The Economics of Cocaine Capitalism

by Rensselaer Lee

The Andean drug industry's growth over the past 20 years has made cocaine a major element in the economic life of several western hemisphere countries. Today, cocaine produced primarily in Colombia, Bolivia and Peru is Latin America's second most important export after petroleum. The drug's traffickers reap annual revenues estimated at $9-10 billion. Cocaine accounts for approximately two-thirds of all United States spending on illicit drugs--$31 billion of the country's $49 billion retail market in 1993. Americans spend more on cocaine than on airline tickets, gas utilities or magazines and newspapers.

Cocaine has been a costly enterprise for the Americas politically and socially for a long time, but the dynamics of cocaine capitalism is still poorly understood. Fundamentally, cocaine is an economic phenomenon. It is an important, if illegitimate, producer of wealth and income in South American countries. In the Andean states and Mexico, now the transit center for most cocaine entering the United States, the illegal cocaine economy is intertwined with the legal economy. Its most visible effects-violence, corruption, delegitimation of government and moral decay-are unambiguously negative. Cocaine money has compromised criminal justice systems and governing institutions throughout the hemisphere.

As of early spring, for example, Colombian President Ernesto Samper and his closest associates stood accused of illegal enrichment and electoral fraud in connection with a donation of $6 million by the Cali cartel to his 1994 presidential election campaign. The cartel, a trafficking coalition based in the Valle de Cauca department, has largely replaced the Medellín cartel. Samper was under pressure to resign. Citing the "corrosive impact of drug-related corruption" in government, the United States cut off most of its aid to Colombia. In Bolivia, former President Jaime Paz Zamora is under investigation for protecting cocaine traffickers while in office. One notorious action was his appointment in 1991 of a known drug trafficker, Faustino Rico Toro, to head Bolivia's Special Narcotics Forces. Under U.S. pressure, Paz rescinded the appointment and Rico Toro is being held in the United States on drug-related charges.

In Mexico organized crime enjoys the collusive support of national institutions, such as the Revolutionary Institutional Party (the dominant political party), the attorney general's office and the federal judicial police. Some Cali cartel funds reportedly infiltrated the 1994 PRI campaign of President Ernesto Zedillo. The Mexican government vigorously denies this.

Mexico's drug traffickers are establishing factories, warehouses and trucking companies as legal fronts to take advantage of the cross-border commerce opened up by the North American Free Trade Agreement. Ownership of banks, financial institutions and travel agencies provides cover for laundering drug money.

Elsewhere in the Americas Cuba was rocked by a 1989 drug scandal that linked top government officials with Medellín kingpin Pablo Escobar in the transport of six tons of cocaine to the U.S. through Cuba. Castro executed four offenders and jailed many others. Panama's General Manuel Noriega reportedly accepted almost $5 million from the Medellín cartel in the 1980s and permitted the cartel to ship more than four tons of cocaine through Panama to the United States. He was convicted by a U.S. federal court in 1992 of drug trafficking, money laundering and racketeering and sentenced to 40 years in prison. He is now appealing.

Cocaine is also associated with increases in assassination, terrorism and subversion. In the 1980s senior government officials and political figures in Colombia-among them a justice minister, an attorney general, a Supreme Court justice, the governor of Colombia's most populous department (Antioquia) and a leading Liberal Party candidate for president-were gunned down by the Medellín cartel. Between 1989 and 1993 cartel-sponsored car bombings and killings took the lives of at least 1,500 Colombians. The rise of Colombia's cocaine industry, which first became a significant export business in the mid-1970s, appears to correlate with a threefold increase in the murder rate since 1975. (Colombia's homicide rate at 78 per 100,000 in 1994 is roughly seven times the rate in Washington, D.C.)

Cocaine revenues also support guerrilla movements such as the Revolutionary Armed Forces of Colombia and Peru's Shining Path. In Colombia, guerrilla organizations have collected more than $700 million in the 1990s by taxing the cocaine and heroin trade and by processing these drugs themselves. Other guerrilla activities, including robbery, extortion and kidnapping, yielded approximately $800 million. The war against guerrillas has bled the economies of Colombia and Peru of billions of dollars and killed thousands; in Colombia an estimated 17,000 people died as a result of guerrilla actions between 1990 and 1994.

