Several months ago I wrote about the tariffs levied on certain European wines in October. My take then was that they would have a relatively modest impact on the U.S. wine market overall. Since then the Office of the U.S. Trade Representative (USTR) has proposed a second, larger round of tariffs – which, if enacted, could potentially be a game changer.
Given the uproar this proposal has caused, I thought it would be helpful to update the numbers given in the original piece as well as to briefly discuss some of the potential implications of the expanded tariffs for the U.S. wine market and industry.
To recap, the October tariffs covered most still wines from France, Spain, Germany and the United Kingdom. But sparkling wines and still wines with more than 14% alcohol or packaged in containers of two liters or more were excluded, which left some leeway for producers to skirt the tariffs. Moreover, the tariff was set at a relatively modest 25%, a cost that producers and importers could bear for a time without increasing retail prices substantially.
The first round of tariffs would have ensnared 25% of all U.S. imports by value and 16% by volume based on my analysis of 2018 United States International Trade Commission data (USITC).
The second round of tariffs proposed in December threatens to take the war on European wine to a new level. The naughty list has been expanded to include all 28 EU countries and extended to encompass virtually all wine categories (Vermouth is the lone exception). This would more than triple both the value and volume of wine subject to tariffs and eliminate the possibility of avoiding them by changing packaging or juicing alcohol content. Perhaps more importantly, the new proposal stipulates a tariff as high as 100% - an impossible cost increase to bear without raising prices even in the short run.
All told, the existing and proposed tariffs would have hit 98% of European imports by value in 2018, or $4.7 billion worth of wine (customs value, which is the price paid by the importer excluding freight, insurance and other charges). The initial tariffs applied to just $1.5 billion. This represents a staggering three-quarters of all U.S. imports by value. In 9L equivalent terms, the volume of tariff impacted wine would swell from 20 million to 69 million cases – more than half of all wine imported into the U.S.
To put this into perspective, total annual wine sales in the U.S. are just a touch over 400 million cases. Based on back of the envelope calculations, European wines garner roughly a 17% share of the market by volume – or one in every six bottles sold - and a full 27% of sales by value. Thus, if put into place, the tariffs would impact a sizeable swath of the overall market.
So what are the implications of the existing and proposed tariffs if they were to be enacted? The answer depends heavily on the actual tariff level chosen as well as market participants’ expectations of how long they might remain in effect, so it is impossible to say anything definitive at this point. Nonetheless, a few broad-brush and tentative generalizations can be made.
First, European wine prices would rise. Margins are just too thin for most brands, particularly lower-tier products, for producers and importers to swallow the full cost of even a 25% tariff for long. They would eventually be forced to pass on some or all of it down the chain to consumers. And we all know from Econ 101 that when the price of a product increases – demand and sales decrease – though there are a few exceptions and the magnitude of the decline can vary from product to product.
Wine is a complex product, and unique in many ways, but the laws of economics still apply. Just ask any large wine producer who’s tried to take price recently!
So if the additional tariffs are enacted, prices will rise, and European wine sales will decline. The greater the tariff – the greater the decline. Assuming it is set somewhere in the range from the current 25% to the threatened 100%, the impact could range from moderate to profound. This would clearly be bad news for Euro-wine consumers as well as importers, distributors, and retailers focused on European wines who will be squeezed by declining sales and contracting margins.
Some of the lost sales will be gone for good, but much of the decline will be offset by higher sales of non-European wines as consumers gravitate to lower-cost substitutes. If you’ve seen arguments implying there are no substitutes for European wine and that the tariffs won’t boost domestic sales - don’t buy them. True, there are no “perfect” substitutes for high-end Bordeaux, Burgundy or Barolo, but the number of consumers who will eschew wine entirely or drastically reduce consumption before considering wines from other regions is likely to be modest. Moreover, price increasingly trumps region in the consumer buying calculus moving from the higher to lower tiers of the market.
Thus, the tariffs would benefit U.S. wineries in the short run by juicing sales and perhaps reinvigorating pricing power. Obviously, they will have to compete with other new-world producers including Argentina, Chile, Australia and New Zealand for a share of the pie.
This is just basic economics. Of course, the actual dynamics are more complicated and would play out differently across market segments including geographies, categories and price points, and a rigorous analysis based on actual details of the enacted tariffs would be required to flesh out the numbers.
U.S. producers are well positioned to take advantage of this opportunity as supply has outstripped demand in recent years, leading to a glut in inventory. Large-and mid-sized wineries with strong distribution networks should benefit most, while boutique producers selling through the direct-to-consumer channel are likely to see less of a boost. Growing domestic sales would also benefit growers, many of whom struggled to sell all their grapes and cover cost increases in 2019.
There are also potential risks. For one, Europe could retaliate with tariffs on American wines. However, at around $450 million in 2018, U.S. wine exports to Europe were just a fraction of the $4.8 billion in imports received from the EU, so there is less at stake. Nonetheless, they did represent 57% of total U.S. export volume and one-third of value. A large tariff could also disrupt the path to market for some wineries if distributors and retailers are put out of business, and higher prices could alienate consumers further depressing demand in the years ahead.
In the end, tariffs and protectionism are not the solution to the challenges facing the wine industry, and the USTR proposal is an unwelcome distraction that is injecting uncertainty in a market and economic landscape that is already rife with uncertainty. Don't panic - this is simply a proposal at this point and no timeline has been given pertaining to when a decision will be made. Nevertheless, wineries should be prepared to respond quickly and in an informed manner if the new tariffs are enacted. Contact Vintage Economics for more nuanced analysis of the proposed tariffs and their strategic implications.