How to get licensing of the legal marijuana market wrong

This article from Politico caught my attention last month:

What’s happening to [owner of The Reefinery in Los Angeles, Greg] Meguerian is a window into one widespread side effect of marijuana legalization in the U.S.: In many cases it has fueled, rather than eliminated, the black market. In Los Angeles, unlicensed businesses greatly outnumber legal ones; in Oregon, a glut of low-priced legal cannabis has pushed illegal growers to export their goods across borders into other states where it’s still illegal, leaving law enforcement overwhelmed.

Legal marijuana and illegal marijuana are substitutes. That should not be a surprised to anyone. They are not quite perfect substitutes (goods that are, in the eyes of consumers, identical), because illegal marijuana does come with social or moral costs such as the stigma of buying an illegal good, or the risk of being fined for making an illegal purchase. However, they are close substitutes, and so if you make one of them relatively more expensive, some (many?) consumers will switch to purchasing the others:

“Cannabis consumers are rational economic actors,” Hudak, the Brookings... expert, said. “They’re probably going to pick the cheaper option. In a lot of states, that would mean black market cannabis.”

No surprises there. One of the major costs for legal cannabis businesses is the cost associated with complying with licensing and other regulations. And that creates a problem:

High startup costs, licensing fees, and taxes make it hard for cannabis businesses to compete with unlicensed dispensaries that get equal billing on Weedmaps, the Yelp of cannabis. Los Angeles, for instance, is estimated to have more than 1,000 dispensaries, according to some advocates, but only 200 of them are licensed. This means the vast majority are illegal businesses.

If you increase the costs of doing business for the legal cannabis businesses, they will have to raise prices. Higher prices shift some consumers to the illegal cannabis businesses, and therefore make the illegal businesses more profitable. That encourages more illegal cannabis businesses to set up. If you're going to make a product legal, why on earth would you set it up in such a way that encourages the illegal trade in that product? But, that appears to be what is happening.

Part of the problem is the mix of state and federal laws in the US, where individual states have legalised, but marijuana remains illegal at the federal level. States respond to this by creating byzantine licensing regimes, and that raises costs for the legal businesses. To make matters worse, because banks can't legally deal with the marijuana businesses in case they are prosecuted for breaking federal laws, this adds an additional layer of cost to the marijuana businesses. So, how to solve the problem? The article notes:

[California Bureau of Cannabis Control spokesman Alex] Traverso’s solution is much like the approach favored by advocates in Massachusetts and Oregon: Make the market legal at both the state and the national levels...

Traverso, of California Cannabis Controls, says federal access to banking would lower startup costs and provide a financial buffer for new small businesses, encouraging more to switch to the legal market. 

At least in New Zealand we don't have separate federal and state law-making bodies that could create conflicting laws. However, we can only hope that if marijuana is legalised following the upcoming referendum, we will create a licensing regime that is sensible.

[HT: Marginal Revolution]