Introduction
Ever since Richard Nixon declared the first official "war on drugs" in 1969, U.S. drug policy has been driven by the assumption that the best method to curb drug consumption at home is through repression of the supply at "the source" of production abroad. As a former U.S. ambassador to Bolivia once put it, "the closer you get to where it comes from, the more bang you get for your buck." (Quoted in Iyer et al., p.35) Echoing this sentiment, George Bush has proclaimed, "The logic is simple. The cheapest and safest way to eradicate narcotics is to destroy them at their source...we need to wipe out crops wherever they are grown and take out labs wherever they exist." (Quoted in Hoffman).

Following this logic, funding for supply reduction efforts has steadily grown. But while federal anti-drug spending increased by over 300 percent between 1980 and 1988, the cocaine supply grew tenfold and cocaine prices dropped by as much as 80 percent. By the end of the decade, the failure of the policy was painfully clear: more drugs were available at cheaper prices in more places than ever before.

Yet as we enter the 1990s the Bush administration remains firmly committed to the supply-side strategy, interpreting past failure as merely a problem of inadequate funding and political will. This has created a dangerous logic of escalation: the consistent response to failure has been to escalate the drug war abroad. Thus, the greater the policy failure, the greater the escalation. Yet the supply-side strategy's poor performance is not simply the result of mismanagement or lack of adequate resources. As economist Peter Reuter has noted, it is inherent in the very structure of the problem itself. (Reuter, p.80)

This has been especially true in Peru and Bolivia, the source of most of the world's supply of coca used to make cocaine. U.S. efforts to repress the coca trade have ignored both the market logic of the illicit trade and the economic realities of coca dependency in the two crisis-stricken countries. Moreover, even as the United States attacks the coca economy, it promotes harsh economic austerity programs which actually fuel the coca trade. Consequently, U.S. economic and anti-narcotics strategies end up being both contradictory and counterproductive.

The Market Logic of Supply and Demand

While the Bush administration preaches the virtues of the market, its drug policy defies the market logic of the drug trade by literally turning the law of supply and demand on its head: according to federal drug policy strategists, reducing the supply will lower demand by driving street prices up and making drugs scarcer.

However, it is extremely difficult to affect the U.S. street price through supply reduction efforts. Peter Reuter calculates that "Even very large increases in the producer country prices will have but a negligible impact on the U.S. price and hence consumption. The international programs can work only by creating an absolute scarcity of the drugs for U.S. consumption." (Reuter, p.83) Thus, even if supply were reduced by half, it would have a minimal impact on the U.S. street price. Furthermore, any price increase would mean higher profits — creating an incen-tive for more producers and dealers to enter the market.

The inherent difficulties in achieving even mini-mal reductions in supply are most evident in Peru's Upper Huallaga valley and in Bolivia's Chapare region, the two largest coca growing zones in the world. Eradication programs in the two coca-rich regions have failed to even keep up with new coca growth, which has expanded at least ten percent per year throughout the last decade. In response to U.S. eradication efforts, peasant coca produc-ers have simply migrated to even more remote areas farther from government control. Attempts to eradicate coca therefore produce a balloon effect: squeezing produc-tion in one area simply causes it to pop out in another. The greater the repression, the greater the expansion.

Thus, ironically, U.S. law enforcement efforts are partly to blame for spreading coca farming to areas often previously untouched by the crop. Among the many negative consequences of this expansion has been wide-spread environmental damage: Marc Dourojeanni, a forest engineer with the Inter-American Development Bank, estimates that 1.7 million acres in the Amazon have been directly or indirectly destroyed as a result of coca produc-tion. Coca expansion, he estimates, is responsible for ten percent of Peru's total deforestation and is now the largest cash crop in the Peruvian Amazon. (Dourojeanni, p.5)

The potential for coca growth along the eastern slopes of the Andes and in the Amazon river basin create conditions for almost infinite supply. Even if coca could somehow be eradicated in Peru and Bolivia (through the use of herbicides, for example), coca could easily jump national borders to new growing areas, such as in Brazil's vast tropical interior.

Eradication efforts are thus faced with an inescap-able truth: as long as consumer demand remains high and peasant producers lack viable economic alternatives, eradicating coca in one area will only stimulate production elsewhere. Past experience (not only with coca but with marijuana and the opium poppy as well) has shown that even while law enforcement efforts may at times enjoy short-term success by disrupting supply routes, the market eventually adjusts. But while the market logic of the coca trade provides a formidable barrier to supply reduction efforts, the supply-side policy faces an even greater obstacle: Peruvian and Bolivian narcoeconomic realities.

