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A cost benefit analysis of cannabis legalisation

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A new ISER study into the economic impact of legalising cannabis has been released this week.

The research by Professor Stephen Pudney, Dr Emilia Del Bono and Dr Mark Bryan analyses the cost benefits of legalisation.

The main conclusions of Licensing and regulation of the cannabis market in England and Wales: Towards a cost benefit analysis are as follows:-

1. The heated public debate on cannabis policy is much too limited in scope. This study has identified seventeen distinct sources of social cost or benefit that might contribute to the outcome of a comprehensive market reform and attempted to quantify thirteen of them. The relative importance of these sources depends critically on the form of regulation and the nature of market responses to reform. Consequently, any considered view on the question of reform needs to take account of a large number of factors and be contingent on a specific view about the detailed nature of the reform. Few of the most vocal participants in the debate on drug policy reform take a sufficiently broad perspective.

2. At present, there is so much uncertainty about some of the important issues involved in the introduction of a licensed and regulated cannabis market that a clear conclusion is not possible. In particular there is a lack of a good understanding of the demand behaviour which underlies the steady fall in cannabis prevalence over the last decade or so, and the degree to which the association between cannabis use and long-term adverse outcomes is truly causal. In the researchers’ view, all unambiguous claims for or against radical policy options should be treated with caution.

3. Psychopharmacological research suggests that harm from cannabis use is related to the chemical composition of the drug, so product regulation similar to that in the tobacco market would have some advantages. Several alternative forms of regulation could be used in a licensed market and policy designers need to bear in mind the different consequences each might have for the harmfulness of consumption. Relatively laisser faire reforms which encourage large numbers of small producers make it difficult to control product characteristics and may lead to higher levels of overall potency and in turn more harmful long-term outcomes.

4. Cost benefit evaluations should not assume that there are zero personal benefits from consumption: such an assumption would be unthinkable in any other application of cost benefit analysis. The researchers’ use of a net external benefit criterion is based on the view that the consumer necessarily perceives at least as great a personal benefit from consumption as there is personal cost and risk from consumption. It is a conservative approach, producing results biased in favour of the status quo under the assumption of competent well-informed decision-makers. However, we need a much better understanding of the vulnerable groups who may be making poor consumption decisions because of inadequate information or imperfectly developed decision-making capacity.

5. Given the lack of a convincing empirical model of market demand for high- and low-potency forms of cannabis and the uncertainty about the form that product regulation would take, there is a wide range of plausible market responses to reform. It is likely that consumption in overall volume terms will rise significantly as a consequence of the switch to legal status and the lower price that results. But it is possible that, for some forms of product regulation, average potency would fall, with aggregate consumption of the psychoactive ingredient THC rising much less than consumption of the good itself, and possibly even declining.

6. The direct impacts of reform in terms of potential changes in aggregate policing, criminal justice and drug treatment costs appear to be modest and largely insensitive to the nature of regulation and the market response to it. The study estimates an annual aggregate net benefit of roughly £200-300m from this source as a consequence of a move to a regulated market.

7. Another direct effect of reform will come through its impact on drug-related crime. One might expect crime related to cannabis consumption to increase if reform reduces price and increases demand, while crime related to cannabis supply would be reduced as illicit supply is driven out of the market. At the individual level, this study finds no statistically significant evidence of a causal link between cannabis use and acquisitive or violent crime, but a modest significant link with supply activity – suggesting an overall net saving on crime costs from reform. However, the large size of the cannabis market, the potentially high personal costs for the victims of violent crime, and the substantial statistical uncertainty around the estimates imply that, at the aggregate level, projected net social benefit of reform is highly uncertain. the researchers are confident of a substantial additional net benefit from reform through a reduction in drug-related crime if it is assumed that the demand response is low or moderate. However, if very large demand responses to market reform are envisaged, it is not possible to draw any definite conclusions about the cost-benefit balance for the impact on crime.

