Table 6.4. Characteristics of the tobacco support program: flue-cured tobacco, 1975-2000

Year

197j

I Y76

  -...
lY//

  ->
I')/b

1 Y79

1 W)

1981

192

1983

1 w4

I')85

1986

1987

I 'MS

IWY

1 Y90

1991

1992

1993

1994

1995

1996

1997

1998

1 YY9

2000

National
marketing
quota
(million lbs.)

National      Real average
average        support
support price      price*
(cents/lb.)        (cents/lb.)

No-net-cost assessment+
    (cents/lb.)

Producers    Buyers

1,4Y I
1,26S

1,116

1,117

1,095

1,094

1,013

I ,o 13

y 10

804

775

7,Y

707

754

891

S/S

878

892

PI2

803

93s

xi4

974

813

666

533

93.2

106.0

113.8

I21 .o

139.3

141.5

158.7

169.9

I hY.Y

I W.C)

1hY.Y

143.8

143.5

144.2

14h.S

I4X.S

152.8

133.0

157.7

138.3

139.7

160.1

163.1

162.8

163.2

164.0

173.2

186.3

lS7.8

185.6

178.1

171.7

174.6

176.1

170.6

lh3.5
137.Y$

131.2

126.3

121.Y

118.4

113.8

112.3

111.2

109.1

106.8

104.8

102.0

101.0

99.9

98.0

95.6"

3.0

7.0

7.0

2.50

2.50

2.00

1.13

1.12

1 .oo

1 .oo

I .oo

1.00

3.00

0.80

1 .oo

1 .oo

1 .oo

1 .oo

2.50

1.50

2.00

1.13

1.12

I .oo

I .oo

1.00

3.00

5.00

I .80

1.80

1 .oo

1 .oo

1.00

2.50

*Real a\`erage support price is obtained by di\Gding the nominal support price by the national Consumer
Price Index; the average of 1982-1984 is the benchmark.
`No-net-cost assessment includes marketing budget deficit assessments from 1991 through 1998.
IThe effective support price in 1985 Leas 165.0 cents/lb. by reduction of certain grades.
`I'reliminarv estimate.
Sources: Us. Department of Agriculture 1997b, IY99a,b.


Table 6.5. Characteristics of the tobacco support program: burley tobacco, 1975-2000

1975

1976

977

978

979

1 980

981

982

1 983

983

985

986

987

1 988

989

Year

1990

1991

19Y2

1993

1994

1993

1996

1997

1998

1999

2000

National          National      Real average
marketing          average        support
quota       support price*      price+
(million lbs.)        (cents/lb.)        (cents/lb.)

670             96.1           178.6

635             109.3            192.1

636             117.3            193.6

614             124.7            191.3

614             133.3            183.6

614             145.9            177.1

660             163.6            180.0

680             175.1            181.5

647             175.1            175.8

582             175.1           168.5

524             148.8            138.3

493             14X.8            133.x

464             148.8            131.0

473             150.0            126.8

5x7             153.2            123.5

601             155.8            IIY.2

724             158.4            116.3

668             164.Y            II 7.5

602             168.3            116.5

536             171.4            115.7

546             1/2..i            113.2

631             173.7            110.7

704             17h.0            109.7

635             177.8            1OY.l

4.51             178.9            7 07.3

247              180.5           105.2"

No-net-cost assessment7
    (cents/lb.)

Producers    Buyers

1.0

3.0

9.0

4.0

2.75

2.00

0.80

1.00

1.00

I .oo

I .oo

I .oo

4.50

1 .oo

1 .oo

1 .oo

3.00

3.00

3.00

1.25

2.00

0.80

1.00

1 .oo

I .oo

I .oo

3.50

3.60

I .oo

1 .oo

1 .oo

3.00

3.00

3.00

*The support price \vas reduced from 178.8 cents/lb. and the no-net-cost assessment was reduced from
30 cents/lb. bv Public La\v F-157, sec. 6 (IYH5).
+Real average support price is obtained by dividing the nominal support price by the national Consumer
Price Index; the a\.erage of IYP2-1984 is the benchmark.
iNo-net-cost assessment includes nlarketin;: budget deficit assessments from 1991 through 1998.
Vi-eliminary estimate.
Sources: U.S. Department of Agriculture lYY7a; 1998a,b; 1999a. 2000.


prices for domesticall\, grow\-ii tobacco are artificiallv
high. Some estimates of the distortions resulting from
the support program \1-cre pro\.ided by Sumner and
Alston (1985) in their analysis of the economic conse-
quences of renio\-ing the tobacco price support svstem.
Their estimates 12.ere based on a detailed simultaneous
equations model of the supplv and demand for tobacco
and tobacco products (cigarettes) that allows for sub-
stitution bet\\-een domestic and foreign tobacco in ciga-
rette production. The authors estimated that domestic
tobacco output K-ould rise by 5&100 percent or more
if supplv restrictions \vere eliminated. This large in-
crease in the quantitv of tobacco supplied should lead to
sharp reductions iii- tobacco prices. As a result of the
increase in output, tobacco prices I\Y~LI~CI fall b\. 3-30
percent, and the \-ariabilitv of tobacco prices ~vnulcl in-
crease. Ho\\.el.er, o\.erall rel'enues from tobacco grow\--
ing ~vould rise bv 15-60 percent or more.

Moreo\.er,this analysis predicted that the sharp
drop in domestic tobacco prices that \\~oulcl follo\\~ the
removal of supplv restrictions ~~0~11d lead domestic
producers of cigaiettes and other tobacco products to
use less foreign-gro\\,n tobacco.  These estimates as-
sumed the elimination of the program in 1983 and thus
do not take into account the more recent changes in its
operation. More recent estimates from Zhang and co-
leagues (2000) suggest that the conclusions of Suninel
and Alston (1985) still applv. For example, thev esti-
mated that the price support program raised tobacco
leaf prices by 36 cents a pound in 199-l. This price is
about 21 percent above the estimated price in the ab-
sence of the support program.

  The removal of the support program should also
make domestic tobacco growers more competiti\.e in
world markets. In the 198Os, U.S. tobacco prices ex-
ceeded world market prices by JO-60 cents per pound
(Warner 1988). Although part of the differential can
be explained by the higher quality of U.S. tobacco, a
significant factor is the U.S. tobacco support program.
Sumner and Alston (1985) predicted that U.S. tobacco
exports would have grown bv about 100 percent if the
tobacco support program hai been eliminated in 1983.
This change would have had an ad\rcrse impact on
foreign tobacco growers, as producers of foreign ciga-
rettes and other tobacco products increased their use
of tobacco grown in the United States.

  Although the artificially high prices resulting
from the support program tend to increase the income
of small tobacco farmers, thev likely recei\re relativelv
less benefit from the program than the tobacco quota
owners. Because most small tobacco farmers rent some
or all of their allotments from the quota o\vners at a
significant cost (Watkins 1990), these farmers pav rents

equix-alent to the excess value created by the support
program. In the absence of the program, reduced in-
come for these farmers lvould likely be offset by the
resulting reduced rent they paid. Quota owners, on
the other hand, have been estimated to lose about $800
million annually M'ere the support program eliminated
(Sumner and Alston 1985).

  Despite the differing likely effects on quota own-
ers and small tobacco growers, eliminating the tobacco
support program \~ould probably not alter existing
trends in the concentration of tobacco production into
larger farms (Sumner and Alston 19%). Rucker and
colleagues (1995) ha1.e estimated that eliminating the
program's intercounty restrictions on the transfer of
tobacco quotas I\-ould ha\ e little o\serall impact beyond
redistributing lvealth from some tobacco growers and
quota 011 ners to others. (Consequently, these research-
ers suggest that the restrictions have remained in ef-
fect not because the gains associated with them are
large but because the political costs of removing them
are.)  Moreo\.er, remo\%~g supports would cause a
mo\.ement a\vav from regions \vhere the costs of grow-
in;; tobacco ari relativelv high torz-ard those where
costs arc relati\.el>. Io~v. -The loss of income to quota
o\\`ners \zo~ild lead to reductions in personal income
of up to 2-3 percent for counties that are highly de-
pendent on tobacco; larger losses would occur in the
relati\.elv high-cost counties. However, total incomes
would rise in areas that experienced a great expan-
sion ~JI tobacco growing. In comparison, the effect of
altering another government program would be con-
siderable. Increases in cigarette excise taxes are also
likely to bring significant losses to quota owners.
Sumner and Wohlgenant (1985) estimated that dou-
bling the federal cigarette excise tax in 1983 would
louver quota oM.ners' lease income by an average of 13
percent, or about $44 million.

  As a result of the sharp drop in the price of to-
bacco, cigarette prices could fall. Tobacco costs, how-
ever, are a relatively small component of cigarette
prices. Grise (1995) estimates that the 40- to 50-cent
per pound drop in tobacco prices resulting from the
elimination of the support program r~ould reduce ciga-
rette prices by only l-2 percent. Zhang and colleagues
(2000) estimaie an even smaller impact, concluding that
cigarette prices are 0.52 percent higher than they would
be in the absence of the support program. As noted
by Sumner and Alston (19851, a reduction in cigarette
prices would lead to a rise in U.S. cigarette exports.
Moreo\.er, estimates of the price responsiveness of ciga-
rette demand (described in "Effect of Price on Demand
for Tobacco Products," later in this chapter) suggest
that the reduction would lead to an increase of no more


than 1 percent in cigarette smoking. At least part of
the increase \voulcl come from increased smoking
among young people.

  Opponents of the tobacco support program sug-
gest that it can be removed w+th little impact on the
farmers it is intended to benefit. For example, the less
than 2-percent reductions in cigarette price that would
result from eliminating the support program could be
more than offset by an increased excise tax on ciga-
rettes. A portion of the revenues generated from the
tax hike could be used to help tobacco farmers diver-
sify into other crops (through low-interest loans,
grants, or other programs) or to purchase the farmer's
tobacco base to retire it from tobacco growing (Northup
1993). Similarly, some of the funds could be used to
develop nonfarm businesses, train farmers for other
occupations, provide income support, and offer other
economic support for local economies in transition
(Womach 1994a).

  Critics also point out that the support program
creates indirect political consequences: the depen-
dence created by the support program results in a
strong political constituency, composed of tobacco
farmers and holders of tobacco allotments, that can
impede legislation to reduce tobacco use (Taylor 1984;
Warner 1988; Zhang and Husten 1998). In the absence
of the support program, tobacco growing \vould likely
become much more concentrated (Sumner and Alston
1985). Warner (1988) has observed that the reduction
in numbers would lead to reduced political influence.
Moreover, he describes the apparent inconsistency
present when one arm of the federal government seem-
ingly endorses tobacco production by continuing an
economic support program even as another engages in
numerous activities to reduce tobacco use (Warner 1988).

Evolution of the U.S. Cigarette Industry

  Through much of the 19th century, most of the
demand for tobacco products centered on smokeless
tobacco and cigars (see Chapter 2). Cigarettes were
relatively less popular, although the demand for them
increased gradually during the middle of the century
(USDHHS 1992). The watershed year for the cigarette,
however, was 1881, when James Albert Bonsack an-
nounced his de\,elopment of a machine that replaced
hand-rolling as the primarir means of making ciga-
rettes. The mechanization df production significantly
reduced the costs of manufacturing cigarettes and,
consequently, reduced cigarette prices. The steep de-
clines in cigarette prices relati1.e to the prices of other
tobacco products, due largely to Eonsack's cigarette

machine, contributed significantly to the rapid rise in
the popularity of cigarettes during the late 19th and
early 20th centuries (Wagner 1971).

  James Buchanan Duke was the first cigarette pro-
ducer to acquire rights to the new machines, which he-
installed in 1884. Duke entered into long-term con-
tracts with Bonsack to use the machines at a cost lower
than Bonsack would make them available to other
producers. Because of the resulting substantial cost
advantage in production for his company, Duke
successfully waged price wars with other producers
while still earning relatively high profits. Over the next
decade, the Duke family formed a holding company,
which was composed of their firm and several corn--
petitors they had acquired. By 1889, as a result of its
aggressive pricing and marketing strategies, the hold-
ing company effectively monopolized U.S. cigarette
markets (controlling more than 90 percent of the mar-
ket), as well as portions of the markets for other to-
bacco products. Eventually, in an attempt to avoid
antitrust prosecution under the Sherman Act, the
Dukes converted the holding company into The Ameri-
can Tobacco Company. By 1901, The American Tobacco
Company dominated all of the U.S. tobacco market<
except cigars. The company was also a considerable
presence in cigarette markets around the world.

