LSE paper links Colombia coca aid incentives to cheaper cocaine in Europe

A London School of Economics paper says a policy meant to move Colombian farmers away from coca helped trigger more coca planting instead. For investors, the lesson is familiar: incentives can move supply chains quickly, even in illegal markets where there are no earnings calls or formal disclosures.

The paper by Daniele et al. examines how Colombia’s cocaine supply expanded after 2014 and how that increase showed up in European ports and street prices. A supply expansion means more of a product becomes available, which can push prices lower if demand does not rise at the same pace.

How the incentive changed farmer behavior

The chain starts with Colombia’s negotiations with FARC rebels in 2014, according to the paper. After the major Colombian drug cartels faded in the 1990s, FARC became the country’s main producer and distributor of cocaine, the paper says.

As part of the peace process, Colombia promised economic support to farmers who had planted coca, the crop used to make cocaine, so they could later switch to legal cash crops once a deal was in place. The aim was to encourage a move away from the illegal crop.

Daniele et al. argue the promise created the opposite short-term incentive. Farmers who learned that coca growers could qualify for future support had a reason to plant coca before the program took effect. Between 2015 and 2016, land planted with coca rose by about 62%, based on aerial photographs cited by the paper.

Cheaper inputs added to the supply shock

The paper also points to Venezuela’s currency collapse as a second factor. A currency devaluation means a country’s money loses value against other currencies. In Venezuela’s case, hyperinflation, meaning extremely rapid price increases, pushed the currency sharply lower.

That devaluation encouraged petrol smuggling from Venezuela into Colombia, according to Daniele et al. The paper says Venezuelans could earn money and obtain U.S. dollars through the trade. Petrol also matters because it is used in cocaine production, so cheaper or more available fuel lowered manufacturing costs at the same time coca planting was rising.

Ports became the next pressure point

Once production rose, traffickers needed routes to move cocaine abroad. Colombia has ports, but the paper says Ecuador offered stronger access to global trade routes. Colombian drug groups therefore moved cocaine into Ecuador for onward shipment, according to Daniele et al.

The paper links that shift to higher violence in Ecuadorian port municipalities. Its data show homicide rates rose in those areas as local criminal groups fought over territory tied to the trade.

From ports in Colombia and Ecuador, the cocaine moved toward Europe, according to the paper. Daniele et al. report that European Union port seizures increased after Colombian production climbed. A seizure is an amount intercepted by authorities, so higher seizures can reflect more enforcement, more trafficking volume, or both. The paper presents the increase alongside the Colombian supply shock.

European prices fell

The final effect appeared in street prices, according to the study. With more supply available and demand treated as steady in the paper’s economic framing, prices declined. Daniele et al. estimate that European cocaine prices were about $15 per gram lower by 2018 compared with 2015.

The finding is a clean example of a market mechanism working through a messy real-world system. A subsidy designed to reduce illegal crop production changed farmer incentives, cheaper fuel lowered production costs, ports redirected trade, and Europe saw more seizures and lower prices, according to the LSE paper.

This story draws on original reporting from Klement on Investing.