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POTENTIL IMPLICTIONS OF FREER TRDE FOR THE UNITED STTES ND CNDIN DIRY SECTORS: SPTIL NLYSIS ndrew M. Novakovic, Maurice Doyon and Phillip Bishop This paper presents key results from two studies recently
POTENTIL IMPLICTIONS OF FREER TRDE FOR THE UNITED STTES ND CNDIN DIRY SECTORS: SPTIL NLYSIS ndrew M. Novakovic, Maurice Doyon and Phillip Bishop This paper presents key results from two studies recently completed by members of the Comell Program on Dairy Markets and Policy. The study by Maurice Doyon compares the optimal trade flows of dairy products and marginal values of raw milk that are predicted by a spatial model of the United States and Canada under conditions of free trade or current trade restrictions (Doyon). The implications of free dairy trade in North merica for the viability of U.S. Federal Milk Marketing Orders (US FMMO) is explored in a study by Phillip Bishop (Bishop). Both studies employ highly disaggregated spatial optimization models that represent the production, assembly, processing, distribution, and consumption activities characteristic of dairy market operations. lthough very similar in their basic design, the models used in the two studies have significant differences. The Doyon study focuses on the adjoining regions of the Northeastern United States and the central Canadian provinces of Ontario and Quebec, with a much more aggregated representation of the rest of the United States and Canada. The Bishop model covers all of North merica in more evenly proportioned detail. There are also some differences in the level of product aggregation and other details. In any case, both studies can be thought of as drawing on the same conceptual and mathematical approach to representing milk and dairy product markets. dditionally, both studies begin with establishing a baseline that is predicated on current conditions of current highly restricted trade between the two countries and include a free trade scenario. The latter does not reflect any current policy, nor does it correspond to the requirements under GTT, but it does provide an estimate of the most unrestricted scenario. The presentation begins with the Doyon study and concludes with the Bishop study. Summary conclusions are presented at the end. 208 Proceedings FREE TRDE BETWEEN THE UNITED STTES ND CND WITHOUT DOMESTIC POLICY COMPLICTIONS Observers of the dairy sectors in the United States and Canada are well aware that both countries employ an extensive set of domestic dairy policies and that these policies differ markedly. It goes without saying that any sudden liberalization of trade between the two countries would be grossly affected by and have effects on these domestic policies. Canada would find it immensely difficult to maintain its current regime of relatively high farm prices under its milk marketing quota system and the USFMMO system would find it difficult to enforce producer prices on Canadian shipments of packaged milk to U.S. locations. The latter will be discussed later in this paper. The issue of the Canadian quota system is not studied here. In fact, we take it as a given that free trade must involve either the elimination of the quota system or changes so significant as to render it irrelevant in a free trade analysis. The key issue is, of course, achieving price equilibria in markets for raw milk and dairy products. Unlike more conventional studies that might attempt to estimate changes in production and consumption due to new price equilibria, this study approaches the question of prices as the dual solution of an optimization problem wherein the primal deals with production and consumption based on existing levels. In a sense, the study looks at the shorter term implications for price and leaves the potential impact on production and consumption for another analysis. In so doing, the study obviates any need to find appropriate supply and demand response functions, which in many cases simply do not exist at a level corresponding to the spatial and product disaggregation used in the model. The fact that previous studies of supply and demand response, as well as conventional wisdom, suggest that both behaviours are highly price inelastic helps to support the robustness of this approach. Design of Trade Liberalization Simulations Base scenario is used as a benchmark to evaluate the magnitude of the predicted changes. In the base scenario, all dairy products, except fluid (beverage) milk, could move freely among Canadian regions, while all dairy products are allowed to move freely within the Northeast United States. No dairy product trade is allowed between the United States and Canada. The base simulation is a benchmark, a point of reference. The effects that policy changes had on trade patterns are evaluated in terms of changes relative to the base simulation. The base simulation represented the economic optimum for the period studied, notwithstanding all other factors. In the Free Trade scenario, all dairy products, as well as raw milk, are permitted to move freely across the U.S.