Conference on ‘The Social Cost of Alcohol Abuse’, IRER – University of Neuchatel, Switzerland, 24-25 October, 2003

Keywords: Health;

Abstract

While New Zealand has some measurement of the social costs of alcohol misuse, which the paper reports, the interest in the country, and this paper, has been the shift to implementing policies whose focus is to minimise harm from misuse.

The paper traverses the policy environment from the initial revenue-raising role of the excise duty in 1840. As the frontier society moved to a settled society, policy from the 1890s moved to restricting the consumption of alcohol, with revenue remaining the main fiscal concern. However, in 1989 a new direction was undertaken in which aimed to minimise restrictions on low and zero harm alcohol consumption, and eliminate as far as was practical harm arising from misuse. Over the next 14 years various measures were taken culminating in the latest tax package of May 2003.

The paper traces through these changes. It argues that the policy transformation is not complete, and also discusses some of the inherent tensions in the new approach. In particular the shift from restriction to a liberal regime which treated liquor as a largely normal consumption good, with targeting on harm minimisation, resulted in easing of prohibitions on advertising of liquor.

But the paper also discusses the limitations of the economic approach, for it is not possible to use the policy instruments to target precisely on harm reduction without also limiting some low and zero harm consumption. This emphasises the need for non-economic policy instruments, most pertinently those which change attitudes to alcohol consumption where there remains a ‘frontier’ spirit.

The New Zealand Background

New Zealand is a high income, democratic country of four million people, located in the south-west Pacific over a thousand kilometres to east of Australia. It was the last substantial land mass to be settled, around 1000 years ago by Polynesians who voyaged from the central Pacific. They evolved in to today’s indigenous people, the Maori. About 15 percent of the population have at least one Maori ancestor, although there has been considerable intermarriage.

The first Europeans explorers arrived around 230 years ago (occasional visitors who either neither landed or left no trace aside) and began to brew beer, introducing alcohol to the Maori who had had none before. Sealers and whalers began arriving 200 years ago, followed by missionaries and settlers, although that latter were not significant until about 150 years ago, following New Zealand becoming a British colony in 1840. The settlers evolved a Pakeha culture, evidently of European origin and connected to the dominant world cultures (as indeed does Maori culture) but with distinctive features.

Initially the European based economy based on extracting the natural resources. It was a ‘colony of exploitation’ or ‘quarry’. By the late nineteenth century, however, sustainable farming became important, particularly pastoral farm shipping refrigerated dairy and meat products and wool to Europe. The transition to a ‘colony of permanence’, or settlement, created many tensions, not least involving the regulation of liquor.

Drinking and drunkeness were a feature of the male dominated, shifting, frontier society. The control of these excesses was a priority to the settlement where, not surprisingly, woman who are central to sustainability in a way they are not in the quarry, played a prominent part in the prohibition movement. In 1918 it almost succeeded, when the domestic voters passed the threshold, but votes from soldiers overseas pushed the proportion just below the required 60 percent. The compromise was to restrict access to alcohol, but to do little to tackle drinking attitudes.

Changes after the Second World War were incremental and slow. Six o’clock closing, when drinking in the public houses stopped for the general public, was not abolished until 1967. ALAC, the Alcohol Advisory Council of New Zealand (Kaunihere Whakatupato Waipiro o Aotearoa) was founded in March 1977, as a result of a recommendation of the 1975 Royal Commission into the Sale of Liquor. It was charged with encouraging and promoting moderation in the use of liquor, discouraging and reducing its misuse, and minimising ‘the personal, social, and economic evils resulting from the misuse of liquor’. In 2000 the statute was amended to replace ‘evils’ with ‘harm’.

The excess social costs are substantial. The most comprehensive estimate, based upon the counterfactual of no alcohol misuse – so that the health benefits of moderate alcohol consumption are not netted out – suggests that alcohol misuse reduces effective GDP by 4.0 percent, may well reduce the effective size of unmeasured (informal) economy by a similar amount, and has also reduced the welfare of New Zealanders via additional mortality and morbidity by 2.0 percent and the population of New Zealand by .8 percent. (Easton 1997)

This estimate is for 1990 and there is no subsequent comprehensive update. It is to be hoped that the proportions are lower, reflecting success of the harm minimisation policies. The study did not include law and order costs, as there were no estimates available at the time.

Social Costs of Alcohol Misuse (1990)

Intangible
Effect of population mortality $6,000m
Effect of population morbidity $7,200m

Tangible
Reduced production from mortality $600m
Reduced production from morbidity $1,200m
Additional resources from consumption $900m
Additional resources from not have to treating induced diseases and other consequences $750m

Less
Benefits from consumption -$540m

Total Costs of Abuse $16,110m

Intangible Costs
Total $13,200m
Percentage of total human capital 2.0%

Tangible Costs
Total $2,910m
Percentage of GDP 4.0%

Population Decrease 0.8%

Source: Easton (1997)

For frontier attitudes died as slowly as did the restrictive regulatory environment. Even so, suddenly the old regulatory regime began to be swept away, when the Sale of Liquor Act 1989 stated
“the object of this Act is to establish a reasonable system of control over the sale and supply of liquor to the public with the aim of contributing to the reduction of liquor abuse, so far as that can be achieved by legislative means.” (Italics added)

In future the industry would be regulated by the ordinary commercial laws of the land. The notion that the purpose of the licensing system was solely concerned with reductions in the abuse of liquor (today we are more likely to refer to ‘misuse’ and ‘harm’) and not with restricting access or reducing consumption, was a major break from past legislation.

The change reflected the wider economic reforms of the times, which were focussed on applying market principles in economic and social policy. This paper is primarily about their subsequent development particularly as it applies to taxation, which was affected only later. But first a brief history of taxation of alcohol in New Zealand.

Alcohol Taxation in New Zealand

In 1839, the British Colonial Secretary , Lord Normandy, confidently advised putative Governor Hobson ‘Duties on the import of tobacco, spirits, wines and sugar, will probably supersede the necessity for other taxation …’, (McLintock 1958:90), although beer was not initially taxed. There was a brief six months period from September when the duties were repealed, but since then excise duties on alcohol (and tobacco) have been an ongoing part of New Zealand’s fiscal practice. (Taxation Review Committee 1967: 63)

Normandy’s promise that the revenue source would be sufficient proved unfounded. Admittedly in 1875/6 customs and excise duty made up 91.6 percent of tax revenue, but since then the proportion has been diminishing. In 2002/3 excise duties (including the Good and Services Tax (GST) – a kind of VAT – levied on them) on alcohol and tobacco contributed 3.5 percent of total tax revenue (with a further 1.9 percent coming from customs duty). The decline is not so dramatic relative to total output. Customs and excise duties (including on some other products) was about 4.1 percent of GNP in l875/6, while alcohol and tobacco taxation is expected to be about 1.4 percent of GNP this year. What Normandy underestimated was the revenue demands of future governments.

The decision to tax spirits, tobacco and sugar was initially a matter of administrative convenience. All excise duties generate the possibility of illicit import and production, but these products were reasonably easy to identify, and there were a few key production or transit points at which the duty needed be levied. (Vineyards did not become widespread until after the Second World War.)

Later on, as settler society developed, the taxation of alcohol (and tobacco) was further attractive because its consumption was thought to be indulgent, if not downright evil. Hence the practice of labelling excise duties on them as ‘sin taxes’. In effect alcohol was deemed a ‘demerit good’, whose consumption should be discouraged. The justification for why a good is a demerit (or merit) one is not easily identified by economic analysis. although there is a widely held view that aggregate alcohol misuse is directly correlated aggregate alcohol consumption so a reduction of the first can be necessarily caused by a reduction of the second. However there would also be a reduction of consumption which was not generating and that was only irrelevant if alcohol was not a demerit good.

Ironically alcoholic beverages are also attractive for excise duty because their demand is ‘price inelastic’, that is the quantity purchased is not very sensitive (‘insensitive’) to a change in price. Thus the duties do not reduce consumption, so much as punish by a ‘fine’ those who consumer.

The 1958 Budget and its Aftermath

The notion of taxing less acceptable products was evident in the 1958 budget, when the government, needing to reduce the fiscal deficit, hiked taxes on alcohol and tobacco (and motor spirits). At the time the public saw the ‘Black’ budget as a betrayal of the promises in the 1957 election promise and the punishing of the working man’s pleasure in his ‘beer and baccy’, by a 30 percent rise in the price of alcoholic beverages and a 40 percent rise in the price of tobacco. So dramatic were these hikes that they perceptibly cut consumption despite each product’s price inelasticity of demand (Easton 1967) The public justifications given for these excise hikes were surprisingly thin. The budget speech simply says there is a need for fiscal action and baldly announced the additional impositions. The politically traumatic experience of the 1958 budget meant that subsequent governments were loathe to raise taxes on alcohol.

The 1970s

Tobacco duties were hiked in 1967, and again in 1970, and 1976. The October 1970 Economic Statement said
“Of all the products at present subject to indirect taxation, it is clear that cigarettes and tobacco can be subjected to additional tax without harming in any way the general welfare of the community. In fact it is increasingly argued that discouraging the consumption of these commodities is likely to make a positive contribution to our general health.” (p.12)

This may be the earliest fiscal reference to using taxation to improve health by inhibiting consumption. There was no mention of alcohol and its duty level was left untouched. It is unclear why the two were treated differently. Possibly tobacco excises impacted more greatly on workers who were not the right wing government’s significant supporters. The 1976 announcement contains no justification for the tobacco excise hikes, but this time duties were raised on spirits as well.