  In response to allegations that The American To-
bacco Company was abusing its market position, the
U.S. Department of Justice charged the firm with vio-
lating the Sherman Act. In 1911, the Supreme Court
dissolved the company, thereby creating several new
firms from the conglomerate, including a new Ameri-
can Tobacco Company (which later became American
Brands, Inc.), Liggett & Myers Tobacco Company, R.J.
Reynolds Tobacco Company, and Lorillard Tobacco
Company. The American Tobacco Company was also
divested of its foreign holdings (Imperial Tobacco Ltd.
and British-American Tobacco Company Ltd. [B.A.T.
Company]). Imperial Tobacco Ltd. eventually rno;
nopolized cigarette manufacturing in Great Britain,
and B.A.T. Company concentrated on manufacturing
in British colonies and elsewhere. Both companies
ultimately resumed some operations in the United
States (Johnson 1984). Although Imperial Tobacco Ltd.
eventually dropped out of U.S. markets, B.A.T. Indus-
tries PLC, the parent company of B.A.T. Company,
owns Brown & Williamson Tobacco Corporation, a
large U.S. cigarette manufacturer.

  R.J. Reynolds Tobacco Company (which had nc
cigarette production after the breakup) soon devel-
oped a new type of cigarette by using burley tobacco,
which was quickly copied by the other producers. By
the lY2Os, the cigarette producers were competing


`tsgressi\.elv in promoting their main brand-for ex-
ample, R.J. Revnolds Tobacco Companv's Camel, The
.\merican Tobacco Compan>"s Lucky Strike, and
Liggett Cy: Myers Tobacco Company's Chesterfield. In
addition, firms on the competiti\,e tringe attempted to
compete through price \vith their so-called IO-cent
brands (Robert 1967). (For a more detailed discussion
L,f the domestic operations of U.S. cigarette firms be-
fore World War II, see the Surgeon General's report
$iwX-i/7,y (712~1 H~wltl~ ir7 t/7(, A~7c~riin5 [USDHHS 19921).

  The U.S. Department of Justice e\,entually chal-
lenged the four producers' coordinated \vholesale and
retail pricing practices.  In IY-ll, on the basis of con-
juct starting as earl\ as 1933, these producers xvere
I:harged \vith \,iolatin g the Sherman Act bv conspir-
ing to restrain trade in an attempt to monopolize the
Industry Their \vholesale tobacco-yurchasitig prac-
tices Ivere deemed to be monopsonistic-that is, char-
-1cteristic of a market situation tvhere one buver exerts
.I disproportionate influence-and their retail pricing
\\-a~ thought to reflect collusi\.e beha\,ior. In 1916, bas-
~ng its decision on the no\,el legal concept of "conscious
parallelism," the Supreme Court upheld a jury deci-
,ion that found the firms guiltv. The uniformit\~ of
;>rices at both the \vholesale and ;he retail le\,el (a result
that could occur in anv highly competiti\.e market),
the near-SVnchronoLis increases in prices, and the rais-
ing of 12-holesale prices \vheii labor costs irei-e falling
.vere vieived bv the court as evidence of tacit collusion.

As a result, the firms xvere fined up to $250,000 each, a
relati\.elv minor penaltv compared \zith their profits.

Jol;nson (lY83) and others have noted that the
Court's decision \vas not supported by purely eco-
nomic reasoning. There rvas little if any evidence that
cigarette firms \vere jointly restricting output to raise
cigarette prices and, consequently, profitability. Simi-
larly, there \vas no evidence that the firms limited
their \\rholesale purchases of tobacco to depress to-
bacco prices and production costs and, consequently,
to increase profits.

  The Court's decision had little impact on the sub-
sequent structure of the U.S. cigarette industrv. The
practical result has been that, from 1916 until today,
the combined market shares of the six major firms (five
after the merger of Bro\vn & Williamson and Ameri-
can Brands, Inc.) has exceeded YY percent, although
indi\,idual market shares ha\.e changed significantly
(Table 6.6).

  More important in changing relati1.e market
shares ivas the release of information during the 1950s
and 1960s on the health consequences of cigarette
smoking. In the lYX)s, Philip Morris Companies Inc.,
1i.J. Re~~nolds Tobacco Company, and Lorillard Tobacco
Companv aggressi\,elv marketed filtered cigarettes
(Marlboro, Winston, a'nd Kent, respectii,ely), xvhich
lvere percei\,ed as less dangerous than standard
unfiltered cigarettes; The American Tobacco Companv
and Liggett & Mi,ers Tobacco Company \vere not as

rable 6.6. Domestic market shares of U.S. cigarette firms, selected years

      R.J.     Philip      Brown &     American
Year   Reynolds    Morris     Williamson     Brands     Lorillard

1913       0.2       NA*         NA         35.3        77 1
                                                              &k.

1925      31.6        0.5         NA         31.3         1.9

i 9-10      21.7        9.6          7.8         29.5         5.4

1955      23.8        8.5         10.5         32.9         6.1

1970      31.8       16.8         16.9         19.3        8.7

1975      32.5       23.8          17.0         14.2         7.9

IY80      32.8       30.8         13.7         10.7         9.8

1985      31.:       35.8         11.X         7.4        8.2

1991      27.8       43.4         11.1         7.0        7.3

1996      24.6       47.8         17.2         NA         x.-l

Liggett &
Myers

  34.1

26.6

20.6

  15.6

  6.5

  4.4

  2.2

  5.0

  3.4

  1.9

Total

91.7

91.8

94.6

99.4

100.0

99.8

100.0

99.9

100.0

99.9

-X.4 = Not available.
%xwces: Tennant 1950; O\wton 1981; Clarifeld lY83; Standard & I'oc)r's lYXc), 1993; Federal Trade
.`Ornmission 1997.


s~~cc~ssful in marketing their competing brands
(Johnson 1981). Similarly, after the 1964 release of the
U.S. Surgeon General's first report on the health conse-
quences of cigarette smoking, and after the Federal
Trade Commission's (FTC) publishing of tar and nico-
tine content in the late 1 Y6Os, Philip Morris Companies
Inc. and R.J. Reynolds Tobacco Company introduced
and aggressively marketed lo\v-tar and lobv-nicotine
cigarettes (again, products percei\,ed as healthier than
existing cigarettes), whereas the other companies \vere
less successful. As a result of the brand loyalty these
two firms Lt'ere able to establish at this time, they came
to dominate cigarette markets; in 1996, the two firms
had a combined market share of 73.3 percent.

  Another notable change in the tobacco industry,
beginning in the lY6Os, was the di\.ersification of the
cigarette-manufacturing companies. Perhaps in part to
offset the impact that the campaign to reduce tobacco
use had on the industrv's profitability, the six major
domestic cigarette producers acquired or merged !2-ith
U.S. firms in a \,ariety of nontobacco markets, includ-
ing food, alcoholic beverages, and transportation. Both
U.S. and international cigarette producers significantly
expanded their international acti\-ities. Di\.crsification
was relativelv easv because of the high profitabilitv from
          _ -
cigarettes and the lo~v long-term debt of these firms
(Overton 1981). By 1972, no major domestic cigarette
companv ivas completelv dependent on tobacco for its
revenue (Johnson lY84). Durin, 0 the l%Os, diversifica-
tion strategies and successes among the six firms var-
ied markedly; some firms returned to a focus 011
cigarettes and other tobacco products, \\.hereas others
di\.ersified further. B\, the late l%Os, a three-tiered
classification of \Vorld cigarette producers, based on
their international activities, had emerged: those in-
volved in most global tobacco markets (Philip Morris
Companies Inc., B.A.T. Industries PLC, 1i.J. Reynolds
Tobacco Company, and Rothmans International Tobacco
Ltd.); those \\ith some international, but not global,
activities (including American Brands, Inc.); and smaller
firms concentrating primaril!, on their domestic mar-
kets (including Liggett & Myers Tobacco Company and
Lorillard Tobacco Company) (L'SDHHS lYY2).

Economic Implications of Concentrated Tobacco
Production

  The concentration of production among relati\d)
few firms in the cigarette industry has implications for
cigarette pricin,, ~7 marketing, product de\.elopment, and
other activities. Clearly, the cigarette industrl, is an
oligopoly; no more than six firms ha1.e controlled vir-
tually all cigarette output in the United States for the

past 80 vears (Table 6.6). Economic theory suggests
that fir& in oligopolistic industries have substantiat
market pobver in that their production decisions wilt
have a significant impact on price. Moreover, these
firms recognize their interdependence. That is, each
firm recognizes that its pricing and marketing strate-
gies have a significant impact on the sales and profit-
ability of its competitors, as well as on its own sales
and profitability. Consequently, each firm understands
that its competitors are likely to respond to any changes
in its own pricing, marketing, or other strategies.

  Economic theory provides several possibilities
regarding the conduct and performance of firms in an
oligopolistic industry. At one extreme, if entry is easy
and if sunk (nonrecoverable) costs are low, firms in an
oligopolistic industry will behave competitively. That
is, firms will have little market power (their output
decisions will have little impact on market prices),
prices will reflect the costs of production, and firms
will not earn excessive profits. At the other extreme,
firms could behave collusively, jointly restricting out-
put, raising prices well above costs, and earning very
high profits. Most theoretical models of oligopolistic
industries suggest behavior between the two extremes:
prices and profitability will be above and output will
be below Ivhat would result from highly competitive
behavior, and output will be higher and prices and prof-
itability will be lolver than their levels in a monopo-
lized or highly collusive industry.

  Casual empiricism suggests that cigarette prices
ha1.e historically been bye11 above costs, thereby allow-
ing cigarette producers to achieve a rate of return ~-41
above that earned in most other industries. Even after
the health consequences of cigarette smoking became
apparent, the U.S. tobacco industry led all U.S. indus-
tries in profitability (Miles 1982). Moreover, in the t\vc
major antitrust cases brought against the cigarette in-
dustry in the 20th century, firms were found guilty ir
1911 of monopolization and in 1946 of a conspiracy tc
restrain trade (collusion). Most industry analysts sug-
gest that the primary source of market power in the
cigarette industry is the entry barriers resulting fron?
marketing efforts, tvhich create significant brand loy-
alties that are nearly impossible for a nets producer tc
overcome.

High Tobacco Concentration and the Impact of
Prevention Policies

  The high concentration of the cigarette industrk
and the apparent market polver this concentratior
engenders have implications for the effects of changes
in cigarette taxes and other prevention policies on the


pricing, marketing, and other strategies of cigarette
firms. For example, the historically high profitabilitv
of existing cigarette producers pro\.ides them Lvith thk
resources needed to s~~ccessf~~llv de\-elop and market
new' products, as leas seen in ;he de\.clopment and
introduction of filtered cigarettes in the lY5Os and lots-
tar and lolv-nicotine cigarettes in the 1YhOs in response
to the initial reports linking cigarette smoking to lung
cancer. More recently, in response to the increased
alrareness of the harmful effects of en\-ironmental to-
bacco smoke (ETS) on nonsmokers and the ~~idesprcad
restrictions on smoking that ha\-e been designed to
protect nonsmokers, R.J. Re\,nolds Tobacco Cornpan\,
introduced its Eclipse brand in se\ era1 test markets
beginning in mid-lYY6, and Philip Morris Companies
Inc. is currentI>, testing its Accord brand in the Lnitccl
States and Japan. Both are ostensibl\, "smokt~lt~ss" cig,3-
ret&s, primarilv heating rather than burning tobacco;
consequently, both generate less secondhancl smoke
than con\.entional cigarettes.

  Economic theor\, can predict sonic effect\ of in-
creases in excise tax&on price, output, and profitabil-
itv. At one extreme, tax increases in a perfectl\
competiti\.e market \vith constant costs of production
should result in price increases of the same magnitude
rzith no impact on long-run profitabilitv. Reductions
in output \\.ould depend on the effect that price has
on demand. At another extreme, standard models for
a monopolized market suggest that producers; and
consumers \ynuld share the burden of the tax increase
but consumers \vould pav a greater share of the tax,
because demand is less s&iti\-e than production to
price. Output and profitabilit!, t~ould fall, Ivith smallet
reductions in both-again because demand is less sen-
sitive to price. Recent advances in the theoretical and
empirical study both of oligopolistic behavior and of
the supplv of addictii.e goods haire vielded se\,eral
interesting predictions. Perhaps most interesting is the
possibility that prices ITi increase by more than the
amount of the tax increase i~hen excise taxes are raisecl.

  Several early studies of these relationships pro-
duced generally inconsistent conclusions concerning
hoM' much cigarette prices rzould increase after an in-
crease in cigarette taxes (Barzel 1976; Johnson 1978;
Sumner 1981; Sumner and Ward 1981; Bulo\~ and
Pfleiderer 1983; Bishop and \Ibo 1985; Sulli\,an lY85;
Sumner and Wohlgenant 1983; Ashenfelter and
Sullivan 1987). One general Meakness of these stud-
ies w'as their failure to account for the dynamic inter-
action of firms in an oligopolistic industrv. Instead,
the studies generally assumed that rules fo; the firms'
behavior \vere established, and then, \vith obselved
prices and taxes, the studies lvorked back\\-ard to

determine the degree of competition within the indus-
trv (Harris 1987).

