Bishnupriya Gupta, University of Warwick
Demand for Tea
“Tea is better than wine for it leadeth not to intoxication, neither does it cause a man to say foolish things and repent there of in his sober moments. It is better than water for it does not carry disease; neither does it act like poison as water does when it contains foul and rotten matter.”
This ancient saying from China gained widespread acceptance in Europe during the course of the eighteenth century. Tea displaced beer in Britain and in the Netherlands. In the fight against alcoholism, the temperance movement of the nineteenth century recommended tea as an alternative. Evidence based on contemporary accounts suggests that a tradesman’s family in 1749 in Britain spent three shillings a week for bread and four shillings on tea and sugar. But tea was still too expensive to become common man’s drink. It was only in the nineteenth century that tea became a common beverage for British households. Per capita consumption per year increased from 1.1 pounds in 1820 to 5.9 pounds in 1900 and 9.6 pounds in 1931. By this time the British market had reached a saturation point. In the United States and continental Europe, advertising campaigns encouraging coffee drinkers to switch to tea had limited success (see Table 1).
Table 1: Consumption of Tea: International Market Share
|Year||Share in World Consumption (%)|
|United Kingdom||Rest of Europe||Russia/USSR||North America
(including West Indies)
|Major Producing Countries|
Source: International Tea Committee, Bulletin of Statistics, 1946.
A small proportion of a household’s total budget is spent on tea. At lower levels of income tea consumption responds to changes in income. The income elasticity of demand (i.e. the percentage change in consumption due to a one percent change in income) for tea in India in the 1950s was estimated to be 1.1. But at higher levels of income, the income elasticity of demand for tea tends to be low. For the UK in the interwar years, Richard Stone estimated the price elasticity of demand (i.e. the percentage change in consumption due to a one percent in price) to be -0.32, while the income elasticity was only 0.04. These figures suggest that the market in developed countries would not expand significantly with rising incomes. Furthermore, a decline in price would not have a large effect on the quantity demanded.
In the producer countries, which were less economically developed, the domestic market showed significant expansion from the 1930s onwards. The Indian market increased from 10 million pounds in 1905 to 18 million pounds in 1910, but was only a small proportion of the British consumption of 287 million pounds in 1910. However, there was little effort to expand the domestic market in India until the 1930s. India had a large population and the potential of a large market. As British demand stagnated large sums were spent on advertising campaigns in India. The industry set up demonstrations in tea-making and sold cups of tea at railway stations and local fairs. The Indian market in the 1920s had increased by 15 million pounds to 50 million pounds. Consumption doubled in the 1930s.
Supply of Tea
China had been the major supplier of tea to Britain. Tea was cultivated in small plots of land by peasant farmers, whose output proved inadequate to meet the surge in demand. The slow increase in production together with the political inwardness in China after 1840 led to the search for alternative production centers. Plantations appeared to be an attractive alternative. British experiments with the tea plant in south Asia were successful and led to the development of plantations in Eastern India and in Ceylon (Sir Lanka) from the middle of the nineteenth century. The tea companies attracted investment from Britain and were managed by British agents. By 1860, more than fifty companies were producing tea in Eastern India. Tea companies in India and Ceylon were registered either in London or in Calcutta and Colombo and run by British agents on the basis of long-term agency contracts. The British agents had local counterparts who were responsible for the day-to-day functioning. A typical managing agent owned shares in several companies and was responsible for their management. Consequently, despite the presence of a few hundred companies in India and Ceylon by the early twentieth century, decision making in the industry was in the hands of a few British agents. In 1879, over 70 percent of the teas sold in London were from China. By 1900 China’s share had dramatically declined to 10 percent and the black teas from India and Ceylon constituted the bulk of the market. Table 2 shows market share of the main exporting countries between 1928 and 1940.
Table 2: Production of Tea: International Market Share
|Year||Share in World Exports (%)|
|India||Ceylon||Java and Sumatra|
Source: International Tea Committee, Bulletin of Statistics, 1946.
There are two types of tea. India and Ceylon produced black tea. China produced both black tea and green tea. Both are produced from the same plant. Leaves are steamed and dried to produce green tea. Black tea undergoes fermentation and further oxidization. Tea prices were determined at auctions, London was an important center. Calcutta, Colombo and Amsterdam were the other main centers. Prices depend on the quality of tea. Regional differences in soil, climate and elevation account for differences in quality. The slopes of the Himalayas in and around Darjeeling and the highland areas on the island of Ceylon produce some of the finest teas in the world and command high prices. However, average tea prices depend on the supply costs of common teas. The tea crop is harvested all through the year in the tropical areas, Ceylon and Java. In Eastern India the onset of the winter brings an end to harvesting. The output of tea consists of leaves plucked from the tea bush. Fine plucking reduces quantity, but improves quality while coarse plucking increases output at the cost of quality. In the short run output can be varied by regulating plucking. Increase in output in the long run takes place through increase in cultivation. The tea plants take six to seven years to mature. When prices are high there is an incentive to pluck coarse to increase output in the short-run. This disproportionately increases the quantity of common teas leading to a sharp decline in the average price.
