Journal of Political Risk, Vol. 3, No.3, March 2015.

Jeffrey E. Zinsmeister
Consultant

Abstract

Marijuana legalization advocates in Mexico often point to the cigarette market as a regulatory model for marijuana—a way to control consumption, assure product quality, and reduce the power of narcotraffickers.  While the comparison between the two markets is apt—both are capital-intensive industries that favor economies of scale—it is not a favorable one in the Mexican context.  Due to these market dynamics and pervasive corruption, the Mexican cigarette business is divided into a legal business dominated by two multinational tobacco companies, and a large black market dominated by drug traffickers.  Accusations of corrupt practices are rife with respect to both markets, practices that undermine anti-smoking regulations, increase smoking rates (especially among minors), and enrich organized criminal syndicates.  Perhaps as a consequence, Mexico’s anti-smoking program yields far less in government revenues than it must pay out in increased public health costs.  As legalized marijuana would likely follow this same negative pattern, legalization policies will likely degrade public safety and health in Mexico.

Jeffrey Zinsmeister served as a Narcotics Affairs Officer with the U.S. Department of State from 2012 to 2014, where he administered over $50 million in drug demand reduction and anti-corruption programs in Mexico, including funding for that country’s first drug treatment court.  He currently works as a consultant out of São Paulo, Brazil, and publishes commentary that has appeared in Mexico’s Excelsior and The New York Times.  He holds an A.B. in Social Studies from Harvard College, and a J.D. from the UC Berkeley School of Law.

Introduction

Marijuana legalization in Mexico will likely result in an expanded and lucrative market for the drug, split between the dominant multinational tobacco companies and existing drug cartels. Corruption at all levels of government would limit public control over the industry, allow profit-sharing between narcotraffickers and dishonest officials to continue, and prevent significant improvements in public safety.[1]

An examination of the Mexican cigarette market—held up as a model for a regulated marijuana industry by some prominent Mexican legalization advocates[2]—supports those conclusions.  Cigarettes are indeed a model for legal marijuana, but not in the positive sense that these advocates assert.  Like tobacco, the industrial production and distribution of marijuana is expected to be a lucrative, capital-intensive industry subject to economies of scale, market conditions that encourage the vertical integration and consolidation of the business into a few large companies.  In the Mexican context, these factors mean that two multinational companies dominate the legal tobacco market, and are accused of exploiting the weak rule of law to undermine regulatory efforts through corrupt practices.

Moreover, corruption enables a thriving black market in cigarettes, undermining anti-smoking regulations such as excise taxes, flooding the market with illegal, unregulated cigarettes, and providing a significant source of revenue to organized criminal groups such as the Zetas.  This parallel market also may have counteracted the decline in per capita use of legal cigarettes, calling into question reports indicating falling cigarette consumption—especially among minors.  This would mean that the black market has effectively nullified years of Mexican legislative struggle to control tobacco use through taxes and other anti-smoking measures, laws that met fierce resistance from the tobacco lobby.

Thus, if tobacco is indeed a model for legalized marijuana, it means that a legalized Mexican market will lead to a business dominated by multinational businesses and the same criminal organizations currently growing and selling the drug.  It also means that legalization measures in that country are unlikely to lead to improvements in public safety and public health, and that policies that might be successful in industrialized countries with limited corruption problems may not work in regions that struggle with the rule of law.

Mexico’s Legal Cigarette Market: Dominated by Multinationals

The legal market for cigarettes in Mexico is huge, profitable, and dominated by multinational corporations.  Legal cigarettes generated about $500 million in revenues in 2013.[3]  Two multinationals from the industrialized world, Philip Morris and British American Tobacco, companies with pre-tax margins that approach 40%,[4] dominate the Mexican market, accounting for at least 75% of this half-billion-dollar business.[5]  Globally, the picture is similar; in 2008 six companies controlled over 80% of the world market.[6]  Many of these companies bring in more money than small countries; for example, Philip Morris International’s gross receipts are greater than the GDP of Uruguay.[7]  The reason behind the massive scale of the industry is its capital-intensive nature, particularly in logistics, distribution, and marketing costs, making economies of scale critical to success and fostering consolidation and integration into large conglomerates.[8]

