Narconomics: How To Run a Drug Cartel

by Tom Wainwright

Colombian cocaine manufacturers have protected their profits by tightening control of their supply chains, along the same lines as Walmart. Mexican cartels have expanded on a franchise basis, with the same success as McDonald’s. In El Salvador, the tattooed street gangs, once sworn blood-enemies, have discovered that collusion can sometimes be more profitable than competition. Caribbean criminals use the islands’ fetid prisons as job centers, solving their human-resources problems. Like other big firms, drug cartels have begun to experiment with offshoring, bringing their problems to new, more vulnerable countries.

governments mistakenly equate prohibition with control. Banning drugs, which seems sensible at first, has handed the exclusive rights to a multibillion-dollar industry to the most ruthless organized crime networks in the world. The more I learned about the way the cartels do business, the more I wondered if legalization, far from being a gift to the gangsters, could be their undoing.

predicting the cartels’ next steps, and making sure that the money and lives laid down to stop them are not wasted, is easier when we recognize that they are run like other big multinational companies.

This book is a business manual for drug lords. But it is also a blueprint for how to defeat them.

Since the late 1980s, the coca-producing countries of South America, backed by money and expertise from the United States, have focused their counternarcotic efforts on finding and destroying illegal coca farms. The idea is a simple economic one: if you reduce the supply of a product, you increase its scarcity, driving up its price. Scarcity is what makes gold more expensive than silver, and oil more expensive than water: if lots of people want something, and there isn’t enough to go around, they have to pay more to get their hands on it.

Whereas in 1994 the three countries’ governments destroyed about 6,000 hectares (15,000 acres) of coca,2 in 2014 they laid waste to more than 120,000 hectares (300,000 acres), mostly by hand. It is an extraordinary feat: to picture the scale of the task, imagine every year weeding a garden fourteen times the size of Manhattan (while occasionally being shot at). By the rough calculations of the United Nations, nearly half of all the coca bushes planted in the Andes are now eradicated.

The United Nations says that worldwide demand is stable. This makes for a puzzle: constant demand and restricted supply would normally lead to an increase in price, yet cocaine remains as cheap as ever. How have the cartels managed to defy the basic laws of economics?

Driving down prices and forcing suppliers to be more efficient is great for consumers, of course, and indeed it has benefits for the wider economy—a McKinsey study made the extraordinary finding that Walmart alone was responsible for 12 percent of the US economy’s productivity gains in the second half of the 1990s.5 But for suppliers, it makes life difficult. If a harvest fails and the costs of production go up, you can bet that it is the farmers, not the supermarket or its customers, that will be made to feel the squeeze.

Cartels play a role more like that of large supermarkets, buying produce from farmers, processing and packaging it, and then selling it on to consumers.

armed groups that control the cocaine trade in Colombia act as monopsonies. Under normal market conditions, coca farmers would be able to shop around and sell their leaves to the highest bidder. That would mean that in times of scarcity, coca buyers raised their bids, and the price of the leaf went up. But Colombia’s armed conflict is such that in any given region, there is usually only one group of traffickers that holds sway. That group is the sole local buyer of coca leaf, so it dictates the price, just as Walmart is sometimes able to set the price of the produce it buys. This means that if the cost of producing the leaf goes up—owing to eradication, disease, or anything else—it will be the farmers who bear the cost, not the cartel.

Some European countries, whose diplomats are privately critical of the eradication-focused approach favored by the United States, have established projects to encourage other agricultural industries. The idea is that if it can be made more profitable to grow some other, legal crop than it is to grow coca, then farmers will change their focus. There is interest among cocaleros.

