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Washington voters took a big step in yesterday’s election and approved an initiative, known as I-1183, to privatize state liquor sales.  Privatization of alcohol sales has been an issue I’ve tracked here at TOTM (see e.g., here).  Many states strictly regulate liquor sales through state ownership of liquor stores and required distribution through wholesalers.  These restrictions are frequently described as “wholesale monopoly laws” for that reason.  These distribution schemes have been in place since Prohibition ended in 1933, and wholesalers have effectively lobbied state legislatures to secure and maintain monopoly power over liquor distribution.  State laws were often promulgated with the stated purpose of reducing alcohol’s social harms; however, as James Cooper and I have found in recent research, the negative competitive effects of these laws mostly result in a wealth transfer from consumers to wholesalers with little or none in the way of  offsetting social benefits from reducing the harms associated with alcohol consumption.

Costco and other large retailers backed an initiative similar to I-1183 last year, but a coalition of citizens’ groups – funded by beer and wine wholesalers – were able to convince voters to defeat the initiative.  This year the players were the same, but the outcome was drastically different.  A Seattle Times article explains that this year’s:

“campaign was a battle of corporate interests, with Costco contributing the vast majority of the money for the pro-1183 campaign. . . . The coalition against I-1183 was financed mostly by wine and liquor distributors, who fear that liquor and wine deregulation in the measure will spread to other states.”

Costco contributed a record-breaking $22.5 million to the I-1183 campaign.  The article continues:

Tom Geiger, communication director for the union representing more than 700 workers in state-run liquor stores, said he thought the results raised questions about democracy itself.  “If a private company decides to spend tens of millions of dollars to pass a new law, to buy an election, can they do it?” Geiger asked. The results in this case, he said, suggest they can.

What an odd objection given the history of state alcohol regulation.  I guess the alternative would have been for Costco and other large retailers to influence a policy change by buying the legislature?  But wholesalers have a long history of superiority on that front.  It doesn’t seem too objectionable that, compared to rent-seeking legislation in favor of wholesalers at the expense of consumers, Costco and others took action in their own-self interest to influence citizens that these reforms would make them better off as well.

First, Google had the audacity to include a map in search queries suggesting a user wanted a map.  Consumers liked it.  Then came video.  Then, they came for the beer:

Google’s first attempt at brewing has resulted in a beer that taps ingredients from all across the globe. They teamed up with Delaware craft brewery Dogfish Head to make “URKontinent,” a Belgian Dubbel style beer with flavors from five different continents.

No word yet from the Google’s antitrust-wielding critics whether integration into beer will exclude rivals who vertical search engines who, without access to the beer, have no chance to compete.  Yes, there are specialized beer search sites if you must know (or local beer search).  Or small breweries who, because of Google’s market share in search, cannot compete against Dogfish Head’s newest product.  But before we start the new antitrust investigation, Google has offered some new facts to clarify matters:

Similarly, the project with Dogfish Head brewery was a Googler-driven project organized by a group of craftbrewery aficionados across the company. While our Googlers had fun advising on the creation of a beer recipe, we aren’t receiving any proceeds from the sale of the beer and we have no plans to enter the beer business.

Whew.  What a relief.  But, I’m sure the critics will be watching just in case to see if Dogfish Head jumps in the search rankings.  Donating time and energy to the creation of beer is really just a gateway to more serious exclusionary conduct, right?  And Section 5 of the FTC Act applies to incipient conduct in the beer market, clearly.  Or did the DOJ get beer-related Google activities in the clearance arrangement between the agencies?

Tomorrow, I’ll be presenting my work with James Cooper (FTC), State Regulation of Alcohol Distribution: The Effects of Post & Hold Laws on Output and Social Harms, at the DOJ Antitrust Division in the Economic Analysis Group Seminar.  We’ve received great critical feedback and suggestions for the paper thus far in earlier presentations and suspect that the DOJ economists will be no exception.  I’m looking forward to it.

