Robin Goldstein and Daniel Sumner are economists at UC Davis and co-authors of Can Legal Weed Win? The Blunt Realities of Cannabis Economics. In this podcast, Motley Fool producer Ricky Mulvey talks with them about:
- How federal legalization could help or hurt weed investors.
- Economic lessons from pot laws in Oklahoma and California.
- One surprising way that weed is like bacon.
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This video was recorded on June 4, 2022.
Robin Goldstein: But what's highly elastic is the substitution between legal and illegal, and that's a big theme in our book. People don't have a lot of compelling reasons in many cases to buy the legal stuff when the illegal stuff is available at half the price.
Chris Hill: I'm Chris Hill, and that was Robin Goldstein, an economist at the University of California, Davis, and co-author of the upcoming book entitled, Can Legal Weed Win?. Today we're going to talk about some basic economic concepts through the lens of weed. It's been said that pot makes movies and food more interesting, so why not demand curves? Come on. If you've been listening to the show for a while, you already know, this is not your grandpa's financial show. Ricky Mulvey talked with Goldstein and his co-author Daniel Sumner about their new book and why it's been so difficult for investors to find opportunities in this emerging space.
Ricky Mulvey: Hello, Fools. We're using weed as a gateway drug to get you hooked on economics today. Joining me now are Robin Goldstein and Daniel Sumner. They're co-authors of the book Can Legal Weed Win? and economists at the University of California, Davis. Welcome, Robin and Daniel.
Robin Goldstein: Thanks, Ricky.
Daniel Sumner: Morning.
Ricky Mulvey: Starting off, why are the economics of weed interesting to you? Daniel, I know you've particularly had an interest in this for four decades trying to survey weed growers in California.
Daniel Sumner: Yeah, well, I do the economics of food, wine, Robin likes to call all ingestibles, and it was just natural to think about cannabis in that context. You're right, back when I was a baby economist, one of the first things I thought about doing an empirical study on was the economics of weed farming or cannabis farming back when it was seriously illegal everywhere. We put out a survey, my buddy and I, and we knew we were in trouble when even his brother wouldn't return our survey. At that point, we decided to be theorists and give up trying to get data on weed. But four decades later, I jumped back into it in a big way.
Ricky Mulvey: Robin, how about you?
Robin Goldstein: Weed is really interesting as a topic in economics because of this struggle between legal and illegal, that you don't have the equivalent of it in almost any other market. You've had a market that's been illegal for decades, for most of the century, and then you suddenly have the introduction of a legal market. People have been getting their weed illegally. They've been getting good stuff from people they know. They know where to get it, they know how to get it. Then all of a sudden you launched this big legal market and set up a bunch of new regulations and taxes and the state set up a whole new system for people to get legal. The question is, what motivates consumers to move from the illegal market to the legal market, and what enables businesses to succeed in the legal market? That's super interesting. It's really hard as a topic in economics because of the lack of historical data, you don't have prices and quantities the way you do for most other industries and so we have to get our data in some interesting and challenging ways. But I think it's a topic that's very fun and also illuminating in terms of public policy issues.
Daniel Sumner: Let me add one quick thing to that, and that is this is being played over and over again. The country of Canada has very elaborate and interesting regulations, the state of Massachusetts, Oklahoma going its own route in an interesting way. We have lots of samples of different governments legalizing, if you will, in different ways. Economists love to study economic regulations, and this is a great example of that.
Ricky Mulvey: Yeah, I'm trying to think there's really no products that you could use as a parallel in terms of essentially legal and illegal outside of maybe truffles would be there. But you guys talked about some of the ties between weed and other agricultural products. You mentioned that weed can also be like bacon in terms of price elasticity. How is that?
Daniel Sumner: Let me just say, for some people the price of bacon goes up, they don't change very much, they got to have their bacon. The same's true for weed, of course, the difference is you don't have for many consumers a real close substitute for bacon. I may have a piece of ham in the morning, and I may eat bacon with eggs or I may be a vegan. But for legal weed, you have, as Robin says this, what seems to be a pretty close substitute for lots of potential buyers. That makes it a challenging industry to be in. If you say, gee, I think I will raise my price because customers want this product. If they have a very good alternative, maybe Coke and Pepsi for many years as an example, lots of consumers are pretty indifferent between which one. Then there's the low-price store brand as well in that case. There are parallels with food items and beverages and the like, but you're right, there's no perfect model for us.
