Myth of the Level (Vineyard) Playing Field

Terrain matters, both in wine and in markets.  Many of the world’s best vineyards  cling to hillsides or follow natural contours (like the famous Pewsey Vale vineyard shown here).

While wine people seem to appreciate the challenges and opportunities that complicated terrain presents, economists are drawn (at least metaphorically) to tabletops. We think of the world in competitive terms and seek out “level playing fields” where our favorite theories are most applicable.

The Difference Between Vineyards and Soccer Fields

As a wine economist, I can appreciate the flat and the steep of the wine world and I have come to upon a particular irony.  Wine market reforms in the European Union are intended to create a level playing field and to encourage, induce and sometimes force winegrowers to compete. The days of big subsidies and routine “emergency” distillation are gone, or will be soon, we are told.

But wine markets are as complicated as the vineyard shown above and establishing a flat competitive arena is not a simple matter.  Wine markets are more like vineyards than we like to think.  Tariffs, quotas, subsidies and selling regulations can be brought into line, of course, but that is just the beginning. The uneven contours of the market run very deep.

Whither/Wither the Vines?

I was reminded of this by a recent post on the Tablas Creek Vineyard Blog titled “Whither inexpensive, artisanal California wine?” (Tablas Creek is a well regarded maker of Rhone-inspired wines in California’s Paso Robles area.)

The question that the article posed was whether it made economic sense for the winery to develop a new vineyard property to produce high quality reasonably priced wine (the $20 price point plus or minus a few bucks). The answer? Probably not, but with a rather thorough cost analysis provided so you can see how the various factors (land cost, debt service, planting cost, operating cost, even opportunity cost) factor in.

It’s a really good article for anyone who thinks that the decision to start of vineyard or a winery is an easy one.  (The sommelier  in the video above would do well to read it!)

At the end of the day, the single most important factor was the cost of the land. Even in a depressed market, land costs create a hurdle too high to overcome in Paso Robles.

(Note: I was also struck by planting and operative cost differences associated with dry farming the vines. Much lower cost, somewhat lower yields — worth serious consideration where feasible given the growing water shortage.)

Why are vineyard land prices so high that they make the vineyards themselves uneconomic?  Well, the land has many uses aside from the obvious one of growing wine grapes. Speculators might want to buy it to hold and resell, not operate for the long run. Lifestyle investors push up the price because they consider the amenity value of a vineyard home more than the economic value of its grape crop. These alternative demands can push the price above the level growers can afford.

Tilting the Playing Field

This distorts the playing field on which international wine markets operate. Land costs are a big factor for many expanding New World wineries because those costs are so recent that it is difficult to ignore them.

Land costs are often ignored for Old World producers, I am told — especially the thousands of small winegrowers who have owned their land for several generations. Ignoring the cost of capital allows them to sell for less, depressing prices (and therefore, ironically, the value of their land, too).  Poor economic choices in the Languedoc tilt the playing field against Paso Robles.

But the loudest cries I have heard in this regard are from Australia, not California, where vineyards that produce grapes for bulk wine find themselves more directly in competition with those economically untutored Languedoc vignerons. The low prices that result when French winegrowers ignore the cost of vineyard capital are not the only or even the biggest source of Australia’s current crisis, but they are certainly a contributing factor.

Indian Tariffs and Vino Exceptionalism

A recent book review and an article in today’s Financial Times provoke a short essay on wine exceptionalism.

Bad Samaratans

Choice magazine, a publication of the Americal Library Association, recently asked me to review a book called Bad Samaratans: The Myth of Free Trade and the Secret History of Capitalism by Ha-Joon Chang of the University of Cambridge.  I was happy to do this and gave the book a generally favorable review because the message is a useful one that I have written about in the past.

The advocates of hyper-globalization often tout totally free markets as the only way forward, but the “secret history of capitalism,” as Professor Chang calls it, is that there are plenty of examples of countries that only advanced when they adopted protective measures that gave domestic firms room to grow.  This lesson goes back as far as Alexander Hamilton in the United States, Friedrich List in Europe (and so is not really a secret) and lives today in the economic miracles of Japan and Korea. This  doesn’t mean that protectionism is always good, only that is is not always bad.  Life is complicated.  Deal with it.

I think this view is true in general, but is it also true about wine?  Or is there such a thing as wine exceptionalism?  An article in today’s Financial Times makes we wonder.

Indian Wine Tariffs

The article reports on a dispute between the European Union and India that is apparently headed to the World Trade Organization.  The issue is Indian wine tariffs.  India has tariffs on imported wine and high taxes on domestic products, which is perhaps not unexpected, given India’s low per capita income.  You might expect a country like India to impose high excise taxes on luxury goods as a way of funding needed government programs.  I imagine that wine is a luxury for most Indian households, so a high tariff would be a way of taxing the affluent to benefit the poor.  Wine consumption is very low in India (5 million liters per year, which is practically zero per capita, given India’s huge population) and the high tax is one reason for this.

But the India market is growing, expected to double in the next two years, so there is something at stake here.  More to the point, however, the Indian taxes are not for revenue only — some are intended to protect the nascent Indian wine industry.  That’s the rub.

WTO rules allow countries to have tariffs, but require that they satisfy a “national treatment” rule.  This means that, once foreign products have entered the country and paid the duty, they must be taxed and regulated just like domestic goods.  This is where India has run afoul of the WTO.

