1. Utrecht School of Economics
June 26th, 2014
“E-cigarettes: Legislating the conflicting interests among consumers, tobacco companies, tax authorities and public health”
Tatiana Degtyareva (3755479) Lisaima Luijten (3869202)
Supervisor: Luigi Pinna
Group supervisor: Erwin van Sas

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Contents
Introduction ............................................................................................................................................................. 3
1. Market for tobacco .............................................................................................................................................. 4
“Big Tobacco”: Mayor Global Companies .................................................................................................... 5
Tobacco farmers: EU & US ........................................................................................................................... 6
Consumers ...................................................................................................................................................... 7
Government: Local governments, supranational EU and the US ................................................................... 8
Pharmaceutical industry ................................................................................................................................. 8
1.1 Interdependency between involved parties ................................................................................................... 9
2. Market failures .................................................................................................................................................. 11
Monopolistic (oligopoly) Power ................................................................................................................... 11
Asymmetric information .............................................................................................................................. 12
Negative externalities ................................................................................................................................... 13
“Financial” externalities ............................................................................................................................... 13
“Health” externalities ................................................................................................................................... 15
2.1 Solutions from theoretical frameworks: Coase & Hobbes .......................................................................... 17
The Coase theorem ....................................................................................................................................... 17
The Normative Coase and Hobbes theorems................................................................................................ 18
2.2 Role of taxation........................................................................................................................................... 19
3. Market for e-cigarettes ...................................................................................................................................... 21
3.1 Product and its features ............................................................................................................................... 21
3.2 Comparison with tobacco cigarettes ........................................................................................................... 22
3.3 Competition with tobacco ........................................................................................................................... 24
3.4 Regulation ................................................................................................................................................... 25
European regulation ..................................................................................................................................... 26
USA regulation ............................................................................................................................................. 27
4. “Cutting” the tobacco market – No smoke without fire .................................................................................... 29
4.1 Statistics on smoking .................................................................................................................................. 29
4.2 Conflict of Interests .................................................................................................................................... 30
4.3 Consequences of new regulations ............................................................................................................... 32
4.4 Potential complications ............................................................................................................................... 34
5. Conclusion ........................................................................................................................................................ 36
Recommendations ........................................................................................................................................ 38
Bibliography ......................................................................................................................................................... 39
Appendix A ........................................................................................................................................................... 45
Appendix B ........................................................................................................................................................... 46
Appendix C ........................................................................................................................................................... 48
Appendix D ........................................................................................................................................................... 50

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Introduction
Originated in China, electronic cigarettes found their way to the European and American markets in 2006 and 2007, respectively. But only recently, May 2014, has the European Union effectuated a new Tobacco Product Directive that concerns regulation of tobacco related products including e-cigarettes. This will imply new conditions such as constraints on advertisement, product differentiation, adoption of regulatory rules on e-cigarettes and ban on flavoured cigarettes. The EU claims to impose this regulation in order to protect public health throughout the whole Union. But a question arises: why does the EU want to treat e-cigarettes as another tobacco product that contains no tobacco, and which studies suggest is safer than normal cigarettes (Cahn & Siegel, 2011). Therefore, our research question is whether the motivations to regulate e-cigarettes are more concerned with public health issues or the protection of various private interests.
In order to guide us toward answering this question, we have to define the involved parties and their interests, whether tobacco and e-cigarettes stand in direct competition, and if there is enough evidence to treat them equally. We also need to touch upon such issues as taxation of both products, smoking rates among minors, externalities associated with the tobacco industry, consequences and potential problems that may arise after the regulation is in place.
To answer these questions, we will incorporate the qualitative research methods, which we will do by means of analysis of statistics, documents, professional/academic opinions and legislative acts. All drawn conclusions are supported by most recently available research and anecdotal evidence.
In the light of the attention drawn to the topic by the media and regulatory authorities, this paper provides a discussion relevant to various interest groups. We plan to provide one with enough information on the existing debate around the problem and invite readers for a further debate. This paper may also be useful for the legislative authorities faced with the need for regulation of electronic cigarettes, as we provide our recommendations in the end of the paper.
It is important to mention that there are certain limitations to our research, some of which concern the biasness of the available data, as available research was often conducted and/or funded by interested parties. Therefore, our paper takes a critical approach toward the available data used throughout the research.

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We start our research by outlying the involved parties along with their interest in Section 1. Next, we address the problem of market failures on the market for ‘smoking’, followed by the discussion on taxation. Section 3 concerns electronic cigarettes, their features and place in the market. In Section 4 we present a critical analysis of available statistical data and discuss the consequences of the recent regulations. The final section of the paper answers the main question, provides drawn conclusions and several recommendations. Furthermore, at the end of the paper we have provided four Appendices with illustrative material in order to introduce readers to the products discussed throughout the paper, and extracts from relevant literature.
1. Market for tobacco
As the tobacco industry is characterised by complex relations, Figure 1 below is provided to better display the interdependency of the involved parties. First, each of the involved parties will be discussed separately followed by an analysis of their relation.
Figure 1: Relation Diagram

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“Big Tobacco”: Major Global Companies
Historically, the “Big Tobacco” refers to the three major tobacco corporations in the US. Here we are to include the other global players of the industry. Here “Big Tobacco” is used as a collective name for the biggest and most influential tobacco companies worldwide, who consolidated themselves in five major private companies through privatization and mergers. The big five consists of Philip Morris International, Altria/Philip Morris USA, Japan Tobacco International, British American Tobacco, and Imperial Tobacco. However, apart from these five private companies, there are sixteen state-owned tobacco companies that are leading cigarette manufacturers in specific countries, which we do not include. Nevertheless, the China National Tobacco Corporation, which produced 2.1 trillion of the 5.9 trillion cigarettes produced worldwide in 2008, more than any other tobacco company in the world is also included under our definition of the “Big Tobacco” (Eriksen, Mackay & Ross, 2013).
The current share of approximately 1.1 billion smokers worldwide is expected to grow to 1.64 billion by the year 2025, mainly due to population growth. The ones to reap the benefits from this increase will surely be the top 6 tobacco companies that together control 81% of the world tobacco market. The state-owned China National Tobacco Corporation controls 37.1% of world’s tobacco market and has $91.7 billion annual revenue and $16 billion annual profits. Philip Morris International controls 17.4% of the global tobacco market share and enjoys $67.7 billion annual revenue with $7.5 billion annual profits. Following Philip Morris International is British American Tobacco, which currently holds 12.0% global market share, has annual revenue of $58.1 billion and annual profits sum to $4.2 billion. Japan Tobacco International has 9.6% of global market share, has $65.9 billion annual revenue and $1.5 billion annual profits (Rehn, 2014).
Despite almost identical annual revenue as Philip Morris International, Japan Tobacco International’s profits are just a fraction of Philip Morris’ due to the harsher regulatory conditions in the markets they serve. The fifth largest tobacco company by market share and world’s largest producer of rolling paper, cigars and fine-cut tobacco is Imperial Tobacco. In 2000 they dominated 0.8% of the world market but nowadays enjoy a market share of 4.9% due to aggressive acquisitions. It has annual revenue of $38.4 billion and $2 billion annual profits. Philip Morris U.S.A. was re-branded as 'Altria Group, Inc.'. The company controls 2.8% of global market share, $24.4 billion annual revenue and $3.9 billion in annual profits. Philip Morris International changed strategy in 2008 to evade taxes on U.S. operations, and now manages all overseas markets instead of the Altria Group, Inc. (Rehn, 2014).

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Tobacco farmers: EU & US
Governments in both the European Union and the United States have always been heavily involved with the tobacco farmers.
The main tobacco growing countries in the EU are Greece, Italy, Spain, France and Portugal, with Greece and Italy taking up 75% of the Unions total production. Tobacco is the most heavily subsidised crop per hectare in Europe, which creates distorted incentives and high-levels of inefficiency (Ross, 2004).
Through the Common Agriculture Policy (CAP), approximately € 1 billion was spent on subsidies for tobacco farmers each year throughout the EU. Only an average of € 2 million was spent on smoking prevention programs (McKee et al., 2004).
Subsidies being heavily criticized throughout the Union, the EU has opted for a reform of the CAP in 2001. The reform imposed that from 2001 till 2010, there will be a so called “phasing-out” of tobacco subsidies where farmers will get fewer subsidies, and by 2010 direct payments to these farmers would be abolished completely. Reasons for this were to depress the supply of tobacco. The Commission justified this “phasing-out” period by referring to its obligation under the TEC treaty to ensure a high level of health protection (Häge, 2012).
Although direct payments have been shaped to be granted only to help farmers adapt to the temporary loss of income due to the changing demand within the market, in some cases, like in 2007-2008, direct payments have been granted to certain farmers that would not be justified under the reformed CAP (Burny, 2010). Furthermore, Greece is still receiving subsidies under the 2003 CAP reform and EU farmers are still heavily subsidized through other means of indirect subsidies. Bulgarian farmers get a one euro subsidy for every kilo of tobacco sold whereas Greece receives a four euros per kilo subsidy (Thorpe, 2013).
In the US, as early as 1938, the Agricultural Adjustment Act regulated tobacco farmers. Farmers were issued marketing quotas regulating supply by limiting the amount of tobacco grown. In exchange, farmers were guaranteed a price for their product above the cost of production. The production and location restrictions prevented growers from achieving economies of scale and scope (Agricultural Marketing Resource Center, 2012).
In 2004, The Fair and Equitable Tobacco Reform Act (P.L. 108-357), also called the "tobacco buy-out" or simply “TTPP” came into force. This new act helps farmers through a system of subsidies to compete in the free market as all the quotas, location and advertisement restrictions have been abolished. This act promised to make payments to tobacco farmers