As inflation galloped along in the 1970s at double digit rates, the real value of the excise duties fixed in nominal terms was diminishing, which reduced the real value of government revenue, and the real price which made the licit drug use cheaper. A coalition evolved of those who wanted the government to control and reduce its fiscal deficit, and those who wanted the government to control and reduce the use of licit drugs (or perhaps merely punish the drug users). They may have had quite different objectives, but a common policy prescription for both groups was to raise excise duties. In the 1979 Budget there was some linkage of specific taxes to inflation via the imposition of specific sales taxes.

The 1977 budget speech signalled an apparent change in policy. The first paragraph of the section titled ‘Duty on Alcohol and Tobacco’ says
“The Government is concerned at the high level of public expenditure caused directly by the consumption of tobacco and alcohol. The adverse effects on health of smoking and drinking have been well publicised. Alcohol is also a major cause of many road accidents. The cost of providing health care and treatment in public hospitals and elsewhere for those affected is very high.” (Economic Statement 1977:p.41)

Having set the new higher duty rates the section concludes that the additional revenue ‘will help sustain the high level on health, including the extension of community health services’ Thus a new principle has been introduced. While the duties remained primarily for revenue purposes a justification is now in terms of the costs that the consumption impose on the public. Some of the increase in revenue went directly to particular health promotion and treatment programs. However this ‘tagging’ of some tax revenue for particular purposes did not last.

At the end of the 1970s the purposes of special taxes on alcohol (and tobacco) were:
1. They were relativity easy to levy, with relatively low compliance costs compared to many other products.
2. They were levied on products which were price inelastic so a hike in taxation increased revenue.
3. The tax revenue would contribute to the costs of the health system (and, possibly, the spending of other government agencies) incurred as a result of their consumption.
4. Insofar as the higher taxes raised prices and reduced consumption, that would also contribute to population health.

Lurking in some of the public’s mind was the notion that alcohol was a demerit good whose consumption should be discouraged. However the notion is not mentioned in the later policy statements. As time went on it probably plays an decreasing role in the policy debate and in the public mind. But there remained the recognition that the consumption of alcohol could be a ‘bad’ insofar as it caused negative externalities (or harm), the point captured in 3 above (and possibly 4).

The 1989 Budget Reform

The 1980s were a period of major fiscal reform. Among the important changes impacting on alcohols was taxation on wine was switched in 1986 from a sales tax based on value to an excise duty based on alcohol content. A significant effect of this change is that, for the same total revenue, the price of expensive wines would fall and the price of cheap wines rise. (This has considerable significance for econometric studies attempting to estimate price elasticities. Traditionally they have treated the imposed tax as a proportional sales tax, or that the price range was narrow enough so that the excise duty could be broadly treated as a proportional sales tax. This clearly does not apply for wine where there is a great variation in price.)

Following the 1988 Report on the Review on Excise Duties on Alcoholic Beverages and Tobacco Products (Sullivan Report) the 1989 Budget made major changes.

This is another area of unnecessary complexity and controversy. … The basic case for heavier taxation on alcohol and on tobacco lies in the social costs of their consumption. In the case at least of alcohol this is somewhat arbitrary, since everyone faces the higher taxes on alcohol but most drink only in moderation. Nevertheless the Government believes that the social harm that can be caused by excessive consumption of alcohol justifies the collection of a separate tax related to the alcohol content of alcoholic beverages.

As from tonight the excise duty on alcoholic beverages will be related directly to alcohol content, so that similar products with similar strengths of alcohol will be taxed to the same extent. Only two rates of excise duty [exclusive of GST] will apply:
– On beer and wine, $15 per litre of alcohol;
– On spirits, $30 per litre of alcohol. (1989:20).

In practice it has been difficult to assess the aabv in the ‘wine’ range from 6% to 23% aabv. Instead it is divided into three sub-ranges which are taxed on the basis of $21.096 per litre of ethanol at a point somewhere in each range. (Throughout this paper ethanol is used to mean ‘absolute alcohol’ while ‘alcohol’ usually means a beverage containing alcohol.) The effect is that beverages with higher ethanol in each range are taxed at a lower rate per unit of ethanol than beverages in the same range but with lower unit ethanol. For instance ‘light spirits’ at 23 percent aabv alcohol, was taxed as if it is 18.0 percent aabv alcohol, so the excise duty per unit of ethanol was only 76 percent of the set rate. In effect, every fourth drink tax was free in comparison to a purchase at 18.0 percent aabv. Not surprisingly, businesses took legitimate advantage of this anomaly, with spirits based drinks with a low aabv which were taxed at the wine and beer rate. The policy response is described below.

The Treasury View: 1991

The new regime was not without its difficulties In 1991 the Treasury provided a report in a response to the incoming Minister’s request for a review of alcohol and tobacco taxation, the last comprehensive policy framework report available.

It argued that GST (i.e. a VAT) is the most efficient revenue raising indirect tax instrument, but acknowledges two reasons why there may be a case for separate taxation alcohol:
– the private cost of alcohol use is less than the social cost (i.e. taking account of the cost to others) thereby encouraging irresponsible drug use – the ‘user charge’ argument; and
– some individuals need to be protected from making drug use choices that are not in their own best interests – the ‘irrational consumer’ argument.

The Treasury was troubled by the different excise duty rate for spirits from other beverages. It saw it as historic, and is unable to offer any justification for it, other than history and not abruptly disrupting past relativities. The best strategy, it thought, was to hold duty on spirits constant while the excise duty on the remainder rises with inflation, until they attain the same rate, a practice which had been announced in the 1989 budget. .

The report concludes that
– there is a case for specific taxation of alcohol primarily in terms of recovering user costs, but that the best level of these taxes is difficult to judge:
– the specific excise regime, coupled with some form of indexation arrangement, is the most appropriate system for the taxation of alcohol …;
– there should be a goal of uniform alcohol taxation. (1991:6)

There is no prevention element in this strategy. Excise duty is not seen to have a role in discouraging harm, a view which shifted in 2003. Before then we need to look at what happened over the 1990s.

Levels of Consumption

Not surprisingly the liberalisation of licensing laws resulted in a major increase in outlets, transforming particularly inner cities where bars are now common. What is surprising is that despite the increase in outlets available alcohol for consumption (in effect the amount drunk) has fallen. In the March 1989, the year of the reform, it was 10.0 litres per person over 15, rising to 10.2 litres in
1991, after which has fallen to 8.8 litres in 2001 (although they were as low as 8.5 litres in 1997).

The reasons for the fall are complex. Real alcohol prices rose, there has been an persistent campaign to improve attitudes to alcohol, and drink-driving enforcement is tougher. On the other hand, not only has licensing been more liberal, but prohibition on the television advertising of liquor was abandoned in 1991 the legal age of purchase of liquor was lowered to 18 (the voting age) in throughout the 1990s and there has been an increase in the variety of alcoholic beverages, all of which ought to have lifted consumption to some extent. An optimist might argue that the licensing liberalisation has led to more ‘civilised’ drinking, but the most cautious interpretation is that there has been a long term shift away from heavy drinking, which the liberalisation measures did not reverse.

Youth Consumption

There is one major exception. The evidence points to significant increases in alcohol use and misuse among the young.

The annual Auckland surveys (the longest continuous set available) show that the average number of drinks consumed on one occasion among 14 to 19 year olds increased from 3 to 4 in 1990 to 5 to 6 drinks in 1999. The rise was particular strong at the younger end, with the 14 to 17 year olds increasing from 2 to 3 drinks in 1990 to 5 to 6 in 1999. (Casswell & Bhatta 2001)

The National Alcohol Survey found that the average quantity of ethanol consumed by 14 to 17 year olds doubled between 1995 and 2000. It also rose for 18 to 19 year olds, but fell – or was much the same – for older age groups. A similar pattern applies for frequency of drinking (occasions per year). The survey also found that the 14 to 19 year olds were consuming more on each occasion, in contrast to the older age groups whose rate had not changed much over the five years. (Habgood et al).

There are no long term series but currently over a third of 14 to 17 year olds consider themselves as ‘heavy drinkers’. (ALAC Youth Drinking Monitor 2002) The National Survey found that 7 percent of 14 to 15 year old males, 25 percent of 16-17 year old males and 40 percent of 18-19 year old males were involved in a session of at least 6 standard drinks at least once a week. The latter proportion was more than for 20 to 24 year olds, and the 16-17 year old proportion more than occurs for those over 25 years old. The same patterns apply for females, except their levels are slightly lower (7, 22, and 28 percent). (Habgood et al)

These trends are reinforced by the evidence that the age of first drinking seems to be lowering, although the surveys were not well designed to measure this. It seems that the earlier the age of onset of drinking the more likely the young person is to be involved in heavy drinking in the teenage years. (Lynskey & Ferguson 1995; ALAC 2002)

In summary there has been rising drinking among teenagers in the 1990s, older teenagers appear to be at least as prone to heavy drinking as young adults. The reasons for the change are not certain. In part it is an international phenomenon, but it could also be argued that the thrust of the post-1989 policy to make alcohol consumption as ‘normal’ as possible, exposed young people to an environment where they had to learn to drink in a mature way, without much support to help them in the learning task.

