The monopoly criminal enterprise

The earlier analysis in this chapter examined the production, exchange and consumption of illegal goods and services in a competitive market. We now modify this analysis by examining a monopoly supplier of illegal goods and services. The analysis may also apply to a situation in which oligopolistic suppliers collude and act as a monopoly criminal enterprise or loose network of criminal gangs. Hence, the model can be regarded as a preliminary look at some of the issues involved in the examination of the economics of organised crime.

Consider a monopoly supplier of an illegal good who faces a demand curve of

Suppose again that consumption leads to social external harm of:

Suppose that the good is confiscated with probability p, and that a per unit fine of f is also levied in the event that illegal production is detected. The monopolist's expected total revenue from supplying the good is equal to TR = (1 - p)P(Q)Q, whilst expected total costs are equal to TC = (c + pf )Q. Therefore, the monopolist's profits are:

Equating marginal revenue with marginal cost gives us: or:

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In a market for an illegal good, the monopoly price exceeds the competitive price by a mark-up that depends on the elasticity of demand. This is exactly the same outcome as if the good was legal. All else being equal, if efficient consumption is the goal, then the enforcement authorities will need to impose a fine that is lower in the monopoly industry than that which would be imposed under perfect competition. Indeed, with a monopoly supplier, a subsidy may be needed to ensure efficiency. Intuitively, since the monopolist wants to reduce output in any case, the Pigouvian tax needed to internalise any external costs is smaller than it would be under perfect competition. If, in the absence of confiscation and a fine, the monopolist would maximise profits by restricting output to a level that was below the efficient level, then making production of the good is completely unnecessary, and a subsidy is required.

The analysis seems to suggest that an industry for illegal goods and services which is operated by organised criminal enterprises, which erects barriers to entry to prevent competition, and which keeps prices high, may be preferable to an industry in which there is free entry and exit. But this conclusion neglects many of the costs associated with organised crime. Perhaps the most significant of these are the rentseeking costs associated with securing and maintaining the monopoly criminal franchise. Whereas the rent-seeking costs used by existing and aspiring monopolists in markets for legal goods typically involve employing lobbyists and engaging in relatively harmless activities, the methods employed by criminal enterprises are not as benign, and typically involve extortion; blackmail; fraud; corruption of the police, the judiciary and government officials; theft; violence and murder. The direct costs of engaging in these activities, as well as the indirect or external costs, are likely to be significant.

These rent-seeking costs are not confined to existing criminal enterprises. Monopoly profits create an incentive for entry and may induce others to attempt to take over or extinguish the existing monopolist's operations. In a legal market this would be done by purchasing shares and putting together a takeover bid; but in illegal markets the only way that successful entry is possible is for entrants to gain a comparative advantage in violence. Hence the existence of monopoly rents provides both criminal enterprises and potential entrants with an incentive to invest in a wide range of illegal activities, which have their own direct and indirect social costs.

On the other hand, it is possible that the alternatives to organised crime - disorganised crime - may result in a greater degree of violence as competition between gangs or bosses increases. In addition, there may be economies of scale and scope in illegal activities. There are large fixed costs involved in corrupting public officials, training criminals, creating networks, and finding criminals who are sufficiently 'trustworthy' and skilful. Collusion between criminal gangs allows them to internalise many of the negative externalities that are associated with violence. In other words, the criminal organisation may have natural monopoly characteristics, and it may be efficient to only have one rather than many.

 
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