I’ve mentioned the CARE Act previously (here and here).  On Wednesday, the House Committee on Courts and Competition held a hearing on the revised CARE Act – which would effectively immunize a host of anticompetitive state alcohol regulations from challenge.  The policy tradeoffs here are that the higher prices and reduced consumption associated with competitive restrictions in these markets might be offset by a reduction in the social harms associated with alcohol consumption (e.g. drunk driving, traffic fatalities, medical problems, etc.).  My work with James Cooper is an attempt to empirically identify the magnitude of these competitive and social harm effects concerning post and hold laws, a particular species of state alcohol regulation which provides incentives for alcohol wholesalers to collude and reduces the incentive for sales.  We observe that:

Economic theory would suggest that PH laws reduce unilateral incentives for distributors to reduce prices and may facilitate tacit or explicit collusion, both to the detriment of consumers. Consistent with economic theory, we show that the PH laws reduce consumption by 2-8 percent. We also test whether PH laws provide offsetting benefits in the form of reducing a range of social harms associated with alcohol consumption. We find no evidence of such offsetting benefits. Taken together these results suggest that PH laws are socially harmful and result only in a wealth transfer from marginal alcohol consumers, who are unlikely to exert externalities on society, to wholesalers. These results also suggest a socially beneficial role for antitrust challenges to PH laws and similar anticompetitive state regulation. If states wish to reduce the social ills associated with drinking, our results suggest that increasing taxes and directly targeting social harms are superior policy instruments to PH laws.

Our findings offer a significant reason to be skeptical of legislation such as the CARE Act (both before and after its recent revision).   Our analysis was cited several times during the hearings, including in the submissions by the Wine Institute, comments from the American Bar Association Antitrust Section, and while his written testimony is not available yet, also in Professor Elhauge’s remarks.  You can see the webcast here.  Whether one believes or results are sufficient to push the debate in one direction or another, it is nice to see some of the policy debate focus on evidence.

The paper is available for download here.

The political economy of alcohol regulation has always been fascinating.  But things took an interesting turn of late (HT: Marginal Revolution) when a beer industry trade group took a stand against a proposition that would legalize marijuana in California:

The California Beer & Beverage Distributors is spending money in the state to oppose a marijuana legalization proposition on the ballot in November, according to records filed with the California Secretary of State. The beer sellers are the first competitors of marijuana to officially enter the debate; backers of the initiative are closely watching liquor and wine dealers and the pharmaceutical industry to see if they enter the debate in the remaining weeks.

The story points out that Sierra Nevada and Stone Brewing Company (amongst others one presumes) do not support the actions of the California Beverage & Beer Distributors.   The politics are fascinating, with, for example, the Teamsters and teachers supporting legalization.  The linked story also recently updated with the following (in my view, pretty weak) defensive statement from the CBBD:

First and foremost, we are not opposed to the legalization of marijuana. We have no position on that…That’s for the voters to decide. Second of all, we do not think of [marijuana] as a competitive product in the marketplace,” she said. “That’s not the issue. Our issue is it’s a poorly written initiative. When prohibition was repealed, there was already a regulatory system in place to deal with the distribution or sale of alcohol. Under this initiative, there is not going to be anything in place state run. It’s going to be 500-some different counties and cities” involved in regulating the sale and distribution of marijuana.

So its the CBBD’s general interest in poorly worded initiatives?  Its not the fact that beer and marijuana are likely economic substitutes at the relevant margin that has their attention?  Really?

Economist and occasional TOTM guest blogger Steve Salop (Georgetown) recently sent me the following questions spurred by the local debate over Governor McConnell’s proposal to private the retailing of alcoholic beverages:

I have my first antitrust class of the semester tomorrow.  Among the issues I teach the first week are (1) the fact that demand curves slope down; (2) restrictions on competition tend to reduce output and consumer welfare; (3) state regulation is often used to restrict output.  While procrastinating from class preparation today, I read a Washington Post article about the controversy in Virginia over whether to privatize liquor stores.  The article quotes an epidemiologist who sounds like a closet economist: “If you make it easier to drink, people will drink more. … It’s as simple and basic as that.  This seemed like a great example to use for my class.  (Of course, it’s a little more complicated.  The epidemiologist also said, “And if people drink more, we have more alcohol-related problems.”  And, then he gave his statement, “it’s as simple and basic as that.” )  Okay, there are externalities, even in Virginia.  But, here is where I got confused.  The article refers to a study by George Mason economist Don Boudreaux who apparently did a study (available here) that showed that state privatization did not lead to more alcohol-related problems, at least not more alcohol-related deaths.

So, I have two questions: What should I tell my students about the basics of demand theory?, and the overarching benefits of antitrust over regulation?  Or, is this just one of those “politics trumps economics” arguments: the demand for limited government outweighs the law of downward-sloping demand.