The Taxing Harm Report

At the end of 2002 ALAC commissioned me to write a report on alcohol taxation. After a review of the literature and the existing situation, some of which is reported above, I concluded that while much policy toward alcohol was in the spirit of the 1989 licensing reforms, excise duties on alcohol could be better aligned. In particular, while the purpose of the interventions were to reduce harm, this was not the focus of the taxation regime.

Almost as an aside, the review also showed that the tax regime had created a fiscal anomaly. The 1989 tax package had envisaged that there would be a differential between beer and wine on the one hand and spirits on the other. However the implementation was on the basis of whether the absolute alcohol by volume was above or below 23 percent, so diluted spirits were taxed at a wine and beer rate. Now for highly diluted spirits – the flavoured alcoholic beverages with an aabv similar to beer – this may not have mattered, since the cost per unit of ethanol proved similar to existing drinks perhaps because of packaging costs, at the top end it was possible to produce ‘light spirits’ which were astonishingly cheap. A 1.125 litre bottle, containing 23 standard drinks cost as little as $7.95 at a time when the minimum adult wage was $8.00 an hour. A typical drinker could get drunk on the cost of a cup of coffee. Some did. Anecdote said the main drinkers of light spirits were young people, and there are at least two cases where drinking a bottle and a half of light spirits caused death.

The report argued that there were two types of harm. There was ‘consumption’ harm which was mainly related to the quantity of ethanol drunk regardless of the circumstances, and there was ‘drunkenness’ harm which was the result of excessive consumption of alcohol in particular circumstances. I was unable to find any estimates of proportions between these two types – in any case they would depend on the particularities of a drinking environment – but Eric Single cites that 70 percent of alcohol harm occurred within a year of consumption and this might be equated to the share of ‘drunkenness harm’. (Single 2002)

Could taxation be used to reduce the drunkenness harm? The research literature – albeit thinly – and anecdote – richly – suggests that during heavy drinking the quantity of ethanol imbibed is affected by the price of liquor. The higher the price, the less which is consumed in a session. This is much less true for drinking situations which do not lead to drunkenness, say when the liquor accompanies a meal. A rise in price may lead to reductions in the value of the liquor consumed, as for instance people switch to cheaper wines, but not to the quantity of ethanol consumed. Moreover the price of ethanol in the moderate drinking situations is likely to be much higher than the price in the heavy drinking situations. Anecdotally, one purchases liquor suitable for a meal as much as one can afford, for a heavy drinking session one purchases cheap liquor as measured in the cost of ethanol. It seems likely that for drunkenness harm the minimum price of ethanol matters, while for consumption harm the price of alcohol may matter but the price of ethanol probably does not matter much.

The effect of the existing polices was to target consumption harm (insofar as any harm was being targeted), even though drunkenness harm appeared to be the bigger problem. Moreover the policy levied consumption to contribute to the cost of harm, it did not aim to prevent it. An alternative strategy was to focus on the minimum cost of ethanol, since that would have a real effect on reducing drunkenness harm.

This led to the following executive summary, which sets down the analysis of Taxing Harm as well as the recommendations. (Not all of the 46 paragraphs are reported here.)

Principles

1. The National Drugs Strategy includes the policy objective of ‘the minimiz[ation] of harm caused by alcohol use to both individuals and the community’ where harm is defined as ‘all adverse effects or outcomes, including harm to health as well as detrimental effects on social and family relationships, loss of actual or potential enjoyment or livelihood, and economic or financial costs.’

2. The report recommends that the specific taxes and levies on alcohol be levied with the primary purpose of reducing alcohol misuse and the consequent harm.

3. A secondary purpose, which assists in setting its appropriate level, is that the taxation should enable the government to recover some or all of the expenditure outlays and revenue losses caused by alcohol harm.

The Effects of Excise Duties: How the Market Can Help Reduce Harm

4. The effect of (an increase in) an excise duty or levy is to increase the price of the alcohol on which it is levied.

5. The effect of an increase rise in the price of alcohol is to reduce alcohol consumption to some extent. The extent varies by type of drinker, by drinking situation, and possibly by the quantity drunk in each situation.

6. The biggest reductions in harm from rising alcohol prices are likely to arise from
– reduced teenage consumption;
– inhibiting moderate and heavy drinkers becoming very heavy drinkers, and
– reduced additional drinking in a session.

7. The strongest economic reasons for extra regulation of the alcohol market (including the imposition of excise duty) are
– externalities and the need to bring market prices in relation to social costs;
– the semi-rational or irrational behaviour of teenagers learning to drink, and of heavy drinkers and addicts (although the latter group may not be particularly susceptible to price signals); and possibly
– inhibiting moderate and heavy drinkers becoming very heavy drinkers and addicts.

8. Excise duties based on ethanol are probably mildly regressive, that is they probably impose proportionally more on the poor than the rich. However the biggest redistributional effect of excise duties is the transferring of spending power from heavy drinkers to moderate drinkers and non-drinkers. This transfer is in the opposite direction to the social costs which heavy drinkers impose on others. Thus the main fiscal effect of excise duties on alcohol is to offset the redistributive impact of social costs of alcohol misuse – that is to reverse (in part) the transfer of social costs which heavy drinkers impose on moderate drinkers and non-drinkers.

9. Higher prices for alcohol impact on different consumers if different ways. The evidence suggests that on average while modest drinkers are not greatly affected, heavy drinkers may cut back their drinking by 1 percent for every 1 percent rise in price, and chronic drinkers are almost completely unaffected. Teenagers reduce their drinking in the face of higher prices, and it seems likely that there is less drinking in extended drinking sessions as the price rises. Higher prices may also inhibit moderate drinkers becoming heavy drinkers and heavy drinkers becoming chronic drinkers.

10. In a modern market economy, market prices coordinate the decisions of producers and consumers. To do this effectively, the prices should relate to social costs.

11. While many people are offended by excessive drinking, which in economic terms may classify it as a ‘demerit’ good, this may not be a compelling reason for rasing alcohol prices.

12. While there is some irrationality (or quasi-irrationality) among some alcohol consumers and on some occasions, it is not evident that price policies are particularly helpful in reducing harm from this course. Insofar as irrationality is a problem, other interventions need to be pursued. The report notes however, that teenagers who are being socialised into moderate drinking need special attention.

13. Alcohol is one of a handful of products, where the costs of production do not roughly reflect the overall costs to society of consumption. The excess social costs are substantial. The most comprehensive estimate suggests that alcohol misuse reduces effective GDP by 4.0 percent, may well reduce the effective size of unmeasured (informal) economy by a similar amount, and has also reduced the welfare of New Zealanders via additional mortality and morbidity by 2.0 percent and the population of New Zealand by .8 percent.

14. The excess social costs may be thought of as the economists’ equivalent of harm, in which case the objective of alcohol policy in economic terms is to reduce social costs. Reducing the gap between the prices which individuals make their alcohol consumption decisions and the social cost to the economy will reduce harm, because individuals are less likely to partake of potentially harmful consumption.

15. It is not practical to require alcohol consumer to pay an appropriate insurance for the social costs they may incur with each drink …

17. While a lift in alcohol excise duty will raise prices for all drinkers, many will be better off, insofar as the resulting tax revenue will be recycled back. Under some assumptions, over 70 percent of adults will be better off as a result of this recycling (and also from reductions in harm). This is because heavy drinking is concentrated in a small part of the population. They will be made worse off as a result. On the other hand heavy drinking is the main source of harm, and so the heavy drinkers would be paying for a greater share of the harm they generate.

New Issues

18. Among the new issues facing strategies to reduce alcohol harm are new beverages, and new legislation which liberalises access and attitudes to alcohol. Excise duties probably can do little to assist with any potential harm these may generate …

19. A major new issue is the rising incidence of teenage drinking over the last decade, and the clear evidence that much of it is potentially harmful. Teenagers are sensitive to higher prices. Higher excise duties would reduce their potentially harmful consumption, while they learn to drink like mature adults. (The report also notes that there is also considerable heavy drinking by adults in their early twenties, which would also be reduced by higher excise duties.)

20. A second new development is the introduction of new beverages, for which the cost of ethanol is exceptionally cheap …

The Proposed Excise Duty Regime

23. An excise duty on alcohol can contribute to reducing harm from alcohol misuse by raising the minimum price of alcohol, thus reducing consumption by teenagers and heavy drinkers, and inhibiting the creep of moderate drinkers into heavy drinkers and to chronic drinkers. However, ideally the excise should not impact moderate drinking which is not potentially harmful. In practice this impact cannot be eliminated but it can be moderated by choice of the duty regime.

24. The most effective excise duty with the purpose to reduce harm is likely to be one which is levied on ethanol (the quantity of absolute alcohol), and is particularly concerned with the minimum price of alcohol. A particular merit of this levy regime is that it impacts relatively less on high value (relative to ethanol content) drinks.

