In Legal States Defeating The Marijuana Black Market Likely Will Be Through Economic Forces

By Darren Smith, Weekend Contributor

“I don’t think there’s a lack of supply in Washington State.”—Rick Garza, Director, Washington Liquor Control Board.

Marijuana LeafMarijuana Retailers in Washington ran out of their cash crop after three days of sales. A few were never provided a supply before their grand opening. The Liquor Control Board blames licensees for causing the delays but the first licensees were given their licenses via e-mail around 1:30 AM on the opening day. The board issued the first licenses for growers / producers after the optimal time to begin marijuana cultivation and even went so far as to restrict certain growers by reducing their capacity due to what the board described as “over supply issues.” Prices remain high. It seems the command economy will continue for a while and the black market in all likelihood remains largely untouched.

While supply and price issues are expected to lessen over time the current price of marijuana is greatly above the black market price of the state average of slightly over eight dollars per gram. Marijuana at retailer Altitude in Prosser, WA sold between twenty to thirty dollars per gram while Spokane Green Leaf is twenty five dollars. Most retailers are selling for an average of twenty five. The prices, if unchanged, could be unsustainably high in the long term if supply problems and wholesale cost of up to four thousand dollars per pound are not addressed favorably. The black market will most likely still be a player.

With any legal or black market, market forces are going to be important. With Washington’s approach heavy regulation and high taxation could lessen the chance of eliminating the black market as was proffered by Initiative 502.

The supply chain for the black market is well established and its customer base is accustomed to dealing with it. Several economic factors will play a role.


Washington’s marijuana tax is much higher than Colorado’s. It is taxed at twenty five percent at the producer/grower level, twenty five percent at the processor level, and twenty five percent at retail. This is an excise tax not an income tax where expenses could be factored in to reducing what the merchant pays. Of course, the black market does not pay taxes and could enjoy a greater than seventy percent cost advantage. Furthermore the tax is value added in that the retail tax is based upon markup plus wholesale cost which also includes the producers’ twenty five percent excise tax and the processor’s twenty five percent, compounding the taxation.

Regulatory Cost

black-market-grafThe operation of wholesaler, producer, transporter, processor, and retailer are heavily regulated. Often as has been seen in the pre-licensing stage to be frequently and suddenly changing which can burden merchants with extra costs and down time spent toward compliance. The regulations dictate nearly every aspect of the supply chain from security requirements, signage regulations, procedures, extensive paperwork down to the seed level, store layout that must be approved by the Liquor Control Board, employment restrictions, THC testing for all batches with narrow tolerances for concentration levels and even such granularities such as all employees must wear identification badges, dimensions of the letters on signage, location restrictions, and zoning restrictions at the local level

The punishments for simple violations can be draconian. A retailer can be subject to thousands of dollars in penalties for nearly every violation on a first offense including such violations as an employee who does not wear their nametag or if a grower having a malfunctioning security camera on a second offense could be forced to destroy twenty five percent of their crop. If a THC test is out of range the grower can be required to destroy the entire batch. If the enforcement is heavy this could foster growers to add additional markup due to the possibility of losing a percentage of any given crop due to regulation issues.

The Liquor Control Board has shown that it can increase costs to growers by regulating the production capacity. Taking productive capacity away causes simple supply and demand forces to unfold where the growers’ operation overhead can remain constant so markup will be higher to address the per pound price and to maintain a desired return on investment. The Board requiring a producer to store excess inventory amounts to what is referred to as “Carrying Cost” which is the cost of maintaining an inventory that sits idle and is not shipped. These costs can include storage fees and cost of preventing spoilage. The longer the carrying cost, the greater the expense. Since current trends in the market of conventional goods have become more “just in time” in nature, the marijuana supply chain possibly might not have such a benefit if production supply is overregulated.

The black market has almost no regulatory cost other than the effect of criminalization which has not been fully a deterrent. The producers and distributors have had years of experience factoring costs of a percentage of product seizures into end prices.

Moreover there is always the specter of a catastrophic action against the businesses by the federal government, putting individuals in jeopardy of lengthy prison terms and seizure of assets of the company. The current federal deference is entirely provided by a prioritization by the justice department as to its enforcement actions against legal businesses on the condition of heavy regulation by those states and the efforts to make the product unavailable to minors. A change of administration or policy on the federal level could prove a death blow to the legal industry. To avoid this, the states might increase the regulations and consequently the costs to the legal market in order to protect its tax revenue source.

The federal specter is also likely keeping very large corporations, having great capital resources from setting up shop in these states which would provide significant downward costs to consumers through production efficiencies and greatly increased productivity. Moreover low wholesale costs to the retailer will result in a lower total price paid by the consumer based upon the resulting lower taxes.

