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Marketing Cigarettes and Tobacco
Tobacco and its related products have traditionally played an important role in the U.S. economy. In 2005, tobacco had a farm value of one billion, making it the United States' sixth largest cash crop. The United States is third behind China and Brazil, in world production, and .second behind Brazil in exports. Twenty-three U.S. states and Puerto Rico grow tobacco, twenty-one states manufacture tobacco products, thirty-three states export tobacco, and all fifty states are engaged in the marketing of tobacco products.
In 1964, the Surgeon General's Report documented the adverse health effects of smoking. Since then> many medical experts have repeatedly warned the public that smoking causes lung cancer, low birth weights, and other health problems. Today the World Health Organization (WHO) attributes about 4 million deaths a year to tobacco use, a figure expected to rise to about 10 million deaths a year by 2030. As a result of increased awareness of the consequences of smoking, U.S. cigarette consumption, as well as other forms of tobacco use, have been gradually decreasing. Although health considerations played an important role in discouraging smoking, other factors such as higher cigarette prices, steeper federal and local taxes, and governmental restrictions on smoking in public places also contributed to this decline. Since reaching a peak in 1981, total U.S. cigarette consumption declined by nearly 25 percent, and per capita consumption by 32 percent. In 2005, U.S. cigarette consumption was less than 380 billion cigarettes, accounting for over $80 billion in sales (see Exhibit 1).
The Importance of Tobacco for the U.S. Economy
Taxes on tobacco products contribute significantly to government income and help reduce the budget deficit. As the number of smokers has declined, the government has raised the cigarette tax in order to preserve the level of tax revenues from smoking. The cigarette tax was raised from 8 cents per pack of twenty cigarettes in the period between 1951 and 1982 to 16 cents from 1983 to 1990. In January 2002, the federal cigarette excise tax was raised five cents to 39 cents per pack of twenty cigarettes. In 2004, the tobacco production and related industries contributed $35 billion to government revenues in excise, sales, personal income, and corporate taxes. Of this amount, over $7.7 billion was generated by the federal excise tax on tobacco and over $11.8 billion by state and local taxes. This means that almost 31-3 percent of the retail price of tobacco products in the U.S. ends up in the treasuries of the federal and local governments (see Exhibit 2).
According to a study by the World Health Organization (WHO), the tobacco industry employs millions of people worldwide, in positions ranging from growers, manufacturers, distributors, core suppliers, transporters, to promoters. Over two-thirds of these jobs are in China, India, and Indonesia.
The Importance of
Tobacco Exports______________
In the face of their diminishing domestic market, U.S. tobacco companies are vigorously promoting cigarette exports. Developing countries are home to most of the world's smokers and are therefore the number one target for cigarette exports (see Exhibit 3). The international cigarette market is dominated by U.S. brands (see Exhibit 4). However, U.S. companies would be able to sell even more cigarettes in developing countries if their products were free of import restrictions.
Percentage of Smokers (People of AH Ages Who Have Smoked Several Times in aYear as Part of General Population)
Leading International Cigarette Brands
Company
Units Sold Country (Billions)
Marlboro Hongtashan Mild Seven Red China Bu Is Fu Honghe Prima
Philip Morris China Monopoly Japan Tobacco China Monopoly China Monopoly China Monopoly Reemstal
US
China
japan
China
China
China
Russia
In the peak year of 1996, the U.S. tobacco industry produced 754 billion pieces of cigarettes. In the same year cigarette exports totaled about 241 billion pieces. The exports of tobacco and trade manufactures resulted in a $5.3 billion surplus in the 1996 trade balance for this group of products, about one-fourth of the surplus in all agricultural products.
In 2005, cigarette production declined to 482 billion pieces. Exports fell to $983 million, while imports shrank by 7 percent from the previous year to 653 million pieces. This created a shrinking trade surplus of $342 million that can be attributed mainly to lower demand and higher levels of offshore production. Also, the relatively expensive U.S. tobacco leaf is being replaced in many countries by lesser-grade tobacco leaf grown abroad. Even though the U.S. is still the third leading exporter of leaf tobacco, countries are demonstrating their willingness to sacrifice quality for lower prices by buying leaf tobacco from Brazil, Turkey, and Malawi. U.S. tobacco firms exported to over 100 countries in 2005. The leading destinations for these exports were Belgium-Luxembourg (from there, cigarettes are distributed to individual EU countries), Japan, Russia, Iran, Indonesia, and the Dominican Republic.
