(SOUNDBITE OF BRICE MONTESSUIT AND CHARLES CASTE-BALLEREAU'S "LOST SITUATION")
ROBERT SMITH, HOST:
This is NPR. Hello, and welcome to PLANET MONEY Summer School, your eight-week fast track to riches and power, or at least an understanding of how those things work. This is class No. 3, "Profit & Cocaine." I'm Robert Smith. Every Wednesday till Labor Day, we are tagging along with you to the beach, to the park to teach you the essential principles of econ 101. Oh, and did we mention there is going to be a test? Pass a few simple questions at the end of the course, and we'll put your name on a PLANET MONEY diploma suitable for framing, not suitable to be used as an educational credential.
In class one, we talked about how economists think about individual decisions - costs and benefits, opportunity cost. Class two sorted out those decisions into a market, complete with prices and supply and demand. And now here in class three, we're going to get down to the business of business. What makes a product sell? What are the risks and rewards of being an entrepreneur? And how do you keep competitors out?
Economists often like to look at the extreme cases of something in order to see the principles at work underneath. And that's what we're going to do in this class. The subject of today's lesson and story was one of the most notorious and successful crack dealers in Los Angeles in the 1980s and 1990s.
(SOUNDBITE OF ARCHIVED NPR BROADCAST)
RICKY ROSS: My name is Ricky Ross. I'm known on the streets as Freeway Rick. Well, when I sold drugs, if they'd have told me they was going to legalize it, I would've been mad because I knew that that was going to drive the price down.
SMITH: We should note there's also a successful rapper and music executive named Rick Ross. He took that name as an homage to Freeway Ricky Ross, but the two of them have no connection.
Today on Summer School, we take a look at the economics of drug dealing and do a reality check with an actual drug kingpin. And then at the end of the episode, we'll bring in our economists in residence, Betsey Stevenson and Justin Wolfers, who will show us how the lessons learned on the street can be used to think about how all businesses work.
This episode, "Lessons From A Drug Kingpin," first aired in 2011, and I hosted it with Alex Blumberg, who went on to be something of a kingpin himself in the world of podcasting. OK. Let's do it.
(SOUNDBITE OF ARCHIVED NPR BROADCAST)
ALEX BLUMBERG: We have in front of us a pile of academic papers talking about the economics of illegal drugs, and they all arrive at a surprising conclusion. The conclusion is this; when you make drugs illegal, you end up making drug dealers richer, and you increase the level of crime.
SMITH: And you don't end up reducing drug use by that much, which we should remind people is the whole point of making drugs illegal - to stop people from using drugs and to lower the amount of crime.
BLUMBERG: So here we have these policies that are not doing what they're supposed to be doing. And let's lay out the theory of why that is. OK. So the economics of this are, when you make something illegal, you make it harder and riskier to produce. In the case of drugs, you have to sneak them across the border. You have to pay people more to transport them since they're facing jail time. You have to hire armed guards to, you know, protect your supply. There's all of these added costs, which simply drives up the price. So illegal cocaine is many more times expensive than it would be if it were legal.
SMITH: And any economist can tell you what happens next. When the price of something goes up - surprise - fewer people buy it. Take bananas. If they were 500 bucks a bunch, no one would buy bananas. But crack is different. The demand is what they call inelastic. No matter what it costs, people are willing to pay for it. I mean, it's addictive. So increasing the price just means that more money goes to drug dealers.
BLUMBERG: And to the criminal behavior they engage in - bribing people, buying guns, threatening, hurting or even killing people. That is the theory. But one thing missing from these economic papers - actual drug dealers.
SMITH: And this brings us to Freeway Ricky Ross. He started dealing cocaine in 1979. Then he moved into crack. Then he worked his way up to becoming one of the biggest crack dealers in LA. He was arrested in 1996 and given a life sentence. But in 2009, he was given parole and released.
BLUMBERG: And we thought, here is a perfect person to run these economic theories by and see if they check out.
SMITH: Let's do it. Theory No. 1 - making drugs illegal drives up the price - check.
ROSS: The most I ever made in one day was $3 million went through my hands.