28. Very low alcohol beverages should be exempted from excise duty on the basis that their consumption causes little harm (as well as reducing compliance costs) …

29. As far as is practicable, ethanol should be levied on actual content, and the excise rate should not based on duty bands. Where duty bands have to be used, the within band rate should be set at the top of the band in order to avoid suppliers avoiding actual taxation on ethanol content.

31. Distilled spirits (especially light spirits) can be produced at a considerably lower cost than other forms of alcohol. In order to maintain realistic minimum levels for the price of alcohol, either the base excise duty rate for all alcohol has to be raised, or a differential maintained between spirits needs to be introduced. This report recommends the latter option. …

33. The base level for excise duty is a political judgement to be made through the parliamentary process. That it is a political judgement suggests the need for a wide public debate on the appropriate excise duty rate. An important consideration in setting the base rate is the extent to which the total excise duty should contribute to gross fiscal costs of alcohol harm.

Hypothecation

36. The report does not recommend further hypothecation. …

The Consequences

The two forces which allied in the 1970s to raise excise duties, came together again to lead to a quick implementation of some of the Taxing Harm recommendations. The fiscal imperative was aghast at the tax anomaly and, of course, always willing to generate more revenue: those concerned with harm were anxious to raise the minimum price of ethanol. In May 2003 the excise duty on all alcohol from 15 aabv to 23 aabv was raised to the same level as for full spirits. The implementation differed from the Taxing Harm report’s recommendation of only raising it on spirits. A consequence was that the price of fortified wines and liqueurs also rose, much to the chagrin – according to the media – of the elderly who enjoyed a glass of sherry.

The spectacular change was that light spirits, whose price rose sharply and are no longer produced, indicative that its attraction was primarily as a cheap source of ethanol. On the other hand it appears (the data are not yet available) that there has been little reduction in the consumption of fortified wines and liqueurs, which suggests they are consumed for the entirety of the product.

Why did the government not follow the recommendations of Taxing Harm, especially in including non-spirits in the tax hike? From the Treasury official’s papers are available under the Official Information Act we can distill the following reasoning.

Officials were reluctant to target a minimum price of ethanol. ‘ [T]he excise would be based on production costs. We consider this basis of excise taxation to be inconsistent with encouraging efficiency in production and growth’. There is no further analysis. It is not obvious that the statement is correct. Suppose that a producer were to find some efficiency which halved the cost of producing ethanol so the cheapest sources of liquor fell dramatically. Would the excise duty be left at the current rate? Of course not. The government would soon increase the excise to offset the fall. Would this government reaction discourage producers from looking for efficiencies? Not by much. The producer who introduced the efficient gain would still be selling at a lower price that the competitors after the excise duty increase, so would still reap a reward from the efficiency implementation. The light spirits is an illustration of this principle although the lower cost was the result of a tax anomaly as well as a new cheap source of spirits (from cheese whey). (The reference to ‘growth’ in the Treasury statement is not a hope for more liquor consumption, but that the efficiency gains would release resources for other sectors.)

Once the Treasury advice had rejected the relevance of a minimum price of alcohol, the lowering of the high excise duty threshold from 24 percent to 14 percent aabv, for all alcohol followed. It also gave greater revenue gains. However the puzzle – observed in the 1991 Treasury paper – as to why there should be two excise rates remained. (Recall the Taxing Harm paper explains it because the focus on the minimum price of ethanol and otherwise minimizing the impact of taxation, but not trying to maximise excise revenue, means there is a case for a differential rate between spirits and other forms of liquor reflecting the differences in their production costs.)

Thus the official advice reflected the principles it set out in the 1991 Treasury paper of taxing the consumption of ethanol rather than the harm from ethanol consumption. However the papers agreed to by the cabinet state very clearly that the purpose of excise duties on alcohol is harm minimisation. But since the papers also adopt the excise proposals of the officials, based on taxation of consumption ethanol consumption rather than minimising harm, there is an inconsistency between the principles and the practice.

Future Directions

How long can this inconsistency be maintained? The resolution could go one of two ways. The harm principle could be abandoned, although that would go against the direction of post-war policy development. Alternately the excise duty regime could be oriented more towards the harm principle and less to the consumption principle. That seems likely to lead to more attention to the minimum price of ethanol, even if that involves a concern with production costs. To get the head-space shift it may be necessary to transfer responsibility for excise duties to the health desk of the Treasury, or at least to involve them more than the May package seems to have done.

Whether it is possible to further tune the excise duty on ethanol to target harm is not evident given the practical difficulties of differentiating by circumstance. One can imagine an excise regime where the level rose as the imbiber drunk more, but there is no obvious way to administer it. (If it could be shown some forms of alcohol were inherently more or less harmful than others, then differential excises might be practical by product, but there is as yet no really authoritative and quantified consensus to such propositions.) At this point the development of excise duty as a policy instrument may be exhausted. Other less economic instruments – restrictions, penalties for drunkenness, especially while drive, and programs to change attitudes – will remain relevant and will have to be actively pursued.

‘It is a capital mistake to theorise before one has data’ Sherlock Holmes.

Keywords: Health;

Introduction

There as been various calls for a ‘cost benefit analysis’ of gambling in New Zealand. The expression ‘cost-benefit analysis’ (CBA) has a rigorous meaning in economics, and while there is no need for economics to insist that their meaning of the terms should be universally applied, it is helpful to recognise that the phrase is being used as a short hand for ‘an analysis of the costs and benefits’. Thus the CBA ends up with a single number – a total quantum of which summarises all the costs and benefits in an economy. But even were that quantum zero – so the costs and benefits netted out – there would still be considerable interest in the individual costs and benefits and their incidence. So until there is a consensus to the contrary, I propose to interpret the expression ‘cost benefit analysis’ to be synonymous with ‘the analysis of costs and benefits’ rather than economist’s technical term which in this text I shall refer to as ‘CBA’. I use the expression ‘cost benefit analysis’ to denote both.

Analysing the Costs and Benefits of Gambling

Even so, the best way of analysis the costs and benefits of gambling, or anything else, is to use the analytical framework that underpins a CBA. Of course like Humpty-Dumpty, we can make words mean whatever we want. The fallacy with his approach is that words are used to communicate with others, and if the speaker is their master, those who hear the words may not understand what it is intended to be conveyed. The fact is that expressions such as ‘costs’ and ‘benefits’ are used frequently in public conversation as if they refer to the economists’ notions. To Humpty-Dumpty the words would create confusion.

The core of the economists’ notion of cost is ‘opportunity cost’, that is the cost of forgoing the next relevant opportunity, as explained below. Benefits are treated in a parallel way, so we dont need to develop the economists’ notion of benefit.

The best way to think of an opportunity cost (or benefit) is to consider two situations which for the purpose of gambling might be called the ‘factual’ and the ‘counterfactual’. The factual is usually the current situation, but the counterfactual depends upon a precise formulation of the issue. In the following I am going to assume that we are interested in the question of how much harm – if any – does current levels gambling cause and the extent to which it is offset by benefits. The counterfactual might be a world in which there was no harmful gambling or perhaps a world in which there was no gambling. The choice of the counterfactual requires some judgement, but it depends upon the precise issue of concern.

(Another issue might be a concern as to what will happen if opportunities for gambling in a region were extended. The factual is the current situation and the counterfactual is the situation where the additional outlets or whatever exist.)

Now, in principle, we can compare the various features with the factual situation with the counter-factual scenario. Some will be exactly the same – the sun will get up in the morning in each. Some will be different but not enough to worry about. And there may be some very substantial differences. In principle we make a list of all these differences.

Notice the construction of this list does not really involve economists, but a host of other social scientists (and epidemiologists and accountants). In my experience the economist’s work is very dependent upon the quality of this list, both in terms of the precision of the definition of items on the list and their quantification. Very often people ask whether X or Y or Z can be taken into account in a CBA. The most common response is that if the questioner can specify and quantify the phenomenon adequately on the list, then the economist can do something (economists’ caveats below).

The list is likely to be a very long one. In practice it is shortened by aggregation but even so the list will still remain long and heterogeneous. At this stage the economist applies a valuation to each item of the list. The valuation is done by a set of rules which are based on that the cost/price equals the social marginal cost which is (broadly) the amount of resources that society would exchange for having the opportunity to avoid or incur that particular item. The costing can be tricky and sometimes involves guessing because the data base does not exist.

(There are also some contentious issues of valuation – see the bibliography for papers which discuss some of the disputes. I do not want to minimise these contentions, but I would say that as important as they are, I have been more often let down by enormous gaps in the data which characterises the list.)

If all the items on the list are valued in the same monetary units, they may be added together and that gives (just about) the outcome of a CBA. Over the years I have become uneasy about this simple aggregation. One reason is that it is not always obvious that the aggregation is like with like. For instance, how does one add together goods and services with human mortality and morbidity. (I have argued why it has to be done elsewhere, and could do so again. My concern here is that the public does not always understand sufficiently what has been done, and misunderstanding a statistic undermines its usefulness.)

Perhaps for gambling a greater concern is that the aggregate may obscure the distribution differences between a factual and counterfactual. For instance (harmful) gambling might make children worse off (because the parents gamble away money that should be used for the children’s welfare) and casino shareholders (say) better off. That details of the redistribution may be far more important than the net impacts of the two. CBAs are underpinned by what is sometimes called ‘Hume’s Law’: ‘ a dollar is a dollar, is a dollar’ and it does not matter who gets the dollar, or who loses it. (There are some more sophisticated measures such as the Atkinson-Stiglitz index, but I have never seen them used in a CBA.)

