Factor use and productivity change in the alcoholic beverage industries.

• Author: Xia, Yin

1. Introduction

   Demands for wine, beer, and spirits are, in view of their substitutable nature, often studied in conjunction with one another (Heien and Pompelli 1989; Nelson 1999). Yet the alcoholic beverage industries are connected by similarities in their production processes and inputs as well as by the demand substitutability of their products (Lea and Piggott 1995). These industries are therefore usefully examined together when questions about technical change and productivity growth arise. Little recent attention has been given to the nature of technical adjustments in the beer sector, and no such work seems ever to have been published on wine and spirits. (1)

   Brewing and distilling, and to a smaller extent winemaking, have become increasingly mechanized during the past half century as they have in most other manufacturing sectors. Packaging rates are higher, shelf lives longer, and storage and transportation technology improved (Tremblay 1987; Elzinga 1990, pp. 216, 219; Iserentant 1995; Piggott and Conner 1995; Gisser 1999). The fixed costs associated with these innovations have, broadly speaking, served as an incentive to build fewer and larger plants.

   Industry concentration in the beer sector rose dramatically from the mid-1930s through the mid 1980s. Plant numbers then expanded as microbreweries catered to the new demand for product variety and idiosyncrasy, although four-firm concentration continued to rise through the mid-1990s. In the spirits sector, domiciled largely in the South, distillery numbers continue to decline, spurred by declining aggregate demand as well as scale economies. No such broad consolidation is taking place in the wine industry, where several California and New York firms long have occupied a substantial market share. Instead, wineries numbers have grown rapidly and uninterruptedly since 1970, proliferating in regions long thought inhospitable to wine grape production. Growing consumer interest in wine variety and microclimates, a trend similar to that for microbrews, has abetted this diversification (Goodhue et al. 2000).

   Prices in the alcoholic beverage industries have, in real terms, fallen substantially in the past 40 years. Net prices to brewers have dropped 37%, to wineries 16%, and to distillers 31%. At the same time, real wage rates generally have risen, and, except for brief instability during the 1970s, so have capital rental prices. Real material prices in all three sectors rose from the 1950s through the 1960s, fell through the 1970s, then recovered by the mid-1990s to their early 1970s levels. Relative factor prices in the beer industry, broadly representative of those in the other two sectors, are shown in Figure 1. Wage rates rose relative to both capital and material prices until 1980. Thereafter, wages fell relative to capital but continued to rise relative to material prices (U.S. Bureau of the Census, various years).

   Expenditure shares, illustrated in Figure 2, suggest that the beer industry is the most capital intensive of the three sectors. By the mid-1990s, capital expenditures represented one-third of beer production costs, compared to only one-fifth of wine and distilling costs. On the other hand, raw materials constituted little more than half of beer expenses but nearly 70% of wine and distilling costs. Labor accounted for only 10-12% of expenditures in any of these industries. Figure 2 seems to suggest that, at least since the mid-1970s or early 1980s, capital has substituted for labor and materials in all three sectors. Yet as Figure 1 reveals, much of these share changes are accounted for by the rising relative price of capital.

   The substantial narrowing of output-input price margins in the alcoholic beverage sector suggests that the sector has become more cost efficient through either technical change, scale economies, improved utilization rates, or other means. Technical changes themselves can alter potential scale economies and productive capacities and hence prospects for future variations in industry structure. The exact form of the technical change also influences the distribution of factor demands, with implications for profitability in the machinery and farm production industries and for labor welfare. Finally, trends in final demand patterns, such as the rise of wine and beer niche markets, affect sector returns and thus incentives to expand output and improve efficiency. Disentangling these separate effects gives an improved view of the principal supply forces driving the alcoholic beverage sector. For example, a reliable characterization of factor substitution, which impinges on, among other things, input demands, requires we go beyond expenditure shares and examine the underlying processing technology.

   To shed light on these issues, we investigate how the major features of beer, wine, and spirits production technology have changed during the past four decades. Our approach is to characterize the cost and input demand functions of representative firms, then employ duality principles to draw inferences for the underlying technological structures. The effort throughout is to distinguish among demand, technological, and scale influences on industry performance. To preview our results, we find productivity growth in all three industries to have been quite strong since the 1950s. Scale economies in brewing and distilling remain substantial, providing strong incentives for plant expansion. Virtually no scale economies, however, are evident in wine production. Substitutability among capital, labor, and material inputs is high, although technical change has shifted factor shares toward capital and away from materials.

