NUNO GAROUPA [*]
This article extends the optimal law enforcement literature to organized crime. I model the criminal organization as a vertical structure where the principal extracts some rents from the agents through extortion. As long as extortion is a costless transfer from individuals to the criminal organization, not only the existence of extortion is social welfare improving because it makes engaging in a criminal offense less attractive but it also allows the government to reduce expenditures on law enforcement. When extortion is costly because the criminal organization resorts to threats and violence, the existence of extortion is social welfare diminishing and may lead to higher expenditures on law enforcement. (JEL K4)
The economic analysis of crime has its starting point with Becker's  seminal work: individuals rationally decide whether to engage in criminal activities by comparing the expected returns to crime with the returns to legitimate business. Hence, crime is less attractive if the government increases the probability (certainty) and severity of punishment. Alternatively, by increasing market opportunities, one makes crime less attractive. Becker's main thesis is that, since imposing a fine is costless, this fine should equal an individual's entire wealth and be complemented by a probability of punishment to optimally deter crime.
Most of the literature on crime has focused on the role of deterrence as pointed out in a recent survey by Garoupa . The discussion has been around alternative characterizations of optimal penalties and enforcement strategies in the context of partial equilibrium, where the normative criteria is to minimize a given welfare function that measures the social loss resulting from crime. 
This article extends the optimal law enforcement literature to organized crime. The term "organized crime" has been used with various meanings by scholars and prosecutors in different countries. Some authors use it to define a set of relations among illegal organizations, whereas others use it to indicate a group of illegal activities performed by a given set of agents. Fiorentini and Peltzman  summarize the following characteristics of organized crime: (i) economies of scale and exploitation of monopolistic prices on the supply of illegal goods and services; (ii) practice of violence against other legal and illegal business; (iii) criminal hierarchy with internalization of negative externalities and management of portfolio of risky activities; (iv) avoidance of resource dissipation through competitive lobbying and corruption; and (v) easier access to markets. Abadinsky  classifies organized crime according to activities: (i) racketeering: individuals organize criminal activities to improve their business, (ii) vice operations: individuals provide illegal goods; (iii) theft-fence rings: individuals develop a network on a continuous basis in the business of purchasing and reselling stolen goods; (iv) gangs: individuals band together to enhance their group and influence; and (v) terrorists: individuals get together to commit spectacular criminal acts to undermine an established government.
The distinction between the two main roles of the criminal organization--as government and as a firm--is especially fruitful when applied to the analysis of policymaking. In this respect, we have to distinguish between three main areas of deterrence policies against organized crime: first, the traditional deterrence strategies based on investment in investigate activities and in the judicial and penal systems in order to increase the probability of detection of crimes related to the criminal organizations' activities; second, the deterrence strategies related to the regulatory activities of the government; third, the deterrence policies against money laundering and the investment of illegal profits in legal activities. …