   More recent studies have addressed these weak-
nesses. Harris (1987) used the estimates obtained from
se\,eral studies of cigarette demand and supply to
e\raluate the impact of doubling the federal cigarette
excise tax in 1983; moreover, Harris' framework al-
lo\ved the change in the tax to affect the interaction of
firms in the industrv. Using data on wholesale and
retail cigarette prices as well as the costs of produc-
tion, Harris concluded that the ii-cent increase in the
tax 14 to a 17-cent increase in the retail price of ciga-
rettes. He further argued that the price increase above
the tax hike could not be accounted for by increases in
production costs. Instead, this increase was attributed
to the recognized interdependence of cigarette firms
in an oligopolistic industry; that is, the firms recog-
nize that their profitability \vould rise if all could suc-
cessiull~ restrict output and raise prices. However,
because foi-ma1 agreements on output and prices are
illegal, the firms are alert to other bases on which they
can coordinate their behavior. Harris suggested that
such a base \\`as the announced increase in the federal
ta\, scheduled for January 1, 1983, lvhich served as a
ioordinnting mechanism for a joint oligopolistic price
increase. As Bnrnett and colleagues (1995) note, Har-
ris' analvsis fails to account for existing trends in ciga-
rette prices. Barnett and colleagues argue that Harris
attributed too much of the coordinated rise in price to
the increase in the federal tax, because the upward
trend in prices predates the consideration of the tax
hike. The authors suggest that producers used the in-
troduction of discount cigarettes in 1981 to coordinate
the earlier price hikes for premium brands, because
the lolver-priced "generic brands" would keep more
price-sensitil-e smokers in the market. The spirit of
this argument is the same as Harris', because both sug-
gested that certain e\,ents served as focal points allow-
ing firms to engage in more collusive behavior without
appearing to establish a formal agreement.

  Keeler and colleagues (Sung et al. 1994; Barnett
et al. 19%; Keeler et al. 1996) used national- and state-
lc\.el data to estimate the effects of cigarette tax in-
creases on price. Their empirical models have been
used to examine the interaction of cigarette supply and
demand in determining cigarette prices. By using
alternative assumptions about firm behavior, these
studies formally account for the oligopolistic aspects
of the cigarette industry in their empirical models of
cigarette supplv. At least some of these models also
account for the+addictive nature of cigarette demand.

  In a study using data on all U.S. states from 1960
through 1990, Keeler and colleagues (1996) conclude


c~\\~la~~i thti li\.pnthL5i\ a5 follo~\3: iigdrette firms Lvit1-t
nl,lrht't ~cJ\\ t't- ma\. s;ft relati\ el\, low prices to "hook"
i~~ti5uiilt~r5 on thtsir ddciiiti\-e product, thus raising the
tature ciemdnc-l for their (-igdt-ettes; policies (including
tCl\ incrc~,tssrsJ that reduce future smoking also reduce
the tit-tns' prufitabilitv of maintaining lo\v prices. Nev-
tWhele+s, the relativelv lo\v prices of these for~vard-
looking firms (comp,~;ed \vith those of more myopic
firms) I\-ill still c~ceecl the marginal and average costs
of pr~dustion and distribution. A similar hypothesis
lids been ~tscci to explain studies that found Ihat ciga-
rette producers appear to ad\,ertise beyond the profit-
tn~~simi~ing le~,el (Sholtxlter 1991). These firms rnal
be engC~ging in excessive ad\.crtising (i.e., more than
can be recouped through brand switching among cur-
rent smokers) to attract new consumers and hoping to
I,itcr bcnetit from a hi,gher demand for cigarettes as `i-
result of these tie\vlv addicted consumers.
The rapid incr&ses in cigarette prices since the
e,irl\ I %X)5, I\.liich are only pnrtlv explained bv incrcdst~s
in taxes and costs, thus reflect I-7rofit-maximizing
beha\-ior b>f ;i highly concttitr~~tcd cigarette industr\~
that anticipate5 dtueas.ed future ~lemand as xiditiotiC~l
c'iforts to rcduw tobaccn ust' are implemented (Kecket
c't ,il. 1-W). ;Itl empiric-al dppliiation of this model tc
tlic <uppI\ anti demand for cigarettes (Sho\vnlter IWl)
sLippc)rb tlicwl li\~pothews concerning the belialjor of
tirni5 \\ itli nidrket po\x.t~r that dre selling an addicb\ t`
pt~c~LiLlit.
  ;I 5ci~uicl gtxtup of empirical studies has foc~ised
011 tlic tx~l,itic>ti5liips bc`t\x.twi industrv concentratioti~
tri5tt-iiti~~n5 c>ii iigdrctte ad\~ertising, cigarette pricr~.
,Incl mdrket po\\.er. One such analysis supports the
ion\ twticIndl \\,isdoni that advertising is an important
ic)tiipt`titi\ e strategy in de\~elopin, u and m;lintainin$
br,incl io\~dIt~~ for firms in the cigarette indt.tstr\
~N~u\~~ii ~IW?). Another analvsis, using nn empiricA
niodt>l that ;Illo\\5 firms in an oligopolistic indurtrv tc
h;l\ t` some cicyt-et> of market polver, conclucies ;lial
dd\.cdi5iti~q raist5 market po\vet- and, consequetitl~-
pr~~tit,lbilit\ in the cigarcttt> industrv (TremblCtv anti
Tretnbl,~\~ iW3). A likelv eupl,wati& of this ef&ct i>
that b\, tostcritig lov;llt\T to existing brdncls, cigdrettt
ad\ vr;isiii:g raises LGrri&s to other brand5 that try tc
tlntct- the market and shCue in the profits.
  Se\-et-al studies (Porter 19X6; Mitchell ant?
~~lulherin lc)Sti; Eckard Ic)c)l) ha\,e ~oncl~~deci that bnn-
niti;; ii ~arrtte acl\~crtising from television and radii
    h
mdclv the industr\- c`\ cn less conipetiti\x!, thercbv fur
tlitlr raising pt-nfit~iL%lit\,. One such stud\, atfribufeti
the incrtuses in cigitdte prices after thedadL.ertisitis
bdn to the rcduiecl cotnpt~tition taultin~ front the L7d1-
(Porter I%%). This cotiilu5ion ~vas supported, tc) wnic


Discussion


effecti\-ely in foreign markets (this t),pe of association
is exempt from antitrust lal~ under the Webb-Pomertne
.4ct).

   As Grise (1990) notes, trade in tobacco and tobacco
products would be even higher if not for general trade
policies and, in particular, widespread agricultural and
industrial policies that protect domestic tobacco grow-
ers and producers of tobacco products. Numerous
countries have policies that support domestic tobacco
growing; in the United States, examples are the tobacco
support program and the short-lived mandatory mini-
mum content of domestic tobacco in domestic ciga-
rettes. Likewise, both tariff and nontariff barriers to
trade in tobacco and tobacco products ha\re been
erected around the \vorld. These barriers include quo-
tas, restricted product lists, exchange controls, prior
deposits, mixing regulations, licensing requirements,
and limits on advertising and other promotional ac-
tivities (Grise 1990). Moreover, in se\,eral countries (in-
cluding Japan, South Korea, and Thailand), various
aspects of the manufacture and distribution of cigarettes
have long been controlled by go\rernment monopolies
that have largely prevented the import of foreign ciga-
rettes (GAO 1992).

   When tariff and nontariff barriers to trade are used
to protect domestic tobacco and tobacco products, to-
tal supply of these products is usuallv louver than it
would be others-ise, lvhereas domestic supplv is higher.
In the case of tobacco products, this arrang&ent has
public health benefits resulting from the generally
higher prices and reduced consumption of the pro-
tected products. Domestic suppliers benefit b!r sup
piying more at higher prices. Foreign suppliers,
howei'er, are likely to lose in this arrangement, because
their access to these markets is limited and costs of sup-
plying the markets are higher. In addition, restrictions
on advertising and promotion in gi\ren countries are
likely to make it difficult for nelz firms to successfully
enter newlv opened markets lvhere existing brands are
firmly entrenched (Chaloupka and Corbett 1998).

Past Tobacco-Related Trade Policy

  In general, tobacco products exported from the
United States are specifically exempted from federal
laws and regulations concerning the export of poten-
tially harmful products, including the Federal Hazard-
ous Substances Act (Public La\v 86-613), the Toxic
Substances Control Act (Public Law 94-469), and the
Controlled Substances Act (Public La\v 91-513) (GAO
1992). Similarly, although federal regulations (1) re-
quire that all cigarette packaging and advertising in
the United States contain health rtarning labels and

(2) prohibit television and radio cigarette advertising,
there are no federal regulations or laws concerning the
packaging or advertising of domestically produced
cigarettes that will be exported (GAO 1992).

  Various U.S. policies and programs have been
used to help domestic tobacco growers and cigarette
companies expand into foreign markets (Connolly and
Chen 1993). These policies include the USDA's Food
for Peace Program, which sent more than $1 billion in
domestically produced tobacco to developing countries
in the 1970s and early 198Os, and the 1984 Export Credit
Guarantee Program, which exported domestically
grown tobacco and helped U.S. cigarette producers
enter Mideast markets (including AIgeria, Egypt, Iraq,
and Turkey) (Taylor 1984). Perhaps the most impor-
tant, however, is Section 301 of the Trade Act of 1974
(Public Law 93-618) and its subsequent amendments.

Section 301 of the Trade Act of 1974

  The Trade Act of 1974 was initiated by the Nixon
administration when it sought permission to begin the
Tokyo Round of GATT. GATT, an international trade
agreement honored by nearly 120 countries, governs
various aspects of international trade. (GATT is dis-
cussed in greater detail in "Multinational Trade Agree-
ments," later in this chapter.) The first of these
agreements was reached among 23 nations shortly af-
ter the conclusion of World War II. Since then, seven
rounds have occurred, including the Uruguay Round,
which concluded in April 1994 after more than seven
years of negotiations.

  The Trade Act of 1974 included in its final legis-
lation various measures with the stated purpose of-
promoting free trade. One of these measures was Sec-
tion 301, \vhich gave the President the authority to in-
vestigate cases where trade and other practices of
foreign countries were considered unjustifiable, unrea-
sonable, or discriminatory in that they limited the abil-
ity of U.S. firms to sell their goods and services in
foreign markets.

  Section 301 expanded the authority given to the
President by the Trade Expansion Act of 1962 (Public
La\v X7-794). That earlier legislation allowed for inves-
tigations of unjustifiable trade sanctions (those that di-
rectly violated GATT). Consequently, the act applied
only to goods covered by GATT (which at the time ex-
cluded agricultural products, including tobacco). Set-m
tion 301 expanded presidential authority to include
trade in all C.S. goods and services and allowed the in-
vestigation of practices that were unreasonable but did
not necessarily violate GATT. If negotiations were not-
successful in ieducing or eliminating the unjustifiable


or unreasonable limits on trade, Section 301 authorized
the President to impose retaliatory trade sanctions. Ini-
tially, Section 301 recei\,ed little attention, although it
rz-ould later become a rvidely used tool of U.S. trade
policy (Nivola 1993).

  Section 301 of the Trade Act of lY73 \vas strength-
ened by the Trade and Tariff Act of 1984 (Public Lab\
98-573) and the Omnibus Trade and Competiti\.eness
Act of 1988 (Public La\1 100418). NOM. known as "Su-
per 301," the section required the U.S. Trade Repre-
sentati\,e to annually identify countries and their
practices that consistently limited market access to ti.S.
firms. More important, if negotiations failed to elimi-
nate the unfair trading practices of these countries,
mandatory retaliatory measures \vere to be imposed
unless the President deemed these measures harmful
to U.S. economic interests.

   Four Section 301 cases in the late 1980s dealt \j.ith
cigarettes: cases against Japan in 1985 and Taiil-an in
1986 were initiated by the U.S. Trade Reprtsentati\,t
at the President's request, and cases against South
Korea in 1988 and Thailand in 1989 ivere the result of
the U.S. Cigarette Export Association's petitioning of
the U.S. Trade Representati\,e. Threats of retaliatorv
sanctions under Section 301 led to agreements tvith
each country; as a result, U.S. cigarette firms \vere per-
mitted access to those markets. The opening of the
markets resulted in aggressive tobacco ad\,ertising by
U.S. firms (Roemer 1993). Each of the four newly
"opened" countries has la\vs, regulations, and ordi-
nances concerning cigarette advertising and promo-
tion. The go\,ernments of some of the countries ha\,e
alleged that U.S. cigarette companies have violated
restrictions on advertising and promotion.

   A brief review of the four Section 301 cases fol-
lows; more details are contained in reports from the
GAO (1990, 1992), and an empirical analysis of their
impact on cigarette smoking is contained in Chaloupka
and Laixuthai (1996).