A study conducted by the Economic Research Service of the U.S. Department of Agriculture shows the effects of an excise tax increase of $l-per-pack on the demand for tobacco products. Government revenues would rise by $13.7 billion, and gross revenue to tobacco farmers would fall by $6.2 billion. Wholesale, transportation, and retail businesses'*would lose $1.5 billion of income and manufacturers would lose $3.9 billion. The study also
estimates that the $1 increase in excise tax could cost an estimated 74,700 jobs in the manufacturing, farming, distribution, storage, and sales industries—15,100 of these jobs would be lost in farming. In retail and wholesale establishments, 43,400 jobs could be in jeopardy. Furthermore, 12,800 jobs could be at risk in such related industries as supply paper, packaging, chemicals, equipment, and machinery. Such a domino effect could more than offset the increase in government revenues supplied by the excise tax.
U.S. Trade Policy__________
Tobacco-related revenue is an important source of income for the governments of many countries. As a result, many nations have traditionally blocked the import of cigarettes by imposing high import tariffs, discriminatory taxes, and restrictive marketing and distribution practices. Japan, China, South Korea, and Thailand even set up state monopolies to produce cigarettes. Throughout the 1980s, the Asian tigers ran huge trade surpluses with the United States. When the U.S. annual trade deficit reached a record high of $123 billion in 1984, the Reagan administration turned to the Office of the U.S. Trade Representative (USTR), a federal agency under the Executive Office of the president. Section 301 of the 1974 Trade Act empowered the USTR to investigate unfair trading practices by foreign countries toward U.S. exporters and required that the U.S. government impose sanctions on a culpable foreign government if its trade policy toward U.S. firms was not changed within one year.
Marketing Cigarettes and Tobacco
As U.S. tobacco products were among the most re-.stricted goods, the USTR turned its attention to this case of foreign trade discrimination. The scrutiny was aided by the fact that Japan, South Korea, and Thailand were signatories to the General Agreement on Tariffs and Trade (GATT), and Taiwan was interested in joining as well. By their discriminatory policies toward U.S. cigarette imports, these countries violated the free trade principles they had agreed to respect under the GATT. In September 1985, the White House filed a complaint with the USTR under Section 301 against Japanese restrictions on the sale of cigarettes. After a series of negotiations and mounting pressure from the U.S. government, in September 1986, Japan gave in and allowed imports of U.S. cigarettes. Almost immediately, cigarettes rose from the fortieth to the second most-advertised product on Tokyo television. Imported brands currently control 24.7 percent of the Japanese market with $82.1 billion in annual sales. In 2001, the U.S. share accounted for 95.7 percent of the import market.
China is the world's largest cigarette producer and consumer. In 2003, there were 350 million smokers in China who burned up nearly one-third of the annual 5.5 trillion world cigarettes consumed. Sixty-five percent of these smokers are men, as cigarette use has become a social necessity in China. For example, it is customary to offer a cigarette at a meeting. The rate of Chinese women smokers has risen from 1 percent in 2000 to 5 percent in 2003. In total, the smoking population is growing by 3 million a year in China and overall consumption is increasing. China has relatively low taxes on cigarettes (as compared to alcohol). In 2006, the government passed landmark legislation to cut down on cigarette consumption and comply with WHO treaty obligations. This legislation disallowed new cigarette factories, reorganized the state cigarette monopoly, and phased out cigarette advertising within five years.
All Chinese cigarettes are produced by a state monopoly. Because the Chinese government is eager to acquire advanced technology and marketing know-how from the West, it offered limited partnerships to a few foreign cigarette producers, including RJ. Reynolds and Philip Morris. In 2003, the Chinese government collected 191 billion yuan in cigarette taxes, accounting for about 10 percent of the Chinese government's annual revenue. Out of the top 100 Chinese tax-paying companies, 35 are state-run cigarette manufacturers who provide jobs to over 9 million farmers, workers, and retailers. As a consequence, the government wants to continue to protect its state monopoly from foreign competition. In 1992, the USTR negotiated an agreement under which China promised to eliminate tariffs and other trade barriers on U.S. cigarette imports within two years. The Chinese government, however, has not enforced the agreement.