ROSS: I could make - off of a million bucks, I could make anywhere from 400,000 to 200,000 profit. It varied to who I was selling to and what time of the month it was - you know, a lot of variables on how much I made - if I was giving it to them on credit, stuff like that. So - but I was sure to make 200,000 off of every million, and sometimes I could make as much as 400,000.
BLUMBERG: Let me just ask you, like, how much of the cost of the drug that you were selling was because it was illegal, I guess?
ROSS: Probably - oh, wee (ph) - maybe a thousand times. You can probably get a kilo of cocaine over in Colombia or Peru for maybe $300 or maybe even less than that, you know, if it wasn't illegal because maybe the farmers probably would sell it for, well, it's possible (ph) a head of lettuce 'cause it grows over there, you know, wild. So, I mean, the price probably would drop dramatically. You probably could get a kilo for what it costs about a pack of cigarettes (laughter) - maybe cheaper.
BLUMBERG: Keep in mind Rick bought his kilos of cocaine for $10,000. All right. So next, we ran another part of the theory by him - that at least some of the money he's getting is going to increased crime. Again, check.
ROSS: Well, I had a crew. You know, I had a crew of anywhere from 30 to 40 guys. And that varied, too, from what was going on, you know, how good business was, how many rock houses I was running at the time. You always had appearance of toughness. And I did. You know, I had guys around me that were ruthless and were tough. You know, if I gave the word, they would hurt you.
BLUMBERG: How much - how many guns did your operation have?
ROSS: Who knows?
ROSS: We bought guns regularly 'cause guys would throw guns out the window when the cops get behind them. And we'd lose guns all the time. And it was mandatory when we on the street. Like, if we at the park playing basketball, we had to be strapped, or if we at my tire shop, where we sold drugs from, then we would have guns there.
SMITH: Yeah. It's really amazing the level of expenses that a big-time drug dealer has. I mean, the drug money wouldn't just be for his crew. He would spread it around. I mean, his drug money would find its way into all sorts of other illicit activities in the neighborhood. For instance, he had money that he'd just distribute to the big players around the 'hood.
ROSS: You know, I had a fund, also, you know, where I take care of what's called the big homies. You know, these are the guys that when I grew up were the shot callers, the guys that ran the neighborhood. And, you know, I took care of them. In my neighborhood, anybody can get killed at any time, and for me to walk around the streets the way I did would be dangerous for a lot of people. Most people couldn't do what I did. You know, they couldn't walk around South Central Los Angeles in the middle of Hoover Crip gang or the Swans and live the way I lived - you know, free and open, going to car washes. You know, they kidnap drug dealers in South Central. And I had a special type of pass that most people don't get, and that's because of my good ties that I shared in my wealth.
BLUMBERG: So you basically - it was sort of like you were paying protection money to these people, right?
ROSS: Absolutely. You can call it protection money or big homie money or whatever, but it's all the same thing, absolutely.
BLUMBERG: But it was money going to people who...
ROSS: Didn't sell drugs, but they were robbers.
BLUMBERG: ...Who would be violent. Yeah.
ROSS: They were robbers. They was killers - jackers, as we call them. Absolutely. These guys didn't mind going to jail.
SMITH: So clearly, the academics are right here. Drug money goes to crime. I guess that's not a big surprise. But not all of the money goes to crime and bribes and shady stuff. For example, Freeway Rick Ross owned a lot of real estate - crack houses, cook houses, places he stored his money.
BLUMBERG: There were other expenses - like a huge expense - bail bondsmen. Guys in his crew that he worked with would get picked up by the cops, and he would need to make sure that they would stay loyal to him, so he would do whatever it took to get them out of jail. And, of course, the criminal justice system knew that he was a big-time drug dealer, so they set these bond prices really, really high, so that cost him a lot of money.
SMITH: Yeah. And another group of people who were profiting off of the big-time drug dealer - lawyers. He had lots of lawyers, and they charged him a lot of money. And they came into play when he would have these interesting disputes with the cops.
ROSS: What happened is they had raided a couple places, and there were large amounts of money and no drugs. And they would confiscate the money, and then we would go to court, and the lawyers would get the money back. And that really frustrated them.