Jayall

  The tobacco industry in Japan is largely monopo-
lized by the company Japan Tobacco Inc. In 1979, Ja-
pan was the subject of two Section 301 cases, one
involving cigars, which was prompted by the Cigar
Association of America, and a second related to pipe
tobacco, which was initiated at the request of the As-
sociated Tobacco Manufacturers. The two cases were
resolved in an agreement with Japan, which reduced
market restrictions and lowered import duties (GAO
1990).

  Before 1986, the domestic cigarette monopoly
Leas protected from foreign competition through tar-
iffs of 28 percent on all imported cigarettes and through
Japanese distribution practices, which discriminated
against imported cigarettes. The threat of Section 301
sanctions led to an October 1986 agreement that elimi-
nated Japanese cigarette tariffs and changed excise tax
payment procedures and other distribution practices
that adversely affected imports of U.S. cigarettes. Ex-
isting Japanese policies related to cigarette advertis-
ing and other promotional practices were not affected
by the agreement.

  The agreement resulted in a significant expan-
sion of U.S. cigarette firms in Japan. Japanese imports
of U.S. cigarettes more than tripled in 1987 alone and
Fontinued to rise in 1988 and 1989, by which time the
market share of U.S. firms leas more than 15 percent
(Grise 1990). This growth appeared to have slowed or
stopped in the early 1990s. Total U.S. cigarette exports
to Japan ranged from 54.0 billion to 57.7 billion annu-
alla during 1991-1993.

  A dotvn\vard trend during the 1970s and 1980s in
per capita cigarette consumption in Japan appears to
have re\,ersed itself after theJapanese cigarette markets
\verc opened to U.S. firms. Overall per capita consump-
tion appears to have remained steady or increased
slightly in recent years. However, among Japanese
\lomen, smoking prevalence rose from 8.6 percent in
1986 (before the agreement) to 18.2 percent by 1991. The
1991 rates \vere even higher among young adult women
(27 percent) (Connolly and Chen 1993).

  Part of this increase may be the result of adver-
tising and promotional activities by U.S. cigarette firms
in Japan. Between 1987 and 1990, total expenditures
on cigarette advertising and promotion by U.S. ciga-
rette companies in Japan nearly doubled. Most of these
expenditures tvere on television advertising, which is
allowed in Japan (but subject to some restrictions).
Before the agreement, the domestic monopoly did not
engage in extensive advertising. Afterward, it signifi-
cantly expanded its advertising and promotional ef-
forts. As a result, cigarette advertising moved from
40th to 2nd place in total television advertising in Ja-
pan (Sesser 1993).

Tnizvafr

  Virtually all aspects of the tobacco industry in Tai-
wan are controlled by a state-run monopoly. In 1986,
the U.S. Trade Representative threatened Taiwan with
retaliatory trade sanctions over several governmental
policies that limited the market access of U.S. cigarette
companies. These policies included quotas and tariffs


011 im}wlkd 'is< IrcttLls, `1 twii 011 the rt?ail salt ot ini-
pc~rted cigarettes, and a ban on print ad\-t\rtisin;: of
imported cigarettes. An agreement \\`a~ reached in De-
cember 1986 that reduced tariffs and eliminated other
barriers, thcreb!. allort+ng C.S. cigarette companies
greater access to the TaiIvanese cigarette market. The
agreement also contained se\-era1 restrictions relating
to cigarette packaging (rzhich \vas required to haIre a
specified health \f,ai-ning label) as ~~ell as ad\,ertising
and promotional acti\-ities (e.g., the distribution of free
samples IVES limited and poiiit-of-t7urchase promo-
tions \vere restricted to licensed establishments).

  The agreement greatlv increased C.S. cigarette
companies' access to the Tai\\anese cigarette market.
In 1987 alone, total L'S, cigarette shipments to Taitvan
increased 3+fold, and the market share of U.S. ciga-
rette companies rose from 2 to 17 percent (Grist 1 YYO);
by lYY7, the mark& share of imported cigarettes had
risen to 30 percent (Hsieh ancl \r'in lYY8). Moreover,
TaiLvan's imports of relati\.elv higher-quality U.S. to-
bacco rose, as the portion of U.S. tobacco in Tairvanese
cigarettes increased from 35 to 55 percent to better com-
pete \z,ith imported cigarettes (Grise 1YYOi. Ho\:,ever,
per capita consumption of cigarettes, after increasing
somet\-hat during the 19705 and earlv IYHOs, tell from
1957 through 1996, due to public and $1 ate antismok-
ing policies (Hsieh and \I'in 1998). Smoking pre\-alence
among Tailvancse \~omen significantI\, increased in the
late lY8Os and has remained stables throughout the
1990s (Hsieh and l'in lc)Y8).

  Adwrtising and promotion of U.S. cigarettes af-
ter the agreement are likelv to ha\-<, contributed to the
large rise in the market share of U.S. cisarctte compa-
nies in T<ii\\,an. Before the agreement, the onI\, ad\,er-
tising and promotion permitted b!, the Tai\\.nn-Tobacco
dr Wine Monopol~~ Bureau \t.erc ne\\. product announce-
ments and the use of billboards in tlic Lmrf;lu's brdiirli
offices and distribution centers (GAO lYY2). In 1987,
spending on ad,.ertisiii $ and promotional acti\.ities b\.
U.S. cigarette firms in Tail\-an rose sharpI>, but fcil
somel\.hat in the next three \`ears. Ne\-ertheless, total
spending rose b)' -l3.8 per&t from 1 Y87 to IYYO (GAO
1 YY2). Gi\,eii preagreement restrictions on ad\.ertis-
iii:< and promotion. almost all of these r\peiiditurc>s
rzould have been for poj,it-of-I-7Lirchase and magazine
ad\.ertising. Xd\.ertising by the Tailvanese cigarette
moiiapolv. ho\j.e\.er. ~vds limited elen further after the
ageement.

  Authorities in TaiI\,an ha\-e alleged that point-of-
purchase promotional acti\.ities bv L'S. cigarette com-
panies ha1.e violated the terms of the lYX6 agreement
(GAO 1992). The agreement limits these activities to li-
iensed \~.holesale, distribution, and retail establishments,

Lvhich the Taiivan Tobacco & Wine Monopoly Bureau
defines as those with a permit registering them as
profit-seeking enterprises. Taiwanese authorities con-
tend that U.S. cigarette firms have distorted this defi-
nition to include unlicensed retailers selling cigarettes,
resulting in Midespread advertising and unauthorized
sales of U.S. cigarettes (GAO 1992).

  After 1987, the government of Taiwan enacted
several strong tobacco control policies, largely in re-
sponse to the liberalization of cigarette trade resulting
from the Section 301 agreement (Hsieh and Yin 1998).
Many of these policies were initially rejected by the
U.S. Trade Representative as unfair or discriminatory
toward the tobacco industry and in violation of the
1986 agreement. One contentious issue pertained to
the health warning labels proposed for cigarette ad-
iwtising and packaging. The Taiwanese government
initially proposed a set of strong, rotating health warn-
ing labels that would appear on the front of cigarette
packaging and on all advertising. In response to the
U.S. Trade Representative's opposition, the content of
the label M'as changed to "excessive smoking is dan-
gerous to health," and the label was placed on the side
of packaging (Hsieh and Yin 1998). Eventually, in 1992,
the labels were changed to include six rotating warn-
ings communicating more specific information about
Ihe hazards of smoking.

  The dispute over the Smoking-Hazards Pre\:en-
tion Act, introduced in 1991 \z.ith the stated aim of pro-
tecting the public health by pre\,enting and controlling
damage from tobacco products, \vas even more COP
tcntious (GAO lYY2). The aim of the act \yould be ac-
complished by prohibiting smoking bv those under
IS vears of age, banning \w~ding machine sales of to-
bacco products, limiting the tar and nicotine content
of all cigarettes, rquiring that the packaging of all to-
bacco products include not only health warning labels-
but also tar and nicotine content in Chinese, and ban-
ning all tobacco aj\.ertising and certain other promo-
tional activities. The act \vas immediately challenged-
by the U.S. Trade Representative as a unilateral \,iola-
tion of the 1986 agreement that allowed U.S. cigarette
companies to ad\,ertise in Taiwan (GAO 1992). Sesser
(lY93) reports that a confidential position paper drafted
by the U.S. Trade Representative in January 1992 stated
that the proposal was an attempt to protect the Tai-
ilanese cigarette monopolv from foreign competition
and that the various measures proposed would have
little impact on smoking. In July 1993, the Clinton
administration's US. Trade Representative, Michael
Kantor, stated that his office would not challenge the
act if it was enacted (Sesser 1993). Six years after its
introduction, the Smoking-Hazards Preirention Act l\.as


finall\- enacted j\,ith compromise clauses that permit
cigar&e ad\,ertising in magazines (Hsieh and l'in 19YS).

South Karen

  South Korea's Tobacco & Ginseng Corporation
controls all aspects of that countr\,`s tobacco grn\\-ing
and production, l\.hich hacl traditionall\, been prw
tected bv high tariffs imposed on foreign cigarettes.
In lY82,-South Korea enacted and aggressi\.elv en-
forced legislation making it a criminal offense t(, sell,
bu),, or possess foreign cigarettes (Edd!, and Walden
lYY3). Beginning in 1987 , almost all cigarette ad\.er-
tising and other promotional activities \j.ere banned
b!. the Tobacco Monopol?. Act. After petitioning b!z
the U.S. Cigarette Export Association in Januarl. 1988,
the U.S. Trade Representati\.c in\.estigatcd these prac-
tices. In response to the threat of retaliator\, sanctions
on South Korean textile eNports to the United States, a
Record of Understanding \~as signed hi. the t1x.o coun
tries in May lY88. This agreement opened South Ko-
rt'an cigarette markets to C.S. firms b\. eliminating the
ban on the sale of foreign cigarettes, I-educing tlic tar-
iff on imported cigarettes, alIn\\-in g tht> distribution of
free samples, and allolviii s some print acl\-ertising of
cigarettes and the sponsorship of sporting e\wits. The
agreement also prohibited ad\-ertising that targeted
\vomen and voung people (smoking is prohibited in
South Korea-for persons under 30 wars of age). Fi-
nall\J, all cigarette packagin g and niagazine ad\.ertis-
ins i\.ere required to include a health \\.arning label.
  Although cigarette smoking had been increasing
steaclilv in South Korea during the 19X&, the rate of
oroiztl; in smoking more than tripled ~vhen cigarette
h
markets M'ere opened to foreign competition (Roemer
1993). Much of the increase appeared to have been the
result of dramatic increases in smoking pre\.alence
among voung people. From 1988 to 1989 alone, smok-
ing pre\,alence among male teenagers rose frotll I8 to
30 percent, and smoking pre\.alence among female teen-
agers increased from 2 to 9 percent (Sesser 1993). hluch
of the increase in consumption \~as accounted for bv
the increased use of imported cigarettes. Import share
in the market rose from 0.06 percent before the agree-
ment to nearlv 8.5 percent in 1993 and continued to in-
crease steadilv (U.S. Department of Commerce, Tobacco
Export Task Force Analvsis, unpublished data, No\.em-
ber 13,1995). Part of th; increase mavbe attributable to
an increase in adjrertising bv U.S. cigarette companies
in South Korea after the liberalization of cigarette trade.
In late 1988, South Korea passed the Tobacco Business
Act (effective January 1, 19891, xl-hich limited ad\,er-
tising and promotional efforts to p"int-of-yurchasc

ad\-crtising, magazine adlrertising, and sponsorship of
public e\.ents (GAO 1992). In 1991, the Korea Tobacco
Association (comprising the U.S. Cigarette Export As-
sociation firms and the Korean tobacco monopoly) out-
lined a self-regulating voluntary marketing agreement
to comply \vith the Record of Understanding and the
Tobacco Business Act.

  Ne\,erthelcss, the South Korean government in-
dicates that some promotional activities of U.S. ciga-
rette companies \,iolate the spirit of the Tobacco
Business Act. These allegations concern distribution
of free cigarettes, advertising placement for televised
c\.t`nts sponsored bv U.S. tobacco firms, the distribu-
tion of nontobacco. "gifts" bearing company trade-
marks, r7nd the targeting of youth. Although no formal
actions related to these I,iolations were initiated, the
Koreans did begin renegotiating the Record of Under-
standing i\,ith the United States in 1995. In August
lYY'i, the UniteJ States government agreed to modify
the market access agreement \\rith the Koreans to al-
ln\v them greater flexibilitv to impose nondiscrimina-
tnr!, health-based measures that restrict the use of
tobacco products, including limitations on tobacco
product ad~.ertising.