In this sense, legalization advocates are correct to point out the similarities between the tobacco and marijuana markets.  Like tobacco, cultivating and distributing marijuana on a commercial scale is capital-intensive,[9] and will favor large companies that have access to large cash reserves or access to significant debt or equity financing.  (Although unlike tobacco, marijuana does not have to pass through an expensive curing process, curing represents just a fraction of the total cost of a pack of cigarettes, suggesting that this is a distinction without a difference.[10])  As such, it will likely produce the same business dynamics as tobacco, where a handful of large companies have captured most of the market.  In fact, the existing tobacco conglomerates are likely to be the major players in the marijuana industry, given that they can leverage their existing market presence, brands, and distribution networks to quickly establish a powerful market position and prevent new entrants from gaining a foothold.[11]

Moreover, this mix of profits and size has made the tobacco industry vulnerable to corrupt practices, especially in a nation like Mexico that struggles with enforcement of the rule of law.[12]  Beyond financing sophisticated, expensive lobbying campaigns,[13] Philip Morris and British American Tobacco have been accused of corrupting Mexican legislators and other high-ranking officials to fight tax increases and other anti-tobacco regulations.[14]  These accusations, of course, remain unproven.  Nonetheless, they are consistent with accusations of illegal influence in other developing countries with corruption problems, such as Thailand, Indonesia, and Kyrgyzstan.[15]  These allegations include a curious irregularity in Indonesia in which an unknown individual or group deleted an anti-tobacco clause in a 2009 bill, after it was passed by the Indonesian legislature but before it was sent to the President for signature.[16]

Corruption has also directly diminished the effectiveness of regulating legal cigarette consumption.  A 2012 study by the Mexican Council against Tobacco Use (Consejo Mexicano Contra el Tabaquismo) indicates widespread non-compliance with anti-smoking laws, including sales of loose cigarettes and cigarette sales to minors.[17]  Over half of the individuals surveyed pointed to corruption as the cause of this lawless behavior.[18]

The net result of this approach to tobacco is a net loss for Mexico: its tobacco taxation and control program brings in approximately 30-40% less than the cost that smoking imposes on the Mexican public health system.[19]  Moreover, it remains unclear whether the country’s tax-and-spend anti-tobacco strategy will work over the long-term.  Although official statistics show that the number of Mexican smokers per capita has fallen since 2002, that figure rose slightly between 2008 and 2011 despite additional restrictions on tobacco use.[20]  In addition, tobacco use among minors has risen steadily since 2002, suggesting that anti-smoking measures are less effective at curbing tobacco use among the cohort most vulnerable to its effects.[21]

In addition, as explained below, as taxes have risen, an international black market appears to have filled the gap by supplying low-cost, illegal cigarettes to buyers who cannot afford to purchase heavily-taxed legal brands.  Although data on smokers of contraband tobacco are scarce, some commentators believe that a robust black market may have kept overall tobacco use steady even as taxes and other restrictions decreased consumption of legal cigarettes.[22]  Indeed, the picture of successful anti-tobacco policies that legalizers describe is belied by comments from the official Mexican authority on addictive substances.  In 2013, its then-director bluntly stated, “There is no control over tobacco in Mexico.”[23]

Mexico’s Illegal Cigarette Market: Dominated by the Cartels

Similar to the legal tobacco trade, the Mexican black market for cigarettes is huge and lucrative—save its domination by drug cartels instead of multinationals.  One of almost every five cigarettes sold in Mexico is contraband, totaling around 340 million packs per year in 2013.[24]  Market penetration varies per region, reaching a peak of 32% in the most northern part of the country—almost a full third of all cigarettes sold.[25]  Moreover, illegal cigarettes’ market share appears to be increasing, growing from 15% to 17% in an 18-month period from 2012 to 2013.[26]

These unregulated products are exceedingly dangerous: some contain sawdust, grass, and even fecal matter.[27]  But, they remain popular due to their low price.  Illegal cigarettes cost approximately 10 Mexican pesos per pack, as compared to 28-45 pesos per pack for their legal counterparts.[28]  As taxes on cigarettes rise, currently around 70% of a legal pack’s price, this competitive advantage grows.  In addition, much of this contraband appears “normal” (i.e., sold in packs with commercial logos), and does not look like a dangerous, unregulated product.[29]

