Legalization: Economic boost or hype?
An economic boost or a stronger dollar, what is the onset of the ‘Green rush’ going to do for Canada? October 17th marked a historic date for Canadians, not only politically, but also economically. The legalization of cannabis for recreational use makes Canada only the second country to do so, after Uruguay. The cannabis industry, however, does not play by exactly the same rules as other industries. Its competition with the underground cannabis economy and its limitations in the export market are factors that sets this industry apart; it is fundamentally different. Nonetheless, it is a symbolic political victory for Prime Minister Justin Trudeau and the Liberal Party of Canada, but what does this mean for Canada’s economy?
The creation of the cannabis industry opens up a whole new legal market, which, of course, can be taxed. Valued at around $23 billion, increased tax revenue is not even the only direct economic benefit of this new industry. Things such as mounting retail sales, job creation, security and, especially, tourism all contribute to the positive economic effect legalization can have in the future. In fact, law firms cannot hire lawyers fast enough to keep up with demand for cannabis specialization. This is all so much so that, according to Toronto-Dominion Bank, Canada’s real gross domestic product will gain an $8 billion boost from the newly legalized cannabis industry. In addition to this, Statistics Canada started including both legitimate and underground cannabis activity in its economic calculations after October 17th. This will, according to TD Bank, have a direct effect on measured growth rates in the final quarter of 2018 and first quarter 2019. Such an increase, however, should be taken with a grain of salt, TD warns. In fact, this increase in growth is partly an accounting illusion. Cannabis related activities already existed and were contributing to the Canadian economy, they just had not been formally measured yet. This is the issue of the underground economy.
The Canadian underground cannabis economy has been in place long before October 17th 2018. More significantly, according to Statistics Canada, the illegal production and consumption of recreational cannabis was worth about $3.3 billion in 2016. What legalization achieved, was that it took some of this underground economy and raised it to the surface level. The issue the legal cannabis industry and the Canadian government is facing right now is one of demand and supply. Neither federal nor provincial governments can cope with the demand for legal cannabis. Currently, the government can only supply 30-60% of demand in the first year, shown in a report by the C.D. Howe institute. In fact, the Société québécoise du cannabis (SQDC) is closing its doors 3 days a week in order to cope with the supply shortages. The key to success, therefore, is to match quantity of cannabis supplied with quantity demanded, and to move demand away from the underground to the legal market. More specifically, it is essential to capture the demand of daily cannabis users. According to a 2016 report from the Office of the Parliamentary Budget Officer, daily users constitute only 14% of total consumers but consume around 66% of all cannabis sold. This begs the question then, how will the government succeed in capturing this demand to root out the underground market?
“There are 3 things that need to be done” to achieve this, says Garo Keresteci, marketing expert in Toronto and founder of Fuse. The first order of business is to secure competitive prices. Indeed, in order to draw demand away from the underground cannabis economy, the government needs to be able to beat the prices of the illicit market. Secondly, cannabis and its derivatives need to be easy to acquire. As it goes in the real-estate business, it is location, location, location. Retailers either need to be conveniently located or online retail needs to be able to deliver cannabis orders quickly; demand needs to be satisfied as soon as possible. Thirdly, the person or point of sale must be knowledgeable about the product. Most users, and especially heavy users, wish to be told about the cannabis they’re buying. Whether it is a recommendation or the specification of its chemical components, knowledge about the cannabis in question is crucial in capturing demand from the underground market. In the illicit market the supply process often meets most of these criteria. Mostly through dealers, a selection of cannabis can be delivered to a consumer’s house at a cheap price and with a recommendation. The legal market’s goal is, thus, to meet these criteria and surpass the illicit market’s within them. The government needs to beat the underground market at their own game, which they are good at, to fully capture the majority of cannabis demand. Only once this is achieved, the Canadian government and the economy can start fully reaping the rewards of this lucrative new industry.
Does this mean that after these 3 criteria are met it is all smooth sailing for the Canadian economy? While the cannabis industry can boost the economy in several ways, one also has to look at the other side of the coin. In fact, Forbes reported earlier this year that alcohol sales dropped 15% in American states with medical cannabis laws and that binge drinking dropped in states with recreational cannabis. From this, we can conclude that alcohol and cannabis are strong substitutes. Therefore, in the long-run, the legalization of cannabis can prompt a significant substitution effect. In other words, if the legal industry can absorb the illicit market and sell cannabis cheaply, quickly and with a degree of passed on knowledge, Canadian consumers might very well give up other intoxicating goods such as alcohol in favour of the flower, edibles and other derivatives. This, in turn, could result in the shrinking of these ‘older’ markets and, thus, have a negative impact on the Canadian economy. While it is impossible to guess exactly which effect will outweigh the other by how much, at this moment, it is fair to say the overall impact of legalization will still be positive to the Canadian economy. But is the national production and sales of cannabis sufficient to significantly boost the Canadian economy? And what about the Canadian dollar? The answers to these questions lie in the export market.
The new cannabis industry is fundamentally different from other industries, not just because of the competing illicit market, but especially because of its limitations in the international market. Since cannabis is still illegal in many international markets, it is impossible for Canada to export all of its derivatives as smoothly as it does with other industries. Because of this international inflexibility, the Canadian dollar should not appreciate relative to other currencies. The only real solution to this issue is time. Canada is now a world leader in the cannabis industry, and many developed nations will take it as a case study on the effects of legalization. It will take time for other countries to adopt a laxer stance on cannabis and its derivatives. So what can Canada do right now on the international platform? While, THC (Tetrahydrocannabinol) is mostly outlawed due to its intoxicating effects, CBD (Cannabidiol) is a different story altogether. Because of the lack of an intoxicating effect and due to its medical qualities, CBD presents a real pharmaceutical business opportunity for Canada in the international market. CBD can be worked into prescription drugs to provide pain relief for multiple sclerosis patients and can equally treat some cases of epilepsy. The international opportunity for CBD has been demonstrated in the United States by the FDA’s decision to approve Epidiolex - a drug that combats two rare forms of childhood epilepsy. If Canada focuses on the medicinal qualities of CBD in cannabis, it can become a pharmaceutical leader for this derivative and equally export technology to grow and cultivate high-CBD cannabis strains. Once Canada is able to achieve dominance in this specific market, and is able to export the medicinal properties of cannabis, the Canadian dollar might appreciate. This is, of course, pure speculation. It is clear to see that if Canada wishes to grow its cannabis export market, it currently has to focus on the pharmaceutical facets of its newly legalized industry.
Ultimately, the strongest short-term effect of the legal cannabis industry will be corporate. Just like the Gold rush of the 19th century, the ‘Green rush’ will reward the companies that find a certain niche within that market. The large long-term effects will take time and effort. Being fundamentally different from any other industry, it will take time for business leaders to adapt and learn the ropes of this new market. The competing underground economy and its international trade inflexibility makes this potential economic booster a long-term project. However, if the legal cannabis market can absorb the illicit market, by respecting the three criteria (availability, affordability and quality of service), and if Canada starts building an export market around the pharmaceutical opportunity of CBD, the Canadian economy could not only see a material economic boost, but potentially also a slight appreciation of the dollar. All in all, the cannabis industry presents Canada with a chance to become a world leader in a fast growing industry; of which the economic reward depends on Canada’s strategic opportunism within it.