Beeronomics: Information Economics and Organic Beer

In economics information plays a pivotal role in the efficiency of markets.  One of the assumptions that underlies the result that free markets are Pareto efficient (i.e. maximize total welfare surplus) is that there is full and complete information.  What this means in a product market (among other things) is that consumers know everything there is about a product and can therefore value it appropriately before you buy.  I have blogged about this in terms of beer - highlighting the fact that with a new beer you don't really know until you try how much you value a particular brew.   But this general principle applies in many areas, you might value locally sourced ingredients and be willing to pay more for them at a farmers market for instance, or you might prefer to buy milk from cows that are not given growth hormones.  But you don't know unless you are told whether produce is local or milk is BGH free.  [And by the way this has nothing to do with whether milk from BGH free cows is better or healthier, only if consumers value it differently - but presumably consumers value it differently because they believe there is a difference or some positive probability that there is a difference]

So suppose you value products that are Organic and therefore decide to buy a Deschutes Green Lakes Organic Ale.  This is a beer that is considered organic per the USDAs guidelines.  Ah but wait, it turns out that it is only the malted barley that is grown organically, the hops, according to current USDA rules are allowed to be used in non-organic form in an organic beer (apparently one of only three whole crops thus allowed).   Jeff at Beervana has a nice follow-up blog post explaining the organic rules and the exception.  The justification for this exception for hops is that there are currently too few organic hops being grown (apparently they are very difficult to grow 100% organically).  The irony is that a main reason there are so few hops grown organically probably has a lot to do with the exception itself.  If you can call a beer organic that uses non-organic hops, there is little reason to try and get organic hops and little reason to try and grow them.

Business wise, this is frustrating to organic hop growers - a USDA ruling ending the hops exception would be huge, it would instantaneously create a massive demand.  Economically speaking, the exception creates a market failure for the reasons I mention above.  I am a pretty enthusiastic craft beer enthusiast and until I read Jeff's post I had no idea of the hops exception so I am willing to bet that most consumers don't know either.  This means they cannot accurately value the beer they buy and a sub-optional market outcome results.

Brewer Matt Swihart of Double Mountain commented on Jeff's post and added that:

In terms of ethicality, I've always felt it disingenuous to label a beer 100% organic when made with conventional hops. It is misleading the consumer as hops are grown under substantial pest pressure while barley is a reasonable "soft" crop to grow in that conventional farming of barley requires very little pesticide and nitrogen use. Organic barley and conventional barley have very similar environmental footprints...

So it is possible that it is really hops that matter when consumers are looking for and choosing to buy 'organic beer.' [As an aside, consumers might like organic because they like the idea of limiting chemical applications in the environment, in which case Matt's analysis is correct, or they might like it because they think it is a healthier alternative, in which case I am not so sure as hop vines might be treated before they flower and thus the flower itself might not have any chemical residue whereas barley might retain the residue.  Anyone know?]

Now there is a way forward without the USDA.  If brewers started using organic hops and labeling their beer as 'made with all-organic barley and hops' this might start to alert consumers to the difference and might spur demand for organic hops. As an economist there are few things as universal as the fact that more information is better for the efficiency of markets, so I support any effort to provide more accurate information about all goods.

As a parting note, Matt also points out that:    

"...brewing is carbon positive. Growing the hops and barley for beer produce more carbon than consumed in the production of the crops and the beverage. What a beautiful thing. Save the planet! drink a beer!"

I don't know if Matt is including transportation and refrigeration in this, but who cares? It id another good reason to have a beer.  And by the way, if you haven't had Double Mountain beer - what the heck is wrong with you?  Matt's beers are sublimely crafted and his commitment to the highest quality ingredients is evident in the beer.  Go find some.

Information, Markets and the Subprime Mess

Though not specific to Oregon, the mortgage market mess is certainly quite relevant given that it affects Oregonians just a s much as anyone else. What strikes me most about the sub-prime mortgage crisis is how it paints, in stark relief, just how important information is for efficient market outcomes. This is a general theme, not specific to mortgage markets.

