I have a few other topics I am in the middle of essays about, but I thought I would write a quick comment on this one and save Snowdon the trouble of having to be the one to always point out Anna Gilmore’s junk science.
Gilmore decides to fancy herself an economist in her latest article (Tobacco Control 2010, “The case for OFSMOKE: how tobacco price regulation is needed to promote the health of markets, government revenue and the public” – don’t worry about the title, it does not really have much to do with the article). Actually, her second author is apparently at a business or public policy school, but if he is actually an economist, more the pity that this is such junk. The article deals with the concept of “market failure”, economics jargon for factors that interfere with the invisible hand causing the free market to provide optimal allocation of goods, labor, etc. The most familiar example is probably “negative externalities”, where someone who is not a party to a transaction or decision (and thus cannot demand compensation or otherwise influence what is happening) suffers because of it, anything from pollution to traffic to increased public expenditures on healthcare. In that case, more of the activity takes place than is optimal from the perspective of economic efficiency (which roughly means maximizing how well off everyone is). The market failure that they use as their excuse for this article is “market power”. Basically, market power exists when a seller (or a buyer, but let’s just stick with the one case) controls so much of the market that it can increase its profits by doing something other than selling at the competitive fair market price.
Generally this refers to being able to raise prices and increase profit. A grocery store cannot decide “hey, we would make a lot more money if we sold Coke for twice the price; we would sell a bit less, but make a lot more profit”. What would happen is that they would sell almost none (and perhaps lose other business too) because it is easy for consumers to find a fair price elsewhere. A movie theater, on the other hand, can sell Coke at many times the competitive price because they have the ultimate form of power over the market: they are a monopoly seller of Coke for everyone in the theater. Sure, they might sell twice as much if they offered it at the grocery store price, but they are making five (ten? maybe twenty?) times as much per unit sold, and so they come out ahead. Because they have that market power, they can increase their profits by selling fewer units for more money, unlike the grocery store in the competitive market that would sell almost nothing at the higher price.
Backing up a step to the more familiar market failure, Gilmore et al. have a throwaway line about externalities existing in the “tobacco” market (alluding to second-hand smoke and the possible increase in medical costs that someone else pays for), though what they do not admit is that taxes on cigarettes pay for considerably more than the external cost to society, and taxes on smokeless tobacco are basically pure revenue since the externalities are trivial, so the market failure is actually in the other direction. That is, the taxes raise the prices well above what would be efficient to eliminate the market failure. Put another way, if we really believed that tobacco taxes were just a way to make up for negative externalities (which if not corrected will lead to an inefficiently high level of smoking), as is often claimed, then the rates have been set so that there is too little smoking. Really! That is not to say that I think there is too little smoking. But if Gilmore et al. are going to play the game of pretending to care about market failures, they are stuck with the implications of it, and so apparently they think there is too little smoking. This becomes even more apparent when we further examine the implications of producers having market power, which they claim bothers them.
A bit of background in basic economics is needed here, so bear with me for a couple of paragraphs. How can a company with market power increase its profit? By selling less, but at a higher profit per unit. The case of the movie theater is a bit misleading because basically they set the price and sell whatever quantity people buy. A better way to think of it in most cases is that the producer constrains the supply, which means that people are willing to pay more for the last unit because there is what might be called a shortage. But either way you think of it, this should be obvious: You cannot sell as much of something if you decide to push the price up to Y as you could at the competitive “market clearing” price X (Y>X). Whether you can better get your head around that by thinking “if they raise the price, they will sell less” or “if they want the price to be higher, they need to supply less” does not really matter – whichever works for you. The basic point is that if a seller has market power and so can reduce supply or raise the price then they can make more profit (at the expense of consumers, who are not able to buy as much as cheaply as they could).
So what does this mean? When a company (say the electricity or cable television/internet company) has a monopoly (in that case a “natural monopoly” because it makes no sense for another company to duplicate their infrastructure by stringing cables), if we do not have strong government controls to keep the price down, the company will jack up the price to an inefficient (from the view of an economist) or unfair (in the typical consumer view) level. For the case of cigarettes, it means that because there are relatively few cigarette makers supplying most jurisdictions (especially at the high-quality end of the market) and there are not price controls, the suppliers can make a bit more money by restricting supply a bit. And while they cannot do so as much as the perfect monopoly that controls all the Coke in the theater or cables in a town, they inevitably do so to some extent. So what Gilmore et al. are complaining about is a market failure that causes a *reduction* in supply.
I can see why Gilmore and friends are so incensed about that – their sense of worth is justified by the popularity of cigarettes, and those evil cigarette companies are reducing the popularity (sales/supply) of the product just to make more money.
To be less glib (but arguably just as damning), when you read the article it becomes clear that what they are really bothered by are the industry profits per se, not market failure or even the consumption of cigarettes. It is not so much that they worry for humanity as they just hate particular companies. I guess that should have been obvious. They try to dress it up a bit with allusions to economic policy, but that is really just an attempt to dress up personal pique. (Note also that since the Western cigarette companies are publicly traded and widely held, this is basically just an attempt to confiscate the share value held by thousands or perhaps millions of random investors. If the idea is to attack capitalism, though, there are much better targets.)
