THE IMPACT

OF

PRIVATIZING THE LIQUOR CONTROL BOARD OF ONTARIO

by

Nuri T. Jazairi

Department of Economics

York University

Toronto, September 1994





INTERIM REPORT











This report has been prepared for the Ontario Liquor Boards Employees' Union.







C O N T E N T S



01. INTRODUCTION 03

02. BACKGROUND 06

03. LCBO PRIVATIZATION : PRO AND CON 15

04. WHY ARE PRICES LIKELY TO INCREASE UNDER PRIVATIZATION ? 22

05. CONSUMER CHOICE 27

06. LCBO MODERNIZATION 31

07. PROFITS AND TAXES GENERATED BY THE LCBO 36

08. FALLING SALES 43

09. SMUGGLING AND ILLEGAL MANUFACTURING 48

10. SOCIAL RESPONSIBILITY POLICY 56

11. ALCOHOL AVAILABILITY, ALCOHOL ABUSE, AND PUBLIC ATTITUDE 60

12. THE COST OF ALCOHOL ABUSE 66

13. LCBO PRICING 71

14. IMPLICATIONS FOR ONTARIO WINE INDUSTRY 78

15. UNEMPLOYMENT IMPLICATIONS 83

16. THE ALBERTA EXPERIMENT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

17. SUMMARY AND CONCLUSIONS 93

18. REFERENCES 102



01. INTRODUCTION



In Canada the sale of alcoholic beverages is within the provincial jurisdiction, and it is done through liquor control authorities. In recent years politicians in and out of government in several provinces, including Ontario, have made statements advocating the privatization of the sale and distribution of all alcoholic beverages. In September 1993, Alberta became the first province to begin privatizing its liquor control board. Basically, privatization means change of ownership which by itself, some would argue, is of limited importance. The objective of privatization is normally to achieve economic efficiency and commercial profitability. The basic economic argument is that crown corporations cannot utilize resources at minimum cost because they tend to become bureaucratic, confused and inefficient. But privatization may also be advocated and implemented for purely political and ideological reasons such as the control of public expenditures, limiting the role of government in managing the economy ("roll back the frontiers of the state"), redistributing wealth ("property owning democracy"), and weakening trade unions.

It is, however, widely acknowledged that the privatization of provincial liquor control boards raises many policy issues and concerns both economic and social. This report attempts to address some of these issues and concerns which might arise if the Liquor Control Board of Ontario (LCBO) were privatized. We shall examine the impact of privatization on alcohol prices, consumer choice and service, provincial revenues and smuggling, alcohol abuse, the Ontario wine industry, unemployment, and related issues and concerns.



The report begins with Section 2 containing background material on the alcohol beverage industry and the LCBO. Theoretical considerations for and against privatization are discussed in the context of the LCBO case in Section 3. The body of the report is organized around four major issues. First, the impact of LCBO privatization on consumers in terms of prices, choice and service. These are discussed in Sections 4, 5, and 6. Second, revenue implications in terms of profits and taxes generated by the LCBO, falling sales, and the illegal alcohol market in Ontario. These are discussed in Sections 7, 8, and 9. Third, in Sections 10, 11 and 12 we discuss the LCBO social responsibility policy, the restricted availability of alcohol, and the cost of alcohol abuse. Fourth, LCBO pricing policy, implications for the Ontario wine and grape industry, and for unemployment in the province are discussed in Sections 13, 14, and 15. Section 16 provides an overview of the consequences of the Alberta experiment. Summary and conclusions are contained in Section 17.



02. BACKGROUND

The Liquor Control Board of Ontario was established in 1927 by the Liquor Control Act to "control the sale, transportation and delivery" of alcoholic beverages in Ontario. The sale of beverage alcohol in Canada occurs through various channels. The table on the following page contains a detailed picture of alcohol sales channels in Ontario. In 1993/94, about 85% of alcohol sales in the province are through legal channels - LCBO stores, the breweries and wineries retail outlets, and other legal channels specified in the table. Smuggling and illegal wine manufacturing account for about 15% of alcohol sales in Ontario.

The LCBO buys spirits, wines, and beer from domestic and foreign suppliers for distribution and sale in Ontario to consumers and establishments licensed by the LCBO companion organization,







the Liquor Licence Board of Ontario ( LLBO ) , which was

established in 1947. The LCBO operates retail stores, oversees private agency stores in small rural communities, and regulates Brewers Retail stores, Ontario wineries stores, and privately operated duty-free stores. The LLBO, on the other hand, regulates the sale of alcohol in more than 14,500 licensed establishments, as well as alcohol advertising and promotions.

In its first year of operation, the LCBO opened 86 stores, sales were $12.3 million, and it employed 875 people. To-day the LCBO is the largest retailer of alcoholic beverages in the western world. It operates more than 600 stores across the province, more than 80 agency stores, and duty-free stores. It regulates the sale of alcoholic products in 430 Brewers Retail stores, 320 Ontario winery stores, and 10 privately-owned duty free stores. It has about 5000 full-time and part-time employees, annual sales fluctuate around almost $2 billion, and the number of regular products listed fluctuated between 2,302 in 1993 and 2,974 in 1989. The number of vintages listings and duty-free listings comprised about 1,500 products in 1993. During the last ten years, from 1984 to 1993, the LCBO has brought the provincial and federal governments a total of $ 11.694 billion in profits and taxes. A brief chronology of the highlights in the history of LCBO appears at the end of this section.

Financially, the LCBO projects strength, security and stability, despite declining sales between 1991 and 1993, and increased cost of products. It has assets of about $118 million in 1993 (net book value of stores, warehouses, and office equipment) and profits of $615 million in 1993 and $675 million in 1992. During the past two years the administrative and operating expenses were virtually unchanged at about $ 323 million in each year or about 18% of the sales. Board expenses, it must be noted, cover the cost of both control and wholesaling as well as the cost of retailing.

In recent years the LCBO has evolved into a well-managed, modern and progressive retailer. It has adhered to its social function as a regulatory agency as well as generating substantial income to the provincial and federal governments. The LCBO has broadened its social responsibilities in committing itself to protecting the environment, expanding and improving its services to consumers, implementing sound financial and management practices, and providing safe, fair and equitable working conditions for its employees. All products are tested for quality, and are available, at uniform prices, throughout the province in small rural areas as well as in large urban centres.

At the national level, the value of alcohol sales in 1991/92 through the stores and agencies of the liquor control boards and through the breweries, wineries and their retail outlets, was over $10 billion. The relative shares of spirits, beer, and wine were about 30%, 53%, and 17%, respectively. Imports, mostly wine and spirits, were just over $600 million; and exports, mostly spirits and beer, were just over $660 million. In terms of legal channels of alcohol sales, there are differences across the country. In Ontario, Quebec, and British Columbia, spirits are sold in control boards stores, and wines and beer are sold both in privately-owned retail outlets and in stores operated by liquor control boards. In Newfoundland and Manitoba, spirits and wines are sold in control boards stores, and beer is sold in private stores as well as in control boards stores. Last year Alberta has privatised the retailing, but not wholesaling, of its entire liquor market. In Saskatchewan, Nova Scotia, New Brunswick, and PEI, all three types of alcohol beverages are sold in stores operated by liquor control boards [See: Laxer, Green, Harrison, and Neu (1994)].

At the manufacturing level, the alcoholic beverage products industries in Canada are brewing, distilling, and wine-making. In 1992, the value of shipments by these industries was just over $4 billion, with direct employment totalling about 9,200 people. Additional employment of about 5,000 people is generated by distribution and retailing by the breweries and wineries. Malting, 60% in the Prairies, and grape-growing, almost entirely in Ontario, are two other small economic activities connected with the alcoholic beverage products industries. (Industry, Science and Technology Canada, Industry Profile series contains useful information about the alcoholic beverage industries in Canada.)

