The Economics of Geographical Indications
|Chapter 3 – GI Club Statics (Quality Exogenous to the Firm)
Texte intégral
3.1. Abstract
1In this chapter, the same model outlined in the previous chapter is developed in a static framework to determine the optimal size of the GI club, in terms of output, membership, and its optimal financing. The model considers the reputation of the GI as a localized club asset for the firm, with partial exclusion (outsiders to the GI region are excluded from its benefits) and no, or partial, rivalry in benefits among insiders. It is shown that under partial rivalry in benefits, both output and membership are reduced with the subsequent allocative and competitive effects, in an equilibrium that approaches the cartel equilibrium. The geographical confinement of output is demonstrated to impact factor prices and quantities. State subsidization is shown to lead to potential inefficiencies stemming from price and incentive distortions.
3.2. Introduction
2A judgment by the European Court of Justice in 2003 on non-Parma controlled slicing and packaging of Parma ham ruled that if the product specifications of a GI included slicing and packaging at the place of origin, then supermarkets were prevented from reducing costs by slicing and packaging the ham themselves (ECJ 2003).
3This chapter complements the dynamic analysis of the previous chapter with a partial equilibrium static framework, on the assumption that a standard of quality is applied exogenously within a GI club. This assumption is reasonable for most GI labels – particularly for European appellations of origin, which have product specifications detailed up to the slicing and packaging procedures – but for well-established GIs from developing countries as well, as minimum standards of quality are often imposed very early in the process of GI consolidation as a first best policy to avoid free-riding (Cf. model in Chapter 2).
- 28 In the model of the previous chapter, if q is exogenously set at q, the model becomes one of perfec (...)
4Shapiro established the superiority of minimum quality standards in 1982, which, as shown in the literature review, has been a consistent finding in recent papers on reputation. Shapiro’s first and second theorems (1982, p. 23-24), which apply under broad assumptions, state that “if consumers expect the firm to produce at the perfect information profit-maximizing quality level, it will be optimal for the firm to produce a lower quality” (Theorem 1, p. 23), and that “any self-fulfilling quality level lies below the perfect information quality level”, qopt (Theorem 2, p. 24).28 He goes on to clarify that, under the self-fulfilling quality level, “the monopolist earns lower profits (…) than he would under perfect information” (p. 25). Correspondingly, if he could commit himself to producing qopt, and could signal this commitment (through, for example, a warranty of the “satisfied or reimbursed” type), he could do better (p. 25). Shapiro thus concludes that “the incentive to provide warranties does not arise from competitive pressures, but rather from a desire by the monopolist to commit himself” (p. 26).
- 29 The GI is an asset rather than an input due to the fact that it is not consumed over the production (...)
5Building on these early findings, the reputation of the protected GI is still considered as a club asset,29 but reputation is assumed to depend on both quality and other factors. Quality is now taken as exogenous, and a static partial equilibrium framework is developed, where the GI is subject to potential dilution phenomena
6The focus of the chapter is on the optimality conditions for the provision of reputation, output, membership, and the club finance mechanism under non-rivalry and under partial rivalry due to dilution phenomena caused by crowding and over-supply. Several extensions are proposed regarding the potential capacity limitations due to the geographical confinement of production of the GI good; State subsidization of GI-related costs; and competition concerns such as cartelization and oligopolistic competition. Finally, issues regarding potential monopsonistic concerns and the replication of GIs are briefly sketched.
3.3. Model set-up
7The inverse demand function p(R) is assumed to increase with reputation R(PR > 0 and pRR < 0). Reputation is assumed to be linked to quality q but not one-to-one, in contrast with the previous chapter. Instead, reputation is assumed to be affected by quality and by other activities financed by the GI club such as advertising, lobbying, marketing, research and development, administration, promotion, standardization processes, conformity assessment facilities, legal costs, etc. The choice variable for the GI club is reputation R through a cost-sharing function G(R) that includes setting a minimum standard of quality
8and other expenses. Regarding supply, the assumptions are that club membership N consists of identical profit-maximizing firms, all facing complete markets for inputs and using the same technology, and that the geographical confinement of production imposes a limit on total output, which cannot exceed a fixed level
9Costs for the firm are production costs with
10and the firm’s share of GI-related costs G(R)/N. The choice variable for the firm is the level of output x.
- 30 “Congestion” or “crowding” are two words used in the literature on the theory of clubs. For a GI, t (...)
11In this context, a potential “congestion” phenomenon30 will manifest through a downward shift in demand, caused by dispersion in quality and dilution of the GI reputation. The dilution function is embedded in the demand function. Three scenarios are explored:
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Dilution caused by increased membership N;
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Dilution caused by an increase in total output X; and
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Dilution caused by both.
- 31 In standard consumer club theory, the toll or tax per unit of output corresponds to the “visitation (...)
- 32 The questions regarding exclusion costs for non-legitimate GI users are addressed in Chapter 4, wh (...)
12It will be shown that depending on the congestion function, payments will involve a fixed “membership fee” per firm G/N = m, a toll or tax per unit of output, G/N = tx,31 or a combination of the two G/N = m + tx. Following traditional club theory, the membership fee and toll are considered in this model to determine the entry of potential legitimate club members and, ultimately, club membership N.32
3.4. Club optimality conditions
3.4.1. Non-rivalry in benefits
13Following standard club theory, maximization occurs at the firm level, with values at the aggregate defining club choices. Demand and GI-related costs are assumed to increase with reputation, firm-level production costs increase with output and quality. For clarity, firm subscripts are dropped, lower case letters refer to quantities for the firm, capital letters to aggregates, and subscripts to partial derivatives.