  Perhaps the most publicized and contentious
Section 301 dispute Ilas initiated by the U.S. Trade
Representati\-e in response to petitioning by the U.S.
Cigarette Export Association in April 1989 over
Thailand's \,irtual ban on the import of cigarettes and
complete ban on cigarette ad\,ertising and other pro-
motional activities in that country. The complaint cited
\-arious restrictions on the importation and sale of ciga-
rettes and referred to discriminatory duties and taxes
on cigarette imports (GAO 1992). `All aspects of the
domestic tobacco markets in Thailand are controlled
by a go\.ernment-run monopoly, which stopped its
0w.n cigarette advertising and promotion in April 1988.
Ho\j.ever, foreign companies continued their activities,
\vhich prompted a total government ban on cigarette
ad\,ertising in Thailand in February 1989. The formal
investigation began in May. After no agreement could
be reached, the U.S. Trade Representative consented
to submit the complaint to the GATT dispute resolu-
tion process.

  The panel created by GATT investigated the U.S.
complaint that the import barriers and advertising
restrictions lvere a \riolation of the international
agreement's principles.  In October 1990, the GATT
Council sustained the panel's recommendations and
ruled that the ban on imports \\.as a \.iolation of the


GATT treaty. However, the council upheld the high
Thai cigarette excise taxes (applied to both domestic
and foreign cigarettes) and the right of the government
to restrict the overall supply of cigarettes. Regarding
the Thai advertising ban, the council noted that GATT
allows member nations to use lrarious policies to pro-
tect public health if the policies are applied to both
domestic and foreign products. A cigarette advertis-
ing ban that made it difficult for new foreign firms to
compete with existing domestic firms was ruled justi-
fiable under the treaty, because alloying advertising
could stimulate the demand for cigarettes, particularly
among youth (Contracting Parties to the General
Agreement on Tariffs and Trade 1991; Roemer 1993).
This decision teas based on Article XX of GATT, which
states that:

Subject to the requirement that such measures are
not applied in a manner which p1-ould constitute a
means of arbitrary or unjustifiable discrimination
between countries where the same conditions pre-
vail, or a disguised restriction on international
trade, nothing in this Agreement shall be construed
to prevent the adoption or enforcement by any
contracting parties of measures necessary to
protect human health [or] necessary to secure
compliance with 1aM.s or regulations which are not
inconsistent with the provisions of this Agreement.

  The GATT ruling led to an agreement in No\,en-
ber 1990 betlveen the Cnited States and Thailand that
allowed the importation of U.S. cigarettes into Thai-
land. Imported cigarettes were then subject to the same
laM-s and regulations as those marketed by the Thai
Tobacco Monopoly (GAO 1992). Thus, U.S. cigarettes
would be taxed the same and subjected to the same
supply restrictions, and the adlpertising and promo-
tion of these cigarettes (including the use of cigarette
company logos, trademarks, and other symbols on
nontobacco products) \vould be prohibited. The Thai
government, however, has indicated that U.S. cigarette
companies have tried to circumvent the ban on pro-
motional activities bv tactics such as sponsoring sport-
ing events and placing cigarette logos or symbols in
televised programming. No formal complaints ha\,e
been filed.

  After its SLICC~SS in upholding the ban on adver-
tising and promotion, the Thai government in 1992
enacted two la\vs restricting smoking: the Non Srnok-
ers Health Protection Act and the Tobacco Products
Control Act. The first act restricted smoking in desig-
nated public places. The second \vas a comprehen-
sive act that required that all tobacco products disclose

their ingredients, allowed the Ministry of Public Health
to determine all aspects of labeling, including health
warnings, and banned the following: smoking by
those under 18 years of age (imposing fines on viola-
tors); vending machine sales; distributing free samples,
exchanges, and gifts of cigarettes; tobacco advertising
(including, under the Thai definition of advertising,
the use of cigarette logos and other symbols on
nontobacco products) except in international maga-
zines and live telecasts originating outside Thailand;
advertising products with the same name as tobacco
products; producing, importing, advertising, and sell-
ing products imitating tobacco products; and selling
cigarettes not complying with th? labeling provisions
(Roemer 1993).

  The cigarette trade agreement that opened the-
Thai cigarette market to US. firms has led to a rise in
imports from less than 1 percent of the market before-
the agreement to about 4 percent in 1993. Because of-
current trends, this change is likely to increase sub-
stantially in the future (e.g., U.S. cigarette exports to
Thailand rose by more than 56 percent from 1992 to
1993). Part of the increase may be the result of in-
creased smoking prevalence among women and young
people in Thailand (USDA 1994a).

Multinational Trade Agreements

The North American Free Trade Agreement

  In 1993, the United States approved the North
American Free Trade Agreement (NAFTA), a compre-
hensive agreement that eliminated most of the barri-
ers to trade between the United States, Canada, and
Mexico; implementation began January 1, 1994. This
agreement further reduced already low trade barrier:
betrveen the United States and Canada resulting fron
an earlier free trade agreement. More important, the
nect agreement substantially reduced existing trade
barriers between the United States and Mexico b)
eliminating all nontariff barriers to trade and by phas-
ing out most tariffs. Mexican tariffs on U.S. tobaccc
and tobacco products were initially set at 50 percent
the 1998 rate was 25 percent. Supporters of the agree
ment argued that it would lower prices, lead to a ne
increase in jobs (particularly in export industries), ant
spur economic growth in all three countries. Oppo
nents countered that U.S. firms would have an incen
tive to shift production to Mexico to reduce labor ant
other operating costs, thereby leading to a net reduc
                       -
tion in C.S. employment.


  Before the agreement, some trends in tobacco
production in the United States, Canada, and Mexico
\vere similar. Total tobacco production and acreage
de\.oted to tobacco grooving in 1990 lrere rvell belo\\
their 1981 levels in all three countries, but doIvnlvard
trends in the United States had reversed b\r 1987. Sim-
larl"; in recent years, tobacco production in Mexico has
been expanding (USDA 1997cl). During the 1980s and
earlv 199Os, cigarette consumption fell sharplv in both
the United States and Canada but rose in Mixico. At
least part of the increase in the Mexican demand fnt
cigarettes resulted from increases in income, \vhich
contributed to a shift to the consumption of higher-
quality cigarettes among Mexican smokers (USDA
1992). Since 1991, ho\Vel.er, cijiarettc imports into
Mexico have fallen as consumer purcliasins po\\.t't
declined; no imports \vere expected in 19% (USDA
1997d).

  Trade in tobacco among the three countries \vas
relati\,elv limited before the agreement. Mesican e\-
ports of iobacco to the United States I\-ere about 3 per-
cent of total esports, or less than 2 percent of total U.S.
tobacco imports. Similarly, less than 1 percent of L.S.
tobacco imports came from Canada, and about 7 per-
cent of U.S. tobacco exports event to Canada. Finally,
almost no tobacco \vas exported from the Cnited States
to Mexico (USDA 1992).

  Trade in tobacco products (mainly cigarettes) \j.as
even more limited before the agreement. In 1990, just
over 0.1 percent of total U.S. cigarette exports \Vetit to
blexico, and only 0.07 percent \2-ent to Canada. Simi-
larly, there \vas no trade in cigarettes betlveen Canada
and Mexico. The only exception \vas for exports of
cigarettes from Canada to the United States, ~~hich
\vere almost 64 percent of total Canadian cigarette ex-
ports and almost 20 percent of total Canadian produc-
tion (USDA 1992). However, as is discussed later in
this chapter (see "International Tobacco Taxes"), most
of these cigarettes M'ere reintroduced into a Canadian
black market to evade the significantly higher Cana-
dian cigarette taxes (Sweanor and Martial 1994).

  Because of the earlier free trade agreement be-
tween the United States and Canada, NAFTA does not
appear to have had a significant impact on trade in
tobacco and tobacco products between the tw.0 coun-
tries. If anything, the reduction in Canadian cigarette
taxes in 1994 has led to a substantial reduction in Ca-
nadian cigarette exports to the United States, as the
smaller differential in cigarette prices reduced the in-
centive to export cigarettes to the United States for
bootlegging back into Canada.

  The agreement's elimination of Mexican import li-
censes on tobacco and cigarettes, and gradual reduction

in Mexican tariffs on tobacco and tobacco products,
holyever, \vere expected to increase Mexican imports
of both flue-cured and burley tobacco as well as ciga-
rettes from the United States (USDA 1992). The elimi-
nation of U.S. tariffs on Mexican tobacco and the
impro\.ed quality of this tobacco wrere also expected
to result in increased Mexican tobacco exports to the
United States. I'ri\,atization of the unmanufactured
tobacco industry in Mexico, however, has changed the
nature of the industry and has led to an improvement
in the quality of Mexican leaf tobacco (USDA 1997d).
The slog\- elimination of tariffs and the improved qual-
ity of domestically grobvn tobacco, coupled with the
decline in the \-alue of the peso, appear to have lim-
ited the impact of NAFTAon trade between the United
States and Mexico in tobacco and tobacco products.
This ma\ change, ho\\-e\-er, as tariffs are further re-
duced and, el,entually, eliminated and if the peso con-
tinues its recent strengthening against the dollar.

  This latest GATT agreement, which concluded in
April 1991, in\rol\,ed 117 countries, and many other
nonmembers have agreed to abide by its provisions.
Formal appro\.al of the agreement by the U.S. Con-
gress came at the end of 1994.

  Se\,eral basic principles are outlined in GATT: a
commitment to achieving free trade by limiting and
eventually eliminating tariff and nontariff barriers to
trade, the notidiscriniinator); application of any restric-
tions on trade to all member countries, the compensa-
tion of trading partners for any damages resulting from
changes in trade barriers, and the negotiated settle-
ment of any trade disputes through an orderly pro-
cess rather than through retaliation. However, GATT
has had no enforcement power.

  Since the conclusion of its first round in 1947,
GATT has led to sharp reductions in tariffs and other
impediments to trade in manufactured goods. Before
the most recent round, GATT had not been applied to
trade in agricultural commodities or services. The 1994
Uruguay Round, however, significantly expanded
GATT's coverage to include trade in agricultural prod-
ucts, ser\,ices, and more. Moreover, the new agree-
ment created the World Trade Organization, a
permanent forum for GATT members to address trade-
related issues among member countries. This forum
strengthened GATT's ability to resolve trade disputes.

  Supporters of the GATT treaty have argued that it
Lvill lead to a substantial increase in world trade to the
economic benefit of all countries inv-olved. For example,
President Bill Clinton stated in the introduction to the


L~LI~LI~!. Round .~gret~niciits .,\ct that the treat), ~\.htw
fullv implemented, ~~.ou]d add 5100-X1(1 billion to the
L.Sl econoni\. annuall\, and \j,ould create hundreds of
thousands of ne\v jobs.  He \\-ent 011 to note tll`lt be-
cause the United States is the \rorld's largest trading
nation, it \VOLII~ be the biggest bencficiari~ of the treat\
CC .S. Congress 1 YYl).

  The Urugua!, Round of GATT \j'as expected to
benefit the U.S. tobacco industry by reducing the his-
torically high tariffs on tobacco and tobacco products
imposed in numerous countries and bv reducing other
lvidelv used nontariff barriers to trad-e. For example,
the European Communitv \\uLII~ reduce tariffs on ci-
gars by 50 percent, tariffs & cigarettes and other manu-
factured tobacco products bv 36 percent, and tariffs
on unmanufactured tobacco bv 20 percent, and the
Philippines \\.auld reduce tariffs on leaf tobacco, ci-
gars, and cigarettes bv 10 percent (USDA 1YWb). Sim-
larlv, foreign access to U.S. markets \\.ould rise, as U.S.
tariifs on cigar lvrappers lvould be eliminated. At the
same time, U.S. tariffs on cigar filler and binder to-
bacco, cigars, and most cl+
              `crirettes 1~0uld be reduced
by JS percent; tobacco stems and refuse LX, 20 percent;
and other unm~~nuiacture~l toL?acco and smoking to-
bacco bv 15 percent (USDA 39Y4b).

More important, Section 472 of the Lrugua!,
Routid Agreements Act allon.ed the President of the
United States to \\.ai\.e Section I lOri(a) c)f the Omnibus
Budget Reconciliation Act of lYY3 if he determined that
this action \vas necessarv or appropriate to conipl\~
\t.ith international trade aqeements that include thi>
United States. As noted pre\.iousl>., the IYY3 lcgisla-
tion recluiring that cigarettes manufactured in the
United States include a minimum of Z percent dc)-
niesticall\, gro\\`n tobacco or face penalties \\.a.5 \\.ai,.ed
b>, President Clinton's tariff rate-quota proclamation
in September 199-I.

