A. How Second-Order Crimes Promote Market Failure, Impose Costs, and Generate Weakness in First-Order Criminal Markets
By their nature, second-order crimes are intimately connected to first-order criminal markets. As a result, second-order crimes can exact costs that weaken demand and promote market failure in first-order criminal markets. They do so by creating the very same conditions that lead to weakness or failure in ordinary markets--they eliminate competition, exploit information asymmetries, and introduce new types of risks and costs into the first-order market.
1. Criminal Exploitation of Asymmetric Information.--In his 1970 article, The Market for “Lemons”: Quality Uncertainty and the Market Mechanism, George Akerlof demonstrated how asymmetric information can lead to market failure by describing a used automobile market in which buyers cannot distinguish between good cars and “lemons.” Akerlof explained that the seller of a used car possesses greater information about the car's quality than potential buyers. Unable to distinguish between good cars and “lemons,” buyers refuse to offer full price for cars that might not be of high quality. Sellers, in turn, refuse to sell good cars for less than their full value, so the only cars offered for sale are likely to be low-value lemons. The result is a downward spiral of lower prices and lower quality, as the asymmetry of information between buyers and sellers causes the “bad cars to drive out the
When asymmetric information threatens legitimate markets, the government is often willing to intervene to prevent inefficiency or market failure. Mandatory labeling requirements and government factory inspections build consumers' confidence that they are getting what they believe they have paid for. State consumer protection laws, such as “lemon laws” that govern automobile markets, diminish the risk that buyers will overpay for defective products. Notably, such regulation serves the interests of both buyers and sellers: Without some intervention to correct the problems created by asymmetric information, the market could fail altogether, to the detriment of all parties. Indeed, there are occasions when overt government intervention may not even be required. In some circumstances, sellers will be sufficiently motivated to privately initiate measures to counter the ill effects of asymmetric information. For example, even without lemon laws, car dealers may offer warranties to reassure buyers that they are not being swindled. Yet even private measures, such as a voluntary seller warranty, require the backing of a legal system to be effective. When asymmetries of information cause a failure in a criminal market, they are far more difficult to resolve.
Criminal markets are particularly likely to involve information asymmetry. Government interventions that help ensure quality in markets for legal goods and services, such as labeling requirements and the promise of frequent government inspections, are not available in black markets. Moreover, private enforcement through the legal system is not an option for criminal market participants. A defrauded purchaser of heroin, for example, cannot simply take his dealer to small claims court or report him to the police for fraud. The characteristics of criminal transactions--primarily the need to avoid detection by law enforcement--also inhibit the flow of information. While purveyors of legal goods and services can use advertising to inform their customers about the quality of their offerings, black market sellers must weigh the economic benefit of advertising against the risk of attracting the attention of law enforcement. Advertising for illegal goods not only raises the risk of detection--in some cases it can be used as evidence of guilt in a subsequent criminal prosecution.
The difficulty of eliminating asymmetries of information in criminal markets does not necessarily mean that criminal markets are prone to fail altogether. While criminal markets have limited legal avenues to correct for asymmetric information, other methods exist to deter individuals from exploiting such imbalances. For example, the threat of retributive violence may deter some individuals from taking advantage of asymmetric information. Moreover, while a stranger may take advantage of an ignorant customer, repeat players have less incentive to exploit their informational advantage. As a result, criminal markets may tend to rely more heavily on repeat relationships that foster trust between market participants. For this reason, it is possible that one's reputation as an honest businessperson may actually matter more in criminal markets than it does in the legitimate business world. Yet the ability to prevent some criminal exploitation of asymmetric information does not mean that information imbalances are not taxing criminal markets. Quite the opposite: By imposing additional costs on a criminal market, information asymmetries act as a tax on the crime itself.
This tax takes two forms. First, efforts to eliminate information asymmetries-- such as doing business only with acquaintances, exacting violent retribution on defrauders, and the like--can be costly. These expenses increase the cost of committing crimes for criminals just as a literal tax would. Second, while strategies that rely on violent retribution, reputation, and doing business with repeat players may reduce the chances that a seller is ripping off his customers, they will not entirely eliminate cheating. In The Corner: A Year in the Life of an Inner-City Neighborhood, David Simon and Edward Burns describe how some drug dealers regularly defraud their customers. According to Simon and Burns, the dealers “stand where they want, sell what they want, and risk only the rage of their victims, or in a rare instance, the ire of a street dealer whose business or reputation suffers by As a result, buyers must internalize some risk that sellers are taking advantage of them. Buyers in criminal markets cannot entirely avoid the lemon problem. Faced with the possibility that sellers are taking advantage of them, buyers will lower the price they are willing to pay just as if there were a literal tax placed on their purchase.
Many second-order crimes involve the exploitation of asymmetric information in criminal markets. The sale of fake drugs, for example, takes advantage of the asymmetry of information between sellers (dealers) and buyers Other second-order crimes may involve less obvious forms of asymmetric information that still produce inefficiencies in the first-order criminal market. A “coyote” or “snakehead” who promises a would-be undocumented immigrant a safe voyage may have an incentive to misrepresent how safe his services are as well as the likelihood that their venture will succeed. Snakehead customers, who possess less information than the smugglers themselves, are likely to demand a discount and may even refuse to participate in the market at all rather than accept the risk that the smuggler has misrepresented the quality of his services. Like drug dealers and used car salesmen, human smugglers may find that possessing superior knowledge of their operations and its attendant dangers actually translates into fewer transactions and lower profits.
