Craft Beer Explosion in a Mature Dull Beer Market

Regular readers of New Zealand economic blogs don't have to go very far to be convinced of the attraction between Economists and beer, as the number of post on Eric Crampton and Seamus Hogan's blog Offsetting Behaviour website can attest.

Besides the obvious, what makes beer so interesting is the extraordinary proliferation of new and diverse craft beers that has occurred in recent years.  Despite the beer market being what economists would describe as "mature" and a "low volume growth" market, recent years have seen a plethora of new entrants trying their hand at commercial success making and selling beer.  In fact just down the road from me in Silverstream, Upper Hutt, is Kereru Brewing (big ups to Chris!  Like your beer mate!) who has just moved to bigger premises.

Kereru isn't alone in its journey from being a "S(sss)" to becoming more a "SM(aaa)", part of the long journey to "SME(eee)". In recent years, along that road has travelled:

• Emersons
• Yeastie Boys
• Garage Project
• Three Boys
• Moa (ok, with floating on the sharemarket, Moa makes full-blow SME..)
• Tuatara
• Renaissance   

And that's just off the top of my head in less than 10 seconds. In 2006, the Brewers Guild of New Zealand was founded.  Here's the members, and it reads like a who's-who of craft brewing.  

Sadly, I'm old enough to remember a New Zealand who's drinking pallets were dominated by the limited offerings of New Zealand's largest breweries: Lion Nathan and Dominion Breweries.  Together, those giants sewed up New Zealand's bars and pubs with agreements which ensured only their mediocre beers would be sold: the practice of "buying taps". 

The anti-competitive issues with those arrangements (which are coming back unfortunately) are not the subject of this blog (although they will be soon).   Instead, what I find interesting, from an economics perspective, is why, in what can only be characterised as a mature low/no growth market, there has been this prodigious growth of craft beers.  

Unlike the market for smart phones, or even social networking connectivity, beer brewing in New Zealand is as old as New Zealand itself. The rapid customer uptake of new i-phones, computer tablets, or the rush of new sign up's to Facebook, are what typifies "growth" markets that attract a rush of new markets like some modern day gold rush.  Each and every one of the recent craft beer makers has put their money where their mouth is and banked on making a dollar from a market dominated by large players in a product hardly considered new.


From the outside of the market looking in, the history of New Zealand's brewing demand doesn't looks like something which should attract these beer entrepreneurs into it.

Figure 1:  Total Beer Available for Consumption:  1984 - 2012

New Zealand's demand for beer is characterised by long run falling beer volumes. Beer volumes have been declined an average 1.1% per year over the duration of Statistics New Zealand's information. Per capita rates of beer available for consumption have approximately halved  over the same time.

However, here's something that collectively entrepreneurs may have sniffed out... Beer prices, over the long run have been steadily sneeking up.  From a low comparative price level base in 1983, consumer beer prices have been increasing fastest than general rates of consumer price inflation (Figure 2).  Beer price to general price "relativities" having been increasing in beer's favour.

Figure 2:  Consumer Price Index - All Group Consumer Prices and CPI Level 3 (Beer) Prices

So, from figure 2, beer prices have over a long period of time been increasing, relative to the price of all over household expenditure commodities.  And in response, the volume of beer consumed has been falling (figure 1).  That's the Law of Demand:  as relative price increases, demand declines.  If the large breweries set the market price for beer, then increasing it faster than the rate of general inflation has had the effect of dampening down the demand for their beer.  From figure 3, the decrease has occurred in the lower alcohol level beers.  As the price of beer in general is becoming more expensive, consumers are shifting to the comparably higher quality/alcohol beers.

But why have craft breweries entered such a market of falling quantities and increasing relative prices now? Given the 30 year history, what's been the trigger point?  What's the smoking gun?  What's the reason why dozens of entreprenuers have taken the punt?

Well - and this is me out in a limb here - but did you seen the Kereru equipment in the background here? And the Garage Project equipment in the foreground here?  Well, it looks a lot like one of these.  And from and economics point of view, THAT looks a LOT like technical progress lowering the fixed costs of micro brewing production. 

If profit is the difference between total beer revenue and total cost of production, then on the total cost of production side of the profit equation, Farra Engineer's  equipment has lowered the total cost of production through lowering the fixed set up costs of entry.  On the total beer revenue side of the profit equation, the dominant brewers have been sneeking up beer prices over time increasing the revenue of beer production.  That's provided the pricing margins for micro-brewers to test the waters with different types of beers despite the higher per unit costs of production associated with their lower volume throughput.

The trigger point probably may have been in 2009, where from figure 2, relative beer to general consumer prices took off AND sometime around then, Farra Enginneering's equipment lowered entry costs (I'm guessing about the time they released 50SBB personal brewer)?

