Thursday, November 15, 2012

What are the Economics of Partial Marijuana Legalization?

Back in July, I learned the striking fact that if marijuana were fully legal, a decent high could be had for a few cents.

Now that Colorado and Washington have legalized marijuana for recreational purposes—no “medical marijuana” fig leaf here or even Dutch-style toleration—will pot prices crater?

Almost certainly not. For starters, both states are trying to make money off pot. They envision a legal framework broadly modeled on alcohol regulation with licensing schemes for production, retailing, and distribution of marijuana, coupled with laws against underage consumption and driving while intoxicated. The states hope to harvest revenue from taxes and licensing fees. When a commodity is cheap, the main driver of the retail price is often excise taxes. And state governments have good reason to want to tax marijuana consumption. Most credible analysis indicates that pot doesn’t pose health risks as serious as those associated with alcohol or tobacco, but dependency is still a real issue and inhaling smoke is still bad for you, so the standard case for sin taxes to promote good health applies. Manufacturers and distributors of marijuana actually welcome the idea of paying taxes since the alternative is going to jail.

But in many ways this isn’t the real reason pot prices will stay pricey. The main roadblock to a dirt-cheap high is that even though marijuana will soon be legal in Washington and Colorado, it’s still illegal in the United States of America. Consequently, entrepreneurs looking to get into the industry are going to be troubled by the reality that both Washington and Colorado are part of the United States of America. On a day-to-day level, this isn’t necessarily a huge deal. The Drug Enforcement Agency only has so many agents, and can’t substitute for the Denver and Seattle Police Departments in terms of routine enforcement of marijuana prohibition. Even with no change in the underlying state laws, simply instructing state and local law enforcement personnel to stop enforcing the law would be in many ways a game-changer.

But in terms of economics, the main way marijuana criminalization raises prices has nothing to do with individual possession or low-level retailing. The issue is that currently marijuana isn’t grown, dried, and distributed the way a normal agricultural product would be.

True legalization ought to drive the price way down by bringing modern cultivation and production methods to bear. In Canada, industrial hemp is grown for about $500 per acre. But that’s done on large farms, not small grow houses. With the application of modern efficient agribusiness methods, marijuana prices should be more like tea prices—closer to $3 an ounce of usable product than the current $300.

Yet none of this is going to happen as long as marijuana cultivation is against federal law. The DEA is not going to be able to police these states rigorously, but they’ll be able to spot a gigantic marijuana farm pretty easily. Even if the Obama administration takes Emily Bazelon’s wise counsel and eases off on federal interference it’s still going to be extremely challenging to raise large quantities of startup capital to finance businesses that remain technically illegal. Even if President Obama suddenly announced he wouldn’t enforce any marijuana laws, pot businesses would still be tenuous. That easing off could be reversed at the drop of a hat, making a decision to go build a marijuana drying and packaging factory quite risky.

And under the more likely scenario where federal enforcement of anti-drug laws remains as rigorous as logistically feasible, would-be marijuana enterprises are going to have even bigger problems. A handful of well-publicized threatening letters to commercial real estate owners threatening asset forfeiture, for example, could deter property owners from signing leases with marijuana retailers. Similar actions could interfere with firms’ willingness to involve themselves in marijuana transportation. None of this will by any means eliminate all marijuana cultivation, transportation, distribution, and retailing—these things all occur under current law, after all. But it does mean that it’s relatively unlikely that the pot business could develop the kind of scale and predictability that would allow for dramatically more efficient operation. Instead, production and distribution will remain relatively artisanal as even the most successful firms are starved of capital.

It’s going to be very challenging for state governments to obtain significant tax revenue from marijuana unless it becomes a real legal industry. This tax argument alone should look increasingly persuasive to politicians in other states, especially nearby ones (Portland is very close to the Washington border) and it’s clear that time is against marijuana prohibition. But we still have a long way to go before we see the nearly free high that could come with real legalization.