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from 2005 till 2014 and summing a total of approximately $10 billion (United States department of Agriculture, 2013).
Apart from subsidies, the US government also supports tobacco farmers through the indirect ‘Federal Crop Insurance Programme’. Private insurance companies provide the insurance with the Federal Government subsidizing a portion of the premiums and some of the companies’ cost related to insuring the farmers (United States Department of Agriculture, 2014).
Recently, the TTPP was heavily debated in the US and farmers were not sure if they would receive their 2014 payment. The Obama administration was planning to only pay a portion of the promised amount but the administration reversed its decision and payments will be paid according to the 2004 TTPP agreements (14News, 2014, Jan 17).
Consumers
There are more than 4,000 chemicals in tobacco smoke, of which at least 250 are known to be harmful and more than 50 are known to cause cancer. The Tobacco Atlas reports that in 2009, the top 5 cigarette consuming countries were China, Russia, the US, Indonesia and Japan, respectively (Eriksen, Mackay & Ross, 2013). Figure 2 presents world cigarette consumption.
Figure 2: World Cigarette Consumption
(Source: Eriksen, Mackay & Ross, 2013)
According to the World Health Organization [WHO] (2014), smoking kills more than 6 million people annually worldwide. Furthermore, statistics show that approximately 80% of the smokers worldwide live in low- and middle-income countries. Due to poverty and harsh economic circumstances, children are often employed on tobacco farms in these low-income

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countries to provide an income for their families. They are especially vulnerable to "green tobacco sickness", which is caused by the absorption of nicotine through the skin due to contact with wet tobacco leaves (WHO, 2014).
Since it is only (relatively) recently that people became aware of the consequences of smoking, and the lag between initial consumption of tobacco and visible signs of illnesses, the tobacco related diseases and death causes by smoking are a fairly new phenomenon. In the 20th century, tobacco caused 100 million deaths and that amount is expected to rise to 1 billion in the 21st century (WHO, 2014).
In Appendix A some health complications that come along with smoking are presented, and apart from these, the overall health of the smoker is diminished.
Government: Local governments, supranational EU and the US
As research increasingly shows that smoking causes negative health effects, governments and international organizations are increasingly involved in containing this deathly addiction from spreading. Local governments are introducing smoking bans in a number of US states, the European Union recently introduced a new Tobacco Product directive that would be effective in all member states and the US is also working towards nationwide implementation of smoking and advertisement bans with respect to cigarettes and other tobacco products.
In this paper ‘Government’ is collectively referred to the local government present in each state in the US, the US government, governments in each member state of the EU and the supranational decision maker, the European Union. Moreover, we include the legislative bodies of both countries.
The Government is not only involved with regulation but also with taxation and exchange of information with the consumers and tobacco companies to best inform, educate and regulate the market.
Pharmaceutical industry
Throughout this paper ‘Pharmaceutical Industry’ refers to the producers, such as Pfizer and GlaxoSmithKline, of Nicotine Replacement Therapy (NRT). The illustrative provisions for the products can be found in the Appendix C.
The Food and Drug Administration (FDA) in the US has approved 5 types of NRT products: patch, gum, nasal spray, inhalers and lozenges. The patches are like a plaster (adhesive bandage), which delivers a nicotine dose through the skin. Some side effects,

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depending on the duration and dose of the nicotine may be skin irritation, racing heartbeat and headache (American Cancer Society, 2014).
The nicotine gum is a ‘fast-acting’ form of substitution for tobacco cigarettes in which nicotine is absorbed through the mouth by chewing on it like a gum. Possible side effects may be throat irritation, racing heartbeat and stomach discomfort. The nasal spray is sprayed in the nose and nicotine is absorbed through the bloodstream. Possible side effects may be nasal irritation, throat irritation and a danger of addiction (American Cancer Society, 2014).
The nicotine inhaler is a plastic tube with a nicotine cartridge inside. It resembles the look of a cigarette and by inhaling; nicotine is delivered to the bloodstream. “Nicotine inhalers are the FDA-approved nicotine replacement method that’s most like smoking a cigarette” (American Cancer Society, 2014).
Possible side effects are upset stomach and mouth and/or throat irritation. This form of NRT carries an additional risk to small children and pets as the used cartridges nevertheless carry enough nicotine in them to cause harm if it gets on skin or mucous membranes. Nicotine-containing lozenges are much like the nicotine gum and are supposed to be sucked on until it is fully dissolved. Side effects such as nausea, heartburn and headache could arise. Some of these products are obtained over the counter and for others; a doctor’s prescription is needed (American Cancer Society, 2014).
A cohort study by the Harvard University and University of Massachusetts conducted by Alpert, Connolly & Biener question the effectiveness of NRT products. They concluded that these products are not effective in helping people stop smoking in the long run, even with or without professional counselling. Although clinical studies show their effectiveness, real life usage suggests otherwise (Alpert, Connolly & Biener, 2013).
1.1 Interdependency between involved parties
Before analysing the Tobacco Industry any further, it is necessary to explain the relation between the involved parties. In Figure 1, a comprehensive scheme is presented with the major players that are relevant to our research and their underlying dependencies and interaction.
The Big Tobacco has a supply/demand relation with consumers and exchange information through scientific research and findings, product information and advertisement. Big Tobacco can be considered an oligopoly as the top 6 players control more than 80% of worldwide market share. This makes the market very important for consumers who demand their addictive product from the Big Tobacco and, in turn, consumers are the top priority for

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these companies to secure their high profits. However, connection with the government is somewhat more complex.
Big Tobacco is linked to local governments and supranational unions such as the European Union through regulations, taxation systems and a subsidy system for tobacco farmers. Throughout the decades, the Big Tobacco has been heavily involved in lobbying of local governments and international organizations. Bero (2003) provides a vast amount of examples where the Tobacco industry was involved in monetary payments to politicians in order to influence decision making, lobbying activities with respect to local governments, international organizations such as the WTO, United Nation and the World Bank and their attempts to influence policy makers and their lobbying activities with the pharmaceutical industry.
The pharmaceutical industry is the one to supply nicotine replacement therapy (NRT) to smokers who want to quit smoking. Document analysis of leaked files done by Bero (2003) shows that the Big Tobacco has well-hidden financial ties with the pharmaceutical companies that promoted both collaboration and competition. “Financial ties between tobacco companies and the chemical, pharmaceutical, and food industries gave the tobacco companies leverage to influence policies that could affect these other industries” (p. 272). For example, the tobacco industry has used its financial ties with pharmaceutical companies to pressure them to weaken their marketing of nicotine replacement therapies (Bero, 2003, p. 272).
The pharmaceutical industry, in turn, stands in direct demand/supply relation with consumers for NRT products. The industry’s relation with the government is that of taxation, regulation and lobbying activities as described in Bero (2003). In the EU, the industry is controlled by marketing authorisation, clinical trials, competition law and intellectual property rights, trade, post-authorisation safety and advertisement laws (Efpia, 2014). This is much the same in the US and is controlled by the Food and Drug Administration (FDA).
As can be observed from Figure 1, the relation between government and consumer is a very important one. Firstly, they exchange information on products, conducted research & findings, advertisement, public education of the consumer, etc. Second, they are linked through the taxation system as consumers pay for cigarette consumption and raise tax revenue for the government. Finally, the maintenance of the public health rests on the responsibility of the Government.
With such blatant conflicts of interest, it is not at all surprising that the parties are lining up to have an input on any impending legislation.

