Addiction as a market failure: using rational addiction results to justify tobacco regulation

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Abstract

Tobacco regulation efforts have been criticized by some academic economists for failing to provide adequate welfare-analytic justification. This paper attempts to address these criticisms. Unlike previous research that has discussed second-hand smoke and health care financing externalities, this paper develops the logic for identifying the much larger market failures attributable to the failure of smokers to fully internalize the costs of their addictive behavior. The focus is on teen addiction as a form of “intrapersonal” externality and observed adult consumption behavior consistent with partial myopia. The importance of peer effects, in the consideration of welfare impacts, is also emphasized.

Introduction

Most governments of developed nations, including those of the United States, Canada, France, Iceland, Finland, Norway, Portugal, Nine Eastern European countries, Sweden, Singapore, Italy, New Zealand, Australia, Japan, and South Africa, have initiated programs of tobacco control (Wyckham, 1997). These programs typically involve excise taxes aimed at demand reduction, restrictions on advertising, label warnings, access restrictions, etc. Tobacco control is clearly an important, worldwide public policy mission. At the same time, however, there has been an active line of economic research arguing against most tobacco control efforts. These economic arguments, based on the principles of consumer sovereignty, assert that tobacco control initiatives are inefficient and reduce the public welfare. Notable authors in this literature are Viscusi (e.g., Viscusi, 1991, Viscusi, 1994) and Tollison and Wagner (e.g., Tollison and Wagner, 1988, Tollison and Wagner, 1992). How can this state of affairs be reconciled?

Traditional analyses of the benefits and costs of tobacco regulation have focused on two primary externalities: (1) financial externalities of added health care cost burdens that smokers may impose on nonsmokers, and (2) environmental externalities of impacts that passive smoking and accidental fires may impose on nonsmokers. Many commentators in the tobacco control debate, however, see these externalities as relatively small. Regarding the burden that smokers may impose on the public through excess public health care costs, see for example, the estimates of Manning et al. (1991) and the conceptual discussion of Warner et al. (1995). Regarding the externality of second-hand smoking, see for example, the reviews by EPA (1992) and Gravelle and Zimmerman (1994).

The focus of this paper is on a third form of market failure — one that provides an alternative approach for the welfare-analytics of tobacco regulation. Since it concerns the costs that smokers fail to internalize and subsequently impose on themselves, this market failure can be thought of as an intrapersonal or addiction externality. As emphasized by many authors (see, for example, Schelling, 1986), by far the largest societal costs of smoking are the costs that smoking imposes on smokers themselves.1 The innovation of this paper is to illustrate how a substantial portion of these costs, amounts sufficient to explain the broad interest in regulatory interventions, can be argued to result from market failure.

To develop this logic, this paper uses three fundamental arguments. The first and most well known has to do with age of consent and the externality that juvenile smokers impose on their future adult selves. To the extent that we as a society do not accept the revealed preferences of children as being indicative of their welfare and we believe that those under the age of consent should not smoke, then we believe that youth smoking represents a market failure. Furthermore, and this is the focus of the argument, to the extent that this youth smoking is addictive, it influences adult behavior and imposes an intrapersonal externality on adult welfare.

The second and perhaps more innovative argument involves the possibility of adult irrationality in cigarette consumption. Although the structure of the modeling approach makes precise estimation difficult, empirical results from the rational addiction literature cast considerable doubt over the fullness of adult rationality in cigarette consumption. This is because, although these empirics do show adult smokers to be somewhat forward looking, the strength of this behavior is relatively weak and is not sufficient to be consistent with full rationality. If these empirical results were accepted, the welfare impacts associated with the estimated failure in rationality would be substantial.

The third argument relates to the treatment of peer effects. Whereas the previous literature measures the excess burden of tobacco taxation using aggregate demand curves, welfare considerations to account for the endogeneity of preferences for goods that exhibit strong peer effects require more subtle analysis. Indeed, it is shown that because of these peer effects the welfare analytics of tobacco taxation become indeterminant and can lead to interpretations of the excess burdens from cigarette taxation that are actually negative.2 Finally, the analysis concludes with brief suggestions for future empirical research strategies that could improve our understanding of these addiction-externality market failures.

Section snippets

The addiction externality of youth smoking

The 1996 U.S. Food and Drug Administration (FDA) anti-tobacco initiative was crafted specifically to combat youth smoking. This strategy made sense for several reasons. First, a casual review of U.S. data reveals that many of today's current adult smokers started smoking when they were below the age of consent. In a 1991 survey of adult ever-smokers aged 30 through 39, 82% reported having first tried a cigarette and 53% reported having begun daily smoking at or before the age of 18. Using 20 as

Evidence for myopia and addiction externalities in adult consumption

Although society at large has little difficulty accepting the notion that children tend to be myopic and has generally favored intervention to reduce youth cigarette consumption, there is much less agreement in attitudes toward intervention designed to influence adult behavior. By the principle of consumer sovereignty, economists have tended to be particularly uncomfortable with the idea of such interventions. Regardless of this, however, results from the rational addiction literature suggest

Peer effects

Why is the smoking participation rate lower for African–American teens than for white teens? Why do those Indian women who can afford cigarettes have very low smoking participation rates, whereas those Indian men who can afford cigarettes have very high participation rates? Why has smoking participation recently become so closely associated with socioeconomic class in the U.S.? Many explanations are available but, in addition to various influences of social approval or disapprobation, it seems

Suggested directions for future research

A problem with both the Chaloupka (1991) and Becker et al. (1994) results is that their estimation approach is not entirely consistent with the underlying rational addiction model.26

Conclusion

As emphasized by Shelling (1986), it is the costs that smoking behavior imposes on smokers themselves that are by far the largest social costs of smoking. This paper has developed logic for identifying intrapersonal externalities in cigarette consumption that can be used to attribute a substantial portion of these costs to market failure. In doing so, this paper addresses what seem to be the fundamental arguments for why we have tobacco control policies.27

Acknowledgements

Although the author did previously work for the United States Food and Drug Administration on the economic analysis for its tobacco regulation initiative, this current work was neither funded nor approved by the FDA and is not intended to reflect any FDA position. Special thanks go to Larry Braslow for the exceptional generosity he has shown in discussing this project and in reviewing early drafts of this paper. Thanks also go to John Lienesch, of the FDA, Michael Grossman, and seminar

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