Here a few thoughts.

First, its good to know that Steve and I teach the same things on the first day of antitrust class.  Things are apparently not too different, at least when it comes to antitrust class, on the other side of the Potomac.

Second, to frame the issues for readers, state-imposed restrictions on competition take many forms and are a common problem faced by antitrust authorities, they often involve “boards” appointed by the state granted authority to regulate particular industries, including the imposition of barriers to entry (recall Eric Helland’s post on the monks fighting against restrictions imposed by the Louisiana funeral industry board — indeed, I remember fondly my time at the Federal Trade Commission with the “Dirty Boards” team whose task was to identify these boards).  The economic welfare analysis for many of these restrictions in straightforward.  The restriction on competition reduces output, raises price, and reduces consumer welfare.  What makes the state restrictions on alcoholic beverages more interesting from an economic perspective is that there is at least a plausible claim to be made that reducing output will also reduce the external social costs associated with alcohol consumption, producing benefits that could potentially offset the negative consumer welfare effects.  The relative magnitudes of these effects is an empirical question.

Third, as Steve’s question observes, the obvious effect of privatization, lifting the competitive restriction, will be to increase output and reduce prices.  The law of demand is pretty easy to follow here.  But doesn’t the law of demand also imply that greater competition and reduced prices implies greater social costs in the form of more “problem drinking?”

On the margin, yes!  Why?  The state restrictions on retail competition as well as those at the wholesaler level, raise price to both marginal consumers with higher demand elasticities at current prices (a 1% increase in price will result in a decrease in consumption greater than 1%)  and infra-marginal drinkers with more inelastic demand at current prices (a 1% increase in price will result in a decrease in consumption less than 1%).  As Steve notes, the law of demand implies that unless the drinkers who create those social harms have perfectly inelastic demand, that is, there consumption is entirely invariant to changes in prices, there will be “some” effect on consumption from “problem drinkers,” and thus some positive effect in reducing external costs (see my earlier post on the CARE Act’s odd approach to burdens of proof regarding this issue).

But note that the source of externalities in this example come from a concentrated group.  As Cook and Moore (2002, p.122) note, “those in the top decile of the drinking distribution consume more than half of all ethanol. Since alcohol problems are also highly concentrated in this group, it seems reasonable to target alcohol-control policies at them.”  The impact of regulatory changes on alcohol consumption and behavior in this concentrated group should the margin focused upon for analysis of the magnitude of any “temperance” effect.

Fourth, as a sidenote, several studies have shown a negative relationship between alcohol prices (often measured by excise taxes) and socially harmful behavior. For example, Saffer & Grossman (1987) and Kenkel (1993) report negative relationships between alcohol prices and drunk-driving. Coate & Grossman (1988) find a negative relationship between price and self-reported underage drinking, but this result disappears when religion and other covariates are introduced. More recently, Markowitz & Grossman (1998) find a negative relationship between state beer excise taxes and domestic violence.  As Cooper and Wright point out in our paper, one potential reason for this seeming inconsistency between Boudreaux’s results (and the other results referred to in the article finding that deregulation increases consumption without increasing social harms, as well as our own results, discussed below) may be that earlier work on the relationship between alcohol prices and the harms we measure was based on samples from the 1970s and early 1980s and thus unable to include the effect of ZT and BAC08 laws. Consistent with more recent research [e.g., Carpenter (2004); Dee (2001)], it appears that ZT and BAC08 laws are important sources of reductions in drunk-driving and teen drinking. Specifically, our results suggest that ZT and BAC08 laws reduce alcohol-related accidents by 7-8% and 4-5%, respectively.

But there is no reason to believe that this reduction will be large, much less large enough to offset the welfare losses imposed on consumers in the form of higher prices and reduced output.  That is an empirical question.

Fifth, the studies finding that reductions in output associated with state-imposed restrictions on competition are not necessarily correlated with significant reductions in the social ills associated with problem drinking (alcohol-related deaths, DUIs, etc.) are consistent with what Cooper and Wright find in our recently study of state post and hold laws.  The post and hold laws operate at the wholesale level, but are also restrictions on competition, making price competition between wholesalers more expensive by prohibiting short-term price reductions, and of course, facilitating collusion by requiring that wholesalers share future price information with rivals in advance.  To review, we find that post and hold laws result in significant reductions in output — representing consumer welfare losses — without any statistically or practically relevant reduction in measures of alcohol-related social costs.  The lack of measurable effect may be because the reduction in consumption is relatively small, leading to only small behavioral changes for those in the top of the alcohol consumption distribution.