Highlights in LCBO History

1679 King Louis XIV's (unenforceable) prohibition decree.

1876 Ontario Licensing Law (Crooks Act).

1916 Ontario Temperance Act.

1927 Liquor Control Act; LCBO established.

1935 Wineries are allowed to open one retail store.

1944 Liquor Authority Control Board is established. 1947 LLBO replaces the Liquor Authority Control Board.

1961 Permits required to purchase liquor are abolished.

1962 First agency stores are licensed.

1969 First self-serve store opens in Weston.

1975 LCBO becomes a crown corporation.

1987 Duty-free stores are opened at border crossings.

1989 New LCBO Quality Assurance Laboratory opens.

1990 Wine Consultants assigned to 40 stores.

1991 Stores & warehouses linked by computer to head office.

1992 Computerized network of inventory and sales installed.

1994 First LCBO store accepts credit cards.



03. THE LCBO PRIVATIZATION: PRO & CON

The objectives and concerns of the LCBO are basically the following:

1. Regulatory control of the sales of alcohol to protect society;

2. Balancing regulatory control with the need to raise revenue for the provincial and federal governments through profits and taxes on alcohol sale;

3. Supporting the domestic wine industry and providing it with incentive through differential pricing, marketing, and promotion practices.

Regulation and competition have been the basic market arrangement through which the LCBO has achieved these objectives. The LCBO (and LLBO) have broad powers to control alcohol consumption in the province, but it is far from being a monopoly. The LCBO share of the Ontario alcoholic beverage market is about 37% of the sales, and only 17% of the volume. More important, the LCBO is as market-oriented in its operations and response to consumer preferences as any privately-owned big business - except that it is not privately-owned.

Social considerations have been officially the declared reason for the regulatory control of alcohol sales. The LCBO two other objectives of raising revenue for the treasury of the province, and supporting the domestic wine industry are equally important, but seldom publically acknowledged. But the economic rationale for the LCBO status goes beyond its three major objectives. In addition, the LCBO enjoys economies of scale - wholesale purchasing and import, transportation and warehousing, a distribution network and marketing - which enable it to have a cost advantage over a fractured network of small alcohol retail stores envisaged under privatization. Because of its size and its economies of scale, its average unit cost is relatively small as a result; and because of this cost advantage and because of its commitment to serve the people of Ontario, the LCBO products are available at competitive uniform prices and first class service throughout the province from the largest urban centre to the smallest rural community. Some of the rural communities of Ontario now adequately served by LCBO and agency stores will almost certainly have no liquor stores under privatization. The private owners of small scale alcohol stores cannot afford to run unprofitable retail outlets in rural Ontario. Finally, through the LCBO the protection of consumers and the environment is guaranteed, while under privatization small alcohol stores may find all sorts of questionable practices irresistable.

Whether the LCBO should or should not be privatized - sold out to private owners - is a question that cannot and should not be answered on the basis of political ideology and generalized faith in the private sector. The success of free enterprise is not the issue, but rather whether unchecked market forces are suitable to the entire liquor market in Ontario. The efficiency of markets is agreed to in principle, but the differences are more subtle than the similarities between situations in which the market or alternative modes of economic organization may be more efficient. It is naive to argue that markets are inherently more efficient than some alternative arrangement. If markets were always more efficient, then large corporations like General Motors would have subcontracted much of their operations to smaller firms. But they do not because it is more profitable that they do these operations themselves in-house. The more efficient and less expensive but controlled health care system in Canada compared with the market-based but expensive and inequitable one in the United States provides a striking example of possible market failures.

It is sometimes optimistically assumed that selling crown corporations to private owners would make funds available to apply against the budget deficit. In fact, Mike Harris, the Leader of the Ontario Progressive Conservative Party, has stated in his election platform, The Common Sense Revolution (May 3, 1994), "We will sell off some assets, such as the LCBO...Every penny will go directly to pay down the $80 billion provincial debt." (page 17; emphasis original). This statement is incorrect. The LCBO (book value) assets are valued at about $118 million. To begin with $118 million is a small amount relative to the $9.43 billion budget deficit [See: Laughren (1994)], and $80 billion provincial debt, in Ontario. In any case, the sale proceeds of a crown corporation must first be used to pay for the book value of its assets before applying what is left over to the budget deficit or whatever. In the case of the LCBO it is unlikely that once the book value of its assets is liquidated, funds would still be left over to apply against the budget deficit or provincial debt.

If the efficiency argument does not apply to the LCBO, and the budget deficit argument is also unlikely to apply, then what other arguments are sometime made in favour of privatization? Another argument is that crown corporations require substantial funds for expansion which the government cannot afford to provide, and the corporations can not acquire equity funds in the money markets unless they are privately owned. This argument may apply to capital intensive corporations, but it certainly does not apply to the LCBO because its capital investment requirements are very small, it has never been in debt, and its rates of return are and have always been phenomenal.



Yet another set of arguments sometimes made in favour of privatization is that public enterprises are poorly managed, cannot compete in the marketplace, shy away from risk-taking, and cannot survive without continued government handouts of taxpayers' money [See: Baumol, Blinder, and Scarth (1988)]. None of these arguments is true in the case of the LCBO. As we shall see in more detail in the following sections of this report, the LCBO is well-managed, competitive, highly profitable, and does not receive nor need any government subsidies.

Privatization of crown corporations should be decided on a case by case basis. There are no general privatization rules applicable to each and every corporation. In the case of the LCBO, it is argued in this report that privatization would be a mistake costly to the people and government of Ontario.



04. WHY ARE PRICES LIKELY TO INCREASE

UNDER PRIVATIZATION ?

Alcohol price comparisons between control and market jurisdictions in Canada and the United States cannot be made on the basis of quick observations for at least two important reasons. First, the qualities and varieties of alcohol products whose prices are being compared may be sufficiently different to warrant significant differences in their prices. Second, differences in transportation costs and alcohol taxes could be the reason for differences in the observed prices of alcohol products in two situations.

Nonetheless, there are some general possible explanations, essentially based on economies of scale arguments, why, under liquor control, revenues are greater and prices are lower than under privatization, other things being equal. The liquor control boards can as single buyers (monopsonists) bargain for lower prices and greater special discounts from suppliers and carriers. The liquor control boards are also likely to have lower operating costs. The privately-owned outlets are fragmented and multiply rapidly, while the control stores are open for fewer hours, and are integrated and centralized in their operations and distribution network. Finally, privately-owned retail outlets require higher rates of return on their capital costs than control boards, and these higher costs, among others, lead to higher alcohol prices under privatization.

Unfortunately, these economies of scale arguments are impossible to quantify for the LCBO case from the information available. The LCBO published operating costs are aggregative and, more important, cover control and wholesale costs as well as the costs of retail operations. However, prior to privatization the ALCB distribution costs for store deliveries were about 32 cents per case. Since privatization distribution costs have increased by 72%, to 55 cents per case, because of the increased number of shipments of smaller size to an increased number of small stores scattered throughout the province. This is an example of how economies-of-scale works in practice.

The possible explanations for higher revenues and lower prices under liquor control were suggested by Professor Julian L. Simon who observed many years ago that in the United States prices were on average more than 11% higher in 27 "private-license states" compared with 16 "monopoly states", and that the treasuries of the monopoly states collected more per capita revenue from alcohol sale than the private-license states [See: Simon (1966)].

The Ontario Committee on Taxation (1968) also found that the "private retailing system yields on the average a much lower return to the public treasury"; the Committee "had no doubt as to the superiority of public over private liquor outlets." (vol. 3, p.403).

Professor Simon's findings on prices have also been supported by recent price comparisons. In 1981 the state of Alabama voted to return the sale of table wines to state stores because of higher prices and limited selection after voting in 1978 to allow their sale in supermarkets. In March 1987, Iowa privatized the retail sale of alcohol. By November/December 1988, a survey conducted by the Iowa Department of Commerce showed that liquor prices in privately-owned stores were 6.1% higher than under state control [See: Fitzgerald and Mulford (1993)].



