Legal Access to Cannabis Increases Competition for Generic Drugmakers

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. This 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.

Cannabis substitutes for pharmaceutical drug use among Medicare (Bradford and Bradford 2016) and Medicaid enrollees (Bradford and Bradford 2018). This implies that legal access to cannabis increases competition in pharmaceutical markets. If drugmakers have market power, increased competition will decrease profits but increase consumer surplus.

We test whether legalization decreases drugmaker profits and increases consumer surplus using two types of empirical analysis. First, we compare investor responses to voter referenda for drugmakers and matched controls to test whether investors expect legal access to cannabis to decrease drugmaker profits. We show that as investors receive new information, they update their beliefs about the probability of introducing the state-level legislation allowing for cannabis use. 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 drugmakers.

Next, we assess the change in drugmaker 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 drugmakers: prices fall and quantities increase after access becomes effective. The effect is stronger for medical access. This result contrasts with Bradford and Bradford (2016), who found a decrease in drug use but did not distinguish between generic and branded drugs.

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