Understanding the consequences of drug legalisation versus prohibition is important for policy. Most recently this subject has gained much political attention not only globally, but specifically in the Netherlands. This study will provide a contribution to the legalisation debate based on a microeconomic analysis of the effects of illegal markets. The research question is how to design a coherent soft drugs policy framework that maximizes social welfare within the Netherlands that precludes most historical, sociological and political debates. In particular, attention is restricted to ‘soft drugs’ better known as cannabis derived products like hashish and marijuana.

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The focus is on the Dutch case, since traditionally the Netherlands has been a forerunner in terms of drug-related policies, as exemplified by coffeeshops. In a country with a population of 16 million about 1 million indicate to use soft drugs on a regular basis. Almost all consumers buy soft drugs in coffeeshops.3 Interestingly, there is no stereotypical Dutch soft drug consumer, since users are representative of the Dutch population, for example in terms of education levels. Prices vary between 150-250 euro per ounce, or equivalently, 5 to 9 euro per gram and are below the European average.

Another reason why the Dutch case is outstanding is because there are no other countries that have coffeeshops. Rather surprisingly given the ease of access in the Netherlands, soft drug consumption with its 6 percent on regular basis is below European average. Within Europe, more than 50 million persons have experience with soft drug consumption, implying about 15-20 percent of the population between 16 and 65 years. Recent data from the United States finds that 25 million people report soft drug usage in 2007, which is relatively higher than in Europe, although enforcement is much higher in America given nearly 1 million arrests for possession of marijuana in 2007.

In the Netherlands cannabis derivatives are currently illegal, yet since the 1970s soft drugs have become available to consumers in coffeeshops where they can buy cannabis products in small amounts without fear of prosecution. Officially, possession and production for personal use are both misdemeanours, but these laws are not enforced in Dutch society; a situation known as gedogen - to tolerate or gedoogbeleid - tolerance policy. As a consequence, neither possession of up to five grams of cannabis nor growing up to five plants is prosecuted.

Conclusion

The propositions presented above provide us with a common understanding of the economic forces within the drugs market. This paper focused on a tentative interpretation of the Dutch drug policy. Key assumptions driving any policy recommendation from an economic perspective are the price elasticity of demand and externalities involved with consumption. A key point many economists have made is that the market structure causes most of the negative externalities, and not necessarily drug consumption; this is obvious in the Netherlands where consumers generally do not fear prosecution.

Two propositions derived from the core model are that i) prohibition hurts consumers and leaves rents to producers, ii) enforcement not only increases the price of drugs but under inelastic demand, enforcement pumps disproportionally more resources into the drug market because consumers and producers alter their behaviour in illegal goods markets. A corollary shows that higher punishment causes an adverse selection process, where only the ‘toughest’ producers remain while earning even more profits and causing greater negative externalities such as increased criminal activity. In other words, prohibition of drugs shifts the supply curve upward.

Enforcement and punishment are effectively a tax on suppliers, which raises their production costs and allows them to profit. Prohibition shifts the demand curve downward and lowers consumption, although it was discussed why this deterrent effect is arguably small. Taking these factors into account together implies higher drug prices under prohibition, which is a disadvantage for consumers.53 Under prohibition the producer surplus results in negative externalities including criminal activity, health problems, distorted education and moral stigmas.

In legalized markets, producers lose the possibility of profits and prices drop to a competitive level.54 In order to balance the possible rise in consumption, government can apply a Pigouvian tax system to raise prices, lower consumption and obtain income transferred from consumption; yet, only up to the point where externalities from consumption can be paid back for. Hence, under legalisation the government earns some income and saves in costs typically put towards enforcement, while compared to prohibition, consumers are better off and producers cannot profit.

In order to estimate the impact of legalisation in the Netherlands a simple mathematical and conceptual model was demonstrated. As there is so much uncertainty about possible policy implications, it is proposed first to levy a tax on drugs that does not extensively affect the current price level. Based on preliminary back-of-the-envelope calibrations one can expect a yearly ‘net’ tax gain of up to 850 million euro in the Netherlands. It is not a concern that legalisation of soft drugs may cause a rapid rise in consumption, because the good is already widely available and prices are kept constant. Regulation and taxation can mitigate consumption and negative externalities though price effects and tax income. The core pillars of Dutch drug policy should remain and they would be strengthened under legalisation.