Living Economics

Strange Bedfellows!
S. Ramamurthy
Government regulation might protect the tobacco industry from ruinous lawsuits.

Most industries would prefer to get the government off their backs, but sometimes it pays for them to get the government on their back as a protective shield.

Philip Morris, the country's largest tobacco company with a market share of more than 50%, is now lobbying members of the Congress to give the FDA regulatory authority over its tobacco products. For Philip Morris, this is a shrewd marketing strategy. Getting an FDA approval over its "safer" and "less hazardous" cigarettes seems to be the best way to get more people to start smoking and discouraging current people from quitting. Moreover, as bigger companies are better able to bear the burdens of regulation, any additional restriction would tend to freeze brand shares, benefiting the market leader.

But what's the government to do? On the one hand, while government regulation might mean a tacit approval of the tobacco industry, it could also shore up the financial health of the industry that generates a dependable source of tax revenues. Last year, Philip Morris accounted for $4.3 billion in federal taxes alone, and an even larger amount in taxes to the state governments. Further, a settlement between major cigarette manufacturers and 46 state governments in November 1998, entitles the states to collectively recover $246 billion over 25 years towards the cost of treating sick smokers.

With such a large sum of money at stake, no wonder state governments are doing all they could to ensure the financial health of the industry. In fact, Florida's attorney general has tried his best to fend off individual smokers from suing the industry to bankruptcy. But even without a bankruptcy, the states have begun to worry that they are squeezing the golden goose too hard. Price hikes have already stopped enough people in Texas from smoking to reduce its share in the settlement money by $90 million. To put it bluntly, the states simply can't afford to have people quitting smoking!

But government protection may not be enough to fend off opportunistic marketers. Many small tobacco start-up companies that are not part of the legal settlement are selling cigarettes at or below pre-settlement prices. Some cut-rate smokes sell for as low as $1 a pack, compared to $3 (and up) charged by the more dominant brands. These discount cigarettes have grabbed nearly 4% of the retail market in the US, up from just 1% in 1997. As these smaller companies gain market share, the settlement allows the major manufacturers to pay less. Further, one major manufacturer, Brown & Williamson Tobacco Corp., is making cigarettes that are sold under the label of one of the upstarts. If these markets continue to shift, the losses to the states could easily run into billions of dollars.

References:
  • Fairclough, G. "Tobacco Deal Has Unintended effect: New Discount Smokes." The Wall Street Journal, 5/1/2001.
  • Flanigan, J. "Philip Morris' Tactic: FDA Regulation." Los Angeles Times, 4/22/2001.
  • Jenkins, Holman "Look Who's Falling in Love With Tort Reform." The Wall Street Journal, 4/26/2000.
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