If may not be a full aggregation. If instead of aggregating to a single monetary amount but finishing with a number of separate items, we have what might be called ‘an analysis of costs and benefits’. Note that the components need not be valued in the same units – a great relief to economists for we are often stretched by the valuation problems.

The Implication for Non-economist Researchers

While the above has not understated the difficulties of applying the economic analysis, it has also drawn attention to that the real need is for a careful, quantified differentiation between a properly specified counterfactual scenario and the factual one.

The ‘industry’ sector part of the difference can, usually, be dealt with relatively easily. Data bases are typically well placed to quantify the differentiation, and there are straight-forward well-attested rules for valuation. In some parts of the industry side there may be gaps, although overseas studies may be helpful. In my experience with health applications, the health sector data bases are more problematic, although sometimes epidemiologists have slaved away to provide credible data about hospital outlays. The same is almost certainly true for the criminal justice system.

The government sector part of the difference is usually straight-forward too (other than public sector industries – see above). It is a mainly matter of the application of known tax rates checked against their revenue in the government accounts.

It is the household sector is the complicated one, because the data is usually grossly inadequate. There are two broad issues.

1. At issue is not the proportion of the population which is subject to a particular phenomenon, but the difference between the proportions in the two scenarios. For instance, suppose the counterfactual differs from the factual by there being no tobacco consumption. What we are interested in then is, say, the proportion who have lung cancer under current circumstances (when there is smoking) to the proportion in the counterfactual (when there is not). Now there will still be some lung cancer even if there were no tobacco consumption, and epidemiologists put a lot of effort into estimating what they call the ‘attributable fraction’ which estimates the additional lung cancer cases as a result of tobacco consumption.

The prevalence and/or incidence data used to calculate the fractions (and also the community levels) is not always as detailed as even the collectors would wish, and often subject to high margins of error. My impression is that there is not sufficiently high quality data for New Zealand, in part because some of the most serious conditions (say criminal behaviour engender by gambling) is, fortunately, a relatively low occurrence and so difficult to quantify with precision. (There is a more on incidence and prevalence in an appendix. I have noticed that non-epidemiologists, myself included, get confused by the distinction unless we close our eyes and try very hard.)

2. Additional to these population figures we need how the phenomenon impacts on the person and those associated with her or him. It is not enough to say that a certain proportion of smokers die from lung cancer caused by tobacco consumption. They go through a harrowing time before that, and their families and friends suffer too, both emotionally and perhaps financially.

The gambling impact is probably more complicated. What we want to know is the various differences in material possessions, health and welfare and so on between family groups with some members involved in harmful gambling and those with none (supposing that is the counterfactual). The exercise of measuring the differences is challenging, but it may not be impossible. While any results will not be entirely satisfactory they should represent progress. (We need not be too despondent if the progress seems limited. Ten years ago I was at a seminar which thought doing the cost of crime attributable to alcohol and illegal drugs was hopeless. Today they are being included in estimates of the social costs of drugs.)

Note that while the data is needed for an analysis of cost and benefits, it is also extremely valuable for all sorts of policy purposes. Think of the implications if we knew something systematic about how harmful gambling by a parent impacted on the children’s education and health.

This leads to a conclusion, but before doing so a word about regional issues. Cost benefit analyses usually cover a national jurisdiction, not least because that is the way the data is usually collected. There is a small literature which looks at the economic and social impacts of gambling, say, on a region or sub-national area. (The procedure could be generalised to look at some other sub-national group such as an ethnic minority or age cohort.) In principle such cost benefit analyses do not involve any new principles compare to national ones. In practice the balance of applications, and therefore potentially the conclusions, is different. Even more practically, the data is even more inadequate. (The two scenarios may be different. For instance the factual may be the region without a casino, the counter-factual may be the region if the casino is introduced.)

Conclusion

Hardly any of this is about the technical side of doing a cost benefit analysis, issues which are covered in papers listed in the bibliography. Rather the paper has tried to provide for economists a robust account of what economists are trying to do, and how ultimately economists are dependent upon what others define and provide. In particular the definition of the factual and counterfactual needs to be given carefully thought out, and the differences of between them carefully measured.

The other point made is that a cost benefit analysis, be it a CBA or an analysis of costs and benefits, is a systematic way of thinking about the entirety of the issue. The value of building one up is more than the numbers that come out at the end. For it forces us to think about the factual and the counterfactual comprehensively, and so move towards an understanding and perhaps policy directions, from a holistic perspective. The economist needs always to keep this in mind too.

Go to top

Appendix Prevalence vs Incidence Based Approaches

The following is an excerpt from International Guidelines for Estimating the Costs of Substance Abuse: Second Edition, 2001.

Estimates of the economic costs of substance abuse may be either prevalence-based or incidence-based. Prevalence-based studies estimate the number of cases of death and hospitalisations attributable to substance abuse in a given year and then estimate the costs that flow from those deaths or hospitalisations (as well as other costs, such as prevention, research and law enforcement costs). Incidence-based studies estimate the number of new cases of death or hospitalisation in a given year and apply a lifetime cost estimate to these new cases. Thus, prevalence-based estimates generally measure the costs of substance abuse in the present and the past in a given year, while incidence-based studies generally estimate the present and future costs of substance abuse in a given year. For ongoing health and social problems such as illicit drug use, the results of prevalence-based and incidence-based estimates are often similar. For health problems that are declining in magnitude (such as smoking in some countries), prevalence-based estimates will generally be lower than incidence-based estimates. For emerging health issues such as epidemics of HIV or Hepatitis infection, incidence-based estimates generally provide higher estimates than prevalence-based estimates, because many infected persons may still be in the latency phase of the diseases.

Go to top

Bibliography: Some References on Social and Economic Impacts of Gambling
Australian Institute for Gambling Research, 2001 :Social and Economic Impacts of Gambling in New Zealand, Final Report.
Banks, G. (2002) The Productivity Commission’s Gambling Inquiry 3 years on.
Collins, D. & H. Lapsley (2003) ‘The Social Costs and Benefits of Gambling: an Introduction to the Economic Issues’ Journal of Gambling Studies, 19(2):123-147.
Rankine, J. & D. Haigh (2003) Social Impacts of Gambling in Manukau City. A report for Manuaku City Council July 2003.
Single, E., D. Collins, B. Easton, H. Harward, & H. Lapsley International Guidelines for Estimating the Costs of Substance Abuse: Second Edition, 2001 (The report will shortly be published by World Health Organisation.)
Walker, D. M. (2003) ‘Methodological Issues in the Social Cost of Gambling Studies’, Journal of Gambling Studies, 19(2):149-183.
Wynne, H. J. & M. Anielski, (2000) The Whistler Symposium Report. The first international symposium on the economic and social impact of gambling..On this Website
Index of articles on evaluation in healthcare.
Gambling in New Zealand: And Economic Overview.

Paper to the Unichem-Life Pharmacy Conference, Rotorua, 31 August 2003.

Keywords: Health;

You might expect an economist to focus on the state of public spending on health. Certainly were I the minister of finance I would. Indeed in a recent speech Michael Cullen expressed some dismay because since 1996 we have been increasing health spending faster than GDP and yet the problem of inadequate health funding appears unresolved.

We can only speculate what might be the effects which are contributing to this apparent black hole, for there is sadly little systematic analysis. They include
– the demographic shift towards the elderly which Mansoor Khawaja has just been discussing;
– a catchup from the cut backs in public health funding in the early 1990s, probably being more expensive than if they had been done at the time because it is cheaper to treat early than late.
– a bigger share of the funding going into preventative health care, but the benefits not yet appearing;
– some switching out of private health care to public health care, indicated by the falling proportion of the population with private health insurance;
– some of the funding increases have gone into reducing the cost of health care to particular groups – especially children – so that we may be more financially equitable between the sick and the well, without necessarily having improved health status.
– probably there is still waste in excessive managerial overheads on one hand, and new primary care providers that have not yet settled in on the other;
– new (expensive) medical technologies.

Some of these effects are transitory, although they may take decades to work their way through, others reflect fundamental changes elsewhere in the economy. Today I want to focus on but one, related to technology, and reflect on how it might affect the pharmacy industry. Talking about new medical technologies is misleading for it is a consequence of a more fundamental, more obvious, and yet more overlooked change to health care, one which has many subtle implications with which we are struggling to deal. That change is that the health system is steadily moving away from saving lives to enhancing the quality of life. That does not mean that the significance of life saving and prolongation has diminished – it is still has the highest priority. The change is that an increasing proportion of activity is concerned with improving the quality of life.

The point is that these increasingly expensive new technologies are meeting new needs, not just meeting old needs better. I want to illustrate the principle with a problem I worked on a few years ago. I am not medically trained, so I may get the story a little wrong, hopefully at the edges. In any case medical knowledge has moved on. Even so the story I tell is indicative of a common problem which those involved financing health care take.

In 1999 the Multiple Sclerosis Society approached me in regard to a very expensive drug, beta-interferon or ‘betatron’, which moderated the impact of the disease but which, at the time, Pharmac did not provide free because of its great expense.