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2. Market failures
As it is discussed in the context of the welfare economics, there are situations when markets fail to allocate resources efficiently – and give rise to market failures. There are two main reasons for market failures – market power and nonexistence of markets (Rosen & Gayer, 2010). In the market for tobacco presence of market power serves as a main reason for the rise of market failures, of which several will be discussed further on.
In economics, demerit goods are goods that have a negative effect on, not only the consumer, but others as well. It is perceived to be harmful and socially undesirable throughout society (a more extensive economic discussion of demerit goods is provided in Section 2.1, with a graphic representation in Figure 6). Some still consume them as not everyone discounts risks equally and just like alcohol and drugs, tobacco products are considered to be demerit goods and society would like to see their demand and supply being decreased.
Monopolistic (oligopoly) Power
Monopoly is defined as a single supplier. While pure monopoly is rare, monopoly power is much more common and can exist even when there is more than one supplier. Markets with only two suppliers are called duopoly; and with few firms − an oligopoly.
Monopoly is associated with entry barriers, such as predatory and limits pricing, high set up costs, vertical integration, large-scale economies and others. Moreover, there are costs associated with monopoly power, such as limited choice, high prices, restricted output, lower consumer surplus, excess rents, asymmetric information, productive inefficiency, allocative inefficiency and net welfare loss (Motta, 2004). Those associated with tobacco industry are discussed below.
The tobacco market is very similar to the one characterised by oligopoly, as mentioned previously, 80% of the market is under control of six players (Rhen, 2014). Due to the high concentration of tobacco industry and addictive nature of tobacco, tobacco producers have significant monopoly powers. An example of this was “Operation Berkshire”, where the companies Philip Morris, R.J. Reynolds, British American Tobacco, Rothmans, Reemtsma, and U.K. tobacco companies Gallagher and Imperia formed an international conspiracy block in 1977 with the goal of creating controversy about the health effects of smoking (Bero, 2003, p. 273-274).
The non-competitiveness of the industry can be seen from the increase in prices that usually exceeds the tax increase, as under monopoly, price exceeds costs. Furthermore,

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cigarette companies were known to distribute free cigarettes at colleges in the past, as well as significantly lowering the price of cigarettes in order to attract more addicted consumers. On the contrary, around 1980s, when more information about the health hazards became available to the public, the demand for cigarettes has dropped while prices increased, which characterises one of the features associated with the monopoly power, namely, asymmetric information (Becker, Grossman & Murphy, 1994).
Furthermore, since the Big Tobacco “enjoys” its power, in order to make profit, the price charged is above the competitive level and definitely above the costs, which creates the net efficiency loss – the deadweight loss. Size of the deadweight loss depends on the elasticity of demand. Since demand for tobacco is relatively inelastic, due to addictive nature of the product, the deadweight loss increases, as the monopolist is able to charge a higher price; this is known as the allocative inefficiency. Next, there is a productive inefficiency as the cost of performing is higher under monopoly rather than under the competition, as monopolists tends to use less efficient technology and is reluctant to innovate. This inefficiency creates additional welfare loss (Motta, 2004).
Asymmetric information
A key market failure of the industry is that of asymmetric information, where the Big Tobacco is better informed than the other parties (consumers & government) involved in the transaction. “Studies show that few people understand the specific health risks of tobacco use. For example, a 2009 survey in China revealed that only 38% of smokers knew that smoking causes coronary heart disease and only 27% knew that it causes stroke” (WHO, 2013).
Jha et al. (2000) mention that there are two main reasons for information asymmetry to arise in the tobacco industry. First, the industry has deliberately hid information from the Government and consumers with respect to the true addictive nature of the product. Consumers have also been purposefully misguided as these companies refrained from giving information on the severe health effects of smoking despite their internal knowledge on the matter. The industry also used advertisement to convince the public that certain variation of cigarettes – light /mild – are “safer” than others while they knew that this was not the case.
This problem goes even further as Jha et al. (2000) and Bero (2003) discuss the fact that tobacco companies have persuaded journalist to refrain from reporting on the health implications of smoking, intense lobbying in international health organisations and even funded biased scientific research to misguide consumers and governments. They would also

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fund unrelated scientific research to mislead authorities from their activities and research. All this would be done through industry lawyers, offshore partners and other third parties.
The second reason mentioned by Jha et al. (2000) is the fact that there is a lag (delay) between consumption and signs from illness since the start of smoking. Since consumers gather information from their peers and passed experiences, a good risk assessment is hindered by the fact that the health implications only arise a few decades later. This fact is also the reason why it is only recently that scientific researchers are able to give supported evidence of the true malicious consequences of smoking.
Negative externalities
The second market failure is externality. By externality is meant a benefit or cost that “occurs when the activity of one entity directly affects the welfare of another in a way that is outside the market mechanism” (Rosen & Gayer, 2010, p. 47). Externalities concerning tobacco come both from the producer as well as from the use of cigarettes and these are to be subdivided in the financial and health externalities.
“Financial” externalities
In this category, we first considered the increased chance for fires due to cigarette consumption. In 2011, the U.S. fire departments responded to an estimated 90,000 ‘cigarette consumption caused’ fires. These resulted in an estimated 540 civilian deaths, 1,640 civilian injuries and $621 million in direct property damage. Most of these deaths were caused by fires that initiated in bedrooms (40%) or in living rooms, family rooms or dens (35%). The other 72,400 ‘cigarette consumption caused’ fires were predominantly outdoor fires (Hall, 2013). In London, ‘cigarette consumption caused’ fires are the second most common cause of fires at home and result in more deaths than any other type of fire (London Fire Brigade, 2014).
The reason for this section to be placed under externality is the fact that these ‘cigarette consumption caused’ fires could not only harm the smoker and its property but others as well. In Hall (2013) is showed that between 2007 and 2011, only 4% of ‘cigarette consumption caused’ fires were intentional and only 1% of associated deaths occurred in intentional fires. Also, only 1% of home ‘cigarette consumption caused’ fires involved someone playing with the smoking material. Furthermore, studies found that 24% of fatal victims were not the smoker whose cigarette started the fire. From these victims, 34% were children of the smokers, 25% were neighbours or friends of the smokers, 14% were spouses

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or partners of the smokers, 13% were parents of the smokers and 14% had other relationships.
Secondly, the lost opportunity cost ought to be considered. Tobacco farmers could be growing other −maybe nutritious− crops instead of tobacco plants. This will not only benefit them and their family as they eliminate the chance of getting "green tobacco sickness", but the population at large by increasing availability of nutritious crops. Also, the land and resources could be put to better use.
Apart from lost opportunity costs from farmers, negative externalities around the work place should be considered. Employees who smoke impose a significant monetary burden on their employer and the economy as a whole. In Berman, Crane, Seiber & Munur (2013) is found that employers face an estimated total annual excess cost of approximately $5,816 for each employee who smokes. They found the relation between smoking and absenteeism to cost an estimated $516 annually per smoker as employees miss on working days.
Another cost to the employer is the reduced productivity due to nicotine addiction because of the employees lost work time due to smoking breaks. This was found to amount to an average of 8 to 30 minutes per day per smoking employee. “Productivity loss due to smoking breaks is by far the largest single cost that a private employer incurs from a smoking employee. Fortunately, it is a cost that can be completely eliminated by smoking cessation” (Berman, Crane, Seiber & Munur, 2013, p. 3).
The forth, negative “financial” externality is the increase of health care costs. Berman, Crane, Seiber & Munur (2013) state that smoking employees lead to excess healthcare expenses. An employer with no smoking employees is likely to obtain a discount in insurance premiums due to the fact that its labour force is likely to have lower overall healthcare costs. Respectively, insurance premiums are likely to be higher for employers when there are more smokers in their labour force. This not only represents a cost to employers, but also for the community at large as smokers can influence the cost of health care at large.
In Jha, Musgrove, Chaloupka & Yurekli (2000) is discussed that 6 to 15% of total healthcare costs are attributed to smoking in high-income countries. In most low- and middle- income countries, the annual costs of healthcare attributable to smoking are lower. “To the extent that taxes, co-payments, or social insurance premiums are not differentially higher for smokers, the higher medical costs attributable to smokers will be at least partly borne by non- smokers” (Jha, Musgrove, Chaloupka & Yurekli, 2000, p. 160).

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“Health” externalities
Smoking not only causes health complications for the individual smoker, but also makes way for heath externalities to arise. With “health” externalities we refer to the physical burden placed on the non-smokers through second-hand smoking.
Second-hand smoke is a combination of ‘sidestream’ smoke from the burning tip of a cigarette, cigar, or pipe, and ‘mainstream’ smoke, which smokers exhale. The Western Pacific region had the highest rate of second-hand smoke exposure in the world, with over 50% of men, women, and children being exposed to second-hand smoke in the year 2004. From Figure 3 is to be seen that in 2004, Europe had the highest percentage of death attributable to second-hand smoke.
Figure 3: Global Share of Death due to Secondhand smoke
(Source: Eriksen, Mackay & Ross, 2013)
Inhaling second-hand smoke causes immediate harm to the cardiovascular and respiratory systems. Long-term contact to second-hand smoke can also cause lung cancer. Pregnant women, fetuses, and infants exposed to second-hand smoke are particularly at high risk for negative health externalities as can be seen from Figure 4 (Eriksen, Mackay & Ross, 2013).