14A representative firm maximizes profits with respect to its choice variable, output x, subject to the constraints that profits be non-negative and that total output does not exceed the absolute total determined by the geographical confinement of production
15Reputation R is a choice variable for the club, through G(R):
16The first-order conditions with respect to reputation, output and membership are:
Figure 3.4.a: GI club optimality conditions, non-rivalry

Figure 3.4.a shows the optimality conditions under non-rivalry for a given membership Ñ, in the case of a linear G(R) function. The Samuelson condition holds through the reputation condition (top right quadrant), which determines GI-related expenses. The output condition (top left) reflects marginal cost pricing. The membership condition is not binding (not drafted). The constraints (non-negative profits and limit on total output) determine the range for club membership N. The cost of provision of GI-related services is internalized by the firms through the membership fee m G/N. The shaded areas correspond to firm production costs, profits, and GI expenses.
17The conditions with respect to reputation R and output x have to be fulfilled simultaneously at the optimum. There is an optimal level of R that must reflect how much all firms would be willing to pay to get one additional unit of R, which defines its optimal level of provision. The reputation condition equates, at the club level, the marginal return from a one-unit increase in reputation (the increase in demand price times total output, pRX) to its marginal total cost GR. This is the traditional Samuelson condition for public goods, which holds for club goods as well. Under non-rivalry in benefits, GI-related expenses are determined exclusively by the reputation condition; the assumption of decreasing returns of the investment in the GI reputation pRR < 0 ensures that provision is limited to a positive value. The membership fee m = G/N ensures that the cost of provision is internalized by the firms. The output condition follows the standard efficiency condition of marginal cost pricing.
18The membership condition is not binding. The range for the club membership N is determined by the two constraints that profits be non-negative and that total output do not exceed the capacity limitations inherent to the geographical confinement of production of the GI good. These constraints always apply but will be omitted from now onwards.
19Figure 3.4.a depicts the situation for a given level of membership, set (arbitrarily) at N. The two top quadrants give the solutions to the output and reputation conditions respectively, given Ñ. The lower left-hand quadrant gives the range for membership. In this example, for simplicity, G(R) is assumed to be linear. The shaded areas correspond to firm production costs, profits, and GI-expenses.
3.4.2. Partial rivalry in benefits
a) Dilution by crowding (increase in the number of producers)
20Let’s assume an increase in the number of firms producing the GI good (increase in membership N) implies dispersion in quality and thus the dilution of the reputation of the GI with the corresponding negative effect in price. In this variant of the main model, it is assumed that both the inverse demand function and GI-related costs are a function of membership, with pN < 0.
21A representative firm maximizes profits with respect to its choice variable, output x, subject to achieving non-negative profits and a total output that does not exceed the capacity limitation (omitted below). Reputation R is a choice variable for the club, through G(R,N):
22The first-order conditions are:
23The output and reputation conditions are identical to those found under non-rivalry; the Samuelson condition holds and there is marginal cost pricing, actual levels of output and reputation, however, differ. In addition, the membership condition (FOC with respect to N) is now binding for within-club optimality: it equates the marginal cost owed to crowding at the firm level
24 to the saving owed to cost-sharing, a reduction of the fee
- 33 If
25Note that by assumption pN < 0, but while GI-related costs are likely to increase with membership (in which case GN > 0), this need not be the case.33
26The membership condition then determines the level of membership N through the fee m, which must compensate for the marginal cost owed to crowding at the aggregate level (m = GN – pNX). If both these crowding effects are important (i.e. if GN >> 0 and –pNX >> 0), there will be an incentive for the club to impose high membership fees to limit the number of firms operating in the GI terroir, leading to a higher market concentration (profits must be non-negative), with the corresponding negative competitive effect.
27Total expenses G(R) are determined jointly by the reputation and the membership conditions. With crowding through N, the constraints (non-negative profits and capped total output) impose restrictions on firm-level and total outputs, but club membership is determined by the membership condition.
Figure 3.4.b: GI club optimality conditions, partial rivalry through crowding

Figure 3.4.b shows the optimality conditions under partial rivalry due to crowding, in the case of a linear G(R) function. The Samuelson condition holds through the reputation condition (top right quadrant). The output condition implies marginal cost pricing. The membership condition defines membership through the fee m which must equate the marginal cost owed to crowding in the aggregate. Total expenses G(R) are determined jointly by the reputation and membership conditions. The shaded areas correspond to club production costs, profits, and GI-related expenses. The figure is constructed so that the membership equilibrium level is the same as that of Figure 3.4.a, to show that under dilution due to crowding the equilibrium levels of reputation and club profits are lower than under non-rivalry.
