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Canada’s marijuana industry needs innovation to thrive, not protection

Frances Woolley is a professor of economics at Carleton University

The Task Force on Marijuana Legalization and Regulation did not say, "create a marijuana marketing board." Yet its recommendations would, if implemented, effectively impose a supply management system on cannabis. Suppliers would be licensed, and subject to production limits. These controls would be set so as to "align supply with likely demand."

A marijuana marketing board would protect existing producers, and keep prices high. For the Task Force, this was precisely the point. They wanted to encourage "market diversity," create "a space for smaller-scale production" and prevent "the development of monopolies or large conglomerates."

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The Task Force had good reasons to be concerned about small-scale growers. Producers squeezed out of the legal market might continue to produce and sell illegally, carving out a niche by offering a tax-free product and targeting underserved markets, such as youth and after-hours sales. One of the most important goals on the marijuana legalization agenda is keeping cannabis out of the hands of children and youth. Driving small producers underground could subvert that goal.

Yet, ultimately, a legal marijuana market based on small-scale production is doomed to failure. Absent severe penalties for illicit production, legal marijuana cannot compete with illegally produced weed on a price per gram basis. Legal "craft cannabis" growers will be producing essentially the same product, and using essentially the same technology, as reputable illicit dealers. Yet they will incur costs underground producers can avoid, such as payroll taxes, licensing fees, and regulatory compliance costs. What's more, legal marijuana will be taxed. Suppliers of illicit weed will win any price war.

Legal producers can only out-compete illicit ones through the creation of high-quality, branded cannabis products. Fortunately, there is enormous scope for "upselling" and product differentiation in the marijuana industry. Cannabis differs, at a fundamental level, from drugs such as alcohol or tobacco. The various marijuana strains produce quite different "highs." Ones with high levels of the cannabinoid CBD have analgesic, anti-inflammatory, and anti-anxiety properties, while those with more THC have stronger psychoactive effects, producing a "stoned" feeling.

Innovative U.S. companies are producing products such as Mr. Moxey's Ginger Mints, with a high CDB/low THC cannabinoid blend that leaves your breath and perspective refreshed. They are differentiating their offerings by creating lower-potency products, such as Crescendo's white chocolate THC truffles (with fresh lemon and a hint of juniper berries). It is the availability of these kinds of products that will induce buyers to switch to the legal market.

Yet building and branding a high-quality product requires research and development, investment in processing facilities, and money for marketing. Moreover, if marijuana processing is in any way similar to the processing of beer, tobacco, or other foods and beverages, it will be subject to economies of scale. Large producers, and ones with capital to invest, will be able to make a higher-quality product at a lower cost than smaller ones.

So, if the legal marijuana market is to be successful, it cannot entrench and protect existing suppliers. Out-competing the illicit market requires that consumers be able to access the best possible products at a competitive price. Suppliers who sell products consumers want to buy need to be able to expand at the expense of less efficient ones. Depending upon the technology of marijuana production, that might lead to the legal marijuana market being dominated by a few large producers.

Basically, marijuana regulators face a trade-off between protecting inefficient producers and raising revenue. Canadians will not be willing to pay more for legal marijuana than it would cost to obtain a comparable product elsewhere. When producers' costs are relatively high, governments will have to impose lower taxes, because otherwise consumers will not buy in the legal market.

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If the recommendations of the Task Force are implemented, the trade-off between raising revenue and protecting producers will become particularly acute, because Canadians will be allowed up to four plants per residence for personal use. This is why a marijuana marketing board may fail where milk marketing boards have succeeded: it is much easier to grow one's own weed than produce one's own cheese. Home production seriously limits any marketing board's ability to protect producers and control supply.

The idea that marijuana legalization will lead to large-scale job creation, and big revenue windfalls, is a pipe dream. The legal market has to be efficient to out-compete illicit production, and efficiency is as likely to kill jobs as create them. The revenue raising possibilities of marijuana are strictly limited. The stronger argument for marijuana legalization is simply this: Canadians will be able to enjoy better-quality drugs.

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About the Author

Frances Woolley is a professor of economics at Carleton University, where she teaches public finance. Professor Woolley is a former Secretary Treasurer of the Canadian Economics Association, and currently co-editor of Review of Economics of the Household. Her research on taxation and the family was awarded the Purvis Prize in 2001 and the John Vanderkamp Award in 1997. More


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