-Canada border. Free trade is not likely to occur in the short run. However, the scenario has two desirable qualities. One is that free trade is easy to model. The second is that it represents a normative upper limit of trade liberalization. For this Novakovic, Doyon and Bishop 209 simulation, all constraints on the movements of dairy products between the United States and Canada are removed. Thus, Quebec and Ontario could export or import any of seven dairy products, including raw milk, to and from the Northeast. This is also the case for a Canadian aggregated excess demand point and a U.S. aggregated excess supply point, which together represent the rest of the relevant components of the United States and Canada. Results of the Base Scenario The simulation results are expressed as changes in quantity trade flows and shadow prices. Trade flow maps provide a pictorial view of the results. To simplify the presentation of results, the many supply, processing, and demand points in the Northeast US is disaggregated into five smaller multi-state regions. Northern New England (NNE) is comprised of Vermont, Maine and New Hampshire. Southern New England (SNE) is made up of New Jersey, Rhode Island, Connecticut, and Massachusetts. Maryland, Washington D.C. and Delaware formed the Middle tlantic (MT) region. New York (NY) and Pennsylvania (P) are the two other regions. Similarly, Ontario and Quebec points are aggregated into regions defined by the two provinces-on and PQ, respectively. The excess demand point for the rest of Canada (CED) and the excess supply point for the rest of the United States (USES) make up the remainder of the model. Shadow Prices. Shadow prices indicate the amount by which the objective function would be reduced if an additional unit of a milk component is made available. Two types of shadow prices are generated by the model-a supply shadow price and a processing shadow price. The supply shadow price corresponded to raw milk at the farm with a fixed ratio of butterfat to skim nonfat (SNF). lthough the ratio is fixed within each region, the ratio varied from one region to the next. In contrast, the processing shadow price, reflecting values at the plant is comprised of two prices, one for butterfat and one for skim non-fat (SNF). Thus, for a particular product in a region, the shadow price for butterfat may increase while the shadow price for SNF may have decreased under trade liberalizing policies. If a shadow price increased from one simulation to another, then the relative incentive to market milk increased and vice versa. Thus, the magnitude or the direction of a shadow price change is not relevant. Only the magnitude of a shadow price relative to those of other regions for the same product have relevance in assessing the impacts of different trade policies. Trade Flow Maps. Trade flow maps are useful for finding cross-border movements and can be used to illustrate differences in trade flows between simulations. Triangles represent processing plants, and lines from the triangles represent product movements from plants to consumption points. The lines that represent flows are not proportional to quantities. Therefore, an insignificant flow and a large flow of a particular dairy product would be represented by lines with identical appearance. 210 Proceedings Raw Milk Movements. Because fewer raw milk movements exist relative to finished product movements and because their variability across simulations is not significant, raw milk flows will be discussed only briefly. Milk destined for fluid milk plants travelled moderate to long distances, but few milk supplies used in the production of dry and condensed milk are located far from the processing plants. Furthermore, butter plants had such short raw milk movements associated with them that no supply to processing movements are discerable. The explanation is found in the costs associated with transportation, i.e. the higher the product's distribution cost, the closer the processing plants are to the consumption points. The number of plants is also dependent on transportation costs. If a product is relatively inexpensive to transport, it is more efficient to have a few large plants located near supply points than many smaller plants located near consumption points. Processing to Demand Movements. In the base simulation, Quebec shipped butter, cheddar cheese and dry and condensed milk to Ontario and the CED. Results are illustrated for cheddar cheese in Map 1. -t Map 1. Cheddar Cheese: Processing to Demand Movements Novakovic, Doyon and Bishop 211 Quebec also shipped specialty cheese to the CED, and imported yogurt and frozen dessert from Ontario. Ontario shipped frozen dessert and yogurt to the CED and Quebec, and exported cheddar and specialty cheese to the CED. Specialty cheese results are illustrated in Map 2.?