The marijuana economy

"Where does the money come from?" is a question asked throughout The Great Gatsby, the ripping new film version of F. Scott Fitzgerald's novel about the Roaring Twenties. The answer, of course, is booze.

“Where does the money come from?” is a question asked throughout The Great Gatsby, the ripping new film version of F. Scott Fitzgerald’s novel about the Roaring Twenties.

The answer, of course, is booze. Prohibition looks wickedly fun in The Great Gatsby. And the film touches on all the reasons why more serious policy analysts have long viewed Prohibition as an almost laughably bad public policy.

These include the fact that Prohibition didn’t stop alcohol use, and may have encouraged it since booze got cheaper in many places after unregulated and untaxed producers jumped into the market. Governments lost a source of tax revenue, while organized crime got rich. Even worse, booze bosses soon had bigger and better-funded organizations to enter the racketeering, drugs, prostitution and gambling markets. Booze money corrupted public officials and taught a large portion of the population that it was socially acceptable to break laws.

Which brings up the marijuana economy today. Fact and anecdote underline the similarities with the Prohibition era.

Health Canada’s annual weed-use survey is highly informative. In 2011, almost 40 per cent of Canadians reported having used marijuana, including 9 per cent in the previous year. That figure jumps to 22 per cent for Canadians aged 15-24. The average age of first use for this age group is 15 years and seven months.

The survey doesn’t provide separate numbers for the Yukon, but there’s no reason to think marijuana is less popular here. A 2007 survey of 450 students at a Whitehorse high school had 17 per cent reporting they had smoked bud at school, three times as many who had consumed alcohol. That’s at school, not counting use at home and elsewhere.

BYTE, a prominent Yukon youth organization, did a survey at the Dawson City Music Festival in 2012. Almost 90 per cent of the 136 respondents said they had tried marijuana. Of the 70 people who reported trying to buy drugs in Dawson, 29 per cent said they were “easy to find.”

Probably a similar percentage of New Yorkers knew the secret knock to get into one of Gatsby’s speakeasies.

A friend was recently in a Vancouver breakfast restaurant. In the booth behind him, he could overhear a recently graduated man talking with his aunt and uncle about his career plans. They talked openly about the young man’s aspirations to become a marijuana wholesaler, shipping the demon weed to dealers in smaller interior towns.

There seems to be a trend towards legalization, or at least decriminalization. Eight B.C. mayors signed a letter last year supporting an end to prohibition. Hundreds of B.C. municipal politicians voted in favour of a resolution calling the B.C. government to look seriously at regulation and taxation of marijuana. Across the border, around 20 states have legalized or decriminalized weed to some extent.

Putting to one side the health and moral effects, what is the economic impact likely to be if marijuana prohibition ends up in the history books like alcohol prohibition?

It is clear that marijuana is big business. Reliable statistics are hard to come by, of course, but BC Business Magazine estimated that in 2008 the province’s industry was worth $7.5 billion and had a workforce of 250,000 from production to distribution. In 2004, the Fraser Institute estimated weed drove 1.5-4.6 per cent of B.C.‘s economy. Researchers at UBC and Simon Fraser recently estimated that the B.C. market, not including export to the U.S. and other provinces, was around $500 million a year. RAND Corporation research puts the national marijuana market at $3-4 billion not counting exports, with about 10 per cent of the population using the product.

How would legalization change this? The first thing to think about is supply and demand, then how legalization would affect each stage of the supply chain.

Post-legalization, demand would likely increase at a given price due to the removal of the criminal stigma. This effect could be less than many think, however, since 85 per cent of marijuana is consumed by daily users according to the UBC research. These people probably already get as much as they need. The impact would probably be on casual users.

Supply would also increase at a given price, since the risk of arrest would be eliminated. This would likely cause a sharp fall in price. To prevent cheap weed from provoking an increase in consumption, governments would probably slap on high taxes like they do for booze and cigarettes. In 2004, the Fraser Institute estimated that the retail value of marijuana was about $15,000 per kilogram, with the cost of production around $2,500. A tax of $12,500 per kilogram could be levied to keep the retail price the same as during prohibition.

Government could put the tax lower to drive black marketers out of business, or higher to increase revenue and cut consumption. The latter policy risks continued black market activity, as with illegal cigarettes in the 1990s.

If Canadians smoke 160,000 kilos of pot per year, as the Fraser Institute estimates, then this would yield $2 billion in direct tax revenue.

If one assumes the government taxes keep the retail price stable after legalization, the biggest economic impact is likely to be on the marijuana business itself. Margins will fall for producers, processors and distributors as the government taxes bite. Some customers will probably also shift from their current suppliers to more “normal” retail outlets. Many customers would probably also move to more professional suppliers who provided more certainty about quality control.

In short, the marijuana business would be much less risky, and also much less profitable. The normal laws of economics would start to apply, and inefficient players would be forced out of the market. National Public Radio’s Planet Money recently interviewed a weed distributor who left a state where his product had been decriminalized since margins were down.

Don’t expect legalization to happen quickly. But deficit-stricken governments will be under increasing pressure to reduce spending on jails and increase tax revenues. It may not be a coincidence that the U.S. didn’t repeal alcohol prohibition until the Great Depression hit, more than 10 years after Gatsby started his wild parties.

Keith Halliday is a Yukon economist and author of the MacBride Museum’s Aurore of the Yukon series of historical children’s adventure novels.

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