Given most craft beers exceed 5.0% alcohol,  I'm really looking forward to see how this graph changes over the next few years:

Figure 3:  Beer Available for Consumption by Alcohol Strength

Because, despite the fact beer is an "old" market, as a consumer I want choice and variety in what is available to drink.  If lowering the cost of beer production has generated a whiff of profit in the noses of micro-brewers and created the opportunity for them to experiment with the demand for non-lagers or non-India Pale Ales, then I'm as every bit interested in giving them a go as I am in downloading the last app of Grumpy Birds for my smart phone.

And THAT untapped consumer market for non-traditional beers which retail for comparable prices as stock-standard run-of-the-mill lagers is what drives the growth in craft beer, and makes Jamesie a very happy Economist.

Networked Societies and Growth in Cities

I am currently training for the Graperide so have started putting in some hours on my bike.  To pass the time in the saddle, I've been listening to BBC's "Analysis" podcasts, today's listenings including Professor Manuel Castells' interview on Alternative Economic Cultures.

Professor Castell identifies the internet as the vehicle for new(ish) global and collective collaborations between individuals who now share knowledge in networked groups.  Previously, economics saw a similar knowledge sharing function as being the reason for the growth of city structures.  Information spillovers occurring between different groups of business and individuals cross-pollinated the thinking and ideas of other business and individuals within a tight geographic area, leading to the rise of cities.

These two ideas seem at odds and imply different "futures" for city structures, and - inevitably - the value of geographic-tied property rights. Or alternatively,  the continued growth of cities suggest internet-based networks have little eroded information spillovers associated with cities.  What Professor Castell describes may have little actual impact on how businesses and commerce transacts.  Or is what he describes something we should be looking out for in the near future.

One of the reasons people cluster is to share ideas and thinking.  Bouncing ideas between each other, discussing related issues, sharing experience and knowledge has an "externality" effect:  collective information sharing confers collective benefits on all participants.  In fact, economics has long identified these collective effects as reasons for the rise of cities.

However, Professor Castell, back in the 1990's, was one of the first commentators to view the impact of the rise of the internet as something cultural-shifting.  In his podcast, he describes the internet as leading to a "networked society", as opposed to a "hierarchical society".  The difference relates to how people cluster to interact, with hierarchical processes relating to being a member of a social organisation. Prior to the internet, people socially interacted through membership of clubs and organisations; for example, their local Cosmopolitan Club, church, sports clubs, toastmaster's group etc.  Social interaction and engagement happened "within" a structure.

The internet uncoupled social engagement from specific organisational structures, offering individuals alternative channels to exchange ideas and socially engage.  Twitter, YouTube, Blog, etc have all lead to people engaging and interacting with a network of people rather than having to find physical structures with like-minded values.  People are now free to engage, converse and transact without geographic boundaries.

I have no idea who is "right", but aren't these ideas fascinating?!?

Welcome to 2013!

Productivity - at what cost?

I attended the Government Economics Network Annual Conference yesterday.  Top marks to all the speakers who presented some facinating talks on recent changes to the UK welfare system (Trevor Huddleston), new approaches to modelling household behaviour (Martin Weale), and a rolicking-good discussion of the persistent costs for individuals of unemployment spells (Tim Maloney).  I strongly encourage other economists to get involved in these events, I myself have taken away new thinking about how I'm going to approach some of the modelling work I do thanks to Prof Weale.

But the thing which really got me thinking on the day was the panel discussion on "The Productivity Paradox".  The cut and thrust is (and I'll go back and pull some OECD stats if they're not posted), New Zealand has been in the bottom third of the OECD countries for productivity for the last approximate 40 years.  Prior to the late 1970's we were actually up in the top 25%, then within the space of a decade, we plunged to bottom third, and we've been there ever since.

Pretty horrible performance and the panel came up with some reasons why our comparative preformances compared to other OECD countries may be so bad.  Lack of competition was touted, significant investment in low growth sectors another reason, wrong investment (ie not in high margin industries) a third.  All very good reasons.

But for me, the relevant questions now - 40 years after the horse has bolted the pen - is what would it cost to improve productivity?  Starting out from a low productivity base, being so far behind the eight-ball vis-a-vis other countries, what costs are imposed, and who pays, for even trying to get back into the top 25%?  Lots of great ideas about shifting investment to high tech industries and etc, but within that picture, is that shift "costless"?  And who "pays"?

I suspect rural areas, and workers pay.  And that move is not costless.

more later as I build some evidence...

Addendum:
Statistics New Zealand publish "Innovation in New Zealand" an interesting little read...  Lots of interesting content, including this summary: which included that in 2012, there was no link between innovators and non-innovators for performance measure perceptions such as productivity.  While innovators aggregate profitability was twice that of non-innovators, however, innovations tended to occur in industries with small GDP contributions...  Thats pretty much what Roger Procter was saying...

