Saturday 11 June 2022

The value of market power in alcohol sales

As Reason reported this week, Massachusetts is looking at revising its alcohol sales restrictions. The current regime is interesting because:

Massachusetts restricts license availability in two ways: creating quotas on how many licenses are available based on an area's population and restricting the number of licenses a single entity can own. While some other states have population quotas or quantity caps, very few have both of these restrictions in place at the same time.

Population quotas for alcohol retailing licenses ensure that only one license can be granted per several thousand residents in a municipality, based on a formula laid out in state law. There is a quota in place for both on-premise establishments like restaurants, as well as off-premise sellers like grocery and liquor stores.

The result of this limitation is that if a certain region has already met its quota for licenses, then any new retailers hoping to open up are barred from obtaining a license. If an alcohol seller goes out of business, however, that old license can become available on the so-called secondary market.

Since these secondary licenses are often the only chance for a new business to gain the right to sell alcohol, they have become immensely expensive in certain parts of the state. In Boston, bar liquor licenses have sold for north of $450,000. In states where population quotas do not exist, licenses can cost less than $100, underscoring the extent to which Massachusetts unnecessarily saddles its businesses with prohibitive startup costs.

If the government restricts the number of alcohol licences, then this restricts competition in the market for alcohol, and creates some market power for the holders of licences. As you can see in this 2018 post, this would lead to the price of alcohol being higher, but more importantly, the profits of sellers would be higher with the restrictions than if there was more competition. That's why a bar licence in Boston can sell for $450,000, when in other states a similar licence sells for less than $100. The prospective bar owner is willing to pay a premium for the licence, because they know that it grants them market power. They can recoup the cost of the licence through their higher future profits, generated by that market power. The value of that market power is measured by the premium paid for the licence.

Now, if the Massachusetts state government was smart, and wanted to maximise the profits they generate from the sale of alcohol licences, they would require that licences are surrendered to the state when a seller goes out of business. The licence could then be auctioned to the highest bidder. This way, the government would be able to extract nearly all of the monopoly profits from the buyer of the licence, because in theory that is the most that the buyer would be willing to pay for the licence. That the Massachusetts state government doesn't do that, and that licences are instead sold on a secondary market, is interesting in itself.

Also interesting, but not surprising, is that licence holders prefer the current regulations, over an alternative that would increase competition. An industry group represented licence holders has even gone so far as to offer a proposal that:

...cleverly packages a decrease in the most valuable type of license as an increase. Worse yet, the proposal does nothing to address the state's quota restrictions. This means that the overall pool of alcohol licenses would not increase, further condemning the state to its current restrictive system.

This is an example of rent seeking behaviour. The current licence holders are very profitable, so they have a strong incentive to try and protect (or even entrench) their current position, so that they can remain equally (or more) profitable in the future. This is why firms sometimes surprisingly prefer their own industry to be strictly regulated - it keeps out the competition.

Also interesting is that this is also a case where public health advocates might actually agree with the alcohol sellers. As I noted in my 2018 post, having local alcohol monopolies increases the price, and reduces the quantity of alcohol consumed, leading to less alcohol-related harm. This is almost literally the example of 'bootleggers and Baptists', first coined by the economist Bruce Yandle in the 1980s. Yandle noted that government regulations are often supported both by groups that propose the regulation (the Baptists), and by groups that should in theory be harmed but actually profit from the regulation (the bootleggers).

So, market power in alcohol sales may have value in two ways - value for the licence holders (higher profits) and value for public health (lower alcohol-related harm).

[HT: Eric Crampton at Offsetting Behaviour]

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