Corruption in Mexico and beyond, is a major, or perhaps even the primary, enabler of this illegal parallel market.  Contraband cigarettes sold in Mexico come from abroad, mainly from Asia and Paraguay.[30]  Despite the scarcity of information about this shadow cigarette market, investigative reporters have uncovered information about the Paraguayan value chain.[31]  Although such information is not necessarily representative of other supply routes, it does shed some light on the business.

The manufacture and distribution of illegal cigarettes from Paraguay mirrors in many ways the corruption-riddled supply chain of illegal narcotics.  Production is centered in a South American country plagued by corruption and a weak rule of law.  There, high-ranking officials, including president Horacio Manuel Cartes Jara, own stakes in massive factories that churn out at least 42 million cigarettes per year, more than 10 times the national demand.[32]  The remainder is exported, largely illegally, via the tri-border area with Brazil and Argentina.[33]  The companies’ Paraguayan connections facilitate the cigarettes’ egress from Paraguay, while the large, porous Brazilian and Argentine borders make entry easy.[34]

From there, cigarettes bound to Mexico pass down the Paraná River to the sea.  Some shipments turn north through the Atlantic.[35]  In transit, most likely in Panama and the Caribbean, Mexican cartels take over the business, bringing them to the Corozal Free Trade Zone in Belize, on the Mexican border.[36]  There, small-scale traffickers bring the contraband into Mexico, bribing border officials as necessary.[37]  The other route goes south, west, and then north through the Pacific, touching Panama en route to northwestern Mexico and ultimately to large northern cities like Ciudad Juarez for distribution.[38]

Once in Mexico, a wide distribution network takes the cigarettes to wholesalers and then to retail sellers, who hawk them by the pack or cigarette at markets, mom-and-pop stores, and on the street.  These retail channels are the most important in the country, accounting for over 80% of legal cigarette sales in 2011.[39]  Federal law enforcement is thin and corruption among local police prevents lower-level crackdowns.

Thus, in contrast to the traditional statehouse quid pro quo bribery that large tobacco companies allegedly practice, corruption in the black market spans the spectrum from ex-presidents to municipal police officers.  Corrupt practices or porous borders facilitate almost every step of the cigarettes’ journey from South America to the Mexican consumer—not unlike narcotics.

Worse still, the trade in illegal cigarettes is so lucrative that it represents a significant source of revenue for cartels.  Exact numbers are impossible to calculate, but Guatemalan officials indicate that tobacco smuggling, along with arms and human trafficking, comprises around half of the Zeta cartel’s revenues.[40]

Beyond simply financing organized crime, the overall impact of this black market both to the Mexican treasury and people is significant.  Cigarette smuggling costs Mexico around five billion pesos (about $335 million dollars) per year in lost revenues, and raises health care expenses by an undetermined amount.  Moreover, the low cost of illegal cigarettes means that minors are more likely to smoke them, exposing a vulnerable demographic to unregulated, dangerous substances.[41]  And more holistically, the black market undermines anti-tobacco legislation by perpetuating corruption and by providing a substitute product for those whom vice taxes would otherwise deter from smoking.  According to the latest Mexican National Survey on Addictions, contraband cigarettes and the widespread availability of loose cigarettes may even be a factor in the rise in youth smoking between 2002 and 2011.[42]

Is This the Future of Legalized Marijuana in Mexico?

Marijuana legalizers are thus correct in citing the semi-regulated tobacco market as a model for legalized marijuana.  The problem is that the comparison is not a positive one.  The Mexican tobacco industry is large, lucrative, and controlled by huge multinationals and narcotraffickers.  Corruption and a large black market undercut Mexico’s extensive regulatory efforts, taken in spite of heavy lobbying pressure, and provide minors with easy access to cigarettes.  Moreover, the more legal cigarettes are taxed, the more space opens for cheap smuggled cigarettes to take their place, particularly with low-income and underage smokers.  Tax revenues are insufficient to pay treatment costs of addicts.  Smuggling provides a large revenue stream to organized crime.