2. Approach

   Consider a firm's minimized cost

   C = G(Y,[W.sub.l],[W.sub.m],K,D,t)+[W.sub.k]K],

   where Y is output, K is the capital quantity, [W.sub.i] is labor wage, [W.sub.m] is materials price, [W.sub.k] is the rental price of capital, D is a dummy variable representing a discrete technology shift, and t is a time trend reflecting continuous technical change. L will refer to labor quantity, including skilled and unskilled workers, and M to material quantity, primarily raw farm products or prepared mashes, packaging supplies, and (to a minor extent) energy. Raw products in beer brewing are malted barley or other grain; in wine production, grapes; and in spirits, corn, rye, barley, and wheat (Lea and Piggott 1995). In 1992, the proportion of production materials accounted for by agricultural products was 13% in the beer sector, 50% in the wine sector, and 36% in the spirits sector. Most of the rest were in container supplies (U.S. Bureau of the Census, various years).

   We employ the following generalized Leontief form for cost function G in Equation 1 (Morrison 1988, 1997; Park and Kwon 1995):

   G = Y[([[alpha].sub.ll][W.sub.t]+2[[alpha].sub.lm][W.sup.0.5.sub.l][W.sup .0.5.sub.m]+[[alpha].sub.mm][W.sub.m])+([[beta].sub.ly][W.sub.l]Y.sup .0.5]+[[beta].sub.lt][W.sub.l][t.sup.0.5]+[[beta].sub.my][W.sub.m][Y. sup.0.5]+[[beta].sub.mt][W.sub.m][t.sup.0.5])

   +[[beta].sub.yy]Y+2[[beta].sub.yt]Y.sup.0.5][t.sup.0.5]+[[beta].sub.t t]t)(W.sub.l]+[W.sub.m])]+[Y.sup.0.5][K.sup.0.5][)[[gamma].sub.lkd]D) [W.sub.l]+[[gamma].sub.lk]+[[delta].sub.lkd]D)[W.sub.l]+([[gamma].sub .mk]+[[delta].sub.mkd]D)[W.sub.m]

   + (([[gamma].sub.uk]+[[delta].sub.ukd]D)[Y.sup.0.5]+([[gamma].sub.yk]+[ [delta].sub.tkd]D)[t.sup.0.5])(W.sub.l]+[W.sub.m])]+([[gamma].sub.kk] +[[delta].sub.kkd]D)K([W.sub.l]+[W.sub.m]). (2)

   Linear homogeneity in input prices and symmetry of the input-price Hessian matrix are imposed on this specification. Monotonicity in (Y, [W.sub.l], [W.sub.m],K), convexity in K (i.e., [[delta].sup.2]G/[[delta]K.sup.2] > 0), and concavity in factor prices are not and must be tested for.

   Kerkvliet et al. (1998) and Gisser (1999) show that technical change in the 1970s beer industry was too sudden to be modeled adequately by a trend variable alone. Evidence suggests that similarly rapid changes were taking place during the same decade in the spirits sector and, perhaps to a smaller extent, in winemaking (Adams Business Media, annual issues; Lea and Piggott 1995). Goodwin and Brester (1995) find that the most pronounced structural changes in the aggregate food processing sector occurred in the 1980s rather than the 1970s, commencing in 1980 and largely completed around 1986. We examine the possibility of a relatively discrete technological jump during any of these periods by permitting the capital-related parameters [[gamma].sub.lk], [[gamma].sub.mk], [[gamma].sub.yk], and [[gamma].sub.kk] in Equation 2 to shift. (2) Alternative shift points were examined, including 1971, 1972, 1973, the early 1980s, and 1986. On the basis of goodness-of-fit criteria, a 1971 shift point was selected in all thre e industries. However, remaining parameter estimates were very robust to alternative shift points.

   Output prices were specified as endogenous by modeling, for each representative firm, an output demand function of the form P = [[eta].sub.0] + [[eta].sub.1]Y + [[eta].sub.2]I + [[eta].sub.3]t, where P is output price and I is disposable personal income. The demands were estimated in conjunction with the firm's generalized supply function, [partial]G/[partial]Y = P[1 + [theta]/[[epsilon].sub.YP]], in which [[epsilon].sub.YP] [approximately equal to] P/[[eta].sub.1]Yis the output demand flexibility and [[theta] a market power parameter (Park and Kwon 1995). (3) Output pricing approaches the competitive norm as [theta] approaches zero and tends toward monopoly as [theta] approaches unity. Finally, labor and material demands were fitted by differentiating Equation 2 with respect to the corresponding factor price. Although nonlinear forms of the output demand functions might have been used, our data were found to be an unreliable basis for estimating own-price elasticities even in the vicinity of the sample mean. We therefore constrained [[eta].sub.1] to correspond at...