Panel Paper: Legal Access to Cannabis Increases Competition for Generic Pharmaceutical Manufacturers

Friday, November 8, 2019
I.M Pei Tower: Majestic Level, Majestic Ballroom (Sheraton Denver Downtown)

*Names in bold indicate Presenter

Ziemowit Bednarek1, Jacqueline Doremus1 and Sarah Stith2, (1)California Polytechnic State University, (2)University of New Mexico

Despite its classification as a Schedule 1 drug with no medical value and high potential for abuse, popular opinion is growing to support access to cannabis. In 1995, a Gallup poll estimated that only 25% of Americans favored the idea of using cannabis for medical purposes. The same poll showed 60% support in 2016. The result is an enormous public health experiment, with states legalizing access through voter referenda. Since 1996, voter referenda legalized access to cannabis for medical or recreational use in 29 states.

Prior studies have shown that cannabis substitutes for conventional pharmaceutical drug use, which implies that legal access to cannabis increases competition in pharmaceutical markets. If conventional pharmaceutical manufacturers have market power, increased competition will decrease profits but increase consumer surplus, i.e., patient benefits.

We test whether legalization decreases pharmaceutical manufacturer profits and increases consumer surplus using two empirical analyses. First, we compare pharmaceutical manufacturer investor responses to legalization using matched controls to test whether investors expect legal access to cannabis to decrease profits. We show that as investors receive new information through the referenda, they update their beliefs regarding the expected profitability of conventional pharmaceutical manufacturers leading to a decrease in the stock value. Consistent with the assumption of market efficiency, this in turn impacts the stock valuation of pharmaceutical companies. We show that the negative market effect of the medical cannabis legislation is both statistically and economically significant and that negative effects are stronger for generic drug makers.

Next, we assess the change in drug maker margins for branded and generic drugs after medical and recreational access becomes effective using Medicaid data. We find strong evidence that legal access to cannabis increases competition for generic drugs: prices fall and quantities increase after access becomes effective. The effect is stronger for medical access. This result adds to the prior literature showing a decrease in drug use but did not distinguish between generic and branded drugs.

These results identify a new channel for positive externalities from legalizing access to cannabis. Beyond its own therapeutic effects, access to cannabis creates a positive externality by increasing competition in the generic drug market, decreasing costs and potentially increasing access to generic drugs.