There appears to be little reason to believe that a legal marijuana industry will look much different. Additionally, eliminating the black market through lower taxes on marijuana would be similarly counterproductive.  Cheap, legal marijuana would likely result in an explosion of users, with no tax revenue to offset the additional addiction-related health care expenditures or the costs of secondary effects like driving under the influence, lost productivity, and respiratory problems.  It would also remove one of the principal economic justifications for legalized marijuana—expansion of the tax base.

All of the above means being skeptical of claims that narcotics legalization in Mexico will improve public security, impact narcotraffickers in any significant fashion, or represent a net gain for the national treasury.  It also means that legalization will likely overburden Mexico’s already-fragile public health system, either diverting resources from other public health needs or leaving addicts and those with drug-related problems untreated.  Finally, and on a more global level, it suggests that legalization measures are less likely to have their intended effects in countries with high rates of corruption.

Dr. Anders Corr provided editorial oversight for this paper. JPR Status: Working Paper, archived 3/14/2015.

[1] Jeffrey E. Zinsmeister. “Opinión del experto nacional – La legalización de la mariguana.” Excélsior. September 13, 2014. Accessed March 10, 2015. http://www.excelsior.com.mx/opinion/opinion-del-experto-nacional/2014/09/13/981459.

[2] See, e.g., “Marihuana: expertos contra el registro estatal de los usuarios.” El País. October 24, 2012. Accessed March 10, 2015. http://www.infodrogas.gub.uy/prensa/20121024/20121024_elpais_001.htm.

[3] Euroresearch and Consulting. Report Overview, World Cigarettes – Mexico 2014. December 2014. Accessed March 10, 2015. http://www.bigmarketresearch.com/world-cigarettes-mexico-2014-market.

[4] Rosalba O’Brien. “British American Tobacco benefits as emerging market smokers try top brands.” Reuters. February 28, 2013. Accessed March 10, 2015. http://uk.reuters.com/article/2013/02/28/uk-britishamericantobacco-idUKBRE91R09X20130228.; Matt Kratz. “Consumers: You make these 10 companies rich.” USA Today Money. May 20, 2014. Accessed March 10, 2015. http://americasmarkets.usatoday.com/2014/05/20/youre-making-these-companies-rich/.

[5] Secretaria de Salud, “Encuesta Nacional de Adicciones 2011 – Tabaco,” 35. http://encuestas.insp.mx/ena/ena2011/ENA2011_tabaco.pdf (Marlboro (red and white), Camel, and Benson & Hedges brands totaled 77.3% of sales in 2011); Executive Summary, Country Report: Tobacco in Mexico. Euromonitor International. July 2014. Accessed March 10, 2015. http://www.euromonitor.com/tobacco-in-mexico/report.

[6] “Global Cigarette Market Share.” The Tobacco Atlas. Accessed March 10, 2015. http://www.tobaccoatlas.org/industry/tobacco_companies/global_market/.

[7] See Duff Wilson. “Cigarette Giants in Global Fight on Tighter Rules.” The New York Times. November 13, 2010. Accessed March 10, 2015. http://www.nytimes.com/2010/11/14/business/global/14smoke.html?_r=0.

[8] Michael Fleagle. “Tobacco” Henry B. Tippie School of Management Research. February 12, 2014. Accessed March 10, 2015. http://tippie.uiowa.edu/henry/reports14/tobacco.pdf; Frank Maier-Rigaud. “The Commission Proposal for a European Tobacco Products Directive – a Critical Evaluation of the Roland Berger Studies.” Accessed March 10, 2015. http://lem.cnrs.fr/LinkClick.aspx?fileticket=uMWr1YFbrEw%3D&tabid=1198&language=fr-FR; Richard Gallagher. “Industry Analysis: Tobacco.” Value Line. Accessed March 10, 2015. http://www.valueline.com/Stocks/Industries/Industry_Analysis__Tobacco.aspx#.VOIVXlPF_8k; Monzer Kahf, “Economics of Tobacco,” The Journal of IMA (June 1979): 49. http://jima.imana.org/article/viewFile/5726/10_3-9.

