Expanding a Monopoly: The Vineyards of Champagne, France

4th Annual Conference in World History and Economics Appalachian State University Boone, NC April 18, 2009

Mark L. Wilson Associate Professor of Economics West Virginia University Tech [email protected]

Abstract The Champagne region of France enjoys a long-standing monopoly over the production and pricing of bubbly wine. Monopolies such as this typically distort economic outcomes and transfer wealth among groups. The French government is contemplating a widening of the Champagne region. This paper examines the gains and losses from such a monopoly expansion with attention to the transitional gains trap. Part 1 explores the history of the Champagne monopoly. This section discusses historical limits to competition and pricing behaviors, world demand for champagne and demand growth over time. Part 2 evaluates the conundrum faced by the French government: a declining share of the world champagne market. This section also discusses the mechanics of monopoly constraints including the wealth transfers which occur when public monopolies extend privileges. Part 3 discusses anticipated gains and losses from altering the Champagne monopoly, including the transitional gains trap. The paper concludes by examining the expected land revaluation and output levels when Champagne extends it boundaries.

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Introduction It is hard to find a product with a better brand name than Champagne. The bubbly, sparkling wine is closely associated with celebrations all over the world. But there is a difference between the official Champagne, France product and the generic version of sparkling wine. The official Champagne wine is trying to maintain its nearly 100-year old monopoly. This paper covers the history of the Champagne monopoly, explaining how and why a subset of wines is held in such high esteem. The paper also identifies market forces and substitutes which have attenuated the strength of the monopoly. To maintain its monopoly, Champagne must respond to competition from these substitutes. The French government, the entity which created and supports the monopoly, has decided to expand the boundaries of the Champagne region. This move will change production levels, land values and ultimately affect the world market for champagne. The paper concludes by identifying the timeline and nature of the changes in the monopoly, and predicts short-term and long-term changes in wealth which are likely to occur.

History of the Champagne Monopoly The Champagne region of France, 50 miles east of Paris, has held a prominent place in European trade for centuries. In the Middle Ages Champagne took advantage of its crossroads location for North-South trade from the North Sea to the Mediterranean and East-West trade from Frankish to Germanic kingdoms. During this time, grapes were first planted in the chalky, hilly terrain of Champagne. The soil and climate were favorable for grape production, particularly the pinot noir variety. By an accident of history, local winemakers invented and popularized the highly fermented, bubbly wine which carries the name Champagne (Kladstrup and Kladtsrup 2006).

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Simply inventing a new type of wine is not sufficient to establish a monopoly because there are many wine varieties from which to choose. To establish a monopoly, some government intervention or forbearance is also required. In Champagne, the French government protected champagne producers through the “appellation” system. Since the 1930’s, The Apellations of Controlled Origin (ACO) has labeled wines by connecting them to a special geographical growth area.

The ACO also imposes viticulture limitations such as permissible yield per hectare,

pruning rules and irrigation rules. Today, the official Champagne region consists of 84,016 farmland acres and 319 villages (Gaffney 2008). This special appellation confers a monopoly privilege1 to winemakers because entry into grape production is prohibited to farmers in adjoining geographical areas. Thus, the holders of the Champagne designation can produce grapes and sell as much sparkling wine as they want and charge monopoly prices.

In addition to output and pricing advantages, landowners in

Champagne have done well, too. A hectare (approximately 2.5 acres) is worth about $1 million in Champagne but fetches only $6,000 on the border of the Champagne region. We can also measure the strength of the monopoly indirectly: land nearby Champagne is used to raise beets, barley and wheat whereas land inside Champagne produces grapes almost exclusively. The Champagne monopoly has existed since 1927 with no appreciable boundary changes (Carvajal 2008).

Changes in Champagne Monopoly Power Monopolies rarely exist forever because they are susceptible to changing supply and demand patterns. But private monopolies usually have a shorter existence than public monopolies.

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Technically, a monopoly is a single firm. In the situation of Champagne, it is technically a cartel wherein several winemaking firms band together to act like a monopoly. To simplify, I will use monopoly to describe the workings of the Champagne cartel.

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Private monopolies, like the National Football League, earn excess profits until such time as market forces wear down the monopoly’s advantage.

Competition occurs over time in a

dynamic modern economy due to new products and new production techniques.

Public

monopolies, however, may exist much longer due to their governmental protection. Public utilities, for example, are monopolies conferred by the awarding of special licenses. This special protection can continue for many years. The Champagne region falls into the category of a publically protected monopoly. The long-term success of the Champagne monopoly is now threatened by competition from California sparkling wine.

California sparkling wine is produced by the “American

Methode Champenoise” which is the U.S. counterpart to the French fermentation process. The result is a sparkling wine which tastes very much like champagne. I could find no evidence of blind-test comparisons between the two methods, but I would guess the sparkling wine products are nearly indistinguishable from champagne. As a result of the close substitution, sales of the California sparkling wine have been growing appreciably over time. This has challenged the monopoly.

Conversely, growing world demand from China, Japan, India and the United

Kingdom, has pushed up prices and increased the value of the monopoly (Bauerova 2007). Historical sales of California and French champagne are shown in Figure 1 (sales of both U.S. and French champagne surged greatly in 1999 as worldwide millennial celebrations caused demand to spike).

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Figure 1. French and California Champagne Sales, 1995-2007

Sources: Eurostat, Prodcom Data 1995-2007 and California State Board of Equalization. French data is reported in millions of liters; California data is reported in thousands of nineliter cases.

Economic Profits from the Champagne Monopoly Economic theory predicts that monopoly firms are able to expand or contract output to until they reach the optimal level, i.e., the situation where marginal cost equals marginal revenue. This output results in maximum firm profits. Figure 2 identifies the customary monopoly outcome at the optimal output Q2 and price P2 (we make the simplifying assumption that marginal costs are constant over this range of output). Currently, however, the Champagne monopoly faces an output constraint due to the shortage of land on which to produce additional grapes. This constraint prevents the monopoly from expanding output to the profit maximizing level. The monopoly would like to increase output from Q1 to Q2, but cannot do so because the current acreage limitations restrict grape output to Q1. Thus, prices are too high and quantity is too low under current conditions. These high prices have exposed French champagne makers to market 5

share attrition. Competition has eroded their market, especially competition from sparkling wine produced in California. A comparison of the hatched rectangles in Figure 2 gives a rough estimate of lost profit opportunity by producing at Q1 instead of Q2. Clearly, this monopoly would like to increase output.

Figure 2. Expanding Champagne Region Output to Increase Monopoly Profits P

P1 P2

MC

D

Q1 MR

Q2

Q MR

Market Response to Monopoly World demand for champagne is growing significantly. Emerging markets such as India, Russia and China demand more. So do Japan and the United Kingdom. Estimates suggest world demand is growing at more than five percent per year and has now reached sales of $7 billion (Gaffney 2008). As a response, vineyards around the world have been expanding, too. Nowhere is this expansion more evident than in California, a chief competitor to Champagne because the U.S. is a huge market and major importer of French wines. Although California sparkling wine is not officially “Champagne,” it is a close substitute. As a result of growing worldwide demand 6

and a nearly identical tasting product, California sparkling wine sales have grown sharply over the past decade.

French Lawmakers Method and Timeline for Extending Champagne Region As a result of market forces, French lawmakers face a two-pronged problem in protecting the monopoly: increased competition from imitators and limited output due to capacity constraints faced by Champagne.

To respond to the first problem, French politicians have restricted

sparkling wine imports into Europe and have launched a public awareness campaign to sully the image of imitators (Bauerova 2007). For the capacity problem, French lawmakers have agreed to expand the Champagne region.