In Ontario, a recent price comparison of alcohol products sold both in Ontario and in Buffalo found that 160 out of 254 products were priced lower at the LCBO stores. In Alberta where alcohol retail stores have been privatized since September 1993, but where wholesaling is still under government control, the Globe and Mail (July 5, 1994) reported that "prices for some products have risen by as much as 25%". There are many reported price comparisons based on Alberta's still brief experience, but all, including some by Statistics Canada, show that alcohol prices have increased since privatization a year ago [See: Laxer, Green, Harrison, and Neu (1994)]. In addition, there is bound to be an urban-rural price differential under privatization which discriminates against consumers of the same products.



05. CONSUMER CHOICE

Consumers' interests are involved directly or indirectly in all matters arising from the sale of beverage alcohol in the province. In particular, as it has been argued in the previous section, alcohol prices are likely to increase under privatization. In this section we shall discuss specifically the important question of consumer choice and the selection of products available in LCBO stores, and in the event of privatization those likely to be found in private stores.

The LCBO carries a very wide selection of quality-tested products throughout the province at uniform prices. In the past five years, LCBO average stock has been 4,000 different products of the three types of beverage alcohol. In 1992, for example, total products' listings contained 4,051 products of which 2,391 were on the regular list, another 1,506 on the vintages list, and 154 products on the duty-free list. In addition, the LCBO offers Private Ordering service through which customers, agents, and licensees can place orders for importing products not regularly in stock from anywhere in the world. All LCBO products are tested for quality, and screened by product experts and consultants. Recently the LCBO began publishing a new Classics Catalogue of vintages, and introduced a phone/fax ordering service.

The LCBO retail outlets carry the several thousand products regularly in stock in different types of stores to meet the different needs of the consumers and of the communities they serve. In addition to LCBO regular stores, there are some designated as full-service stores, which offer the full range of all LCBO products and services; mini stores are located in high traffic areas and carry popular brands; combination stores are regular LCBO stores that carry also the full range of domestic beer products; agency stores are private alcohol retail outlets in small rural communities; seasonal stores are located in resort areas; and duty-free stores in international airports and border crossings.

Service in French is provided in 115 LCBO stores across Ontario, and many stores are in a position to serve customers in languages other than English and French. The LCBO store in Chinatown in Toronto has Chinese signage. LCBO toll-free telephone service called Infoline has bilingual information officers and experts answering customers questions on LCBO products, services, and policies. All LCBO stores have information centres and free brochures on topics such as vintages, special occasion permits, home delivery, returning unopened products, and tours of wineries, distilleries, and breweries.



Under privatization, consumer choice is likely to be one of the first casualties. Reports based on the experiences of Iowa and Alberta suggest that there will be less selection under privatization [See: Laxer, Green, Harrison, and Neu (1994)]. Basically, a network of small private stores cannot afford to carry even a fraction of the thousands of different products presently available in LCBO stores. Many customer services currently provided by the LCBO are likely to disappear under privatization. Alcoholic products will still be required to meet the standards of the federal Food and Drug Act, but regular quality control testing, and quality screening by product experts and consultants will disappear. Small, privately-owned retail stores have neither the means nor the expertise to provide this type of service. The convenience of one being able to buy liquor in corner stores open for business for longer hours than LCBO stores normally are, will come at a heavy price in terms of the range of products available, guaranteed quality, and alcohol abuse in society.



06. LCBO MODERNIZATION

The LCBO has evolved in recent years as a progressive and innovative enterprise as well as a competitive and profitable business. Its broad objectives of marketing a complex range of products at competitive prices, transferring huge sums of money to the provincial and federal governments, balancing profitability with regulatory control and social responsibility, supporting the Ontario wine industry, providing better service to consumers, providing better working conditions to its employees, and protecting the environment, are not easy to balance, and present it with many challenges. Yet it has been remarkably successful in meeting all these objectives.

The late Jack Ackroyd, during his tenure as LCBO Chair from 1984 to 1990, used to tell his store managers: " I want you to run these stores as if there were another liquor store right across the street and, if the customer doesn't like your service, you lose that customer." Guided by this self-motivated drive for excellence, the LCBO success in improving customer service in recent years has been spectacular indeed. It has been modernizing

its retail stores to meet the needs of consumers through computerization of information about product availability and inventory management, design features and convenient locations of its stores, and the integration and co-ordination of its operations and divisions to share ideas and experiences in better serving the consumers. The LCBO is already a first-class retailer in the province providing a clean and organized shopping environment and readily available products and information in both urban and rural areas throughout the province.

Equally spectacular but invisible are LCBO achievements in the important area of quality control. The LCBO is a world leader in quality testing, research and product analysis in its Quality Assurance Laboratory. In 1991, for example, 138,091 quality tests were performed on 7,341 alcohol products. About 14% of the tested products failed to meet LCBO quality standards. Further, the LCBO regularly tests products already on shelves for possible deterioration as well as testing new and incoming products for deficiencies or contaminants. There are in fact three types of quality testing at the LCBO. First, quality assurance testing which means testing to insure that the product is safe for human consumption as required by the federal Food and Drug Act. Second, quality control testing to verify that the product specifications and quality characteristics are indeed as claimed by the manufacturer. These two types are laboratory tests. Third, there is in-store organoleptic testing for vintage and taste by the LCBO Vintages/Product Knowledge Support group of more than forty product experts and wine consultants who regularly screen wines and other products for taste and guaranteed quality, and offer advice to consumers.

The LCBO has recently modernized its technologies, and has installed computer information systems to readily identify inventories, process sales, data, and respond to changing market conditions. The LCBO also conducts extensive market research into consumer preferences, consumption patterns, and store locations.

The LCBO has adapted to changing business conditions and has taken many initiatives to meet its revenue-generating obligations despite increasing legal and illegal competition and declining sales. Financial and management initiatives and advances include computerized inventory management and forecasting, improved warehousing, distribution, marketing, and banking practices, and electronic data interchange.



Finally, the LCBO views protecting the environment as one of its social responsibilities. In 1990 it created an Environmental Management department to develop and implement waste management programmes for the LCBO. The department operates according to government directives and guidelines, and is responsible for developing and monitoring environmental policies and programmes for all LCBO stores and activities across the province. In this context the LCBO has conducted studies and implemented many programmes to reduce, reuse, and recycle alcohol containers and waste materials.



07. PROFITS AND TAXES GENERATED

BY THE LCBO

The LCBO is a highly profitable business owned by the government of Ontario. It is also a significant component of the economy of the province. It pays substantial sums of money in the form of profit to the government of Ontario, and it pays large sums of taxes to the provincial and federal governments. It employs about 5000 people, and its contribution to the gross domestic product of the province is about two billion dollars a year.

The table on the following page contains details of the profits and taxes collected by the two levels of government from the LCBO in the last ten years. The "profits" are transfer payments to the provincial treasury roughly equal to the LCBO net income from

Profits & Taxes Collected

by Provincial and Federal Governments

1984-1993 (in $000000's)





Y E A R

(End March 31)



P R O V I N C I A L



F E D E R A L



T O T A L



Profits



Taxes



SUBTOTAL



Taxes



1984



520



148



668



334



1,002



1985



602



159



761



384



1,145



1986



638



164



802



339



1,141



1987



645



175



820



390



1,210



1988



635



183



818



396



1,214



1989



645



189



834



406



1,240



1990



640



198



838



412



1,250



1991



650



191



841



385



1,226



1992



675



182



857



316



1,173



1993



615



179



794



299



1,093



T O T A L



6,265



1,768



8,033



3,661



11,694



Source: LCBO Annual Report (various issues).

sales of products . In 1993 , the LCBO paid the provincial

government about $800 million in profits ($615 million) and taxes. It also paid $300 million in taxes to the federal government during the same year, bringing the total paid to the two levels of

government in 1993 alone to about $1,100 million. In the last ten years the LCBO paid the provincial government a total of $8,033 million in profits and taxes, and the federal government $3,661 million in taxes, bringing the total paid to the two levels of government to $11,694 million in the past decade. These payments were made despite declining sales and growing legal and illegal competition faced by the LCBO in the last several years.

