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An Economic Analysis of a Drug-Selling ANECONOMIC ANALYSIS OFADRUG-SELLING GANG’S FINANCES* STEVEN D. LEVITT AND SUDHIR ALLADI VENKATESH Weuse a uniquedata set detailing the nancialactivities of a drug-selling streetgang toanalyze gang economics.On average,earnings in the gang are somewhatabove the legitimate labor market alternative. The enormous risks of drug selling,however ,morethan offset this small wage premium. Compensation withinthe gang ishighly skewed, and the prospect of futureriches, not current wages,is the primary economicmotivation. The gang engagesin repeated gang wars andsometimes prices below marginal cost. Our resultssuggest that economic factorsalone are unlikely to adequately explain individual participation in the gang organg behavior. Streetgangs havea longhistory in Americancities {Thrasher 1927}. Untilrecently ,gangs wereorganized primarily as social peergroups. Any economicactivities were of secondary impor- tance{Suttles 1968; Klein1995}. Thelast twodecades, however , havegiven rise to a dramatic transformationin streetgangs, or what Taylor{1990} termstheir ‘ ‘corporatization.’’ Whencrack becamewidely available in themid-1980s, sold in smallquantities in fragmentedstreet-corner markets, street gangs becamethe logicaldistributors. The potential pro t in drug dealing dwarfed that previouslyavailable togangs throughother criminal chan- nels.As aconsequence,gangs becamesystematically involved in thedistribution ofvarious narcotic substances including heroin and crack-cocaine{Block and Block1993}. Recentacademic literature on gangs has examinedsome aspects oftheir nancial activities.Hagedorn {1988} and Padilla {1992} suggestthat gang memberspursue nancial activitiesin responseto alienation from legitimate labor markets. Jankowski’ s {1991} study of37 gangs found that nearlyall ofthem had an expressedcommitment to illicit revenuegeneration, but that *Wewould like to thank Autry Harrisonfor his assistance on the project, JonathanCaulkins, Philip Cook, Jeffrey Fagan, Richard Freeman,Herbert Gans, AlejandroGaviria, Edward Glaeser,Timothy Groseclose, Nicholas Harney ,Lewis Kornhauser,LanceLochner ,AnnePiehl, Ron Nobles, David Rothman, Catherine Wolfram,anonymous referees, and Lawrence Katz, aswell as numerous seminar participantsand anonymous informants for providing access to some of thedata. TheNational Science Foundation and the National Consortium for Violence Researchprovided nancialsupport. Correspondence should be addressed to StevenLevitt, Department of Economics, University of Chicago, 1126 East 59th Street,Chicago, IL 60637. E-mail addresses: slevitt@midway .uchicago.edu; [email protected]. r 2000by thePresident and Fellowsof Harvard Collegeand theMassachusetts Institute of Technology. The Quarterly Journal ofEconomics, August 2000 755 756 QUARTERLY JOURNALOF ECONOMICS performancediffered accordingto various factors including organi- zational structureand communityrelations. Spergel {1995} has shownsigni cant racial and ethnicdifferences in illegal entrepre- neurism.Akerlof and Yellen{1994} presenta modelanalyzing the relationshipbetween police enforcement against gangs and com- munitycooperation. 1 In spite ofthis pioneeringwork, however , manygaps in theliterature remain. Although quantitative data aresometimes used anecdotally,thereis littlein theway of systematicdata collection.Virtually all oftheexisting scholarship is based onverbal reports by gang members,or in exceptional cases,direct observation of trafficking {Bourgois1989; Williams 1989}. Theillicit natureof gang activitiesand thelack of formal accountingprocedures have precluded moresystematic quantita- tiveanalysis priorto this study.Finally,manyof the studies reportthat gangs areembedded in citywide hierarchies,but they donot examine the impact ofthis organizationalstructure on a gang’s nancial dealings. Anumberof researchers have estimated the returns to crime {Freeman1992; Grogger1995; Viscusi 1996; Wilsonand Abra- hamse1992} and drug selling{Reuter, MacCoun, and Murphy 1990; Fagan 1992; Hagedorn1994} throughthe use of self- reports.2 Thereturns to drug sellingtend tobemuch greater than that ofother criminal activities, with frequentdrug sellers reportingmean annual incomesin therange of $20,000–$30,000. Studies relyingon ethnographicobservation, however, ndmuch lowervalues for drug-related earnings,e.g., Bourgois {1995} and Padilla {1992}. Oneexplanation forthis discrepancy is that the self-reportand ethnographicstudies havefocused on very differ- entpopulations. The self-report studies havetended tosurvey independentdrug dealers,i.e., those with nogang affiliation, whereasethnographic research has focusedon low-levelmembers ofa hierarchy.Independents arelikely to have greater ability , experience,and accessto capital than ‘‘footsoldiers’ ’ whosit at the lowend of the street gang’ s organizationalhierarchy .Ourdata, whichspan thelevels of a gang hierarchy,fromrank-and- le membersto imprisoned leaders, offer a partial solutionto this problem.Higher-level gang membersmay tend tohave similar characteristicsto independents. In contrastto the returns to crime, there has beenlittle 1.There is also a relatedliterature on organized crime (see, for instance, Reuter{1983} and Schelling {1984}). 