~ fx?i,?... a heese-pcessing to Demand vemets Map 2. Specialty Cheese: Processing to Demand Movements New York imported butter from Vermont, Pennsylvania, and Maryland in the base simulation. However, New York exported frozen dessert and yogurt to Pennsylvania, Maryland, and Vermont, and imported frozen dessert from Vermont as well. New York also exported cheddar cheese, dry and condensed milk, and specialty cheese to SNE. Pennsylvania exported butter to Maryland, New York, and New Jersey, while it imported yogurt from New York. Pennsylvania exported yogurt to the US aggregated excess demand (USED), Maryland, District of Columbia, Delaware, and New Jersey. Pennsylvania also exported cheddar cheese, dry and condensed milk and specialty cheese to New York City, SNE and MT. Vermont exported butter and frozen dessert to New York, and frozen dessert to Maine. Vermont also exported cheddar cheese, specialty cheese and dry and condensed milk to New York, SNE, and the other NNE regions. The USES exported cheddar cheese 212 Proceedings to Western New York, Pennsylvania and SNE, while it exported dry and condensed milk to New York, Pennsylvania, SNE, and MT. Map 3 shows that fluid milk is a local business with short movements from plants to the consumers. The map also reveals that the optimal market structure consists of numerous plants, with plant density highest near large metropolitan areas. In contrast, butter plants are less numerous and have longer processing to consumer movements. The market structure of butter processing plants is nearly opposite that of fluid milk plants, and the results imply that there exists an economic incentive for butter plants to locate near supply points. al ,^ I 0, fluid milk is rather to expensive transport, I w. dry but and condensed milk are relatively Base Scenario onuiy Fluid Mlk--Processing M8lklrocessing to Demand emannd Movements Map 3. Fluid Milk: Processing to Demand Movements In general, lower transportation costs fort an produt plants fewr to process that product and longer movements of that product from processing to demand. For example, fluid milk is rather expensive to transport, but dry and condensed milk are relatively inexpensive to ship. The base simulation resulted in 121 plants processing fluid milk but only 9 plants processing dry and condensed milk. The plant density shown in the preceding maps may be misleading because differences in plant differences size are not addressed. The size of processing plants differs significantly across regions in the base. For example, New York and SNE fluid plants are twice as big as those in the other regions. For yogurt, the plants with the highest average size are found in Novakovic, Doyon and Bishop 213 Quebec, Ontario and Pennsylvania, while the smallest plants are in NNE and New York. New York and MT ice cream plants are twice the size of the Quebec and Ontario ice cream plants. Regarding cheddar and specialty cheese plants, Pennsylvania and New York have the largest plants. On average the largest dry and condensed milk plants are in Quebec, Ontario and NNE, while the largest butter plants are in Ontario, Pennsylvania and SNE. summary of the net interregional trade flows for all products combined can be observed in Map 4. ' &.::t,,;t- - CDSS 1, di} :' ;;, / $:. i.jj USES Base Simulation-Net Interregional Trade Flows ll Products Map 4. Net Interregional Trade Flows: ll Dairy Products in Million of Kilograms of Products Map 5 presents the supply shadow prices for the base simulation. The supply shadow prices increased from the northwest to the southeast in the Northeast United States, from east to west in Quebec, and from west to east in Ontario. In general, supply shadow prices are higher in Canada than they are in the Northeast United States. fluid milk shadow price is calculated using the butterfat and SNF processing shadow price generated by the model. Fluid milk is chosen for the processing shadow price 214 Proceedings contour maps, because it is the most consistent product across regions and is present in significant quantities in all regions. Map 6 presents the processing ( fluid milk) shadow price for the base simulation. In the Canadian regions, shadow prices increased from east to west, while in Northeast United States they increased from northwest to southeast. Processing shadow prices are much higher in Canada than in the United States regions, the highest values occurring in Northeastern Ontario. Map 5. Supply Shadow Prices: Canadian Dollars per Hectoliter Novakovic, Doyon and Bishop 215 Map 6. Processing Shadow Prices: Canadian Dollars per Hectoliter Free Trade