Unhealthful News 217 - Economic innumeracy and tobacco substitution

The always-simmering debate about the core math curriculum in high school and college has heated up a bit lately.  Are the abstract courses badly designed, or are American students just lazy?  Does the limited "real world" usefulness of what is taught mean that is should not be mandatory, or is it a core skill for being able to function in the world?  I am convinced that a lot of this issue would be resolved if algebra and calculus courses were taught with an eye toward microeconomics rather than the Newtonian physics that seems to usually motivate them.  They would be more practical and more motivating.

A great frustration, which I expect most practical economists share with me, is that there is so little general education about economic thinking.  Thus, we are constantly having to explain things that are so obvious to us that it takes effort to figure out how to even begin to explain them.  Sadly, liberal arts economics classes do not emphasize the core thinking and math, but tend to mostly be economic history filled with big picture abstractions, simplistic finance, and a maybe a few little calculations that are not enough to generate real understanding.  Over and over, I have to include in my reports an explanation for why money is a measure or a marker but not a real resource in itself, how measuring the value of a nonmarket good (e.g., saved lives) in dollar terms does not mean that it is equivalent to "mere money", the difference between a real cost and a transfer, etc.  In conversation, I find that it is remarkably difficult to explain why paying cash (if you are able) versus taking a loan to get a durable good (house, car) is not a moral issue of financial responsibility, but is simply a decision about whether you want to invest your cash in the good or in something else.  All of these are quite obvious -- or would be if everyone were taught math in terms of economics rather than the less useful (for 99.9% of the population) physics.

However, few bits of economic innumeracy are as troubling as the failure to understand the basic workings of supply and demand in a market.  (Note:  Perhaps the right term is "economic illiteracy", but I like "innumeracy" because it emphasizes that the understanding largely depends on having enough basic math skills.) 

Today the press dutifully reported on a new a post in CDC's weekly newsletter that reported that due to punishing taxes on cigarettes, many smokers are instead buying cigars and loose tobacco that has lower taxes.  The New York Times reported it in a very matter-of-fact and accurate way.  The key big-picture information was:

“While consumption patterns of traditional cigarettes have continued to decline, when we take into account these alternative cigarettelike products, we’re seeing a lack of change in the overall consumption of burned tobacco that is being inhaled,” said Terry Pechacek, associate director for science with the C.D.C. Office on Smoking and Health in Atlanta and one of the report’s authors.

That will not stop the anti-tobacco industry from claiming ongoing success when it suits them, of course.  I do not anticipate CDC or the rest of that industry backing off on their efforts to keep smokers from switching to low risk alternatives.  But back to the topic for today....

Surprisingly, the NYT did not wander into nanny state propaganda or economic innumeracy, thanks to the reporting of Roni Caryn Rabin, who is much better than most of their staff and the headline writer who chose the matter-of-fact "Big cigars offer way for smokers to save" and "More smokers switch to less-taxed loose tobacco and cigars".  Equally surprising, most of the other news reports avoided the trap too.  But definitely not all all.  For example, the Detroit Free Press headlined their story "Tobacco companies profit from loophole" and used this lead quote:

"This report demonstrates that the the tobacco industry is as resourceful, and as predatory, as ever," says Thomas Glynn, director of international cancer control at the American Cancer Society.

The DFP story and the ACS quote, and others like them, demonstrate two fundamental bits of economic innumeracy.  The first is the mistake of thinking that supply creates demand rather than the other way around.  What actually happened is that the price of one good kept climbing while an inferior (in the eyes of the consumer -- else they already would have been buying it) good remained cheaper, and once the price differential was high enough, some consumers accepted the reduction in quality and switched.  Specifically they switched from cigarettes to pipe tobacco, which they rolled themselves, or to "little cigars" or the even lower-taxed "big cigars", a category that has consistently been protected from excise taxes because rich people like them.  It is consumers that are resourceful.  Once the consumer started being resourceful, something happened that would only surprise the innumerate:  People started buying out all the supplies of pipe tobacco, and in response, the producers started producing more.  And when the cigars that are just big enough to be in the cheaper "big" category became more popular, more of them were made too (as well as the little ones which have more taxes but are a better substitute for cigarettes).

Why was there a market?  The economically innumerate would have us believe that it was somehow created by the producers.  Yes, some suppliers can push their products to some extent (advertising works in some cases, though not all).  But tobacco suppliers really cannot -- they are so restricted in their advertising that they cannot really tell consumers much, and only can respond to what consumers already know.  Price sensitive consumers are quick to figure out where the bargains are. Yes, the suppliers are obviously cheating a bit, selling huge quantities of "pipe tobacco" that they know is getting rolled into cigarettes -- but again, it is the consumers who are seeking out that product, and so someone is going to supply it.

Who benefited from this?  The economically innumerate would have us believe that it was those evil producers.  But in a competitive market like this, the producers cannot capture windfall profits from the price differential (which was created by the government) because competition drives down the price until only normal net revenue are available.  Roughly the same modest net revenue is available from producing loose tobacco, cheap cigars, or cheap cigarettes -- or most any other fast moving consumer goods.  (Premium brand cigarettes are a different story -- the producers make more profit there.)  It was not the producers who benefited, it was the consumers.

Of course, nothing infuriates the anti-tobacco industry more than impoverished tobacco consumers (poor people being most willing to give up some quality to get a lower price) avoiding the financial punishment that they "deserve".  This was evident in the immediate flurry of press releases and blogs that have called for raising taxes on these other products to eliminate this money-saving option, which of course is The Way Things Are Supposed To Be.  You know who else will be happy about that change?  The makers of premium cigarettes.  From the Detroit Free Press article:

Altria, the parent company of the country's leading cigarette maker, Philip Morris USA, believes "that little cigars and roll-your-own tobacco should pay the same tax as cigarettes, as Congress intended," spokesman David Sylvia said.

Funny how everyone that is not Congress is always so sure that Congress intended to do what was best for their own interests.

The fact that so many commentators seem to find consumers seeking cheaper alternatives to be shocking or nefarious bodes ill for both economic numeracy and future policies.  They seem to not understand that trying to manipulate markets is like trying to push on the sides of a balloon to reduce its total volume:  There is an equilibrium volume that is created by gas pressure (or consumer demand), and you can affect it a small amount by pushing.  But if you try to make a big change you will find the balloon (or markets) popping out somewhere where you are not pushing.  A little bit of pressure (or taxes) shrinks the volume some, but a lot of pushing mostly just moves the volume to somewhere new.  If the pressure is extended to include loose tobacco or cigars, the volume will move somewhere else.  If we create some pressure relief by keeping low-risk smoke-free alternatives cheap and available, and constantly improving in quality, much of the pressure will find its way there, which would be great for public health (but ruinous for the anti-tobacco industry, and thus they fight that possibility with a desperate fury).  But if all the legal "loopholes" are closed, the pressure relief will be in the form of newly profitable black markets.

That is all simple and obvious to anyone with basic economic numeracy.  Unfortunately, another way of phrasing that statement is "almost no one seems to understand that".