[9] See, e.g,. John Bell. “Legal weed could spark a Portland-area industrial space boom.” Portland Business Journal. December 4, 2014. Accessed March 10, 2015. http://www.bizjournals.com/portland/blog/real-estate-daily/2014/12/legal-weed-could-spark-a-portland-area-industrial.html?page=all; Alec Bruce. “In the Moment.” Atlantic Business Maganize. December 16, 2014. Accessed March 10, 2015. http://www.atlanticbusinessmagazine.net/article/in-the-moment/.

[10] According to Philip Morris International’s investor information, tobacco accounts for around 20% of the total cost of a cigarette, of which curing costs are but a portion.  Marketing and other overhead is the largest cost center, representing about 43% of total costs. “Consumer Analyst Group of New York (CAGNY) Conference February 23, 2012.” Philip Morris International. February 23, 2012. Accessed March 10, 2015. http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MTI3Mzg0fENoaWxkSUQ9LTF8VHlwZT0z&t=1.

[11] Perhaps for this reason, Big Tobacco has seriously contemplated entering the marijuana business as early as the 1970s; see Dan Kedmey. “Cigarette Giants in Global Fight on Tighter Rules.” Time. June 3, 2014. Accessed March 10, 2015. http://time.com/2817517/tobacco-companies-marijuana/.

[12] Corruption Perception Index, 2012-2014, Transparency International. Accessed February 19, 2015. https://www.transparency.org/research/cpi/.

[13] Editorial staff. “¿Cómo cabildean las empresas [tabacaleras] en México?” Nexos. August 2, 2011. Accessed March 10, 2015. http://redaccion.nexos.com.mx/?p=3276; Centro de Investigación y Docencia Económicas, “Identificación de las estrategias de la industria tabacalera en México,” December 2010. Accessed March 10, 2015. http://www.cide.edu/publicaciones/status/dts/DTEJ%2051.pdf; Juan Núñez Guadarrama. “Las tabacaleras, dueñas del balón.” CNN Expansión. April 28, 2010. Accessed March 10, 2015. http://www.cnnexpansion.com/opinion/2010/04/27/tabaco-ieps-cigarro-salud-cnnexpansion.

[14] Diego Cevallos. “CORRUPTION-MEXICO: Tobacco Companies Accused of Bribing Legislators.” Inter Press Service News Agency. October 26, 2005. Accessed March 10, 2015. http://www.ipsnews.net/2005/10/corruption-mexico-tobacco-companies-accused-of-bribing-legislators/; Editorial staff. “Donaciones de tabacaleras, jineteadas en Salud.” Proceso. November 5, 2006. Accessed March 10, 2015. http://hemeroteca.proceso.com.mx/?page_id=278958&a51dc26366d99bb5fa29cea4747565fec=95159&rl=wh; Alejandro Madrazo-Lajous, Ángela Guerrero-Alcántara, “Estrategias de la industria tabacalera en México para interferir en las políticas de control del tabaco,” Salud Pública de México 54 (2012): 315-22. http://bvs.insp.mx/rsp/articulos/articulo_e4.php?id=002735.

[15] U.S. Securities and Exchange Commission, “SEC Charges Two Global Tobacco Companies With Bribery,” August 6, 2010. Accessed March 10, 2015. http://www.sec.gov/news/press/2010/2010-144.htm.

[16] Angela Dewan. “Indonesian Court Hears Pro-Tobacco Testimony.” Voice of America. February 9, 2011. Accessed March 10, 2015. http://www.voanews.com/content/indonesian-court-hears-testimony-that-tobacco-is-not-addictive-115715414/167031.html.

[17] Ángeles Cruz Martínez. “La corrupción y la falta de interés oficial limitan cumplimiento de la ley antitabaco.” La Jornada. October 10, 2012. Accessed March 10, 2015. http://www.jornada.unam.mx/2012/10/10/sociedad/046n1soc; Consejo Mexicano Contra el Tabaquismo, “Estudio Nacional de Tabaquismo 2012,” 6 & 53. http://www.parametria.com.mx/carta_parametrica.php?cp=4421.