28Figure 3.4. depicts the situation of dilution due to crowding. The top right quadrant shows the reputation condition at the level of the club. The top left quadrant indicates the equilibrium finance condition for the club. The shaded areas show club production costs, profits, and GI expenses. Under partial rivalry due to crowding (increase in the number of firms), the equilibrium levels of reputation and club profits are lower than under non-rivalry (Figure 3.4.a). The quadrant depicting GI membership relates two curves, the optimal level of membership given reputation and the optimal level of reputation given membership. Both curves are positively sloped (not necessarily linear). For the whole system to be stable, however, the latter must be steeper.
b) Dilution by oversupply (due to an increase in total output)
29Let’s assume now that the reputation of the GI is now affected by an increase in total output (X = Nx). This time, it is assumed that the inverse demand function and GI-related costs are a function of total output, with px< 0 and no particular assumption regarding Gx. The firm will again maximize profits subject to the same constraints (non-negative profits and limit to total output), but the case of partial rivalry through total output is assimilated to a case of monopolistic competition:
30The first-order conditions are:
31The GI-provision/reputation condition remains the same (Samuelson condition). The membership fee is replaced by a toll per unit of output t that also redefines the output condition and leads to efficiency in production according to marginal cost pricing as in the previous model, with full internalization by the firm of the negative externality that its increase in output confers to all members. The toll is aimed at limiting total output, not the number of firms operating within the GI-club, but membership N will be defined indirectly by the production technology (through the output condition) and the condition that profits be non-negative. Dilution through output has thus a competitive effect. The three conditions must be met simultaneously for an optimum.
32Figure 3.4.c depicts the situation for a simplified scenario in which the congestion function is only included in the inverse demand function (and not in GI expenses). This dilution phenomenon implies a concave inverse demand function as of some level of output (top left quadrant). To facilitate comparisons, the figure is drawn such that the optimal membership N* equals the membership selected arbitrarily for Figure 3.4.a (N* = Ñ. The toll, internalized in the output condition, implies a lower level of output per firm, and thereby a higher GI-related fee per firm in comparison with the non-rivalry case, as the curve for GI-related expenses per unit of output is steeper. The shaded areas show that under potential GI dilution, profits per firm are lower. The quadrant depicting GI membership relates two curves, the optimal level of membership given reputation and the optimal level of reputation given membership. Both curves are positively sloped (not necessarily linear). For the whole system to be stable, however, the latter must be steeper.
Figure 3.4.c: GI club optimality conditions, partial rivalry through oversupply

Figure 3.4.c depicts dilution through an effect of total output in inverse demand function (but not in GI expenses). The output and the membership condition imply the adoption of a tax/toll per unit of output. The shaded areas show that profits are lower than under non rivalry.
c) Dilution by crowding and oversupply
33Table 3.4.a compares the situation with and without potential dilution phenomena, under the assumption that both total output and membership affect inverse demand and GI-related costs.
34The output and GI-provision conditions remain the same. The optimal cost-sharing of expenses G, which, together with the output condition, determine membership, includes both a membership fee (fee per member, that is) and a toll per unit of output. The three conditions must be met simultaneously for an optimum. Under this scenario, the optimal club pricing mechanism is designed to affect both total output and membership (the latter directly through the membership fee and indirectly through the output condition).
3.5. State subsidization
35GI-related costs are often partially subsidized by the State. In the hypothetical case of the subsidization of all GI-related costs, club firms do not internalize the costs of the GI, but still benefit from the mark-up allowed by the GI’s reputation. In this extreme situation, firms would not efficiently bank on the value of the GI; rather, they would capture a rent allowed by subsidization, to the detriment of taxpayers. Thiedig and Sylvander (2000) point out that “most of the prime costs of [GI] clubs were already paid by the generations that founded the reputation”, but also add that establishment, maintenance, and exclusion costs differ from country to country (p. 435).
- 34 Ordonnance n° 2006-1547 of the Ministère de l'Agriculture et de la Pêche, 7 December 2006.
36In France, prior to 2006, a parafiscal tax charged to GI producers on output volumes covered less than 20 per cent of the budget of the former Institut National des Appellations d’Origine (INAO) (Thiedig and Sylvander 2000, p. 435) – the balance was financed by the Ministry of Agriculture (p. 434). Since December 2006, INAO has become the Institut National de l’Origine et de la Qualité, and in addition to administering the French AOs and GIs, it controls the labels on Spécialité Traditionnelle Garantie, Agriculture Biologique, and Label Rouge (for meat). INAO’s budget in 2009 was EUR 20.5 million, with 75 per cent still financed by Ministerial endowment, 20 per cent by fees collected on production, and 5 per cent through its own resources.34
37A few authors argue that GIs fulfil a social role in promoting rural development, protecting consumers, rewarding indigenous peoples, and so forth (Rangnekar 2003b; OECD 2000), thereby justifying public “provision” – i.e. public financing – of establishment, maintenance, and exclusion costs (but the argument is polemical).
38There is, however, a less sensitive issue that exhibits broader consensus – the subsidization of expenses related to the enforcement of protection. As Thiedig and Sylvander (2000) point out, the costs of perfect exclusion could be exorbitant for a single club: “a protection level of the French AOC Champagne could not be financed by a club itself, just imagine the number of inspectors needed to monitor all retailers in the world” (p. 435). They conclude that “inspection costs are so enormous compared to profits that GIs will be provided only if they are borne by the public” (p. 435). Similar arguments apply to enforcement expenses for other IPRs such as trademarks, patents, and copyrights. This is an issue that is not easily resolved with regard to its welfare implications. The blurrier the frontier between enforcement and other GI-related costs, the more controversial the issue becomes. For example, in court, the State is usually involved in the protection of a particular GI, while the enforcement of trademark protection is usually the burden of the owner (Escudero 2001). Once a GI is protected, enforcement structures have a deterrent effect on impostors. This issue is partially addressed in Chapter 4.
