10/17/2018 13:29 EDT | Updated 10/17/2018 13:31 EDT

Legal Weed May Not Be Able To Compete With The Black Market

Letting municipalities ban cannabis stores may be pragmatic politically, but that lets black markets continue unabated.

Today's launch of legal recreational cannabis in Canada brings many challenges. Retailers are now worrying about possible product shortages or web site glitches. Governments are still debating how to handle amnesties, impaired driving and workplace safety.

But legalization day also marks the start of several interesting competitions. Some resemble those in various industries, while others are unique to cannabis.

The most important competition from a public policy perspective is between legal cannabis and black markets. Squeezing-out illegal suppliers is a key legalization goal.

(Stephen MacGillivray/The Canadian Press via AP)
A Cannabis NB retail store in Fredericton, New Brunswick, on Oct. 16, 2018.

The black market's head start

As I've noted before, it'll be tough to lure customers away from established illegal vendors. For one thing, cannabis-infused foods and drinks aren't yet legal. Black markets will monopolize those products for another year.

Dried cannabis and oils are legal now, but may experience shortages. But those should disappear next year as more growers become operational.

Places to legally shop are also scarce in most provinces. Quebec only has 12 stores open, and Ontario won't have any brick-and-mortar stores until spring. By contrast, Alberta has 100 stores opening this month. As store counts grow, legal cannabis will grab more market share.

Pricing also handicaps legal vendors. They must pay fees and taxes while competing with street prices around $7.20 per gram.

Provinces with more stores per capital will dampen their black markets best.

However, legal cannabis might eventually undercut illegal weed. Mass production is already reducing per-gram growing costs below $0.75, and is heading for $0.20. Moving production to countries with lower wages and warmer climates could drop that to $0.05.

Promotional marketing could also give legal cannabis an advantage. But federal law restricts advertising to "informational" purposes; no cartoon characters or happy puppies. That makes it harder to build brand reputations.

The pre-existing "grey-market" dispensaries further complicate the legal-illegal competition. Will most close or go legit? If not, they'll provide another challenge for legal retailers.

The least bad policy?

Whose policy will work best? More precisely, which ones will come closest to achieving governments' varied and competing societal objectives?

Provinces with more stores per capital will dampen their black markets best. Alberta will likely lead there, given the large number of private-sector stores expected. New Brunswick's public-sector retail network also looks good relative to its population.

By contrast, Quebec has just 12 government-run stores initially for 8.4 million residents. It's put tight limits on consumption. And its new premier wants the minimum age raised to 21. It's hard to see that strategy discouraging illicit dealers.

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Other government decisions will also be tested. Letting municipalities ban cannabis stores may be pragmatic politically, but that lets black markets continue unabated.

Similarly, Newfoundland's desire for a local cannabis supply is understandable. But offering a $40 million tax break to get it will look expensive if cannabis surpluses eventually materialize as expected.

So, these next few weeks will be challenging, interesting and constantly changing, to say the least.

This article, by Michael J. Armstrong, Associate professor of operations research at the Goodman School of Business, Brock University, is republished from The Conversation under a Creative Commons license.

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