Andean Coca Dependency

Even while the administration pursues a policy that assumes coca production can simply be isolated like a tumor and surgically removed through aggressive law enforcement, the reality is that the coca economy is thoroughly integrated into the Peruvian and Bolivian financial systems and is a critical source of jobs for hun-dreds of thousands of peasant farmers. A review of these economic realities is sobering.

Peru. While data on the size of the drug trade necessarily represent rough estimates, coca has undeni-ably been both Peru's single most important economic activity and biggest growth industry for over a decade. The coca trade generates approximately $800 million to $1.2 billion annually in desperately needed foreign exchange — representing about 30 percent of the total value'of all other exports combined. But the significance of these figures can only be appreciated within the context of Peru's deepening economic crisis:

From 1988 to 1989 Peru's legal economy shrank by 20 percent — the biggest drop in the hemisphere. Last year, the official inflation rate reached 2,775 percent. While inflation skyrocketed, real wages dropped 60 per-cent. Sixty-five percent of the population remains either unemployed or underemployed. Meanwhile, the IMF, the World Bank, and the Inter-American Development Bank have cut off credits, and commercial bank lending has dried up as a result of Peru's inability to finance its foreign debt. (See Andreas, 1990)

With the formal economy crumbling, the jobs and revenues generated by the "informal" coca economy have softened the impact of the crisis. In the Upper Huallaga valley, coca acreage has expanded roughly 10 percent per year to its present estimated size of 250,000 acres. The valley has been a magnet of migration, attracting thou-sands of colonists who lack viable economic alternatives in the legal economy. By one estimate, as many as 70,000 Peruvians have moved to the valley in the last three years alone. (See Andreas, 1990)

The foreign exchange generated by sales of coca paste to Colombian traffickers enter the economy in two ways:

1) Coca dollars are sold for local currency to money-changers who travel to the valley from Peru's busy parallel exchange market on Ocona street in downtown Lima. These cambistas return to Lima to sell the dollars at a slight profit. According to the Lima economic consulting firm Apoyo, $3 million a day is exchanged on the parallel market, most of it coca dollars. (See Kawell) "If the cambistas suddenly disappeared, there would be a huge adverse impact on the country," says Jorge Fernandez Baca, a Peruvian economist who studies the underground economy. "Importers couldn't get along without them because they need dollars to buy goods from abroad."
(Kandell, p.10a)

2) Coca dollars are also absorbed into the national economy directly through the banking system. The country's major banks — including the central bank — buy dollars on Ocona street, but purchase most of their coca dollars directly through their busy branches in the Upper Huallaga valley. Consequently, most small towns in the valley move more dollars than many of the country's large cities. Once into the financial system, these dollars are "clean" and can be used to meet the country's many foreign exchange needs, including financing the foreign debt. See Andean Report, Kawell, Andreas and Youngers, Compodonico)

Peru's financial institutions began courting drug money in the late 1970s when, according to economist R.T. Naylor in his book Hot Money and the Politics of Debt, "Peru deliberately abolished exchange controls to attract coca-dollars, exchanging them for local currency or for dollar-denominated certificates of deposit (CDs) with no questions asked. Peruvian banks rapidly expanded into cocaine country to sop up the flow." (Naylor, p.180)

In April 1985 the Andean Report, a business newsletter that monitors economic developments in Peru, noted that "the wide-open Central Bank rules governing foreign exchange...[have] made Peru as easy a place as Panama to hide, change, launder and transfer large amounts of cash through the banking system." (Andean Report, p.43)

As foreign exchange reserves have dried up and debts have grown, the nation's financial system has had little choice but to tolerate dollars from any source — legal or illegal. In the words of one central bank official, "Coca is our first export product. It is illegal, but it pro-vides us with needed reserves. It helps the country's balance of payments..." (Quoted in Naylor, p.178)

With net international reserves depleted by January 1988, President Garcia opened foreign exchange houses, encouraged importers to buy dollars from the parallel market to finance their imports, and declared a tax amnesty on all repatriated dollars, with no questions asked. These measures facilitated the absorption of coca dollars into the economy, making Peru one of the most "dollarized" countries in Latin America. The continued decline of the Peruvian economy will mean growing state dependence on — and therefore tolerance of — the underground coca trade. (See Compodonico)

Bolivia. Bolivia's economy is even more tied to the coca trade. An estimated $600 million in coca dollars flows into the Bolivian economy each year — an enormous amount considering it is at least equal to the revenues generated by all other exports combined. As many as 500,000 workers are dependent on the coca trade. (See The Economist) These are impressive figures in a country of barely 7 million people. But as in Peru, their true impor-tance can only be appreciated within the context of the country's worst economic crisis of the century.