On the retailer side state law prohibits the sale of products or services that are not marijuana, marijuana products, or marijuana paraphernalia related. The business cannot sell other items that could be used to allow for marijuana products to be sold at lower cost than competitors. An example of this with conventional retailers would be Loss Leaders of other products to draw in customers to buy the more profitable main products. Plus, the restriction to only certain products makes the business as a whole more vulnerable to wholesale price swings if producers are low to chose from and their sole offering is one product line.

Low Supplier Availability to the Consumer

We have shown in recent articles that there is a growing trend among counties and municipalities to prevent legal marijuana entities from setting up shop in their jurisdiction. There are presently entire counties within Washington having prohibition, requiring consumers to travel for sometimes hours to obtain a legal product elsewhere. This is a great deterrent to engaging in legal trade and since demand continues to be present in these areas the black market remains the only source.

Also due to federal regulations interstate and international commerce is prohibited even between legal states, thereby reducing supply and outsourcing. The black market has multiple suppliers from differing countries and even a local option depending on market and growing conditions. Black market distributors may choose wider and more diverse sources thereby enjoying greater flexibility and cost control.

Costs of Production

The black market will have lower production costs due to constraints against the legal market.

104248208The most efficient locations for growing marijuana are located largely in Eastern Washington in open spaces having access to water. Sunlight is free, and often is water. Since the large illegal grows are often located outside on land unregulated by landlords or property ownership the cost to the producer for infrastructure is low. Moreover, the efficiency of outdoor grows is significantly greater than indoor which is required by statute. Indoor grows require high amounts of electricity due to lighting and HVAC. Plus, grows are constrained by the size of the building where the outside grows are elastic. Utility costs are higher in Western Washington as is cost of land and building space. While indoor operations are maintained by the black market, they can still be less costly due to less constraints as to location regulations and other factors previously mentioned.

The Black Market Is A More Liberal Free Market

One large constraint to the legal market is the possibility of single point of failure by the Liquor Control Board to all aspects of the marijuana economy. Three individuals, the Liquor Control Board Members themselves, have no marijuana experience have almost total regulatory authority over the industry. Poor decisions by these three individuals can have systemic and cascading negative effects on all stakeholders. The black market however has greater influence over conditions of supply and costs and can bypass nearly all specific regulatory constraints, other than the illegal nature of its business that has existed for decades to which the industry has become accustomed to. Moreover, if a link in the supply chain fails in the black market another can take it over readily. If on the other hand a legal retailer fails for whatever reason and is the only source of product within a geographic location the time and cost necessary for replacement is significantly greater.

Edible marijuana products offer an insight into free market constraints. In Washington the labeling of food products is slow. Every product label must be approved, similar to liquor labeling requirements. The effect this has is to bottleneck the process and restrict the industry to changing its products quickly to address consumer demands or take advantage of niches that quickly come forth. The constraints also apply to THC levels where the black market can supply product to what it gauges its customer base more quickly.

Inelastic Consumer Base

The number of individual consumers willing to regularly use marijuana might not rise as easily as with those who adopt other products. Some products were virtually unknown or unavailable to consumers have become common household goods, such as smart phones and televisions which are ubiquitous. The present marijuana consumer could remain at a fairly static percentage but individuals who previously did not smoke marijuana likely will not do so in great numbers. The pre-prohibition consumer is accustomed to trading with the black market. Over time newer generations of consumer could be more resistant to trading in the black market if socialized into the legal trade. It remains to be seen of course how many new users enter the marijuana market but one needs to factor in the downward trend of tobacco smokers as a possible analog to gauge overall marijuana use. If the potential consumer base is too low attracting large companies with high capital and competition that can effectively reduce prices might prove to be difficult. This would lend advantage to the black market.

Costs to the Consumer

In the end, what could be the ultimate factor in whether the black market or the legal market prevails is going to be price. With all the factors listed previously involved at the present stage the black market enjoys a great advantage over the legal market. The tipping point will come when the consumer has freely available product for a price that is satisfactory. The legal market can enjoy a higher price if the allure of the black market is lower such as the want to deal with a legal seller and not dealing with sometimes unsavory providers of the black market. But this discrepancy cannot be wide.

One way the black market might address this would be to flood the market with cheap marijuana. Since the black market is not constrained by price controls, tariffs or anti-dumping laws, it is free to do so. An advantage they have would be that the distributors and cartels have vast cash reserves to endure selling marijuana at a loss to crush the competition with the legal market. A wide availability of cheap, illegal marijuana can be put fledgling stakeholders, having greater costs and constraints, out of business.


At this stage in the legalization of marijuana the overall success of defeating the black market is going to be largely economic in nature. If the state and federal governments are not responsive to the needs of the legal market we can expect to see the entrenched black market remain the greater supplier. As a result, the war on drugs could be a war of attrition between the market stakeholders on both sides of the law.

