Creating a Realistic Econometric Model
For the World Coffee Economy
By: Ted R. Lingle
Econometric modeling can be a highly effective tool to carry out simulation analysis
related to plausible supply management policies by coffee producing countries. Both the
International Coffee Organization (ICO) and the Association of Coffee Producing
Counties (ACPC) have been working on developing new models to assist them in
developing greater understanding of the dynamics of the world coffee market. Historical
data clearly shows that both quality and price play a role in creating consumer demand for
coffee. Many organizations in the coffee trade, including the Specialty Coffee
Association of America (SCAA), have lobbied the ICO and ACPC to include a quality
dimension in their new models. While both the ICO and ACPC acknowledge the link
between quality and consumption, they were reluctant to adopt a new view coffee as a
differentiated product rather than the traditional view of coffee as a commodity.
Consequently, the underlying question concerning their new work in econometric
modeling is simply, does it go far enough in creating a “real life” econometric view of
the dynamics of the coffee industry?”
What makes this third dimension of hedonic attributes so critically important for a
consumable product, such as coffee, is that it is the basis for recognizing that coffee is not
a true commodity. Coffee fails the true test of a commodity that requires a product to be
a one-for-one substitute for any other similar competing product, such as the case with
sugar. Just as the market place recognizes this reality every day through “differentials,”
the econometric models need to take this aspect of coffee into their calculations as well.
In predicting future demand and price levels for coffee, it makes an enormous difference
whether the increases in supply will be created by growth in the available quantities of
well-prepared mild Arabicas or poorly prepared Robustas. A well-conceived model
should be able to make this non-substitutability factor part of the simulation analysis.
In order to understand how this concept of adding a hedonic dimension to an econometric
model would work, it is necessary to start with a few simple numbers. First, let us
assume: (1) total world coffee production is 100 M bags; (2) total world consumption is
also 100 M bags, with 75 M bags used by consuming countries and 25 M bags used by
producing countries; and (3) total world stocks remain constant at 25 M bags. This is
approximately the situation in today’s coffee market. Second, let us add the hedonic
factors: (1) Arabica production is 60 M bags (including 8 M bags of specialty coffee,
while Robusta is 30 M bags; and (2) “triage” represents 10 M bags of the annual coffee
production and consumption. And third, let us assume that these would be “equilibrium”
conditions that result in a constant price, barring any changes in either supply or demand.
(Author’s note: “Triage” is defined as anything mixed in with coffee that does not
“substantially transform” chemically during the roasting process in a manner similar to a
normal coffee beans. In Brazil these coffees are identified as “PVA coffees.” Most
specifically it includes black, immature, and fermented beans that retain a much higher
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than normal concentration of DiCQA (form of chlorogenic acid) that imparts a highly
displeasing sour and bitter taste to brewed coffee. An estimate of triage production by
individual country for the 1999/00-crop year is given in the accompanying table.)
Two-dimensional econometric models deal only with the first assumption. Simply put, if
the world supply increases to 105 M bags, without a corresponding increase in demand,
then the world surplus with grow by the excess 5 M bags, causing a decrease in price
levels. Conversely, increases in demand without corresponding increases in supply will
lead to decreasing stocks and higher prices. While this methodology may effectively deal
with a statistical model anticipating the growth of new coffee markets in Asia and Eastern
Europe, it offers little in the way of analysis for establishing supply management policies
for the current market.
The hedonic dimension adds a more “real life” aspect to the model. Let’s first examine
the physiological aspect of Robusta coffees, as pertains to their caffeine content. Studies
have shown that there is a direct correlation between the amounts of coffee consumed by
individual drinkers and the level of caffeine their blood stream. In essence, all coffee
drinkers regulate the amount of coffee (and caffeine) they ingest in order to maintain a
desired level of caffeine in their systems. Since Robusta coffees contain twice the
amount of caffeine as Arabica coffees, a typical four-cup per day drinker of Arabica
coffees would become a two-cup per day drinker of Robusta coffees. Empirical evidence
of this aspect of coffee consumption is readily available in the Northern European
countries that exhibit high levels of coffee consumption and correspondingly low levels
of Robusta usage. It is also demonstrated by the recent German experience of declining
coffee consumption linked with higher levels of Robusta usage – emulating the
experience in the US market. Thus, hedonic analysis would create a model in which
continued increases in the percentage of Robusta production relative to the total market
would inevitably lead to lower consumption levels, greater surpluses, and lower prices. It
could also forecast the trend for increasing differentials between Arabica and Robusta
coffees, as the former becomes more highly valued than the latter.
This same concept holds true for the use of “triage” coffees as well. If one accepts the
assumption that the majority of “triage” is used for “local consumption,” then the model
would show that: (1) while “triage” accounts for 10% of total world production and
consumption, it represents less than 3% of coffee exports; whereas (2) it accounts for
40% of the coffees retained for local consumption, i.e. 10 M bags of the 25 M bags
consumed internally. (Unfortunately, since statistical data is not available for exports of
various grades of coffee, actual use of “triage” coffees can only be based on estimates.)
However, it is easy to understand why consumption continues to lag in many producing
countries, and why promotional efforts in producing countries have often met with
failure, except in Brazil where their “Purity” campaign has been a resounding success.
With producing country domestic consumption representing one fourth of the world
coffee market, a sophisticated econometric model would show the significant financial
impact of finding alternative uses for these “triage” coffees. In the Americas for example,
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if just 4 M bags of triage coffees were removed from the market place, resulting in an 8
M bag increase in producing country consumption – 4 M bags as replacement and 4 M
bags in the growth of domestic consumption, average coffee price levels for both Arabica
and Robust would increase substantially. A good econometric model could project how
much as well as which countries would be impacted most significantly. The models
would also show how retention schemes for low-grade coffees in developing markets
could be more effective than the non-sustainable retention schemes for high-grade coffees
in established markets.
Hedonic analysis would also uncover specific situations that were adversely impacting
growth in consumption. The assumption that “triage” is consumed in local markets does
not hold true for all producing countries. For example, the ten-year growth in the
production of Vietnam Robusta coffees has resulted in 7 M bags of Robusta coffees
added to the market, but it has also created a growth of approximately 1.5 M bags of
“triage” coffees, of which over 1 M bags end up as exports. A three dimensional
econometric model would show when and where this was too much “DiCQA” in coffee
beverages, which lead to declining consumption in those markets where it is used, and the
model could also suggest effective supply management policies to deal with the specific
consumption declines that excessive exports of “triage” coffees were creating.
The world coffee economy needs an effective tool for econometric modeling. It is a key
element in any strategy to increase the value and volume of coffee consumption
worldwide. Two-dimensional models of the past are no longer suited to the “real life”
contingencies of today’s world in which the consumer is learning to view coffee as a
differentiated agricultural product similar to wine. Consumers no longer regard coffee as
a commodity, and therefore it cannot be managed as one. The role of both the ICO and
ACPC should be to create the most sophisticated econometric models available, and then
to provide as much meaningful and accurate statistical data as possible, so that the supply
management policies coordinated on a worldwide level serve both the needs of producing
and consuming countries.
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