[18] Id., 58.

[19] Juan Núñez Guadarrama. “Las tabacaleras, dueñas del balón.” CNN Expansión. April 28, 2010. Accessed March 10, 2015. http://www.cnnexpansion.com/opinion/2010/04/27/tabaco-ieps-cigarro-salud-cnnexpansion. (data from 2010); Ricardo Cantú, “An Optimal Tobacco Tax,” Global Development Network, 3.; http://www.gdn.int/admin/uploads/editor/files/GDN_PEMRP_EGAP_PS_Health.pdf (data from 2013).

[20] Secretaria de Salud, “Encuesta Nacional de Adicciones 2011 – Tabaco,” 25. http://encuestas.insp.mx/ena/ena2011/ENA2011_tabaco.pdf.

[21] Id., 37.

[22] “Report: Cigarette Tax Hike Caused ‘Proliferation of Contraband’ in Mexico.” Breitbart. September 8, 2012. Accessed March 10, 2015. http://www.breitbart.com/national-security/2012/09/08/report-cigarette-tax-hike-caused-proliferation-of-contraband-in-mexico/.

[23] Blanca Valadez. “Legalizar la mariguana resulta irracional: Cano Valle.” Milenio. August 5, 2013. Accessed March 10, 2015. http://www.milenio.com/tendencias/Legalizar-mariguana-irracional-Cano-Valle_0_129587183.html (“No hay control del tabaco en México.”).

[24] Ernesto Méndez, “Narco domina el tabaco ilegal; de contrabando, 17 de cada 100 cigarros en México.” Excélsior, November 20, 2013. Accessed March 10, 2015. http://www.excelsior.com.mx/nacional/2013/11/20/929617.

[25] Id.

[26] Id.

[27] Id.

[28] Id.; personal research in Mexico City.

[29] Ernesto Méndez, “Narco domina el tabaco ilegal; de contrabando, 17 de cada 100 cigarros en México.” Excélsior, November 20, 2013. Accessed March 10, 2015. http://www.excelsior.com.mx/nacional/2013/11/20/929617; Tabacaleras Hernandarias. Accessed March 10, 2015. http://www.th.com.py/.

[30] Ernesto Méndez, “Narco domina el tabaco ilegal; de contrabando, 17 de cada 100 cigarros en México.” Excélsior, November 20, 2013. Accessed March 10, 2015. http://www.excelsior.com.mx/nacional/2013/11/20/929617.

[31] Vítor Hugo Michel. “Enriquece contrabando a presidente paraguayo.” Milenio. December 8, 2014. Accessed March 10, 2015. http://www.milenio.com/politica/Enriquece_contrabando_presidente_paraguayo-contrabando_de_tabaco-cigarrillos_ilegales_0_423557650.html.

[32] Ernesto Méndez, “Narco domina el tabaco ilegal; de contrabando, 17 de cada 100 cigarros en México.” Excélsior, November 20, 2013. Accessed March 10, 2015. http://www.excelsior.com.mx/nacional/2013/11/20/929617.

[33] Id.

[34] Id.

[35] Id.

[36] Id.

[37] Id.

[38] Id.

[39] Secretaria de Salud, “Encuesta Nacional de Adicciones 2011 – Tabaco,” 34-35. http://encuestas.insp.mx/ena/ena2011/ENA2011_tabaco.pdf.

[40] Ernesto Méndez, “Narco domina el tabaco ilegal; de contrabando, 17 de cada 100 cigarros en México.” Excélsior, November 20, 2013. Accessed March 10, 2015. http://www.excelsior.com.mx/nacional/2013/11/20/929617.

[41] Vítor Hugo Michel. “Enriquece contrabando a presidente paraguayo.” Milenio. December 8, 2014. Accessed March 10, 2015. http://www.milenio.com/politica/Enriquece_contrabando_presidente_paraguayo-contrabando_de_tabaco-cigarrillos_ilegales_0_423557650.html.

[42] Secretaria de Salud, “Encuesta Nacional de Adicciones 2011 – Tabaco,” 84. http://encuestas.insp.mx/ena/ena2011/ENA2011_tabaco.pdf.