(by Bruce Lyons) Europe’s highest court last week decided against the governments of Austria, France and Ireland who have each adopted minimum retail price legislation for tobacco in an attempt to reduce smoking. At first sight, the Court’s decision may appear to be a blow against public health, but in truth it should be seen as a victory for those who want to use the price system efficiently to control smoking.
Each of these three countries has ‘pro-health’ legislation of a similar form. This imposes minimum prices set between 90% and 97% of average prices for manufactured tobacco. For example, the French figure of 95% means that no retail price can be more than 5% less than the average. This is great for established brands with large market shares because it undermines both the ability of smaller brands to compete and the possibility of entry by low cost brands from home or abroad. A price difference of considerably more than 5% is likely to be needed to tempt smokers away from their favourite brand; and given some price dispersion across existing brands, very much less than a 5% discount will be achievable in practice. The European Court of Justice has a long-standing preoccupation with the European Treaty’s aim of market integration, and it is the protectionist effect of these measures on intra-EU trade that was foremost in their decision to strike down these national laws.
However, the Court’s reasoning could have been much strengthened by considering also the effects of minimum price legislation on tacit collusion and brand promotion activities. Given a degree of brand loyalty and that firms cannot legally undercut the average by more than a very small percentage, firms can nudge up prices without fear of loss of market share. Others will follow suit and profit margins rise. Promotional activities, including product placement on the shelves, advertising and sponsorship, consequently have a bigger payoff as each extra unit sold becomes so much more profitable. The result is a switch of competitive strategy to these demand enhancing activities and possibly even higher tobacco consumption despite higher prices.
An effective smoking-suppression programme should squeeze margins at the same time as raising retail prices. The obvious way to do this is simply to raise the tax on tobacco. This is competitively neutral and benefits the treasury instead of tobacco manufacturers. If supermarkets are found to be distorting competition or undermining policy objectives by loss-leading with cigarettes, it remains possible to prohibit below-cost selling of tobacco.
Some of you (especially smokers and libertarians) may be wondering why it is a good thing to tax smoking so heavily. Others will point to unanticipated addiction, health care costs, secondary smoking, etc. This note is not about such issues. My point is simply that given the decision to use the price system to control smoking, minimum price controls are the wrong way to do it.