Fluctuations in Prices
In the first half of the twentieth century, the tea industry saw wide fluctuations in prices. During the First World War, the British government undertook purchases of tea to avoid a shortage in supply. This guaranteed a market for the producers. The boom in prices in the early 1920s encouraged an increase in acreage under tea not just in India and Ceylon, but also in Java and Sumatra, territories in the Dutch East Indies. In India, it encouraged planting and establishment of new plantations in the hills of the southern India. The increased acreage was followed by an increase in output with a lag of a few years. As in many other agricultural commodities the international market showed signs of excess supply towards the end of the 1920s and stocks accumulated. The collapse of tea prices in 1929 was not simply a result of decline in demand with the onset of the Depression in 1929; high supply had become a feature of the industry following the post war expansion in acreage.
Figure 1: Average Tea Prices
Source: International Tea Committee, Bulletin of Statistics, 1946.
The Tea Cartel
During this period price support schemes were put in place for several agricultural commodities by forming collusive agreements or cartels. As primary products have low price elasticities of demand, output restriction increases the profits of the producers and is in their collective interest. Early attempts at collusion in tea had not been successful, but as prices tumbled, the tea producers’ associations in the three major producing countries set up the International Tea Agreement in 1930. The Tea Associations in India, Ceylon and the Dutch East Indies agreed to reduce output to prevent a further fall in prices. This was a voluntary agreement, where each tea company belonging to the Tea Associations in the producer countries signed up to cut back output. There were many firms in the industry. However as the firms were managed by a few agents who made decisions about how much to produce, effective firm size was larger and increased the viability of a collusive agreement. Each producer in a cartel has an incentive to cheat and free ride on the compliance of other firms. But when firms face a threat that the agreement will be abandoned and prices will decline if participants do not comply, the agreement can be sustained. Economic theory predicts that collusion can be sustained by price wars — any sign of noncompliance such as falling prices, leads every firm to abandon the agreement and increase output bringing about a further fall in prices. Collusion can be sustained more easily in markets were output is produced by few firms.
The International Tea Agreement was abandoned in 1931 and 1932. When the figures were added up it emerged that the promised reduction by Java and Sumatra in the Dutch East Indies had not been made. Any reduction made by the European Estates had been counterbalanced by increased production on the part of the native producers. The agreement fell apart. The Tea Associations in India and Ceylon blamed Java and Sumatra for the failure to restrict output in accordance with the scheme of 1930. The conflict of interest between large producing firms and smaller producers in terms of what each can gain from the cartel prevented a continuation of the collusive arrangement. Producers in the country with the smallest market share were not keen to be a part of the arrangement. But India and Ceylon continued to negotiate for an agreement rather have a price war. Negotiations and bargaining were much more important in collusion in the tea market. Contrary to what theory suggests, there is no evidence of a price war. As prices declined further, producers in Java and Sumatra were more willing to be a part of such an agreement. A second International Tea Agreement was signed in 1933. All the participating countries faced a reduction in exports by 15 percent of the maximum attained in any of the years 1929-32. Export quotas were assigned to individual firms, but the quota could be traded. The agreement covered a period of five years. Legislation was adopted in the participating countries, which made the export quota legally binding and limited expansion in acreage up to a maximum of 0.5 percent per year. The International Tea Agreement of 1933 was a successful case cartelization. The agreement lasted right up to the Second World War when the conditions in the market changed. The agreement led to an immediate upward movement in prices (See Figure 1). As Table 3 shows, most firms in India and Ceylon reduced output in response to the agreement. There is no doubt that the success of the agreement depended on the legislation passed in the producing countries in 1933. There had been no legal backing in the case of the previous agreement. It froze the relative market share of the producers and prevented new firms from entering the tea market. The International Tea Committee appeared to have a clearly thought out strategy and seemed to act with considerable foresight. Export of tea seeds from the three participating countries was prohibited. It was only when Kenya, Uganda, Tanganyika and Nyasaland agreed to limit new planting that the export restrictions were eased.
The Economist commented in August 1933:
“Producers of commodities like wheat and sugar may envy the facility with which the tea growing industry obtained a 30 percent rise in average tea prices and a 90 percent enhancement of tea share values — all within the space of a little more than six months.”
Compliance to the Tea Agreement
Percent of Firms in Region Reducing Output
|Reduced Output by 10%||56%||17%|
|Reduced Output by 15%||52%||51%|
Note: The figure of 10 percent is used as the expected reduction. In 1930 the negotiated level varied between 15 percent and 3 percent depending on the quality of tea. In 1933 exports were to be reduced by 15 percent. Output reduction may be expected to be less as firms sell a share of the output in the domestic market.
Sources: Mincing Lane Tea & Rubber Brokers’ Association, A Guide to Investors and Investors’ India Year Books.
Griffiths, Percival. The History of the Indian Tea Industry. London: Weidenfeld and Nicolson, 1967
Gupta, Bishnupriya. “Collusion in the Indian Tea Industry in the Great Depression: An Analysis of Panel Data.” Explorations in Economic History 34, no. 2 (1997): 155-173.
Gupta, Bishnupriya. “The International Tea Cartel during the Great Depression, 1929-33.” Journal of Economic History 61, no.1 (2001): 144-159.
Macfarlane, Alan and Iris. Macfarlane, Green Gold: The Empire of Tea. London: Ebury Press, 2003.
Sarkar, Goutam. The World Tea Economy. Delhi: Oxford University Press, 1972.
Wickizer, Vernon D. Coffee, Tea and Cocoa: An Economic and Political Analysis. Stanford: Stanford University Press, 1951.