   The redactions in t~~bacco-rcl`ite~l trade barriers
achie\.ed in the Uruguay Round appear to ha\.e had a
dramatic impact on global trade in tobacco and tobacco
products (Chaloupka and Corbctt IYY8). From IYW to
1997, for example, there \~as a 12.5percent increase in
unmanufacturecl tobacco exports globall\~, follows ing a
decade of almost no grol\.th; similarli; global cigarette
exports rose bv 12 percent from 199.3 to I YYh, l\Iiile glo-
bal cigarette c&sumption rose by, 5 percent (Chaloupka
and Corbett 1998). As discussed pre\~iousl~~, ho\Ve\,er,
the GATT Council's resolution of the tobacco-related
dispute bet\\-een Thailand and the Cnited States clearl\*
indicates that the adoption and implementation of
strong tobacco control policies aimed at improving
public health is consistent L\.ith the liberalization of
trade.

Discussion and Recent Developments

  The threat of retaliatory trade sanctions undel
Section 301 of the Trade Act of 1974 has successfu]]\-
opened some foreign markets to U.C cigarette manL]-
facturers, thereby significantly expanding trade in to.
bacco products between the United States and these
countries. Chaloupka and Laixuthai (1996), in their
empirical examination of these agreements, concluded
that the market share of L.S. cigarette companies in
the affected countries 1~2s 600 percent higher, on a\.-
erage, in 1991 than it should have been in the absence
of these agreements. More important, they concluded
that o\.erall cigarette smoking rose as a result of the
Section 301 agreements. Chaloupka and Laixuthai
(I 9%) estimated that per capita cigarette consumption
in 19Yl \vas 10 percent higher, on al'erage, in the four
countries than it should ha\,e been had the markets
remained closed to U.S. cigarettes. They attributed the
increase in smoking to gwater competition in the cig-
rette markets, resulting in 1oIrer cigarette prices and
increased cigarette ad\,ertising. In addition, they pre-
dieted that similar actions in other historically clowd
countries ~~-0uld lead to similar increases in cigarettt
smoking:.

  SimilarI>., the imylemcnt~itioli of multinationa
algrwnients liberalizing trade, including trade in tr>
bacco and tobacco products, is likely to further increase
L`.S. clports of tobacco and tobacco products to COLIU
tries around the \\wrld. A probable consequctic~~ 0
this incrt>ase is that the prices of cigarettes and othe
tc>bacco products \\.ill fall as trade barriers are reduce-c
or eliminated and competition is enhanced. As is di\
cusst~l in dt,tail later in this chapter (see "Effect of Prim4
on Demand for Tobacco Products"), reductions in prier
\\.ill stimulate the uw of cigarettes, particulnrl\r ~llll~i~l~
`lclolt+xcYlts `17ld \ oun g adult5 Bcc~lLlse ot the sLlL~~t<lll
tial health cons~equences associated \\,ith cigirctts
smoking, one likelv result of the increased liberalija
tion (IF trade in tobacco and tobacco products, then, i
;1 global increase in rnorbiditv and mortnlitv related Ii
cigarette smoking and other tobacco use. Recent ehtj
mate5 confirm the relationship betn-een trade liberal
i/ation and tobacco ~1st'. Tavlor and colleagues (i
press) conclude that reductions in trade barriers SIC-
balls ha\.e led to increased tobacco use, kvith tht, lars
est impact in lore- and middle-income countries.

  The apparent conflict bct\\feen some L'.S. politic
that promote free trade and help U.S. firms enter f01
eign tobacco markets and other U.S. policies that bnt
discouI-alge smoking; domesticallv and support intern;
tional efforts to reduce tobacco ~7se has been descriLw
in tl\-o GAO reports. The reports \\`ere completed `


.  Rather than ha\-ing one polic!. dominate, Congress
could require that health matters be included in
the tr;tcle police process through the participation
  of the LSDHHS so that these issues could be con-
  sidered case b\, case.

  Se\,rral factors indicate that the apparent cli-
~hotomy bct\veen trade and health policy is changing
in fa\.or ot' the third approach suggested bv the GAO.
For example, in 1989 d bill \\.dci introducecl 111 Congress
to (I) require U.S. cigarette firms in foreign markets to
operate under the same ' :guidelincs as the\. do in do-
mestic markets, (2) mandate health learning labels on
all exported tobacco products, and (3) sti-oiigl>~ discour-
dge the esecuti\.c branch from assisting U.S. tobacco
conipan\i efforts to open forei,
                   `~711 tobacco mdrket5
t Knenier~ lYY3J. Later that \sear. as ;I result of the U.S.
Trade Reprewnt,lti\ c'\ in\ cstigdtion ot Thdil~iiid'~
trdde practices, `3 public hedrin, l' 011 the i`l5C' L\ `15 IlCld

Sumerous congressmen, public health officials, and
others (including former L;.S. Surgeon General C.
E\,erett Koop) testified against tobacco-related U.S.
trade policies (Eddy and Walden 1993). Although nei-
ther effort Leas successful (the bill did not pass, and
the hearing produced ii0 change in trade policy), both
linhcd the issue vf the health consequences of tobacco
LIW to U.S. trade polis\,. The 1990 GAO report, for ex-
Ll~npl~, \\.as the direct ;csult of the failed 1989 bill.

  More rcientlv, interagencv discussions betlveen
the cjtfic`e of the U.S. Trade Ripresentative and offi-
ci,jls from the USDHHS ha\,e pursued the harmoniza-
tion of trade and health policv Lvhile representatives
tram the LSDHHS ha\ e participated in recent nego-
tiations \\.ith T;lii\-an, South Korea, and others concern-
in;: cigart>ttc trade issues (Holzman 1997). Moreover,
the U.S. Trade Reprtsentati\~c has shown greater sen-
siti\ it\, to public health concerns and has not opposed
nr,nililcrimin~t~~r~, tobacco control legislation in other
c~~untrics (Bloom .I YYX; National Cancer Policy Board
IYYS). This position has been formalized as pait of the
Doggt'tt Amendment to the Department of Commerce
and Relattd Aseiicies Appropriations Act, 1998, that
allo\\,s for the uw of Section 301 ill \`ery limited cir-
cumst,inces. Specifically, the Doggett Amendment,
spconsored b\, Lloyd Doggett (D-TX), states that:

None of the funds pro\icled bv this Act shall be
a\.ailable to promote the sale or export of tobacco
or tobacco products, or to seek the reduction or
remo\-al by anv foreign country of restrictions on
the marketing of tobacco or tobacco products, ex-
ccpt for restrictions \1.hich are not applied equally
to all tobacco or tobacco products of the same type
(Public Lar\~ 105119, Section 61X).

Similar glidelines rz.ere Distributed by the Clinton
administration to all diplomatic posts in February 1998.
These guidelines state that:

In light of the serious health consequences of to-
bacco use, the U.S. Government \vill not promote
the sale or export of tobacco or tobacco products
or seek the reduction or removal by any foreign
country of iiondisci~iiiiiiiator~ restrictions on
the marketing of tobacco or tobacco products. At
the same time, the U.S. Government will continue
to seek elimination of discriminators trade prac-
tices and lvill stri1.e to ensure that U.S. firms are
accorded the same trcatnient in fowign countries
~5 that countrv's o\vn firms and firms from other
countries (The National Economic Council and
The N~ltion,ll Styurit\. Council of the White House,


Final Guiclelincs on IHealth, Trade, and Commer-
cial Issues, facsimile transmission to all diplomatic
and consular posts, February 16, 1998).

Moreo\,er, as part of the guidelines, U.S. diplomatic
"posts are encouraged to assist and promote tobacco-
control efforts in host countries."

  Several important issues remain unresolved.
Perhaps most important is the opening of Chinese ciga-
rette markets to U.S. and other multinational tobacco
companies as part of China's World Trade Organiza-
tion accession. With more than 300 million cigarette
smokers (67 percent of men but only 7 percent of
lvomen), China is a particularly attractive market for
international cigarette producers. In recent years, U.S.
and other multinational tobacco companies have en-
tered the Chinese tobacco markets through joint ven-
tures with the Chinese government's tobacco
monopoly, the China National Tobacco Corporation
(Holzman 1997).

Economic Impact of the U.S. Tobacco
Industry

  Tobacco grooving played a key role in the devel-
opment and groll-th of the U.S. economv. Throughout
much of the 20th century, holve\,er, the-importance of
tobacco to the overall economy has diminished sig-
nificantly, although its regional and local importance
in some areas remains high.  Several recent studies
provide more detailed c\.idence concerning the eco-
nomic importance of tobacco to the U.S. economv.

A recent study by American Economics Cr&p,
Inc. ([AEG] 19%), lrhich i1.a~ funded bv the tobacco
industry, provides some information concerning the
impact of tobacco on the U.S. economy in 1994. The
report updates similar pre\,ious reports by other firms,
including that by Price Waterhouse (lYY2). AEG di-
vided the macroeconomic effects of tobacco into those
affecting the core sector, \\,hich includes tobacco pro-
duction and distribution, and those affecting the sup-
plier sector, ivhich consists of industries producing and
distributing intermediate goods for the core sector (in-
cluding the goods and services used in cigarette prc>-
duction). The analysis also separately considered
expenditure-induced impacts, Lvhich depend on the
multiplier effects associated with spending by those
in the core and supplier sectors, and tobacco-related
tax revenues, including those raised by tobacco taxes,
general sales taxes on tobacco products, and income
and other taxes on tobacco industrv emplovees and
firms. The studv estimated that in 1494, mori than I .8

million persons were employed, earning $54.3 billio
in wages and benefits, as a result of the tobacco busj
ness in the United States. Total estimated tax revenue
from tobacco were almost $36 billion in 1994. The rt
port concluded that tobacco made a significant contr
bution in every state and the District of Columbia.

  Several recent studies, however, have indicate,
that these estimates significantly overstated the ccc
nomic impact of tobacco on the U.S. economy. At th
request of the Coalition on Smoking OR Health (CSH
Arthur Andersen Economic Consulting (1993) rc
viewed the Price Waterhouse estimates for 1990. The
concluded that, as a result of several methodologic:
flaws, the Price Waterhouse "employment and job lo:
figures are grossly inflated" (p. 1). For example, of th
681,351 jobs Price Waterhouse attributed to tobacco i
its core and supplier sectors, only 259,616 were direct1
related to tobacco growing, manufacturing, warehou:
ing, and wholesaling. Of the difference, 166,791 wer
retail jobs and 254,944 were supplier jobs, most of whit
Lvere not devoted full-time to tobacco. Thus, statin
that these jobs depended on tobacco was inaccurate.

  Other studies questioned the Price Waterhous
assumption that every one job that is dependent o
tobacco creates, through the multiplier effect, an add
tiona12.35 jobs throughout the economy. This assume
effect would result because those who purchase tobacc
products would generate income for those who produc
and those who distribute tobacco, who in turn woul
spend this income on other goods and services-thereb
generating income for others, as this effect spread eve
further. Warner (1994) and Arthur Andersen Econom
Consulting (1993) noted that this multiplier effect
likely to significantly overstate the impact of tobaccf
because it implicitly makes the incorrect assumptio
that money spent on tobacco would not be spent else
Lvhere in the absence of tobacco. Instead, those func
not spent on tobacco would be spent on other gooc
and services, creating jobs and generating income th;
~rould also be spent.

   Warner and Fulton (1994) addressed these issue
by using a macroeconomic model to consider the nl
impact of tobacco on the economy of one state, Mich
gan. The Price Waterhouse study had estimated thi
direct tobacco-related employment in Michigan w:
7,721 in 1YYO and that all tobacco-related employmel
in Michigan totaled 69,575. Warner and Fulton (198
estimated that in 1992 in Michigan, 7,843 jobs direct1
depended on tobacco but that only an additional 11,28
jobs lvere either indirectly related to tobacco or induce
by spending from those whose jobs were dependeI
on tobacco. (This estimate for indirect tobacco-relate
jobs did not consider [as the Price Waterhouse estimai


did] the impact of income deri\,ed from tobacco pro-
duction and distribution in the rest of the nation and
spent on products produced in Michigan.) These re-
searchers further estimated that, in the absence of to-
bacco, total employment in Michigan should ha\.e risen
b!, about 5,600 because of a redistribution of spending
aLcay from tobacco products to other goods and ser-
I-ices, including those more integral to the Michigan
economv. As a result of the changes in employment,
total incbmes in Michigan ~\fould have been $226 mil-
lion higher in 1992 in the absence of tobacco. This
amount resulted not only from incomes associated
xvith nelv jobs but also from higher incomes for those
\lith existing jobs (in part because of a change in job
mix from lolver-income to higher-income jobs in the
absence of tobacco).