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Figure 4: Health Externalities in Children & Adults
(Source: Eriksen, Mackay & Ross, 2013)
The WTO reports that second-hand smoke causes over 600,000 premature deaths per year. Over 40% of children have at least one smoking parent and roughly 50% of children regularly breathe air polluted by tobacco smoke in public places. From Figure 5 is to be seen that children accounted for 28% of the deaths attributable to second-hand smoke in 2004. Also, second-hand smoke causes low birth weight in pregnant women (WHO, 2014).
Figure 5: Share of Death from Secondhand Smoke (Source: Eriksen, Mackay & Ross, 2013)

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2.1 Solutions from theoretical frameworks: Coase & Hobbes
The Coase theorem
Economic theory states that in the presence of externalities, inefficiencies may rise in the market. Economists have come up with several responses to this problem. First of all, the Coase theorem concerning bargaining that leads to efficient allocation of resources could be used to analyse the restraints present in order to efficiently deal and solve the externalities arising from smoking. The theory originally deals with disputes on property matters but can be bent to include other matters.
In Coase (1960) is said that when transaction costs are zero and rights are well defined and tradable, an efficient use of resources could results from bargaining, regardless of the legal assignment of property rights. In light of this paper, efficient use of resources could be the efficient use of land, public healthcare, ‘productive’ labour force, other resources used or destroyed by the production of tobacco products or the act of smoking or any costs imposed on the non-smoker by the smoker. Rights stand here to mean the right to ‘clean air’. Also, externalities arising from smoking are a public, rather than a private matter as it influences society at large.
One can see the obvious hurdles in trying to apply these equilibrium conditions to the subject of smoking. In order to even reach an efficient equilibrium, the involved parties should be able to bargain with one and other. In the case of smokers, non-smokers and the big Tobacco, this would be virtually impossible as it is extremely difficult to bargain with and between large groups. Secondly, assessing the exact monetary harm or benefit to each party may prove to be impossible (uncertainty) and effective bargaining is hindered. Thirdly, the transaction costs would be enormous to rally up the involved parties (search costs), calculate the costs and benefit of the involved parties (bargaining costs), deciding on the matter and actually execute (enforcement costs) the bargained ‘solution’. Furthermore, the problem of asymmetric information that dominates the tobacco industry is one that would hinder effective bargaining as history portrays the tobacco industry as one not to be trusted. In addition, even by including the Government as a private player in this dispute would not lead to a smoother course of the matter, as all participants are large in number and diverse in interest.
Lee (1991) says that it is widely believed that smokers impose costs on society by imposing disproportionate demands on the health care industry, decreasing the productivity of the economy with excessive absenteeism, and by imposing tobacco smoke on others. Furthermore, he argues that ‘Coasian’ conditions that would lead to the optimal

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internalization of costs are best satisfied in a private setting where personal decisions on smoking are made, rather than in a political setting where public policy decisions on smoking are made. We agree with his reasoning that efficiency is often better obtained when disputed in a private setting, but in light of the difficulties preventing efficient bargaining mentioned above, we do not think that would be the best solution and the application of the Coase theorem is of great difficulty, if not, impossible.
The Normative Coase and Hobbes theorems
Since the conditions do not permit for a bargaining approach by the Coase theorem, we analyse this matter of externalities in light of the Normative Coase and Hobbes theorems. They solve the problem of externalities by “internalizing” the costs of occurred dispute.
In Cooter and Ulen (2014) we find that when the transaction costs are significant, initial allocation of rights does matter. From here we can opt for a Normative Coase approach where the law should be structured so to reduce transaction costs and with this, remove the barriers to private agreements, or the Normative Hobbes approach, where the law is tailored to minimize the failures arising in private agreements.
To start with, Lee (1991) points out that in recent years, attitudes toward public smoking have shifted property rights away from smokers and towards non-smokers. This means that non-smokers have the right to, let us say ‘clean air’, and it is only through consent and compensation that the smokers can “buy the non-smoker out” of this right. If the normative Coase approach is adopted, the law should find gateways to lower the transaction costs. In the light of the smoking problem, we do not see a way in which the law could achieve this efficiently giving the nature and scope of the problem. Even if the law achieves the lowering of transaction costs, the mutual agreement between so many people will prove to be impossible. If a Normative Hobbes approach is opted for, it will also prove extremely difficult, if not close to impossible to achieve the lowering of harm caused in private agreements. The reason for this is the fact that it concerns failure not only in private matters but the smoking phenomenon harms the world population at large and cannot be left to decide and bargained with trough private disputes. For these reasons, a different mechanism is opted for; regulation and taxation by the Government.
In McCormick & Stone (2007) is stated that the 3 out of the 4 main reasons for government intervention is the presence of externalities, asymmetric information and vulnerable individuals and demerit goods. This justifies why the regulation of the tobacco industry cannot be left in the hands of the tobacco market but is regulated by the Government

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instead. Riley (2012) says that in the case of demerit goods, the free market may fail to take into account the negative externalities of consumption due to the fact that the social costs exceed the private costs. In Figure 6 is an illustrational aid provided by Riley (2012) where the interception point Q3 is depicted as the social optimal level of consumption that takes into account the information failure of consumers and where the negative externalities are internalized.
Figure 6: Demerit goods
(Source: Riley, 2012)
2.2 Role of taxation
One important aspect that needs analysis is the taxation of tobacco products and the tax revenue for governments.
Historically, the tobacco market was mostly in hands of a single firm or controlled by local governments. Throughout the decades, it shifted to privately owned companies and currently the industry is dominated by oligopolies (Jha & Chaloupka, 2000). Tax revenue from the tobacco industry amounts to over € 100 billion annually throughout the European Union and is one of the main sources of income for governments (Berger, 2013). In the US, tax revenue summed to over $17 billion in 2012 (Bloomberg, 2012).
The “benefit principle” discussed by Jha & Chaloupka (2000) is to be the principle where users of a particular government-provided service pay through taxation according to

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their derived benefit from the particular consumption. With respect to taxes on tobacco products, this implies that smokers pay for the imposed cost to the government through private and public health care, imposed negative externalities of smoking on society and other costs of smoking as discussed in the previous section.
According to Ramsey (1927), efficiency of taxation is when a product that is taxed would generate a substantial level of revenue, while minimizing the welfare loss related with the higher prices resulting from the taxes. Furthermore, the ‘Ramsey Rule’ states that the level of taxes ought to be contrariwise related to the price-elasticity of demand, holding the supply elasticity constant. This means that goods with relatively inelastic demand −such as tobacco products, as proven by Jha & Chaloupka (2000) − ought to be taxed more heavily, while relatively elastic demanded products ought to be taxed less.
As stated by Jha & Chaloupka (2000), the demand for tobacco products is fairly inelastic in the short term in most countries. Due to the addictive nature of this product, it is only in the long run that increases in price could affect consumption, making tobacco products relatively inelastic in the short run. Also, studies from high-income countries show that the youth and young adults, less educated individuals and those with lower income will be more reactive to price increases of tobacco products. This means that increase of the tax rate will lead to a decrease in cigarette smoking but at the same time increase tax revenue substantially. From 3 to 5% of government revenue in high-income countries has historically been generated through tobacco taxes and through estimations; the authors have derived that a 10% increase in taxes would lead to an increase of approximately 7% in cigarette tax revenue. This means that the “Ramsey Rule” checks positive as tobacco taxes generate high revenues, while having a moderately small impact on social welfare.
The literature on externalities prescribes that individuals ought to internalize the costs they impose on others by their actions. Pigou (1962) suggested that taxation could be an optimal mechanism to improve economic efficiency in the presence of negative externalities. This being said, it would seem logical to tax a product, only proportionate to its imposed damage to society, and use these tax revenues to limit or otherwise try to counterbalance the imposed externality in the best way possible. Although countries use these proceeds to fund advertising campaigns against smoking, funding of health care, research on health implications of smoking and other health related activities, they also use tobacco tax revenue to fund other government activities and as governments have grown to be highly dependent on these proceeds, they are of high importance for fiscal policies (Jha & Chaloupka, 2000).

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3. Market for e-cigarettes
Before entering the discussion on the placement of the electronic cigarettes on the market and the way they should be regulated, it is necessary to understand what electronic cigarettes are along with their main features. Appendix B provides illustrational examples of existing e- cigarettes. This section will address the issue of the role of e-cigarettes on the market for “smoking” and will discuss the existing regulation debate.
3.1 Product and its features
Originated in China, electronic cigarettes found their way to the European and American markets in 2006 and 2007, respectively. Since then they have gained considerable attention. A lot of research has been conducted around the product, mainly on acute exposure, nicotine delivery and consumer response, with little information available on this new, rapidly developing industry (Noel, Rees & Connolly, 2011).
E-cigarette, also referred to as ‘vapor’ (or ‘vapour’), is a hand-held device that consists of an atomiser that heats the liquid mixture of nicotine, flavourings and dulitans; the main block powers the device with a battery and at the end of it there is a cap with a lamp (Jacobs & Robinson, 2014). Nicotine is being delivered through the battery-powered vaporization of a nicotine/propylene-glycol solution. Though ‘smoking’ electronic cigarette (called ‘vaping’) mimics smoking, there is no combustion; therefore the user inhales vapour, not smoke. Despite the fact that electronic cigarettes deliver nicotine, they contain no tobacco. It is presupposed that vaping is less harmful than smoking as it does not have various toxicants unlike tobacco smoke. Additionally, electronic cigarettes not only allow mimicking smoking but also deliver nicotine, which basically addresses both pharmacologic and behavioural components of the cigarette addiction (Cahn & Siegel, 2011).
Today e-cigarettes are presented in various sizes, shapes, colours, flavours and price ranges. Various features, such as design, battery capacity and weight, are being constantly improved, along with disposability of the device. Moreover, electronic cigarettes are becoming more and more accessible. E-cigarettes are marketed by small distributors on internet and in kiosks, rather than by the tobacco industry or pharmaceutical industry. One can buy e-cigarettes in kiosks and shopping malls, as well as on the internet, where e-cigarettes were originally marketed.