These figures refer only to profits and taxes generated by LCBO sales of alcoholic beverage. They do not include licence fees and permits paid by the Liquor Licence Board to the Treasurer of Ontario ($511 million in 1993), nor of course do they include retail taxes and levies collected by Brewers' and wineries' retail stores. Further, they also exclude corporate, realty and business taxes paid by the distilleries, wineries, breweries and licensees, and Ontario retail sales tax collected by licensees and agency stores on sales of alcoholic products. However, the three major sources of provincial revenue from beverage alcohol are LCBO markup and taxes and levies, taxes and fees on sales of domestic wine and beer, and LLBO license fees and permits.

The LCBO also contributes annually more than $300 million ($323 million in 1993) to the economy of Ontario in salaries, rents, and the purchase of various goods and services. This sum of money of course has, in addition, an expansionary (multiplier) effect on the economy of the province two or three times larger than the original amount injected into the economy. Further, while the typical crown corporation lives on borrowing and is deeply in debt, the LCBO is not only never in debt, but it is fully self-supportive. All LCBO salaries and operating costs are paid for from its own income; and, unlike government-funded or subsidized operations, no tax dollars are needed to run the LCBO. In fact, as was just pointed out, the LCBO is not only self-supportive but pays profits and collects taxes for the provincial and federal governments without extra charge or cost.

One way of looking at the importance of the profits paid by the LCBO to the provincial government is in relation to provincial income tax payable. In 1990, Ontario had 5,361,460 taxpayers. They paid $13,309 million in income tax to the province (about one-third of the total income tax paid by Ontarians). In 1990, the LCBO paid the provincial government $640 million in profits only. This amounts to 4.8% of the total income tax paid to the province in 1990, or about $120 for each taxpayer. The profits and taxes paid by the LCBO in 1990 to the provincial government were $838 million or about $156 for each taxpayer. The conclusion is that in the event of LCBO privatization income taxes in Ontario are likely to increase to make up for lost profits and taxes currently paid to the Treasurer of the Province by the LCBO.

Another way of looking at the contribution of the LCBO to the Ontario Treasury is in relation to the budget deficit and provincial debt. Figures published with the budget in May 1994, indicate that the 1993-94 deficit is $9.43 billion, and the accumulated debt is $80 billion. Without the profits and taxes paid by the LCBO into the treasury, both the deficit and the debt are likely to worsen. Beverage alcohol sold in drug stores and grocery stores under privatization will certainly mean, among other things, that the provincial treasury would no longer receive the more than $600 million from the LCBO in profits only. Further, the treasury will also lose much of the personal income tax paid by the LCBO employees. The small business corporate tax, if any, paid by stores selling alcohol under privatization is not likely to compensate the province for even a fraction of those losses.

Finally, one might ask what is the market value of the LCBO ? In 1993, the book value of the LCBO net assets was $118 million, and its were profits $615 million. This yields a rate of return equal to 520%, which is extremely high in comparison with common market rates of return. Professor Léo-Paul Lauzon of the University of Quebec argued in his SAQ privatization study that because the SAQ annual profits are $350 million, its market value is or should be the equivalent of $7 billion because this is the amount of money required to be invested in assets yielding 5% rate of return a year in order to have annual profits of $350 million. If this argument is applied to the LCBO, then its equivalent market value based on its 1993 profits is more than $12 billion.













08. LCBO FALLING SALES

The LCBO is one of the major retailers of alcoholic beverages in Ontario. Its share of the forecasted sales for 1993-94 is 37% of the total value of $5.4 billion, and 17% of the total volume of 1.034 billion litres. The other legal competitors are Brewers Retail stores, Ontario wine stores, U-Brews, and cross-border shopping.

However, in the past several years, the value of LCBO sales has been falling, especially in the spirits category, as shown in the table on the following page, which contains details of the LCBO sales from 1989 to 1993. The sales of the wineries and breweries are also included. The table shows, for example, that the value of sales of Canadian spirits fell from $941 million in 1989 to $756 million in 1993, or by about 20%. The sales of imported spirits also declined during the same period though by a smaller amount. LCBO total sales also fell by about 11% from $1.99 billion in

































1990 to $1.78 billion in 1993.

The steady fall in the LCBO sales may in part be due to a general trend of falling sales of alcoholic beverages in Canada and other western countries. In 1989, for example, 78% of people aged 15 and over in Canada were current drinkers compared with 82% in 1978 (Canadian Social Trends - Spring, 1991). According to figures published by Societe des alcools Quebec (SAQ) and quoted by Professor Leo-Paul Lauzon in his 1994 study of the privatization of SAQ, in the last ten years alcohol consumption has been falling in North America and western Europe. To this extent, the fall in the LCBO sales may be partly explained by a general trend of falling alcoholic consumption in the western world.

The LCBO suffered the decline in sales despite the fact that it is price competitive. The table on the following page contains a summary of the value and volume of sales and product unit prices (value divided by volume), and rate of inflation in Ontario from 1989 to 1993. Thus, for example, the price per litre of spirits increased by 11.6% from 1989 to 1993; and the price of wine

Product Prices and Inflation, 1989-1993

Value in $000's, Volume in 000's Litres

Price $ per Litre





Product


1989


1993


Value


Volume


Price


Value


Volume


Price


Spirits


1,241,687


67,227


18.47


1,042,162


50,565


20.61


Wine


529,364


75,379


7.02


530,950


67,618


7.85


Beer


151,470


60558


2.50


206,884


71,964


2.88


Price Change from 1989 to 1993


Spirits


11.6%


Wine


11.8%


Beer


15.2%


Ontario Inflation Rate from 1989 to 1993 = 12.7%


Source: LCBO Annual Report 1992-93 & Statistics Canada: Consumer Prices and Price Indexes, October 1993 and December 1990.

increased by 11.8% for the same period. The rate of inflation in Ontario for 1993 relative to 1989 was 12.7%. Thus the real price of spirits and wine has in fact declined by about one percent from 1989 to 1993.



In addition to its being price competitive, the LCBO offers customers a broad selection of products from producers in North America and throughout the world, and has constantly strived to improve its services to consumers, redesign many of its stores, and increase its efficiency. The fall in LCBO sales can undoubtedly be partly due to a general trend of falling alcohol consumption, especially spirits, as well as to other factors such as the climate of economic recession, the resentment of heavy taxes on alcoholic beverages, and legal competition from breweries, wineries, and cross-border shopping. The fall of sales may also be due to the growing and significant competition from illegal sale of alcoholic beverages through smuggling and illegal manufacturing. The magnitude and impact of this illegal competition are discussed in the next section.

09. SMUGGLING AND ILLEGAL MANUFACTURING

The black market economy in beverage alcohol consists primarily of the smuggling of spirits and illegal manufacturing of wine. Alcohol smuggling and illegal manufacturing, while by no means a new phenomenon, have been growing in recent years and continue to grow exponentially. According to one LCBO document, for example, illegal alcohol seizures from licensees have increased by 3000% during a period of one year recently. Hardly a week passes by without thousands of cases of smuggled liquor being confiscated in Ontario.

The following table (based on a chart prepared by the LCBO as part of a closely argued submission by Mr Andrew S. Brandt, its chair and CEO, to the Standing Committee on Finance and







Economic Affairs of the Ontario Legislature, in November 1993, on the impact of alcohol smuggling and illegal manufacturing [See: Brandt(1993)]) provides a breakdown of the value and volume of the beverage alcohol market in Ontario. LCBO estimates of the alcohol black market are generally consistent with similar estimates by the Association of Canadian Distillers (ACD), and have been adopted, and "blown-up for Canada on the basis of population", in a study by Statistics Canada on The Size of the Underground Economy in Canada (June, 1994).

The LCBO estimates its losses due to the black market during the fiscal year 1993-94 at just over $806 million, or about 15% of the total alcohol market in the province. Smuggling accounts for about $496 million (19.081 million litres at a unit price of $26 per litre). Illegal manufacturing accounts for about $321 million, or almost 6% of the total alcohol market (about 40 million litres at $8 a litre).

