The end of the war on drugs?

What's happened?

This month, two American states, Colorado and Washington, took the historic step of legalising the use and possession of marijuana. In Washington, a new law established a system of state-licensed cannabis growers, processors, and shops, where adults can buy up to an ounce of the drug. In Colorado, it became legal for adults to possess up to one ounce and to grow up to six plants.

The legalisation process isn't complete, as marijuana is still outlawed by US federal law. But it's a big shift from the total prohibition stance America has adopted since 1914. It's also a more radical policy than even the most progressive European states. The two states may soon find an unlikely ally in Uruguay, where politicians are also weighing up legalisation plans.

Is this the end of the war on drugs'?

Western nations have had a policy of prohibition, apart from medical use, for at least a century. In 1971, President Richard Nixon updated the strategy to launch the war on drugs'. This advocated robust military action against producers in supplier countries such as Latin America and Afghanistan. In consumer nations, police locked up those using or dealing drugs.

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The mantra held sway for much of the last 30 years, but in the last decade, criticism of the war on drugs has increased. Some claim it's futile as it doesn't cut drug use. Others say it does more harm than good. The 2011 Global Commission on Drug Policy, an international committee made up of former presidents and policymakers, concluded: "The global war on drugs has failed, with devastating consequences for individuals and societies around the world".

Prohibition, they said, pushes drug users into contact with criminals, making it harder to treat addicts and increasing their exposure to other forms of crime. Military action against drug producers and traffickers has made the host countries less stable.

In Mexico a war on drugs is responsible for almost 50,000 deaths in the last five years, almost as many as America suffered in Vietnam.

What about the cost?

The economic sense of drug prohibition is also debatable. Trying to catch producers, suppliers and consumers costs money, while leaving the industry to drug barons means the government misses out on potential revenues. A study by the libertarian Cato Institute in America found that legalising all drugs in America would save state and federal governments around $42bn a year.

Taxing the newly legalised industry at rates similar to those on alcohol and tobacco would raise another $46bn a year. The author, Harvard economist Jeffrey Miron, estimates that if just cannabis was legalised, then the fiscal benefit would still amount to $17.4bn.

Legalisation could also help the US trade deficit. In 2010, analyst group Stratfor estimated that American consumers spend about $40bn a year on Mexican drug imports. If the States legalised drugs fully, domestic producers could meet this demand and cut imports.

If, however, it only legalises consumption and not production, producing countries would enjoy an export boom. Politicians in Mexico have discussed plans to legalise marijuana trafficking and sell directly to US states where consumption is legal.

Does it work in practice?

It's hard to say; we are short of examples. Despite its fame as the drug centre of Europe, the Netherlands hasn't legalised drugs: since the 1970s the Dutch police have simply had a tolerance policy that allows people to possess up to five grammes, or grow up to five plants. So while the government saves money on policing casual users, it still hunts traffickers, and doesn't receive tax revenue from the sale of drugs.

Portugal is the only EU state officially to decriminalise drugs: using drugs is a civil rather than a criminal offence. Again, it doesn't reap any revenue: it simply frees up police time. But it's worth noting that in both countries drug use is below the European average.

What are the potential downsides?

The UN asserts in its 2012 World Drug Report that "the international drug control system seems to be acting as a brake on drug use, particularly among adults who are less willing to transgress laws by consuming drugs". If you believe prohibition cuts consumption, then a key argument against legalisation is health.

Even marijuana has several harmful side effects: it provokes psychotic episodes in some users and can lower the IQ permanently if smoked by adolescents for prolonged periods of time, according to a study in the US journal, Proceedings of the National Academy of Sciences. So those in favour of prohibition claim increased consumption could hit productivity.

Take Somalia and Yemen, says Colin Freeman in The Daily Telegraph. Drugs are a "mainstream national pastime" and it has "cramped the work ethic". "Yemen is very different to the UK", but it gives a "glimpse" of a society where drugs are accepted.

Profits in pot

While it remains to be seen how the Washington and Colorado decisions will be reconciled with federal laws, there is already a booming American market for medical marijuana. In the past few years increasing numbers of states now 18 allow cannabis to be prescribed for medical reasons, such as pain relief. The small, but fast-growing market, is estimated at $1.7bn.

For investors looking to play this (highly risky) story, says Marketwatch.com, there are several options. Medical Marijuana (US: MJNA) sells several edible cannabis solutions, such as marijuana-infused ice-cream. Another option is Medbox (US: MDBX), which makes cannabis vending machines. Here in Britain, GW Pharmaceuticals (LN: GWP) markets Sativex, the world's first marijuana-based medicine.