So — I’ve written a lot and am not sure I’ve answered Steve’s original question.  What should he tell his antitrust class about demand theory, antitrust vs. regulation, and political economy of privatization in light of the Virginia ABC example?  Here’s a few answers:

1. The Virginia ABC example does nothing to change the bottom line: (1) the law of demand lives on, (2) restrictions on competition reduce output and raise price and reduce consumer welfare, and (3) states frequently restrict competition with the predicted consequences — I might add the Demsetzian point that these state imposed restrictions are the toughest to get rid of, even for antitrust.

2. Calculating the impact of a regulatory change on consumer welfare can be tough.  Here, I think highlighting the tradeoff between welfare reductions of the conventional antitrust sort and reducing negative externalities would be a very useful exercise for the class.   On the theoretical end, I think it requires the distinction between marginal and infra-marginal consumers that is tool antitrust lawyers should have in their toolkit (price discrimination, market definition, vertical restraints, etc.).  While predicting the output effects are straightforward, the welfare analysis is a bit more complicated in economic terms.

3. For antitrust lawyers, it is worth thinking about how to convince a generalist judge about the relevant economics in this setting.   Having students understand the complexities and learn to simultaneously teach, translate and persuade the court of the relevant economic and empirical analysis is something we should be encouraging the students to think about on day one.

4. I can’t think of any great examples for the demand for limited government trumping the law of demand, but the persistence of the state alcohol monopolies despite their negative economic consequences on consumers gives a wonderful opportunity to talk about cartel formation and stability, as well as the political economy of these laws more generally.  For politics trumping economics more generally, see “Rent Control” or the proposed antitrust exemption for newspapers.

In an earlier post on the CARE Act, I highlighted the fact that the law would essentially immunize state laws regulating the distribution and sale of beer, wine and liquor wholesalers from challenge under the Commerce clause and the Sherman Act.  For more details on the CARE Act, see the earlier post, but the bottom line is that the CARE Act will put an end to successful challenges to anticompetitive state regulation protecting alcohol wholesalers such as the Costco v. Maleng or Granholm v. Heald.  In this post, I want to focus on a recent empirical research project that I undertook with FTC lawyer and economist James Cooper evaluating both the competitive effects and social harms from these state regulations of alcohol distribution.   For those who want to skip the background and get straight to the paper, here is the SSRN link to “State Regulation of Alcohol Distribution: The Effects of Post and Hold Laws on Output and Social Harms.”  The paper has also been released as part of the FTC Bureau of Economics working paper series.

But first, I want to set the table a little bit with a bit of background that motivated our research and then turn to discussing our results and their implications for the current CARE Act debate.

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The Comprehensive Alcohol Regulatory Effectiveness Act — yes, the “CARE Act” — or HR 5034, is a piece of legislation aimed at supporting “State-based alcohol regulation.”  Recall the Supreme Court’s decision in Granholm v. Heald, which held that states could either allow in-state and out-of-state retailers to directly ship wine to consumers or could prohibit it for both, but couldn’t ban direct shipment only for out-of-state sellers while allowing in for in-state sellers.  Most states thus far have opened up direct shipping laws to the benefit of consumers.    While we occasionally criticize the Federal Trade Commission from time to time here at TOTM, its own research demonstrating that state regulation banning direct shipment and e-commerce harmed consumers is an excellent example of the potential for competition research and development impacting regulatory debates.  Indeed, Justice Kennedy’s majority opinion in Granholm cites the FTC study (not to mention co-blogger Mike Sykuta’s work here) a number of times.  But in addition to direct shipment laws, there are a whole host of state laws regulating the sale and distribution of alcohol.  Some of them have obviously pernicious competitive consequences for consumers as well as producers.  The beneficiaries are the wholesalers who have successfully lobbied for the protection of the state.  Fundamentally, the CARE Act aims to place these laws beyond the reach of any challenge under the Commerce Clause as per Granholm, the Sherman Act, or any other federal legislation.  Whether the CARE Act has any ancillary social benefits is an important empirical question — but you can bet that the first-order effect of the law, if it were to go into effect, would be to increase beer, wine and liquor prices.  More on the CARE Act and state regulation of alcoholic beverages below the fold.

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