3.5.1. Full subsidization, non-rivalry
39Efficiency is achieved as long as the provision condition is fulfilled by the State. Assume that the State subsidizes the entire amount of G necessary to achieve the required reputation level R , and therefore p(R), such that the Samuelson condition is fulfilled:
Reputation condition : GR = pRX
40Firms will set output according to profit maximization, subject to non-negative profits:
41Under non-rivalry, the output condition leads to marginal cost pricing, regardless of whether GI firms are charged a membership fee or whether GI-related costs are subsidized. However, the caveat with subsidization is that the firms’ average costs are reduced, which implies that firms capture a pure rent equal to the membership fee, to the detriment of taxpayers, with the consequent welfare implications. The reputation of the GI becomes a pure public good for the GI firms. In addition, when costs are not internalized by the beneficiaries following a pricing in accordance with the Samuelson condition, the likely outcome is the under-provision of the GI asset, reputation, as the incentive for the State to provide it diminishes with its limited or non-existent return.
3.5.2. Partial rivalry
42A more realistic scenario is that of partial State subsidization, up to a share s of total GI-related costs, in a context of potential dilution. If GI-provision is determined by the original function under non-rivalry, and dilution costs are not internalized by the firm, there will be room for increases in output, due to lower average costs, with the consequent effect on price. To ensure the correct representation of the incentives, the entire function must be re-optimized, although the result is not an optimum.
43This becomes a two-stage game. In the first stage, the State assesses what the firms and the club will do given a certain expenditure on GI-related activities. In other words, the state solves for the equilibrium x° and N°, given Ḡ, and provides for the optimal level of G based on the reputation condition. In the second stage, firms optimize according to the State’s anticipated results, although the output levels decided by the firms and the pricing mechanism decided by the club will consider the subsidy. The three conditions have to be met simultaneously for an optimum:
44The optimal cost-sharing decided by the club, after discounting the subsidy, once again includes a membership fee and a toll per unit of output. However, the marginal costs owed to crowding on the side of the G function are not internalized (they are “equated” to zero, although they are not zero); only the impact of output and membership on the price is internalized. If GN or Gx are low, the impact of subsidization on the pricing mechanism is lower. In addition, |pNX| and |pXX| are higher than in the absence of a subsidy, as firm-level average costs are lower (due to a lower m° and a lower t°), inducing a higher output which retro-feeds into a lower p.
45The final structure of the cost-sharing function depends on the partial derivatives of G and P with respect to N and X. The likely outcome is that both the fee and the toll will be lower under subsidization, while output and membership will be higher, and the firms will receive a rent. State subsidization leads to inefficiencies with allocative, competitive, and welfare implications, due to the incentive for firms to employ additional resources to capture the rent offered by the State until complete rent dissipation is achieved. The problem is that, in such a situation, it is not clear whether an optimum can be reached. With State subsidization, there might be multiple equilibria.
46Feehan and Batina (2004) analysed the impact of a free access public input entering the production function of some private good. In their model, total output is inefficiently increased, which leads them to argue that “in the absence of (…) factor taxes, or their equivalent in the form (of) a direct user charge (…), it would be difficult to assess whether a congested public infrastructure is a signal of inadequate supply or is simply the result of excessive use due to free access” (p. 14). Their conclusion is valid here too: with State subsidization and partial rivalry, it is difficult to assess whether a low price of the GI good is a signal of inadequate investment in the GI and its reputation, or if it reflects the dilution of the GI caused by oversupply due to cheap membership.
3.6. Geographical confinement, GI saturation, and factor markets
47Thiedig and Sylvander (2002), citing Johnson (1988), note that “Champagne wine production stretches 24,500 ha and an additional over 4,800 ha are qualified”, and that “the price of land qualified to produce Champagne vineyard is about 25 times the price of normal wine growing land, a high price due to strict scarcity” (p. 432). They also point out that product specifications can create additional scarcity for factors that are otherwise not strictly dependent on land use (p. 432). The authors use that example to illustrate that GIs often “support monopolistic action by limiting the production factor land, a natural restriction might force the output left of optimum and lead to a suboptimal situation” (p. 432).
48With a strong level of protection, the GI is produced exclusively by the firms in the GI locality. Also, as previously discussed, most GIs are linked to agricultural products, for which, due to the geographical confinement of GI production, land is a resource in finite (fixed) supply. Assume that land l is a non-mobile factor in finite supply, fixed at
49with a price r. Other inputs such as capital and labour are represented by k and assumed to be in infinite supply at an exogenous price of
- 35 This is a strong assumption, as know-how is essential to the success of a GI.
50,35 and x(l, k) is a linearly homogenous production function. Only the non-rivalry scenario is explored, although the analysis is easily extended to include congestion/dilution functions:
51The output condition is obtained by setting the FOC with respect to l and k to zero; it remains the standard marginal cost pricing. As long as the land available is not entirely exploited, the optimality conditions remain the same. As supply increases following increases in demand, however, higher levels of output (higher isoquants) are reached by acquiring and hiring additional inputs in amounts that equate their marginal rate of technical substitution to their relative prices. Once land capacity
52is reached, land becomes scarce, and factor relative prices have to adjust to reach higher isoquants with less land and more of the other inputs. The price of land starts rising in an inverse substitution effect. Land, not being mobile, differs in price within and outside the GI area. If GI firms are not vertically integrated (i.e. if they do not own the land), part of the GI rent is captured by landowners inside the GI area.