Multiple Sclerosis is a chronic neurological disease which affects the myelin in the brain, leading to progressive loss of control over some muscles. We are familiar with MS sufferers on crutches or in wheelchairs, but that is a late stage of the disease, often decades after it has struck. The early stages involves acute episodes of illness often leading to periods of hospitalisation. For some, but not all, patients a course of betatron reduces these episodes in frequency and severity, and the treatment can mean they can return to living a reasonably normal life during the early stages. It also seems likely that prevention of these early stage episodes will delay the onset of the later stages of MS when there is less control over limbs. For a number of good scientific reasons this is conjecture, but in my work I used the common assumption, that where betatron was effective, it could delay the onset of the wheelchair stage by at least ten years.

A course of betatron is expensive – around $20,000 a year, and all the more effectively expensive because it does not work on all patients. Moreover it is more expensive than the costs of hospitalisation and other treatments which it avoids in the early stages of the disease. A pertinent element of the evaluation is that it does not seem that MS shortens life, it reduces its quality – I avoid saying it ‘only’ reduces its quality, because MS sufferers say it can be a big reduction. So the significant gains from the use of the medication are the enhanced quality of life of patients, both in the short term and also from the future delays in the progression of the disease. The economic problem I faced was whether the quality of life gains justified the considerable additional outlays of the medication. For some people the gains are so great they were purchasing the drug privately – some were literally bankrupted themselves or the family to do so. But not everyone could afford that amount, which is more than the average income of a New Zealander.

For the record, Pharmac agreed to provide the drug on a limited basis, the aim being to ensure it only went to those MS patients who would benefit. However, my purpose of telling you this story is to illustrate that this new medical technology was about life enhancing rather than life saving, and how it is much harder to decide what to do in such circumstances: who if any should receive free a new medicine. Betatron does not cure multiple sclerosis, it may delay its rate of progression, it does not reduce health costs. Its significance is it raises the quality of life of those who respond to it.

It would be easy to say that we should give the same priority to life enhancement as we do to life saving, but in truth the notion is a very encompassing one. Look around your pharmacy. You would probably argue that most of what you sell enhances the life of your customers. For instance, there are women who say their life would be devastated had they not recourse to cosmetics. Why then if betatron now available free from Pharmac, cosmetics are not? To complicate the story further, there may be free cosmetic treatment for the port wine stain of a birthmark or the removal of a tattoo. Why not if a psychiatrist recommends to a patient to get a make-over is that not paid for the state? While these examples might be thought of as extremes, it is difficult for common sense to draw a line in the between them separating what should be government funded from what could be privately funded. Note that because of the financing implications that line may be a function of the cost of treatment.

And just in case you think the contents od a pharmacy is the problem, the supermarket next door can argue that it also supplies life enhancing products. Why should we charge for life enhancing food if we provide life enhancing medicines free? (Should pharmacies distribute red wine on prescription?) My answer today to the paid-free dichotomy is not one of deep philosophy but the sort of pragmatism that one might expect from Pharmac or the Minister of Finance. There is a tight fiscal constraint, which arises from the limits on the willingness of the public to pay tax, and so each funding or availability decision has to be made incrementally, with the hope that they will not be over-influenced by special interest groups but show some sort of retrospective coherence. One suspects that we are well inside the boundary of what commonsense says should be funded, but additionally there is the constant worry that a great many of the treatments – including drug therapies – are not as effective as is claimed. Indeed often there is not a great deal of compelling scientific evidence for their effectiveness. The temptation, were I minister of finance or health, would be to introduce a program of eliminating the subsidy on well-established but scientifically unproven therapies, although the resistance from both those who use them for treatment and those who being treated makes this a politically unattractive option, even if it is fiscally responsible.

This does not directly impact upon pharmacists, since the decision to dispense government subsidised medication is made by others. Your task it is to ensure the dispensing is done efficiently to the required quality standards, that there is a minimisation of waste, and that the recipient is as fully informed as what is reasonable in the circumstances.

However, I want to suggest that the fiscal pressures plus another important social change is leading to another prominent healthcare task for pharmacists. That change is the shift from the view that the medical profession is responsible for the nation’s health to that the individual has responsibility for management of their own health (and their children’s) , supported by the medical profession. This transformation reflects, I think, two crucial changes in the postwar era. The first is a general shift to the liberal values of self-responsibility and the retreat of the big-brother state. The second is the realisation that while particular acute incidents are health and life threatening – for instance an inflamed appendix – how one conducts one’s life affects one’s overall health, the frequency of those acute incidents, and even their outcome. So while the medical professions are no less committed to dealing with the acute incidents, they are likely to add that their contribution could be avoided or substantially reduced if patients ate and drunk sensibly, exercised regularly, did not smoke, and so on. This message is so strong today, that even smokers are likely to say they are less entitled to treatment because they smoke, despite their contributing generously to the cost of public health system via the excise duties on tobacco.

This self-management approach involves a different approach from the health system, treating the public and private parts of it as a coherent whole. In comparison to the regime of professional responsibility, it is less obvious that one’s doctor is the gateway into the system based on self-management. Certainly, and I am agreeing here with recent developments in primary care, it make sense to have a special relationship with a particular general practitioner or practitioner group. But what self-management does is to subtly shift the focus from illness to well-health. While general practitioners might try to relocate themselves in that direction, the fact is that the majority of their work is likely to be past the point when self-management is sufficient by itself and where some sort of professional sick-care seems necessary.

It does not necessarily follow that the self-managed individual usually needs the counsel of the medical professional, but insofar as he or she does, that professional may be a pharmacist, who is not only dispensing prescribed medication, but is also providing information, therapeutic products, and possibly some services. I am offering this as a tentative suggestion, for they may be no need for an advisor or perhaps some other health professional such as the district nurse may do the job.

But let me explore a little about what the well-health pharmacist might look like, noting that this downplays the traditional role of the pharmacist as back-end of the GP dispensing prescribed medicines, and emphasises the front-end as health professional before the doctor.

Perhaps I should say that it seems likely that there may be no single model for the dispensing pharmacist. One obvious option is what might be called the ‘main street chemist’ which locates in the CBD of a large city and is in competition with other nearby pharmacists, but also with the supermarket for dietary supplements and body care products, and with special stores for body care products and so on. My impression is that the majority of customers are not attached to any particular main street chemist, and insofar as they are self managing they consult a convenient pharmacist on a casual basis.

The contrasting model may be the community chemist, typically located in a neighbourhood shopping centre with not much local competition either from other pharmacists or alternative providers of non-dispensing services, except perhaps the local supermarket. The customer may be much more attached to the pharmacy, repeatedly coming back to it for a variety of products and services, and may be well known to its staff – even with a computerised record. A typical conversation with the staff during a purchase may often be wider than the immediate concern and include an exchange of the customer’s health status with the pharmacist offering advice or extending knowledge – as well as the weather. The best placed community chemists will be very close to the local general practitioners’ clinic so not only are they the front and back end of the GP, but an adjacent geographical one. Perhaps there may even be some exchange of records.

Now this scenario may not be very different from the current practical situation of many existing pharmacists. What I am concerned here with is the change in head-space which the self-management approach involves. A practical example is the existence of over-the-counter medicines, the range of which has been increased in recent years. From the perspective of the standard commercial model, the purchase is an interesting one, because unlike the purchase of most products there are contra-indications when it should not be consumed. OTC medicines are one of the ultimates in health self-management, and for good reasons pharmacists are given an exclusive responsibility for selling them. This exclusivity may give pharmacists the unique selling proposition which they hope will give them a viable commercial future to practice their profession.

While health self-management rests on a liberal philosophy of people being independent and self-responsible, and is to be pursued for that reason alone, it also both reduces and increases the pressure on public spending. The spending reductions occur because effective self-management involves better prevention and early identification, each of which put less pressure on the public health system. Similarly, self prescribing with the support of a pharmacist may be considerably cheaper in resources than going to a doctor on a routine matter, with the bigger private cost being offset by time savings.

On the other hand, better management of health care may prolong life, eventually leading to greater public costs for the longer living elderly. This is a common paradox in health policy. Abolition of smoking prolongs life and adds to medical costs. The fiscally ideal cigarette might be one that extinguishes each smoker on the day he or she becomes eligible for New Zealand Superannuation. The resolution to such paradoxes is the concern is no longer simply saving lives but of enhancing its quality. Well-health strategies tip the balance away from medical treatments for avoidable conditions towards necessary ones for unavoidable ones.

Now economists are not very good at predicting the future, and I would be even less so about chemists, for I have not done a close study of the pharmacists’ industry. So I cannot tell you whether the industry will go down the main street or community pathway or how much of each, or perhaps there is a third way I have not addressed. My professional interest – the focus of this talk – is the implications of well-health strategies, especially today as they apply to pharmacies. You could decide to describe pharmacies as ‘well-health’ centres as a marketing ploy. I leave you to decide how effective that would be, and the extent to which it would give you a competitive edge over those who are contesting some of your markets. My economist caution is that the community pharmacy strategy probably involves giving free or near free services, at the very minimum spending a little more time with each customer. Of course one might say that the resulting customer loyalty pays for itself, and while I do not want to discourage such a notion, I wonder as to just how profitable it might be.