There is another way of looking at these figures. The $806 million of illegal sales consisted of smuggled spirits, and illegally manufactured wines. In 1993 the LCBO sales of spirits and wines totalled $1,573 million. Thus the illegal market in spirits and wines accounts for more than half of all the LCBO sales in these two categories. Further, it has been estimated by winery experts that illegal wine manufacturing in Ontario is greater than all legal wine production in the province. It is scarcely possible to exaggerate the scale and magnitude of law breaking in the alcohol market in Ontario.

As noted earlier, alcohol consumption in the United States and Canada has been falling in recent years. But despite the similarity of consumption patterns in the two countries , ACD estimates that the decline in alcohol sales in Canada is 60% greater than in the United States, and attributes this disparity to illegal alcohol sales in this country which go unrecorded.

But the losses to society caused by the black market in beverage alcohol go beyond LCBO lost sales and government lost revenues. In addition to law enforcement costs, the following are some of the more general losses involved.

First, there are serious health risks as a result of marketing alcoholic products which often fail to meet LCBO quality standards and testing procedures. LCBO investigators have found, for example, black market products whose alcohol content reaches lethal levels, or which is in sub-standard storage and containers. Secondly, the black market, unlike the LCBO retail outlets, does not respect the legal drinking age or intoxication limits. Thirdly, the illegal alcohol market exists and flourishes at the expense of more 10,000 people of honest tax-payers employed in the legal alcohol industry, and related economic activities such as transportation and promotion.

The underground economy exists almost entirely because of the imposition of relatively high taxes in general. Smuggling of spirits and illegal manufacturing of wines are profitable in Ontario because they are relatively heavily taxed. Alcohol use and abuse impose social costs on society: increased health care costs, production losses, crime, fires, traffic accidents, and welfare costs. The "optimal tax" on alcohol, some would argue, should be set at a level sufficient to compensate society for the social costs associated with alcohol consumption. However, alcohol is addictive and therefore its use is seldom sufficiently sensitive to alcohol prices (and taxes). Instead higher taxes divert demand from the LCBO to the illegal market. Estimates of "own-price elasticity" of demand for spirits and wines vary widely over the elastic/inelastic range, and are perhaps difficult to quantify accurately because there are many factors in addition to price (and income) which determine the alcohol consumption [See: Johnson, Oksanen, Veal, and Fretz (1992)]. Whatever the case, there is hardly a more important reason other than taxes for the underground economy whether in cigarettes, alcohol, or many other markets. (A study in a 1993 issue of the Canadian Tax Journal, by Peter Spiro of the Ontario Ministry of Treasury and Economics, "finds that there has been a substantial increase in the underground economy since the introduction of the GST").



Under privatization alcohol smuggling is likely to intensify, and social and law enforcement problems related to the black market economy in beverage alcohol will increase. It is easier for smugglers to sell their products to the owners of private stores than directly to individual consumers; and it is more profitable for owners of private stores to join the underground economy than to buy their merchandise legally. In the event of higher alcohol prices under privatization, the primary reason for black market activities will be reinforced. Finally, law enforcement will become more difficult because of the increase in smuggling and the illegal manufacturing of alcoholic products and the increase in the number of retail outlets.



10. SOCIAL RESPONSIBILITY POLICY

It is the social policy of the LCBO to control alcohol consumption and prevent its abuse through pricing and marketing measures. The consequences of alcohol abuse to the individuals concerned and to society can hardly be exaggerated. The estimated number of alcoholics in Canada in 1989 was 486,100 (201,800 in Ontario); in 1990 the number of deaths directly attributed to alcohol was 2,959 (1,159 in Ontario); and the number of deaths indirectly attributed to alcohol was 15,665 (5,390 in Ontario). The economic and social costs of alcohol abuse in Canada have been estimated, as discussed in Section 12, at $5.7 billion in 1981 ($1.7 billion in Ontario).

Social responsibility is proclaimed in LCBO publications as a fundamental objective of the corporation and plays a major part in its operations. It must be noted from the outset that the LCBO adherence to social responsibility is at a cost to itself, including loss of revenue. For example, the Board's reduced markup on light wine and beer, and hence reduced sale price and reduced revenue, is intended to influence consumer preference in favour of less-intoxicating, and hence less harmful, alcoholic beverage.



The LCBO has played and continues to play a key role in implementing government social programmes and policies against alcohol abuse. True to its original dual mandates of making money for the government and the regulatory control of the use of alcohol in society, the LCBO continued to "merchandise the right products, to the right people, for the right reasons". Measures aiming at educating and protecting the public include co-operating with groups such as Mothers Against Drunk Driving through anti-drinking and driving messages and education material. The LCBO has also launched its own Challenge and Refusal programme under which figures available by the end of March 1993 indicate that more than 210,000 persons were challenged when they wanted to purchase alcohol while appearing intoxicated or under the legal drinking age, and 50,000 were refused service. About 13,500 of those 50,000 were found already intoxicated, and the others were under age or could not prove their age.

As a result of LCBO-supported government campaigns against alcohol-related offences, the number of Liquor Act offenses in Ontario, as shown in the table on the following page, has declined from 137,483 offenses in 1984 to 98,035 offenses in 1991, the latest year for which figures are available. Alcohol is too ingrained in our culture to be prohibited, as we all know, but the LCBO has helped greatly in limiting its abuse and related offences.





11. ALCOHOL AVAILABILITY, ALCOHOL ABUSE AND PUBLIC ATTITUDE



Alcohol control measures include age restriction, prices and taxes, type and content of beverage, marketing and advertising, and 'availability' in terms of the number of outlets and hours of sale. At present there are in Ontario more than 600 LCBO stores, 80 agency stores, 320 winery stores, 430 Brewers Retail stores, for off-premises consumption; and more than 14,500 licensed establishments for on-premises consumption. While there is no shortage of alcohol outlets at present, the availability of alcohol through these many outlets is not without restrictions - they all operate under the supervision of the LCBO and LLBO. Under privatization the likely multiplying of privately owned small stores selling alcoholic products virtually 24 hours a day, 7 days a week, may not only increase the level of consumption in general, but more important the population groups already at risk, the alcoholics and under age, will become far more vulnerable to alcohol abuse.

Experience shows that privatization of the sale of alcohol leads to a sharp increase in the number of private outlets selling alcohol. In 1978 when wine in Quebec became available in grocery stores, the number of outlets selling wine jumped from about 370 to about 7,000 within the year, and then to about 19,000 a year later. In September 1993, when Alberta decided to privatize the sale of beverage alcohol, the number of retail stores in the province increased from 204 to 417, with several hundreds of new licenses approved (Calgary Herald, May 29, 1994). In Calgary, for example, there were 24 liquor stores in September 1993, before privatization. In May 1994, after the privatization of the Alberta Liquor Control Board, Calgary had 59 privately owned liquor stores, plus about 100 licence applications for new liquor stores approved in principle according to the Calgary Herald, May 29, 1994. Figures for the United States, published by the Distilled Spirits Council, show that the number of liquor stores per million of residents in privatized states such as New York and Maryland is six to four times more than the corresponding number for control states such as Ohio and Pennsylvania. Increases in the numbers of alcohol retail stores occurred also in Iowa and West Virginia following privatization.

There are two primary reasons for the substantial increase in the number of retail outlets selling alcohol under privatization. First, small private stores can become retailers of alcohol beverage at a small capital cost; and, secondly, the owners of the small stores

are under the mistaken impression that selling alcohol is the road to riches.

However, it is not clear whether increased availability of alcohol under privatization does also lead to increased consumption. In the past twenty years there have been many studies of this question with conflicting results. For example, Wagenaar and Holder (1991) found substantial long-run increases in the apparent consumption of wine following privatization in Iowa and West Virginia; however, apparent consumption of spirits decreased in both states. Mulford, Ledolter and Fitzgerald (1992) studied privatization in Iowa and found that there was no long-run change in wine consumption. Adrian, Ferguson and Her (1994) found that the increased availability of wine in Quebec after 1978 did not increase apparent consumption.

