A calm Friday evening in downtown Richmond, my former college roommate and I are on the back porch exchanging economic thought experiments, as we often do. The conversation expands to micro economic decision making and the interactions of Bertrand and Cournot competition, when we suddenly we hear a cluster of roaring claps, echoing through the still streets, followed shortly by whizzing police sirens. “Probably just another gang murder,” says my colleague dismissively as we retreat indoors. The thought then began stirring in my head that since economics predicates itself on rational decision makers, why should gangs and their members behave any differently? The logic of decision making, organization, and competition must be universally human; thus my curiosity over the economic structures and practices of gangs began.

Organization is paramount in the efficient performance of any economic behavior, especially that which includes constant evasion of police and law enforcement. This bureaucracy of gangs lends itself often to that of a corporate entity, with a top tiered CEO making all high level decisions and overseeing interactions with other organizations, legal or illegal. The selection of a leader is a peculiar practice, as strength of resume and education clearly aren’t a top concern for qualifications. Considering theory of natural selection, it seems to often be either the most intelligent, the most ruthless, or some combination of both who assume leadership and veneration. For this, I see two prevalent means, which are commonplace both in real gang organizations and depicted in entertainment. The first of which is similar to a president-vice president relationship, the second resembles a startup or entrepreneurial form of leadership.

To illustrate this, I refer to the two most well known names in crime organization: Al Capone and Pablo Escobar. Capone thrived in the distribution of illegal alcohol during the prohibition era, and gained his seat on the throne after the death of the Italian gang’s former leader, Johnny Torrio. Capone managed to assert himself as the right-hand-man of Torrio, and was the natural choice of successor, similar to the assassination of a president. Given this status as the most trusted by the incumbent leader, Capone demonstrated his ability to manage and organize the business practices of their cartel most effectively, making him an acceptable candidate for the executive position.

In the second case, Escobar assumed his leadership in a start-up fashion, beginning with car theft, then smuggling of cigarettes, and then advancing his skills onto the higher grossing market of cocaine. His large scale success however, came from negotiating the collaboration of various, smaller, and often competing drug organizations of the Colombian cocaine trade. This consolidation allowed Pablo to achieve the rank of cartel boss by undertaking powerful economic and industrial practices.

Such efficient execution gave the Medellin Cartel an effective monopoly on cocaine exports in the 70’s and 80’s, as competition had been eliminated through mergers. His economic engineering did not stop with horizontal integration, as he began to pursue vertical integration: creating contractual obligations with crop growers and producers, as well as an efficient mechanism for delivery to the United States market using commercial airline pilots as mules and even purchasing his own Boeing 727’s. Given these clever moves, coupled with the unrelenting violence of “The Cocaine Wars” leading up to the early 1980’s, Escobar managed to phase out any Cuban or Mexican competition and become the uncontested Market leader, supplying an estimated 85% of all cocaine in America. His market dominance became so extreme that he eventually caused an oversupply, and the price of his product dropped by nearly 25%. No matter, however, as his proficient economies of scale were still generating multiple billions in annual profit.

Violence is not a secret in the cartel business model, and provides for a greater ability to pursue monopoly rights. The rent seeking costs of monopolies simply cannot be measured when murder is the common mechanism. This suggests the Stackelberg Model of competition to bear the closest resemblance. If the stage is set with a market leader in place as an incumbent, and a new entrant makes an attempt for market share, the leader will act to discourage competition, and the follower (the entrant) will react. This system of signal exchange can be ascribed to gang competition, as any signs of new competition will typically be discouraged by violence.

Rank and file members of gang organization hold great importance considering the obvious need for runners (distributors of product), treasurers (managers of liquid assets), foot soldiers (those who execute of sale), and enforcers (security and hit men). What incentives do lower-ranking members have to pursue such legal risks, as well as risk of violence from competition? Many would cite the lacking economic opportunity from which many of these organizations and their members originate. Other incentives include misconceptions of future wealth, much like the film Wall Street in the 1980’s led many Americans to pursue the banking industry. Levitt has calculated the average wage of a low level member to be around $6 an hour with some calculations suggesting it’s lower, around $3 an hour, making this career less than comparable with minimum wage jobs. Taking into account the marginally low gains relative to opportunity costs and implicitly low valuation for life in their business practices, overzealous visions of grandeur appear omnipresent.  

Levitt’s investigation into a particular local street gang revealed interesting metrics about their pricing practices. Using the Lerner index (price-marginal cost/price), he found that gangs tend to add a substantial markup beyond their marginal cost price point. This suggests market power, but as his paper describes other gangs being present in the same city, I suspect the market power to be purely regional, as many consumers of their products typically do not have practical means of travel. The Lerner index also showed that during times of inter-gang turf warfare, prices dropped below marginal cost, illustrating a willingness to take a loss in order to usurp market share. this  signal to rival gangs attempting to enter the market is very indicative of a Bertrand Model of price-based oligopoly competition.

In an investigation of the economic practices of black market operators, it is expedient to consider the macroeconomic implications they bring about. The three major black market actions, counterfeiting, drug trafficking, and illegal gambling have been estimated to have a total market worth of $590 billion. Total United States illegal operations have been totaled at $625.63 billion, accounting for 0.034% of the 2016 US GDP. Foreign Policy Magazine has calculated the global black market worth to be over $10 trillion dollars, making it the second largest annual economy behind the United States. In the 1980’s heyday of Pablo Escobar, Colombia’s $10 billion dollar drug business accounted for 6% of their gross domestic product. The wealth available from this industry is so vast that Escobar at one point, facing threats of extradition to the United States to face trial, offered to pay off the entirety of the nation’s $13 billion dollar foreign debt in exchange for protection from US extradition. This ability to impact a nation’s macroeconomic standing illustrates the extent to which cartels and gangs have been able to affect the annual economic performances of a given nation. It is also worth mentioning the costs to society, in the realm of addiction and violence, and to the government in attempts to enforce and lessen the presence of gangs and their externalities within communities.

The sophisticated business practices and game theoretical actions of gang members both at the local urban level as well as the upper tier international organization tranches have been a growing interest for economists in the past 15-20 years, and merits further study. The assumptions of rational decision making within the field of economics has been vindicated by the natural practices of what are, more often than not, the less educated and less informed members of society, operating with little or no formal knowledge of corporate practices or industry interactions of competitive markets. In my hometown of Richmond, Virginia, gang warfare and drug epidemics have caused a great loss in social welfare for decades. While the dark ages of the 1990’s are now behind us, recent 40% reported increase in murder rates in 2016 combined with a 40% increase in heroin overdose rate in 2015 suggest we have seen a local minimum in gang presence, and a trend upwards is likely in the coming years.

The Economic Practices and Structures of Gangs and Cartels