With the opening of the markets of the former Soviet Union and Eastern Europe at the beginning of the 1990s, U.S. tobacco manufacturers found new opportunities for expansion. With 60 percent of their populations smoking, Hungary, Poland, Bulgaria, the former Yugoslav
republics, the Czech Republic, and Slovakia are among the top ten nations in per capita cigarette consumption. Armenia, Georgia, Azerbaijan, Russia, Ukraine, and Moldova rank among the top twenty. Unlike in Asia in the 1980s, U.S. companies are welcomed here as contributors of new technology and scarce investment funds. As part of the privatization process in the formerly communist countries, U.S. cigarette producers were able to buy previously state-owned cigarette factories and are quickly gaining ground in these new markets. Also, these producers are developing infrastructure in these countries with the long-term goal of moving production there due to a more advantageous cost structure and more supportive tax regulations. Some analysts project that over the next decade, Western tobacco manufacturers will gain control over the entire Eastern European cigarette market, which will more than make up for the revenues lost at home.
The power of emerging markets is evidenced in the record profits of the international tobacco industry in 2005 despite higher taxes, stronger regulations, and a decline in smokers in developed countries. Due to the inelastic demand for tobacco and smokers in developing countries switching to more expensive brands, the tobacco industry continues to increase profits.
In addition to these market developments, the European Union agreed to cut export subsidies and reduce tariffs on both unmanufactured and manufactured tobacco, Japan promised to maintain zero duty on cigarettes and to lower duty on cigars, and New Zealand reduced its tariff on cigarettes. Finally, with China's accession to the WTO in February 2001, the decrease in tariffs and quotas allowed tobacco exports to enter the Chinese cigarette market.
Tobacco Marketing in the United States and the Developing World
In the United States, tobacco advertising is highly restricted. Tobacco television commercials are not allowed, but print advertisements are acceptable. In recent years, the advertisements of the tobacco industry have been eclipsed by the "countermarketing" of the anti-tobacco lobby. For example, in a commercial by an anti-tobacco group called Truth, teenagers place 1,200 body bags outside the headquarters of a major tobacco company. Such hard-hitting advertisements are paid for with money from litigation lawsuits against the tobacco industry. They target adolescents and teenagers with the aim of "denormalizing" smoking and preventing them from starting.
In the developing world, it is relatively easy for tobacco companies to market their products through advertising. Governments impose few regulations on the
tobacco industry. More than 40 developing countries do not require health warnings on cigarettes, and most countries opt for vague health warnings in English rather than local languages. The advertising reflects the aspirations of the developing world to emulate the West: brand names include "Diplomat" (Ghana), "High Society" (Nigeria), and "Sportsman" (Kenya). Additionally, tobacco companies target women in their advertisements, realizing the potential of an untapped market. Advertisements directed towards women associate smoking with feminism, weight control, and Western-style independence.
Countermarketing has been shown to increase smoking cessation in countries that are willing to regulate tobacco. South Africa, Singapore, and,Thailand have all reduced their smoking rates through large-scale health education programs combined with bans on tobacco advertising and sponsorship, public smoke-free zones, and requirements to make warning labels large and clear. The WHO Framework on Tobacco Control commits nations to ban tobacco advertising and requires large warning labels that cover at least 30 percent of<the entire package. A total of 124 nations, mostly in the developing world, have become parties to the convention.
Government Support of the Tobacco Industry
The U.S. Department of Agriculture (USDA) administers laws to stabilize tobacco production and prices. According to the Tobacco Institute, without this regulation, more tobacco would be produced and prices would be lower. In 2000, the Commodity Credit Corporation, an agency established in 1933 to administer comraodity stabilization programs for the USDA, made new loans to tobacco farmers of an estimated $395 bill' n. These loans are to be repaid with interest as collateral tobacco is sold CCC price support policies ended with the American Jobs Creation Act of 2004, which terminated federal quota and price support programs for tobacco through a $20 billion quota buyout and compensation package, thereby terminating these CCC programs.
Until the late 1980s, the U.S. government was in strong support of the tobacco industry. It funded three export promotion programs: the Foreign Market Development Program (also known as the Cooperator Program), the Targeted Export Assistance Program, and the Export Credit Guarantee programs. The most important of these were the Export Credit Guarantee Programs administered by the Commodity Credit Corporation (CCC) of the Department of Agriculture. Under these programs, the CCC underwrote credit extended by the private banking sector in the United States to approved foreign banks to pay for tobacco and other agricultural products sold by U.S. firms to foreign buyers. Between October 1985 and September 1989, sixty-six companies received guarantees of credits under these programs for
the sale of 127 million pounds of tobacco with a market value of $214 million. The Targeted Export Assistance Program's purpose was to counteract the adverse effects of subsidies, import quotas, or other unfair trade practices on U.S. agricultural products. Under this program, Tobacco Associates, a private organization entrusted to carry out this endeavor, received $5 million in funding in 1990 to provide certain countries with the technical know-how, training, and equipment to manufacture cigarettes that use U.S. tobacco. In addition, Tobacco Associates received funds from the USDA to promote market development activities for U.S. tobacco products.
