Thursday, March 25, 2010

Utah should undo its liquor monopoly

By Vijay K. Mathur

Published in Standard-Examiner, March 24, 20010, Ogden, UT

Recently, Utah media reported that the state of Utah had a banner year in liquor sales, taxes and profits to the state general fund in 2009. The Utah Department of Alcoholic Beverage Control (UDABC) is very jubilant about its performance. Along with liquor monopoly, perhaps the state would consider monopoly in the gun market to protect its citizens from harm from guns.

The constitutional right to bear arms does not prohibit state monopoly in guns. We all have heard NRA's comment about gun control that guns do not kill people, people kill people. Could we apply the same logic to alcohol use? Alcohol use does not kill people but people who abuse alcohol kill people. Where is the logic behind state liquor monopoly?

Like the gun business, we should have a free market in the liquor business, with some degree of regulation for public safety. However, my intention in this article is to discuss state liquor monopoly in Utah and not gun control.

A competitive market, where there are many buyers and sellers of product, is the most efficient market structure. In a competitive market, sellers can not fix prices or quantities. The efficiency of perfect competition assures us lower prices than any other market structure, assuming no "market failure" due to, for example, spillover benefits and costs, barriers to entry, asymmetric information. When markets fail, it requires regulation. "Natural monopoly" is also deemed as a failure of competitive market, and hence it requires regulation.

Natural monopoly arises when, due to the product-technology, cost per unit of output falls as output increases. Decreasing per unit cost threatens competition, hence results in a monopoly. Therefore, such products require regulated monopolies, as in cable television, electricity production, and natural gas business.

Regulation is intended to lower prices and increase output at levels beneficial to society, as well as assure monopolies a fair return on investments. Liquor sales do not fit the natural monopoly model based upon cost structure.

Hence, there are some questions which need to be addressed.

Is private retail liquor monopoly inefficient? The answer is yes. A profit maximizing unregulated monopoly, where there is a single seller, controls prices or quantities, which thus control prices. This results in higher prices and lower quantities sold, causing what economists call "dead-weight loss" (DWL). DWL represents a net loss in social value of output to all (not captured as gain by any one) due to inefficiencies. Additional social loss occurs when monopoly spends resources to keep its monopoly power. Exercise of monopoly power is against antitrust laws.

Is state monopoly worse than private monopoly? The answer is yes. Private monopoly is always threatened by entry of new businesses to undermine the monopoly power of the incumbent when there are no or lower barriers to entry. Examples of barriers to entry are large upfront costs of entering into business, legal barriers, regulatory barriers, implicit threats by an incumbent to make the entry of potential entrants unprofitable. On the other hand, state liquor monopoly faces no threats of entry and hence the state has no incentive to lower its monopoly price.

Is the state monopoly guided by motives other than profits? Even though the official reason is that it is not guided by profits, UDABC always brags about how much profit it is generating for the state's general fund. In 2009 it generated $60 million to the fund, almost double the amount of 2000, in addition to state tax revenue and funds for the school lunch program.

What are other possible motives for state liquor monopoly? It is claimed that it is aimed at protecting young people from alcohol abuse and perhaps reducing violence, traffic fatalities and other costs to society due to alcohol abuse. First, there is no evidence that adverse consequences of alcohol abuse will be worse if there is a competitive private market with sensible regulations and enforcement. Second, Pacific Institute of Research and Evaluation reports that underage drinking "is widespread" in Utah. In fact, the percent of 12th graders reporting use of alcohol is greater than those using cigarettes (not a state monopoly). Third, MADD reports that underage drinking cost $324 million (most of it due to violence) to the citizens of Utah in 2007, almost six times the profit to the state's general fund. Fourth, alcohol related motor vehicle crashes resulting in injury and deaths increased almost 12 percent from 2001-2006, close to 2 percent per year.

If morality is the issue with liquor consumption, according to the "Word of Wisdom" of the LDS church, it makes more sense to privatize the market, like with tobacco, coffee and tea, and enforce some targeted common sense regulations to protect society from harmful effects of alcohol abuse; at the same time it will promote efficiency in the market for liquor. Thus the state will gain enough tax revenues with business growth to subsidize different programs.

Mathur is former chairman of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden, UT.

No comments: