The CARE Act and State Regulation of Alcohol Distribution: The Competitive and Social Effects of Post and Hold Laws

Josh Wright —  12 August 2010

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.

Economic analysis and existing empirical evidence tells us that many of these state laws are likely to have anticompetitve effects in terms of raising prices and reducing output for wine, beer and liquor consumers.  These state laws range from a “three-tier” system that restricts vertical integration, to limits on direct shipment, to mandating exclusive territories or “just cause” laws that restrict the ability of a producer to terminate a wholesaler.

These state laws also include lesser known “Post and Hold” laws.  PH laws require that alcohol distributors (wholesalers) share future prices with rivals by “posting” then in advance, and then “hold” these prices for a specified period of time.  The PH requirements have at least two pernicious effects on consumers.  The first is to facilitate collusion between wholesalers by mandating the sharing of future prices.  The second is that the “hold” requirement decreases incentives to reduce price, experiment with temporary sales, as well as reducing the ability to adjust prices to reflect changing supply and demand conditions.

As I wrote:

An exemption for beer and wine wholesalers simply doesn’t make sense on competition policy grounds unless it can be shown that the social harms associated with reduced consumer welfare caused by higher prices and reduced output is more than offset by gains from “promoting temperance.”A serious cost-benefit analysis of state regulations of the alcoholic beverage industry raises empirical questions concerning these tradeoffs.  We know that consumers are harmed from higher prices and reduced output.  But it is possible that those effects are dominated by benefits associated with reduced consumption leading to reduced social harms.  The CARE Act legislates away an rigorous attempt to deal with these tradeoffs, and bets consumer dollars in the process, by assuming that the reduction in alcohol consumption is “always worth it.”   But there is little empirical evidence that many of these state restrictions are associated with social benefits.

I promised in the earlier post that I’d share some of my recent empirical research on this question. And I’ve recently posted “State Regulation of Alcohol Distribution: The Effects of Post and Hold Laws on Output and Social Harms.”  It is co-authored with FTC lawyer and economist James Cooper.

Cooper and I make an attempt to carry out the empirical analysis suggested above, that is, assess both the competitive effects and social harms created by a state alcohol regulation.  In our case, we focus on post and hold laws.  What we find on the competitive effects side is fairly straightforward: the post and hold laws have the predicted effect, i.e. they reduce consumption by 2-8 percent.  This represents a loss in consumer welfare.  The real empirical question is whether the post and hold laws offer any offsetting benefits in terms of promoting “temperance” and reducing the social ills associated with drinking.  One might think that the reduction in consumption implies a necessary reduction in social harms.  But that need not be the case if the reduction in consumption comes largely from “marginal” consumers rather than “infra-marginal” consumers with more inelastic demand for alcohol.

To preview, that is exactly what we find.  Here’s the abstract:

The Twenty-first Amendment repealed prohibition, but granted the states broad power to regulate the distribution and sale of alcohol to consumers within their borders. Pursuant to this authority, states have established a complex web of regulations that limit the ability of beer, wine, and liquor producers to control the distribution of their product. From a consumer welfare perspective, one of the most potentially harmful state alcohol distribution regulations are “post and hold” laws (“PH laws”). PH laws require that alcohol distributors share future prices with rivals by “posting” them in advance, and then “hold” these prices for a specified period of time. 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.

Check out the paper.  We hope that it contributes some much needed empirical evidence to the policy debates surrounding the regulation of alcohol and questions about the costs of antitrust exemptions and the relative value of antitrust to exemptions in such a setting.

Comments welcome.

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