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3.2 Comparison with tobacco cigarettes
In their research Cahn & Siegel (2011) examined various studies on the effect of electronic cigarettes. It was found that from the estimated 10,000–100,000 chemicals in cigarette smoke about 5,300 have ever been identified. These findings give one more comprehensive knowledge of the chemical constituents of e-cigarettes compared to tobacco ones. Sixteen studies have been identified that quite extensively characterize the components contained in electronic cigarette liquid and vapour using gas chromatography mass spectrometry (GC-MS). These studies found that the primary components of e-cigarette cartridges are nicotine, propylene glycol (PG), and glycerine. However, many regulatory agencies focus on potential health hazards associated with tobacco-specific nitrosamines (TSNAs) and diethylene glycol (DEG).
TSNAs have been detected in two studies at trace levels. The maximum level of total TSNAs reported was 8.2 ng/g. This compares with a similar level of 8.0 ng in a nicotine patch, and it is orders of magnitude lower than TSNA levels in regular cigarettes. However, e- cigarettes contain only 0.07–0.2 per cent of the TSNAs present in cigarettes, a 500-fold to 1400-fold reduction in concentration.
Reported presence of DEG in one of the eighteen cartridges studied by the US Food and Drug Administration (FDA) is worrisome, yet none of the other 15 studies found any DEG. No other chemicals apart from TSNAs and DEG, at levels detected in e-cigarettes, raise serious health concerns. Despite the limitations of already conducted research, most of the existing evidence justifies their higher safety compared to the tobacco cigarettes and comparability in toxicity to conventional nicotine replacement products.
However, one cannot ignore the fact that regulating a product that does not contain tobacco under the tobacco directive is, if not strange, than suspicious. As previously explained, there is no evidence in support of harmfulness of the e-cigarettes found, which proves them to be a much safer “substitute”. So what are the arguments that are being most frequently used in support of such strict regulation?
Cahn & Siegel (2011) in their research managed to formulate five most common arguments in support of heavy regulation of tobacco cigarettes. The first argument states that “promotion of safer alternatives will inhibit smoking cessation/prevention efforts” (p. 24), meaning that addiction will simply be shifted to a new product, e-cigarettes, and reduced hard may attract new, non-smoking user.

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A second argument concerns the combustion, as it is the combustion of tobacco that produces inherently dangerous exposures. Therefore search for a ‘safer’ cigarette is pointless; there cannot be a “safer” tobacco as we cannot adequately measure the actual risk.
Another argument refers to the “bad” history of tobacco, when tobacco products promoted as “safer” were found to be not healthier or even more harmful. Misleading labels, such as ‘light’ made consumers think that they were being exposed to lower levels of toxic chemicals. Thus, “alternatives promoted as safer may prove more or equally dangerous, leading to false or unsupported claims and to the misleading of the public” (Cahn & Siegel, 2011, p. 24).
The fourth argument states that nicotine replacement therapy (NRT) has not been effective, meaning that harm reduction equals harm maintenance. NRT does not treat one from the addiction but rather maintains it as it was found to be non-effective. Above all NRT ensures that Big Tobacco (the large tobacco industry companies) will not lose its customers.
Finally, the fifth argument is based on the distrust to the Big Tobacco based on its earlier history of provision of safer alternatives. Supporters of this argument say that tobacco companies, based on their history of lies and deception, simply cannot be trusted to develop and market a safer tobacco alternative; tobacco harm reduction will necessarily benefit the tobacco industry regardless of what else might be achieved.
After the brief discussion of these arguments, authors put prospective on the applicability of them to the electronic cigarettes. First of all, electronic cigarettes could entice smokers who were not otherwise inclined, to attempt to quit. Cahn & Siegel (2011) find the use of electronic cigarettes by non-smokers to be a theoretical concern, which has no evidence that youths or non-smokers are using the product. Therefore, it was concluded that regulations can address the marketing and sales of e-cigarettes to minors.
Next, as obvious as it may sound, e-cigarettes, such as NRT, are not tobacco products and do not involve combustion, which refutes the validity of the second argument as related to the e-cigarettes.
Argument three was found invalid as none of the chemicals present in tobacco smoke, has been shown to be present in the cartridges or vapour of electronic cigarettes in anything greater than trace quantities. Moreover, reported the presence of carcinogens is similar to that in NRT products, which has not been mentioned previously. This creates no doubt that e- cigarettes are safer.
The fourth argument does not hold, as e-cigarettes were “designed with the express purpose of replicating the act of smoking, without using tobacco” (Cahn & Siegel, 2011, p.

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27). Nowadays there are whole online communities of ‘vapers’ who compare different vapours. No other non-tobacco nicotine product has therefore created such dedication among its users, “suggesting the rare promise of the electronic cigarette as a smoking cessation tool” (Cahn & Siegel, 2011, p. 27).
Finally, electronic cigarettes are not tobacco products and are not (yet) produced by tobacco companies. Rather than being helpful to cigarette makers, electronic cigarettes compete directly against them. This competition is definitely worth mentioning as electronic cigarettes are slowly overtaking the market.
3.3 Competition with tobacco
According to Jacobs and Robinson (2014) the tobacco industry “has a poor record with new products containing the addictive nicotine but not tobacco”. The US maker of Camel cigarettes pumped $300 million into a smokeless cigarette in the 1980s. Initial reviews were negative as smokers complained about the taste of burning plastic. A year later the product was canned. Therefore, sudden growth in popularity of the e-cigarettes took tobacco multinationals by surprise.
Some analysts predicted e-cigarettes to disrupt the tobacco market and take over the tobacco sales in the US in less than a decade. Not taking action now might mean no sales tomorrow; that is why the industry has been forced to meet growing demand. The big four – Philip Morris International, Imperial Tobacco, Japan Tobacco International and RJ Reynolds – now have e-cigarettes either on the market or in development. That explains why many small private companies, which serve as innovation providers, were acquired by tobacco companies.
It is rather evident that electronic cigarettes are the disruptive innovation on the market for smoking. They have started as a rather exclusive product that was imperfect, however, now has gained considerable improvements and is already moving up the market. E-cigarettes have a real potential to eventually displace tobacco cigarettes.
Finally, Jacobs and Robinson (2014) mention that in advanced economies, e-cigarettes could cause the salvation of the tobacco industry (although not tobacco farmers). While in emerging markets cigarette sales are growing, “anti-smoking policies in the developed world mean that sales have fallen”.
In their turn Farsalinos & Stimson (2014) concluded in their research that consumers prefer using electronic cigarettes as a guilt-free smoking due to absence of health risks associated with tobacco smoking. In this context, e-cigarettes are in direct competition with

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cigarettes, as nicotine in electronic cigarettes is identical to nicotine in tobacco in its molecular structure. Moreover, most of the e-cigarettes users have been successful in giving up smoking, which was proved in a recent study in England. Users of e-cigarettes were found successful at giving up smoking, unlike with different NRT as nicotine patches or gum (Brown, Beard, Kotz, Michie, & West, 2014).
As one can see, there is enough evidence in support of “guiltiness” of the electronic cigarettes in the light of harmfulness, as opposed to the regular cigarettes. Not only do they not contain tobacco, but also help to quit consuming it unlike any of the NRT. Promotion of electronic cigarettes may leave the Big Tobacco insolvent as there will be no need for NRT, which mainly consists of tobacco, but most importantly the actual cigarettes. There is a sharp competitive edge between these two very similar, but at the same time, so different products.
3.4 Regulation
Main obstacle associated with tobacco cigarettes is creation of externalities, which calls for a proper regulation. However, as previously discussed, second-hand smoking and cancer risks are non-applicable to the electronic cigarettes. E-cigarettes are a relatively new product that does not really fit into any of the existing categories. Since electronic cigarettes do contain nicotine but no tobacco and only recreate the act of smoking, they are neither tobacco products nor cessation devices. In this light, there are several views on how e-cigarettes should be regulated. Some want to regulate them as medicines, others to classify them as tobacco products with all the implied restrictions.
Crucially, regulation of e-cigarettes has an ex post character, as emergence of the product on the market has far gone. Therefore, to prevent the use of e-cigarettes getting out of hand, there is an option of applying existing regulation for a similar/comparable product. In this context tobacco cigarettes are serving as a benchmark used to regulate the electronic cigarettes due to comparability of the attributes. In the worldwide practice there are several countries, including Australia and Brazil, which have entirely banned e-cigarettes. However, is it the case for Europe and States?
Further on, we will discuss currently existing approaches to the regulation of electronic cigarettes in Europe and United States. Here we are talking about different legal systems, those of civil and common law, respectively. Despite the differences in legal systems there is another important difference, which lies in the implementation. As implementation of laws by Member States of the EU has a “top to the bottom” character, where EU legislation is formulated on the supranational lever and is then implemented by Member States into the