It is still highly plausible that increased availability of alcohol,

other things being equal, is likely to increase consumption in general. More important is the fact that, other things being equal, unrestricted access to alcohol under privatization will increase alcohol abuse by the population groups at risk even if the level of consumption by the majority of the population remains more or less unaffected. This is the main reason for the social concern about, and for the public opposition to, the unrestricted availability of alcoholic products.

Figures in the table on the following page from a study published

Public Opinion Regarding Alcohol Policy Questions, Age 15+, 1981



Question


YES


NO


Don't Know


Should Alcohol be Sold in Corner Stores ?

C A N A D A

O N T A R I O









23.2

25.3









73.0

70.4









3.0

3.2



Should Alcohol Have Warning Labels ?


C A N A D A

O N T A R I O







73.8

71.9









22.3

23.1









3.1

3.7



Source: Alcohol and Other Drug Use by Canadians: A National Alcohol and Other Drugs Survey (1989) Technical Report, prepared by Marc Eliany et al. for Health and Welfare Canada,

Ottawa, June 1992, page 406.







by Health and Welfare Canada in 1992, referenced below, show that almost three-quarters of the people of Ontario are against the sale of alcohol beverages in corner stores; and also favour adding warning labels on alcoholic beverages containers. In addition, the same study (pages 36 and 395) found that very few Ontarians (3.9%) favour lowering the legal drinking age of 19 years.







12. THE COST OF ALCOHOL ABUSE





A major objective of the 1927 Liquor Control Act, which established the LCBO, was to "control the sale" of alcoholic beverages. The LCBO has directed its efforts over the years to serving the people of Ontario in a socially responsible environment and price competitive market.

The economic and social costs of alcohol abuse arise from increased health care expenses, lost production, cost of increased law enforcement activities, cost of increased social welfare, and fire losses and traffic accidents.

A study by Manuella Adrian (1988), a senior scientist with the Addiction Research Foundation, "conservatively" estimated the economic and social costs of alcohol abuse in 1981 at $5.7 billion in Canada, and $1.7 billion in Ontario. A breakdown of these

estimates into their major cost components is given in the table on the following page.

The figures in the table show that in 1981 excess health care costs due to alcohol abuse were $2.1 billion in Canada, and $558 million in Ontario; production losses were about $1.3 billion in Canada, and $519 million in Ontario; law enforcement costs were $654 million in Canada, and $169 in Ontario; and social welfare costs were about $1.4 billion in Canada, and $330 million in Ontario.

When these 1981 figures were adjusted for the national rate of inflation from 1981 to 1993, the corresponding total economic and social costs of alcohol abuse in 1993 are about $9.8 billion in Canada, and $2.9 billion in Ontario.









Components of the Cost of Alcohol Abuse (1981 Prices)





Cost Component


Canada ($m)


Ontario ($m)


Health Care


2,113.8


557.9 5


Labour Productivity Losses


1,283.2


519.3


Law Enforcement


654.3


169.3


Social Welfare


1,391.2


329.9


Fire Losses


5.8


2.4 *


Traffic Accidents


224.0


94.1 *


TOTAL


5,672.3


1,672.9




Source: Manuella Adrian: "Social Costs of Alcohol", Canadian Journal of Public Health, vol. 79, September/October 1988, pp. 316-322. The * in the last rows are proportional estimates for Ontario based on multiplying Adrian's national estimates by 0.42.













The decontrol of the sale of alcoholic beverages through privatization will almost certainly increase the economic and social costs of alcohol abuse to the extent privatization increases alcohol abuse. The basic reason why privatization is likely to increase alcohol sale is that alcoholic products will be more readily available and widely advertised in convenience, drug, and grocery stores. In Calgary, for example, there were 24 liquor stores in September 1993, before privatization. In May 1994, after the privatization of the Alberta Liquor Control Board, Calgary had 59 privately owned liquor stores, plus about 100 license applications for new liquor stores approved in principle according to the Calgary Herald, May 29, 1994. Figures for the United States, published by the Distilled Spirits Council, show that the number of liquor stores per million of residents in privatized states such as New York and Maryland is six to four times more than the corresponding number for control states such as Ohio and Pennsylvania. More liquor retail outlets and alcohol promotion lead to increase in alcohol abuse; and this in turn leads to increases in alcohol-related deaths and illnesses, production losses and reduced labour productivity, crimes, traffic accidents, fire losses, and dependence on social welfare. In contrast, liquor control limits access to alcoholic beverages in a socially responsible manner. Limiting access to alcoholic beverages in a socially responsible manner is one important area of social and economic policy where the Liquor Control Board of Ontario makes a huge positive contribution.



13. LCBO PRICING



The LCBO pricing policies are designed, by inference and implication though not always acknowledged, to control alcohol consumption, to generate revenue for the provincial and federal governments, and to support the domestic alcohol beverage industry, especially providing incentive to Ontario wine. Within this framework, the prices of LCBO products are set subject to three major policy constraints. First, all product prices are uniform throughout the province despite inevitable differential costs such as transportation and distribution costs. Second, the LCBO has a system of "floor pricing", minimum selling price set for each product as part of its social responsibility mandate to control and discourage alcohol consumption. Third, less-intoxicating beverages such as light wines and beer are in effect sold by the LCBO at reduced prices, again the object of the exercise being to influence consumption patterns as part of the Board social responsibility commitment.

But otherwise the structure of the markup, and taxes and levies that make up the final retail price presents a complicated picture.

Examples of detailed breakdown of the LCBO pricing and taxes and levies on domestic and imported spirits, wines, and beers, as of March 1993, are contained in the table on the following page.

Spirits: For both imported and domestic spirits, the supplier price and freight account for only 17% of the final LCBO retail price. The markup varies from 145% (as in the table) to 131% of the total landed costs (supplier price and freight plus custom excise and import duties), depending on product and whether domestic or imported spirits. In addition to the markup, there are provincial and federal taxes (other than excise and import duties) and levies







adding up to more than 50% of the landed costs. Thus the markup

and all the provincial and federal taxes and levies account for about 83 cents of every dollar spent on spirits in Ontario.



Wine: The pricing of domestic wine and imported wine is highly differential. To begin with, suppliers of Ontario wine and of other domestic wine are paid the same price (as shown in the table) as suppliers of imported wine, although one would expect domestic wines should be cheaper at least because of lower transportation costs for Ontario wine. The markup on imported wine is typically 70% (as shown in the table) of the total landed costs, but in general it varies from about 60% to about 115% of landed costs. The markup on Ontario wines is typically about 34% (as shown in the table) of the total landed costs, but in general it varies from a low of 34% to a high of 100%. The important point to note is that the LCBO through its differential markup on domestic and imported wines is not necessarily maximizing its own revenues. Professor Keith Acheson of Carleton University estimated the revenue loss to the LCBO due to differential markup on domestic and imported wines at more than 10% of LCBO wine sales [See: Acheson(1977); see also: Acheson(1983) and Liebowitz and Bridgeman(1983)]. However, because of international trade agreements the differential pricing of domestic and imported wines is in the process of being phased out. At present, it is estimated that the markup and all the provincial and federal taxes and levies account for about 65 cents of every dollar spent on wines in Ontario.



Beer: In 1993 a new system of beer pricing, listing and distribution came into effect in Ontario as a result of international trade agreements and recent rulings by GATT. Basically, both domestic and imported beers are now treated equally in pricing, and that imported beer is now sold in Brewers Retail stores as well as in LCBO stores. This latter arrangement would affect LCBO revenues adversely, but LCBO sales of imported beer form only 5% of 1993 total alcohol beverage sales by Board stores. The markup and all provincial and federal taxes and levies account for about 69 cents of every dollar spent on beer in Ontario. The breweries, however, argue that based on "tax per litre of alcohol", beer in Ontario is taxed more heavily than spirits and wines [See: Brewers of Ontario(1994)].