Extending the grape-growing region allows increased

production while retaining quality control and the vitality of a key export industry. Choosing which plots are annexed and which are not will be decided by the suitability of land for growing high quality grapes. Selection is not easy due to political bargaining. Land values in the newly-created Champagne region will be steeply higher than before and, if the region is over-expanded, higher grape and champagne production might overshoot the profit maximizing level of output. Also, there are short-run effects which differ from long-run effects. Considering all this, French lawmakers agreed to enlarge the boundary of the Champagne region by 3 percent. The highly political choice of which new areas to include is going on now and the final decisions will be made by 2010. Land adjoining the current Champagne region is being examined for suitability. Since land values and employment prospects are expected to rise sharply in the newly-annexed area, there is much competition to be selected as one of the new sites (Gaffney 2008).

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Implications of Changing the Monopoly Both short-run and long-run responses will occur when the annexation is completed. I will address these in turn. In the short-run, land values in the newly annexed area will go up steeply. Some estimates put this increase in valuation at a multiple of 150 (Carvajal 2008). This happened in the U.S. when the Agricultural Adjustment Act protected farm incomes in the 1930’s (Tullock 1975). It happened again in more recent times when Alaskan land and business values rose in the 1980’s upon the discovery of oil there (Tullock 1986). We expect land in the current Champagne region will increase, too, because the present value of the monopoly will increase. All told, both the newly-annexed area and the current Champagne area will see property values increase. This explains support for the annexation by both groups of landowners. In the long-run, however, the monopoly rents will dissipate. To use the words of Gordon Tullock, the area faces a “transitional gains trap” (Tullock 1975). Namely, when the boundary changes, landowners in the newly-created Champagne stand to realize a one-time increase in land values. Those landowners outside the boundary will gain nothing. But those inside the new boundary should not gloat too much: the value of the windfall boundary change will be quickly capitalized into land values, increasing the opportunity cost of land ownership.

If the

Champagne landowner subsequently sells, only he can gain. The buying party cannot capture a piece of the monopoly but rather realizes only a normal return.

Conclusion Expansion of the Champagne region results in capricious economic outcomes. On one hand, the monopoly rents of Champagne region workers and landowners will increase due to the expansion because the monopoly will increase output to the optimal level in response to the 8

sizeable increase in world champagne demand. Increased outputs will lower world champagne prices and increase Champagne’s market share and profits. On the other hand, landowners and workers in that region of France who do not secure the Champagne distinction do not gain. Farmland inside Champagne will be expensive and used for grape production whereas land outside the region will be cheap by comparison and used for beets, barley and wheat. Some of these capricious redistributions could be mitigated by a new set of “fairness rules,” but these rules are even harder to agree upon than the boundary changes (Sansing, VanDoren 1991). One winemaker finds hope in these changing times by quoting Winston Churchill on champagne: “In victory I deserve it; in defeat I need it” (Kladstrup and Kladstrup 2006).

References Bauerova, Ladka. “Champagne Shortage No Flash in the Vineyard as LVMH Rally Quickens,” Bloomberg Press, December 31, 2007. Carvajal, Doreen. “France Looks to Expand Champagne Production,” International Herald Tribune, June 13, 2008. Gaffney, Jacob. “Champagne Region Set to Expand,” Wine Spectator, March 14, 2008. Kladstrup, Don and Petie. Champagne, How the World’s Most Glamorous Wine Triumphed over War and Hard Times, Harper Perennial, 2006. Sansing, Richard, and Peter M. VanDoren. “Escaping the Transitional Gains Trap,” Journal of Policy Analysis and Management, (13:3), 1991, pp. 565-570. Tullock, Gordon. “The Transitional Gains Trap,” Bell Journal of Economics, Autumn 1975, pp. 671-680. Tullock, Gordon. “Transitional Gains and Transfers,” Cato Journal, Spring/Summer 1986, pp. 143-154.

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