53Since input income shares are determined exclusively by technical considerations, land’s intensity of use, and its degree of substitutability with other factors, ultimately determine the path of its relative price. For example, assuming a Cobb-Douglas production function of degree 1 and marginal cost pricing, input income shares are constant, equal to their exponent in the function. If output increases, and the amount of land available is fixed, the price of land has to go up in order to keep its share in total revenue constant. The increase in r with total output is a function of the magnitude of the exponent of land in the production function, , the GI good price p, and available land
54Once land capacity is reached, the producer moves up the inelastic land supply curve, hiring other factors and affecting relative factor prices. Indeed, this is a source of sub-optimality, since at the market prices prevailing at the border of the GI region, output could be much higher for the same total cost. Eventually, the sub-optimality will depend on the size of the demand for the GI product, the (generally small) size of the GI area, land factor-intensity of use, and factors substitutability.
3.7. Cartel and oligopolistic behaviour
55The OECD has had a permanent interest in competition issues within the agricultural sector and GI clubs in particular. In a report issued in 2000, the OECD notes that in April 1992, Cantal cheese producers’ 1987 plan that limited total supply was also found to limit competition. Some years later, in November 1996, the Italian Competition Council found the Parmigiano Reggiano and the Grana Padano Consortia guilty of restricting market competition through the adoption of a plan limiting total annual output via production and market allocation agreements among firms and the two consortia. A case against Gorgonzola was also opened in 1998 (OECD 2000). In January 1999, moreover, the Italian Competition Authority rejected the application by the Parma and San Daniele ham consortia for an extension of the authorization of production agreements that had been granted until 31 December 1998 under Article 4 of Law no. 287/1990. This decision was made on the grounds that after the protection of their products as appellations of origin in June 1996, production quotas were unnecessary and inappropriate with respect to the declared objective of conforming to the prescribed production methods, since special bodies performed these tasks under Italian and Community law (OECD 2005).
56Although there have been a few judicial cases involving uncompetitive practices within and among GI clubs, most OECD countries have explicit exemptions for the agricultural sector in the application of antitrust law. The 2005 OECD report includes 15 countries contributions; all exhibit some level of explicit antitrust exemptions for the agricultural sector. For example, EC law exempts agricultural goods from the prohibition of anti-competitive horizontal and vertical agreements, but not from merger control and abuse control provisions (Art.2.1(1) of Regulation 26/62 of 4 April 1962). Mexico has a general antitrust law exemption for cooperatives aimed at export markets, which in 2005 applied to 210 “integrating firms […] in the agricultural sector”. Similar provisions apply to agricultural products specifically in Australia and New Zealand (Trade Practices Act and Commerce Act respectively, though the latter has been dormant since its inception). In Norway, which is not an EU member, the Competition Act of May 2004 continued the agricultural industry’s antitrust exemption for joint selling. In the United States, exemptions from antitrust enforcement for agricultural cooperatives “to collectively process, prepare for market, handle, and market their products” have existed since 1922 under the Capper-Volstead Act, but are not extended to predatory or coercive conduct, or to mergers or collaborations with non-covered entities. Article 3 of the Swiss Act on Cartels contains antitrust exemptions for joint-activity organizations enumerated in article 8 of Swiss agricultural law, including measures to “adjust the offer to the needs of the market”. In Korea, the Monopoly Regulation and Fair Trade Act does not envisage exemptions, however legal exceptions and exemptions regarding agricultural cooperatives prevail. In Chinese Taipei, the agricultural sector is not exempt from the application of competition law, but both the Constitution and the Co-operative Act “require that the state encourage and facilitate cooperatives”.
57Despite the existence of a few judicial cases wherein GIs-related uncompetitive behaviour has been proved and sentenced, the prevalence of antitrust exemptions for the agricultural sector support the assumption that most cases of anticompetitive behaviour never make it to the courts. In the previous sections, it was assumed that firms were operating under perfect competition, with each firm behaving as a price-taker. This section looks at the allocative, competitive, and welfare implications of the constitution of a cartel by the firms producing a particular GI. The analysis is quite standard, and I will therefore consider the simplest case. It is assumed that there are only a few firms affiliated with a particular GI (small N), that said firms operate in a highly differentiated niche market or are large players in the market for identical and similar products, and that their total output impacts the price.
58This scenario corresponds with the assumption of congestion of the inverse demand function through over-supply. The difference between the cartel and previous models is that the G function is left unaffected by total output, and that output decisions are no longer decentralized; a cartel will maximize the profit function for the entire GI club and distribute output quotas accordingly:
- 36 MR can be written as a function of total output because its value is the same no matter which firm’ (...)
59The reputation condition determines the level of provision of GI services. The output condition gives the standard result of cartel behaviour: marginal revenue equals marginal cost, and production quotas are determined accordingly, within a limited range determined by the constraints on total output and non-negative profits.36 Firms benefit from a mark-up over marginal cost and increased profits, while firm and aggregate outputs are lower. Interestingly, the membership condition imposes the additional restriction that marginal revenue equals average cost, which can be interpreted as a long term efficiency condition (since marginal revenue equals marginal cost); but the membership condition is not binding regarding membership N in an oligopolistic situation, in which, rather, N is a given. Similar to the case of non-rivalry, only a maximum membership fee is imposed through the requirement of non-negative profits, which constitutes an additional cost to entry for potential competitors. If it is kept low, so that profits are indeed positive, the incentive for competitors to enter the market to capture rents is very real.