  Warner and colleagues (1996) extended this
analysis to examine the impact of tobacco on the re-
gional economies of the United States. The research-
ers examined the effects of reducing or eliminating
domestic expenditures on tobacco on nine regional
economies (the eight regions defined bv the L'.S. Dc-
partment of Commerce, Bureau of Economic Anal\,-
sis, subdi\.iding the Southeast into tit-o parts based on
tobacco grooving and producing). The\, estimated that
the elimination of spending on tobacco products in
1993 IVould ha\,e led to 303,000 fexver jobs in the South-
east tobacco region, 12-bile increasing jobs in all othci
regions bv about the same amount. B\, the \`ear 2000,
they estimated that, under this scenario, the ioss in jobs
in the tobacco region ~~ould fall to about 222,000 as
the regional economy adjusts, \Vhile the net impact
nationally \vould be an increase in jobs of 133,000. A
more realistic scenario-one that doubles the recent
rate of decline in tobacco use-is estimated to ha1.e
smaller effects on employment. Warner and colleagues
(1996) estimated a loss of 36,600 jobs in the tobacccl
region by the year 2000, an amount equal to 0.2 per-
cent of total regional emplovment. They concluded that
the industry's claims concerning job losses resulting
from reduced tobacco use are significantly overstated
and that the impact of tobacco on employment should
not be a primary concern, given the magnitude of the
toll it takes on health.

  The AEG and Price Waterhouse reports \vere lim-
ited also because thev presented static estimates of the
economic impact of tobacco (Arthur Andersen Economic
Consulting 1993). That is, the reports ignored underly-
ing trends in the domestic demand for cigarettes, trends
in the import and export of tobacco and tobacco prod-
ucts, and changes in agricultural and manufacturing
technologies that themselves are reducing employment
in tobacco grooving and manufacturing. Warner and

Fulton (199-I) considered these factors by predicting the
net impact that eliminating tobacco-related revenues
t~,ould have on the Michigan economy if existing down-
\\,ard trends in tobacco sales continued: by 2005, the
loss of re\`enue from tobacco in Michigan would yield
a net gain of 1,500 jobs in the state.

   A similar issue was considered in two recent re-
ports of the USDA (1993, 1997~). The reports noted
that the large declines in tobacco production through-
out the 1980s had a relatively minor impact on the
macroeconomics of major tobacco-growing regions.
Indeed, total personal income, adjusted for inflation,
gre\l- bv 13-57 percent from 1979 through 1989 in the
nine major regions analyzed; the average growth in
all U.S. tobacco-grooving counties was 28 percent
(USDA 1993). This phenomenon M'as attributed to the
relatil-elv small share of tobacco in these diverse re-
gional economies (on average, less than 1 percent of
total income ivas accounted for by tobacco in tobacco-
cTro\\.ing counties). E\,en though acreage devoted to
b
tobacco grooving has declined over time, rising prices
ha\,e helped to keep gross income from tobacco grow:-
in;: relati\.clv stable, lvhile clearlv reducing the share
of tobacco iti local economies (USDA 1997~).

  Critics of higher cigarette excise taxes and other
policies to reduce tobacco USE have argued that the
ni~lcroeconomic consequences of these policies would
be significant, particularly for some state and local
economies. For example, economist Dwight R. Lee
predicted that the 75-cent increase in the federal ciga-
rette excise tax included in the proposed 1993 Health
Securitv Act should lead to a loss of about 82,000 jobs
and 51 .G billion in incomes in the tobacco sector, which
\j-ould cause an additional loss of 192,000 jobs and an
attendant loss of income throughout the economy (U.S.
House of Representatives 1994). He further noted that
southern states lvould be particularly hard hit by this
tax increase.