According to the Financial Times article, three Indian states, Goa, Maharashtra and Tamil Nadu, which represent important potential import wine markets, impose additional discriminatory domestic taxes on foreign wines, while exempting domestic wines to try to encourage the growth of the industry.    The FT reports that

India imposes customs duties of up to 150 per cent on bottled wines and spirits at the border. These are supposed to be equivalent to the excise duties paid by domestic producers.

But the EU says Maharashtra is imposing a special fee on imported wines and exempting local producers of wines and spirits from excise duty. Goa and Tamil Nadu are charging extra import fees while Tamil Nadu continues to operate restrictions on the sale of imports.

This is contrary to WTO rules, if the accusations are true, and hence bad trade policy. But is it good economic development policy?  That is, is it a good idea way to build the Indian wine sector? Or is wine different?

Vino Exceptionalism

I have to admit that my answer is, no!  I have studied a lot of countries that have chosen to try to protect their domestic wine industry from foreign competition and I am not aware of a single case — not one — where it was effective.  Captive markets (in wine if not more generally — sorry Prof. Chang) seem to breed what Albert O. Hirschman used to call “lazy monopolists.”  The wines they produce are easy money — made to appeal to a least common denominator market and quality products are neglected in a sort of tragedy of the vineyard commons.

Quality wine emerged only when competition was introduced.  This was true for Argentina, Canada, New Zealand, Washington State and now, I believe, in Languedoc in the South of France, although it is still too soon to tell how EU market reforms will work there.  If vino exceptionalism holds for India, then I suspect that their protective policies will not benefit them much.  Indian wine drinkers may thank the EU in the short run for its vigorous prosecution of WTO rules.  Indian wine producers may also thank them in the long run for forcing them to focus on quality in order to compete with imports.

The Fall and Rise of the British Wine Market

People are always surprised when I tell them that Great Britain is the most important import wine market in the world. How is this possible? Britain is so much smaller than the U.S. and the British are known to prefer beer and spirits to wine. How can they be an important wine market?

One part of the answer is that most countries that consume a lot of wine actually produce a lot, too, and so are not necessarily large net importers. This is obviously true of France, Italy and Spain and it’s even true of the United States. Countries that consume in large quantities but aren’t also major producers are rare. Britain’s wine production until recently has been tiny, so most wine is imported wine and that makes their market very important. British wine production is creeping up now, however, driven by global climate change. Rising temperatures are making it possible to produce good and even exceptional wines in Britain. It is said that some British sparkling wines already rival the best of Champagne.

A second piece of the puzzle was revealed to me recently in an excellent book by George Mason economics professor John V.C. Nye called War, Wine, and Taxes: The Political Economy of Anglo-French Trade, 1689-1900 (Princeton University Press, 2007). Professor Nye deals with many interesting topics in this book; I’m going to focus on the wine story here and not try to cover everything.

Britain was not always a beer and spirits culture. Wine was cheap and plentiful in Britain in the middle ages and Britain did in fact have its own vast vineyards for 300 years starting in 1152 because Bordeaux was British territory! The loss of those vineyards and then war with France caused Britain to turn away from French wines to those from Spain and Portugal and then, finally, from wine generally.

Faced with the need to generate war revenue, Britain imposed tariffs on wine imports. Significally, these were not excise tariffs (10% or 20% of value), but specific tariffs (x number of pence per bottle or gallon). Excise tariffs would have had an equal proportionate impact on wines of all prices, but specific tariffs introduced a bias against cheap wine. Suppose that the tariff is $10 per bottle, for example. The effect on a $100 bottle of imported wine is relatively small — the price rises by 10% and demand probably declines somewhat. The impact on a $5 bottle of wine is enormous, however. Its relative price rises prohibitively. Who will pay $15 for a $5 bottle of wine? Its market evaporates.

(Note: Transportation costs , which are more or less the same regardless of price, have something of this same effect. This helps explain why that cheap but lovely bottle of local wine you enjoyed in Provence never shows up on your grocers’ shelves here in the U.S.. By the time the transportation costs are paid it would no longer be cheap and you might not find it quite so lovely.)

The British drinks market was thus split in two. Elites continued to drink and collect fine red Bordeaux wines that they called “claret.” The masses switched from wine to now relatively less expensive beer. And Britain acquired its reputation as a beer drinking nation.

Professor Nye argues that British brewers were able to take advantage of technological innovations that allowed for large economies of scale in beer production. Once they had a near monopoly on the British drinks market, they could build huge factories to satisfy the captive demand at low production costs.

An interesting “invisible handshake” arrangement evolved, according to Nye, between the brewers and the revenue-hungry British state. The brewers permitted themselves to by taxed at fairly high rates in return for tariff protection from wine imports, which gave them a large captive market. The economies of scale in brewing were so significant as to make it profitable both for the brewers and for the taxman — so long as cheap wine was kept away.

Britain’s entry in to the Common Market combined with Margaret Thatcher’s later market reforms broke up this nice arrangement and established an environment where British wine demand could return. Britain was required to “harmonize” its wine tariffs with European partners, which removed the bias against popularly priced wines. And the market reforms allowed wine to be sold more widely and competitively, especially through supermarket chains. With wine available and at good prices, Britain’s thirst for the vine returned.

Thus did Britain, once the most important export wine market in the world, become so again because of the cost of war, the nature of specific tariffs, the economics of brewing, Britain’s entry into the Common Market and Mrs. Thatcher’s market reforms.