Coffee, consumer choice, and the consequences of Columbus

Jonathan Hersh, Joachim Voth

03 September 2009

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What’s a cup of coffee worth to you? A lot, given the price of a “venti latte” at Starbucks. In this column, we argue that almost all coffee for sale today is a steal. Imagine a world without that morning kick from hot, caffeinated (and often sweet) liquid. How much would you be willing to pay to get it?

Instead of asking modern-day consumers to imagine a world without coffee, we go back to a time when coffee, tea, and sugar actually were new goods. Techniques for measuring the gains from newly imported goods have made progress recently (e.g. Broda and Weinstein 2006). Using historical data on prices and quantities for these “new luxuries”, we estimate their value to consumers. It turns out to have been very large. By 1850, English consumers were better off by 15-20% as a result of new goods. The Age of Discoveries boosted peoples’ well-being – not by changing the quantities or prices of goods that Europeans already knew in 1500, but by expanding the range of goods that consumers could buy.

Comparing these gains to more recent new goods, we find that – from a welfare perspective – sugar, tea, and coffee mattered more back then than did the recent introduction of the internet, computers, satellite television, and mobile phones combined.

The dramatic rise of colonial luxuries

Tea reached Europe from China in 1606, spreading to France in 1630, and finally to England in 1650 (Goodman 1995). Coffee spread through the Middle East and arrived in Europe in 1615. Sugar, available before 1500 in limited quantities, only became affordable once production centres developed in the Caribbean starting in the mid 17th century.
At first, these goods were luxuries rarely consumed by the lower and middle classes. Gradually, the real price of these goods began to fall, as the use of slaves on large-scale plantations in the Caribbean, advances in production technology, better shipping, and increased sophistication of trade networks all contributed to declining costs.

Figure 1 shows the real price of tea (left panel) and per capita tea consumption (right panel) for the years 1690-1850. The real price falls from 614 pence per pound in 1690 to 54 pence in 1850, a decline of 91% (Clark 2004). Consumption, not surprisingly, grows commensurately, starting at very low levels in 1690 (Forrest 1973) and growing to 2.43 lbs per capita per year in 1854-56 (Mokyr 1988). Both sugar and coffee exhibit a similar pattern; sugar fell from 32 pence per pound in 1600 to 5.7 pence, with consumption rising to a staggering 33 lbs per capita in 1854-56 (Clark 2004; Mokyr 1988). Far from being trivial expenditures, these goods grew to occupy a surprisingly large share of the average household’s budget.

Figure 1. Tea consumption, 1690-1850

By the end of the period, sugar, coffee, and tea constituted 7.2% of an average English household’s budget, and roughly 10% of their food expenditure (Horrell 1996). To put this in perspective, personal consumption expenditure on personal computers in the US in 2004 was only 0.6% of consumption expenditure, meaning that, by at least one metric, the average Englishman valued sugar more than the average American values his or her computer (Greenwood and Kopecky 2009). And neither were these goods reserved solely for the wealthy, as budget shares across incomes confirm these goods were broadly consumed across class lines (Horrell 1996).

Bread and butter (and beer) measurement: Real wages before 1850

Prior to 1700, the average European consumed 182 kg of bread and 182 litres of beer per year (Allen 1992). Half of all spending was on beer and bread, and fully three-quarters of all calories came from these two sources alone. The reason for massive beer consumption was simple – water was often contaminated. This was especially true in the cities. Brewed beer was safe. It is hence not surprising that it was consumed throughout the day, often with breakfast, and in all forms – including as beer soup in the morning (Schivelbusch 1992).

Prior to 1800, European consumption depended predominately on the price of grain. Even in the relatively dynamic northwest, real wages during the early modern period remain below the peak reached after the Black Death. Figure 2 shows real wages for England from 1400-1860, as calculated by Clark (2005) and by Phelps-Brown and Hopkins (1981). Following labour shortages brought on by the Black Death, real wages reached a peak in the 1450s. After 1500, real wages declined dramatically, reaching a low point in 1600 at between two-thirds and two-fifths their peak plague level. After 1600, real wages recovered somewhat, but growth was anaemic. Even in 1760, the canonical start date of the Industrial Revolution, real wages were significantly less they had been in the late Middle Ages.

Figure 2. Real wages 1400-1860

The consumption basket underlying both of the series in Figure 2 is largely static and dominated by the price of wheat. To be fair, one series eventually begins to track the prices of some of new goods, but this is well after their introduction. Thus, it misses what was potentially the largest gain – the change from not being able to purchase a good at any price to being able to purchase it at the observed price. Furthermore, nowhere in these measures are welfare gains from greater diversity captured.

Getting welfare gains right

The problem of accounting for new goods is not new. Both the Stigler Commission (1961) and the Boskin Commission (1996) noted that there is a new product bias in the Consumer Price Index. This occurs when new products are either not added to the CPI or are included only with a long lag. There are now several approaches to deal with these problems; we use one that is particularly suited to the challenges of our dataset.