Ricky Mulvey: In your research for Can Legal Weed Win?, what did you learn about price elasticity especially, in the legal market, you're seeing states like, let's say, Oklahoma and Colorado on the lower-end, where maybe there's a little bit less regulation, and then states like Illinois where it's taxed all the way and you see the legal market very much running up against the illegal market?
Daniel Sumner: The real challenge is having data to really estimate that.
Robin Goldstein: It's really hard to have historical data on elasticity. But when we look at the whole market, legal plus illegal, all weed, then we say, that's pretty inelastic because if the price of weed goes up or down a little bit and people who smoke regularly want to get their weed their way, and so we think it's pretty elastic. But what's highly elastic is the substitution between legal and illegal, and that's a big theme in our book. People don't have a lot of compelling reasons in many cases, to buy the legal stuff when the illegal stuff is available at half the price, or even three-quarters of the price. If the illegal stuff, you take it out of the package, you smoke it, you get the same feeling, no one can just inspect a flower or a smoke a joint and say, oh, from the taste or smell of that, or the effects on me, I know whether that's legal or illegal. Fundamentally, the products are very similar, the illegal and the legal stuff. That's why we think that it's a pretty elastic substitution between those two goods.
Daniel Sumner: That in the market as a whole, obviously there are individual consumers. Some people will say, gee, I don't want to mess with an illegal market. I'm going to buy it down at the mall or from somebody that's got a state license and is certified in various ways, or maybe they say, gee, I trust the government to inspect this product, so I think it's safer. The product itself is safer. These are perceptions that people have. The same thing happens in other markets. Of course, there are people that say, I'm only going to buy milk if it's organic. There's a huge price difference there.
Organic milk is double the cost of conventional milk. But some people are convinced that's the route they're going to go, and prices obviously haven't kept them out of the organic market for milk. For the market as a whole, there's substitution there. We know that looking at lots and lots of products, and Robin's point that the physical product most people can't tell the difference, matters to a lot of consumers, and a lot of people are at the low end. Parallel with wine again, most of the wine sold isn't $200 a bottle Napa Valley cabernet sauvignon, most of the wines sold come from the broad acre agriculture where wine grapes are grown as a commodity. The same thing happens with weed.
Ricky Mulvey: You guys do mention in the book there is two photos of, this is legal weed and this is illegal weed, try to spot the difference. But there are some advantages to a legal market which you have regular operating hours, you might have more choices for a consumer, a lot of people don't want to buy things illegally, and I think that is also a huge consumer driver of preference when you open up the market. You guys also talk about another tricky part for investors, is finding the total addressable market for weed, and there's a lot of sky-high expectations from a lot of Wall Street banks. Why do you disagree with that and then have essentially the total addressable weed market close to what it is now, even with full federal legalization possibly on the horizon?
Daniel Sumner: Let me jump in that very quickly and then I'll turn it over to Rob, and the biggest point is to get volume to expand for legal weed, prices need to be more competitive, so prices come down. Secondly, there's lots of room for innovation that lowers cost of production on the legal weed side, just the innovations we have routinely for corn or kale, better farming techniques and improved lighting and all those things, technical changes that will bring prices down, that may well allow quantities to expand, but you bring down price, your quantity expands, revenue may stay the same, so when we say the total size of the industry measured, say by gross sales revenue, we see there are pressures to keep that not that much bigger than it is now. We emphasize the illegal weed as competition, but legal is still a quarter of the whole market in some places up to half of the whole market in other locations.
Robin Goldstein: As more states legalize, if you're looking at the whole U.S. market, more states legalize, of course, you grow the legal market by volume. As Dan said in the long run if prices come down, the total addressable market size is price times quantity, and so if you have decreasing prices and increasing quantities, those two effects counteract each other, and so the total market size as measured by total retail sales may or may not go up a lot. There are a lot of people out there who say, oh, you legalize weed and the amount of total weed consumed just goes way up. There's always people out there who just start smoking weed suddenly when it's legal and who've never smoked before. The data doesn't really seem to support that theory, and when you look at historical data going back in the Netherlands and other places around the world, you don't see legalization tending to cause a huge increase, maybe there's a little modest increase in the amount of weed total consumed, but we don't think that's a big effect, and so that's another misconception we think that's being used to drive some overly high estimates of the total market size in the future.
Ricky Mulvey: I've heard a lot of legalization proponents give the picture of, hey, why wouldn't you want legal pot? You can just tax it so much, and then people will enjoy that and you guys push back against that in your book, can you describe why?