BLUMBERG: Wait; so they would raid one of your houses. There would be a whole bunch of money there. But there wouldn't...
BLUMBERG: ...Be any drugs.
BLUMBERG: So you would go to the - you would actually go and say, I'm an honest businessman; that was my money; they have no right to take my money.
ROSS: Absolutely. I wouldn't go myself personally.
BLUMBERG: No, of course not.
ROSS: I had people in the system set up to where we could claim the money.
SMITH: You know, they found in a house in South Central - that's $400,000. Wouldn't that naturally - wouldn't you naturally think that's drug money?
ROSS: I mean, would you think that if it was Beverly Hills?
SMITH: True enough. True enough.
ROSS: And even if you think that, you'd have to prove it, you know, in court. It's not what you think. It's what you can prove.
BLUMBERG: Right. And they couldn't prove that it was drug money, so you got it back.
ROSS: Absolutely. And they got frustrated with that. So what they started doing is they started - when they come into the house, they would bring their own drugs, and then they would plant drugs. And that makes it tougher for you to come to court and say, you know, your honor, I had $400,000 in here, and it's missing (laughter), because now there was two kis (ph) in there, too. So now you got to tell the judge, your honor, the kis (ph) ain't mine, but the money is.
ROSS: I think that's a - you know, a hard pitch.
SMITH: So we have these quasi-legal expenses. I mean, the money is going to people who probably pay taxes on it - lawyers and bail bondsmen. But then there are the expenses that are sort of in between. You know, they're under the table, but on the face, there's nothing illegal about these expenses. You know, take all the cash that Ricky's making. Every business just deposits it in their account. Freeway Rick couldn't do that.
ROSS: Counting 300,000, 400,000 can be time-consuming.
BLUMBERG: How did you count the money? Who did you get to count the money?
ROSS: Well, in the end, 'cause money became a chore, so I hired a couple girls, and it was their job to count money all day.
BLUMBERG: That's another cost of something being illegal. You have to hire people to count it, whereas if you just take it to a bank, you know, you...
ROSS: Absolutely. And then you got to worry about if they steal it...
ROSS: ...Because it's underground.
BLUMBERG: So - yeah. And you can't go and you can't file a claim against your underground drug money counters if you think they're skimming.
ROSS: No, no.
BLUMBERG: So even though he's paying these women and they're not explicitly doing anything illegal - like, just counting money isn't illegal - but there is also a social cost even here. In other words, these women are probably young. They're coming in. They're seeing this big-time drug dealer. They think this is the way to make money - going into drugs.
And that was, of course, also part of the social cost of what Rick was doing, aside from the fact that crack is incredibly, you know, addictive. It decimated inner-city communities. Creating the idea that, like, this is the only way out, this is the only way to get rich - that's also a big part of, like, the social cost of drug dealing.
SMITH: And we should say that as Rick is going through his internal dialogue about his own costs, he did not bring up a lot about the fact that this did devastate cities and he was partially responsible for it.
BLUMBERG: Right, although now he says on his website that he feels bad about that and he's trying to undo some of the damage that he caused.
Now, there are a couple of the academic theories - the economists' theories, though, that did not check out when we ran them by Freeway Rick. For example, there is this one theory you see cited a lot in the literature that one of the factors that drives up the cost of drugs - you have to compensate people for the risk - the risk of going to jail, the risk of getting shot or killed.
So, you know, it's just generally people who have dangerous jobs tend to make more money - miners, people who work on fishing boats - you know, those fishing boats out in Alaska. You need to pay them more since what they're doing is so risky. And the theory is that the same thing would apply to people in the drug trade. But that theory, at least in Rick's case, did not check out.
ROSS: Well, you know, first of all, when you come from where I was when I started selling drugs, you know, you feel hopeless. You don't think you're going to live past 24 years old. Going to jail, come out with stripes - really wasn't any risk. I mean, everything that I had going on at the time was nothing. You know, I was like a lump on a log. So the risk that most people would look at - I mean, you know, you could get killed, go to prison - was OK.
BLUMBERG: So you didn't really think - you weren't thinking, like, I'm taking a lot of risk here; I have to get it compensated.
