Abstract
In this paper, we use a differential game analysis to study the dynamic strategic interaction between a criminal gang extorting money from local shop owners and the local police force. In particular, we are interested in characterizing the factors that are important in determining whether the capital stock of local shop owners continues to grow in spite of extortion or whether criminal activity leads to a phase of stagnation of the local economy. A Markov perfect equilibrium of the game is characterized in order to address this question and several policy implications are set out regarding measures to facilitate growth in regions affected by extortion.
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