Trouble Brewing for Craft Beer

By Matthew Mitchell and Christopher Koopman of US News and World Report

Craft brewing is more popular than ever. Even President Obama is brewing his own beer. However, if you sit down with the people who are brave enough to turn this hobby into a commercial enterprise, it won’t be long before you hear about the obstacles they face getting their product into the hands of thirsty consumers. All entrepreneurs face hurdles in starting their businesses, but craft brewers face a unique set of challenges which both undermine consumer welfare and privilege some in the industry at the expense of competition and innovation.

Recently, Evan Feinberg of Generation Opportunity described some of the barriers craft brewers face. In one instance, a brewer — who does not prepare any food — was told he had to install a hood for a food oven that he did not even own. Another brewer — who does not use poultry in his beer — was nearly kept from operating because he did not have the equipment to handle raw chicken.

Brewers face multiple regulations and multiple regulators at the federal, state and local levels of government.

At the federal level, brewers need approval from regulators before they can sell their first beer or brand it with their label. Sometimes this one step can take 100 days. Depending on their ingredients and methods, their formula may need to be approved. This can take another 60 days.

At the state level, brewers must comply with additional (oftentimes redundant) rules. In Virginia, for instance, the first step is a license from the state. Regulators can deny this license for a number of subjective reasons, including a belief that the brewer is “physically unable to carry out the business of brewing,” lacks “good moral character” or fails “to demonstrate financial responsibility.” The license may even be refused if the state decides there are already enough brewers in the locality, and adding another would be detrimental to the area’s “interest, morals, safety or welfare.”

Once in business, brewers face more hurdles. Among the least efficient regulations are the “franchise laws” that restrict their ability to sell beer directly to consumers, instead mandating that they sell through distributors. These rules can even dictate how brewers may contract with distributors. For example, some grant distributors exclusive territories, and others limit the ability of a brewer to choose to work with someone else. A recent survey found that in most cases, these rules make consumers worse off.

As our colleague Antony Davies recently explained, the costs of complying with excessive regulations keep many aspiring brewers from starting businesses. They also affect the decisions young breweries make when deciding how to grow their business. As Steve Hindy, founder of Brooklyn Brewery, recently wrote, “some small brewers refuse to enter certain markets because of the local distributors’ reputation. That’s bad for these businesses, and bad for the economy, but particularly bad for consumers, who would love to try the latest popular craft beers but can’t find them in their state.”

In a Mercatus Center paper released this week, we found that a brewer in Virginia must complete approximately 12 separate regulatory steps before he can sell his beer to consumers. This iscomparable to the regulatory barriers faced by entrepreneurs in Venezuela or China, two places notorious for their excessive barriers to entry.

How has this regulatory mess come to exist? We found two explanations.

First, regulators have little incentive to take into account the combined effect they and their fellow-regulators have on craft brewers. No single regulation seems that overwhelming, but when all of them are taken together, they are just that. Many regulators fail to look at the bigger picture, and don’t see that regulations at the federal, state and local levels are piled one on top of one another.

Second, while many of these regulations have social justifications, their practical effect is to privilege existing firms and industries at the expense of newcomers and consumers. This is what economist Bruce Yandel calls the “bootlegger and Baptist” theory of regulation. The idea takes its name from blue laws forbidding alcohol sales on Sundays. These laws are often supported by a “strange bedfellows” coalition of publicly-minded activists concerned with excessive alcohol consumption (“Baptists”) and privately-motivated firms (“bootleggers”) who stand to gain from rules limiting competition. In theirforthcoming book, Yandle and his grandson, fellow-economist Adam Smith, show how widespread the phenomenon is.

This theory helps explain why the three-tier system persists. When brewing laws were enacted following the repeal of prohibition, the stated intent was to limit overconsumption by limiting the ability of brewers to sell directly to consumers. However, the practical effect in recent years has been to increase the market power of incumbent distributors at the expense of craft brewers. So while it was initially justified on public interest grounds, the system has created an entrenched interest with a financial stake in seeing old policies persist.

With the growing popularity of craft brewing across the country, many policymakers have attempted to “rescue” craft brewers by pro­posing targeted assistance, exemptions, subsidies and other privileges to help them enter the market. As economists Christopher Coyne and Lotta Moberg show in a new working paper, tar­geted privileges are typically ineffective and come with their own set of problems.

Moreover, they are an attempt to use policy to solve a problem created by bad policy. A more direct and effective solution would be to clear the tangle of regulations that stand between craft brew­ers and their customers. This way, brewers can succeed or fail based on their ability to craft quality beer rather than their ability to navigate red tape.