ROSS: No, no. I didn't really - I mean, the compensation was already enormous and overwhelming. I couldn't believe that it paid so well.
BLUMBERG: You would've done it for a lot less, is what you're saying.
ROSS: Oh, absolutely.
SMITH: Talking to Rick, we realized that there's something here that economists don't take into account. There was this emotional component to the work that Rick was doing. At least when you get to Rick's level, drug dealing is complicated, it's multifaceted, it's engaging.
BLUMBERG: Yeah. Like, Rick was basically a CEO. He was a manager. He was a publicist. He was his own accountant. He was even the head chemist.
SMITH: So, Alex, let's just back up for a second here and look at this situation. Society was doing everything it possibly could to make Ricky Ross' life miserable. His product was illegal. His costs were enormous, as we've established. He was a hunted man.
BLUMBERG: Literally a hunted man. He said that there was a police task force in LA devoted entirely to putting him in prison.
SMITH: But despite all the money and the effort that the most powerful nation on Earth was spending to make Rick Ross give up his job...
ROSS: I loved it. I felt like I was on top of the world. I felt I was powerful. I felt I'd came - I didn't have to answer to nobody. I mean, it was a dream. It was every man's dream to be free.
BLUMBERG: Do you miss it?
ROSS: Oh, absolutely. Absolutely. I'd rather be doing that than anything else, almost. Everything else became almost, like, secondary to my work.
SMITH: You know, it's funny. You were talking about how great it was for a while, and one of the words you used was the freedom of it. And yet, when you describe this in detail, I'm not hearing a lot of freedom. You had this task force, people are out to kill you, and spotters, and you're sneaking around in the middle of the night.
BLUMBERG: You have to be up at 2:30 every morning.
SMITH: You're moving houses back-and-forth. This didn't sound - this sounds like a man who has very little freedom in his life.
ROSS: Well, you know what? When you look at it from that angle, it is. But when you look at it from where I came from, then I felt like I had all the freedom in the world.
BLUMBERG: How much of it was just sort of, like, the actual job, and how much of it was just the feeling of being good at something and running this enterprise well?
ROSS: Well, you love the feeling of - that you're good. So it didn't feel like it was a burden, you know, to sneak around at night. I've been sneaking around at night since I was, you know, 17 years old, stealing cars. You know, so this had became - it's like when you're saying - you're saying that it's not freedom, but from where I come from, this is a way of life. This is the way we live. It's nothing wrong with living like that, sneaking around at night, hiding. You know, we've been hiding all our life.
BLUMBERG: So, Robert, one question remains at the end of our journey here with Freeway Rick. What does this all mean? I mean, are we saying we should be legalizing crack? I mean, if we really did want to make the Freeway Ricks of the world go away, we would take away their earning potential, I guess, right?
SMITH: Yeah, by legalizing drugs and dropping the price. And some of the economists we spoke to said, yeah, of course. Making it illegal makes dealers richer. It creates more violence and crime and doesn't do that much to drive down demand. So clearly, legalize it.
BLUMBERG: Other economists, though - they weren't so sure. Peter Reuter has written a book about the illegal drug market. He's written many, many papers. He is a big expert in this field. And he says, legalizing something like crack, there would definitely be trade-offs.
PETER REUTER: Legalization would dramatically reduce crime. Obviously, the drug market crime would disappear and many drug-related crimes, where it's sort of - that's in the business. Economic-compulsive crimes - that is, crimes committed in order to pay for expensive illegal drugs - that would go down a lot, too. What goes on the other side - I'm making up the number here - 5 million more persons addicted. That's a big number. How do we compare the bad outcomes in the two cases - a very large increase in addiction with a very large decrease in crime? You know, I take them both to be real, but I don't know how - that's a value judgment...
BLUMBERG: How do you - which is better, and which is worse?
REUTER: ...As to which is better.
BLUMBERG: Yeah, yeah.
SMITH: And as for Rick, when it comes to the legalization, it's complicated for him. A lot of the reason Rick says he got into drugs in the first place was because he was illiterate. I mean, think about that. Everything we've just heard - he ran a multimillion-dollar business empire without being able to read and write. He learned to read and write in prison.
