Report to the Presidential Commission on Tobacco
The declining national marketing quotas for United States tobacco reflect a number of factors that have negatively affected demand for U.S. tobacco and reduced the world market share of U.S. tobacco producers. One way to understand these declines is to think of the problem in terms of eroding market power. Market power can be thought of as the ability to set the price of U.S. tobacco by restricting the supply of U.S. tobacco available on the world market via the tobacco program. The historical success of the U.S. tobacco program in garnering higher prices for U.S. tobacco than would have been obtained with unregulated tobacco production is critically dependent on the market power of U.S. tobacco in the world market.
Market power has eroded as a result of declines in demand for U.S. tobacco resulting from: 1) declines in U.S. consumer demand due to health concerns surrounding smoking, higher cigarette excise taxes, and higher cigarette prices due to the tobacco settlement and litigation costs, 2) declines in cigarette exports by U.S. cigarette manufacturers, 3) substitution for both quality and quantity of tobacco in cigarettes (lower tobacco use per cigarette) as a result of technological changes in cigarette production such as filters and flavorings, and 4) substitution away from U.S. tobacco as a result of the development of cheaper tobaccos of similar quality in foreign countries, such as Brazil. As market power erodes, the national marketing quotas must be set at lower levels in order to maintain price. Ironically, smaller quotas decrease the world market share of U.S. tobacco which further decreases market power. Decreasing market power makes maintenance of a tobacco program increasingly dependent on political intervention.
As market power has eroded over the last 20 years, numerous options have been discussed. The program modifications of the early and mid-1980=s that included price reduction were options actually implemented and were in part responsible for the recovery of quota in the late 1980=s and early 1990=s. Several policy options for the current program situation are presented below. In evaluating these options, it is important to understand the potential effect of changes in farm level tobacco prices on the quantity of tobacco demanded by domestic and foreign cigarette manufacturers.
Potential effects of price changes on quantity demanded (sold)
Data from the 1950=s through the 1970=s indicated that for a 1 percent decline in U.S. flue-cured price, unmanufactured exports would expand by 2 to 2.5 percent. The results of the price support reduction in 1985 seem to bear this out since exports rebounded from around 350 million pounds to over 400 million pounds over a 5 year period. Demand by U.S. cigarette manufacturers is much less responsive to changes in price than is the export market. Research indicates for a 1 percent decline in U.S. flue-cured price, the quantity demanded has historically increased around 0.9 percent and for a 1 percent decline in burley price, quantity demanded has increased only about 0.1 percent. These relationships change over time and undoubtedly are substantially different today than 15 years ago. As closer substitutes for U.S. tobacco have been developed, purchasers are more sensitive to changes in U.S. tobacco prices since they can more easily switch to tobacco produced elsewhere. One possible exception to this generalization is unmanufactured flue-cured tobacco exports. U.S. flue-cured exports may be very price sensitive at much lower prices, for example prices near those of Zimbabwe or Brazil. But at the higher prices under the U.S. program many Aprice sensitive@ foreign buyers may have already abandoned the U.S. market, leaving less price sensitive foreign buyers. These Aprice sensitive@ buyers may be hard to lure back without large price declines. Sufficient data (enough years of data) to conduct analyses that could confirm or refute these suspicions are difficult to obtain at present.
When price is lowered, a lower return to