14. IMPLICATIONS FOR ONTARIO

WINE INDUSTRY



As related by Percy Rowe in his book The Wines of Canada, wine was excluded from prohibition when the Ontario Temperance Act of 1916 was passed because of pressure from grape growers: 'the grape growers of the Niagara Peninsula...descended upon the members of the provincial legislature with wrath: "Where," they asked, "are we going to sell our grapes?".' To this day the provincial government and the grape growers and the wineries "have been inextricably involved in the industry", as the Tanner (1986) task force put it. There is little doubt that Ontario grape growers and wineries will be among the big losers if the LCBO is privatized.

The Canadian wine industry is concentrated in Ontario, British Columbia and Quebec, which together account for about 90% of the total shipments valued in 1992 at $291 million. About 2000 people are employed both in wine production and by wineries in retail and distribution, and in bottling operations. Ontario accounts for about 35% of the wine production in the country. Full-time and part-time grape growers are about 750, and the farm gate value of grape sold for processing was estimated in 1990 at about $23 million [See: Industry, Science and Technology Canada (1991)]. About 90% of the grape growers are in Ontario; the crop is about 50,000 tonnes, and the wineries are required to buy a minimum of 25,000 tonnes.

In 1992 the retail value of wine sales in Canada was about $1.8 billion, with 36% being domestic wine. In the same year the retail value of wine sales in Ontario was $574 million, about one-third of it domestic wine. The wineries in Ontario and other provinces, unlike the distilleries and breweries across Canada, are vulnerable to foreign competition both fair and unfair for several reasons. These include lack of economies of scale, limited access to competitively priced grapes, consumer perception of product quality which favours imported wine, and possible subsidies of foreign producers from their own governments. Thus the European and U.S. wineries have both cost and marketing advantages over domestic wineries. The cost advantages are based on scale economies, quality grapes at economical prices, and possible government subsidies. The marketing advantages are based on established reputations and brand recognition.

LCBO pricing and marketing policies are supportive of Ontario wines over imported wines (and over other domestic wines because of provincial trade barriers - these barriers are, however, being phased out). There are at least five areas where LCBO practices are favourable to the Ontario wine industry.

First, LCBO markup policy favours domestic wine over imported wine. The arithmetic details of this differential markup are discussed in the section on LCBO pricing. It is also noted there that because of international trade agreements, this differential markup is in the process of being phased out.

Second, the LCBO has a "non-discriminating reference price", which is a minimum price at present set at $18.65 per case of 9 litres below which the Board does not accept sell offers from foreign suppliers. In effect this policy means that foreign suppliers cannot outbid Ontario suppliers below the minimum reference price, and that Ontario wine is possibly priced above its competitive market price.

Third, in 1993 wine sales by wineries stores were about $75 million. The wineries pay in effect licensing fees to the LLBO on the sales equal 2% of basic price, plus 29 cents per litre, and a small environmental levy. This represents a transfer of revenue from the Ontario Treasury to the wineries, and it is a major sacrifice by the LCBO because if these wine sales by wineries stores were made by the LCBO they would have been subject to LCBO markup and LCBO wine levies which amount to about 50% of the basic price.

Fourth, the LCBO permits a large number of wineries retail stores to sell Ontario wines. Retail sales of domestic wine is a zero-sum game in which the gains of the wineries stores are the losses of the LCBO stores.

Fifth, the listings of wines by the LCBO could favour in terms of availability and promotion Ontario wines over imported wines, and even over other domestic wines (in 1993 there were 409 listings of Ontario wines and only 11 other domestic wines). As noted above, these provincial trade barriers are being phased out.





15. UNEMPLOYMENT IMPLICATIONS



The most serious implication of a possible LCBO privatization is what will happen to the workforce it now employs given the realities of the job market in Ontario and in the country. The LCBO is a progressive employer of a committed and customer-oriented workforce. It provides secure employment to some 5000 people classified as permanent and casual, and full-time and part-time. Even casual employees are guaranteed a certain minimum number of hours of work each week. These employees are recognized in many LCBO documents as the corporation's greatest strength. Many of them have several years of experience and on- the-job training. The management and employees' union have worked in harmony and cooperation in providing solutions to issues relating to employment equity and security, health and safety, development opportunities and training, and educational programmes.

Using 60%, the percentage of salaries and benefits to operating expenses implied in the figures published in the 1983/84 Annual Report, the annual average of employees' compensation during the last five years is about $180 million, and in 1994 it is probably about $200 million or more (in 1994 salaries and benefits are about 72% of the operating expenses).

In the event of LCBO privatization, probably only few of its employees could re-enter the job market. Small privately-owned retailers will replace less profitable items and reorganize their shelves to fill with popular best sellers of spirits and wines. Only major privately-owned liquor stores are likely to hire some of the employees that used to work for the LCBO. In Calgary, the owner of a liquor store expecting $4 million in sales this year told a Calgary Herald reporter (May 29, 1994) that he and others like him have "a big edge in product knowledge" because they have hired former Alberta Liquor Control Board employees. But the smaller stores neither need nor can afford to hire former ALCB employees. In West Virginia after privatization in January 1991, it has been estimated by a labour organization that only about 10% to 25% of the former state stores employees were rehired by private stores. In Ontario where the rate of unemployment in June 1994 is 9.5%, with 507,000 people unemployed, the labour market almost certainly will not absorb even a fraction of the 5000 LCBO employees if laid off.

The laying off of LCBO employees would mean huge losses to the treasury and economy of Ontario. Unemployment insurance would replace about 60% of the lost income of the insured unemployed persons. Immediate one-time unemployment compensation and further lost income tax normally paid by LCBO employees and lost-output cost are among the many losses to the treasury and economy of Ontario. One way of looking at these losses is according to an estimate (made by the American economist Arthur Okun) of the relation between unemployment and loss of output. Each 1% loss of employment translates into a 3% loss of output per year. The 5000 LCBO employees if laid off would increase unemployment in the province (whose labour force is 5,450,000 persons) by about 0.092% . This would translate into 0.28% loss of output. The current value of gross domestic product of the province at market prices is more than $280 billion. Therefore the output loss of additional 5000 unemployed persons is about $780 million a year.

But the unemployment spillover effect of the LCBO privatization will not be confined to the LCBO employees only. The sale and manufacturing of alcoholic beverage in Ontario, and in other provinces, are vertically integrated. Thus the LCBO privatization is certain to disrupt the entire alcoholic beverage industries in the province, and to cause unemployment in these industries themselves and in related sectors of the economy.







16. THE ALBERTA EXPERIMENT



A year ago, on September 2, 1993, Alberta began privatizing liquor retailing in the province. By the end of March 1994, all 204 ALCB stores were sold or closed. In June 1994, Alberta also announced the privatization of its liquor warehousing and distribution.

About 1,500 ALCB employees have been laid off, including 100 head office staff, and about 600 management and full-time staff. The ALCB had real estate holdings valued at about $115 million. By July 1994, the ALCB had sold 111 store properties at 54.2 million. The book value of these 111 stores is said to be $50 million. However, the ALCB still has unsold stores after 9 months on the market, and an office/warehouse complex which was expensive to build and expensive to operate, yet hard to sell.

An objective assessment of the costs and benefits of the Alberta experiment is very important not only for Alberta, but for the rest of the country - especially for those provinces which are considering or might consider the privatization of their own liquor control boards. While the Alberta liquor market is still in transition and inevitable disruption, early indications suggest that the experiment "is becoming counterproductive" as was conceded by Alberta Premier Ralph Klein (Calgary Herald, January 19, 1994). What happened so far is that product prices are higher, product selection is smaller, warehousing and distribution costs are higher, and social costs are higher. These are the documented conclusions found in a study by the Canadian Wine Institute (1994).

