Does Drug Prohibition Inhibit Economic Development?

Even the most dedicated opponent of drug prohibition might not guess that this policy harms economic development.

Yet claims in a recent WSJ story, combined with research on the relation between banking and development, suggests just such an impact.

The reason is that drug prohibition fosters anti-money laundering laws; which then discourage U.S. banks from doing business in Mexico; which then impedes Mexican banking; which then negatively impacts development.

The WSJ story says,

U.S. banks are cutting off a growing number of customers in Mexico, deciding that business south of the border might not be worth the risks in the wake of mounting regulatory warnings.

At issue are correspondent-banking relationships that allow Mexican banks to facilitate cross-border transactions and meet their clients’ needs for dealing in dollars—in effect, giving them access to the U.S. financial system. The global firms that provide those services are increasingly wary of dealing with Mexican banks as well as their customers, according to U.S. bankers and people familiar with the matter.

And why are U.S. banks worried about regulation?  Because 

U.S. financial regulators have long warned about the risks in Mexico of money laundering tied to the drug trade. The urgency spiked more than a year ago, when the Financial Crimes Enforcement Network, a unit of the Treasury Department, sent notices warning banks of the risk that drug cartels were laundering money through correspondent accounts … Earlier, the Office of the Comptroller of the Currency sent a cautionary note to some big U.S. banks about their Mexico banking activities.

As for evidence that banking is important for economic development, see this paper by Scott Fulford of Boston College (featured soon in a Cato Research Brief).  Fulford writes:

Do banks matter for growth and how? This paper examines the effects of national banks in the United States from 1870–1900. I use the discontinuity in entry caused by a large minimum size requirement to identify the effects of banking. For the counties on the margin between getting a bank and not, gaining a bank increased production per person by 10%. National banks in rural areas improved agriculture over manufacturing, moving counties towards geographic comparative advantage. Since these banks made few long-term loans, the evidence suggests that the provision of working capital and liquidity matter for growth.

Bad policies (drug prohibition) breed more bad policies (anti-money-laundering laws), which have additional adverse consequences that few could plausibly have forseen.  This is one reason why any government interference with liberty, no matter how well intentioned or seemingly well justified, should face extreme skepticism.