GB525 Unit 3 Trade Policy Analysis Example

A 25 Percent Duty on One Bottle of Bourbon: A Unit 3 Trade Policy Analysis Traced to the German Shelf

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Purdue University Global

GB525: Global Business Environment

Unit 3 Trade Policy Analysis

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[Date]

The distillery, its prices, volumes and margins are composite and illustrative; the trade measure, the German spirits tax and the sources cited are real.

The Measure

In June 2018 the European Union imposed an additional duty of 25 percent on a list of US products, including American whiskey, in response to US tariffs on steel and aluminum imports (European Commission, 2018). The duty is ad valorem, charged on the customs value at the EU border, on top of the ordinary duty rate, which for whiskey is zero. It was suspended from 2022 under an arrangement on steel and aluminum, and whiskey returned to proposed countermeasure lists during later trade disputes. For a distillery planning its German business, the duty is a recurring risk rather than a past event, and the analysis treats it as a measure that could return at the same rate.

The Distillery

Old Hollow Distilling, a composite mid-size distillery near Bardstown, sells a 90-proof bourbon in Germany through one importer. German shipments are about 180,000 bottles a year, roughly 11 percent of its volume and a larger share of its growth. The bottle sells in German supermarkets and specialty shops near 31 euros.

Exhibit 1: The Price Build for One 700 ml Bottle

All figures in euros, at an exchange rate of 1.08 dollars to the euro. The first column is without the retaliatory duty; the second is with it.

Ex-distillery price: $11.00, or 10.19 in both cases.

Freight and insurance to Hamburg: 0.60, giving a customs value of 10.79.

Retaliatory duty at 25 percent of customs value: none; 2.70.

German spirits tax: Germany taxes spirits at 1,303 euros per hectoliter of pure alcohol. A 700 ml bottle at 40 percent alcohol by volume holds 0.28 liters of pure alcohol, so the tax is 3.65 in both cases.

Landed cost: 14.43; 17.13.

Importer's margin of 30 percent on landed cost: price to retailer 18.76; 22.27.

Retailer's margin of 40 percent on cost: price before VAT 26.27; 31.18.

VAT at 19 percent: shelf price 31.26; 37.10.

A duty of 2.70 euros becomes a shelf increase of about 5.84 euros, because the importer's margin, the retailer's margin and VAT are each charged as a percentage of a price that already includes it.

The shelf price rises about 18.7 percent. Krugman et al. (2022) explain that who bears a tariff depends on how buyers and sellers respond to price, and the build shows a second point: in a chain where margins are percentages, the final price can rise by more than the duty itself unless someone in the chain gives up part of their margin.

Exhibit 2: The Volume Effect

German bourbon buyers have substitutes: Scotch, Irish whiskey and German whiskies at similar price points. Using a composite price elasticity of about 1.2 for the brand, an 18.7 percent price increase would reduce German volume by about 22 percent, from 180,000 to about 140,000 bottles. Old Hollow's contribution on each bottle is about $4.20, so the lost volume would cost about $168,000 a year in contribution.

The estimate is uncertain. Amiti et al. (2019) found that US tariffs in 2018 were passed almost entirely into the prices paid by US importers, which suggests that exporters did not cut their own prices much to absorb them. If Old Hollow does nothing, the price increase may well pass through to the shelf in full.

Four Responses

1. Absorb part of the duty at the distillery. Cutting the ex-distillery price by 15 percent, to $9.35, would lower the customs value and the duty, and keep the shelf price near 32.97 euros, about 5.5 percent above today. It would cost about $1.65 a bottle, or about $277,000 a year at a volume near 168,000 bottles, more than the contribution it protects.

2. Ask the chain to keep fixed margins. If the importer and retailer kept their current margins in euros rather than as percentages, the shelf increase would be the duty plus VAT on it, about 3.21 euros, roughly 10 percent, and the volume loss would shrink to about 12 percent. The importer has an interest in this, because its own volume would fall otherwise, but the retailer controls the shelf price.

3. Shift volume to markets without the duty. Exports to Japan, Australia and Canada are not affected. But those markets are smaller for Old Hollow, and shifting sales would take years of distributor building.

4. Hold price and accept the volume loss. This is the simplest response and protects margins on the bottles that do sell, at the cost of about $168,000 of contribution and shelf position that may be hard to regain.

Recommendation

Share the cost along the chain without cutting the distillery's price. Old Hollow should ask the importer to hold its margin in euros while the duty is in force and to support a retailer agreement keeping the shelf price near 34.50 euros, and it should fund about $30,000 of joint promotion in return. In the composite figures, the shelf increase would be about 10 percent, the volume loss about 12 percent, or 22,100 bottles, and the lost contribution about $93,000. With the promotion, the total cost is about $123,000, against about $168,000 if Old Hollow does nothing and about $277,000 if it absorbs the duty itself.

The analysis also suggests a planning step that does not depend on the duty: building the Japanese and Canadian distributor relationships now, so that a future measure falls on a smaller share of the business.

Who Else Bears the Duty

The distillery is not the only party that pays. German consumers who keep buying pay about 5.84 euros more a bottle. The importer earns its 30 percent on a higher landed cost but sells fewer bottles, and its customs and tax payments rise. The German state collects the duty and more VAT on each bottle sold, but less spirits tax and VAT on the bottles not sold. In Kentucky, a distillery that loses German volume buys less grain and fewer barrels, so the effect reaches suppliers who never ship abroad. A trade measure aimed at a government's steel policy therefore lands on a chain of private parties in both countries, which is the reason firms in exposed industries track trade disputes as closely as they track their own costs.

What the Analysis Leaves Out

It ignores exchange rate changes, which could offset or deepen the effect; a weaker dollar would partly cancel the duty. It treats the elasticity as fixed, though loyal buyers may be less sensitive than the composite figure assumes. It also leaves out retaliation's political course: a measure imposed in a trade dispute can be raised, suspended or removed with little notice, which is why the recommendation is temporary and conditional.

References

Amiti, M., Redding, S. J., & Weinstein, D. E. (2019). The impact of the 2018 tariffs on prices and welfare. Journal of Economic Perspectives, 33(4), 187-210. https://doi.org/10.1257/jep.33.4.187

European Commission. (2018). Commission Implementing Regulation (EU) 2018/886 of 20 June 2018 on certain commercial policy measures concerning certain products originating in the United States of America. Official Journal of the European Union.

Krugman, P. R., Obstfeld, M., & Melitz, M. J. (2022). International economics: Theory and policy (12th ed.). Pearson.