FOOL ON THE HILL
Philip Morris on the Hot Seat

The maker of Marlboro brand cigarettes apologized for a ghoulish economic study that concluded smoking isn't costing the Czech government money despite the higher medical costs of treating smoking-related illnesses. What really has people angry is the report's conclusion that the government's cost is further offset by the early deaths of smokers. It may be creepy, but it's an economic analysis, not an assessment of the intangible value of human life, or a claim that lower costs from early deaths are a net good for the Czech Republic.

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By Richard McCaffery (TMF Gibson)
August 2, 2001

July was a lousy month for executives at tobacco company Philip Morris (NYSE: MO), but the moral outrage over a report on smoking in the Czech Republic is unwarranted.

The maker of Marlboro brand cigarettes apologized for a ghoulish economic study that concluded smoking isn't costing the Czech government money despite the higher medical costs of treating smoking-related illnesses. It turns out, according to the study, that taxes offset the costs. What really has people angry, however, is the report's conclusion that the government's cost is further offset by the early deaths of smokers.

It's hard to put a gentle spin on that kind of data.

Newspaper columnists, talk-show hosts, and even some economists are livid. The cry went out that the New York company, despite its friendlier commercials and charity work, hasn't changed.

I'm indifferent to Philip Morris, but I'm compelled to stick up for economists occasionally because their way of looking at the world has improved my thinking. In fact, my opinion of big tobacco's liability has changed mainly because of economics and economists, those same social scientists criticized for knowing the price of everything and the value of nothing.

Initially, I was unsympathetic to litigation against tobacco companies, which provide a legal product consumers desire. Who needs Philip Morris to tell them smoking is dangerous? I wouldn't go to Harley-Davidson (NYSE: HDI) for information about motorcycle fatalities. Waiting around for a moralistic confession from tobacco companies is a waste of time, but it's also unnecessary. In addition to the government, which regulates the tobacco industry, the vast division of labor that exists in the U.S. has produced an abundance of third-party organizations happy to address tobacco-related safety issues.

Anyway, economists understand that the cost of a product goes beyond the price tag, and this is where my thinking changed about the company's liability. For example, economists recognize opportunity costs, which represent the opportunities given up when one choice is made over another. If I choose to go to the racetrack instead of taking my niece to the zoo, I'd better have a productive day at the track because the value of time spent with my niece is embedded in every wager.

Economists also recognize externalities, or costs that crop up when my actions interfere with your rights. Say I own a factory that ejects billions of sulfur particles into the sky. If I'm polluting the air you breathe, I'm intruding on your rights by poisoning a community resource. For years, companies got to pollute the skies free of charge. Fortunately, things are changing. We have stricter air-quality laws and companies must pay for prevention and cleanup costs.

That sounds simple enough, but it's a big mistake to assume it's easy in execution, or that only bureaucrats shilling for special-interest groups could get things wrong. The government has a tricky job here. On one hand, companies that pollute the air, even mildly, should bear the costs. On the other hand, if we make the costs too high we're creating reasons why entrepreneurs -- who aren't saints, but deserve credit for taking risks many people wouldn't  -- won't start new businesses.

If you want to see an economy crash-land, take away the incentive to start new companies. The point is that reasonable people will disagree about the correct amount of these environmental costs, because some things are very hard to quantify -- and this makes it hard to create good legislation.

This brings us back to Philip Morris. The cost of cigarettes goes beyond what it costs Philip Morris to buy the tobacco, roll the cigarettes, package, and distribute the product. If government has to foot the bill for higher medical costs, Philip Morris should share in those costs. That's part of the cost of doing business. So is the company's charity work. 

But the reaction to this report in one sense is out of whack. On one hand, it's hard to believe smoking yields a net gain for the country's budget, even with high excise taxes. The report concludes that in 1999 smoking produced a gain of 5.8 billion koruna -- about $150 million -- for the Czech government, which includes the offsetting savings of people dying earlier than expected from smoking related-illnesses. I understand the hostile reaction to that conclusion, mainly because Philip Morris commissioned the report. Whether it's biased isn't even the issue. The point is that it has the appearance of a conflict of interest.

On the other hand, moral outrage about aspects of the report is overdone. The "positive effects" cited in the report relate strictly to the impact on the Czech Republic's budget. It may be creepy, but it's an economic analysis, not an assessment of the intangible value of human life or a claim that lower costs from early deaths are a net good for the Czech Republic. 

Most people understand you can't put a price tag on human life. We know this. With that in mind, however, come back to planet Earth and face a few of the difficult decisions life forces us to make -- decisions that, like it or not, demand that we examine costs and benefits, even regarding precious intangibles such as human life.

We put price tags on human life all the time. Insurance adjusters do it in wrongful death lawsuits: They start with basic discounted cash flow analysis, then add or subtract for intangibles such as whether the deceased had a spouse or children, on the plus side, or any disease that would have cut the person's life short, on the minus side. (If you want to know more, check out Adam Davidson's morbid but fascinating story on this topic in the August issue of Harper's magazine. Subscription required.)

On the other side of this fight, juries in wrongful death lawsuits routinely put numbers on human life as recompense to the living. In other words, the public understands it's OK to put a price tag on human life if you must -- as long as the number is big enough.

Philip Morris regularly faces claims that its products cost the government and society billions of dollars. This is probably true, but if I'm running Philip Morris, I'm not going to close up shop: The market has proven that there is a strong, persistent demand for my products. Instead, the first thing I'm going to do is try to figure out if it's an accurate claim, then quantify the costs. Would any individual act differently?

Let's say we live on the same street and you claim that my dog goes to the bathroom on your lawn every day. I can take your word for it and pay anything you want -- which may be the right thing to do to keep the peace -- or I can try to figure out if my dog is really to blame, if he's the only one, and whether the costs you want me to bear cover reasonable damages or include something extra for your rose garden. We'll probably disagree, but there's nothing inherently evil in working your way through that process whether you're an average homeowner or a big tobacco company.

Now, imagine I discover that my dog is actually fertilizing your lawn, and therefore providing -- strictly in an agricultural sense -- some benefits. You're going to think I'm crazy. At the very least, you're going to question my conclusions. I'd better know I'm in for a fight if I come to you with this information, and this is where Philip Morris should have been a lot smarter. Even if I'm right, common sense urges care in how I use these facts. Maybe if I'm smart I'll just use them to keep my damages down a bit.

Like it or not, however, there's an economic argument to be made that qualifies the amount I should be willing to pay. That doesn't mean I'm bragging about my dog's activities -- as some have said Philip Morris did -- just that the costs are more involved than they looked at first glance, and that all the costs and offsetting savings should be considered when you are undertaking an economic analysis.

Have a great day.

Richard McCaffery, capitalist dog, doesn't own shares of Philip Morris. The Motley Fool is investors writing for investors.