and smugglers. Rather, by adding to the producers' risks, the effect of stronger enforcement would be to increase the price at each stage in the chain of supply. But since prices at the manufacturing stages represent a tiny part of the final price, action against coca and cocaine producers in the Andes (of the kind championed by Mr. Bush) has little effect on the street price in the United States.

Mr. Reuter reckons that a tripling of the price of coca leaves would increase the street price of cocaine in the United States by less than two percent. Or, to look at it another way: the cost of smuggling a kilo of cocaine to an American port could triple and still leave the smugglers in profit, even if the price they received remained the same.

Aside from economic difficulties, attempts to repress the drug trade in the Andean countries have also been dogged by corruption and lack of political will. Peru's armed forces have made progress against the Shining Path guerrillas in the Upper Huallaga valley (a coca-producing area), but have been less than zealous in pursuing the drug trade itself. Some officers appear to have joined it. In Colombia, despite the honorable record of many politicians, judges and police chiefs, the security forces have taken little action against the Cali traffickers — who collaborated in the pursuit of Escobar. But, to repeat Mr. Reuter's point, it would make little difference if the institutions of the drug-producing countries were entirely uncorrupt.

Repression has not merely failed. By fragmenting the industry and encouraging innovation, it has actually made the drug trade harder to fight. Both effects are apparent in the changing shape of the Andean cocaine industry.

A decade ago, most of the coca used to make cocaine was grown in just two areas: Peru's Upper Huallaga valley, and the Chapare region in Bolivia. After initial processing on site, cocaine paste was flown in light planes to Colombia for refining. Exports to the United States were controlled by a handful of illegal entrepreneurs, based mainly in Medellin and Cali. Now, the industry is much more complicated.

Cultivation of coca has declined in the Upper Huallaga valley since 1992, partly because a leaf-eating fungus hit the most densely planted areas. It has risen only slightly in the Chapare thanks mainly to a program financed by America, under which coca farmers are paid to withdraw fields from production. But coca has spread elsewhere across northwestern Latin America, pushing into increasingly remote areas. Today coca is grown not only in new parts of Peru and Bolivia but also in Venezuela and Panama. And production has surged in Colombia: The area under cultivation may have doubled in the past two years, to 80,000 hectares — bigger than the area under coca in Bolivia, and enough to nullify the effect of the Peruvian fungus.

Drug processing and exporting have also become fragmented. Peruvian traffickers have begun to export cocaine direct, instead of selling semi-processed paste to Colombians. One theory links both this and the growth of the coca crop in Colombia to the installation of American radars on the border between Peru and Colombia and to the Peruvian government's decision to shoot planes down that do not have flight plans registered in advance.

In Colombia, the DEA says that Cali has replaced Medellin as the center of the industry and supplies roughly three-quarters of the cocaine reaching the United States. But several other important trafficking organizations have emerged. As well as reorganized remnants of the Medellin organization, they include outfits based on Colombia's north coast, in other areas of the Cauca valley near Cali, in the eastern plains and in Bogota, the capital.

ONE OF THE THINGS that makes analyzing Colombia's drug industry difficult is that Ameri ca's policy-makers and journalists are too fond of the term "cartel." The DEA coined it, applying it first to the Medellin traffickers and now to their counterparts in Cali. Economics, evidently, is not among the DEA's strengths.

A cartel is a coalition of producers acting together to restrict supply and drive up the price of their product. Yet, as Francisco Thoumi of Bogota University of the Andes argues, the cocaine "cartels" have increased production probably threefold over the past 15 years, allowing the average wholesale price in the United States to fall by 75 percent. Moreover, behind that average, prices vary a great deal from city to city.

So although there is evidence of coordination among different cocaine producers, and of control by certain specialists over aspects of the business such as transport and smuggling, there is little evidence that certain traffickers (such as Escobar and Jorge Luis Ochoa) ever tried to restrict supply, and none that they ever succeeded. Mr. Thoumi suggests the terms "exporters' association" or "cooperative" to describe the Cali organization. Others talk of "syndicates" or of a commodities-style "cocaine exchange."

There is more to this than semantics. Though everyone agrees that the Cali traffickers currently dominate the business, it is unclear how tightly they control the market — and it is harder to defeat an enemy that you do not understand. A senior DEA official says their organization is like "the board of directors of a large corporation, which has a number of vice presidents, each in charge of a different branch." But another experienced DEA official, who dislikes the term "cartel," says that Cali is "a consortium [whose members] work together when it suits them, otherwise not. They cooperate on some deals but not on others."

