11/07/2012

Legalized Marijuana for Recreational Use          

An interesting result from the recent elections is that, of the 18 states that have legalized the use of pot for certain medical conditions, Washington and Colorado have legalized it for recreational use. If marijuana grown in these states is 'exported' to surrounding states, increasing supply, this could result in the Mexican drug cartel's loss of monopoly, resulting in a serious reduction of sales and revenues.

IMCO (The Mexican Institute for Competitiveness in Mexico City) estimates that, of the $2 billion in current sales, $1.4 billion would be lost to the new competition. This loss would severely hamper their ability to conduct business, (i.e., wages for drug mules, bribes to police and government officials, purchase of US-issue full-auto assault rifles, disposal of the bodies, etc, ad nauseum) so much so that they may not be able  to stay in business due to the high fixed and variable costs incurred under bloated monopolistic pricing where one cartel or gang controls the drug traffic in any given area.

An article in The Economist  estimates that variable costs of 'homegrown bud' will be $4,000 per kilo, with THC levels 4 times that of the Mexican variety. The price of this high quality product would be in effect, half of the Mexican price for equivalent amounts of the active ingredient, THC. With the loss of monopolistic pricing from a supply infusion of less expensive and higher quality goods, the demand curve shifts hard left and the price of dope falls to competitive pricing levels. According to IMCO, 70% of their market share would be lost. The drug cartels may not be able to react quickly enough to reduce long term variable costs to stay viable; officials and police would be sensitive to reductions in fees. It is unlikely that the drug lords would disappear because of the current high margins and piles of cash, but maybe in time their control, influence and strangle hold on Mexican border towns would be substantially reduced.

(It is not the intent of this post to condone or advocate the use of any illegal substances)

12 comments:

Dominick said...
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Dominick said...

I read a funny joke yesterday: "Colorado and Washington have legalized pot, buy stock in Doritos!"

Another interesting element to this debate would be how the supply of police officers and sheriff's deputies would be affected in surrounding states. If this legalization effort were to stand, exportation to other states would remain illegal. States such as Oregon, Idaho, Wyoming, Nebraska, Kansas, Oklahoma and Utah are pretty far removed from the Mexican border. Hypothetically, I wonder if increasing the presence (supply) of officers and deputies, especially in border towns, could be justified (demand) through increased fees (which could result from an increase in arrests). Conversely, would the U.S. Border Patrol and towns which are near the U.S./Mexico border realize a need for layoffs due to a potential decrease in traffic? The only caveat would be whether the criminal justice system in general collects enough fees from prosecuted offenders to actually affect the demand for policing services.

Dillin said...

I thought the commentary at the bottom of this article was interesting. Most people were worried about the Mexicans losing this revenue. People were also worried about how the U.S. government could tax home grown weed.

First of all, the Mexican cartels can still benefit from economies of scale. Even if you are allowed to grow your own marijuana, you can only grow a small amount. Marijuana farms can produce weed at a much lower cost. I am able to grow my own fruits and vegetables, but I don’t, because it is cheaper for me to buy it from a store.

That brings me to my next point. The U.S. government will have a hard time taxing home grown marijuana. Last time I checked, we are not taxed on growing corn in our backyard. If marijuana grows in popularity, inevitably people that do not want to grow their own will still want to smoke it. This will lead to companies producing it and selling through retail operations. This is where the government will get their tax revenues.

Clayton Parry said...

While, I agree that the legalization of marijuana could result in the loss of a monopoly for the drug cartels I do not think that is likely to happen any time soon. The drug cartels have been in business for many years, and that is what has brought them to the size of production they maintain. Having a new law in place will likely bring about many other regulations and restrictions. Like, how will it be taxed, controlled and distributed, just to name a potential few.
One of the thoughts I do have on the effect for drug cartels is if they will find a way to start growing their product in these states; thus reducing costs and interference from the law. With some states becoming pot friendly these states could also serve as major distribution centers for the cartels to work through. If this homegrown pot does become a serious threat to their business I wonder if they would escalate the violence in the US to defend their “turf.”
The article also mentioned cocaine. If the legalized marijuana does begin to capture some of the drug cartels market share will they begin to produce more or traffic more of other drugs? The cartels could offset their losses by offering substitute products such as cocaine, meth, etc.
The “exporting” of pot to other states seems like a risky business where the potential losses from criminal prosecution, if caught, would outweigh the benefits of the extra revenue. With the law allowing people to enjoy marijuana in state the risks would be less for people to travel to Colorado or Washington rather then get caught with legalized pot out of state. Cartels are willing to incur these cost, to them it is just the cost of doing business. Sadly, the loss of human life is also just calculated as a cost of business.

Trevor said...

Interesting post. This is certainly a loaded topic, as there is no doubt that the legal recreational use of marijuana in Washington and Colorado has many positive and negative implications for local, national and even international economies.