2. Second-Order Crimes Can Impose Costs That Weaken First-Order Criminal Markets.--Guns are often regarded as “an essential tool of commerce” in illegal markets. In the absence of legal systems to resolve disputes, guns may be used by market participants to enforce contracts, guarantee physical safety, and ensure the quality of goods and services. Yet the use of gun violence (or the threat of gun violence) in illegal markets as a substitute for legal mechanisms of dispute resolution does not necessarily mean that guns improve the ability of illegal markets to function properly. In fact, gun possession and gun violence, like many second-order crimes, can impose significant costs on first-order criminal markets.
As an initial matter, it is by no means assured that guns are needed for illegal markets to function. Instead, gun possession may present market participants with a prisoner's dilemma--a situation in which participants would prefer a world where no one carries a gun to a world where everyone carries a gun. However, because coordination is difficult and each participant cannot afford to be the only one who isn't “packing,” all participants may be forced to arm themselves. As a result, the fact that illegal market participants tend to rely heavily on guns does not prove that the existence of guns lowers the cost of conducting illegal business.
Moreover, gun possession almost certainly imposes significant costs on criminal activity. Drug dealers, aware that the presence of guns increases their chance of being injured or killed, have to be compensated for the risks that they take. This additional compensation is often described as a “risk premium.” The need to pay dealers a risk premium will shift the supply curve to the left, raising the price of drugs and reducing the total quantity of drug crimes committed. To the extent that buyers are also threatened by the proliferation of guns, the demand curve will be shifted to the left as well, resulting in a further decrease in drug crimes. As discussed below, laws that enhance the penalties for possessing a firearm while engaging in drug-related activities may well be justified by society's interest in reducing gun violence. However, the same enhancements may also lower the costs of engaging in the first-order criminal drug market.
Some second-order crimes, like the smuggling of illegal aliens, undeniably increase the total quantity of first-order crimes committed. Yet even these second-order crimes can impose costs on the first-order market that complicate criminalization efforts. As described above, there are enormous risks associated with using the services of a human smuggler. When smugglers fail to take sufficient precautions to protect their customers, it is the would-be immigrants who pay the sometimes fatal price. While tragic, the risks associated with utilizing the services of a human smuggler also have the effect of raising the expected cost of attempting to enter the country illegally (the first-order crime). Thus even those second-order offenses that are essential to the commission of a first-order crime entail costs that have deterrent value. This complex relationship between first- and second-order crimes greatly complicates efforts to regulate antisocial behavior with the criminal law.
3. Second-Order Crimes Can Weaken Competition in First-Order Criminal Markets.--The basic criticism of imperfectly competitive markets is that such markets (usually) fail to allocate resources efficiently by producing less than the optimal amount of a given good. The result is a net loss to society that is often referred to as “deadweight loss.” Imperfectly competitive criminal markets are more difficult to evaluate. On the one hand, imperfect criminal markets in which sellers possess pricing power likely underproduce crime. Given the negative impact of crime on social welfare, this would suggest that an imperfect criminal market is preferable to a perfectly competitive one. Similarly, some have suggested that criminal monopolists and cartels have both the incentive and the ability to impose a certain level of discipline over criminal activities that is good both for business and for society as a whole. For example, centralized criminal enterprises may recognize that the sale of drugs to children or the execution of witnesses during a freight hijacking can trigger undesirable police attention and a political backlash that impose substantial costs on their other criminal activities. In this respect, the public is likely to prefer criminal activity in an imperfectly competitive market to less “organized” crime.
Unfortunately, there are also significant costs associated with imperfect criminal markets. Because producers in imperfect markets make outsized profits, imperfect criminal markets are full of incentives for criminals to enter and fight for market position. The negative externalities associated with the violent struggle for control of the market may well outweigh the benefits (or reduced costs) that flow from the underproduction of crime. Moreover, it is not necessarily the case that increased centralization will reduce the number of crimes committed. If centralization reduces the transaction costs associated with coordinating other criminal ventures, a reduction in the number of criminals (or criminal organizations) might result in an increase in the total quantity of crimes committed. Criminal monopolies can impose other costs on society as well. The successful commission of some crimes (such as some forms of extortion) may require significant resources available only to criminal enterprises of substantial size and strength. Similarly, criminal cartels and monopolies are in a better position to corrupt local law enforcement and other public officials.
It is difficult, if not impossible, to determine with certainty whether society is better off with a centralized, imperfectly competitive criminal market or one that is characterized by many small criminal organizations with little individual control over the total quantity of crime produced. However, the difficulty in ascertaining the costs and benefits of competition in criminal markets does not make criminal market structure irrelevant. The structure of a criminal market clearly has a significant impact on the level of harm inflicted upon society. Consequently, it is appropriate to identify the impact that second-order crimes may have on the structure of criminal markets.
The most obvious second-order crime affecting criminal market structure is the use of violence (often gun violence) to reduce competition in a first-order criminal market. It is not uncommon for criminals to use guns and gun violence to suppress competition and increase their market power. In their analysis of the finances of a drug-selling gang, economists Steven Levitt and Sudhir Venkatesh observed that a violent gang war can substantially increase the prevailing gang's influence over the price of illegal drugs. They observed that the gang in their study was able to charge substantially higher prices for crack cocaine following a gang war that effectively doubled the area under their control. The use of violence to seize “drug turf,” like other second-order crimes, imposes significant costs on society. It also, however, creates inefficiencies in the first-order drug market. The violent consolidation of the drug market raises drug prices and reduces the total quantity of drugs sold.
Policymakers thus face a difficult choice. By intervening to prevent the second-order crime of drug related violence, policymakers inadvertently perfect the first-order illegal drug market--increasing its efficiency, lowering the price of illegal drugs, and, ultimately, increasing the quantity of drugs sold.