One method pioneered by Hausman (1996) looks at the welfare gain from the introduction of Apple-Cinnamon Cheerios, a relatively marginal improvement of the art of breakfast cereals. He still finds a welfare gain equivalent to 0.002% of 1992 consumption expenditure. Other scholars have looked at gains from the introduction of the minivan (Petrin 2002), online booksellers (Brynjolfsson et al. 2003), and satellite TV (Goolsbee and Petrin 2004), finding significant gains. Most of these methods rely on household level data for adoption rates and price variation across consumers – data requirements that are exacting in an historical context.

Greenwood and Kopecky (2009) introduce a method that makes less stringent demands of the data. Their approach is more macroeconomic and requires aggregate data on prices and take-up rates of a new consumption item. When working with historical data, this is an advantage. They calculate welfare gains by estimating the value of the first unit of a new good. Effectively, they ask which degree of preference for the new good can be inferred from changes in consumption patterns in the aggregate, given a known path for quantities consumed and prices. It is their measurement approach that we implement with our historical data.

Equivalent variation (EV) is the amount of additional income you would have to give to a consumer so that his or her welfare without the new good is equivalent to that obtained with the good. Our results for 1850 show a gain of 8.0% for sugar, 7.9% for tea, and 1.5% for coffee. Combined, this implies that the average Englishman’s welfare was improved by 17% through the addition of these three goods alone. At a technical level, the reason why we find such a large gain is that English citizens consumed much more tea, sugar, and coffee even when the price had only fallen by a little, shortly after the introduction of the good. This means that the reservation price – the price that would set demand to zero – is quite high. Consequently, towards the end of the early modern period, when prices were much lower, consumers could reap a huge windfall. They could buy goods they valued enormously for a song.

Our analysis is complicated by the vagaries of the data. Smuggling for some of the goods was rife. Data is particularly scattered in the early years of adoption. Tariff changes and wars influenced volumes consumed. We attempt to account for all of these factors and find that our results are unaffected. As a further robustness check, we adopt an alternative “short-cut” method suggested by Hausman and find welfare gains of 13.5% for sugar and tea alone.

We think of our results for tea, sugar, and coffee as a lower bound on the discoveries’ overall effect. They stand pars pro toto for a wider range of “new goods” that arrived on European shores as a result of overseas expansion. The addition of tomatoes, potatoes, exotic spices, polenta, and tobacco transformed consumption habits in even more fundamental ways than did sugar, tea, and coffee. If the rise in consumption of all of these colonial goods was measured accurately, welfare gains for European consumers after 1492 would have been even larger than our findings suggest.

Conclusions

There is a broad consensus that living standards stagnated for millennia before the Industrial Revolution. Only after the “Malthus to Solow” transition (Hansen and Prescott 2002, Galor 2005) did welfare start to increase. Clark (2007) concluded that the average Englishman in 1800 lived no better than their ancestors on the African savannahs. We argue that stagnating long-run real wage indices partly reflect measurement error. Life in early modern Britain got better – much better. By the 18th century at the latest, consumption habits had undergone a profound transformation. Previously unmeasured welfare gains added at least 15% to the income of Englishmen by 1850.

Table 1. Impact of new goods on welfare

Good Welfare gain Year Source
Modern goods      
Apple Cinnamon Cheerios 0.002% 1992 Hausman (1996)
Personal computers 3.5-4% 2004 Kopecky & Greenwood (2009)
Minivans 0.03% 1988 Petrin (2002)
Satellite TV 0.04-0.06% 2001 Goolsbee & Petrin (2004)
Internet 2-3*% 2005 Goolsbee & Klenow (2006)
Mobile phones 0.46-0.9% 1996 Hausman (1999)
       
Colonial Luxuries      
Sugar 7.58-8.03% 1600-1850 this study
Tea 7.28-7.85% 1600-1850 this study
Coffee 1.45-1.54% 1600-1850 this study

Notes: Welfare results from this study are generated using Clark data wiht preferred p calibration. * for linearization case.

Table 1 compares welfare gains for recently introduced new goods with our results. Minivans, satellite TV, the internet, and mobile phones have made life better. The single biggest addition to welfare comes from the introduction of personal computers, credited by Greenwood and Kopecky with a gain of 3.5-4% of consumption expenditure. Compared to these figures, the gains for coffee, tea, and sugar look very large. This is partly because there were so few goods at the time. In an age when beer and bread dominated diets, just a bit of caffeine and sugar made life a lot sweeter. New Apple-Cinnamon flavoured Cheerios may cheer aficionados for this particular type of cereal. Yet being able to replace beer soup, porridge, and cold cuts with milky, sugary coffee and bread with jam was arguably much nicer. In addition, exotic new goods from the Americas and the Far East – pepper and nutmeg, tea and sugar, coffee and tobacco, chocolate and cloves – improved living standards by far more than modern consumers, sated by an ever-expanding range of new goods, can readily appreciate. The reason why seemingly mundane goods like sugar, coffee and tea made a big difference to living standards is that life was not just “nasty, brutish, and short” at their time of introduction – it was also (in culinary terms) grey, boring, and bland.

References

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Topics:  Development

Tags:  coffee, consumer choice, welfare gains

PhD student in economics, Boston University

UBS Professor of Macroeconomics and Financial Markets, Department of Economics, Zurich University

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