Regulating the Trade in Recreational Drugs

Abstract

This paper examines the market for illegal recreational drugs. Under the present regime of illegality, the law acts as a barrier to entry of other firms. It also restricts the information available to consumers. Both of these effects increase the market power of traders. Other negative consequences of illegality include the use of violence to enforce contracts, poor quality control and the use of illegal activities to finance the purchase of drugs.

However, legalizing the trade is likely to lead to greater drug use in the long run. This follows from the addictive nature of recreational drugs. Initial use of the drugs will drastically reduce consumers' price elasticity at any given level of consumption. Firms can increase the extent of the market by using introduction strategies, reducing consumers' price elasticities. Since newly introduced consumers have no brand loyalty, introduction strategies are public goods for firms. Free rider problems will produce oligopoly and collusion. Legalization will lead oligopolistic firms to expand the market.

To avoid these problems it is suggested that the recreational drugs industry should be nationalised, not legalised.