Tariff Tantrum: China’s Shot in the Dark with EU Brandy Measures
China’s recent decision to impose tariffs on European brandy, particularly French brands like Hennessy and Remy Martin, could backfire. By adding a 30.6% to 39% tariff on imported brandy, the Chinese government is ostensibly targeting French producers in response to the EU’s tariffs on Chinese-made electric vehicles. While this might hurt some French producers and push imported brandy out of reach for many middle-class consumers in China, the elite, whose demand for luxury goods is price inelastic, will continue to purchase these products at higher prices.
The real issue, however, is the unintended boost this policy will give to China’s already thriving black market for counterfeit alcohol. Just as Hong Kong experienced after their significant tobacco tax increase in 2023, China could see a similar surge in black market activity. The move may end up inflicting more damage on China’s economy and public health than it does on French brandy makers. If we are to consider this “making a rod for their own back” thesis, we must start with one single point of departure; the brandy market in China is already an astonishing 70% in the hands of the black market (Brandyclassics.com, 2012) (noting I could not find more recent numbers — this was a 2012 study).
There are some interesting features of the brandy market in China that help us also frame this conversation, some of which I have experienced first-hand while living in Beijing. Firstly, the brandy consumption in China is about the fancy bottle and the brand name bottle; the quality of the contents matters almost not at all. The cachet that exclusive European brandy carries is almost exclusively a message, particularly cognac, of success and successful young professionals often build bars in their houses and stock them with luxury cognacs. Elites in the public sector likewise signal their stature with the same fancy bottles. But, again, what is in the bottle is far from central.
So, 70% of China’s brandy market was already out of reach of European brandies before this tariff, and many consumers don’t care about the quality of the actual brandy.
So where will it go from here? Some prognostications.
The Elite Will Keep Drinking, But the Middle-Class Won’t
Yes, these tariffs will make imported French brandy more expensive. A 39% tariff on a bottle of Hennessy, already priced as a luxury item, will place it far beyond the wallets of most middle-class consumers. However, the ultra-wealthy, who have a long-standing affinity for luxury goods, are unlikely to change their consumption habits. Studies have shown that luxury goods like high-end alcohols often maintain stable demand among elites, even when prices rise significantly. As the Financial Times reported, the “price inelasticity” of luxury goods consumption among the elite means they are more concerned with prestige than price, and French brandy will likely remain a symbol of status and wealth.
By making legitimate brandy more expensive, the government is essentially driving middle-class consumers into the hands of counterfeiters. One of the clearest effects of excise taxes, as highlighted in research on alcohol taxation, is their disproportionate impact on low-income consumers. When prices rise due to taxes or tariffs, lower-income drinkers are hit hardest, as they are less able to absorb the increased costs. This often drives them toward cheaper, lower-quality alternatives, which in China’s case likely means a significant shift towards counterfeit alcohol. The black market for counterfeit alcohol, already a major issue, could see a surge in demand as these consumers seek affordable options, increasing the risks of dangerous substances like methanol in the alcohol they consume. This mirrors findings from excise tax studies in other regions, where low-income groups bore the brunt of price hikes and were driven to riskier consumption behaviour.
This situation quite specifically mirrors what happened in Hong Kong following the 31% increase in tobacco tax in February 2023. Just as legal cigarette prices skyrocketed, pushing consumers toward the black market, middle-class Chinese consumers will be priced out of legitimate brandy and likely turn to counterfeit products. The surge in illegal trade that Hong Kong experienced, where authorities seized over 191 million untaxed cigarettes, serves as a warning for China’s future under this new tariff regime.
Counterfeit alcohol is not only a public health risk but also an economic one. Methanol poisoning, for example, is a real danger in China’s black market alcohol trade. In a 2019 case, several people died after consuming fake alcohol containing methanol, a substance that can cause blindness, organ failure, and death.
Elites in China will not suffer from the price hikes on imported brandy, such as Hennessy and Remy Martin, because their demand for luxury goods is almost entirely price inelastic. Even with significant tariffs and price increases, their purchasing behaviour remains unchanged. For the wealthy, brandy is a status symbol, and their consumption is driven by prestige rather than price. Studies have shown that luxury items maintain consistent demand among high-income individuals, regardless of price fluctuations, which means that elites will continue to buy these products without any impact on their lifestyle.
If you had to draw a demand curve for these elites and their brandy it would look something like this:
A Booming Black Market for Counterfeit Alcohol
China’s black market for counterfeit alcohol is massive, and the new tariffs will likely expand it further. Currently, an estimated 25% of the alcohol consumed in China comes from unregulated or homemade sources, with much of it being counterfeit. This market includes fake versions of luxury spirits like brandy, which can be sold for a fraction of the price of legitimate bottles. These counterfeit products are often dangerous, as they are made with methanol or other harmful substances.
In Hong Kong, the cigarette black market grew significantly after the tax hike, not just in volume but in value. The HK$700 million (approximately US$89 million) worth of untaxed cigarettes seized represented a massive loss in potential tax revenue — an issue China may soon face with counterfeit brandy. If middle-class consumers increasingly turn to fake alcohol, as they did to black-market cigarettes in Hong Kong, the Chinese government stands to lose a significant amount of tax revenue while fuelling the underground economy.
Research on China’s alcohol consumption shows that counterfeit and low-quality alcohol is more prevalent in rural areas, but with middle-class consumers now squeezed out of the legitimate market due to tariffs, the urban black market is likely to see significant growth. Like other countries where black markets have flourished under high tariffs, China may experience a surge in illegal production and distribution. A comparable example comes from the U.S. during Prohibition, where a government-imposed alcohol ban led to the proliferation of dangerous bootleg alcohol. This unintended consequence mirrors what we may see in China if the middle-class increasingly turns to counterfeit brandy.