So let me suggests two strategy issues you might ponder on. The first is whether there are well-health activities that the government might contract pharmacists to do. Recently, it has been putting considerable emphasis of primary health care, funding a wide range of organisations – not all of which, I am afraid, have proved effective. Should well-health pharmacies be seeking some of the action, and if so what contribution could they make? Should you tender from the local DHB to provide preventive and advice services? (As an aside, this is quite a different issue from a possible need to subsidise some pharmacies to ensure that some communities have one where otherwise it may not be commercially viable.)

The other issue is what role might a well-health pharmacy have in relation to other health providers. Should you more systematically allow other local providers – such as podiatrists – to advertise in your shop? (What guarantees of quality do you give? Do you only allow some sorts of providers to advertise excluding, say, some alternative medicine providers?)

The big one is, of course, your relationship with general practitioners. Recall how I suggested there was an element in well-health of your being the GP’s front door, and not the just the back door dispenser. I suspect that is an issue fraught with complexities, because many general practitioners see their medical centres as well-health in addition to being sick-care agents.

These are only suggestions, intended to provoke you. Perhaps you can identify other possibilities which arise from a well-health strategy. Perhaps you may conclude that pharmacies are not part of a national well-health strategy.

In summary then, my theme has been that here is an ongoing transformation of the health system from professional management of individual health to self-management where the professional supports the individual. We do not seem to be sufficiently exploring the implications of this transformation, so I have suggested that perhaps pharmacists have a significant role to play in getting the best for the nation out of the transformation.

Let me conclude then with Skol, Kia ora, Well-health.

Go to top

This is a report was commissioned by The Select Committee on Health in August 2003. It’s report Inquiry into the Proposal to Establish a Trans-Tasman Agency to Regulate Therapeutic Products was released in December 2003, which means the accompanying papers are also now in the public domain. This is published in part because of its intrinsic interest, but also because it is a small contribution to the literature on New Zealand cost-benefit studies.

Keywords: Health;

Executive Summary

Using a Cost Benefit Analysis Framework, this report reviews the NZIER Assessment of Regulatory Options for Therapeutic Products to answer the following two questions.

Should there be an Extension to the Coverage of the Regulated Therapeutic Products?(Para 4.10)

The unsatisfactory situation in regard of the regulation of therapeutic products needs to be addressed. The simplest option would be an enhancement of the current regime. That would involve the industry in about another $32m to $48m p.a. compliance costs adding perhaps 2 to 3 percent to prices on average.
These additional costs would be offset by following unquantifiable benefits.
– benefits of reduced self-regulatory costs and of reduced disruptions when there is a failure of one (group of) product(s);
– improvements in information and confidence of consumers;
– possibly some quality improvements of products and some reductions in adverse medical events.
The unquantifiable benefits may exceed the identified costs. However the incidence of the costs (and benefits) will not be proportional and some products may be withdrawn from the market because of higher compliance costs.
The main risks are that the gains would be nonexistent or insubstantial.

Should there be a Trans-Tasman Regulatory Agency? (Para 5.13)

If New Zealand is to enhance its current regulatory regime for therapeutic products it seems likely that the compliance costs could be substantially reduced by some an international arrangement.
One such arrangement is the Trans-Tasman Agency (TTA). It is thought to reduce compliance costs on average by $26m-$39m p.a. (1.6-2.0 percent). This would reduce compliance costs of extending to a comprehensive scheme to about .5 percent of prices, on average.
The unquantified benefits of the scheme (additional to the comprehensive regulatory arrangement) would be additional exports. An unquantified cost may be the loss of jobs to Australia. An additional risk arises from the difficulties of renegotiating an international agreement if the new regime does not work properly.
Any international intercourse involves some loss of sovereignty. The TTA proposal is no exception. It is a political decision as to whether the trade-off of the sovereignty loss is compensated by the reductions in compliance costs, which in the case of the TTA seem substantial.
The Select Committee should also consider the possibility of Mutual Recognition Arrangements, insofar as the TTA is not the only means of implementing an international regulatory arrangement. If it is practical, it may be useful to have a separate economic evaluation done on it.

An appendix which brought together the three tables in the body of the text is omitted.

1. Introduction

1.1. The Select Committee on Health enquiring into a proposal for a trans-Tasman agency to regulate therapeutic products has commissioned this report to provide an independent assessment and summary of the economic evidence presented to it, especially of the cost-benefit assessment provided by the NZIER to Medsafe and published as Appendix 3 to their Submission to the Select Committee.

1.2 This report is based upon the NZIER assessment, supplemented where necessary, by information from other reports also submitted to the Select Committee.

1.3 A major aim of this report has been to summarise the assessment. Some of the fine detail in the NZIER’s assessment has been omitted. It is not thought that any of the omissions materially affect the conclusions.

2. Cost-Benefit Analyses

2.1 Cost-Benefit Analysis (CBA) is a standard economic method for evaluating the economics of some proposal. It is not controversial, Other common criticism of the method is that it pays insufficient attention to the distributional impact of a proposal or to risks (variations around the central forecasts). In practice they can be quantified to some degree, although often albeit it clumsily. The accompanying narrative should draw attention to these issues, insofar as they may seriously affect the outcome.

2.2 At the heart of a CBA is a list of all the effects of the proposal compared to some base case (often the ‘status quo’), the quantification and valuation of each effect, and the addition of the values into a net benefit (if beneficial effects exceed costs) or vice versa. Usually the proposal is sufficiently complicated that not able to all its effects can be quantified, either because some effects are unmeasurable or because suitable data is not available. Any significant omissions are mentioned in the narrative which accompanies the calculations.

2.3 In my opinion, the NZIER report, meets the standards of a professional Cost-Benefit Analysis.

3. The Issues

3.1 The issue is complicated by there being two separate proposals:
Issue 1. Should the current regulatory regime be extension to cover complementary healthcare products and medical devices? (Section 4)
Issue 2. Should the current regulatory agency (Medsafe) be replaced by an alternative arrangement, most notably but not only, by a proposed Trans-Tasman Agency. (Section 5)

3.2 For presentational purposes, it is proposed to treat the two issue independently, although there is some interdependence between them. In one direction, an element for any justification for the extension of coverage has to include the cost of doing so, which in part depends upon the regulatory agency. In the other, the feasibility of different agencies – especially cross-national ones – may depend upon a commonality of coverage.

3.3 While in principle the Select Committee’s concern is with the establishment of a Trans-Tasman agency to regulate therapeutic products, it is clear that many of the submissions are concerned with the question of the extension of the regulation, irrespective of the agency which does it.

4. Should there be an Extension to the Coverage of the Regulated Therapeutic Products?

4.1 The case for the extension of the coverage of regulated therapeutic products is set out in Medsafe’s Submission to the Health Committee. It reports a need for new legislation because the current legislation is ‘unworkable’ (p.17), and suggests that some of the therapeutic products are being distributed in contravention to the Medicines Act. (p.9) (An implication is that the situation – and therefore the status quo – would be very different, were the law enforced). It also identifies actual instances where there appears to have been a serious public health risk as a result of inadequate regulation. (p.22-62)

4.2 It would appear that new legislation is overdue. The NZIER report evaluates this option by comparing the additional costs and benefits of an enhanced regulatory regime. The status quo option is the current regime – that is with current levels of enforcement of the Medicine Acts. They report that the number of activities (applications, variations and annual renewals ) would increase from 8000 a year to 37,000 a year, and the total agency costs would rise from $8m to $43m a year, as staff numbers increased from 62 to 319. (Table 8) Additionally there is the direct cost to businesses of complying with the regulatory regime, which they estimate as a further $7.7m a year. (Table 9) (The data on which the assessment is based were provided by Medsafe to the NZIER or, in some cases , are the NZIER’s own assessments. They have not been independently verified.)

4.3 The NZIER estimates of the resulting increase in costs as a result of the enhanced regulatory framework are as follows. The first column is the type of therapy, the second is the total increase in costs, the third is the increase as a percentage of industry turnover, and the final column gives a range for the percentage increase based upon the NZIER assessment. (Table 10)

I: ADDITIONAL COMPLIANCE COSTS from the enhanced regulatory regime compared to the current one.

4.4 In assessing this table it should be noted that
(i) It is assumed that Medsafe will fully cost charge. This adds an extra $3.6m p.a. to business costs. Strictly this is a separate policy issue, but it does not markedly affect any conclusions. These could be offset by a $3.5m p.a. reduction in trans-Tasman import duties.
(ii) The percentage of turnover figures are averages. In particular Medsafe says that as much as 95 percent of current complementary health care products will be subject to a regulation involving self-assessment. It seems likely that many products will hardly be affected by the new regime. On the other hand a few may have a sufficient increase in their compliance costs to be withdrawn from sale, following consumer resistance to the higher prices.

4.5 The figures reported in Paragraph 4.3 are true resource costs (after a minor adjustment mentioned in Paragraph 4.4 (i)). The NZIER was unable to quantify the following benefits from a comprehensive regulatory regime.
Those to the industry include that it would reduce the costs of industry-self regulation. Also, in the event of some disruption over one or a particular group of products (say of a class of complementary health care products), there would be less industry wide disruption from falling sales, because the public would have more confidence in the other products.
Consumers would have more information, and more confidence in the quality of the products they are purchasing. They would also benefit from any pressure the regulatory regime put on suppliers to improve the quality of their products. Perhaps most importantly, consumers would be less likely to suffer from adverse events.

