July 14, 2008 by by Michael Veseth (University of Puget Sound and The Wine Economist)

Adam Smith is generally regarded as the Father of Economics, even though many wrote on economic topics before him. Was he also the Father of Wine Economics? 

The case for Smith’s paternity is made in the most obvious (and least likely) of places, The Wealth of Nation (1776), his most famous work. It is the obvious source because Smith wrote about everything in Wealth of Nations: history, theory, policy, even provided practical advice. It is the least likely place to look, however, because it is so little read (really read, if you know what I mean) and because people only remember the book for two thing: the Invisible Hand and the Pin Factory example of the division of labor. But there is a lot more to be found, including an early treatise on wine economics.

Adam Smith wrote a good deal about wine. This was partly because he traveled in France and learned about wine markets first hand. But it was also a fact that Britain was for centuries a wine-drinking country, as John Nye’s fine book explains, just as it is so today, with a practical interest in wine market concerns.

The foundation of Smith’s wine economics is laid out early in Wealth of Nations, Book One, Chapter 11: Of the Rent of Land. Here Smith tries to explain why some kinds of land earn more than other lands. Land suitable for viticulture earns higher rent, Smith said, and has long done so.

That the vineyard, when properly planted and brought to perfection, was the most valuable part of the farm, seems to have been an undoubted maxim in the ancient agriculture as it is in the modern through all the wine countries

But viticultural profits were constantly threatened, Smith argued. Not by nature, although this could cause bad crops, and not by high taxes, although he argued against them. The chief threat (or perceived threat) to viticultural earnings was expansion to new lands. Old vineyards, as he called them, were threatened by New Vineyards — and would seek protection from them or to prevent their development. This section reads very well today if you change Old Vineyards to Old World wine and New Vineyards to New World Wine. Certainly New World Wines (and their vineyard, cellar and marketing practices) are seen by many Old World producers as a threat to their livelihood. Adam Smith understood why Old would seek by any means to prevent development of the New. You don’t have to have a Ph.D. in economics to already know that he did not approve.

Smith wrote about terroir, too. I can’t really say that Adam Smith invented terroir, the idea of a special taste of place that winemakers strive for, but I can say that he understood its economic value. Smith wrote that

The vine is more affected by the difference in soils than any other fruit tree. From some it derives a flavour which no culture or management can equal, it is supposed, upon any other. This flavour, real or imaginary, is sometimes peculiar to the produce of a few vineyards; sometimes it extends through the greater part of a small district and sometimes through a considerable part of a large province.

I note with interest that Smith recognized terroir and doubted the reality of its existence in the same sentence (”real or imagined”). It isn’t terroir that really matters to a wine economist, I suppose, it is only that people think there is terroir. Smith wrote at length about the economics of these special wines and, because of their limited quantities, the premium prices they could command. Any modern winemaker, upon reading this section, would immediately try to create an A.V.A. to cash in on the possibility of terroir by limiting supply.

The whole quantity of such wines that is brought to market falls short of the effectual demand, or the demand of those who would be willing to pay … The whole quantity, therefore, can be disposed of to those who are willing to pay more, which necessarily raises the price above that of common wine.

A small part of this higher price … is sufficient to pay the wages of the extraordinary wages bestowed upon their cultivation, and the profits of the extraordinary stock which puts this labor in motion.

Smith’s treatment of wine is not complete - there is no discussion of cork versus screw-cap, for example, and no treatment of en primeur wine futures, but what he does say shows pretty clearly how well he understood the political economy of wine.

So, to answer the question that started this entry, is Adam Smith the Father of Wine Economics? Probably not, is my answer. His analysis in Wealth of Nations is certainly very good, but I am pretty sure that earlier economists did not ignore the wine market. The reason: because wine was so very important to economy and society from the earliest days.

July 10, 2008, by  Karl Storchmann (Journal of Wine Economics)

The impact of weather on wine quality has been well documented for thousands of years. However, not until recently have economists approached this phenomenon quantitatively. As documented by Orley Ashenfelter (see our article about Judging Bordeaux Vintages: Intuition and Super Crunching), warm and dry weather in the Bordeaux region can produce a wine that is substantially more expensive than a wine from a wet and cold vintage. In regions that are already at the temperature optimum the relationship may be the other way 'round.

