Drugs trade `the third largest economy'

Narcotics: New report reveals colossal scale of trafficking and money laundering, much of it flowing through Britain

THE DRUGS business is the third biggest economy in the world today. In fact, according to more alarmist estimates of its value, it could even be starting to catch up with the United States as the leading player in the world economy.

Like any other business, organised crime has gone global, and the drugs trade is its most profitable sector. Of necessity, the figures are mainly guesswork, but the Financial Action Task Force (FATF) of the Group of Seven leading industrial nations (G7) has estimated that at least $120bn (pounds 73bn) from the drugs trade are laundered through the world's financial system a year.

This extremely conservative estimate amounts to about the same as the total amount of funds invested legally in the emerging market economies last year.

The comparison gives some idea of the potential that drugs money - much of it flowing through London, the biggest foreign-exchange trading centre in the world - has to disrupt the financial markets. After all, 1998 was scarcely a calm year in the markets.

The G7, whose finance ministers met in Bonn at the weekend, set up the FATF to combat money laundering, bribery and other financial aspects of organised crime. Its existence is a tacit admission that these powerful countries need to engage in combat with their illegal counterparts.

For the possibility of financial turbulence is actually the least of the G7's worries. The growth of the illegal drugs trade has led to a mounting bill for the medical, social and policing costs. In the US, the annual social cost is estimated to be about $67bn a year, according to the 1998 National Drug Strategy. More than one-third of the country's new cases of HIV are linked to the injection of drugs.

In the United Kingdom, the direct cost of dealing with serious drug abusers is estimated at well over pounds 4bn a year. The Office for National Statistics puts the size of the drugs economy in the UK at up to 1.2 per cent of official gross domestic product.

While it is impossible to compile comprehensive statistics - estimates of the annual value of the worldwide trade in illegal drugs range between $1,500bn to $5,000bn - the direct costs alone are clearly sizeable.

But the negative economic impact goes beyond the direct costs of patching up the damage caused by drugs. It even goes beyond the indirect costs crime imposes by disrupting the efficient functioning of the economy, making the costs of crime-prevention a kind of tax. Illegal drugs, like legal alcohol, also devalue the quality of the workforce. The policing of the problem diverts resources that could be put to other uses.

However, perhaps the most serious impact of the problem, as far as economists are concerned, is the way that illegal drugs degrade the institutions of politics and society. Take a recent example. One of the serious issues facing the G7 this weekend was the slump in Japan, where the economy is contracting for the second year running, and has not really grown at all for most of the decade.

At the heart of the country's economic crisis is a near-bankrupt banking system, saddled with trillions of yen in debts that will never be repaid. The defaults were triggered in 1995 by the collapse of local savings banks that had been forced to accept bad loans by the local yakuza, the Japanese mafia.

Drugs form Latin America's most successful export business, and provide its biggest cash crop. The region is peculiarly vulnerable to capital flight in part because its most dynamic entrepreneurs, the drugs barons, shift funds abroad. In Colombia, the Medellin cartel once even proposed to pay off the country's foreign debt in cash in return for legitimacy - a deal halted by the US.

Similarly, experts such as Manuel Castells, an eminent sociologist at Berkeley, in California, argue that Russia's economy is doomed to perpetual chaos because of the activities of organised crime. The government is unable to collect tax, but the mafias can.

The drug-financed illegal economy has filled the vacuum created by the transition from Communism, and its dominance now prevents the emergence of normal economic institutions.

The FATF has reported that money laundering takes place not just through offshore financial centres, but also through high-street lawyers and accountants, banks and bureaux de change. The drugs business is eating away at the economy from within, for market economies are defined by their institutions.

Predominant among these is the rule of law in upholding property rights. The illegal drugs trade has grown to a scale that is undermining this basic framework. It is threatening the ability of the world's biggest economies to continue prospering.