A Model of the Indirect Effect of Crime on the Demand for Money

Revista Mexicana de Economía y Finanzas Nueva Época, Vol. 13 No. 4, (2018), pp. 571-584 DOI: http://dx.doi.org/10.21919/remef.v13i4.339 A Model of the Indirect Effect of Crime on the Demand for Money Luis Raúl Rodríguez-Reyes1 Instituto Tecnológico y de Estudios Superiores de Occidente (ITESO) (Primera recepción: 18/diciembre/2017, última recepción: 23/abril/2018, aceptado: 26/junio/2018) Abstract This paper studies the indirect relation between the demand for money and crime, which emerges from the defensive actions of companies against criminal clients. A theoretical search model is built in which companies trade with criminal clients who consume without paying, allowing the former to hire private security. The model produces two balances in pure strategies. First, if the cost of security is high, companies do not hire private security and the criminal buyers do not carry money. Second, if the cost of security is low, the high demand for money is reestablished. This construct is formalized in a purely theoretical model that generates proposals that can be proven empirically, establishing a future line of research. It should be noted that the indirect effect described has not been discussed in relevant literature. As a result, the existence of an indirect channel between crime and money that emerges from a market externality is demonstrated: the demand of companies for private security endogenously determines the demand for money of the economy. JEL Classification: D21, D62, D83, E41, K42 Keywords: Crime, Private Security, Demand for Money, Market Externality, Indirect Effect Un Modelo del Efecto Indirecto del Crimen en la Demanda de Dinero Resumen Este documento estudia la relación indirecta entre la demanda de dinero y el crimen, la cual emerge de la defensa de empresas en contra de clientes criminales. Se construye un modelo de teoría de búsqueda en el cual empresas comercian con clientes criminales que consumen sin pagar, permitiéndose la contratación de seguridad privada. El modelo produce dos equilibrios en estrategias puras. Primero, si el costo de seguridad es alto, las empresas no contratan seguridad privada y los compradores criminales no portan dinero. Segundo, si el costo de seguridad es bajo, el estado de alta demanda de dinero se reestablece. Este constructo se formaliza en un modelo teórico puro, que genera proposiciones comprobables empíricamente, estableciendo una futura línea de investigación. Es importante notar que el efecto indirecto descrito no se ha discutido en la literatura relevante. Como resultado, se demuestra la existencia de un canal indirecto entre crimen y dinero, que surge de una externalidad de mercado: la demanda de las empresas por seguridad privada determina endógenamente la demanda de dinero de la economía. Clasificación JEL: D21, D62, D83, E41, K42 Palabras clave: Crimen, Seguridad Privada, Demanda de Dinero, Externalidad de Mercado, Efecto Indirecto 1 Correspondence to: Luis Raúl Rodríguez-Reyes. Departamento de Economía, Administración y Mer- cadología, Instituto Tecnológico y de Estudios Superiores de Occidente (ITESO). Periférico Sur Manuel Gómez Morín 8585. C.P. 45604 Tlaquepaque, Jalisco, México. E-mail: . Tel: +52 (33) 3669 3434. Ext. 3098. 572 REMEF (The Mexican Journal of Economics and Finance) A Model of the Indirect Effect of Crime on the Demand for Money 1. Introduction Crime against firms can cause disruptions in general economic activity in a region or even a country, and this can occur, not only in crime-ridden-societies, but also in relatively safe countries, with good provision of public security and good record enforcing the rule of law. Early research on this matter was proposed by (Bartel, 1975), who analyzed firm’s demand for protection in the U.S. Bartel developed a theoretical model in which criminals may steal products from firms, and cash can be stolen, but only as cash is recognized as another commodity for the financial industry. In her empirical research within the paper, she shows that to determine their demand for protection, firms react to the probability of crime and the size of the loss, and that even if the substitution between public and private security expenditure is theoretically predicted, such relationship does not hold significant with actual data. Recent empirical research on the subject also supports the negative relationship between crime and private security expenditure. For instance, (Meehan and Benson, 2017) departed from the hypothesis that private security produces positive spillovers on other firms that do not hire it by increasing the expected cost of criminal behavior. Working with a state-level U.S. data in an instrumental variable approach, they found that robbery and property crimes are deterred by the existence of private security. Another example is provided by (Ariel et al., 2017), who measured the efficacy of private policing in deterring crime, using train stations in the southwest of Britain as a part of an intervention under random treatment and control conditions. They employed marginal means and odds ratio analysis to conclude that the presence of uniformed private security guards discourage criminal behavior. There is also evidence of the size of firm’s expenditure in private security in emerging economies. For instance, (Amin, 2009) conducted an empirical analysis to determine how small and large businesses are affected by crime. Using data from the World Bank’s Enterprise Surveys of 2007, he calculates that, in 14 Latin American countries, 58 % of firms pay 1.3 % of annual sales, on average, for private security. Another instance is provided by (Enamorado et al., 2016), who explored the empirical relationship between income inequality and violent crime rates in Mexican municipalities. In their initial analysis, using the World Bank’s Enterprise Surveys of 2012, they compute that 42.8 percent of Mexico’s firms spend 2.2 percent of their annual sales in private security measures. The objective of this research paper is to study the way in which the interaction between the firm’s demand for private security and crime indirectly affects the demand for money. To analyze the potential economic disruptions produced by such indirect effect, two assumptions are in place. First, the paper studies criminal activity that does not involve the use money2 . Second, only property crime is analyzed. The first assumption is imposed to secure that any effect of crime on the demand for money is indirect, while the second is a way to simplify the environment in the model to be developed during the next sections of this paper. That is, from now on, money cannot be stolen or being used as a medium of exchange in shady deals, and crime is defined as the unlawful takeover of produce without the appropriated payment. The hypothesis analyzed here is that this kind of crime, as defined above, disturbs the transactional demand for money in a different way regular cash-related crime d (...truncated)