Daniel Sumner: It's really a combination of taxes and regulations and not just the taxes, so in a lot of states, people have also said, oh, this is a new legal business. Here's every regulation we have ever imagined, we'd like to put on anything, we'll put all of them on weed, we want it to be perfectly safe, perfectly healthy, absolutely pure as it's being grown, and we're going to regulate when the stores are open and when they're closed, and everything else you can name and every one of those regulations is costly, so we like to say wonderful regulations, but they're not free and you need to take that into account, and then you start paying taxes on top of that.
California's governor announced a few days ago that he's going to try to eliminate the cultivation tax at least temporarily, we'll see if it happens, but here as in other places, it's taxed all the way up and down the supply chain, both at the state level and at the local level. The worst thing in the world for investors, I think would be federal legalization that added a whole new level of regulations and taxes on top of all that we've got now, and in that sense, federal legalization may be a disadvantage for the industry, sadly, just because it would be handled in a way that makes it that much harder for people to have the industry be a success.
Ricky Mulvey: What are some of the lessons from California's long history of legalization? You guys spend some time on Prop 64 and a lot of unintended consequences there, particularly with public consumption and that sort of thing. As you looked at some of those regulations, what did you learn?
Daniel Sumner: Let me jump in and say they're just two quick things there. One is in some ways, by making it legal, you made it illegal, and what I mean by that is, California had a very long history of medical cannabis medicinal or medical cannabis that was very lightly regulated and had very few rules to be legal, the consumer had to have a use card, they got that from a doctor. You could get it in 15 minutes online. Some people did, and there were retail stores called dispensaries, but the supply chain was unregulated and untaxed, and that meant people who are on the farming side of the processing side, the manufacturing side, we're doing things really without any regulations or taxes, and then when you legalized it for adult use, they came in with a whole range of things that people had to comply with, including getting a license, which many companies, large and small in the medical weed business found it impossible to do, not because the regulations were too hard, but for example, you had to make arrangements locally.
Hire your lawyers, rent your space, do all that then wait two years to get a license, and that was just a financial demand that people in the weed business couldn't do, so they thought they were legal before and they became illegal, and that was really rough on a lot of businesses there. The currently operating system has streamlined some of that, but it's still the case. Let me give you Robin's favorite regulation to point to. I've been told, I don't know, I go to bed early, but I've been told people smoke weed after 10 o'clock at night, and some people want to find the product after 10 o'clock at night, but the state law says any legal weed business closes at 10 o'clock at the latest, so what do you do? You are having a party, if you wanted to get a six pack of beer you'd go down the store and buy a six pack of beer, but if you want weed, the illegal market is the only thing available to you, and you ask, why would you want to drive people to the illegal market in the middle of the night?
Daniel Sumner: It's hard to picture why you'd have a regulation to want to do that. But it's all very well intended, but doesn't seem to capture reality well as it should.
Robin Goldstein: I was just going to add that when you have these regulations, you were talking about reliable opening hours. It's ironic, having these reliable, predictable opening hours that ends up in the case of the 10:00 p.m. curfew, shifting market share away from legal and toward illegal. I was just going to add that in the old system before all these regulations and taxes went into effect in 2018, you had just the medical market. It was limited to in-state consumers and it was limited to people who had a California ID, 18 and over and had a doctor's recommendation. The doctor's recommendation was really easy to come by, and so that wasn't that much of a limiting thing. It was essentially a very open and free market and you had low prices and a lot of competition for quality.
There were other things that went into effect after the more heavily regulated market. For example, consumers could go into a store before. With the old medical system, they could go into a store and smell and inspect the buds from a big jar. It's still in its infancy, this consumer awareness or understanding of what the product is and how to evaluate quality. But one of the big ways is you smell it. You pick it up, you hold it, you smell it, you look at the bud. You can always do that. They take a jar and you could look at the products and that's how you could decide between brands or between different strains. Now with the packaging regulations, you can't do that. It's all pre-packaged and it's often an opaque packaging. Sometimes they give you a little sample in a glass jar, but you can't smell it and you can't hold it and look at it. That's again another pressure that might make people want to stay in the illegal market because the illegal dealer is going to allow them to look at stuff and inspect it.
Ricky Mulvey: At the very least, it becomes much more difficult to sell when you don't have that tactile experience. On the flip side of California, you guys highlight Oklahoma. What are some of the economic lessons you guys found from Oklahoma, which has a very low priced weed, but as of now just a medical-only market?
Robin Goldstein: Oklahoma is a really interesting case that we talk about in the book, in Can Legal Weed Win?. One of the reasons it's so interesting is because it's medical-only as you say. But the density of dispensaries, of retailers, is much higher than anywhere else in the country. Oklahoma has more dispensaries or more retail shops where you can buy legal weed than California does, with the population one-tenth the size. They are just on every street corner. It's a competitive market. Some people will fail.