The Bolivian economy plummeted into a deep depression in the early 1980s: between 1980 and 1985, the gross national product fell 20 percent, per capita consump-tion declined 30 percent, family income dropped by 28 percent, and unemployment doubled. Inflation reached an astonishing 24,000 percent in 1985. Between 1984 and 1986, Bolivia's legal exports shrank by 25 percent. (See Healy, Kawell)

Meanwhile, the country was caught in a debt squeeze: by 1985, foreign exchange reserves were depleted and debt payments to multilateral lending agencies exceeded new financing, generating a net capital transfer out of the country. (See Sachs) In the absence of foreign loans, the deficit could only be covered by buying dollars on the parallel foreign exchange market (meaning coca dollars), which in turn required the printing of more local currency. This, of course, fueled hyperinflation.

The biggest shock came in October 1985, when the bottom fell out of the market for Bolivia's principle legiti-mate export, tin. World tin prices fell by 54 percent from mid-1985 to mid-1986. To make matters worse, in January 1986, the oil price collapsed, bringing down with it the price of what had replaced tin as Bolivia's biggest legiti-mate export, natural gas.

But while these legal exports declined, coca boomed. The number of coca growers tripled between 1980 Euid 1986, and coca production in 1983 was triple the 1981 level. (See Healy) A 1986 study by Bolivian economist Samuel Doria Medina found that four fifths of the ex-changes in Bolivia's parallel currency market could be traced back to sales of coca and coca paste. He estimates that 80 percent of the supply of dollars needed by the Bolivian economy between 1984 and 1985 came from drug related activities. (Blanes, p.145)

Flavio Machicado, Bolivia's former finance minis-ter has observed that "Bolivia has gone from the economy of tin to the economy of coca. If narcotics were to disappear overnight, we would have rampant unemployment. There would be open protest and violence." (Quoted in The Economist, p.24)

The Austerity-Coca Link

Ignoring these overwhelming economic realities, the United States has escalated the drug war in Bolivia. Yet ironically, even as the anti-coca campaign has intensi-fied, Washington has promoted harsh economic austerity measures which have actually deepened the country's dependence on the jobs and revenues generated by the coca trade. This contradiction began in mid-1985 and remains largely ignored by Washington policy-makers. Moreover, it is being repeated in Peru under the new government of Alberto Fujimori.

When Victor Paz Estensorro was elected president of Bolivia in June 1985, he implemented the most severe IMF austerity package ever attempted in Latin America in an effort to revive the economy and make peace with the International financial community. A report by the Wash-ington-based Institute for International Economics de-scribes Bolivia as "perhaps the most extreme case of adoption of the policies that constitute the 'Washington consensus.'" According to the report, "The Bolivian plan looks almost like a laboratory experiment of everything Washington preaches..." (Williamson, p.36)

The austerity program cut deep: The Bolivian peso was devalued by 95 percent, gas prices rose tenfold, import and export restrictions were lifted, government subsidies were eliminated, bread, electricity, telephone and transit prices jumped. Union leaders were arrested and labor demonstrations suppressed. Some 25,000 tin miners were laid off. (See Healy, Compodonico)

But while Paz Estensorro's "New Economic Policy" (NPE) was being praised in Washington and on the pages of the business press, its successful implementation was directly tied to the booming coca trade. The influx of coca dollars is "the only way we've been able to balance the balance of payments," says Rolando Morales, professor of economics at Bolivia's San Andres University and former president of the association of economists. (Zuckerman, p. 115) According to Morales, Paz Estensorro "promulgated several different measures designed to recycle coca dollars in the economy." (Ibid.) These included deregulating the foreign exchange market, lifting import restrictions, prohibiting official inquiries into the source of wealth brought into Bolivia, and granting a tax amnesty to repatriated capital.