In Latin America the narcotics trade is associated with production and trafficking rather than with consumption. According to a 1992 survey, only 1 percent of the Colombian population had used cocaine at least once, compared with over 9 percent of the population in the U.S. In Peru and Bolivia, the figure ranges from 1 to 3 percent. U.S. law enforcement and public health costs related to drug abuse is estimated by the White House to be $67 billion annually. In a fortunate departure from the Latin American pattern, however, criminality associated with drugs is relatively minor; and high-level corruption and drug-sponsored killings of top officials so far are not characteristic of cocaine operations in the U.S.

Cocaine capitalism's appeal as a producer of income is obvious. The dynamics, however, is understood only by an examination in detail of how the cocaine and legal economies are intertwined in the Andean states and Mexico. The economic behavior of cocaine elites in some respects resembles the behavior of legitimate business elites. But economies heavily influenced by inflows of cocaine money-Colombia is the archetypal example- appear to perform differently from economies that are not narcotics-driven. Supplier countries generally experience important economic costs as well as benefits. The economic ambiguity creates ambivalence toward the drug trade, weakens the resolve of government in dealing with it and complicates the development of successful counternarcotics strategies in the hemisphere.

Money is power and the cocaine industry clearly uses that potent instrument in the Andean source countries. Exact figures on cocaine's economic role are lacking although the best estimates suggest that earnings are equivalent to approximately 4 to 5 percent of the Gross Domestic Product (GDP) in Bolivia and Peru and 8 percent in Colombia. In Bolivia and Peru, cocaine exports are an estimated 20 to 35 percent of the legal exports; for Colombia the estimate is more than 90 percent. If such figures are even close to being accurate, the cocaine industry is an important economic interest in Peru and Bolivia and a dominant force in Colombia.

Another measure of impact is employment. An estimated 450,000 to 500,000 Andeans work in the cocaine trafficking cycle-most in cultivating and harvesting coca leaves and the rest in refining, transportation, money-handling and providing security. About 1.0 to 1.5 percent of Colombia's labor force and 2.5 to 3.0 percent in Peru and Bolivia work in cocaine. (In the United States 200,000 or 0.15 percent of the labor force have jobs in the cocaine distribution chain.) The multiplier effect of the cocaine industry, however, extends throughout the Andean economies, creating broad, though largely hidden, constituencies for the industry. The late Medellín cartel kingpin Pablo Escobar made the point clearly: "The entire economy benefits from drug money; those who traffic and those who do not. If a drug trafficker builds a house, the peasant who cuts the wood for it benefits from that." Beneficiaries include importers of chemicals used in refining, workers who build traffickers' luxury apartments and public officials who sell protection and other favors.

The organization and earnings distribution of the cocaine industry differ from country to country. Bolivia and Peru are predominant in the production of coca leaves while Colombia, which accounts for 70 to 80 percent of the world's supply of cocaine, controls most of the international traffic in the drug. Mexican traffickers are increasingly involved in cocaine supply chains and distribution networks and may eventually challenge Colombian dominance.

Colombian traffickers realize most of the cocaine smuggling profits since a kilo of the drug increases in value 20 times from the Colombian point of export to the point of entry in the United States and Europe. The price paid to small producers of coca leaves is only 2 percent of the U.S. wholesale price. In Peru and Bolivia about two-thirds of coca and cocaine income accrues to farmers and small processors and only about one-third to exporting organizations. The Peruvians and Bolivians rely largely on Colombian exporters to transport and market their cocaine. Thus, cocaine has differing dimensions of influence.

In Colombia drug traffickers have far greater financial capacity for "system penetration"-lobbying, bribes and legal investments-than do coca farmers and rural workers of Peru and Bolivia, who represent their countries' principal "cocaine problem" but lack powerful establishments. The cocaine economy of these fairly democratic states, with large populations that benefit from its existence, is significant enough to achieve a degree of political legitimacy. For poor farmers coca cultivation, which earns up to five times the income from legal crops, is a lucrative safety net. In Colombia traffickers' huge earnings irrigate a substantial portion of the economies of Medellín, Cali and other cities. It is little wonder that the Andean coca constituencies have largely succeeded in blocking forcible eradication of coca crops in Bolivia and in Peru and maintaining trafficking in Colombia.

One measure of influence in the Andean countries derives from trafficker expenditures. Much of the cocaine money that flows back to the countries of origin is spent in operating expenses, including payments to farmers, refiners and shippers and to bribe officials. A portion also is devoted to conspicuous personal consumption-e.g., gold chains, yachts, Ming porcelain and antique automobiles. Some of the repatriated earnings are channeled into investments-such as capital improvements in the cocaine industry itself, including cargo aircraft, boats, communications and encryption devices-and some in more or less legal activities.