Maybe in some cases, there are too many stores and there's fierce competition, but it's good for consumers. Overall, the industry there is really robust and growing fast in spite of being medical-only. We think one of the main reasons for that is they just made it really easy to get a license. You apply for a license, it's like getting a hunting or fishing license. You send in the paperwork, and you get back the license and you have the state's go-ahead to open the store. The story we like to tell is that in Oklahoma, the amount of time that elapsed between the passing of the ballot question, legalizing medical weed, and the first stores opening was about nine hours. The stores opened the next morning after the ballot question passed. In Vermont, the ballot question passed and four years later they still don't have a single store open.
Ricky Mulvey: You guys write, quote, "Outside investors have already lost enormous amounts of money on legal weed, and we expect that unless the situation changes, many will continue to do so." What situational factors are you talking about there?
Robin Goldstein: Regulations and taxes coming back down to Earth in terms of making viable businesses more possible. It varies dramatically by state. In Colorado and Washington, you do see a legal weed market that's more competitive with illegal because the prices are much lower. On the other hand, when the prices are much lower, you don't make as much money with [laughs] illegal weed business. Once there's interstate trade, which is something that will probably come with federal legalization, you will see these opportunities for larger scale for companies that can really be national scale. Instead of opening many businesses in 20 different states, like the multi-state operators are doing now, you will have the ability to really have more centralized facilities and really efficient production. There will be some winners in that game for sure, but who knows where they're going to be? Maybe they're going to be in Wyoming or Oklahoma, or maybe within a national trade, maybe Saskatchewan is going to become a big player or Mexico.
The problem is that for states where it's really expensive right now to produce because of local regulations and also just higher priced places that are for economic fundamental reasons like high electricity costs or high labor costs, water, just the input costs are high, those places are going to have a hard time competing, just like they have a hard time competing. Massachusetts isn't very competitive in the avocado market, [laughs] and we don't expect that it's going to be that easy for Massachusetts companies because of climate and other factors, it's not that cheap to produce weed there. It's going to be hard for them, too, to compete in exports. There's going to be some concentration of production in places that are cheap and favorable and with favorable climate conditions coming to dominate the market. I think that's what investors need to think about really long and hard.
Ricky Mulvey: Robin, you've closely studied how marketing affects perceptions, especially in the case of high-priced wine. Is there a big difference in how consumers consume or perceive high-end weed? Are there parallels with the flower, the oils, vapes, edibles?
Robin Goldstein: Yeah. The way I got into economics originally long time ago was because of blind wine tastings. I was interested in why people couldn't tell the difference between $100 wine and a $5 wine in a blind tasting. Why do people want to spend so much more on wine when you pour out the liquid from the bottle, or you cover up the label and people can't tell the difference or don't prefer the expensive product? You're seeing that in weed in spades. I think even more than with the wine or beer because the consumer understanding of this product is just so rudimentary and its infancy is just something that's been illegal. You get weed from some dude on the street and [laughs] you're not really like analyzing the quality of it very well. You're seeing the emergence in legal market of a lot of very high-end brands. There's a perception, there's a common belief that, for example, the highest potency weed is the highest quality and therefore the most expensive. The really fancy expensive stuff is 30%-32% THC.
The cheaper stuff is 20%, 25% THC. That's one of the hallmarks of expensive fancy weed at the moment. Interestingly, there's actually very little scientific evidence that the potency as measured by THC content is actually that well correlated with either how high it gets you or how high quality the effects are. That may be a red herring in terms of measuring quality. People don't evaluate the quality of the wine based on what alcohol percentage it is. The other factor that you see is these designer strains, fashionable strains of weed. For example, right now, purple strains are very popular and are commanding higher prices in the market. I see that as a fashion trend. As with wine, these things come and go and ebb and flow. You have, this year it's a purple weed, next year it's going to be orange weed, who knows. It's just chaos. [laughs] I think that it's important for consumers to look past the hype on these supposed quality markers and just try things and figure out for themselves what they like and don't like. It may have very little to do with the price.
Ricky Mulvey: Robin Goldstein, Dan Sumner, authors of Can Legal Weed Win?. Thank you so much for joining us on Motley Fool Money.
Daniel Sumner: Thank you.
Robin Goldstein: Thanks for having us, Ricky.
Chris Hill: As always, people on the program may have an interest in the stocks they talk about. The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening, we'll see you tomorrow.
