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More indications of the battle between free enterprise and regulation in Washington’s recreational marijuana market

A reader pointed me toward this report from CNBC: Washington has more pot than it can smoke.

Feels like I hit a jackpot in watching the battle between free enterprise and crushing regulation. Follow along with me as I highlight the story with editorial comments on capitalism and regulation.

You may want to get a fresh cup of coffee. This will be along article.

Why so much discussion?

Why am I spending so much time writing about medical marijuana? As a general matter I don’t give a hoot about this marketplace because I have zero interest in this or any other market for intoxicants.

The medical marijuana markets are a natural experiment in a small, separately visible, newly created market and the impact regulation has on the development of that sort-of-legal industry.

Opportunities to see whether regulations strangle an industry are so limited everywhere else in the economy because other markets are large, well-developed, complex, intertwined, and have already adjusted to regulation.

With medical marijuana we can watch a brand-new industry adjust to brand-new regulations.

Back to the article.

There is apparently a huge excess supply of recreational marijuana over demand in Washington State.

In part this is due to dramatic differences in the overall geography of Washington compared to Colorado. In part it is due to regulation.

In Washington, recreational marijuana may be grown in open fields as well as hothouses. In Colorado only hothouse production is allowed.

That means in Washington you can grow outside in fields as well as in greenhouses. Regulations means there initially will be more raised in Washington than Colorado because there are more options for growers.

Apparently the weather last year was ideal for raising marijuana in Washington, thus growers had a bumper crop.

Alternative sources have huge price advantage

Each stage of the medical marijuana industry in Washington is taxed separately. Growers, processors, and retailers pay separate taxes which, according to the article, can add up to 75% of the retail price.

The article says there is a lot of illegal marijuana flowing into the state from Oregon and California. In addition the legal so-called medical marijuana is not taxed in the state.

That means there are two major competitors to retail outlets of recreational marijuana: a flood of illegal marijuana and dramatically lower-priced medicinal marijuana. Each competition source has a major price advantage.

Regulation is forcing the prices of recreational marijuana far above medicinal or state-illegal alternatives. Consumers pay a large premium to buy in a stored licensed for recreational sales. That is an intentional regulatory impact.

The article says the state handed out far more grower licenses than retail licenses, meaning that supply of recreational marijuana is guaranteed to outstrip immediate demand. Growers have lots of competitors. That distortion is due to regulatory design.

The article says a large number of additional retail stores will be opening in the next several months, which may balance supply and demand. Regulation has slowed that balancing compared to what the market would have already done on its own.

Other factors

Tourism cuts against the Washington market as well when compared to Colorado. Lots of people travel to Colorado for vacation which is driving a large portion of the recreational market, based on other articles I have read.

Not only is there not as much travel for skiing, but Colorado doesn’t have as many other nearby states with medical stores. Thus Colorado is more appealing and closer to a lot of potential customers.

If free enterprise was allowed to be in play, that glut of product in Washington would be put on a truck and delivered to Colorado retailers. Can’t happen. The protections against state and local prosecution only apply in the state that has legalized product. Cross the Washington border and there is no protection from non-federal prosecution. Thus none of the glut can be moved to Colorado.

Free enterprise is in play in another area:  A quoted grower is trying to develop a branded product line. His creativity, which is what you see in capitalism, includes developing a set of trading cards that describe the various strains of marijuana he sells. Weird as that may be, and as offensive as some people may find the idea of trading cards that promote recreational marijuana, you have to admire the creativity and entrepreneurial spirit.

The market glut has dropped prices severely and this particular grower has filed for bankruptcy protection.

Supply and demand

Another quoted grower mentions that retailers were complaining back in July because they were being charged extremely high prices. The reason? There were only a few producers on the market back then.

The quote says retailers were attributing this to “gouging”.

Looks quite different to me. If there are only a few sellers and lots of buyers then there will be a high price.

Sounds to me like supply and demand in the free market was working exactly the way it is supposed to be. Following along with me as we look at three data points for the supply and demand curves:

  • Very few sellers plus lots of buyers equals very high price. Unidentified retailers called this “gouging”.
  • More sellers come on the market means the price will drop. Retailers likely considered this acceptable.
  • Bumper crop for all open-air growers means a huge increase in supply and the price will drop dramatically.  I doubt any retailers are throwing around the word unfair.

That looks like a shifting supply curve intersecting a relatively stable demand curve.

When the price was high last summer, retailers thought it was gouging. When the price is extremely low now, growers are the ones who consider the price unfair because many are going bankrupt.

Welcome to capitalism, guys. (Every person quoted in the article is a guy, by the way.)

Bankruptcy clears the playing field

In a free market when a market player goes belly up,  bankruptcy is the next step.  Then, someone else with a lower cost structure will step in. Another market participant will buy up the resources of the bankrupt firm for pennies on the dollar and be able to operate more efficiently.

That is exactly what’s happening.

A named grower in California wants to move into the Washington market.  He is looking to buy existing facilities for a fraction of what they were worth a year ago. That’s the way capitalism works. If you’re a consumer, you will be paying even lower prices.

Article closes with the comment that there is 45,000 pounds of product on the market that nobody wants. As I mentioned earlier, if free enterprise was in play, the product would already be on the shelves somewhere in Colorado.

The grower who filed bankruptcy says some other growers are giving the product away just to move the product and build loyalty with retailers and customers. If you think prices will recover, that’s a pretty good strategy. It also reduces your storage costs and security needs.

Conclusion

An overall theme I see in the article is that the market is starting to adjust to the temporary oversupply of product and the growing but unknown increase in demand. The adjustment would be much further along except for a heavy load of regulations and restrictions. State requirements are postponing the balancing of supply and demand at both the wholesale and retail level. Prices and supply on the market are distorted as a result.

Looks to me like we are already seeing the disruptive effect of regulation. I didn’t think it would be this visible this quickly.

What do you think?

Reasonably polite comments welcome.

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2 thoughts on “More indications of the battle between free enterprise and regulation in Washington’s recreational marijuana market

  1. Jim,
    Here is another part of the regulations that is strangling a portion of the industry – growers.
    By Colorado not allowing open-field growing, they are really limiting the amount of people who can start in the growing business, which will keep the prices of pot higher.
    Having to enter the growing business by spending huge amounts of upfront money to build hot houses, grow lights, electric bills, etc. will make it hard for many to get started, either because they don’t have the funds, or because they are intimidated by putting out the upfront costs and/or the process of building the infrastructure.
    Just being able to basically dig holes and plant (open-field growing) would bring many into growing and bring down the prices.

    • Hi Mark:

      There is more to the open field method, such as tagging every plant and tracing it to the final retail product, but the point stands. The reduction in growers, with higher operating costs, will both reduce the number of suppliers and increase their breakeven point. On the other hand, allowing open field as in Washington has produced a glut at least for the first season.

      Jim

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