At least on paper, the step from weather to climate is a small one. For the last 6-8 years, there has been is a growing body of literature on the relationship between viticulture and global warming. Some of these papers assess the economic impact on wine and vineyard prices. (see, for instance, "Go North Young Grapes" in SLATE) others evaluate the impact of global warming on wine quality (e.g., this article in the journal 'Climatic Change').

 

Last year, Greg Jones, a climatologist at Southern Oregon University, and collaborators published a widely noticed paper in the Proceedings of the National Academy of Science PNAS (click here for the paper). They predict that increases in the frequency of extreme hot days (>35°C) during the growing season will eliminate winegrape production in many areas of the United States, including parts of the Napa Valley. Grape and wine production will likely be restricted to a narrow West Coast region and the Northwest and Northeast, areas currently facing challenges related to excess moisture.

 

At the Annual Conference of the America Association of Wine Economists in Portland (Aug 14-16) Greg Jones (together with Gregory Goodrich of Western Kentucky University) will present a paper that evaluates the causes of longer growing seasons, less year-to-year variability and fewer frost days on the U.S. West Coast. Is really global warming the sole driving force or are these effects caused by periodical phenomena such as El Niño–Southern Oscillation (ENSO) and the Pacific Decadal Oscillation (PDO)?

 

The result: The currently experienced longer growing seasons and small year-to-year variability is the result of a combined effect of both a general temperature increases and periodical effects. When the PDO returns to a multi-decadal cold phase, wine growers across the western USA will likely experience greater variability in wine quality.

 

Here is their abstract:

Trends in climate variables important to winegrape production in the western United States include fewer frost days, longer growing seasons, and higher spring and growing season temperatures. These trends have been related to a steady increase in wine quality and a decrease in year-to-year variability. While the trends in climate have been linked to increasing sea surface temperatures in the eastern Pacific, it is unknown whether this is caused by climate change or may be part of natural oscillations in the Pacific. In this study, 15 climate variables important to winegrape production were analyzed for 10 wine regions over the western USA. The variables were stratified by phases of the El Niño–Southern Oscillation (ENSO) and the Pacific Decadal Oscillation (PDO), both separately and then in combination (modulation effect) to determine if there are any significant differences between teleconnections. ‘Wine Spectator’ vintage ratings for Cabernet Sauvignon wines from the Napa Valley were also stratified by the same method, and multivariate statistics were used to determine which variables are most important to wine quality.

 

ENSO phase by itself was not found to be important to either climate variability in wine regions in the western USA or wine quality in Napa Valley, but the cold phase of the PDO was found to be associated with increased spring frosts and a shorter growing season that results in lower ratings relative to warm PDO. The combination of neutral ENSO conditions during the cold phase of the PDO was nearly always associated with low quality wine in the Napa Valley, which is a function of cold springs with increased frost risk, cool growing seasons, and ripening period rainfall (cold PDO), and above-average bloom and summer rainfall (neutral ENSO). Although climate trends toward generally warmer growing seasons with less frost risk have occurred, this research highlights the impact of climate variability on wine quality where, should the PDO return to a multi-decadal cold phase, wine growers in the Napa Valley and across the western USA will likely experience greater variability in wine quality.

 

Evidence of these conditions have occurred during the 2007-08 winter and into spring 2008 where a much colder and wetter than normal winter in the PNW and northern California has been seen. A lingering moderate to strong La Niña event in the tropical Pacific has been boosted by the influence of the larger cold phase of the PDO in the North Pacific. The result has been higher snow packs throughout most of Washington, Oregon, and northern California and anywhere from a one to four week delayed bud break or bloom (grapevines and orchard fruit, respectively) followed by an increased frequency of frost. During the third week of April 2008, some of coldest conditions since the mid 1970s caused widespread damage to everything from cherries, peaches, pears, apples, to winegrapes. As of April 24^th winegrape growers in Sonoma and Napa had already estimated a 10-25% yield loss due to frost and are still waiting for spring to come.

June 30, 2008, by  Karl Storchmann (Journal of Wine Economics)


Wine economics increasingly establishes itself as a distinct economic discipline. Recently, "The Economic Journal" published a series of wine-related articles. Needless to say that all articles are by editors or board members of the "Journal of Wine Economics"




Richard Baldwin Professor of International Economics at the Graduate Institute in Geneva, CEPR Policy Director, and VoxEU.org Editor-in-Chief summarizes the articles as follows:

"Why do economists have to take the fun out of everything?

