Saturday 27 December 2014

Wine drinkers can rest easy: basic economics tells us bad harvest won't mean price rise

Published 26/11/2013 | 21:34

China will be the largest wine consumer in Asia by 2020, with demand rising by 5pc every year

What do bottles of wine and Florida oranges have in common? More to the point, how will price changes hurt the average Irish household?

There are very few real laws in economics. What economists have are regularities we observe more often than not, and some accounting rules to add things up in the right way. Really that's it.

Economists of my vintage (get it?) were all trained using the story of the Florida orange. When a cold snap hits the Florida region, so the story goes, the orange crop fails, causing prices to rise across the world.

The cold snap is a pure 'supply' shock, where nothing about the orange juice drinker changes, but the conditions underlying the supply of the stuff change. The solution is the price mechanism -- prices will respond until next year's harvest comes in. We were drilled on the Florida orange story so often I can't drink orange juice without thinking about it.

Now take the global market for wine. Irish people should care about this because more than 1.5 million of us drink the delicious stuff, it's 26pc of the market for all alcohol, and it is worth more than €1.6bn even though we now consume about as much alcohol overall as we did in 1994. Given our precarious economic situation, staring at individual markets like this one makes a lot of sense, because we can get a sense of what is happening in the 'real' economy.

We are told the price of wine is about to go up. Demand for wine in the US and China is going through the roof. More than 100 million people are now drinking wine in the US, with demand in China rising by more than 5pc every year for the last 10 years as incomes rise there. China will be the largest wine consumer in Asia by 2020.

Combined with a series of modest recent harvests, an argument has recently been made that the price of the red stuff is due to rise markedly for Irish consumers. This story has been floating around recently, and there's a good deal of truth to it -- just the economics are wrong, because it assumes prices and quantities won't adjust to market changes. They will.

First, wine takes time to make. Today's harvest doesn't impact this year's product; at the slowest pace of production, it takes a year or two. Suppliers can always profitably dig into inventories if they need to. Notice the big difference between wine and that awful orange -- it isn't just price that adjusts, quantity supplied can adjust too.

Wine isn't produced in one place, and there is no one type of wine. The market is global and segmented. Spain, for example, recorded a very high level of production in 2012, but this is projected to fall over the next few years due to changes in EU regulations, as well as poorer harvests in general, while the market for Malbec looks worrying in the short run. The world is a big place, and so is the market for wine. Overall the difference between the amount of wine consumed and produced is projected to be about 281 million hectolitres, while consumption will be about 251 million hectolitres. The worldwide volume is enough to meet demand for the short term, even forgetting about inventories.

Exchange rates also play a large part in moving Argentinian wine, for example, across the globe. These are pure market forces at work, and they are a joy to behold if you teach this kind of thing. The price of wine is likely to remain around the same for Irish consumers into the near future.

Now, a few things can happen, because expectations might just change. Producers can flood the market with cheaper stuff, eat into their inventories, or just jack up prices.

In practice they can do all three, as it is a very big market. The consumer in Ireland, already highly taxed on these purchases, and drinking more wine than ever before, will find their pockets squeezed really only if the Government markedly increases taxes on this category.

The world is not a simple place, where cold snaps killing oranges hit you right in the wallet. There are many reactions out there to unexpected changes, and as long as the consumer is happy to keep drinking wine, producers will try to keep prices relatively stable for them.

Irish Independent

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