60Table 3.7.a shows the results once dilution is added. Strikingly, the decentralized decisions at the firm level in a club framework are very close (if not identical) to the centralized decision at the club level in a cartel framework. The only difference is that the membership condition is not binding for the level of membership in the cartel, and nor is, consequently, the finance condition (membership fee and toll). This is presumably due to the fact that as cartels operate for a given level of membership, fees and tolls do not need to internalize all potential externalities to reach the optimum. In any case, not only are cartels illegal in most of the world, they are unstable. This is predominantly due to the potential entry of competitors who seek to benefit from the cartel rents, but also due to within-cartel information asymmetries, collective action problems, and the incentive to capture rents through the expansion of output.
61Even when competitive behaviour is assumed, under certain market conditions the outcome might still differ from marginal cost pricing. For example, if, under oligopolistic competition, a club firm has some market power (due to a strong brand for example), the final outcome would be somewhere between the perfect competition and the cartel outcomes. The Cournot competition model reflects the best strategy a firm may adopt if it knows its market power (the effect of its output over price), but not the output decisions of its competitors. This situation is explored in Chapter 4. A similar result is obtained when GI firms gain a competitive advantage over their rivals through product differentiation schemes and branding. Once a firm invests in differentiation activities, the firm is not a price-taker anymore; it faces a downward-sloping demand curve. In addition to the condition that product differentiation activities should be pursued up to the point where their marginal revenue equals their marginal cost, profit maximization leads to the typical condition that marginal revenue equals marginal cost.
62Thiedig and Sylvander contend that “with a polypolistic behaviour the price will not even cover the total average costs and the product would not be supplied anymore” (p. 431). Their argument, however, is incomplete, since the new demand curve is drawn in accordance with the assumption of a substitution process in demand, but if the industry is competitive to begin with, as stated above, the shift in demand would be lower, and the new demand curve would pass through the point where average cost equals marginal cost. That said, it is true that a sudden change in the industry towards more competition would imperil the entire GI group. Following such a change, supply could be ensured only through a differentiation campaign that shifted outward the demand curve again, up to point where marginal cost equals average cost.
3.8. Other issues not developed formally
3.8.1. Monopsonistic behaviour
63Tequila (Mexico), in a recent paper, is associated with an almost endemic case of supply chain market failure (Bowen & Zapata 2009). In 1974, the GI for Tequila was the first to be given legal protection outside Europe, and it has become one of the most successful, having achieved recognition by the United States and Canada in 1993 and by the European Union in 1997. Production of Tequila more than doubled between 1995 and 2005, reaching 210 million litres. And yet, Bowen & Zapata demonstrate that the GI for Tequila has largely failed to benefit either the local population or the environment in its region of origin. As the market has been largely appropriated by transnational liquor companies, agave farmers have been excluded from the supply chain altogether, leading to increased environmental degradation, reductions in quality, and a gradual elimination of traditional practices.
64Briefly, these conclusions arise from the following documented facts:
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Tequila is made of at least 51 per cent blue agave, which is grown within a GI region of 11 million hectares. While the Tequila mixto is often sold in bulk and bottled outside of Mexico, the Tequila made from 100 per cent blue agave must, by law, be bottled within the GI region. The land reforms of 1917-1949 led small landowners, the ejidatarios, to supply the agave to the Tequila distilleries, often through intermediaries known as coyotes, who traditionally “buy at very low prices”. The 1992 amendment to Article 27 of the Mexican Constitution legalized the rental and sale of previous inalienable ejido (land), so that Tequila companies could increasingly integrate vertically to ensure their supply of agave. Only a small minority of the 12,000 ejidatarios were able to get contract arrangements, the first best option for small landowners in terms of income security.
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- 37 Intangible Business The Power 100 included two brands of Tequila in 2006 and four in 2009: Cuervo ( (...)
Even though 124 firms are registered to produce Tequila, four firms (Cuervo, Sauza, Herradura, and Cazadores) control approximately 67 per cent of the market, exacerbating the unbalance. The downside of success, as illustrated by Bowen and Zapata, is that “Tequila is evolving into a generic, mass-produced liquor; and the farmer knowledge, artisanal production practices, and environmental resources that are associated with the specificity and heritage of tequila are being degraded”.37
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In addition, numerous fluctuations in climatic, sanitary, and market conditions have made the market for agave extremely unstable. The average price of agave skyrocketed from MXN 1.57 pesos per kilogram in 1998 to MXN 19.08 pesos per kilogram in 2000, and back down to previous levels in 2006 (in real terms). Supply chain and State actors have been unable to coordinate supply and demand, or to establish a base price for agave.
65In 2005, the OECD issued a Report on a Policy Roundtable Concerning Competition and Regulation in Agriculture: Monopsony Buying and Joint Selling. The report singles out the support of a brand or an appellation (a GI) as one of the four “pro-competitive” reasons for joint-activities, together with economies of scale and scope, advertising, and research. As this statement applies to issues regarding reputation, quality building, and signalling concerns, however, the question as to “the extent to which competition within a [GI] consortium should be mandated” remains open (p. 114). The OECD begins by noting that “buyer power is a common concern of competition agencies examining the agricultural sector” (p. 97), and then goes on to outline prevalent anticompetitive practices in the sector, such as: cost-sharing for unbranded products; price-setting or quantity-setting joint activities, and their cartel-like monitoring mechanisms; bid-rigging; price asymmetries, and aberrations between farm gate and retail prices; potential anticompetitive effects of buyer-established quality standards; and imbalances in bargaining power due to market concentration in production and retail, among others. These practices are exacerbated by the fact that, as described above, the agricultural sector is usually exempt from the application of antitrust law to its full extent.