Wine lovers worldwide enjoy discussing the finer points of terroir; Saint-Estèphe is harder than Pauillac, as every connoisseur recognises. It’s the heavier, thicker soils, don’t you know?

All bunk, according to recent research by Olivier Gergaud and Victor Ginsburgh. Using a database on terroir characteristics such as land characteristics (exposures of vineyards) and techniques (grape varieties, picking method, bottling, etc.) in 100 vineyards combined with data on measures of quality (ratings and auction prices), they show that endowments don’t matter. It’s technology. The French marketing myth of terroir won’t die easily, but the smart money should ignore it.

Publishing in the same issue of The Economic Journal, the dean of terroir debunkers – Orley Ashenfelter – studies the prices of Bordeaux vintages. Older Bordeaux taste better so the same wine is sold twice; when it’s young en primeur and when it’s ready for decanting.

In a sober market, the wine’s en-primeur price should be an unbiased predictor of its ready-to-drink price. Not so. The quality and prices of vintage Bordeaux is predicted by the weather that created the grapes, but this easily measured determinant is ignored by purchasers at the en primeur auctions. Instead, the prices paid by early buyers are influenced by tasting results, especially the ratings of Robert Parker.

Smart money ignores Parker. Get a weather report for the vintage year and a copy of Ashenfelter’s ‘Predicting the Quality and Prices of Bordeaux Wine'.

Fine advice if you’re aiming for value-for-money in your cellar. Making money requires a different approach. Predicting a beauty contest winner is not, as Keynes famously opined, a matter of judging beauty but rather judging the judges judgment on beauty. When it comes to Bordeaux, the judge-in-chief is Robert Parker.

Michael Visser and colleagues estimated the Parker effect on en primeur prices using a clever quirk. For years, Parker has come to Bordeaux to taste and grade the wine when it is extremely young. Statistically, his grades have a huge impact on prices. But in 2003, it didn’t work. Fearing war in Iraq, Robert stayed home in the Spring of 2003 and his grades were published only after the determination of the en primeur prices. Using the 2002 and 2003 en primeur prices for approximately 250 wines from a large Bordeaux wine broker, they estimate the Parker effect. About 2.80 euros per bottle."

This article was published by VoxEU.org on June 28 at www.voxeu.org/index.php?q=node/1274

June 25, 2008, by Michael Veseth (University of Puget Sound and The Wine Economist)


You know that wine economics has become mainstream when you find yourself listening to it on the car radio.

June 20, 2008, by Robin Goldstein (fearlesscritic.com) and Johan Almenberg (Stockholm School of Economics)


Suppose good X is similar to good Y, but has a considerably higher price tag. Most of us would probably expect good X to be slightly better than good Y along some dimension. Such an expectation would not imply that we would always purchase good X: the difference in how much we appreciate the two goods may be small, and not worth the increased expense. The point is simply that it seems reasonable to expect there to be some noticeable additional quality to the more expensive good.

 

In the forthcoming issue of the Journal of Wine Economics, we present our study “Do More Expensive Wines Taste Better? Evidence from a Large Sample of Blind Tastings” (joint work with A. Dreber, J. W. Emerson, A. Herschkowitsch, and J. Katz). Our main finding is that participants in blind tastings do not appreciate expensive wines more than cheap wines. In our sample of over 6,000 blind tasting observations, compiled by food and wine critic Robin Goldstein and discussed at length in his new book, The Wine Trials (Fearless Critic Media, 2008), we find that the correlation between price and overall rating is in fact small and negative, suggesting that individuals on average enjoy more expensive wines slightly less.

 
There is no reason to expect individuals with a great deal of experience of drinking wine to be similar to individuals with little experience in this regard. Using wine training (such as participation in a sommelier course) as a proxy for wine expertise, we were able to separate these “experts” from the rest of the tasters in the sample. We find indications of a small positive correlation for experts. This correlation is only marginally significant (the p-value is just below 0.10, despite the large sample size) and the coefficient is quite small, suggesting that even for expert tasters the correlation between price and subjective appreciation is less than overwhelming.

In both cases, the coefficients are of a moderate magnitude, but non-negligible, given that wine prices cover such a large range. Suppose that Wine X costs ten times more then Wine Y in dollar terms. In terms of a 100-point scale, such as that used by Wine Spectator, our estimates predict that non-experts will assign an overall rating that is four points lower for wine X, whereas experts will assign an overall rating that is seven points higher.

