The War on Consumer Surplus: To Fight Tobacco Use, "Prominent Economists" Have Turned Welfare Economics on Its Head

By Lemieux, Pierre | Regulation, Spring 2017 | Go to article overview

The War on Consumer Surplus: To Fight Tobacco Use, "Prominent Economists" Have Turned Welfare Economics on Its Head


Lemieux, Pierre, Regulation


At least 77 national governments now impose graphic health warnings--images of diseased lungs, cancerous mouths, and such--on cigarette packs and other tobacco packaging. The United States is the major holdout, but that may be changing. In 2012, a federal district court struck down a 2011 regulation by the U.S. Food and Drug Administration that would have mandated graphic health warnings. Anti-tobacco groups are now suing the FDA to force it to try graphic warnings again.

The ultimate goal of anti-smoking groups is to impose "plain packaging": mandating that tobacco product packaging show only a brand name in standard fonts along with health warnings against a drab background. They have already achieved this in Australia. In three European countries--the United Kingdom, France, and Ireland--a similar obligation is being phased in. Several other national governments (including the Canadian government) are considering the measure. Plain packaging is the new frontier of tobacco control.

COST-BENEFIT ANALYSIS

In Australia, plain packaging was implemented on December 1, 2012. At the beginning of 2016, the Australian government published a series of evaluation reports purporting to show that the experience has been a success, reducing the smoking prevalence by 0.55 percentage points to 17.21%. The reports included a cost-benefit analysis of the policy, which concluded that the benefits of plain packaging exceed the costs. The FDA also produced a Regulatory Impact Analysis to justify its 2011 regulation. In order to reach their conclusions, both analyses abandoned standard methodology by tampering with what economists call the "consumer surplus."

Cost-benefit analysis is the practical implementation of welfare economics, a field of economic theory. It provides a method for evaluating government policies, programs, and projects according to their contribution to "social welfare"--that is, to the utility or welfare of all individuals in society. Subtracting the social costs of the policy from its social benefits gives the change in social welfare.

Welfare economics and cost-benefit analysis stand on the normative side of economics. What should be done is the question. Instead of importing an external notion of what is moral or good, economists traditionally have used individual preferences as the ultimate criterion. Individual preferences constitute the foundation of the cost-benefit methodology: all costs and benefits are defined from the point of view of the subjective preferences of the individuals involved.

Social costs are the total cost of real resources (labor and capital) used in the project or policy under consideration. They are made of private (or internalized) costs and external costs. Internalized costs are borne by the willing parties in a transaction and those parties have ample incentive to consider the costs when deciding whether to trade. Likewise, the parties naturally consider the internalized benefits. External costs--also called "negative externalities"--are real costs that are shifted to unwilling third parties; a classic example is pollution. Similarly and symmetrically, social benefits are the sum of private benefits to individuals and of any external benefits generated for third parties.

The main source of private benefits is "consumer surplus," defined as the difference between what individuals would be willing to pay for a good or service (or activity) and the price they effectively pay. Technically, it is the area under the demand curve less consumer expenditures. It is the net benefit that consumers get. As welfare economist and cost-benefit expert E.J. Mishan wrote, "The consumer's surplus is the most crucial concept in the measurement of social benefits in any social cost-benefit calculation." The normative significance of consumer surplus comes from it being entirely based on individual preferences--that is, on each individual evaluating what is good or bad for himself. …

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