The process of converting coca leaves to cocaine powder is continually evolving as the cocineros, or “cooks,” develop new recipes in their clandestine jungle laboratories. It is usually done in two steps. The first is to convert the coca leaves to a damp, cream-colored paste known as cocaine base. To do this, one ton of fresh leaves is dried out until it weighs more like 300 kilograms. The dried leaves are then chopped up into smaller pieces and mixed with a toxic brew of chemicals, including cement, fertilizer, and gasoline, which coaxes the cocaine out of the waxy leaves. The remaining plant matter is then filtered out, the chemicals removed (at least, most of them), and the remaining residue boiled down. The result is about 1 kilogram of cocaine base. To turn this paste into cocaine hydrochloride, as snortable cocaine powder is formally known, it is mixed with a solvent such as acetone, and with hydrochloric acid.9 The resulting mixture is filtered and dried to derive just under a kilogram of pure cocaine: C17H21NO4.

Markups vary from store to store and from product to product, but most retail businesses sell their merchandise for between 10 percent and 100 percent more than the wholesale price. That may sound like a lot, but it is nothing compared with the way that cocaine’s price increases as it gets closer to its market.

Look at the evolution of the price of a kilogram of the drug, as it makes its way from the Andes to Los Angeles. To make that much cocaine, one needs somewhere in the neighborhood of 350 kilograms of dried coca leaves. Based on price data from Colombia obtained by Gallego and Rico, that would cost about $385. Once this is converted into a kilo of cocaine, it can sell in Colombia for $800. According to figures pulled together by Beau Kilmer and Peter Reuter at the RAND Corporation, an American think tank, that same kilo is worth $2,200 by the time it is exported from Colombia, and it has climbed to $14,500 by the time it is imported to the United States. After being transferred to a midlevel dealer, its price climbs to $19,500. Finally, it is sold by street-level dealers for $78,000.10 Even these soaring figures do not quite get across the scale of the markups involved in the cocaine business. At each of these stages, the drug is diluted, as traffickers and dealers “cut” the drug with other substances, to make it go further. Take this into account, and the price of a pure kilogram of cocaine at the retail end is in fact about $122,000.

the reason that cocaine becomes so expensive is that shipping it around the world in secret incurs all sorts of expenses, from murdering rivals (see next chapter) to bribing officials.

In sum, by trebling the price of cocaine’s raw ingredient in South America—something no policy has yet gotten close to achieving—the best-case scenario is that cocaine’s retail price in the United States would rise by 0.6 percent. This does not seem like a good return on the billions of dollars invested in disrupting the supply of leaves in the Andes.

Governments are approaching the cocaine market as if it were the chocolate market, in which a rise in the price of cocoa beans leads to a corresponding rise in the price of chocolate bars. In reality, it is more like the art market, in which the tiny cost of the raw materials is insignificant compared with the high price of the finished product. Attempts to raise the price of cocaine by forcing up the cost of coca leaves is a bit like trying to drive up the price of art by raising the cost of paint.

One might have expected the methodical elimination of most of the country’s leading criminal kingpins to put the cartels out of business. In fact, it did no such thing. Throughout Calderón’s presidency, the quantity of drugs being smuggled over the American border showed little sign of diminishing, and the number of young men going into the narcotics business remained high.

Mexico’s cartels and El Salvador’s maras operate in the same region of the world, dealing the same products, and with the same readiness to resort to violence. Why is it then that in the space of a few years Mexico’s gangsters became so much more violent, while El Salvador’s calmed down? Or, thinking about it like an economist, why did one market see heightened competition and the other collusion?

What do ordinary businesses do when regulators thwart their takeover plans? One course of action is to try a different regulator in another jurisdiction. Consider the case of a proposed merger between General Electric (GE) and Honeywell in 2000. To the horror of its competitors, GE announced that it intended to acquire Honeywell, a giant technology firm that manufactures everything from burglar alarms to helicopter parts. America’s competition authorities gave the deal the go-ahead. But GE’s rivals were not going to settle for that, so they went elsewhere, to the European competition authorities. Examining the same facts, the European commissioners reached a different conclusion: the deal was not in the interests of competition, they found, noting that Honeywell’s jet-engine business, when combined with GE’s own portfolio, could create a monopoly in some markets. GE’s rivals were thus able to block the decision of one regulator by appealing to another.