First, I think it is a bit wishful to hope that these changes will dramatically cripple the drug cartels in Mexico. Most cartels trade not only in drugs, but in weapons, humans and even animals. Likely these organizations have their hands in plenty of other shady business to float their books as they adjust to the new supply and demand impacts resultant from Washington and Colorado’s pot legalization. Such adjustments might include pushing more cartel drugs (marijuana, narcotics, etc.) into other already vulnerable areas before distribution across the country, or perhaps even intimidation and threat to new establishments in Washington and Colorado.

Dominick also starts to hint at an interesting economic impact from this change when he questions the increasing or decreasing supply of law enforcement and border officers. Should Colorado and Washington indeed see “exports” of their legal marijuana to surrounding states where said marijuana becomes illegal as foot is set across the border, will these states now find a greater demand for law enforcement to be fighting the illegal introduction of marijuana from both foreign and domestic sources?

Again, my opinion is that we won’t see a dramatic shift in cartel activity or power. Rather, these organizations will simply find other methods and ways to continue.

I am more interested in the various ways that this might impact other industries in our national economy. As a quick example, newspapers in California saw a significant increase in advertising revenue as legal medical marijuana dispensaries competed for consumers. What other industries will see such impacts? Perhaps like Dominick’s joke suggests we all ought to buy stock in Doritos and Funyuns.

Dave Tufte said...

madhatter 100/100
Dominick: 50/50
Dillin: 50/50
Clayton Parry: 50/50
Trevor: 50/50 (although I didn't check the spelling of Funyuns).

Get ready for a long comment ... marijuana always captures students' attention in class discussions. ;) This will be broken into two pieces.

First, a cute anecdote: This topic came up in my ECON 2020 (macro principles) class this week too - totally off-topic there, but that's what people wanted to discuss. Anyway, I realized while talking to them about prohibition / decriminalization / legalization that this had been a major topic of class discussion in the first month I was ever aloud to teach: a 1 hour a week small group breakout session that accompanied a 3 hour big room principles class. The thing is, that was 1982 (!!) and we're still talking about it in classes 30 years later.

Madhatter has one (big) problem with the analysis. I don't see any reason for demand to shift at all, much less to take a "hard left". The underlying reason for this would need to be something like people liking marijuana better than they do now, and I don't see that. There are two effects on supply. Legalization might shift supply to the right, and drive prices down. That's fine, but really isn't madhatter's point. So, moving on to the second one, madhatter argues that legalization would reduce monopoly power. This will reduce the ability to mark up price over marginal cost. Pushing mark-up towards zero will cause a movement along demand (to the right). My conclusion that prices will fall matches madhatter's; perhaps madhatter fell for the common issue in doing economics of starting from the obvious answer and trying to justify it, rather than starting from the beginning and working towards the answer.

Dominick's joke made me laugh. Did you?

In my house, the big joke this week was that we're going to get stopped at the Utah border when we come back from a family trip to Colorado on the 22nd.

I think Dominick has raised an interesting issue. But practically, I see an asymmetry in the response of governments to spending needs: pressure for increases makes spending rise, but pressure for decreases doesn't as consistently lead to spending drops. So, yes, I'd expect local enforcement budgets to go up, but I wouldn't expect national ones to go down. That's cynical, and doesn't have a lot to do with economics, but that's how it works in my mind.

Dave Tufte said...

Dillin's point is fine. I think what he's saying is that the short-run and long-run effects will be different. Fair enough.

That calls for another bit of navel-gazing. This is a blog ... I hope you're amused. Back in the 70's, When I was too young to be interested, one of my older brother's friends dumped a bunch of seeds in my dad's tomato garden. Without knowing it, he fertilized and watered the heck out of them. I remember the problems he had with these big weeds, but neither my dad or me knew what they were until year's later when my brother told us.

Clayton Parry's riff on Dillin's short vs. long distinction has a precedent. This sounds a lot like the story of Las Vegas: started by organized crime moving their previously illegal activities into new legal venues, and in the long-run getting co-opted by more efficient corporate structures (there's still organized crime in Las Vegas, but no one has any illusions that the corporate bottom line is what drives decisions there now).

I absolutely think Clayton is right about the cartels moving into other products more heavily. The way to think about them is as consumer products conglomerates — like Proctor and Gamble. Such enterprises have lots of product lines on which they make zero economic profits, but their main business is the handful that make positive economic profits. Take one away and they'll try to boost the other ones. I see that reducing the ability of an individual enterprise to mark-up though, because of the increased competition. So I wouldn't be surprised if there is a small effect that hurts the cartels' cocaine and/or meth business.

Trevor said...

Dr. Tufte, for your reference. I had to check it myself before I posted :)

(P.S. I do not want to count this as one of my required comments for this block)

Dave Tufte said...

Trevor: you're fine, I won't count that one.

FWIW: Your link made me look up Funyuns in Wikipedia. The first cultural reference listed there is apropos for this thread.

Jake said...
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Jake said...

Now that's hilarious, Dr. Tufte! As I was reading through this thread and reviewing the links posted within the comments, I don't think I would have ever noticed that.

This isn't one of my comments for a grade. It has nothing to do about economics, and plus, I have to write a post this round. However, I just wanted to say that what Professor Tufte pointed out is funny.

Dave Tufte said...

:)