In this post, I summarize my takeaways from Daniel Okrent’s book Last Call: The Rise and Fall of Prohibition. All quotes, unless otherwise noted, are from the book.
Introduction
Some things don’t change. People’s desire to consume alcohol seems to be one of them. As shown in the figure below, every generation of Americans over the last 150 years consumed fairly similar amounts of alcohol. The only exception to this pattern was the Prohibition era (1920-1933), during which the sale of alcoholic beverages was banned. As the policy intended, alcohol consumption dropped to zero during these years. Hurray!
Of course, I’m kidding. Alcohol consumption was alive and well. It just didn’t show up in the official statistics, which means we must rely on estimated consumption for this period. According to a paper by Miron and Zwiebel (1991), alcohol consumption initially dropped to around 30% of pre-Prohibition levels, increasing to 60-70% of pre-Prohibition levels within a few years.
There are three points to note here. The first and most important one is that Prohibition was a failure. It failed to eliminate alcohol consumption, which was supposedly its goal. This is a point worth remembering, especially for those harboring ambitions of large-scale social engineering.
The second point is that, despite the policy’s eventual failure, alcohol consumption dropped quite substantially initially. Upon reflection, this initial drop is not very surprising. The status quo was disturbed, and people couldn’t source their alcohol from their usual suppliers. New supply chains took time to be established. Then experimentation started, and people found legal and illegal workarounds. At some point, everything was back to business as usual.
As a methodological aside, many policies are evaluated shortly after they are introduced. Considering our example, imagine if someone had measured the effectiveness of Prohibition in early 1920. At that point, Prohibition may have seemed quite effective, as consumption dropped to 30% of what it had been only a few months earlier. Extrapolating from early results, however, would have led to a wrong guess about long-term trends.
The pattern of initially promising results followed by long-term failure is by no means unique to alcohol bans. Early evaluations frequently overestimate policy effectiveness because they are done before people can adopt compensating behavior.
The third point to note is that, once the dust settled and people found new suppliers, the effect of the policy wasn’t very large—an estimated 30-40% reduction relative to pre-Prohibition levels. This seems sizeable at first, but we need to consider that a similar change in consumption can easily come about by a moderately large price increase. Prohibition was, by definition, a price increase. And an extreme one at that. It meant the product couldn’t be legally purchased at any price, implying an infinite price.
As the ban was implemented less than perfectly, the price was not infinite, but it still increased substantially. The Miron and Zwiebel (1991) study I mentioned earlier cites a source from 1932 that claims that alcohol prices in 1930 were 3 times as high as pre-Prohibition prices. Even if people are not very price-sensitive, they would reduce their alcohol consumption quite a bit when faced with such a large price hike.
Now let’s turn our attention to some of the legal and illegal ways in which human ingenuity transformed the infinite price of alcohol into a merely high price.
If there is a will, there is a way
Existing stock exempted
When the alcohol ban came into effect, you could no longer drink newly acquired alcohol. You could drink, however, what you had in your house before the ban. This loophole was well-known in advance, incentivizing people to quickly stock up on alcohol.
Joseph P. Kennedy sold off much of the stock from his father’s East Boston liquor business to grateful friends and associates, and cellared several thousands of dollars’ worth of wine in his Brookline house. […] In New Orleans civic leader Walter Parker, a member of the Stratford Club, built two new wine cellars in his house, purchased a stock of more than five thousand bottles, and proceeded to dip into it daily for the next fourteen years. In Los Angeles, Charlotte Hennessy, mother of actress Mary Pickford, simply bought the entire inventory of a liquor store and had it relocated to her basement.
Laws that treat everyone equally in theory might treat different people differently in practice. Few people had the financial means and the storage capacity to amass a formidable stockpile of alcoholic beverages. Unsurprisingly, those who did tended to be both rich and well-connected.
Doctor, prescribe me a shot
Other loopholes were more uniformly available to people from all backgrounds. One example of this was the medicinal use of alcohol. A person could get a doctor’s prescription and go to a pharmacy to collect the prescribed medication—for example, pints of Paul Jones Rye, Old Pirate Rum, or White Star Brandy. A few months into Prohibition, 15,000 doctors requested permits, and pharmacies were eager to comply with the onslaught of new prescriptions.
Allowing one type of establishment to dispense alcohol while prohibiting others from doing the same was not unknown to New Yorkers. A generation earlier, in 1896, New York enacted the Raines law that prohibited saloons from operating on Sundays—their most profitable day. The same law carved out an exception for hotels, defined as establishments that had at least 10 bedrooms and served meals. By now, you may have guessed what happened next:
In Brooklyn alone, where there had been thirteen hotels before the Raines Law, there were soon more than two thousand – virtually all of them saloons whose back rooms of upstairs spaces had been subdivided by the addition of flimsy walls, made accommodating by the provision of threadbare cots, and turned profitable by the new business they immediately and inevitably attracted: prostitution. The requirement that these “hotels” offer food was solved with the invention of the “Raines sandwich,” described by Jacob Riis as “consisting of two pieces of bread with a brick between…set out on the counter […]”.
Cat-and-mouse game
It’s difficult to ban all uses of a mainstream product. Alcohol, for instance, is an important input in industrial processes. Banning it completely would lead to disruptions in the supply of critical products, including hand sanitizers, disinfectants, pharmaceutical products, cosmetics, paints, and varnishes.