Drug cartels go through a similar process. Unable to persuade Ciudad Juárez’s regulator—the local police—to allow his takeover of the city’s drugs business to go ahead, El Chapo appealed to a different authority. Fortunately for him, Mexico’s multilayered policing system made this possible. In Mexico, each of the 2,000-plus local governments has its own police force (at least in theory; some rural ones are all but nonexistent). On top of that, each of the thirty-one states has its own, separate force. The final layer is the federales (federal police), an elite squad—all things being relative—of more heavily armed, better trained officers, which operates around the country and was significantly expanded during the Calderón presidency.

The Juárez cartel’s reaction to the attempted takeover was similar to that of ordinary firms facing such a threat. One of its first acts was to begin a public-relations campaign against the firm trying to take it over. Advertisements painted by hand onto sheets, known as narcomantas—literally, “narco blankets”—began appearing all over northwestern Mexico, urging locals to resist El Chapo. Rather than being simple drug traffickers, the banners claimed, El Chapo and his Sinaloan cronies were thieves, rapists, and even double agents of the government.

The defining feature of El Salvador’s young mareros is their head-to-toe tattoos. Like Old Lin, nearly all gang members sport body art declaring their allegiance to either the Salvatrucha or Barrio 18. The inkings are indirectly responsible for much of the country’s violence, as they effectively paint a bull’s-eye on the body of any young gangster who wanders into territory controlled by rival mara. But they may also make collusion between the gangs more likely.

The high levels of violence in border towns have led to calls from some people in the United States for crossings to be shut down. Yet economics suggests the opposite: by opening more of them, each would become less valuable, and less worth fighting for. True, it would give cartels more opportunities to smuggle their drugs into the United States. But clampdowns on supply have tended to have little impact on the total amount of contraband being smuggled, or on the drugs’ price (see Chapter 1). Opening more border crossings could reduce the amount of fighting, with little impact on the American illegal-drugs market.

Above all, the examples of Mexico and El Salvador show the difference that changing market conditions can make. More than 4,000 Salvadorans were saved by a spell of cooperation between their country’s maras, whereas some 60,000 Mexicans died because of an increase in competition among their country’s drug cartels. Neither outcome was inevitable. With stakes like that, governments should consider ways to shape these markets, rather than simply charge into battle to shut them down at any cost.

The narcotics game has an image of ruthless professionalism, with clinical hit men, ingenious smugglers, and logistical experts combining to outwit the police. Sometimes the business works like that. But it is also characterized by stunning incompetence.

One British smuggler estimated that of the cocaine “mules” he sends on flights from the Caribbean to the United Kingdom, one in four will be stopped. Every arrest or death means another tedious round of hiring and vetting.

The one way that criminal organizations can enforce contracts is with violence, which is why a capacity to intimidate and kill is at the heart of any drug cartel’s success. But deploying violence is an expensive course of action and bad for business.

These two conundrums—how to hire staff, and how to make sure they do what they are told—are what occupy drug cartels’ human-resources managers. Running complex operations using an ever-churning payroll of low-skilled, unpredictable workers who are prone to sabotaging deals through sheer stupidity is no mean feat. The organizations that best accomplish it are those that are most serious about their approach to personnel.

In other words, the gang faces what economists call a collective-action problem. Everyone stands to gain if all members can agree not to exploit each other, but the individual incentives for exploiting are so strong that it is unlikely that everyone will stick to the agreement.

The elaborateness of the Familia’s rules, which run to six articles and dozens of subsections, may say as much about the boredom of prison life as it does about the gang’s organization. (The same is probably true of some of its other more Boy-Scoutish activities, which supposedly include making bombs out of match heads, writing secret messages in urine, and communicating in Náhuatl, the ancient language of the Aztecs.)

But the purpose of the constitution is clear: persuading members to join gangs isn’t easy, and only through a careful system of checks and balances can the organization ensure that membership is something that is likely to appeal to new recruits. As Skarbek writes: “Despite being a murderous prison gang, [La Nuestra Familia] has taken active and rational steps toward promoting effective internal governance institutions.”