In a nutshell, the story of the sub-prime mortgage mess goes like this: Lenders, eager to generate new mortgages that they were finding willing buyers for, kept dipping deeper and deeper into the barrel of qualified borrowers. After a while they were scraping the bottom and lending to very risky buyers, compensating the risk by offering very expensive loans. But the expense of the loans was usually delayed by a small period (one, two, three years) - enough time, in other words to off-load the paper and a lot more to follow before the expense kicked in and ignited a wave of defaults. Here is where the information problem kicked in. The wholesalers who were buying the paper and bundling it with a lot of other paper and selling bulk mortgages to investment banks didn't really know what they were buying. Only the people who wrote the loans really know who it was they were lending to. Credit rating agencies were relied upon to provide evaluations of the loans, but they were not effective in assessing the increasing risk of these sub-prime loans.

Then it happened, the expensive parts of the loans kicked in, the default rates started skyrocketing and all of a sudden investment banks, taking huge losses, were not so interested in buying up new paper, especially sub-prime paper but even mortgages from borrowers of moderate risk. This meant that the amount of money available to lend to home buyers dried up precipitously. All because of a lack of information.

Information is essential for efficient markets - it is their life-blood. One of the key assumptions in the familiar Adam Smith 'invisible hand' story is complete information - essentially that everyone who participates in a market knows everything about everything. In this case when there is so little information, speculation ensues and all of a sudden a credit market that looked so efficient, collapses. What is striking to me is that when serious market failures happen (like the lack of credible information in mortgage markets) regulation is an appropriate thing to discuss. What type and how much is debatable, but hoping the market will correct itself in the face of such a lacuna of information is not good governance.

Update: an excellent article in the Wall Street Journal today on Bernanke and the Fed and their response to the sub-prime mess.

On Economics and Beer

My friend and I had lunch at the Lucky Labrador brew pub in Portland recently and enjoyed pints of their fresh hop concoction "The Mutt." Yum - think Beaujolais Nouveau in beer, perhaps a little green tasting but very interesting. But that's not the point of this screed. What is the point is that we ordered our pints and were served, wonder of wonders, a real pint! Three cheers for Lucky Lab! In case you are unaware (as most are), the typical 'pint' served in the typical pub in Oregon is no such thing. They are served in what are known as shaker glasses, the very popular, thick, stackable straight sided glasses like the one in the picture. Thing is, these glasses hold about 13oz. Don't believe it? Well, if you have ever bought a souvenir glass from a pub and taken it home and poured yourself a nice bottle of beer in it, you'll no doubt notice that the beer with a bit of head fits perfectly. This is a subject the aforementioned friend has blogged about himself. This has become a pet peeve of mine. Not that I mind pubs using the shaker glasses - I quite like them - but these pubs have no business calling what they serve a 'pint' of beer. (Word of caution, there are shaker style glasses that are a full 16oz, but they are very rare) Update: Join the new Honest Pint Project!!

Which finally brings me to the economics point: a classic market failure for which government intervention is appropriate is what is known as 'asymmetric information.' One of the most classic economics papers of all time is a fairly simple story of used cars and shows that since owners of used cars know much more about the true quality of the car than prospective buyers, market inefficiencies can result. Thus governments can step in an enact truth in advertising laws, anti-fraud laws, etc. In my current example, most customers do not know they they are being served considerably less than a pint and when informed of this, often react in outrage. But how are they to know, do we expect customers to bring in their own measures? Of course not, we rely on the government to enact and enforce laws that protect us - the free market will simply not work properly (as it would if we could all tell just by looking precisely how much we are being served). True this is 'small beer' in terms of import, but switch the commodity in question to gasoline and you can see how quickly a small problem can be made big. Note that what is required here is a non-market intervention, an extra-market enforcement of laws that assures market efficiency.

Economics and Beer cont...

What is perhaps most surprising about the beer case is that this is not a new problem brought about by a popular glass. The British have been requiring a government stamp on pint glasses used in pubs since 1699 to assure the 'punters' that they are getting a right measure of the best bitter. (Something by the way that is changing due to the vagaries of the EU) There you have not only an economically correct government regulation, but one that works beautifully - all parties are immediately satisfied that a full imperial pint is being served and the government has little to do, but licence glass manufacturers and verify on occasion that they are meeting the 20oz requirement. So why not in the US?