During the Clinton administration, the U.S. government discontinued all export promotion programs related to tobacco and tobacco manufacturers. Under the Bush administration, the U.S. government's anti-tobacco stance has softened. U.S. trade officials opposed South Korea's 40 percent duty on imported cigarettes. They objected to this discriminatory trade practice, arguing the duty was aimed at protecting domestic brands rather than promoting health. Despite the current regulations, the tobacco industry maintains a powerful position in the U.S. Congress through comprehensive lobbying efforts, which spent $23 million in 2004. During the 2004 U.S. presidential elections, the tobacco industry contributed $4 million to the campaigns of the candidates. As of September 2005, tobacco companies had given over $1.1 million to political action committees, federal candidates, and national parties.
Conflicting Objectives
The past involvement of the U.S. government in furthering the export of tobacco has generated controversy within the United States. The U.S. government, spearheaded by the Department of Health and Human Services, has been actively discouraging smoking on the domestic scene. In addition, the United States is a strong supporter of the worldwide antismoking movement. The Department of Health and Human Services serves as a collaborating headquarters for the United Nations World Health Organization and maintains close relationships with other health organizations around the world in sharing information on the detrimental health effects of smoking. Despite a strong U.S. commitment to curb smoking the international level, the U.S. Senate failed to ratify the World Health Organization Framework on Tobacco Control in 2005. The agreement has been hailed as the first-ever global health treaty and has been ratified by countries containing over 70% of the world's population. The treaty aims to strongly regulate the tobacco industry on an international scale, but it was rejected by the United States due to its vague mandates.
The government has not initiated any concrete steps to reduce U.S. tobacco exports and U.S. investment in cigarette production abroad. This is partly due to the fact
that many in government believe that U.S. tobacco products are merely capturing an existing market share now -or previously controlled by state monopolies. In contrast to this claim, the National Bureau of Economic Research estimated that U.S. entry in the 1980s into countries previously closed to cigarette imports pushed up the average per capita cigarette consumption by almost 10 percent in the targeted countries. This occurred due to increased advertising and price competition caused by the entry of U.S. products.
This situation reflects a conflict between morality and economics. Projections show that the declining U.S. cigarette consumption can be easily replaced by foreign markets over the next decade. Thus, by pursuing an anti-smoking policy only at home, the U.S. government is not risking too much. On the contrary, a smaller number of U.S. smokers will significantly reduce the U.S. health system's expenditures on the treatment of smoking-related illnesses. However, the U.S. policy of permissiveness toward cigarette exports is at odds with government's involvement in the worldwide campaign to reduce smoking for health reasons. Conflicting opinions can be heard from different representatives of the government. While Representative Henry A. Waxman of California and former U.S. Surgeon General C. Everett Koop continue to be staunch supporters of the antismoking campaign and principal opponents of U.S. tobacco exports, Governor Paul E. Patton of Kentucky, who established the Governor's Tobacco Marketing and Export Advisory Council, and former Senator Jesse Helms of North Carolina continue to fight against government regulation of tobacco sales and are key supporters of tobacco exports.
The dividing force is economics: In 2001, North Carolina (where flue-cured tobacco is grown) was the number-one tobacco-growing state with annual production of tobacco crops averaging 386 million pounds. Kentucky (where burley is grown) comes in at a close second with tobacco production topping 254 million pounds. Due to declining production because of the government buyouts, by 2005 North Carolina cash receipts dropped to $620 million and Kentucky cash receipts dropped to $250 million.
Questions for Discussion
1. Should U.S. exports of tobacco products be permitted in light of the domestic campaign against smoking?
2. Should the U.S. government be involved in tearing down foreign trade barriers to U.S. tobacco? Should the personal preference of the president affect U.S. trade policy?
3. Should export promotion support be provided to U.S. tobacco producers? What about such support for the export of U.S. beef, which may cause obesity abroad?
4. To what degree should ethics influence
government policy or corporate decision making in the case of tobacco exports?
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