In El Salvador, Old Lin is able to run his jail like a fiefdom, because it has been reserved exclusively for members of the 18th Street Gang. A raid on a prison in Acapulco, Mexico, a few years ago discovered that inmates had managed to “smuggle in” one hundred fighting cocks, nineteen prostitutes, and two peacocks. In another Mexican prison, prisoners were found raffling off a luxury cell that they had equipped with air-conditioning, a fridge, and a DVD player. Allowing gangs to run jails in this way makes for a quiet life for prison wardens, but it greatly strengthens the criminals. If a prisoner is not a member of the 18th Street Gang when he enters Old Lin’s prison, he certainly is by the time he emerges.

Drug cartels can’t, as mentioned earlier, go to the courts and get their problems resolved. Although at first blush the only method they have to ensure that contracts are honored is the threat of nasty consequences, the evidence shows that, on the whole, the drug importers tend to do their best to avoid violence.

“the drug trade, even at this high level, is run in a manner similar to that of any small business in which managers have to make decisions about individuals . . . that reflect the need to preserve relationships.” Because of the difficulty involved in hiring new employees, and in making new contacts in the import and export game, drug traffickers may in fact be more forgiving of mistakes than legitimate firms, they suggest: “Given the impediments to information flows in these markets, relationships may be even more important than in legal markets.”

Few researchers have published any evidence that there are benefits to be had from creating a monocultural workplace.8 It seems odd, then, that so many criminal gangs seem to organize themselves on this basis. It is tempting to assume that it is simply because criminals are nasty people, to whom racism, a nasty trait, comes naturally. But that seems to go against most of what we have seen so far about criminal gangs, which so often mimic ordinary firms in doing what is best for business.

(Smuggling cash out of Europe is made much easier by the existence of the €500 bill, a ludicrously high-value banknote that has made life much easier for criminals, who can hide €20,000 in a single cigarette packet. In some European countries the bills are known as “bin Ladens”: everyone knows they exist, but no one apart from criminals ever sees them.)

Sending a teenager to jail costs more than it would to send him to Eton College, the private boarding school in England that educated Princes William and Harry.

Making it harder for cartels to recruit people has a knock-on benefit. The analysis of failed cocaine deals in Europe shows that when things go wrong, drug dealers can be surprisingly forgiving people. The reason for this isn’t that they are a charitable bunch; rather, it is because they have to preserve the limited network of contacts that they have.

One can only treat members of staff as disposable if there is a steady stream of replacements lined up. In the past, Dominican gangsters have had few qualms about bumping off uncooperative associates or sending them to war against other gangs, as they have always had new employees on tap. If prisons in the Dominican Republic—and other places—can tighten that tap, gangs will have to behave more like Pete the patient Dutch dealer, anxious to hang on to what contacts they have, and more likely to resolve their problems peacefully.

Yet far from being viewed with disgust, the people who run it enjoy a reputation as semirespectable outlaws, in both their home countries and abroad. Their transformation in the popular imagination, from seedy, brutal thugs to lovable rogues, is one of the most dramatic public-relations (PR) coups in the business world.

Instead, marketing professionals are directing their energies elsewhere—and so are the cartels. A decade ago the branding gurus Al and Laura Ries argued that traditional advertising had lost its power and that it was becoming easier to change consumers’ perceptions through advertising’s cousin, PR.4 More recently, social media have allowed firms instantly to spread their PR messages online through what David Meerman Scott calls “newsjacking.” Unlike advertising, PR ignores the paid-for advertising space in newspapers and on air, and instead focuses on influencing the much more valuable realm of editorial column inches and TV news spots. An admiring article in a newspaper carries more weight than a paid-for ad on the opposite page. PR Daily, a US trade paper, estimates that editorial space is worth three times as much as paid-for advertising space. Companies are jostling to get their messages into this sought-after area, lobbying journalists as never before to mention their clients in articles. In Britain, the number of people working in PR (47,800) now exceeds the number of journalists (45,000).5