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National law. Whereas in the US, States formulate the legislation and later on it is being used to provide guidance for the National law, “bottoms up” approach. We start with the regulation of e-cigarettes in the EU and carry on with the US regulation supported by comments.
European regulation
In the European Union electronic cigarettes are covered by 17 EU directives and regulations covering general product safety, chemical safety, electrical safety, weights and measures, etc. Under the new legislation, e-cigarettes will be regulated under the Tobacco Products Directive. The latest directive that came in power in May of this year restricts ingredients and strength of the nicotine, along with advertising, as it is for tobacco products (Farsalinos & Stimson, 2014).
Nevertheless, in the UK e-cigarette are regulated as medicine, meaning that from 2016 all e-cigarettes on sale have to be approved by the Medicines and Healthcare Products Regulatory Agency, just as any other drug. However, this has not stopped the proposition of a public ‘vaping’ ban in Wales (Jacobs & Robinson, 2014). Along with the UK, Sweden, Germany and Greece have proposed e-cigarettes to be regulated as medical products and devices. Proposed medicinal regulation was rejected by the European Parliament in favour of a consumer model of regulation. However, there have been court cases in Europe challenging the classification of electronic cigarettes as medicinal products and one more case in the USA. In all of these cases, the court ruled to prohibit regulating electronic cigarettes as medications (Farsalinos & Stimson, 2014).
Farsalinos & Stimson (2014) discussed the potential for regulating the e-cigarettes as medicinal product, where they foresee certain challenges, as electronic cigarettes will most probably be changed into another form of NRT, pharmaceutical nicotine inhaler, which is currently unnecessary. Moreover, such a product will not be accepted by the public as e- cigarettes are accepted now. Additionally, the authors find regulation of e-cigarettes as tobacco “inappropriate, disproportionate and misleading” (p.4), as risks associated with tobacco will be transferred upon e-cigarettes where it is not the case. Farsalinos & Stimson (2014) suggest that the main criterion for regulation should be “to serve public health in the most efficient way rather than to make the work of the regulators easier” (p.4). They conclude by suggesting a development of regulation specifically designed for electronic cigarettes, which would address the “unique aspects of the product and the way they are adopted and used by consumers” (p.5).

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Further we will discuss the regulation of electronic cigarettes in the USA and address currently ongoing debate associated with this issue.
USA regulation
Regulation of e-cigarettes in the USA has merged around the Food and Drug Administration (FDA). FDA has a regulatory jurisdiction over cigarettes and smokeless tobacco. They have recently announced an authority over e-cigarettes, along with cigars, pipe tobacco and other products to be given to the federal government. However, FDA’s jurisdiction over electronic cigarettes will become formal when the rules become final, which may take months or years. The jurisdiction has not been gained when the rules were proposed.
Currently the FDA is working on the regulation document, draft of which was introduced to the companies, their lawyers and health experts across the country on April 24. The proposed document contained 241 pages and included such issues as limitation of sales to minors, but did not address the issues of marketing and regulation of flavouring. These issues are very tricky but necessary to handle, which is being done now. It has been acknowledges that a need of new ruling may arise (Tavernise & Meier, 2014).
There is currently a debate about the proposed regulation of the FDA, as a new research found the e-cigarettes to be more dangerous than previously estimated. Yet, long- term effects of vapours are unclear; nonetheless, there is no clear evidence that it causes cancer or heart disease as cigarette smoking. “Many researchers agree that e-cigarettes will turn out to be much safer than conventional cigarettes, an idea that e-cigarette companies have made much of in their advertising” (The New York Times, 2014). Along with the latter, many are in support of the view that the regulation proposed by FDA is not proportionate.
The US is currently the biggest market for vapours, where regulation varies tremendously from State to State. While FDA is working on the regulation, on the state level there have already been regulations in place. State legislatures have passed laws prohibiting e- cigarette sale to minors, the new FDA regulations would extend that ban to all 50 states. These rules are not approved yet and for now would not override state laws. In the meantime, those state laws include other provisions — including varying definitions of e-cigarettes. Five states — Alaska, Kentucky, Vermont, Wisconsin and Virginia — explicitly say that e- cigarettes are not tobacco products. In at least eighteen states e-cigarettes are added to the nontobacco category without explicit elaboration on the absence of relatedness to tobacco; and ten states have considered e-cigarettes as tobacco products (Richtel, 2014).

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There is an ongoing debate over the regulation of e-cigarettes in the US. Some of the opinions presented on topic in The New York Times (2014), are more/less in support for the proposed regulation. The former chief of the Tobacco Use Prevention Service in Oklahoma, Doug Matheny, supports the regulation. According to him, recently three biggest companies – Philip Morris, R.J. Reynolds and Lorillard –collaborated to promote “Trojan horse legislation” in Oklahoma, where an e-cigarettes use rate is very high. Collectively, the companies, by means of lobbying, were pushing a law that declared ‘vapor products’ and ‘alternative nicotine products’ to be nontobacco products. Another law would have eliminated state excise taxes on all future non-combustible tobacco products. Therefore, D. Matheny thinks that states need the FDA to establish strong standards for tobacco products and e- cigarettes. New policies should recognize different degrees of risk associated with new products, whereas community should educate youth and promote a healthy lifestyle.
Sheelah A. Feinberg, the director of the NYC Coalition for a Smoke-Free City, is also of the opinion that e-cigarettes should be strictly marketed. She thinks that FDA should restrict marketing and flavours, and require packaging to have warnings about the dangers of nicotine poisoning; FDA should impose high product standards along with regulation of the nicotine levels. Finally, Ms. Feinberg finds it urgent for FDA to review and evaluate e- cigarettes quickly, to prevent existence and emergence of potentially dangerous products.
On the contrary, Amy L. Fairchild, a professor of sociomedical sciences at Columbia University's Mailman School of Public Health, says that to the current smokers, teenagers or minors, e-cigarettes seem most appealing, mainly due to the flavours. Moreover, Dr. Fairchild finds it critical not to limit the potential of e-cigarettes as to really challenge tobacco cigarettes. In her opinion the proposed document sets the stage “for a more tolerant approach to tobacco control” as it leaves e-cigarettes “in a position to outstrip tobacco cigarettes in popularity and market share” (The New York Times, 2014).
In support of the adjustment of proposed regulation, Norman Siege, civil rights and civil liberties lawyer in New York City, mentioned the 2010 federal lawsuit, where the district court observed that “the FDA had cited no evidence to show electronic cigarettes harmed anyone”. Therefore, without evidence the FDA should “tread lightly” (The New York Times, 2014). Thus, FDA should not advocate media restrictions without sufficient data indicating that e-cigarettes are harmful.

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4. “Cutting” the tobacco market – No smoke without fire
4.1 Statistics on smoking
It is well known that tobacco is used in various ways and devices, where cigarette smoking is the most common. Other ways include cigars, pipes, chutta, and beedis (Indian cigarettes). There are also smokeless forms of tobacco, which include snuff, chewing tobacco, paste and dipping (Patel, 1999).
Narayan, Chadha, Hanson, Tandon, Shekhawat, Fernandes & Gopinath (1996) found that each year, worldwide use of tobacco resulted in approximately 3 million deaths. Nearly one third of those deaths occurred in India. Based on those findings it was estimated that there will be 10 million per year tobacco related deaths worldwide will by 2020; majority of these deaths would occur in the developing countries as India and China (Patel, 1999).
More recently the World Health Organization (2014) has found that tobacco caused 100 million deaths in the 20th century; and 1 billion deaths are projected to take place in the 21st century if current tendency continues. Finally, tobacco-related deaths are approximated to surpass 8 million per year by 2030, which is yet unchecked.
The latest statistics from the WHO (2014) also show that tobacco use kills nearly 6 million people a year from direct and second-hand smoking worldwide. Approximately half of current smokers will eventually die of a tobacco-related disease. Moreover, it has been highlighted that the smoking is so maleficent due to the lag of several years between the time when one takes up tobacco use and the time when his/her health suffers.
Next important part of the smoking statistics concerns use by minors. Just as mentioned in the previous sections, use of cigarettes by minors raises great concerns with policymakers who are supporting the heavy regulation of e-cigarettes.
From the National Survey on Drug Use and Health in USA, Substance Abuse and Mental Health Services Administration (SAMHSA, 2011) found that more than 80% of regular smokers starts up before the age of 18; 90% do so before they reach their 20s, as reported by Tobacco-Free Kids (2014). These finding could serve as a justification for the strict regulation of the tobacco cigarettes and, thus, the electronic ones.
Despite this, it is important to mention that consumers were found to prefer using electronic cigarettes as a guilt-free smoking due to absence of health risks associated with tobacco smoking. In this context, e-cigarettes are in direct competition with cigarettes, as nicotine in electronic cigarettes is identical to nicotine in tobacco in its molecular structure