It's not you, it's me!

Dear Blog,

It's not you, it's me. This time apart, this lack of posting is nothing you've done. I still love you!

But over this last week and a bit, I feel a gap has grown between us. I'm spending more time with my wife - my job, that I have not given you, my blog mistress, the time care and attention you so richly deserve.

But fear not sweet sweet blog mistress, Christmas break is coming. And I shall lavish sweet and tender affection upon you.  I will share with you my inner economic thoughts.  And I will once again upload graphs into your ample domain.

Until Christmas... Xxx

Yours, your overworked stress out civil servant,
James

Real Markets and Money Markets

Last year, well before the US presidential election, I was in a bar having a heated conversation with some guy who had been listening to too much Tea Party rhetoric, although he wasn't aware of its origins at the time.  From points 20, 21, 31, 32 cited in that link, part of the issues the Tea Party have is with the size of debt - there's too much of it, its all owned by the banks, and its growth is unsustainable.

Where this guy was coming from was that banks take yours and my money, then lend it out 5, 10, 15 whatever times, and every single time they're charging somebody interest on that debt!  So mine or his deposited $100 gets lent out 5, 10, 15 whatever times and balloons out to $1500 worth of debt!  And on that $1500, if it all gets paid back in a year, and the banks were able to charge 9%, then that's $135 worth of new debt that collectively the country owes purely because of how banks abuse yours and my deposits!  Which means someone has to work harder, or work longer, or suffer under growing debt to pay $135 more debt than what existed 1 year ago!

He was getting quite heated about this - this was an outrage!  Abusive bank practices perpetuate the proliferation of debt and were the road to madness.  Then he went on to talk about how the US banking system is privately owned by US Central Banks - and this all added to the conspiracy of shadowy figures somewhere who's deep dark plan was to royally root America for some nefarious purpose, of which he could only speculate.  But maybe Zionists were involved in there somewhere....  His thinking was American centric, obviously because he read something from someone over there.

In economics, we like to think of the world in models, our favour being market models.  In these models, economic activity occurs in separate and discrete markets which are all, however, deeply inter-related.  Stylised models of the economy talk about the:

• Labour Market:  where workers sell their labour efforts to producers and receive a wage which they use to consume or invest.
• Goods Market:  where producers use financial capital (paying interest) to employ workers (paying wages) to produce goods and services which are sold for profit (receiving prices) to either domestic or overseas consumers.
  
• Money Market:  where financial capital is supplied by lenders and financially intermediated to borrowers in return for interest.
• The Rest of the World: where quantities of goods and money comes from or goes to.  Changes in the rest of the world demand for New Zealand goods or financial assets effects New Zealand's exchange rate.

There's a little more to it than this, but this is a very basic stylised model of the economy.

Within this picture all the markets quantities are deeply integrated, with changes in one market effecting others all other markets.  There's disagreement about the pace of change, and whether changes propagate simultaneously or with lag.  But just assume for the moment, that changes ultimately occur.  Each individual market have both quantity and price dimensions, where changes in quantities demanded and supplied affect the market's prices.  And its normally the prices generated within each market which connect the different markets together (a bit of a simplification, but run with this for a bit). 

Decreases in the quantity of labour for hire in the Labour Market increases wage prices, and adds to the cost of producing goods and services in the Goods Market.  Increased wage prices also increase the financial capital needed for production in the Goods Market, increasing the demand for money in the Money Market, putting pressure in interest rates.  Increased costs of production leads to increased costs of New Zealand goods and services, which relative to the Rest of the Work, decreases the overseas demand for our goods and services.  Decreases in demand lead business to reduce the amount of goods and services they produce, decreasing thier demand for labour.  Decreasing in the demand for labour puts downward pressure on wages back in the Labour market, and the initial "shock" to the system which started in the Labour Market is returns back to the Labour Market through the interaction the shock has had throughout the system. 

That's only one potential "channel" for the transmission of shocks and responses around the model.  Potentially, the increase in interest rates can attract overseas capital as one response, and that itself has implications within the system.

But the important point is that everything is connected, everything is inter-related, and no market is an "island" where changes can occur in isolation.  Economists create careers perturbing models like this and getting a sense about how changes oscillate through and around "the system".

Getting back to the this bar-fly's point:  bank's can't make money and debt in isolation - the demand for finance is tied to the demand for goods and services, which is itself tied to production.  They match dollar-for-dollar. Increase in debt is match by a corresponding increases in amounts spent on goods and services, which matches dollar for dollar to an increase in the returns to the incomes of the factor's for production.  Interest payments are achievable because production processes generate "value added" - an excess of income over the costs of production.  In fact, that's the engine of economic growth and why the Gross Domestic Production of economies normally increases over time :)

Thinking about markets and models of the economy is how economists avoid fuzzy thinking, especially from unbalanced political rhetoric.