Economics and drug markets

Posted on October 23, 2014 · Posted in Blog

In recent weeks, police celebrated a number of drug busts. Methamphetamines in Perth, marijuana in South Australia.

Referring, I think, to the methamphetamines bust, I heard one TV report state that it was a big blow to the supply of drugs in Australia.

Anybody who’s studied year 1 economics will know that reducing supply will often result in higher prices. This depends of course on the elasticity of demand for drugs, or how much demand will change as prices increase. The problem of course is that, if demand doesn’t change, higher prices will simply encourage new suppliers to enter the market. And then we’re back to square one.

An excellent report by the London School of Economics (LSE), published earlier this year, raises exactly this point, speaking about global supply-focused drug policies:

In a world where demand remains relatively constant, suppressing supply can have short-run price effects. However, in a footloose industry like illicit drugs, these price increases incentivise a new rise in supply, via shifting commodity supply chains. This then feeds back into lower prices and an eventual return to a market equilibrium similar to that which existed prior to the supply-reduction intervention.

So while the drug raids in Australia are surely not a bad thing. We better not kid ourselves that this is a permanent hit to the supply of drugs in Australia.

Australia needs to rethink its approach to regulating and policing drugs, and as the LSE pointed out, “the most immediate task is ensuring a sound economic basis for policies”.