BLUMBERG: And his basic take is - and a lot of academics would agree with him, by the way - you need to attack the demand side of this equation. Try and reduce the reasons people want to use and sell crack in the first place. So that would mean addressing the desperation that drives people to become addicts or that drives them to become dealers.
And that is Rick's new job. Since getting out of prison, he now travels around and talks to youth groups and schools - anybody who will have him, basically. And he lays out the other side of this economic equation that you're in when you're a drug dealer, which is it's hard to retire as a drug dealer. You get shot or you go to prison. And once you go to prison, everything you've made, all the money you've made - it's gone. A multimillion-dollar business that you've spent years and years building, developing expertise in, developing your connoisseurship for cocaine - it can all be gone in a second.
(SOUNDBITE OF HENRI LANZ, SKINNY WILLIAMS AND WILLIAM RAPPAPORT'S "HAIL THE KING")
SMITH: After the break, we will bring in our Summer School economists, and we'll discuss what Ricky Ross - Freeway Ricky Ross - can teach any entrepreneur about how to run a business.
(SOUNDBITE OF HENRI LANZ, SKINNY WILLIAMS AND WILLIAM RAPPAPORT'S "HAIL THE KING")
SMITH: We are back with PLANET MONEY Summer School - class No. 3, "Profit & Cocaine." And listening along with us are certified famous economists Betsey Stevenson and Justin Wolfers from the University of Michigan.
BETSEY STEVENSON: Hi.
JUSTIN WOLFERS: Hey.
SMITH: So is Rick Ross - is he in a good business? Like, is this the kind of situation that businesses dream about being in?
WOLFERS: Rick Ross is a good economist, and that he is selling a product that has a characteristic economists call inelastic. When there's inelastic demand for something, people keep buying it even when the price rises. So therefore, the cops are boosting his bottom line.
SMITH: We should make sure we clearly define our vocabulary words here - inelastic demand. When we talked about demand last week, we said that for most products, when the price goes up, people buy less of the products. But there are a few products where there's not an easy substitute, so that when the price goes up, people may buy a little less of it, but they will keep buying the product - inelastic demand.
WOLFERS: That's exactly right. The amount by which high prices scare people away is not very much. That's what inelastic means.
SMITH: And if you can find something with inelastic demand, I mean, that's - that is a very good business opportunity.
WOLFERS: That's the good news for Mr. Ross...
WOLFERS: ...Which is he can bump up his price a fair bit and he's not going to lose many customers.
SMITH: And there's a different addictive substance that you talk about in your textbook.
WOLFERS: Coffee. And so coffee - some of us are, in fact, addicted. And there are some national chains that jacked the price up and charge $4 for a venti latte. And that is taking advantage of my inelastic demand for coffee.
SMITH: But this wasn't - this was a big insight of Howard Schultz and Starbucks because 20 years ago, coffee did feel like this substance with elastic demand. Like, it was cheap. You could get it anywhere. It was generally kind of bad coffee. Nobody seemed to care that much.
STEVENSON: Right. But this comes to this idea of substitutability. Back then, when all coffee tasted terrible, there wasn't much of a difference between two different cups of coffee, so why would you pay more for the coffee at one diner versus the coffee at another diner? Coffee was treated almost the way we think about gasoline at different stations. So if you have the price of gas is much higher at a station across the street, then why would you buy from them? The gas between the two stations is going to fuel your car the same.
STEVENSON: Well, people used to think coffee - the two different cups of coffee, they're going to fuel my body the same. And the insight that Howard Schultz had was maybe there are actually some important product differences across coffee.
WOLFERS: He's also creating caffeine addictions. The greater those caffeine addictions, the more inelastic people's demand and, therefore, the greater is his ability to raise prices. It's really important to Howard that you don't just want one coffee a day - that you need three and you need them no matter what the price.
SMITH: Which, you know, if we're going to tell business stories, is also similar to Apple and the iPhone. There are substitutes, but they've worked very hard to make you think if you are an Apple phone user that that is a special object of which there is no substitute and which, apparently, you will spend hundreds and hundreds and hundreds of dollars on.