The influence of drug money in the Colombian economy is pervasive. Ownership of agricultural land by drug dealers directly or through intermediaries increased from 1 million hectares in the late 1980s to an estimated 3 to 4 million hectares in 1993-94. Today, traffickers own or control 8 to 11 percent of Colombia's agriculturally usable land in at least 250 of the 1,060 municipalities, making them an acknowledged force in the economic life of the rural areas. With the ascendancy of the Cali cartel, drug dealers' penetration of legal business spheres has reached significant new levels.

Traffickers' legal investments include business activities that serve both legitimate and illegal purposes-so called "dual use" investments of a kind pervasive in Latin America. Trafficker- owned pharmaceutical laboratories, retail drug stores and battery factories sell legitimate products but also serve as fronts for diversion of such items as chemicals used to manufacture cocaine. Agribusinesses facilitate the smuggling of cocaine in containers of such products as shrimp, fruit pulp or cut flowers.

Traffickers' haciendas and ranches in Colombia's hinterlands may provide training grounds for paramilitary armies or house infrastructure such as laboratories, airstrips and storage sites. Some narco-investments relate to intelligence operations such as trafficker-owned taxi companies in Cali that report on movements of Colombian and foreign counternarcotics personnel.

The economic effects of the drug trade have been widely debated by economists and sharp differences exist. Francisco Thoumi of Bogotá argues, for instance, that the drug industry has "depressed the growth of the formal sector of the economy" and that the Colombian economy "would do better without drugs than with them." Harvard scholars Mario de Franco and Ricardo Godoy write that "cocaine production confers unambiguous benefits to Bolivia. A 10 percent increase in cocaine production raises GDP by 2 percent and lowers unemployment by 6 percent." There is disagreement on the magnitude of costs and benefits, but most observers agree that cocaine has a negative as well as a positive side. Because the industry tends to displace legal economic activity, income from cocaine may come at the expense of a reduction in legal income. Viewed in these terms, cocaine is a parasite that absorbs resources that otherwise could be used for legal activity. In Bolivia the diversion of labor from legitimate agriculture to coca farming explains a decline in non-coca productivity. The same phenomenon applies in Colombian textile and chemical businesses.

A high cost of the trade are expenditures to enforce drug laws, prosecute drug kingpins and implement treatment and prevention programs. Funds must be diverted from other activities. Colombia's drug budget was about $1 billion in 1995, about 2 percent of GDP. Almost 90 percent went to the Ministry of Defense, which includes the National Police, for crop eradication and countertrafficking activities. (In the United States spending is less than 0.3 percent of GDP.) Peru and Bolivia also finance costly drug-control efforts.

Another cost is what economists call "Dutch Disease," i.e., inflation in domestic currencies caused by the inflow of illegal narco-dollars. Narco-dollars flooding Andean economies stimulate booms in certain economic sectors, such as construction and real estate; yet overvalued local currencies discourage production of legal exports by making imports cheaper, forcing local producers to compete against cheap imports. A related problem is contraband. A considerable portion of narcotics earnings is thought to enter the Andean countries via under-invoicing of imports or outright smuggling. Twenty percent of all Colombian imports are said to enter the country illegally. Not all short-term capital inflows, however, can be traced to drugs; the "Dutch Disease" is not confined to cocaine or heroin exports or to illegal industries. The big danger is that a country may lose its ability to produce tradables and become dependent on illegal exports.

Narco-investment patterns are another source of concern. The risk of seizure and the desire to hide evidence of earnings may lead to avoidance of traditional financial investments and create a preference for legitimate businesses that cover illegal activities. In a study of 20 of Medellín's most important traffickers in 1988, economist Mario Arango found that 75 percent wanted to put their money in real estate, apartments, office buildings and ranching. Certain basic sectors of the economy-mining, energy, textiles and manufacturing-received little investment.. Thus, distortions in the nation's natural pattern of development can occur.

Drug dealers are not primarily concerned with making a profit from importing goods. Rather, imports are a means of converting dollars to pesos and of disguising the origins of their funds (laundering money). One scheme involved the purchase of machine tools in Miami and their resale in Colombia at 30 percent below the purchase price; it almost forced the legal distributor in Colombia out of business. Greg Passic, a financial specialist in the U.S. Drug Enforcement Administration, says that Caterpillar tractors are bought in the United States with drug money and transported to Colombia. "They sell for less in Bogotá than in Miami," he notes.