66The study of monopsonistic behaviour within the club goods model developed in this section is left for future research. This section will thus only outline a couple of themes that may be relevant to GIs, with reference to classic economic theory.
67First, monopsonistic power has been linked to monopolistic power. According to this theory, a dominant position in the procurement market can arise as a result of reduced competition in the sales market. Any firm that has market power upstream (with consumers) will usually have it downstream (with suppliers). According to this theory, any GI club with oligopolistic power will potentially have oligopsonistic power.
68Second, the agricultural sector, to which most of GIs belong, is prone to imbalances in bargaining positions, as indicated by the 2005 OECD Report. In this report, the United States observes that “historically, exemptions from antitrust enforcement have been created for labour unions and for agricultural cooperatives, in part based on the assumption that industrial employers and agricultural processors have monopsony power[…] According to the “countervailing power” theory, efficiency and consumer welfare may be enhanced by allowing exercise of monopoly power on the selling side to avoid input prices to depress below competitive levels” (OECD 2005, p. 180).
69Third, regulatory factors that limit input mobility can indirectly grant monopsonistic power to processors. This implies that the geographical confinement of production of GI goods might exacerbate eventual concerns over monopsonistic power of GI firms, with a correspondingly greater effect on the non-mobile factor, land. As demonstrated in the Champagne example, however, factor-owners in a context of market saturation and geographical confinement of output can expect higher rewards for their assets, thus granting factor-owners a natural “countervailing power”. Which of these two effects will eventually prevail is clearly a function of institutional and market conditions.
70A fourth source of oligopsonistic power is factors’ preferences regarding firm characteristics. GI firms might have local oligopsonistic power over factors (workers, landowners) that strongly prefer working for them as opposed to other firms.
71Fifth, from the perspective of competition law, it has been argued that vertical integration may reduce or eliminate inefficiencies due to monopsonistic power. This mechanism for, example, has been at play since the 1992 amendment to the Mexican Constitution that legalized the rental and sale of previous inalienable ejido, at the price of increased mass-production and loss of specificity and heritage (Bowen 2009).
3.8.2. Total economy view-point: the issue of GI replication
- 38 The Database of Origin and Registration of the European Commission – or DOOR Database – is a databa (...)
- 39 Technically, registration in the European system starts in 1996, but the Consortia and regulations (...)
72Under European Commission legislation, there are three categories of GIs (term taken in its general meaning, not to be confounded with PGIs): protected designations of origin (PDOs); protected geographical indications (PGIs); and traditional specialities guaranteed (TSGs). Until November 2012, according to the DOOR database,38Italy had 270 indications; of these, 37 were for meat products, and 9 for prosciutto crudo. First came San Daniele in 1961, then Parma in 1963 (the “Re dei Prosciutti”). These were so successful that they prompted other regions in Italy and abroad to build their own GIs around raw ham. Veneto Berico-Euganeo was registered in 1971, Toscano in 1990, Carpegna and Modena in 1996, all registered PDOs.39 Three PGIs were later added to the list: Norcia in June 1997, Sauris in April 2010 and Amatriciano in July 2011.
- 40 Unattributed quote reproduced in various internet sites, such as http://www.cellartours.com/italy/g (...)
73While not identical, all these raw hams are cured in the same fashion as the broader region, but, for example, San Daniele promoters claim that “it is the unique climatic conditions of the Friuli region, with its higher altitudes and drier air, that give Prosciutto di San Daniele its unique flavour and texture”, adding that “it is cured with the bottom part of the leg bone, in a feature that makes for a very rustic-looking ham”.40 This phenomenon of club “replication” exists in other sectors such as sparkling wine, wine, and liquors (Tequila and Mezcal both are made of agave), to name a few.
- 41 In the case of GIs and trademarks, the intellectual property right is linked exclusively to the nam (...)
74A GI club represents a particular variety. Although production processes could be exactly replicated, the GI name cannot be used as a signalling device by non-members, to say nothing of the fact that proponents of GIs often link quality to the terroir which is exclusive to each particular GI. However, close substitutes can exist; another region may invest in a GI variety of its own and compete in the same market segment.41
75A branch of the economic literature has studied club goods from the point of view of the total economy (please refer to Cornes and Sandler (1996) for an excellent overview). Suffice to say at this point that issues typically revolve around the optimal number of clubs, optimality and equilibrium for local public goods, heterogeneous consumers, mixed clubs, government provision, and so forth. This is yet another dimension in which the framework developed in this section could be expanded, which is left at this time for future research.
3.9. Concluding remarks
76In this chapter, in contrast to Chapter 2, quality is taken as exogenous, and a static partial equilibrium framework is developed wherein the GI is characterized as a localized club asset, with imperfect exclusion and non-rivalry in benefits, which can be subject to potential dilution phenomena (depreciation) due to membership crowding and oversupply. In this framework, GI-related expenses, output, membership, and club finance are all determined simultaneously. It is demonstrated that under partial rivalry in benefits, both output and membership are reduced, with the subsequent allocative and competitive effects, in an equilibrium set of variables that dangerously approaches the cartel equilibrium. State subsidization is shown to lead to potential inefficiencies stemming from price and incentive distortions. The impact of the geographical confinement of output on factor prices is also analysed. Finally, issues regarding potential monopsonistic concerns and the replication of GIs are briefly discussed, although the formal analysis is reserved for future research.