The DEA identified some of Cali's most powerful drug entrepreneurs long ago. They include the Rodriguez Orejuela brothers, Gilberto and Miguel, whose specialties are transporting cocaine to America and money-laundering; Jose Santacruz Londono, who controls wholesale distribution in New York; and three other family clans — the Grajales, whom the DEA believes are important exporters of cocaine to Europe, the Herreras, and the Urdinolas. But Alvaro Camacho, a sociologist at Bogota's National University, says that each town in the Cauca valley now has one or two import-ant drug entrepren-eurs operating more or less independently. He says a kind of class structure has developed: at the bottom is a group ofyoung and murderous former gunmen, who have become small-scale cocaine entrepreneurs in their own right.

SOME COLOMBIANS ARGUE that the success of the senior Cali traffickers is due mainly to their political strategy. Whereas Escobar attempted to enter politics openly — and, when thwarted, threw down a military challenge that the state could not ignore — the Cali entrepreneurs quietly cultivated political influence through corruption (though their ways of dealing with traitors have been no less brutal for that). And while Escobar reacted violently to rebuffs by Colombia's traditional elite, his Cali rivals bided their time, investing in a parallel, and legal, business empire.

Other analysts claim that Cali's emergence as the leader of the cocaine industry is due not just to political skills, but also to the sophisticated business methods that the traffickers have used to contain risk and maintain or expand their profits. In certain respects, Colombia's drug entrepreneurs have done this with all the acumen and professionalism of, say, the big international tobacco companies. In developing these methods, Cali's entrepreneurs have been in the forefront:

•    Reducing risk. Mr. Thoumi argues that this aim has determined the opaque structure of the industry — with its mixture of compartmentalized businesses (to increase secrecy) and various forms of association (to make sharing information, especially about the authorities, easier). It has also meant that the family business, where ties of loyalty are strong, has been the typical form of enterprise.

Risks can be reduced in other ways. Cali has extended its reach to the first level of distribution in America; exploiting this greater degree of control, the town's traffickers can demand payment up-front before any cocaine is shipped. Wholesale distributors are required to offer collateral in Colombia— normally a property but sometimes also the names and addresses of family members in the United States.

Achieving economies of scale. Although Escobar and his associates developed large-scale production facilities (in the form of big cocaine-processing labs in Colombia's eastern plains) , these involved greater losses when detected. For the past 10 years, labs have tended to be dispersed over a wider area, including neighboring countries such as Venezuela, Ecuador and Brazil. Economies of scale have been sought not in production but in transport.

The pioneer was Carlos Lehder (currently serving a life sentence in the United States). In 1978, Mr. Lehder bought a small island in the Bahamas, and began using it as a base for regular flights to small airstrips in the southeastern United States. This service, for which he charged a fee to cocaine producers in Colombia, accepted loads of 250 kilos or more. Previously, loads had been limited to what could be concealed by individual smugglers ("mules") passing through airports.

The next step was to use commercial aircraft. In 1982 customs agents discovered two tons of cocaine in a shipment ofjeans at Miami International Airport. The DEA reckoned the drugs came from 15 different trafficking organizations.
In addition, Cali's entrepreneurs rely heavily on merchant shipping, using ever more elaborate methods of concealment. (Recent seizures have found cocaine hidden in concrete fence-posts, in cans of fruit juice and stuffed inside frozen fish.) This has permitted shipments of up to 20 tons. Since 10 million containers pass through America's ports each year (of which customs agents search only four percent) , this method further reduces the risk of detection. In the same way, the newest thing in transport — the use of semi-submersible craft and homemade submarines to ferry drugs from Colombia's north coast to Puerto Rico — lessens risk at the same time as providing opportunities for shipping in bulk.

•    Just-in-time supply. Since most value in an illegal business is added in the final market, competitive advantage derives from an ability to provide continuous supply, which in turn ensures control over distribution networks. Stocks must be maintained at all points along the smuggling pipeline to minimize the effect of lost shipments. The success of the Cali traffickers in this respect may have been a decisive factor in their gaining control of distribution networks in America after 1989-90, when the Medellin traffickers were distracted by a Colombian government crackdown. Such is their confidence in the system that the Cali shippers offer insurance against lost supplies.

•    Developing new products and markets. The DEA blames Dominican drug dealers in New York for the introduction of crack, a form of cocaine which has a more powerful effect in smaller, cheaper quantities — and which therefore created a new and wider market. Other forms of innovation have paid off too. As the price of cocaine tumbled in the late 1980s, when the American market became saturated, the Colombian industry turned to Europe; the Cali traffickers may have made a distribution deal with the Italian mafia.