Why, then, do the cartels so often court publicity with their gruesome executions? Many of their killings seem designed for a mass audience, filmed and promoted online using similar techniques to terrorist groups such as the Islamic State. In Ciudad Juárez, a pathologist once told me that the most dangerous time to step outside was at 5:45 p.m., because that was when the cartels would carry out their murders in order to lead the 6:00 p.m. evening news. The reason is often because one gang is seeking to cause trouble on the patch of a rival.

even though CSR seems to be flagging in some legitimate industries, it is thriving in the underworld. Some high-rolling criminals have acquired a reputation for carrying out ostentatious acts of philanthropy. Shorty Guzmán, who liked to strut around the poshest restaurants of Sinaloa, was known for the thousand-dollar tips he gave to waiters. Pablo Escobar gave out Christmas presents to the children of Medellín, built roller-skating rinks, and even housing for the poor. La Familia Michoacana provides cheap loans to businesses, and an informal “dispute resolution” service (which no one tends to question). Many drug lords have paid for the construction of churches. Mexicans even have a word for this: narcolimosnas, or drug alms. On a small chapel in the state of Hidalgo there is a brass plaque that reads: “Donated by Heriberto Lazcano Lazcano,” followed by a quote from Psalms. Lazcano, also known as “The Executioner,” was the leader of the Zetas cartel and reportedly enjoyed feeding his victims to pet lions and tigers. (He met a more ordinary end, shot dead by marines in 2012.)

The reason for CSR’s popularity among drug traffickers is straightforward: whereas it isn’t immediately obvious how General Motors’ shareholders are enriched by the company’s donating money to the Detroit Opera House, the benefit to drug lords of being good corporate citizens is very clear. As Ryanair, the Slim empire, and countless others show, it is perfectly possible to run a successful business without being very popular. In the criminal world, however, entrepreneurs’ freedom depends on their maintaining a basic level of support among the people in whose communities they operate. If the Sinaloa cartel goes out of business, the monthly pensions supposedly given out to the elderly in some parts of the sierra will cease. That isn’t to say that the cartels are good for society: the corruption, violence, and fear that they generate have held Mexico back for decades and have dissuaded far more inward investment than drugs have ever generated. But the larger the constituency of people who feel they have something to lose if the cartel goes down, the less likely that is to happen.

The single-most-effective way to undermine gangsters’ “charitable” efforts is for the state to up its own game in the provision of basic public services. If the police and courts in Mexico City’s violent suburbs had been doing their job properly, Rosa the septuagenarian killer-cleaner would not have dreamed of looking for a hit man to do the job for her. If the government of Medellín had spent a bit more on parks, swimming pools, or youth clubs, Colombians would have been less impressed by Pablo Escobar’s roller-skating rinks. If the government of Mexico provided proper pensions to the elderly, no one would line up to receive handouts from Shorty Guzmán’s henchmen. And if Mexican banks were less stingy with their credit (they lend half as much as their counterparts in Brazil, and one-third as much as those in Chile),13 households and businesses would be less likely to borrow money from the mob.

Honduras has a track record that few can rival. It was the original “banana republic,” so called because its politicians were so easily bribed and bossed around by the foreign fruit companies that arrived in the nineteenth century.

How did the Honduran state become so rotten? “It’s due to our geographic situation,” the minister says. Honduras sits smack in the middle of Central America, sandwiched between the cocaine-producing countries of South America and the insatiable consumers of the United States. “We are between those who consume drugs and those who produce them. So logically, we are a corridor of traffic,” Bonilla says.

loss of a half-million-dollar aircraft will add an extra $1,000 to the cost of smuggling each of the 500 or so kilos that it can carry. Those kilograms retail for more than $100,000 once they reach the United States. So the retail price of the drug will be pushed up by less than 1 percent, even if the cartels have to crash and abandon a plane on every shipment.

Whereas once upon a time firms were anchored to a particular country, or at least a continent, today’s corporations are willing to go wherever in the world offers the best business conditions. Jack Welch, a former head of General Electric, has mused that it would be handy for a firm to have its factories on giant barges, so that they could be floated around the world, docking in whichever country offered the best economic conditions at the time.