Why, then, do everyday wine drinkers spend money on expensive wines? The price tag itself may influence how much we appreciate the good. This is in line with a familiar finding in marketing research: increasing the price of a good sometimes increases the demand for the good for psychological reasons alone (see for example Cialdini, 1998), by signaling that the good is covetable. Goldstein explores this effect in The Wine Trials, which examines the methods of modern wine marketing, the undue deference of consumers toward numerical ratings in industry publications such as Wine Spectator, and the inconsistencies between controlled blind-tasting results and those sorts of ratings, which exhibit a strong positive correlation with price.

In a sense, our paper is a companion piece to Plassmann et al. (2008), in which experimental subjects reported higher levels of satisfaction from wine they were told was more expensive, even when it wasn’t; functional magnetic resonance imaging suggested that their brains responded differently to the taste experience itself. While Plassmann et al. seek to isolate the effect of contextual information (about price) on the experience of the wine, we seek to remove all contextual information (about price, producer, country of origin, varietal etc) and look at the subjective appreciation of the wine itself.

 
References:

Cialdini, R B (1998) Influence: The Psychology of Persuasion. New York: Collins.

Goldstein, R. (2008). The Wine Trials. Austin: Fearless Critic Media.

Plassmann, H, J O’Doherty, B Shiv and A Rangel (2008). Marketing Actions Can Modulate Neural Representations of Experienced Pleasantness. Proceedings of the National Academy of Sciences 105(3): 1050-1054.

June 16, 2008, by Michael Veseth (University of Puget Sound and The Wine Economist)

June 12, 2008, by Omer Gokcecus, Seton Hall University (gokcekom@shu.edu)

Increasingly wines arrive in the American wine market from all over the world. Accomplishments such as being on the Wine Spectator’s yearly best 100 wines for vintages from places such as Argentina or South Africa would not have been possible fifteen years ago.  Yet the market continues to expand with wine produced in more and more countries around the world.  The American wine market is one of the most open in the world. The result is that the American wine drinker has increasingly diverse options in their wine choice.  Yet, with all this diversity, is the American consumer benefiting through cheaper and better quality wines? 

To answer this question, my graduate student, Andrew Fargnoli and I wrote an article in the Journal of Wine Economics, (December 2007: 2(2), pp. 187-195), “Is Globalization Good for Wine Drinkers in the United States?” where we analyzed changes in price, quality, and variety of wines available to consumers since 1988. We focused on these three dimensions because it is sensible to think that wine drinkers will be better off with lower prices, higher quality, and greater variety.

To determine the nature of the changes in wine price, quality and variety, we examined the Wine Spectator’s Top 100 list which has been published every year since 1988.  If average American wine drinkers were each year to go out and buy the top 100 wines, would they pay less money, have better quality and more variety in national origin in 2005 than in 1988?  Each year the Wine Spectator uses the same four factors to determine the list. They are taste, availability, price, and the x-factor, which takes into account how significant the wine’s achievement for that year has been.  These factors exclude the very expensive, the very rare and boutique wines and allows our study to concentrate on the so-called “average” American wine drinker. 

Our findings show that globalization has benefited the American wine drinker. We find that there is an overall decrease in the real price of a shopping cart of all 100 wines from year to year. For instance, the real price (in 1988 prices) for the basket of the entire Top 100 list was $4,313 in 1988; $3,132 in 1993; $2,533 in 1999; and $2,421 in 2004.  That is nearly a 44% decrease in prices from 1988 to 2004.  At the same time, there was no significant change in the quality of the wines on the Top 100 list. From 1988 to 2005, average score did fluctuate within a range of 1.66 points—the difference between highest average score 93.61 (in 1988) and the lowest average score 91.95 (in 1996).  But as a whole these fluctuations in quality can be tacked up to chance and are not significant.

In terms of variety, the number of countries appearing on the Top 100 lists over the 18 years represented in this study increases, from six countries in 1988 to a total of eleven countries in 2005.  In 1988, only six countries—namely France, Italy, Spain, U.S., New Zealand, and Lebanon (the latter two each with only one wine)—are represented. In 2005, the number of countries nearly doubles to eleven.