2.See Fagan and Freeman {1999} for a survey ofthisliterature. ADRUG-SELLING GANG’S FINANCES 757 attentionpaid tothe ‘ ‘careerpath’ ’ ofgang members,market structure,organizational forms, competitive strategies, and how economicactivity is structuredin theabsence of legallyenforce- able contracts. 3 In this paper weare able todirectly analyze for the rsttime a wide rangeof economicissues related to gangs and drug distribution.We do sothrough the use of auniquedata set containingdetailed nancial informationover a recentfour-year periodfor a now-defunct gang.These data weremaintained by the leaderof thegroup as amanagementtool for tracking the gang’ s nancial activitiesand formonitoring the behavior of gang members.Updated monthly,thedata includebreakdowns of costs and revenuesinto major components, as wellas informationon thedistribution ofprots as wagesto gang membersat different levelsof thehierarchy .Informationon bothprice and quantity is included.These nancial data aresupplemented with informa- tionon thenumbers of violentdeaths, injuries, and arrestsof gang membersover this period,as wellas interviewsand observational analysis ofthe gang. While the data sufferfrom important limitationsand anumberof potential biases (which appear below),they nonetheless represent a substantial improvementon previouslyavailable information. Usingthese data, weanalyze theextent to which the indi- vidual and collectiveactions of gang participants canreasonably becharacterized as emanatingout of economic maximization. We address threedifferent issuesin this regard.First, we examine theeconomic returns to drug dealing relativeto legitimate labor marketactivities. The higher the returns to drug selling,the more likelyit is that theeconomic aspects ofthe gang areparamount. Wethen consider the causes and consequencesof gang wars. Finally,weanalyze therisk trade-offs madeby gang membersand whetherthese can bereconciled with optimizing decisionmaking. Anumberof insights emergefrom the paper .Street-level sellersappear toearn roughly the minimum wage. Earnings within thegang areenormously skewed, however, with high-level gang membersearning far morethan theirlegitimate market alternative.Thus, the primary economic motivation for low-level gang membersappears tobe the possibility ofrising up through thehierarchy ,as in thetournament model of Lazear and Rosen {1981}. Theaverage wage in thegang (taking intoaccount all 3.Southerland and Potter {1993} is anexception on thislast point. 758 QUARTERLY JOURNALOF ECONOMICS levelsof thehierarchy) is perhaps somewhatabove the available legitimatemarket alternatives, but notappreciably higher. Gang wars arecostly ,bothin termsof lost lives and lost prots. Almost all ofthedeaths ofdrug sellersare concentrated in war periods.Moreover, the violence keeps customers away .This negativeshock to demand is associatedwith afall of20– 30 percentin boththe price and quantity ofdrugs sold during ghting,and thedrug operationbecomes far lesspro table. In spite ofthis, the gang discussed in this paper ghts with rivals roughlyone-fourth of the time. Gang wars arealso an extremely costlymeans of dispute resolution,but giventhe absence of legally enforceableproperty rights and contracts,other means of resolv- ing conicts may be circumscribed. There is alsoevidence that frequentgang wars arethe result of an agencyproblem, namely thedesire of low-level gang membersto build areputationfor toughnessmay be in theirpersonal interest, but will almost assuredly becostly to thegang as awhole.We also document that thegang pricesbelow marginal cost during gang wars.Such pricing canbe reconciled with economicoptimization if mainte- nanceof market share is importantand thereare switching costs amongdrug purchasers{Klemperer 1995}, but maysimply reect awed decisionmaking. Finally,drug sellingis an extremelydangerous activity . Deathrates in thesample are 7 percentannually .Giventhe relativelylow economic returns to drug sellingnoted above, the implied willingnessto accept risk on thepart ofthe participants is ordersof magnitudehigher than is typically observedin valueof life calculations.This suggests either that gang membershave veryunusual preferences,that theex post realizationof death rateswas verydifferent than theex anteexpectation, systematic miscalculationof risk, or thepresence of importantnoneconomic
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