8. The indirect effects of policy reform include the social costs of long-term impacts on physical and mental health, the impact on labour market outcomes through the scarring effect of a criminal record, and the ‘gateway’ effect on the risk of involvement with harder drugs. For all of these, the researchers estimate the external costs and benefits to the rest of society, excluding the internal costs and benefits borne by the cannabis user. These indirect impacts of reform are hard to estimate with any confidence because of the difficulty of isolating the effect of unobserved confounding factors that produce spurious correlation between cannabis use and observed outcomes. The public debate about cannabis policy has focused heavily on mental health costs, but we find these to be modest, because of the relatively small number of individuals involved and the modest effect size suggested by the research literature. In total, the researchers expect net external costs of the impact on physical and mental health to range from zero for the low demand response scenario to around £85m in the case of a strong demand response to reform. Even in the worst case, these costs are modest in relation to projected savings on policing and criminal justice costs.

9. The estimated modest external net benefits from reform through the avoidance of scarring effects of criminal records in the labour market of roughly the same magnitude as the external cost to society of the impact on mental health.

10. Another greatly exaggerated focus of the public debate on cannabis policy is the “gateway effect” – the possible increase in risk of involvement in hard drugs caused by exposure to cannabis. The researchers find the evidence for a large gateway effect among cannabis consumers is weak, and there is an often-overlooked offsetting gateway on the supply side, drawing cannabis users into drug dealing. Licensing of supply might lead to a rise in demand and thus harm through the demand gateway, but it would also remove many people from illicit cannabis supply and thus reduce harm through the supply gateway. Estimates suggest that reform could generate a net external benefit in the range £20-80m under the most plausible assumption of a moderate demand increase. Only a large demand response would be likely to generate a net social cost.

11. Overall, taking account of all thirteen reform effects that researchers were able to estimate quantitatively, the total effect of reform is a net external benefit of around £280-460m if they anticipate a low demand response; a net benefit of £100-415m for the most plausible moderate demand response; and a projected net external cost of £430 in the case of a large demand response. This last estimate is very uncertain, with an indicative range of uncertainty from -£1.3bn to +£400m.

12. There are many other possible effects of reform which the researchers believe are not possible to quantify with any degree of confidence. Four of these may be particularly important: indirect effects of relative price changes on the consumption of other harmful substances including tobacco, alcohol and other illicit drugs; failures of decision making by certain vulnerable groups whose evaluations of their personal costs and benefits may be unreliable as a basis for welfare evaluation; the possible improvement in the credibility of health information achievable by separating health messages from legal penalties; and the possibility of “drug tourism” as a response to a unilateral UK policy initiative. Although this study cannot quantify these effects, it is likely that they will follow a similar pattern to the quantified effects: no substantial net social costs if demand response is low or moderate and a risk of large social costs only if the demand response is large. The degree of uncertainty, particularly in the last case, is again very high.

13. Tax revenues are a transfer of resources within society rather than a net benefit to society, but they are an important aspect of policy outcomes. This study estimates that tax revenue from licensed cannabis supply in England and Wales would fall somewhere in the range £0.4-0.9bn, which is far less than some of the assumptions that have appeared in the policy debate. The researchers expect tax revenue to be lower in the case of strong demand response to reform, because of the large residual illicit market for high-potency cannabis that could exist in that case. Overall, the contribution of cannabis licensing in England and Wales to reduction of the government deficit is expected to lie in the range £0.5- £1.25bn.

14. Uncertainty about the magnitude of certain impacts and the response of demand to market reform make it impossible to give an unambiguous ex ante evaluation of the net social benefit of reform. However, it seems clear that the risk of large net social costs is only significant if there is a large demand response to reform. This suggests that a good way to proceed in practice might be to introduce the reform together with a monitoring system to give early warning of any large demand response, particularly among the very young or other vulnerable groups. One of the clear lessons to be learned from policy experience over the last decade or so is that it is possible to reverse policy quickly if monitoring were to suggest a large expansion of demand. Policy monitoring should distinguish between consumption of low- and high-potency forms of cannabis, since the largest social costs are linked to the latter rather than the former.

Commenting on the findings Professor Stephen Pudney stressed the need for further research to provide authoritative evidence for policy makers, because of the lack of data available at present.

“This study has revealed the existence of large gaps in our knowledge and in the data resources that would be required to supply the missing evidence. Some of these gaps could be filled by carrying out quite straightforward research – for example, to improve estimates of policing and criminal justice unit costs. Some gaps may never be filled adequately, because of the extreme difficulty of estimating the true long-term causal effects of variations in drug use on outcomes. Two important areas of uncertainty where progress may be possible are drug-related crime and drug demand behaviour, but it would require greater sustained investments in data and research effort.”

Photo credit: wwarby