By Darren Smith


KGW News
V. Vizu, Photo Credit
Law Enforcement Sources

The views expressed in this posting are the author’s alone and not those of the blog, the host, or other weekend bloggers. As an open forum, weekend bloggers post independently without pre-approval or review. Content and any displays or art are solely their decision and responsibility.

25 thoughts on “In Legal States Defeating The Marijuana Black Market Likely Will Be Through Economic Forces”

  1. So what? The free markets will sort it out provided that the feds don’t try to negate states rights. There’s not even been enough time to honestly speculate on this.

  2. U.S.: Marijuana PTSD Researcher Abruptly Fired From University of Arizona

    A prominent marijuana researcher who only months ago had received rare federal approval to study the effects of cannabis on patients with post traumatic stress disorder has been abruptly fired by the University of Arizona. Professor Suzanne A. Sisley’s dismissal puts her research at risk, and has caused dismay among medical marijuana advocates, reports Evan Halper at The Los Angeles Times. Dr. Sisley, a clinical assistant professor of psychiatry, said she was fired after her research created unwanted attention for the university from legislative Republicans who control its funding.

  3. Darren,
    Well written!
    The way the state has set the stage it gives the underground market a preferred choice to the consumer. This leaves room for Federal intervention, perhaps?

  4. Anything can kill you, Samantha. We all assess risks and make PERSONAL choices on risk/reward. I GUARUNTEE you do the same. Everyone does, some just kid themselves that they don’t. Risk/reward is what makes life worth living. I’m a gambler, mostly craps but blackjack too. I understand odds and probability in those games and life.

  5. That stuff will kill ya’! I was a smoker until 1989. Quit cold turkey. I smoked for 17 years, never tried to quit. I stopped, and never took another puff of tobacco. I am a willful b@stard. That should be no surprise to you.

  6. Samantha, comments like you just made are one reason why I like you. I won’t tell you what I had for dinner. That brings out your dark side.

  7. Quite an exhaustive, detailed study.

    Actually, I’d like to see the black market deep-six these bureaucrats who are doing nothing more than sticking it to consumers. At least the black market guys earn their way. The bureaucrats sit on their a$$es and grow hemorrhoids, have no capital investment, no labor expense, no overhead, no nothing, yet they take a 50% cut, the hogs. Who really needs them?

  8. Incredibly well done Darren.

    From what you say, there seems to be strong “resistance” to the will of the people who voted to legalize marijuana.

    The answer to the problems you describe is in the shadows, as is the black market.

    Thanks for the research.

    I will read this again a time or two.

    State officials who are contemplating this venture of legalization should too.

    (Clue: don’t use a “good ole boy” liquor board system to oversee marijuana dynamics.)

  9. It is interesting that the illegal sources may be cheaper than the illegal sources. I think the State will eventually see the light.

  10. It is strange to me that an entire new industry and infrastructure must be created in every new state that legalizes medical use, much less recreational use.

    There has existed for many many decades a system of legal distribution of prescription drugs involving a patient, a doctor, and a pharmacist. Why can this not simply be reused? Why must we continue to make medical cannabis a special class of medicine with seperate rules and special distribution system??
    Medicine is not taxable in many states, while marijuana as medicine is usually highly taxed, seperatly regulated — all trying to generate income for the state in whatever way, shape, or form their legislatures can invent. As if that is the sole job of the legislature – to increase the income to the state in anyway they can invent or imagine (or, more accurately, in any way they can get away with).

    They perceive this as a “good thing” without seeming to realize that it is all simple parasitism on the body politic. And no organism, no matter how resilient, can long survive if it devotes more energy to maintaining its parasites (even ones that may claim to be symbiotic) than it does to maintaining its own functions. In that case it is lose:lose, with the failure
    Of both the host and subsequently the parasite.
    We continue to grow ever closer to that point with increasing amounts and varieties of taxation, fees, charges, etc.
    We are bleeding our own economy out… And it simply is not sustainable in the long term. This article simply illustrates yet another “creative” taxation scheme, where the legislature perverts the intent of the voters by taking something approved by initiative and taxing it and regulating it to the point where it is no longer capable of meeting what the voters expected or intended with their vote.

  11. Darren, two great posts. Colorado, although they are far from perfect, does not have an adversarial relationship between the govt. and the cannabis industry. Certainly the fact that Colorado had a well run medical cannabis system in place for a decade or so helped w/ their transition to legality. But, I think the very liberal, big govt. state of Washington is giving us just another of millions of examples of the stupidity of govt. The more govt., the more stupidity. I think the stupidity actually grows exponentially as the govt. gets enormous.

  12. It might be that most of the consumers already have a seller and prefer to deal with him or her on the dark side of life. A friend from high school perhaps– who never had another job and needs the income. Someone who loans them money in times of need. A friend in deed.

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