They call their proposal (explained below) “radical”, but if they really cared about reducing smoking rather than their pique about shareholder profits, the serious radical proposal would be to figure out how to make the companies profit more by not selling cigarettes.
So what do they propose? They propose capping the price that producers can charge (i.e., what the manufactures can charge when they sell cigarettes to distributors/merchants) but imposing huge taxes that raise the retail price well above this to reduce demand (and pull in big money for the government who implements the plan at the expense of smokers). They wax about how price caps are enforced on public utilities, conveniently ignoring the fact that the reason this is done is not to intentionally hurt the utilities’ shareholders but to help consumers buy more. I.e., the goal is to make sure that prices are kept low so that consumers can enjoy more electricity or cable television at a reasonable price. In other words, the analogy is “cigarette companies are charging too much and that is hurting consumers who would like to smoke more, so we should impost price caps.” What they are proposing does not actually do anything to correct the market failure, and so has absolutely nothing to do with the justification they try to give. Either they do not understand that point or want to mislead their readers about what the science really says (those familiar with Gilmore’s previous writing may have a bit of a conundrum trying to pick between those).
On top of all that, if they understood enough economics to have any business writing this article, they would know that this is effectively equivalent to what is already done. What they propose is somewhat different, with much more micro-management, but the effect is basically the same as high taxes: A wedge is driven between what the producer collects and what the consumer pays. This raises the price (straightaway lowering demand) while reducing the revenue of the producer. Their plan differs only because *perhaps* they can reduce the profitability of the manufacturers more than just taxing the product does, but that is only if they get the details just right. If they get the micromanagement wrong then either (a) they effectively eliminate legal manufacture (but not the black market), something that governments could do directly if they really thought it was proper, but do not or (b) the policy is exactly equivalent to the taxes we have already. Perhaps the regulators could thread the needle and reduce rents without making it impossible to stay in business, but I seriously doubt it; the amount of effort that goes into setting the right prices for public utilities is huge, and manufacturing cigarettes is a rather more complicated market. To avoid the risk of (a) they will have to tend toward (b).
(I have to include the aside that the market is so much more complicated than electricity and such, which is mostly about just price, and so quality would probably be affected by this regulation. One thing that would likely happen would be to reduce the availability of premium products in favor of lower-end products, since the former would be more expensive to make but would probably face the same price ceiling. This would inconvenience high-end consumers who would be forced to smoke something they liked less or turn to the black market. This might be another bit of a hidden agenda, but again there are easier ways to lower product quality than coming up with some incredibly complicated regulatory scheme, and pretending that such an act is an implication of economic theory is particularly dishonest.)
The most important point is that even if some perfect version of Gilmore’s proposal were pulled off by the bureaucrats, it would do nothing on the consumer side that existing excise taxes do not already do. It would change nothing for public health, in other words. All it would do is take money from the shareholders of cigarette companies and transfer it to the government, and then only if it worked right. This could be done much more easily and honestly by simply imposing an extra corporate tax on cigarette companies or just confiscating some fraction of all publicly held shares; such action, along with the sales taxes, would be exactly the same as the Gilmore proposal, but would be much easier to implement.
So this is their “radical” idea? Putting a new label on basically what is already being done, perhaps with a bit of nationalization of the companies, and making the absurd claim that this has something to do with the economic theory of market failures? The most charitable interpretation is that this is just an attempt to use junk science as an excuse for a preferred policy, to transfer corporate profits to the government (something that can be done any number of ways that would work better if that is what government decides to do). Well, I suppose given Gilmore’s demonstrated abuse of epidemiology there was no reason to expect anything else.
Want a real radical idea, backed by actual economic theory and evidence, one that should be embraced by anyone who cares about the health effects of smoking? How about this: Alter taxes and other regulations such that consumers can buy low-risk nicotine products (of whatever sort) for about 20% less than cigarettes and such that suppliers (who can include any company that is good at selling high-quality-controlled products to consumers) can make more money selling those products and so have the incentive to encourage smokers to switch. (For the economists in the audience, the latter refers only to the short run period of disequilibrium, of course, since excess profits are not possible in the competitive long run.) Unlike the barrage of loony, coercive, and damaging (to the principles of good government and science) proposals that show up with junk science window dressing, I would contend that this would radically reduce the public health burden of nicotine consumption, and it would do so while respecting consumer choice, not making people hate the government, and not undermining the scientific integrity of epidemiology and public health (and now economics).
Update: Chris Snowdon has posted at his Velvet Glove Iron Fist blog some further analysis of this nonsense. He notes some historical examples of supposed anti-smoking activists complaining about manufacturers raising prices and further addresses what this says about their real motives. Also, the title for his post gets the highest possible praise (i.e., I said “damn, I wish I had thought of that”): “You can’t rip people off, that’s our job!”