4.6 The NZIER report mentions Transit New Zealand uses a statistical value of life (avoiding death) of $2.55m. (NZIER report page vi) It seems that it is unlikely that the enhanced regulatory regime will result in the avoidance of premature death and other severe adverse incidents to offset the additional itemised resource costs.

4.7 However it is arguable that the big aggregate gains would be from modest gains in quality life years from many individuals avoiding particular self-medication with unfortunate side effects, that is from sickness or poor health rather than from death. Suppose at any time 16,300 people are currently experiencing a reduction of their quality of life of 10 percent as the result of avoidable side effects, and that was valued at $2,500 a person.[Footnoted: $2,500 is about a tenth of the implicit value of a quality life year that Transit New Zealand uses] That would more than cover the extra compliance costs identified above even if there was no reduction in the self-regulation costs, costs from industry disruption and other consumer benefits identified in paragraph 4.5. I am unable to judge whether such a figure is realistic (Appendix 2 of the Medsafe submission gives some background material), but note that a figure of 16,300 would represent less than 1 percent of the half of the population thought to make some use of the complementry health therapies.

4.8 The main risks from enhancing the regulatory regime would be that the gains mentioned in paragraphs 4.5 and 4.6 would be nonexistent or insubstantial.

4.9 In some ways the exercise presented here is based on a misleading status quo. If the existing situation (which is taken as the status quo in the CBA) is unsatisfactory and unstable, the enhanced regulatory regime is the true status quo of a CBA. (Alternatives might be
– a sharply reduced scope for the Medicine Act – perhaps with consumers having stronger statutory remedies for failure, or
– a vigorous enforcement of the existing law.)

4.10 Conclusion to Should there be an Extension to the Coverage of the Regulated Therapeutic Products?
The unsatisfactory situation in regard of the regulation of therapeutic products needs to be addressed. The simplest option would be an enhancement of the current regime. That would involve the industry in about another $32m to $48m p.a. compliance costs adding perhaps 2 to 3 percent to prices on average.
These additional costs would be offset by following unquantifiable benefits.
– benefits of reduced self-regulatory costs and of reduced disruptions when there is a failure of one (group of) product(s);
– improvements in information and confidence of consumers;
– possibly some quality improvements of products and some reductions in adverse medical events.
The unquantifiable benefits may exceed the identified costs. However the incidence of the costs (and benefits) will not be proportional and some products may be withdrawn from the market because of higher compliance costs.
The main risks are that the gains would be nonexistent or insubstantial.

5. Should there be a Trans-Tasman Regulatory Agency?

5.1 The essence of the proposal that the Select Committee is examining, is that the costs of regulating therapeutic products can be reduced by an international regime in which the costs are shared with other national agencies, in particular Australia.

5.2 The NZIER CBA report looks at two options. One involves a Trans-Tasman Agency (TTA) as proposed in the discussion paper A Proposal for a Trans Tasman Agency to Regulate Therapeutic Products. In the other, New Zealand unilaterally recognizes the decisions from overseas regulators which imposed similar or higher standards than those of New Zealand. This report omits consideration of the unilateral option, as the NZIER finds it less attractive than the TTA option (although in some ways – including lower compliance costs – it is superior to the enhanced domestic regulatory option).

5.3 The TTA option evolved out of the provisions under CER for a Mutual Recognition Arrangement, (MRA) in which the regulatory decisions of one of the Tasman partners would be recognised by the other. Thus any supplier of a therapeutic product would only have to register in Australia or New Zealand and be automatically recognised in the other jurisdiction. That would mean suppliers in country would only have to register once, reducing compliance costs.
It is to be regretted that the submissions made available to me do not provide any detail as to why a MRA has not proceeded. (One factor has been the different regulatory regimes of the two countries, but that would be overcome by New Zealand updating and enhancing its regime.)
It is likely to involve less loss of national autonomy, and also leaves open the possibility of a similar mutual recognition arrangement with other countries (say Canada). (Another minor gain is there could be ‘competition’ from the two regulatory authorities would put downward pressure on compliance costs.) This would further reduce compliance costs, and in New Zealand’s case may encourage exporting to these other countries. This is an expository rather than advisory paper. Its one piece of advice would be
The Select Committee should also consider the possibility of Mutual Recognition Arrangements, insofar as the TTA is not the only means of implementing an international regulatory arrangement. If it is practical, it may be useful to have a separate economic evaluation done on it.

5.4 For expository purposes this report takes a slightly different approach from the NZIER assessment. As presaged, it uses a different status quo, assuming that parliament has decided there is a need for an enhanced regulatory regime because the current one is unsatisfactory and unstable. The choice is whether to impose the enhanced regulatory regime (the new status quo) or the TTA.

5.5 The NZIER estimates of the resulting reductions in costs as a result of the using TTA instead of the enhanced regulatory framework are as follows. The first column is the type of therapy, the second is the total increase in costs, the third is the increase as a percentage of industry turnover, and the final column gives a range for the percentage increase based upon the NZIER assessment. (Table 10)

II: REDUCTION IN COMPLIANCE COSTS for a Trans Tasman Agency Regime Instead of the Enhanced Domestic Regulatory Regime

5.6 Because costs between the two nations are shared, there is a substantial reduction in the compliance costs to the therapeutic drugs industry. Given that the unquantifiable benefits will remain largely the same those considered in paragraphs 4.5 and 4.6 , the TTA option appears advantageous over the enhanced domestic regulatory regime.

5.7 At this stage it useful to compare the increases in compliance costs from the TTA regime over the current regime in a table analogous to that of Paragraph 5.5.

III: INCREMENTAL COMPLIANCE COSTS for a Trans Tasman Agency Regime Instead of the Current Domestic Regulatory Regime (Negative indicates reduction in costs)

(The estimates in Table III is broadly equal to the estimates in Table I minus the estimates in Table II.)

5.8 In summary, the TTA regime would be cheaper to administer than the current regulatory regime in the case of pharmaceuticals, would reduce the compliance costs of imposing the enhanced regulator regime on complementary health care products by two-thirds, and on medical devices by one-third. As paragraph 5.6 noted, there is no obvious loss of economic benefits from the TTA regime relative to the enhanced regulatory regime. (The NZIER mentions that the possibility of additional exports as a result of the simplification of entry to Australia. It also notes there may be net job losses as firms relocate regulatory affairs to Australia. Both effects are likely to be minor.)

5.9 The risks for this option include those which apply for the enhanced regulatory option (paragraph 4.7 of this report) although the estimates are less reliable (because the proposal involves more unknown parameters and experiences). Additionally there is the risk that if the new regime proves not to work properly, it is likely to be harder to reform because it involves an international partner.

5.10 The economics does not address the issue of the impact of economic sovereignty – in this context the ability of a nation to use all the economic instruments available to it. Sovereignty losses are not fully quantifiable, yet there may be a tradeoff between the loss of sovereignty and the gains from either cheaper regulation (relative to the enhanced regulatory option) or better regulation (relative to current regulatory practices).

5.11 Any tradeoff to be assessed by parliament. At one level the issue is one of deep principle – as the paper by Professor Burrows draws attention to. Such issues are generally outside the economics profession’s competence, although they would observe that any international economic intercourse involves some loss of sovereignty. Usually the smaller partner in the transaction suffers the greater loss.
At a practical level, one might ask under what circumstances might New Zealand want to adopt a different approach or treatment of a class of therapeutic products from Australia? It may be in this case, such circumstances would occur so infrequently that the practical loss of sovereignty would be small.

5.12 It may be that a mutual recognition agreement may involve slightly less loss of sovereignty (albeit possibly offset by a slightly higher compliance costs). However its importance is more about national economic strategy. One view is that CER was about forming some sort of economic union with Australia to obtain gains particularly from a bigger market. This is the view implicit in the NZIER report. An alternative view is that CER is part of a strategy of opening up the New Zealand economy to the whole world. Thus any particular arrangement (such as the regulation of therapeutic policies) is always tested as to whether it enables New Zealand to engage with a wider international economy.

5.13 Conclusion to Should there be a Trans-Tasman Regulatory Agency? If New Zealand is to enhance its current regulatory regime for therapeutic products it seems likely that the compliance costs could be substantially reduced by some an international arrangement.
One such arrangement is the Trans-Tasman Agency (TTA). It is thought to reduce compliance costs on average by $26m-$39m p.a. (1.6-2.0 percent). This would reduce compliance costs of extending to a comprehensive scheme to about .5 percent of prices, on average.
The unquantified benefits of the scheme (additional to the comprehensive regulatory arrangement) would be additional exports. An unquantified cost may be the loss of jobs to Australia. An additional risk arises from the difficulties of renegotiating an international agreement if the new regime does not work properly.
Any international intercourse involves some loss of sovereignty. The TTA proposal is no exception. It is a political decision as to whether the trade-off of the sovereignty loss is compensated by the reductions in compliance costs, which in the case of the TTA seem substantial.
The Select Committee should also consider the possibility of Mutual Recognition Arrangements, insofar as the TTA is not the only means of implementing an international regulatory arrangement. If it is practical, it may be useful to have a separate economic evaluation done on it.Go to top