How Mafia Crackdowns Drive Competition and Innovation in Local Economies

The Italian Mafia is synonymous with organized crime and some of the country’s most powerful groups wield fearsome power across the world. Their strongholds start at the municipal level. Pablo Slutzky, a finance assistant professor at the University of Maryland’s Robert H. Smith School of Business, studies how the mafia’s presence impacts local economies.

In research published in Management Science, Slutzky and co-author Stefan Zeume of the University of Illinois at Urbana-Champaign look at what happens to the economy in Italy when law enforcement cracks down on organized crime.

“When you fight the mafia, companies start competing on price and quality, so they have incentives to innovate,” Slutzky says.

Organized crime distorts the competitive landscape at the very local level, acting as a barrier to market entry and competition, which disrupts economic efficiency, says Slutzky.

The mafia in Italy runs cartels that hinder competition, protecting certain firms that are forced to share a cut of revenues and blocking new ones from entering the market. The mafia is also known to funnel money it makes through illegal activities – like drug and people trafficking, gambling and prostitution – through legitimate business. This money laundering falsely inflates those firms’ revenues and profits and helps inefficient firms survive.

Slutzky uses the example of a local coffee shop to illustrate:

“The mafia will take protection money from that coffee shop and make sure there is no other coffee shop in the area. Having no competition will increase that shop’s revenues and by being more profitable, the mafia will be able to extract more money from it. If there is competition, it won’t make as much money and they won’t be able to take as big of a cut.”

Slutzky says anecdotal evidence pointed to this occurrence in many towns in Italy, but he wanted to study the degree to which it was happening and which industries were most affected.

The researchers were able to pull data from a “natural experiment” – a concerted effort by Italian law enforcement to fight the mafia by going to people they suspected were linked to the crime organization. “If their expenses didn’t match their reported income, they would start an investigation.”

If someone reports making $40,000 a year, but drives a $400,000 Ferrari, that’s suspicious, says Slutzky.

“A new law was passed allowing the Italian government to confiscate goods,” he says. “Italy confiscated the goods and made sure people knew about it. They’d confiscate the Ferrari, turn it into a police car and drive it around town. Not only did they want to make a dent in the financial assets of those connected to the mafia, they also wanted to hurt their reputation.”

Slutzky and Zeume looked at data from 1995-2015 from confiscations in Italy to see where local mafias were weakening. They looked at data from the more than 8,000 local municipalities in the country.

When the mafia is weakened in a municipality, more firms enter the market, Slutzky says. It also causes some firms to exit the market because they suffer from having to compete. “Firms in the non-tradable sector – like coffee shops and local service providers – suffer because without the mafia stifling competition, markets become more crowded and competitive, so they can’t charge monopolistic prices.”

But firms that produce tradable goods that can be sold in other markets benefit when the local mafia loses power. “That’s because even if they were forced to pay the mafia off for protection, they never actually benefited from a mafia presence because they couldn’t charge more for their goods in outside markets,” says Slutzky.

This is the first research to quantify the effect of the mafia at this micro level of how municipalities are affected, says Slutzky. The turnover of firms increases by about 12% relative to prior years, he says. This is mostly driven by an increase in the number of firms entering the market relative to the period before a crackdown.

Slutzky says these insights can be useful in economies beyond Italy.

“Italy is unique, but organized crime is everywhere. Fighting it is a way to foster economic growth and innovation.”

The research, “Organized Crime and Firms: Evidence from Antimafia Enforcement Actions ,” is published in Management Science.