  Similar arguments, based on the AEG and Price
Waterhouse analvses, were made in the recent debate
over proposed national tobacco legislation. For rea-
sons noted pre\Tiously, predictions based on these es-
timates are almost certain to substantially overstate the
effects of higher tobacco taxes and stronger preven-
tion policies on the U.S. macroeconomy. As discussed
previously, Warner and colleagues' (1996) regional
analysis of the economic role of tobacco concluded that
tobacco has a negative net economic impact in all
but the most tobacco-dependent region. Thus, it ap-
pears inappropriate to raise concerns about adverse
economic impact in opposing policy measures that
~~~ould cliscourage tobacco use.


  Moreo\w, nidn\. supporters ot legislation calling
for increases in the ciiarettc excise ta\ ha\ e urged that
measures be included to mitigate the p<wiible ad\.erse
economic impact of the higher taxes for tobacco-
producing regions. For example, Richard J. Durbin
(D-IL) suggested that part of the re\`enues from higher
cigarette excise taxes could be earmarked for efforts
to help tobacco farmers srz,itch to other crops, thereby
easing the transition for tobacco-producing regions.
Likewise, the CSH (1993) recommended that a portion
of new tobacco tax revenues be earmarked for buying
out tobacco allotments, constructing infrastructure and
modernizing equipment for agricultural di\rersifica-
tion, and stimulating economic de\.elopment in areas
relative117 dependent on tobacco. Similarly, President
Clinton ialled for assistance for tobacco farmers and
their communities to be included in any tobacco legis-
lation sent to him (USDA 1998a).

  A final objection to the AEG and Price Water-
house estimates is that thev failed to consider the health
and other consequences of cigarette smoking (Arthur
Andersen Economic Consulting 1993). In one sense,
they underestimated the economic contribution of
cigarette smoking. As Schelling (I%%) and Warner
(1994) note with some irony, the emplo\:ment figures
in these and other industrv-ful-tded studies do not

include the income that tobacco generates for health
care personnel, undertakers, and a variety of other per-
sons \t,hose jobs are related to the negative health con-
sequences of tobacco use; nor do these industr\;-
estimates include the considerable income derivei
from specifically smoking-related services, such as air
filtration systems. The total amount spent in the
United States to treat smoking-related illnesses has
been estimated to exceed the total amount spent on
tobacco products (Centers for Disease Control and-
Prevention [CDC] 1994; Warner 1994). Similarly, as
described in greater detail later in this chapter (ill-
"Estimates of the Costs of Smoking"), the Price-
Waterhouse study did not include other economic costs
associated kzith cigarette smoking, such as lost pro-
ductivity due to smoking-related morbidity and mor-
talitv. Finally, as Northup (1993) states, the Price
Wat&house estimates of employment dependent on
tobacco invite a disturbing comparison, for they im-
ply that "one person must die each year to sustain t\vo
jobs. Put another Ivay, at least twenty-two people must
die to support the forty-four year career of a [tobacco
industrv] employee. Surely, no one would argue that-
this is an acceptable trade-off. It is absurd for the to-
bacco industrv to use lost jobs as a rationale for not
sa\-ing li\.es" ip. X6).

Effect of Price on Demand for Tobacco Products

   One of the fundamental lades of economics is that
of the do\vnl\,ard-sloping demand cur\.c: as the price
of a product rises, the quantit): demanded of that prod-
uct falls. In the terminologv ot econonii5ts, this in\-erse
relationship arises from the process knoit-n as the
consumer's constrained utilitv maximization. That is,
r\.hen facing a gi\wi set of prices, consumerci 1%.ill trv to
maximize the benefits or satisfaction the\. recei\,e from
consuming, but these efforts are constrained L7\. the cow
sumers' available resources, including income and time.

  The demand for tobacco products is different
from the demands for most other consumer goods
because of the addictive drug (nicotine) found in these
products. The key implication that addiction has for
demand is that past consumption decisions \vill be
an important determinant of current choices.  For
example, to an addicted smoker, one of the benefits of
continued cigarette smokin g is a\.oiding nicotine

\\ithdrawal. In the past, many researchers vielbred ad-
dicti1.e consumption as an irrational behavior not cow
duci\.e to standard economic analysis (e.g., Elster 1979;
Winston 1980; Schelling 1984). This vierv implied that
the demand for addictive products, including tobacco,
did not tollol~ the basic la\~s of economics, including
that of the do\\.n\2,ard-sloping demand function that
ordinarily applies lvhen constraints (such as cost) are
raised against use. HovveL~er, as rvill be described late?
in this section, numerous studies of cigarette smoking
and other tobacco use, including several recent stud:
ies that explicitly account for tobacco's addictive na-
ture, find a strong inverse relationship betlveen price
and consumption.

  To economists, price includes not only the monc\r
price of purchasing a product but also the time and
other costs associated \vith buying and using that prod-
uct. Measures that limit minors' access to tobacco, for


example, may discourage underaged smoking by rais-
ing the time and potential legal costs associated bvith
obtaining these products. Similarly, sufficientlv strin-
gent restrictions on smoking in public places \~ill raise
the costs of smoking, M-hether by forcing people out-
doors if they want to smoke (thereby increasing time
and perhaps comfort costs) or by imposing fines for
smoking in restricted areas (thereby increasing money
costs).

  The health consequences associated M.ith ciga-
rette smoking are another important component of the
price of cigarettes. As consumers percei\.e greater
health risks from cigarette smoking, their demand for
cigarettes tends to fall. This effect is clearly seen in
the reductions in smoking prevalence and average
rigarette consumption that occurred soon after the re-
lease of the 1964 Surgeon General's report on smok-
ing and health, lvhich for the first time dre\\
r\-idespread public attention to the health problems
caused by cigarette smoking (U.S. Department of
Health, Education, and Welfare 1964). Thus, \vhen
economists and others studv the demand for tobacco
products, efforts are made to include not only mane!'
prices but also measures that reflect the other costs of
consuming these products.

  In addition to price, several other factors affect
the demand for any product. Disposable income,
for example, is an important determinant of demand.
In general, as income rises, so does consumption of
most goods. Economists define these goods as nor-
mal goods. Inferior goods, on the other hand, are those
for which demand falls as income rises. An indi\,i-
dual's tastes or preferences tvill also affect demand.
Because these tastes are difficult to observe and mea-
sure, certain sociodemographic characteristics are LISU-
ally included as proxies in studies of the demand for
tobacco. These characteristics include sex, ethnicity,
education, religious beliefs, marital status, and employ-
ment status.

  Finally, because the addictive nature of tobacco
use has been clearly documented, many recent stud-
ies of demand have tried to account for the effects of
past consumption on current consumption. Many of
these studies were based on a model that applies the
standard rational, utility-maximizing paradigm of eco-
nomics to the consumption of addictive substances
(Becker and Murphy 1988). This model explicitly rec-
ognizes the intertemporal links in consumption by
making current consumption decisions dependent on
past choices. The model thus incorporates the elements
of tolerance, reinforcement, and withdrawal, which
distinguish the consumption of addicti\,e from non-
addictive substances (LSDHHS 1988).

  Although many of the factors described in this
introduction have an important impact on demand,
the studies subsequently reviewed in this section em-
phasize the effects of money prices on cigarette smok-
ing and other tobacco use. In reviewing empirical
studies of the demand for cigarettes and other tobacco
products, this section focuses primarily on estimates
of the price elasticity of demand, which is defined as
the percentage change in consumption that results
from a l-percent increase in price. (An overall reduc-
tion in cigarette consumption comprises both a reduc-
tion in the number of cigarettes consumed by current,
persisting smok ers and a reduction in the prevalence
of smoking itself-which itself comprises both an in-
crease in smoking cessation and a decrease in smok-
ing initiation.)

  Numerous studies have estimated the price elas-
ticitv of demand for cigarettes. These studies used di-
\wse econometric and other statistical methods on
different types of data from many countries. Relatively
fe\\. studies ha\-e examined the demand for other to-
bacco products, and none have examined the effects
on brand choice of the price differentials between pre-
mium brands and the lower-price discount and generic
cigarettes.

Studies Using Aggregate Data

  Se\,eral studies of the demand for cigarettes in
the United States have used aggregate data (Table 6.7).
Some of these M'ere time series studies for the nation
as a tvhole or for geographic units (notably Califor-
nia). Others employed pooled cross-sectional time se-
ries data consisting of annual observations for some or
a11 states over time. Price elasticity (the percentage
change in the quantity demanded resulting from a
l-percent increase in price) estimates obtained from
recent studies using aggregate data fall in the overall
wide range of -0.14 to -1.12, but most of these estimates
are betr-2-een -0.3 and -0.5. Differences in the estimates
resulted from differences in theoretical and empirical
modeling, in the data employed, and in the economet-
ric and statistical methods used to analyze these data.

  All but two of these studies were econometric
studies that tried to control for other factors that could
affect the demand for cigarettes, including income,
socioeconomic and demographic factors, and exist-
ing policies for reducing tobacco use. The other two
studies (Baltagi and Goel 1987; Peterson et al. 1992)
used alternative quasi-experimental methods that
compared changes in cigarette consumption in states
with tax increases \vith those in states with no tax in-
creases; both studies obtained estimates of the price


Table 6.7. Recent estimates of the price elasticity of cigarette demand from aggregate data

Study

Advisory Commission
on Intergovernmental
Relations 1985

Estimated price
elasticity

   -0.45

Bishop and Yoo
1985

-0.45

Baltagi and Levin
1986

-0.14

Porter 1986

-0.27

Baltagi and Goel
1987

Seldon and Doroodian
1989

-0.56 (1956-1964)
-0.17 (1972-1983)

   -0.40

Seldon and Boyd
1991

Showalter 1991

-0.22 (short run)
-0.37 (long run)

-0.56 to -0.71

Simonich 1991

-0.37

Tegene 1991

-0.66 (1956)     Time series for United States, 1956-1985; Kalman
-0.15 (1985)     filter methods; allows change in elasticity over time.

Chaloupka and Saffer
1992

-0.28

Time series of state cross-sections, 1975-1985; two-step
endogenous law model; detailed modeling of short-
and long-distance smuggling.

Flewelling et al.
1992

-0.25 to -0.35

Peterson et al. 1992

-0.49

Comments

Time series of state cross-sections, 1981-1983;
ordinary least squares methods; detailed effort to
account for short-distance smuggling of cigarettes.

Time series for United States, 1954-1980; three-stage
least squares methods; simultaneous model of supply
and demand.

Time series of 46 state cross-sections, 1963-1980;
instrumental variables methods; partial adjustment
model used to account for habitual consumption.

Time series for United States, 1947-1982; two-stage
least squares methods; simultaneous model of supply
and demand.

Time series of state cross-sections, 1956-1983;
quasi-experimental methods.

Time series for United States, 1952-1984; three-stage
least squares methods; simultaneous model of demand
and advertising.

Times series for United States, 1953-1984; varying
parameter methods.

Time series of annual state cross-sections, 1956-1988;
simultaneous modeling of supply and demand with
addiction; detailed modeling of short- and long-
distance smuggling.

Quarterly time series for United States, 1960-1983;
two-stage least squares methods.

Quarterly time series for California, 1980-1990;
ordinary least squares and ridge regression methods.

Time series of state cross-sections, 1955-1988;
epidemiologic approach.


Table 6.7. Continued

Study

Keeler et al. 1993

Becker et al. 1994

Harris 1994

Hu et al. 1994

Sung et al. 1994

Barnett et al. 1995

Goel and Morey 1995

Hu et al. 1995b

Moore 1995

Tremblay and
Tremblay 1995

Yurekli and Zhang 2000

Estimated price
elasticity

-0.3 to -0.5
(short run)
-0.5 to -0.6
(long run)

-0.36 to -0.44
(short run)
-0.73 to -0.79
(long run)

-0.47 (1493)

-0.39 (long run)

-0.40 (short run)
-0.18 (long run)

-0.76 to -1.12

-0.28 to -0.37

-0.30 (state tax
elasticity)

Not applicable

-0.41

-0.48 to -0.62

Comments

Monthly time series for California, January 1980-
December 1990; detailed modeling of addiction; full
information maximum likelihood with instrumental
variables and correction for autocorrelation.

Time series of annual state cross-sections, 1956-1985;
instrumental lpariables methods; detailed modeling of
short- and long-distance smuggling and addiction.

Annual time series for United States, 1964-1993;
separate modeling of smoking participation and
average consumption; controls for changes in average
nicotine deliverv per cigarette.

Monthly time series for California, January 1984-
December 1991; intervention analysis.

Time series of annual state cross-sections for 11
ivestern states, 1967-1990; recursive model of supply
and demand M.ith addiction; generalized least squares
methods correcting for heteroscedasticity and
autocorrelation.

Annual time series for United States, 1955-1989;
simultaneous modeling of supply and demand.

Time series of annual state cross-sections, 1959-1982;
joint demands for cigarettes and alcohol; accounts for
addiction.

Quarterly time series for California, 1980-1992;
autoregressive moving-average time-series methods.

Time series of annual state cross-sections, 1954-1988;
reduced form estimates of impact of cigarette taxes on
various smoking-related mortality rates.

Annual time series for United States, 1955-1990;
simultaneous modeling of supply and demand.

Time series of annual state cross-sections, 1970-1995;
detailed modeling of smuggling and clean indoor
air laws.


elasticitv of demand comparable to those obtained in
the econometric studies.

   Several difficulties can be encountered \vhen ana-
lysts use time series data to estimate the demand for
cigarettes. In a time series model, estimated price and
income elasticities of demand are sensitive to the in-
clusion of variables controlling for the effects of other
determinants of smoking, including advertising,
changes in existing policies for reducing tobacco use,
and increased awareness of the health consequences
of smoking. A serious problem can also result from the
high correlations that are likely to exist among many of
the variables reflecting key determinants of smoking.
These correlations can lead to unstable estimates for the
parameters of interest. However, excluding potentially
important but highly correlated determinants of de-
mand could produce biased estimates of the impact of
the included \,ariables on demand. Time series esti-
mates are also more likely to estimate the short-run
responses of demand to changes in independent vari-
ables rather than the long-run responses that are of
greater interest to policymakers. HoLyever, recent
studies using state-of-the-art econometric methods
for time series data have appropriately addressed
many of these difficulties (Seldon and Boyd 1991;
Simonich 1991; Fle\velling et al. 1992; Barnett et al. 1995;
Hu et al. 1995b; Meier and Licari 1997). Almost all of
the estimates obtained from time series methods based
on alternative economic theories and applied to vari-
ous data produced estimates of the price elasticitv of
demand in a relativelv narrolv range, Lvhich ivas cen-
tered on -0.4.

   The use of state cross-sectional data over time
can also create various estimation problems. In gen-
eral, such studies considered in this section employed
data on state taxes paid for cigarette sales; these data
may not accurately reflect average cigarette smoking
within the states, because cigarettes may ha1.e been
smuggled from lolz.-tas states into high-tax states.
(This problem is discussed in detail in "Theoretically
Optimal Cigarette Taxes," later in this chapter.) In
particular, these sales data are likely to overstate COP
sumption in low-tax states and understate consump-
tion in high-tax states. If this smuggling is not
controlled for, estimates of the price elasticity of de-
mand from these data are likelv to overstate the im-
pact of price on cigarette smoki& However, many of
the most recent studies of cigarette demand that em-
ployed pooled time series cross-sectional data for states
made careful efforts to control for both casual and
organized smuggling of cigarettes (Advisory Commis-
sion on Intergovernmental Relations [ACIR] 1985;
Baltagi and Levin 1986; Showalter 1991; Chaloupka

and Saffer 1992; Becker et al. 1994; Yurekli and Zhang
2000). Although imperfect, these efforts should have
significantly reduced the biases associated with the use
of the pooled state data. When analyses controlled-
for the possible smuggling of cigarettes from low-tax
to high-tax states, estimated price elasticities of de--
mand that were based on state tax-paid sales data were
generally in the range of -0.3 to -0.5.

  A further problem in the analysis of aggregate
data arises because cigarette prices are determined by
the interaction of supply and demand. Failing to ac-
count for simultaneity would lead to biased estimates
of the price elasticity of demand. Several recent stud-
ies that employed both pure time series data and
pooled state-level data have theoretically and empiri-
cally modeled the supply and demand for cigarettes
(Bishop and Yoo 1985; Porter 1986; Showalter 1991;
Sung et al. 1994; Barnett et al. 1995; Tremblay and
Tremblay 1995). Most studies that controlled for the
potential simultaneity biases in their aggregate data
produced estimates of the price elasticity of demand
that were in the narrow range found in other studies
An alternative approach to the simultaneity problerr
is to use natural experiments, such as the large increase
in the California cigarette excise tax, to look at the im-
pact of price on demand. Several recent studies have
used this approach (Sung et al. 1994; Hu et al. 1995b)
Estimates of the price elasticities of demand based or
this natural experiment are consistent with those ir
other studies.

  Many of the most recent studies of cigarette de
mand that used aggregate data empirically modelee
the addicti\.e aspects of cigarette consumption in thi
context of Becker and Murphy's (1988) economil
model of addictive behavior (Showalter 1991; Becke
et al. 1994; Sung et al. 1994). One of the most interest
ing implications of the economic models of demant
for addictive goods, including cigarettes, concern
short-run versus long-run effects. Economists gener
ally define the short run as a period during which a
least some factors have not fully responded to th
change being examined. In contrast, the long run i
when all changes have occurred; the Congressionz
Research Service (CRS) defined the long run for ciga
rette demand as 69 years, a time period that would
allow the current 12- to 80-year-old population (whit
includes almost all smokers) to adjust to a change i
cigarette taxes (GravelIe and Zimmerman 1994). Fc
addictive goods, the long-run impact of price o
demand will exceed the short-run impaci because th
latter largely entails current consumption, which reF
resents an established addiction that tends to be s101
to decrease even in the face of a price increase. In th


studies that used such a model, the estimated long-
run impact of price elasticities of demand indeed
exceeded-by up to tlvice as much-the estimates for
the short-run impact, presumably because the long-
run impact reflected would-be newly addicted con-
sumers M'ho Ivere put off bv price increases. (These
short- and long-run effects are further discussed in "To-
bacco Taxation and RelTenues," later in this chapter.)

  Finally, studies employing aggregate data are
generally limited because they estimate the effects of
prices and other factors on aggregate or per capita es-
timates of cigarette consumption. Such studies thus
cannot provide information on the effects of prices and
other policies on smoking prelralence, initiation, ces-
sation, or quantity and tvpe of cigarette smoked. Simi-
larly, these studies can&t explore differences that sex,
age, and socioeconomic status may ha1.e on respow
si\.eness to price and other policies. Furthermore, ag-
gregate studies are of onlv limited use in considering
the health effects of changes in existing policies for
reducing tobacco use. A fe\~ recent studies ha\,e ad-
dressed some of these limitations. Harris (199-f) used
annual time series data on both smoking pre\.alence
and average cigarette consumption among smokers
during 1964-1993. The study estimated that the price
elasticitv of smoking prevalence in 1993 leas -0.738
and that the elasticity for average consumption among
smokers was comparable; the 1993 total price elastic-
itv of demand of -0.47 was comparable to that obtained
in other studies. Towrnsend and colleagues (1991) used
aggregate data on smoking prevalence and average
consumption constructed from the biennial data gath-
ered in the British General Household Surlreys from
1972 through 1990. The study found that men and
women in lower socioeconomic groups \Vere most re-
sponsive to changes in cigarette prices, that women
kvere more responsii,e to price than men, and that
smokers in the youngest age groups (16-19 years and
20-24 years) w&e least affected by price. In another
study, Moore (1995) used state data from 1954 through
1988 to analyze the effects of cigarette taxes on
smoking-related death rates. The study estimated that
a lo-percent increase in cigarette taxes would prevent
an estimated 5,200 smoking-related deaths each vear.

Studies Using Individual-Level Data

  Relatively few studies of cigarette demand have
been based on individual-level data. Table 6.8 sum-
marizes the findings of these studies for samples of
adults, and Table 6.9 presents the results of studies
focusing on adolescents and young adults.

  In general, the estimated price elasticities of de-
mand obtained from these studies were comparable
to those found in the aggregate studies. By using self-
reported measures of smoking prevalence and aver-
age cigarette consumption, these studies avoided some
of the problems associated with aggregate data on state
taxes paid for cigarette sales. Each of these studies
also carefully considered the effect that casual smug-
gling could have on their estimates of the price elas-
ticity of demand. Moreover, because an individual
smoker's purchase decisions are too small to affect the
market price of cigarettes, the use of individual-level
data in these studies a\Toided the potential simultane-
ity biases inherent in the use of aggregate data. How-
e\`er, the use of individual-level data may be subject
to a substantial ecological bias, to the extent that omit-
ted \.nriables affecting tobacco use may be correlated
\vith the included determinants of demand. Exclud-
ing these \.ariables \vill, consequently, produce biased
estimates for the included variables (see the later dis-
cussion of Wasserman et al. 1991). Furthermore, the
use of indi\~idual-lel-el data is subject to potential re-
porting biases. Studies using individual-level data
ha\-e implicitly assumed that underreporting is pro-
portional to true consumption (i.e., heavy, moderate,
and light smokers underreport by the same propor-
tion). With this assumption, elasticity estimates will
not be systematically biased.

   The use of individual-level data allows research-
ers to explore issues difficult to address adequately
lvith aggregate data. In particular, researchers can use
a tw-o-part method to distinguish between the effects
of cigarette price on two decisions: whether to smoke
(smoking prevalence) and how many cigarettes to
smoke (cigarette consumption). Likewise, the effects
of cigarette prices on smoking cessation can be inves-
tigated. Individual-level data also allow researchers
to explore the differential responses of various socio-
economic and demographic groups to changes in ciga-
rette prices and existing prevention policies. However,
the potential underreporting of cigarette consumption
can be problematic in interpreting these data (Warner
1978).

  Lewit and colleagues (Lewit et al. 1981; Lewit and
Coate 1982; Grossman et al. 1983) were the first to use
individual-level data to examine the effects of prices
and smoking prevention policies. Lewit and Coate
(1982) used data on 19,288 persons aged 20-74 years
\yho had participated in the 1976 National Health In-
terlriew Survey. The investigators first estimated the
effects of cigarette price on smoking prevalence and
then looked at the effects of price on cigarette consump-
tion. These equations \vere estimated not only for