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(Farsalinos & Stimson, 2014). Moreover, most of the e-cigarettes users have been successful in giving up smoking, which was proved in a recent study in England. Users of e-cigarettes were found successful at giving up smoking, unlike with different NRT as nicotine patches or gum (Brown, Beard, Kotz, Michie, & West, 2014).
Finally, the online “YouGov” survey found that smokers use e-cigarettes to help them to cut down on smoking and eventually quit. And despite the fear of many that e-cigarettes will encourage others to take up smoking, there was no supporting evidence, as only 1% of people who had never smoked before, have tried electronic cigarettes (Daily Mail Reporter, 2014).
These alarming statistics call for a necessary action from the policymakers. Protecting minors against attempting to smoke, as well as the encouragement of current smokers to quit, is necessary to eliminate the issue of second-hand smoking and to assure the health of the population.
In Oklahoma estimated 18% of high-school students have tried vaping, which is nearly double the national average, there was no evidence found in support of attempt to smoke tobacco cigarettes by minors after vaping (Richtel, 2014). Despite the reasonable fears, which are associated with the tobacco smoking, there is no evidence to assume that minors will take up smoking due to the appearance of the flavoured vapours, which would lead them to try tobacco cigarettes.
4.2 Conflict of Interests
As Pigou (1962) suggests that taxation could be an optimal mechanism to improve economic efficiency in the presence of negative externalities, it would seem optimal to tax e-cigarettes in ‘proportion’ to the externalities arising from the use of these devices. The EU and US legislation regulates and tax electronic cigarettes equally to tobacco cigarettes despite the fact that e-cigarettes are much healthier compared to tobacco cigarettes, more effective than other NRT products; the lack of proof that it leads minors to start smoking and evidence that it is a much safer product in the sense of combustion as the chance of fires is substantially decreased. The reduced amount of both financial and health externalities by the e-cigarettes compared to tobacco cigarettes should call for a differentiated regulation and tax mechanism but this is not the case. This calls upon an analysis of the reasons the industry and government might have to do so anyway.
The emergence of the electronic cigarette is highly disruptive for the Big Tobacco. As users are seeing this as an option to decrease consumption of tobacco cigarettes or quit

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altogether, it could shrink the market share of the Big Tobacco. The potential decease in demand is a real threat where not only cigarette producers could be affected but also tobacco farmers and others in the vertical chain of production. The European Commission had called originally for a stricter regulation of electronic cigarettes, which would have categorized it as a NRT product. 28 EU Member States supported this but the Parliament opted to keep it regulated as a tobacco product after intense lobbying from the tobacco industry (Jolly, 2014). The shrinkage of the Big Tobacco means shrinkage of tax revenue for governments. As tobacco tax revenue have historically accounted for 3 to 5% of government revenue in high- income countries (Jha & Chaloupka, 2000), this is not a number they would like to see decreased as the authors describe how dependent governments have grown to be on these proceeds.
As more people are using e-cigarettes to quit smoking, thus as a NRT product, it also has the potential to decrease the market share for the pharmaceutical industry producing and selling NRT products. Users of e-cigarettes were found successful at giving up smoking, unlike with different NRT such as nicotine patches or gum (Brown, Beard, Kotz, Michie, & West, 2014). Some studies showed that e-cigarettes can deliver nicotine more effectively and considerably diminishes cravings more rapidly than a nicotine inhaler (Non-Smokers’ Rights Association, 2013).
In the US, the threat is so real that companies such as GlaxoSmithKline and Pfizer, which sell nicotine patches and gums that are regulated as NRT, are hoping that the FDA regulates electronic cigarettes as another tobacco product like the European Parliament did, rather than an NRT product like in Britain, as they see e-cigarettes as their direct competition (McArdle, 2014).
In North Carolina a bill was passed which impose a ‘5 cents per ml of nicotine liquid’ tax on e-cigarettes, which was largely lobbied for by Reynolds American, a major producer of both tobacco and electronic cigarettes. In Minnesota a much heftier tax was implemented; 95% of wholesale cost and other US states such as New Jersey and Ohio have pressed for similar high rates (Drenkard, 2014).
A cigarette producer, and especially one that also produces e-cigarettes, asking for taxes on electronic cigarettes may seem against common sense but the rationale behind it appears to be of great strategy. By taxing electronic cigarettes as a tobacco product, e- cigarettes become more expensive and the rate of consumers transitioning from tobacco cigarettes to electronic cigarettes may be depressed. Companies such as Reynolds American that are also involved in the production of e-cigarettes may push to regulate them as they try

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to maintain their market share of the tobacco industry plus reap the proceeds of consumers using and/or switching to e-cigarettes, therefore holding shares in both markets. With this regulation in place the government safeguards its tax revenue by keeping the Big Tobacco ‘in the game’. This does not seem as such an inexplicable phenomenon as “the primary historical motivation, and still the most common rationale for tobacco taxation, is its revenue-generating potential” (Jha & Chaloupka, 2000, p. 254); and governments will be inclined to protect that potential. Furthermore, history proves that governments are not indifferent about inducements and experiencing heavy lobbying activities from the Big Tobacco, as Philip Morris U.S.A., the second most active lobbying organization in America, spent approximately $101 million between 1998 and 2004 in lobbying activities with the Congress alone (Rehn, 2014).
In the article of McArdle (2014), Linda McAvan, the British Labour Party member of the European Parliament who guided the legislation through the chamber in the face of strong opposition from the tobacco industry says that Member States have the option to adapt national legislation to classify e-cigarettes as NRT if they choose so but would prove difficult in practice. Furthermore, Martin Callanan, a British Conservative Party politician opposes regulation of e-cigarettes as it helps people quit smoking and states that it is a huge loss for public health in Europe. Drago Azinovic, president for European operations at Philip Morris International, said that the modification of the EU Tobacco Directive “represents a worrying departure from the E.U.’s basic standards of proportionate, evidenced-based policy making, which will further erode intellectual property rights and undermine the EU charter where these rights are protected”.
4.3 Consequences of new regulations
The 2014/40/EU Directive of the European Parliament and of the Council of April 3, 2014 concerns the regulation of tobacco products. Regulation is needed because “all tobacco products have the potential to cause mortality, morbidity and disability” (p.7). Article 2 of the directive lays down main definitions used throughout the whole legislative documents. In this respect, there are several definitions that one must be equated with; they can be found in Appendix D.
After one has gone through all these numerous definitions, it is crucial to mention again that electronic cigarettes contain no tobacco and involve no combustion, which would exclude them from the category ‘tobacco products’. For those who argue that nicotine is the part of tobacco – nicotine can be gathered from the eggplant even if in small amounts (Cahn

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& Siegel, 2011). Moreover, since there is no tobacco in e-cigarettes, they also do not fall under the definition of the ‘smokeless tobacco product’.
Despite it all, the Commission gave a separate definition to electronic cigarettes, which does not mention a single word about presence of tobacco. Article 20 of the Directive covers the regulation of electronic cigarettes, where all the manufacturing, labelling and other requirements are listed, except flavouring which is left to the Member States’ national legislation. However, the labelling and marketing limitations in the concerned directive are same for vapours as well as for tobacco products. This raises several questions; first of all, what does a tobacco-less product do in the regulation for tobacco products (as defined previously)? Second, if there is no tobacco in e-cigarettes why to regulate it as a tobacco product?
As mentioned in the purpose of the Directive (2014), under number (8): “In accordance with Article 114(3) of the Treaty of the Functioning of the European Union (TFEU), a high level of health protection should be taken as a base for legislative proposals and, in particular, any new developments based on scientific facts should be taken into account. Tobacco products are not ordinary commodities and in view of the particularly harmful effects of tobacco on human health, health protection should be given high importance, in particular, to reduce smoking prevalence among young people” (p.2).
Further on, under number (19): “Considering this Directive's focus on young people, tobacco products other than cigarettes and roll-your-own tobacco, should be granted an exemption from certain requirements relating to ingredients as long as there is no substantial change of circumstances in terms of sales volumes or consumption patterns of young people” (p.4). Both paragraphs mention the ‘young people’; the whole directive is ‘focused’ on young people. Further on, under numbers (21), (26) and (47), ‘young people’ are mentioned again, mainly as a kind of benchmark reference used for exemptions or exclusion from those exemptions. It is stated that “electronic cigarettes can develop into a gateway to nicotine addiction and ultimately traditional tobacco consumption, as they mimic and normalize the action of smoking” (p.7), which justifies the restrictive approach to advertising electronic cigarettes and refill containers. Yet, there is no evidence to support the statement that young people are lured by the electronic cigarettes to take up smoking. Could it be that US take different approach?
First of all, the US regulation will come in place later, thus, definitely after the EU directive which has come in power on May 19, 2014. FDA is opted for using the EU regulation as a guideline.

