The Conservative politician told delegates at a fringe meeting at the party's conference in Manchester that it is important intervention programmes are in place to offer young people involved in crime a way out.
However this must be accompanied by a tough stance on those who offend.
"I was struck by something said to me on an estate that has young kids running drugs," Grayling said.
"When they do go to jail and come out under early release they think they have beaten the system. There are some wrong messages there.
"We have got to deal with problems at the root but if the system sends out the wrong message we make things worse rather than better."
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