The same ethanol is used for drinking and for other purposes. This creates an obvious problem: People can buy alcohol purportedly for industrial use, then go home and drink it. The solution? Force alcohol producers to add poisonous substances like sulphuric acid or formaldehyde to industrial alcohol. This way, people won’t be tempted to consider off-label usage. This theory sounds great on paper, but it didn’t survive the test of reality.
As Okrent noted, “removing the odious additives by redistillation or other procedures was a process any self-respecting chemist could engineer.” Chemists, self-respecting or otherwise, like money. The new businesses that emerged claimed they needed large amounts of industrial alcohol for their legal operations. In reality, they were merely converting denatured (poisonous) alcohol back to drinkable alcohol.
In Hungary, a similar dynamic played out with diesel in the early 1990s. For reasons that are not important here, diesel had a different tax treatment when it was used as fuel than when it was used as heating oil. To prevent people from buying “heating oil” and using it as “fuel”, the government forced producers to add a substance to diesel. This substance was designed to damage car engines, thereby disincentivizing off-label usage. The consequences of this rule wouldn’t have surprised students of Prohibition. Some people amassed unimaginable wealth by reverting the chemical process, selling the cheaper “heating oil” as more expensive “fuel”.
As mentioned before, bans are like an infinite price. So, in both the Prohibition and the diesel examples, the same product is sold at different prices. As long as there is a price differential, people will want to find an arbitrage opportunity. The larger the potential profit, the more creative and risk-seeking they will become in this pursuit.
There is an easy way to eliminate the arbitrage opportunity: sell the product at a single price. Policymakers, however, frequently prefer a different path. They attempt to restrict one specific form of arbitrage. If they are successful, people eventually discover a different form of arbitrage. After some rounds of this cat-and-mouse game, the policymaker may decide to give up and introduce a single price for the product.
Not in my backyard (alcohol edition)
The state can’t put an incorruptible agent at every industrial plant that uses alcohol as input. Neither can it patrol the whole US coastline. At the time of Prohibition, the limit of US territorial waters was 3 nautical miles off the coast. Beyond this line, people could shop around for alcohol as they pleased.
Shopping around for alcohol on a dinghy is a retail operation. Wholesale operations faced challenges of a different magnitude. They needed to be close to small-scale smugglers and other retail operators while staying outside the jurisdiction of the US.
The Bahamas (a British colony at the time) was more than happy to help solve this logistical challenge. Located at a convenient distance from the US, the islanders could earn a handsome profit with almost no work. Alcohol would pour in from, say, Europe and it would then be loaded onto ships heading to the US. The colony would levy an export tax on the goods leaving its port.
The scale of this operation was quite substantial:
In 1918 Scotch exporters had sent 914 gallons of their product to the Bahamas; two years into Prohibition the Bahama-bound export had soared to 386,000 gallons.
For a small island, this was a godsend. The colony’s British governor, not blind to where this sudden wealth came from, said it would be “appropriate to erect […] a monument to Andrew J. Volstead [the author of Prohibition].”
Good times don’t last forever, especially when a government becomes greedy and increases the taxes it levies on its primary money-making activity. The country learned the hard way that smugglers have high price elasticity: when running their businesses becomes expensive, they shift operations elsewhere. In this case, to the much less sunny place of St. Pierre and Miquelon. The tiny archipelago, located only 15 miles off the coast of Newfoundland (Canada), offered much lower export fees. Importantly for Canadian smugglers, the archipelago was French territory:
Under Canadian law no duty was owed on liquor manufactured for export; shippers were required to post a tax bond as their goods left Canada, but would have the bond redeemed on the presentation of landing certificates from a foreign port. […] Vessels hailing from Halifax and other Canadian ports could chug into St. Pierre’s harbour and get legal stamps on the landing certificates required to release the tax deposits from bond.
In other words, Canadian smugglers didn’t want to burn cash anymore on corrupt officials stamping fake landing certificates in distant ports. They much preferred the close archipelago—and its understanding officials. Conveniently, the St. Pierrais government certified landing upon a ship’s arrival in port. A Canadian merchant didn’t even have to inconvenience himself by unloading the cargo first. The port officials would just hand over the landing certificate aboard. This way, the merchant’s money wasn’t tied up in a Canadian tax bond for long.
The case of the Bahamas and St. Pierre and Miquelon is interesting in part because these places benefitted tremendously from Prohibition. The case of Dubai serves as a historical parallel of severe restrictions creating unintended benefits for third parties. When the oppressive, theocratic regime came to power in Iran in 1979, many of Bandar-e Lengeh’s (a port city on the opposite side of the Persian Gulf) most productive people moved their operations to Dubai, contributing to the city’s early success.
Closing thoughts
Banning something has a range of expected and unexpected consequences. If people want the banned product or service badly enough, they will go to great lengths to get it. In this process, they will often use creative and ingenious methods that cannot be anticipated and matched by the regulators. Unless regulators have the political will and capability to control relevant aspects of people’s lives, which is rare, their ban will fail to produce its intended effects. Leaving important moral considerations aside, an argument against bans, therefore, is that they are just not very effective. The failure of Prohibition should serve as a cautionary tale for those who think social ills can be eradicated with a mere stroke of the pen.