Colombia's traffickers also began producing heroin. Although there is some evidence that Colombia's move into heroin production may have been pioneered by smaller trafficking organizations (including leftist guerrillas), Cali is now involved as well. The DEA reports that distributors working for Cali are requiring customers to buy heroin along with cocaine.

• Developing new production technology. Colombia's coca crop was traditionally of poor quality. This is changing. Sergio Uribe, a consultant to the United Nations and author of Colombia's forthcoming national anti-drug plan, says that growers have introduced new higher-yielding Peruvian varieties. And using new methods (involving gasoline and powdered cement), it is possible to extract more usable material during the first stage of processing.

THIS MODERNIZATION of the cocaine industry has an important consequence. It means that even if Colombia succeeds in eliminating the senior Cali traffickers, or in persuading them to surrender, the effect on the industry would almost certainly be short-lived. There is no reason to suppose that the accumulated knowledge of business techniques is held exclusively by the top families. The industry is too diversified for that. Anyway, many key tasks (money laundering, record keeping, information processing) are carried out by hired professionals — accountants, lawyers, systems engineers. Lines of succession have in many cases already been devised. The DEA believes that the Rodriguez Orejuela brothers and their colleagues, for instance, are grooming lieutenants to take over their businesses.

The implications of this are only half-recognized by many American officials. President Clinton has shifted the focus of an ti-drug rhetoric toward education and treatment. But the administration clings to an "integrated" drug strategy — albeit hampered by budget cuts — with interdiction efforts overseas focused on "source" rather than "transit" countries. Britain is also trying to emphasize education and treatment. Other European countries such as Holland have always followed this approach.

Colombia faces an equally difficult, but different, problem. Apart from the violence and corruption spread by an illegal industry, it must cope with a growing economic problem: the misallocation of resources caused by financial dependence on exports of drugs.

Although most of the profits of the drug industry are made in the retail markets of America and Europe, Colombian economists believe that the drug entrepreneurs have repatriated at least $1.5 to $2.5 billion a year for the past decade. The figure may have risen in 1990-92, when the government removed barriers to capital flows in an effort to encourage foreign investment. (Mr. Thoumi notes that these figures also exclude investments in Colombia by drug distributors resident in the United States.) This compares with gross investment by the legal private sector averaging $2.8 billion a year during the 1980s. In other words, drug capital now finances a significant fraction of the country's accumulation of capital.

Though Colombia has a diversified and relatively fast-growing legal economy (thanks partly to sound macroeconomic policies) , its hopes of becoming a Latin American jaguar are now threatened by the distortions induced by drug money. Much of this cash is invested to bestow social legitimacy on the drug entrepreneurs. Traffickers have built clinics and cinemas in their home towns in the Cauca valley, for example. Colombian analysts estimate that drug entrepreneurs o-wn roughly a third of the country's agricultural land. But where the main purpose of investment is to launder drug money, the effect is often to crowd out legal businesses. Loss-making firms from fruit canning plants to furniture stores may have caused legal rivals to fail.

A lot, and perhaps most, of the drug entrepreneurs' investment is made in the quest for further (not necessarily legal) profits. Two activities stand out: importing electrical appliances and building. Markets for contraband electrical appliances have now boomed. The main one in Bogota now occupies eight blocks, and three others have arisen in the south of the city. These benefit consumers by undercutting conventional retailers, but they encourage tax evasion. The biggest risk to the economy, however, may lie in a property boom.

Cranes tower over Cali. Many are being used to build shopping centers, hotels and luxury flats financed by drug money. Construction is likely to grow by nine percent in 1994. (In 1993 it grew even faster, by 12 percent; the economy as a whole expanded by 4.5 percent.) Salomon Kalmanovitz, of Colombia's central bank, fears that the property boom could eventually trigger a collapse in asset values.

He notes that since 1991 the value of urban property has appreciated by 50-60 percent a year, compared with an average inflation rate of 22 percent a year. The immediate headache for the authorities, however, is the rise in the value of the Colombian peso. The influx of drug money coincided with a sharp increase in export earnings from coffee (thanks to record prices) and oil (because of new fields). As a result, the peso has appreciated by 30 percent so far this year in real terms against the dollar, threatening the competitiveness of Colombia's legal exports.

Hitherto Colombia's policy toward the drug trade has been dictated by political and foreign policy considerations. As a result, it has oscillated between repression of the traffickers who challenge the state, and negotiating the surrender of those who do not. By now, the limits of this approach are clear. If Colombia is to break its own debilitating dependence on drugs, the world's rich countries must understand the economics that drives the drug trade. Demand creates supply, prohibition notwithstanding.