77The chapter does not directly address whether or not GIs should be protected (a normative issue), though it does provide a few insights that may prove useful to policymakers. Most papers on the economics of geographical indications focus on price premia, competing regimes (GI versus brands versus labels, etc.), or free-rider problems (with models assuming types, high/low-quality, etc.). This chapter aims at filling a gap in the literature regarding the economic and market structures implied by the legal protection of GIs at the international level under the TRIPS Agreement.
Notes
28 In the model of the previous chapter, if q is exogenously set at q, the model becomes one of perfect information where
At the optimum, qopt should be set at the (maximum) quality level at which p' = c'.
29 The GI is an asset rather than an input due to the fact that it is not consumed over the production process, but may appreciate (or depreciate) just like any other asset following an increase (decrease) in demand or in reputation (dilution).
30 “Congestion” or “crowding” are two words used in the literature on the theory of clubs. For a GI, the term “dilution” (used in the literature on branding) conveys a similar phenomenom.
31 In standard consumer club theory, the toll or tax per unit of output corresponds to the “visitation fee” charged to the consumer for each visit to the club.
32 The questions regarding exclusion costs for non-legitimate GI users are addressed in Chapter 4, which deals with the economics of GI protection and claw-back.
33 If
the membership condition is not binding anymore, and we are not in a situation of crowding or partial-rivalry anymore, as the negative effect in the price of the GI good and on firm revenues is more than compensated by a decrease in the cost of provision of GI-related services. In the previous case of non-rivalry, the marginal cost of a member was zero (pN = 0) and was therefore higher than the saving owed to cost-sharing (negative). For that reason, the membership condition was not binding.
34 Ordonnance n° 2006-1547 of the Ministère de l'Agriculture et de la Pêche, 7 December 2006.
35 This is a strong assumption, as know-how is essential to the success of a GI.
36 MR can be written as a function of total output because its value is the same no matter which firm’s output level is changed, because px = pX and Gx = GX in the cartel context (cf. Nicholson 2002, p. 529).
37 Intangible Business The Power 100 included two brands of Tequila in 2006 and four in 2009: Cuervo (Diageo), ranked 12; Patrón (Patrón Group), 34; Sauza (Beam Global), 36; El Jimador (Brown-Forman), 62. Diageo owns 13 Top 100 brands, including Smirnoff, Johnnie Walker, Baileys, Captain Morgan, J&B, Gordons, Tanqueray. Beam Global owns six, including Jim Beam, Teachers, Courvoisier. Brown-Forman owns five, including Jack Daniels and Finlandia.
38 The Database of Origin and Registration of the European Commission – or DOOR Database – is a database with information on all the protected designations of origin (PDOs); protected geographical indications (PGIs); and traditional specialities guaranteed (TSGs) of the European Union. The DOOR Database was accessed in November 2012 (http://ec.europa.eu/agriculture/quality/door). Out of a total of 292 GIs, 22 duplicates were found for Italy (not counted in the total); of the rest, 247 indications were registered, 10 published and 13 applied.
39 Technically, registration in the European system starts in 1996, but the Consortia and regulations at the national level were established much earlier for San Daniele, Parma,Veneto Berico-Euganeo and Carpegna.
40 Unattributed quote reproduced in various internet sites, such as http://www.cellartours.com/italy/gastronomy/italian-hams.html, and http://www.docstoc.com/docs/12483331/Italian-Food-Glossary.
41 In the case of GIs and trademarks, the intellectual property right is linked exclusively to the name, not to the product specifications. Although it is conceivable that some production process related to a GI good might be patented, this is unlikely (since GIs are based on tradition, potential patents rights are probably forfeited or unclaimed), and even if they were, patent protection would eventually expire. GI production processes are in the public domain.
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Titre | Figure 3.4.a: GI club optimality conditions, non-rivalry |
Légende | Figure 3.4.a shows the optimality conditions under non-rivalry for a given membership Ñ, in the case of a linear G(R) function. The Samuelson condition holds through the reputation condition (top right quadrant), which determines GI-related expenses. The output condition (top left) reflects marginal cost pricing. The membership condition is not binding (not drafted). The constraints (non-negative profits and limit on total output) determine the range for club membership N. The cost of provision of GI-related services is internalized by the firms through the membership fee m G/N. The shaded areas correspond to firm production costs, profits, and GI expenses. |
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Titre | Figure 3.4.b: GI club optimality conditions, partial rivalry through crowding |
Légende | Figure 3.4.b shows the optimality conditions under partial rivalry due to crowding, in the case of a linear G(R) function. The Samuelson condition holds through the reputation condition (top right quadrant). The output condition implies marginal cost pricing. The membership condition defines membership through the fee m which must equate the marginal cost owed to crowding in the aggregate. Total expenses G(R) are determined jointly by the reputation and membership conditions. The shaded areas correspond to club production costs, profits, and GI-related expenses. The figure is constructed so that the membership equilibrium level is the same as that of Figure 3.4.a, to show that under dilution due to crowding the equilibrium levels of reputation and club profits are lower than under non-rivalry. |
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Titre | Figure 3.4.c: GI club optimality conditions, partial rivalry through oversupply |
Légende | Figure 3.4.c depicts dilution through an effect of total output in inverse demand function (but not in GI expenses). The output and the membership condition imply the adoption of a tax/toll per unit of output. The shaded areas show that profits are lower than under non rivalry. |
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Titre | Table 3.4.a: Comparison non-rival versus partially rival GI clubs |
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Titre | Table 3.7.a: Comparison rival versus cartelized GI clubs |
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