A Blow to French Producers, But Not a Knockout
For French brandy producers, these tariffs will certainly sting. China has been a key growth market for French luxury spirits, and the tariff will make it harder for French producers to compete. However, this blow is unlikely to be catastrophic. China’s elite class will still demand luxury goods like brandy, and while sales volumes may dip, the overall market for these high-end products is unlikely to collapse. As studies on luxury consumption habits show, the wealthy’s demand for prestige products like Hennessy is resilient to price increases.
France’s brandy industry might feel some short-term pain, but they will likely recover as their products remain symbols of luxury. The real loss for France will be in the lower-middle-tier consumers who may have occasionally splurged on a bottle of French brandy. With this group now priced out, producers will lose access to a growing consumer base that, in the long run, could have provided sustained demand growth.
China’s Unintended Consequences: Strengthening the Black Market
The most severe impact of this tariff, however, will be felt in China itself.
The Hong Kong cigarette case again serves as a useful comparison. Just as illicit cigarettes are more dangerous due to higher levels of harmful chemicals, counterfeit alcohol in China poses a significant health risk due to the toxic ingredients often used in production. Public health risks, as seen with the sharp rise in black-market cigarette consumption in Hong Kong, will likely intensify in China as counterfeit alcohol becomes more prevalent.
Moreover, the black-market undercuts legitimate businesses, reducing tax revenues for the government. In Hong Kong, had the seized cigarettes been taxed legally, they would have generated HK$477 million in government tax revenue. This mirrors what could happen in China if counterfeit brandy becomes the go-to option for the middle class. The counterfeit alcohol market in China is already worth billions, and with the new tariffs, that number is set to grow.
This is a classic example of what economists call “crime market displacement,” where restrictions in the legal market lead to growth in the underground economy. China’s alcohol black market is sophisticated, with counterfeiters often producing fake versions that are difficult to distinguish from the real thing. Even retailers may unknowingly sell counterfeit alcohol, further complicating efforts to crack down on the trade.
Tax Evasion and Black-Market Growth: Lessons from China’s Import Gaps
A significant study by Fisman & Wei (2004) highlights the direct relationship between tax increases and the rise of black-market activity in China. Their research examined the gap between Hong Kong’s reported exports to China and China’s reported imports, often referred to as the “evasion gap.” The findings revealed that for every 1% increase in the tax rate, there was a corresponding 3% increase in black market evasion. This evasion occurred through misclassification of goods and underreporting of imports to avoid higher taxes.
This relationship is critical for understanding the potential consequences of China’s new tariffs on European brandy. Just as higher taxes fuelled black market growth in other sectors, the steep tariffs on imported brandy may drive more consumers and distributors to the black market, circumventing government controls. The lesson from Fisman and Wei’s study is clear: when legitimate goods become more expensive due to government-imposed tariffs, black market activity flourishes as consumers and sellers find ways to avoid the higher costs.
By making imported brandy less affordable, the Chinese government risks creating a larger, more lucrative counterfeit alcohol market — mirroring the growth of illicit trade observed in Fisman and Wei’s research on tax evasion in China.
China’s Enforcement Challenge
China’s efforts to control the counterfeit alcohol market have been ongoing for years, but enforcement is difficult, especially as counterfeiters become more adept at replicating legitimate products. The new tariffs will likely stretch these enforcement resources even thinner, creating more room for counterfeiters to operate. The government has inadvertently created a perfect storm for the black market: higher prices for legitimate goods and no decrease in consumer demand. This is a boon for counterfeiters, just as Hong Kong’s cigarette black market benefitted from the tobacco tax increase.
The Hong Kong example also highlights the difficulty of controlling these markets once they’ve expanded. Despite significant enforcement efforts, authorities in Hong Kong struggled to stem the flood of untaxed cigarettes, and a similar scenario is likely to unfold in China with brandy.
A Historical Parallel: The U.S. Prohibition Era
China’s situation is not unique. History is full of examples where government playing with regulations, excise, and restrictions on alcohol led to the growth of black markets. The most famous example, of course, is Prohibition in the United States during the 1920s. When the U.S. government banned alcohol, it unintentionally gave rise to a massive underground market. Bootleggers produced and distributed illegal alcohol, often with disastrous consequences for public health. Methanol poisoning became a widespread problem as unscrupulous producers cut corners to increase their profits.
Although China’s tariffs are not as extreme as an outright ban, the economic principle is the same. When legitimate goods are priced out of reach, consumers will turn to cheaper, illegal alternatives. In the case of Prohibition, the U.S. eventually reversed course after realizing the damage caused by the black market. While it’s unlikely that China will reverse its tariffs in the near term, the lessons from history, as well as from the recent Hong Kong cigarette market, are clear: policies that make legitimate alcohol less accessible can have severe unintended consequences.
Conclusion: A Self-Inflicted Wound
China’s new tariffs on French brandy are an attempt to retaliate against the EU, but the policy is likely to cause more harm to China — and middle-class Chinese (as it they did not have enough problems) — than to France. While French producers will feel the pinch, the real pain will be felt by China’s middle-class consumers, who will be driven to the black market for cheaper, counterfeit alternatives. The elites in China, who are really about the cachet of the fancy bottle, will not suffer at all as their demand is almost perfectly price inelastic. This is a dangerous situation for China, both in terms of public health and economic impact. The black market for counterfeit alcohol is already a significant problem, and these tariffs will only make it worse.
Hong Kong’s experience with the cigarette black market is a cautionary tale for China — what was intended to be a policy targeting a foreign producer will instead fuel an illegal industry at home, making the black market the biggest winner from China’s ill-conceived “blowback brandy tariff”.
References:
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