Finally, the presence of narco-capitalism can affect foreign investment in drug-ridden countries. High levels of violence and corruption increase uncertainty and risk and reduce the attractiveness of a country to foreign investors. A fivefold increase in foreign investment in Colombia between 1991 and 1994 is partly attributable to a decline in drug-related violence and reflects the Colombian government's success in dismantling the notorious Medellín cartel. However, the Colombian government's economic opening policies of the 1990s played the principal role in propelling these beneficial investment trends.

At the same time, in certain respects, cocaine has played a positive role. In the Andean countries the influx of hard currency associated with narcotics has made possible more imports and less external debt. Cocaine helped Colombia finance negative balances of trade of $1.7 billion in 1993 and $2.3 billion in 1994. The flow of cheap imports, largely financed by drug money, is a major source of such consumer goods as perfumes, clothing, automobile equipment, TV sets and computers. Consumers benefit although domestic distributors and manufacturers of some products suffer.

Furthermore, cocaine historically has compensated for failures in the legal economy in the Andean countries, especially in Peru and Bolivia, where cocaine provided jobs, income and foreign exchange when all were in short supply. When Bolivia's mineral- based economy collapsed in the late 1970s and early 1980s, coca and cocaine provided alternative employment for unemployed miners. The notion that the cocaine economy provided for the survival of some Peruvians and Bolivians while their economies went into free fall is widely conceded by observers of the Andean scene.

A further economic benefit has been traffickers' financial support of welfare and community development initiatives in poor communities that governments are unable to reach. Pablo Escobar's "Medellín without Slums" project in the early 1980s is an example. Medellín slum dwellers and other beneficiaries of narco traffickers' largess may not buy the argument that the cocaine industry harms the economy. In addition, the economic situation in Colombia has improved during the 1990s in spite of the drug trade. Increased infusions of drug capital, increased Cali dominance of the drug trade, more rational investment patterns by drug dealers and major reductions in drug-sponsored violence appear to correlate with improved economic performance.

The South American cocaine industry reached a plateau at the end of the 1980s. According to U.S. government estimates, almost as much cocaine was produced in the Andes in 1995 as in 1989. The estimate for those years was 800 tons; with losses and seizures the actual amount exported from South America to the United States and Europe could have been 500 to 600 tons. The flow appears unlikely to diminish soon. In Colombia, where the drug kingpins boast extensive investment in industry, real estate, commercial agriculture and financial services, the line between the cocaine economy and the legal economy is increasingly blurred. Because of cocaine's economic clout, the antidrug policies of Andean governments have become more symbolic than substantive and have little effect on trafficking dynamics. Colombia successfully incarcerated a number of top Cali leaders in 1995, but they continue to manage their criminal empires from jail and their trafficking organizations have not been dismantled. Exports of cocaine remain unaffected.

In the United States, according to the White House Office of National Drug Control Policy, cocaine is as cheap, as pure and as available as it was before Colombia's crackdown on the Cali hierarchy. Bolivia and Peru, which account for more than 80 percent of Andean coca leaf output, have not reduced coca cultivation. Neither country will employ aerial spraying against coca, arguably the only practical way to eliminate large concentrations of the crop.

In Bolivia a program to pay $2,000 for each hectare of coca that farmers voluntarily uproot has turned into an egregious U.S. foreign aid fiasco. From 1987 to 1994 approximately 25,232 hectares of coca were voluntarily torn out and $49.7 million paid to farmers. Yet U.S. aid officials in La Paz estimate that during the same period 37,380 hectares of new coca were planted, a net gain of more than 12,000 hectares and a net loss for the program.

Andean countries seem more anxious to contain pernicious manifestations of the cocaine trade, such as narco-terrorist violence and high-level corruption, than to attack the trafficking infrastructure. The aim may be to capture the economic benefit of a lucrative industry while minimizing its negative sociopolitical effects. If so, this is a dangerous and self-defeating strategy.

The drug plight of the Andean countries is not solely of their making. Unless the United States and other industrialized countries curb their voracious appetite for cocaine, little progress is likely in curbing production and export of Andean cocaine.

Rensselaer Lee ('76), president of Global Advisory Services, consults and writes on narcotics, organized crime and political power in Eurasia and Latin America. He wrote "The White Labyrinth: Cocaine and Political Power" and co-authored "The Andean Cocaine Industry," scheduled for publication in July 1996.
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