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As for now, there is no draft of the regulation available to the public, yet consecutive summary can be obtained from the FDA website. Since FDA has authority over the tobacco products’ regulation, they recognise a need for extension of the scope of products concerned in the tobacco regulation. The new regulation will recognise additional tobacco product categories, which will be a subject to general controls, as well as to the premarket review requirements for “new tobacco products” and “modified risk tobacco products” (Deyton & Woodcock, 2011). Those products do include electronic cigarettes. Moreover, “products made or derived from tobacco can be regulated under the Tobacco Control Act unless they are “marketed for therapeutic purposes”, in which case they are regulated as drugs and/or devices” (Deyton & Woodcock, 2011).
It is not yet clear how exactly will e-cigarettes be regulated in the USA, however, the chances are high that they would be given a separate category, that would be treated similar to the ‘electronic cigarette’ product category in the EU directive.
4.4 Potential complications
In the report of the forum on e-cigarettes in Canada, the Non-Smokers’ Rights Association (2013) has extensively discussed potential regulatory option for the electronic cigarettes. Several approaches have been introduced. The first option discussed was regulation of e- cigarettes as a drug/device. For instance, in Australia, New Zealand, Norway and Turkey e- cigarettes have a status of drug and, therefore, are prohibited. The best part about such approach is that goes in line with WHO recommendation and protects public from unproven claims about the effects of e-cigarettes. Moreover, such approach would protect the regulated NRTs from “unfair” competition but increase the manufacturing costs for e-cigarettes and stifle competition. However, there are also downsides to this approach as it fails to address the current situation and would lead to denied access for the smokers to e-cigarettes, which are much safer than tobacco cigarettes. Finally, such regulation would result in making e- cigarettes unattractive to smokers.
Another proposed approach is regulating e-cigarettes as a harm reduction aid. This approach will possibly promote the use of safer nicotine products and will ensure that useful information regarding the risks will be provided. However, following this path would mean avoiding the differentiation between the proven and unproven cessation aids. Moreover, it would provide a marketing advantage over pharmaceutical cessation aids “that have had to undergo a higher level of scientific scrutiny and that must adhere to more legislated restrictions” (Non-Smokers’ Rights Association, 2013, p. 7). Nonetheless, vapours are a part

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of the “phase out” plan for cigarettes in New Zealand. Similarly, in UK, the Health and Clinical Excellence (NICE) recommended to use safer nicotine products suggested to include e-cigarettes to the licensed NRT in the future as some of the currently licensed NRTs provide unclear benefits, “except that it pushes people along the continuum toward quitting” (Non- Smokers’ Rights Association, 2013, p.8). Moreover, NICE oversees the obstacles and propose vapour to be licensed for harm reduction, not cessation and therefore would not need to prove their efficiency; the safety/efficacy is very similar to the nicotine inhaler, which would allow Medicines Healthcare Regulation Authority (MHRA) to ‘cross-refer’ to the evidence on the inhaler.
Next approach concerns regulating e-cigarettes as a consumer product, where consumer protection laws could be used to require minimum product safety and manufacturing standards. Current approach is very limited and has little potential; therefore, it was not discussed in depth.
Fourth approach to regulation is regulating e-cigarettes as a tobacco product, just as in the EU’s latest directive. The main pro of this approach is that it “ends current perverse situation whereby the most hazardous nicotine product — cigarettes — is the least regulated” (Non-Smokers’ Rights Association, 2013, p. 6). Furthermore, it will ensure availability of e- cigarettes to the smokers, while undergoing the obstacles of tobacco control. Final pro is protection of youth, which is achieved through regulating imitation products just as the actual tobacco products, not mentioning the simplified legislation approach. Among cons there is a need for government commitment to provide relative risks information, which is difficult to do. Such regulation would not differentiate between tobacco products based on their level of risk nor ensure a high standard of quality, safety and efficacy. Finally, such approach may “undermine the promotion of e-cigarettes as a quit aid (they would be seen as tobacco products); they would not be covered as a cessation aid by health insurance” (Non-Smokers’ Rights Association, 2013, p. 7).
Finally, the last approach used by several countries, among which are Singapore, Seychelles and Uruguay – an effective ban. Such approach would lead to cutting people off the cheaper and healthier alternative as mentioned in previous sections.
As with all well-intentional objectives, the real impacts are revealed once the unexpected consequences emerge.

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5. Conclusion
Big Tobacco dominated the tobacco industry for decades with minimal disruptions from new emerging products. In 2006/2007, a new product emerged that could potentially disrupt the industry as a whole – electronic cigarettes. As more tobacco consumers started to switch to these new devices, the threat of disruption became real. Surveys report on its increasing use as tobacco smokers are opting for a ‘healthier’ way of smoking by cutting down their consumption of normal cigarettes or quitting altogether. Reports suggest that electronic cigarettes have proven to be much more effective in helping people to quit smoking. This will not only lead to a decrease of the Big Tobacco’s market share but that of the NRT producers as well.
After the emergence of this new product, regulators are trying to control and contain its widespread use. In light of this phenomenon, the European union has adopted a new Tobacco Product Regulation (2014/40/EU Directive) where not only tobacco products such as cigarettes, chewing tobacco and snus are heavily regulated but electronic cigarettes as well, despite the fact that this product contains no tobacco. In the US, the FDA has not come up with a definite way of regulating e-cigarettes but it looks like they are going to adopt the EU’s method and classifying it as a tobacco product.
Despite the ongoing debate concerning the safety of e-cigarettes, there is yet not enough evidence to support the current regulation of vapours, as they have proven to help smokers quit and to be more effective than traditional NRT products. In light of this we question the regulatory choice of the EU and potentially the US as well. Do their motives concern the protection of public health or are they merely protecting private interests? In order to answer our main question, some sub-questions were to be answered in order to guide us toward the answering of our raised questions.
We conclude that the involved parties - Big Tobacco, the Government, consumers and the Pharmaceutical Industry - all have different, and often highly conflicting interests. Big Tobacco is after profit maximization and the defeasance of its market share. The Government has its responsibility to protect the public interest (public health). Since the Government has grown to be highly dependent on the proceeds from tax revenue, the presence of conflicting interests ought to be considered. Consumers of tobacco products, NRT and e-cigarettes are concerned with prices and availability of the demanded products and rely on the Government to undermine the public health. The pharmaceutical industry producing NRT products, much

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like the Big Tobacco, wants to defend its profit and market share unobstructed by the emergence of the electronic cigarette.
Despite the resemblance between e-cigarettes and regular tobacco cigarettes, no evidence has been found to justify their equal regulatory or taxation treatment. The chemicals in e-cigarettes do not exceed the permitted levels and are often less than those present in tobacco cigarettes, and comparable to those in NRT products. Due to the similarities in purpose, e-cigarettes stand in direct competition with the other two.
Taking into consideration the competition and conflicting interests between the involved parties, the chosen regulation is resulting in the indirect protection of market share for both the Big Tobacco and the Pharmaceutical Industry. Above all, it will decrease the transitioning rate of market share from the Big Tobacco and NRT, to the market for e- cigarettes; with this, the Government will secure its channel for tax revenue. A potential consequence is the decreased availability of vapours to consumers. As opposed by a British Conservative Party politician, the EU regulation of e-cigarettes prevents people from quitting smoking and imposes a huge loss for public health in Europe.
The potential problem that could rise in the future is the re-establishment of dominance (monopoly power) of the Big Tobacco as they are buying up startup e-cigarette companies. The ban on advertisement of e-cigarettes could lead to a development of asymmetric information, as the public is held fairly uninformed about these products. With the Big tobacco’s history of inadequate supply of information and the recent development of acquisitions of start-up companies, the problem of asymmetric information could be worsened.
Considering the decreased health and financial externalities of electronic cigarettes, and their potential to help smokers quit, we do not agree with the current regulation of these products. They are distinct from normal cigarettes and are not to be treated equally. Although further research is needed, current findings suggest their decreased toxicity and lower harm on the smokers’ health and others as they do not produce second-hand smoke.
The final argument of the Government to regulate e-cigarettes the way they do, is the argument of minor protection. As minors discount risk differently, they fear that e-cigarettes leads minors to pick up the smoking of tobacco cigarettes. As studies have disproved this, it is to be questioned what other reason the government has to heavily regulate e-cigarettes the way they do. Our findings indicate that the Government is inclined to protect its private interest (tax revenue) more than protecting public health.

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Recommendations
As we do not entirely support the current regulation, we present some suggestions that could better assess the emergence of this new product. Giving the high potential for cessation use, we suggest regulating electronic cigarettes as NRT products for harm reduction purposes rather than cessation, with all the implied safety and standard regulations. This classification will exempt the vapours from proving their efficiency.
We agree with the prohibition of sales and advertisement to minors; however, we find it necessary to provide children with a proper ‘education’ concerning the effects of smoking in order to prevent the future consumption. Furthermore, advertisement bans should be lifted and only permitted to advertise as an NRT product and sale ought to be accompanied by a doctor’s prescription. The downside to the suggested approach concerns limited accessibility and its use as a hard reduction product. But until more extensive research is conducted on its safety and health implications, we suggest this approach to be a better alternative.

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