There have been many surveys of alcohol prices in Alberta since privatization. A frequently quoted survey by the Alberta Liberal Party found that retailers were adding 14% to 17% to the wholesale price. The "wholesale price" is set by the ALCB at 6% below the previous ALCB retail price. If we assume the retailers were adding 15%, which is fairly representative of price increases found in other surveys such as the Andres wines survey, then the 15% increase in retail prices and the 6% discount on the ALCB wholesale price imply that the private retailers require an 18.3% rate of return. (Suppose a product used to be sold for $10 before privatization. After privatization it is sold at $11.50, or 15% higher. The 15% above the $10 previous ALCB price plus the 6% wholesale discount of the $10, add up to $2.10, which is about 18.3% of the private store retail price of $11.50).

There are two other problems related to the structure of product prices rather than the higher price level itself. The first is that in addition to price increases, the Andres brands survey found a price variation of 10% to 25% between stores. The consumer is better off with uniform prices before privatization because there is obviously a cost to the search from store to store for lower prices. The second is that the prices of regular brands have increased by even a greater proportion than the average increase in prices since privatization, while the prices of the premium brands have declined. This is due to the change in the alcohol tax structure. Alberta decided to impose "flat tax" per litre instead of percentage markup (ad valorem tax) on each product. The Alberta government claimed that the new tax structure makes privatization "revenue-neutral". This claim may or may not be true; however, the change in the alcohol tax structure was regressive.

Before privatization, some ALCB stores listed more than 2,000 products. Since privatization, customer selection has been reduced to less than 500 products at store level. Inventories have also been reduced, and the out-of-stock private stores have become common.

The suppliers of alcoholic products, including domestic breweries, distilleries, and wineries, are opposed to the privatization of alcohol retailing. This may appear surprising since retailing, which is the object of privatization, is separate from manufacturing and suppliers' concerns. Yet the suppliers have some good reasons to oppose privatization. The small suppliers have gained open access to the market, which is an advantage. The established major suppliers consider this development unwelcome competition. But there are more serious concerns common to all suppliers. To begin with, it was easier and inexpensive to deal with one customer, the ALCB, than with a disconnected network of small retail stores located throughout the province. Product prices have become unpredictable and can no longer be controlled by suppliers as was the case when the ALCB markups/prices were uniform and already known. Suppliers also faced increases in warehousing costs (which were previously included in the ALCB markups), inventory carrying costs, and administrative costs, among others.



The social costs of privatization in Alberta have also increased. The sale of alcohol to minors has increased. Liquor store robberies have also increased because of extended opening hours and poor security in small private stores. There has also been an increase in cross-border shopping and smuggling.





17. SUMMARY AND CONCLUSIONS



1. In recent years politicians in several provinces, including Ontario, have made statements advocating the privatization of the sale and distribution of all alcoholic beverages.

2. The basic economic argument is that crown corporations cannot utilize resources at minimum cost because they tend to become bureaucratic, confused and inefficient.

3. Privatization may also be advocated and implemented for purely political reasons such as the control of public expenditures.

4. It is acknowledged that the privatization of liquor control boards raises many policy issues and concerns both economic and social. This report examines some of these issues and concerns.

5. The LCBO was established in 1927 to "control the sale, transportation and delivery" of alcoholic beverages in Ontario. Its present objectives and concerns are: protecting society from alcohol abuse; generating revenue for government; and supporting Ontario wine.

6. Another economic rationale for the LCBO status is that it enjoys economies of scale.

7. Whether the LCBO should or should not be privatized is a question that cannot and should not be answered on the basis of political ideology and generalized faith in the private sector. The more efficient and less expensive but controlled health care system in Canada compared with the market-based but expensive and inequitable one in the United States provides a striking example of possible market failures.

8. Selling the LCBO to private owners would not help in reducing the provincial debt because LCBO assets are a small amount relative to the $80 billion debt.

9. Arguments in favour of privatization include that public enterprises are poorly managed, cannot compete in the marketplace, and cannot survive without continued government handouts of taxpayers money. None of these arguments is true in the case of the LCBO. The LCBO is highly profitable, and does not receive nor need any government subsidies.

10. Privatization of crown corporations should be decided on a case by case basis. LCBO privatization would be a mistake costly to the people and government of Ontario.

11. Under liquor control, revenues are greater and prices are lower than under privatization, other things being equal, because of economies of scale. The privately-owned outlets are fragmented, and require higher rates of return on their capital costs than control boards.

12. A study found that in the United States prices were on average more than 11% higher in 27 "private-license states" compared with 16 "monopoly states", and that the treasuries of the monopoly states collected more per capita revenue from alcohol sale than the private-license states. The Ontario Committee on Taxation also found "private retailing system yields on the average a much lower return to the Public treasury"; the Committee had "no doubt as to the superiority of public over private liquor outlets". These findings are supported by recent price comparisons in Alabama and Iowa, and in Alberta.

13. The LCBO retail outlets carry several thousands of products regularly in stock. Under privatization, consumer choice is likely to be one of the first casualties.

14. The LCBO success in improving customer service in recent years has been spectacular indeed. Equally spectacular but invisible are LCBO achievements in the important area of quality testing and control.

15. The LCBO views protecting the environment as one of its social responsibilities, and has a special department for this purpose.

16. In 1993, the LCBO has paid the provincial government about $800 million in profits and taxes. It also paid $300 million in taxes to the federal government during the same year. In the last ten years the LCBO paid the provincial government a total of $8,033 million in profits and taxes, and the federal government $3,661 million in taxes, bringing the total paid to the two levels of government to $11,694 million in the past decade.

17. In the past several years, the value of LCBO sales have been falling partly due to a general trend of falling alcohol consumption, and legal competition from breweries, wineries, and cross-border shopping. Falling sales have also been caused by the growing and significant competition from smuggling and illegal manufacturing. The underground economy in alcoholic products is likely to grow under privatization.

18. It is the social policy of the LCBO to control alcohol consumption and prevent its abuse through pricing and marketing measures. The estimated number of alcoholics in Canada in 1989 was 486,100; in 1990 the number of deaths directly attributed to alcohol was 2,959; and the number of deaths indirectly attributed to alcohol was 15,665.

19. The LCBO adherence to social responsibility is at a cost to itself, including loss of revenue. As a result of LCBO-supported government campaigns against alcohol-related offences, the number of Liquor Act offences in Ontario has declined from 137,483 offences in 1984 to 98,035 offences in 1991.

20. It is highly plausible that increased availability of alcohol under privatization is likely to increase alcohol abuse. The people of Ontario are against the sale of alcohol beverages in corner stores; and against lowering the legal drinking age of 19 years.

21. The economic and social costs of alcohol have been estimated in 1981 at $5.7 billion in Canada, and $1.7 billion in Ontario. In 1993 prices, the corresponding figures are $9.8 billion in Canada, and $2.9 billion in Ontario. The decontrol of the sale of alcoholic beverages through privatization will almost certainly increase the economic and social costs of alcohol abuse.

22. The LCBO pricing policies are designed to discourage alcohol abuse, generate revenue for the provincial and federal governments, and to support the domestic alcohol beverage industry, especially providing incentive to Ontario wine. The markup and all the provincial and federal taxes and levies account for about 83 cents of every dollar spent on spirits in Ontario. The corresponding figures for wine and beer are 65 cents and 69 cents respectively.

23. Ontario grape growers and wineries will be among the big losers if LCBO is privatized. Ontario wineries are vulnerable to foreign competition because of lack of economies of scale, and consumer perception of product quality which favours imported wine.



24. LCBO pricing and marketing policies are supportive of Ontario wines in its differential markup policy, use of minimum reference price paid to all suppliers, favourable licensing conditions for wineries own retail outlets, and marketing and promotion.

25. The most serious implication of a possible LCBO privatization is what will happen to the workforce it now employs given the realities of the job market in Ontario and in the country. The laying off of LCBO employees would mean huge losses to the treasury and economy of Ontario. But the unemployment spillover effect of the LCBO privatization will not be confined to the LCBO employees. The entire alcoholic beverage industries in the province will be affected.

26. Privatization in Alberta has resulted in higher product prices, smaller product selection, higher warehousing and distribution costs, and higher social costs. Alberta Premier Ralph Klein has conceded that the ALCB privatization is "counterproductive".

18. References



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