According to economist R.T. Naylor, "in 1985 the government and banking system "officially went into the laundry business. In an appeal for dope money to come home — all would be forgiven — the new policy decreed that `No proof need be given, at the national, departmen-tal, or municipal level, of the origins of assets invested during the next four months.' The central bank began marketing bearer CDs in dollar denominations with a guaranteed 10 percent rate of return." (Quoted in The Economist, p.24)

By the end of 1986, 80 percent of foreign exchange sales were moving through the central bank, creating a build-up of reserves. Thus, despite a deteriorating trade balance, net reserves reached $245 million in February 1986, up from roughly the $100 million mark in August 1985. (See Zuckerman) "The new exchange policy implied that the state and the Bolivian banking system would legalize, in effect, the dollars from drug trafficking," claims economist Humberto Compodonico. "Without the dollars from drug trafficking, the government would not have been able to end the hyperinflation." (Compodonico, p. 246)

Compodonico points out a fundamental contradic-tion: "On the one hand, the U.S. government pursues the destruction of coca crops and the elimination of drug trafficking, but on the other hand the IMF promotes a liberal exchange policy which legalizes the dollars from drug trafficking." (Ibid.) Ironically, he notes, the "recom-mendations of the IMF in terms of exchange rate policy coincide with the needs of governments to capture the dollars from drug trafficking." (Ibid, p. 255)

At a seminar in Washington D.C. in May 1990, Antonio Aranibar Quiroga, president of the Movimiento Boliviano Libre, a leading Bolivian opposition party, argued that "Without the revenues brought into Bolivia by the coca and cocaine economy, the new economic policy would not have had the slightest possibility of success...This great 'success' of economic austerity was sustained directly by the narco-dollars that greased the machinery of the Bolivia economy."

Equally important, the coca economy has sus-tained the austerity program through the absorption of the unemployed into the coca trade. Testifying before the House Subcommittee on Western Hemispheric Affairs in June 1990, Bolivian political scientist Eduardo Gamarra stated that "Ironically, the NPE [New Economic Policy] has encouraged peasants and laid off workers to flock to coca growing regions to meet the needs of the cocaine industry." (Gamarra, p.7) Thus, for example, when some 25,000 tin miners were laid off in 1985, many found work in the thriving coca economy.

Gamarra told the subcommittee that "For Wash-ington, Bolivia has become the showcase of what other nations in the region could accomplish if free-market principles are allowed to run their economies." But, he pointed out, "several prominent economists have argued that ... any downturn in the coca-cocaine economy could have grave consequences for the continued success of Bolivia's highly regarded NPE [New Economic Policy]." (Gamarra, p.7)

But despite the high social cost of the austerity program and its special relationship to the coca economy, the World Bank representative in Bolivia, Fernando Mendoza, stated in 1987 that `This is a country that for the first time is functioning in an orderly and logical manner." (Quoted in Zuckerman, p.111)

Nevertheless, while fiscal stabilization has been achieved, the IMF's bitter pill has not cured Bolivia's economic ills. In 1987, real wages were down 40 percent from 1985 levels. Industry was operating at between 40-50 percent of capacity. Official unemployment reached 35 percent in 1988. The country's terms of trade dropped by 20.7 percent in 1986, 8.8 percent in 1987, and 10.2 percent in 1988. The value of exports declined continuously from 1985 to 1988. Meanwhile, Bolivia's debt problems contin-ued. By the end of 1988, outstanding debt amounted to around 100 percent of gross domestic product and 700 percent of recorded exports, while debt payments made during 1988 took up over one-half of official export rev-enues. (See Cabezas, Malloy, Mann & Pastor)

Bolivia remains South America's poorest and most cocaine dependent country. It has the highest infant mortality rate and the lowest life expectancy rate in the region. By one estimate, more than one million children are vvithout schools and teachers — a shocking figure considering Bolivia's total population is only 7 million. (Aranibar) The country's $5.3 billion foreign debt remains one of the highest per capita debts in the world. Under these dire economic conditions, it is not hard to under-stand why eradicating the country's most important export crop is not a high priority for most Bolivians. As Herbert Muller, the former director of the Bolivian Central Bank, has put it, "Cocaine is like a cushion that is preventing a social explosion." (Quoted in Isikoff)

Peru is beginning to follow the Bolivian path of painful IMF-style austerity cushioned by the jobs and revenues of the coca trade. On June 30, Peru's president-elect, Alberto Fujimori, announced an outline agreement with the IMF to stabilize the economy. "We will enact a vigorous anti-inflation campaign and program of institu-tional reforms," he said. (Quoted in Lewis) Fujimori desperately wants to restore Peru's relations with the international financial community, which will require meeting payments on at least a portion of the foreign debt and implementing major economic reforms. But as in Bolivia, the "success" of a stabilization program in Peru will be heavily influenced by the fate of the country's coca industry, which must both help absorb the unemployed and generate foreign exchange for the cash-starved economy.

