July 08, 2004

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I assume that making an illegal product is a business like any other except that it faces some additional contraints.
I recently published a study of the marijuana industry in British Columbia where I proposed that marijuana in Canada should be grown, regulated and taxed like any other commodity.

The origins of my interest in B.C. bud came from ongoing research about the great alcohol prohibitions in Canada and the U.S. in the period 1918-1933, although states and provinces had various prohibitions both before and after.

In the course of this research I realized that one central component was missing from all the previous analyses: there was no agreed upon estimate of the amount of alcohol produced during these prohibitions.

This is not all that surprising since illegal production is not likely to be estimated directly for obvious reasons.

My approach to the problem is to use some elementary economic theory to get a first cut at the level of production.

In particular, I assume that making an illegal product is a business like any other except that it faces some additional constraints: it faces a risk of confiscation and penalty as a part of doing business, and the equilibrium rate of return on the enterprise may require a special compensation for that risk.

However, in studying the early part of the last century, there were any number of data difficulties. To find better data I decided to look for an activity in the modern period that was on a scale similar to that of alcohol. This led me to a study of marijuana since, like prohibition era alcohol, it is both illegal to consume and produce and remains widely consumed.

With marijuana there is little evidence that the contemporary prohibition on production and consumption throughout the world is successful in making it unavailable. For those of you who doubt the figures for Canada, ask a child whether he or she knows someone in school from whom they could get marijuana.

Recent surveys report that 19 per cent of 12 and 15-year-olds, and 23 per cent of all Canadians over the age of 15 have tried it. Nearly two million Canadians are reported to be currently using marijuana, or at least have used in the past year.

Older people use less frequently than young people, and the current crop of seniors is the least likely to have ever used, so the total number of Canadians who have had some experience with marijuana is likely to increase as the current generation of seniors declines. Boomers are or were in the vanguard of users, but younger people use more frequently than older.

Even though marijuana growing can be found across Canada, I decided to concentrate on B.C. since I live here and thought it best to be as close to the data as is (legally) possible. In the year 2000 there were 2,800 busts of marijuana grow operations in British Columbia.

Let us try to get some perspective on this number. If the police were able to find and demolish 10 per cent of all grow ops in the province, it would suggest that there were 28,000 grow ops out there.

However, based on a little economic theory and modest data, my own estimate is that there are about 17-18,000 marijuana grow operations at this time although my study presents a range of estimates for different assumptions about the parameters of price, quantity, cost of operation and rate of return.

Since the average operation that was busted had 180 plants and each plant yields about 33 grams of usable dry marijuana, British Columbia's commercial production is probably in the range of 400,000 kilograms, as I assume conservatively that there are four crops a year.

This is a lot of marijuana and it is worth a lot of money although exactly how much depends in part on the units in which the crop is measured.

Although Statistics Canada does not run a survey so our figures are fraught with uncertainty, police data suggest a kilogram of marijuana may sell for as much as $5,000 wholesale. If my estimates about production are reasonable, then the value of the B.C. crop is worth something like $2 billion at the wholesale level.

Naturally, retail would sell for more. Marijuana purchased for $15 by the gram makes a kilogram worth $15,000. Using these units would inflate the final value of the crop by a factor of three. How big is this? In 2000 the gross domestic product (GDP) of British Columbia was roughly $130 billion. Depending on how local production is valued, the ratio of sales of marijuana to the province's GDP is between 1.5 and 4.6 per cent. This number of final sales may not be an outrageous estimate of the contribution to B.C. GDP as there are relatively few imported inputs. British Columbia is likely to consume only 30,000 or so kilograms, the rest is destined for markets in the U.S. or the rest of Canada.

Suppose marijuana were to be made legal: not decriminalized and subject to a fine, but legal to produce and consume.

Standard economic theory suggests price will fall and usage will rise. However, to explore the implications of legalization without affecting consumption (and consequently perturbing the current environment as little as possible), imagine a thought experiment in which we tax marijuana at a rate that keeps the current retail price the same.

In the near term, a tax rate of $7 per cigarette would keep prices roughly the same as they are now.

If Canadian consumption is in the range of 160, 000 kilograms and a cigarette is about half a gram, then the tax revenue implied by this implicit final price standstill taxing arrangement is over $2 billion.

This kind of a revenue guess is of course sensitive to the assumptions about the current price of the product and the costs of production.

The difference between the final sales price and the cost of production goes to distribution costs and a return to investment and risk.

In many cases these returns are going to organized crime and provide base funding for unsavory activities that most of us dislike. Were marijuana to be legal, these funds would no longer be available for mob use. In 1917-18 in Canada, and in the 1920s and early 1930s in the U.S., alcohol production and consumption was heavily restricted or prohibited. Gangsters like Al Capone were able to use the profits from illegal alcohol production to build criminal empires whose legacies we continue to live with nearly a century later.

Removing alcohol prohibition generated and continues to generate many problems, but Murder Inc. was a serious consequence of the prohibition that corrupted policing, politics and society, and I doubt that there is any appetite currently for returning to this period.

If Canada were to legalize marijuana, the biggest potential problem is with the U.S. If the U.S. were to add to trade frictions by requiring special border inspections, then there is no doubt that this could damage our income far beyond any economic advantage that could be obtained through legalization of marijuana.

The basic problem is that legal product could be sold in Canada, but unless legal exporting to the U.S. were permitted, as it was during the early days of alcohol prohibition, illegal exporters would continue to sell to the U.S. However, since there is currently a flood of illegally produced marijuana washing into the U.S., a serious issue is whether legalization and regulation in Canada might do more to reduce the flow of marijuana.

Stephen Easton is a SFU professor of economics and senior scholar at the Fraser Institute. His study is available at www.fraserinstitute.

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