Stricter US Tobacco Legislation May Have Additional Global Consequences

THE NEW YORK TIMES — On June 11th, the Senate approved The Family
Smoking Prevention and Tobacco Control Act, effectively tightening
legislative restraints on the already highly regulated tobacco
industry. (The House passed a similar bill). The bill allows the F.D.A.
to regulate nicotine and chemical content, ban flavorings, and further
restrict the marketing and advertising of tobacco products. However,
such strict regulation, which “stops (just) short of empowering the
F.D.A. to outlaw smoking or ban nicotine,” may create unintended
incentives for tobacco firms with potentially undesirable domestic and
global consequences.

The additional regulation raises compliance costs; which invariably
result in greater production costs, increased prices, higher
market-entry barriers, and decreased opportunity for product
differentiation—all of which point towards increased concentration and
reduced competition in US markets. Domestically, the regulation will
result in more favorable market conditions for established, large-cap
firms who—through enjoying larger customer bases, greater market power,
and lower average costs than smaller-cap firms—will remain relatively
unaffected and can engage in more monopolistic behavior.
Re-equilibration will lower quantity and raise price; producing happier
anti-smoking advocates, and perpetuating the ever-powerful industry giants.

Left to bear the brunt of regulation are smaller firms and (to a much
lesser extent) consumers. Supply and demand dictates that consumers
will decrease demand in response to higher prices. Specifically, the
article states that the officially estimated outcome “reduce(s) youth
smoking by 11 percent and adult smoking by 2 percent.” These estimates,
more than likely, are economically incomplete and exaggerating
benefits. For example, it is impossible to know whether the coefficient
of price elasticity of demand used in estimation accurately represents
the demand for tobacco’s highly inelastic nature. An underrepresented
inelasticity coefficient would overvalue quantity reductions and inflate
estimated social beneft.

Potential for further inaccuracy stems from the presumably performing
CBA pertaining only to US populations and markets. Tobacco, however, is
a tradable good—characterized (in part) by international trade and
opportunity for arbitrage of international regulation standards. It is
thus apparent that the US benefit-cost ratio—based on less than 5% of
the world’s population—offers a privatized view of social benefits;
and—by excluding the vast majority of market participants—an imprecise
assessment of total social benefits. It is entirely feasible for the
total (global) benefit to suffer should adversely affected US firms
take full advantage of differing production costs and market prices
created by regulatory disparities.

Historically, firms have behaved exactly as such. About 20 years, a
U.S. legislation tightening tobacco regulations provoked American firms
to invest heavily in foreign markets, particularly in developing
countries (which often have less or no regulation), to remain
profitable in the face of cost prohibiting regulations. Hong Kong,
which at the time did not have laws regulating firm behavior in tobacco
markets, proved especially appealing for market entry. Tobacco
advertising flooded Hong Kong, greatly increasing smoking rates and
incurring greater social costs on a much larger scale originally
intended. New legislation that further regulates an already highly
regulated industry will exacerbate issues of diminishing marginal
returns; accruing greater and greater costs that are more and more
unlikely to be offset by increasingly smaller social gains.

Authors:
Ka-Wa Chan
Brian McGuckin

Article:
http://www.nytimes.com/2009/06/12/business/12tobacco.html