WOLFERS: Robert, one of my kids smashed my iPhone yesterday, and I just tried to buy an Android, and Betsey is yelling at me that I can't possibly do it. And I think she is something of an Apple addict. And I did try to point out that at the price of a thousand dollars for a phone that perhaps her demand was a little too inelastic, and maybe I should try one of the lower-priced alternatives.
STEVENSON: You did just hit on a, like, actual debate in our household.
WOLFERS: But it's also something - Apple does this consciously.
STEVENSON: It's absolutely the case. It could make its product more useful if it had an iMessage that worked with the Android phones, but it would make an Android phone a closer substitute for an iPhone.
SMITH: I did think with Rick Ross, because, like, he goes through this whole thing about, oh, you know, his profit and inelasticity and how much money he makes and the cost of supplies and everything, and you listen to it and you're like, well, why wouldn't everyone be in this business? Like, this is a great, great business to be in.
WOLFERS: You are aware we put drug dealers in prison? And that's a pretty bad lifestyle choice.
WOLFERS: There's another important concept here, which is what economists call barriers to entry. You're right. It sounds like Rick Ross was owning a lot of money. And so, Robert, maybe you and I should go and start our own drug dealing business. But I bet if we went to Rick Ross' corner and started trying to compete against him, it's not that he'd try and compete with us by lowering the price. He'd try and run us out of town using violence. So there are barriers to entering that market that keep competitors away.
SMITH: Which is also the sign of a good business to be in.
WOLFERS: Absolutely. And businesses repeatedly try to make it difficult for new companies to enter and compete against them.
SMITH: And this actually explains a lot about how businesses - successful businesses work these days. I mean, companies may not use guns to defend themselves, but they use lawyers and regulations and lobbying to make sure that no one else is competing with them on the opposite corner. And in a lot of sectors of the economy, like, this is one of the main ways people compete.
WOLFERS: Absolutely. They'd rather not compete in terms of prices. What they want to do is compete in terms of constructing higher and higher barriers to entry, making it more and more difficult for newcomers to come in.
SMITH: So I'm thinking cable companies, car dealers, beer distributors.
WOLFERS: So they're running off to the government and they're lobbying like hell, saying, look; what we're distributing is so dangerous, you wouldn't want to let anyone else do it.
SMITH: But also doctors and hairdressers, too. Like, do not try and compete with hairdressers.
WOLFERS: My favorite is interior decorators.
WOLFERS: In Florida, you have to get a license to become an interior decorator because a misplaced throw cushion could cause any amount of damage.
SMITH: Freeway Ricky Ross would be proud.
WOLFERS: He would be. And, honestly, he's in the same business as some Florida interior decorators.
SMITH: So our assignment this week is to find a product that you think has inelastic demand and tell us why. Are there no substitutes? How much would you pay for it? Would you pay anything for it? And if this is a brand-name product, maybe there's a reason that this product doesn't have competitors - barriers to entry.
Thank you very much, Jetsin (ph). I think I tried to move your names together.
WOLFERS: Jetsey (ph)? We answer to Jetsey.
SMITH: Jetsey. Thank you so much, Justin and Betsey.
WOLFERS: Thanks, Robert.
(SOUNDBITE OF BRICE MONTESSUIT AND CHARLES CASTE-BALLEREAU'S "LOST SITUATION")
SMITH: All right, students, let us know what you came up with from our assignment this week. Are there addictive products with inelastic demand that we have not thought of? Send your stories to email@example.com. Or you can find us on Facebook, Instagram, Twitter. And we're doing special TikToks reinforcing the economic lessons from Summer School on the TikTok app. We're @planetmoney.
Today's class was produced by Lauren Hodges, with help from James Sneed, Darian Woods, Alexi Horowitz-Ghazi, Nick Fountain and Liza Yeager. Our sound design was from Isaac Rodrigues (ph). It was edited by Alex Goldmark. If, like me, you can't get enough of Betsey Stevenson and Justin Wolfers, later this summer, they're releasing an audio course on the Himalaya app. It's called Think Like an Economist.
Remember, everyone, it is never too early to start studying for the test. I love it when professors say that. I'm Robert Smith. This is NPR. Thanks for listening.
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