Under these crisis conditions, the anti-coca cam-paign is by necessity a low priority for Peru and Bolivia. Consumed by the immediate problems of economic sur- vival, the governments of the two countries lack both the power and the incentive to seriously dent the coca trade. Given this reality, as long as world demand persists and economic conditions are not substantially improved in the Andean producer countries, impoverished peasants will continue to grow coca and creative entrepreneurs will find ways to process and distribute it. Thus, in the end, what will most likely cause the cocaine boom to bust is not the "war on drugs," but rather a change in world drug con-sumption habits or the development of chemical substi-tutes. This would appropriately place the rise and decline of cocaine within a larger historical pattern of Andean dependence on the production of "boom and bust" primary export commodities, such as was the case with silver, rubber, sugar, and tin.

Explaining U.S. Policy

In defiance of these economic realities, the Bush administration continues to intensify the drug war in the Andes. As a result, the United States finds itself sliding down a dangerous and slippery slope — all for a war with no end in sight. A number of political and bureaucratic factors may help explain why the administration continues to pursue a seemingly illogical policy. Unfortunately, the combination of these factors provide a powerful deterrent to meaningful policy reform.

The drug war is first and foremost a political war. The easiest way for Washington policymakers to accumu-late political capital without having to produce immediate results at home has been to target the "external threat"
from drug trafficking. For both the administration and Congress, pointing a finger abroad deflects attention away from the country's deeper problems at home.

Moreover, the drug war has generated its own bureaucratic momentum, giving a wide variety of agencies and organizations an institutional interest in perpetuating the "war on drugs." Anti-narcotics funding has grown impressively despite a federal budget crunch and shrink-ing resources. Thus, not surprisingly, a growing number of agencies and organizations have jumped onto the "drug war bandwagon." The CIA, for example, has reportedly quadrupled its manpower and spending devoted to drug control efforts. (Jehl, p.la )

At least 58 federal agencies and 74 congressional committees now have some level of responsibility for waging the anti-drug campaign, resulting in a complex web of fragmented programs, each with its own priorities and objectives. But while turf wars and budget battles prevail within this labyrinth, these organizations share a common institutional interest in perpetuating the drug war. (See Andreas and Youngers)

Furthermore, many with a vested interest in maintaining the present strength and activity of the military see the "war on drugs" as the most opportune new "front" for a stable and growing U.S. military role abroad. The military's drug war budget is expected to increase from $450 million this year to $1.2 billion in 1991. Encour-aged by the President, the Pentagon has undergone a metamorphosis from bystander to eager participant in the drug war. "We pressed the Pentagon's button" to get more involved in the war on drugs, a congressional official told the Los Angeles Times. "Now its going to be hard to turn them off." (Quoted in Jehl, p. la) The military mindset, according to one U.S. Southern Command briefing, must change from "nuclear megatons" to "cocaine kilos." (Waller et al. p. 17)

William J. Taylor, a former director of national security studies at West Point, explained to Congress: "Absent a widely perceived threat from the Soviet Union and Marxist-Leninist proxies, already constrained DOD [Department of Defense] budgets will be more so" and the U.S. public will question the "necessity and desirability of maintaining a large, standing military force," particularly after years of sizable increases in defense spending and cuts in social spending. "To the extent that narcotics continue to be perceived as a major threat to our security, the use of the military in drug interdictions will increas-ingly be viewed as a positive role worth investment — if it can be demonstrated that the military is effective in these operations." (quoted in Blachman and Sharpe)

Finally, the drug war can also serve as a rationale to pursue other foreign policy objectives, such as support-ing counterinsurgency campaigns. Under the rubric of "anti-narcotics assistance," the United States has provided military aid to countries engaged in battles against insur-gencies and has re-initiated previously banned aid and training to Latin American police forces with abysmal human rights records. As part of President Bush's "Andean Initiative," the Andean drug producing nations will receive more military aid than Central America this year. This includes a $35 million offer of hardware and training to battle the Peruvian Sendero Luminoso insur-gency. But while this will surely please Peru's generals, it will do little to dent the cocaine flow and, more impor-tantly, do absolutely nothing to help cure America's drug problem.

Peter Andreas is with the Institute for Policy Studies, 1601 Connecticut Ave., N.W., Washington, D.C. 20009. (202) 234-9382.

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