Our econometric analyses show that the decreasing wine price over the past 17 years can be explained by the loss of shares of the Old World countries: Replacing a French wine with a U.S. wine lowers the average real price by 1.0%; an Australian wine by 1.1%; and a wine from non-incumbent countries by 1.5%. To put it differently, replacing an Old World wine (French, Italian, etc.) with a New World  wine (US, Australia etc.) lowers the average real price by 1%.  Replacing an Old World wine with a New-New World wine (Chile, South Africa etc.) lowers the average real price by 2.5%. The increased presence of newcomers puts significant downward pressure on prices.

Thanks to globalization, the world of wine is filled with greater variety, the same level of quality and, at least for the wine drinker in the United States, it is also a more affordable one.

This Table provides you with a data summary of the paper!

[This article was published in the June 2008 Issue of Wine Business Monthly]

June 10, 2008, by  Karl Storchmann (Journal of Wine Economics)

For many reasons economists are intrigued by organic and biodynamic wines.  One of the many interesting questions is: Do organic wines command a price premium? And if yes, how high is it?

In general, producing organic produce is significantly more expensive than producing regular produce. Assuming the same crop yields per acre the per ton production cost of organic almonds is about 18% higher than for conventional ones. For broccoli this is about 15%. The cost studies of UC Davis are an excellent source for any kind of crop including grapes. http://coststudies.ucdavis.edu

Below I copied the 2004 cost tables for organic and conventional Chardonnay grapes grown in Sonoma county. (Both Chardonnay reports and many other reports can be downloaded from coststudies.ucdavis.edu)

Assuming a crop yield of 5 tons per acre, conventional grapes cost approximately $2,477 per ton. For the same specific yield, organic grapes cost $2,791 – a difference of almost 13%. However, assuming that per acre yields of organic fruit are normally lower this difference is likely to be much higher. If the organic vineyard yields only 3 tons per acre the cost will shoot above $4500 per ton, i.e., about 80% higher than for conventional grapes.

Conventional Chardonnay (Sonoma County, 2004)

Organic Chardonnay (Sonoma County, 2004)

As a result, organic winegrape growers need to command significantly higher prices to break even. This can easily be seen from the tables that report the respective net returns dependent on prices and crop yields. Even if the organic winegrape grower had the same yield per acre as his conventional counterpart (which he probably does not) he needs a substantial premium to survive.

Conventional Chardonnay (Sonoma County, 2004)

Organic Chardonnay (Sonoma County, 2004)

What does all that mean for organic wine?  The logical consequence must be: organic wine should be substantially more expensive than conventional wine.

 
Magali Delmas of UCLA’s Institute of the Environment and Laura Grant of UC Santa Barbara assessed the “price premium” for organic wines in the U.S. We published a first version of their research as an AAWE Working paper (AAWE Working Paper No. 13) which is downloadable from our website.

Their main finding is a “price paradox for organic wines.” Most wine makers distinguish between certifying their wine as organic and putting it on the label. While the organic certification raises the price by about 13% (probably driven by better quality) putting the eco-label on the bottle will more than offset the price gain and lead to a net loss.

Both will present their research at the AAWE Meetings in Portland (Magali Delmas will also talk about biodynamic wines, but that is a different story).

Here is their abstract:

Eco-labeling signals that a product has been eco-certified. While there is increasing use of eco-labeling practices, there is still little understanding of the conditions under which eco-labels can command price premiums. In this paper, we argue that the certification of environmental practices by a third party should be analyzed as a strategy distinct from although related to the advertisement of the eco-certification through a label posted on the product. By assessing eco-labeling and eco-certification strategies separately, we are able to identify benefits associated with the certification process independently from those associated with the actual label. More specifically, we argue in the context of the wine industry that eco-certification can provide benefits, such as improved reputation in the industry or increased product quality, which can lead to a price premium without the need to use the eco-label. We estimate this price premium of wine due to the eco-certification of grapes using 13,400 observations of wine price, quality rating, varietals, vintage, and number of bottles produced, for the period 1998-2005. Overall, certifying wine increases the price by 13%, yet including an eco-label reduces the price by 20%. This result confirms the negative connotation associated by consumers with organic wine. The price premium of this luxury good due to certification acts independently from its label, a confounding result not previously demonstrated by related literature.

June 4, 2008, by Michael Veseth (University of Puget Sound and The Wine Economist)