Simulation Raw Milk Movements. In the Free Trade simulation, all dairy products and raw milk could move freely between the Canadian and U.S. regions. The results indicate that no movements of fluid milk between the United States and Canada occurred in the Free Trade simulation. This result is a consequence of the transportation cost structure of fluid milk and raw milk. Raw milk is less expensive to transport than fluid milk. Thus, it is not surprising to observe cross-border movements of raw milk to fluid milk plants but no cross-border movements of fluid milk. Based on relative marketing costs, some cross-border movements of raw milk are evident in the Free Trade simulation. Raw milk moved from New York to Ontario and Quebec fluid milk plants, and raw milk from Quebec went to Vermont specialty cheese plants. lthough a limited amount of raw milk moved from Canada to the U.S. and vice versa, in the short run more U.S. milk would be pulled North due to lower U.S. raw milk price. Factor price equalization would put that down toward the levels suggested by the model in the longer run. 216 Proceedings Quebec increased net exports of raw milk for cheddar and specialty cheeses and for ice cream by 7, 13, and 7 points, respectively. t the same time, Quebec increased its net imports of raw milk for fluid milk processing by 8 percentage points. Similarly, Ontario increased its net raw milk imports for fluid milk, ice cream and cheddar cheese by 34, 7, and 3 percentage points, respectively. New York shifted from being a net importer of raw milk for fluid processing in the base simulation to being a net exporter in the Free Trade simulation. The decrease in net imports of raw milk for dry and condensed milk of 2,650 points in NNE resulted from the combined effect of eliminating raw milk imports from New York and diverting local supply to a dry and condensed milk plant. Processing to Demand. The number of plants that received raw milk for a particular product as shown in supply to processing movements maps does not necessarily correspond to the number of plants that effectively processed that product, shown in processing to demand movements maps. This apparent discrepancy resulted from interplant movements. Some plants received raw milk and redirected butterfat and SNF to other plants without performing any processing activities. Under the conditions imposed by the Free Trade simulation, Quebec lost market share for all dairy products except cheddar cheese and ice cream. Quebec significantly increased its net exports of cheddar and shifted from a net importer of ice cream to a net exporter (Table 1). Small losses for fluid milk and specialty cheese are also predicted. The loss of the CED butter market and part of the Ontario butter market to USES resulted in a 33 point decrease in Quebec's net butter exports. The effect of the lost market share is somewhat mitigated by Quebec's butter exports to Maine, Vermont, and New York. Predicted exports of dry and condensed milk to Maine did not compensate for the loss of the CED and Ontario dry and condensed markets to USES. Moreover, Ontario, and to a lesser extent USES, penetrated part of Quebec's domestic market for nonfat dry and condensed milk. s a result, Quebec is expected to lose 4 dry and condensed milk plants and shift from being a net exporter to being a net importer of dry and condensed milk. Quebec also shifted from being a net exporter to being a net importer of yogurt. This is partially due to new exports to Maine and Northern New York. Quebec became a net exporter of ice cream and exported to Vermont and New York. Quebec significantly increased exports of cheddar cheese under the Free Trade simulation trade conditions. comparison of Maps 1 and 2 with Maps 7 and 8 shows new trade dynamics for cheese. Traditional East to West movements in Canada are replaced by North to South movements. Quebec lost its CED and Ontario cheese market to USES and New York, but exports to New England more than compensated for the lost market. However, Quebec's farm and plant values for milk components declined greatly in the Free Trade simulation (Maps 5, 6, 9, and 10). Novakovic, Doyon and Bishop 217 Free Trade Scenario Cheddar Cheese-Processing to Demand Movements Map 7. Cheddar Cheese: Processing to Demand Movements Map 8. Specialty Cheese: Processing to Demand Movements 218 Proceedings Ontario increased its net exports for all dairy products except yogurt and specialty cheese. Net imports of specialty cheese slightly increased. Ontario shifted from being a net exporter of yogurt to being a net importer, and from being a net importer of cheddar cheese to being a net exporter. Ontario's loss of the CED cheddar cheese market to USES is more than compensated by cheddar cheese exports to New York. Ontario also reduced net imports of butter and dry and condensed milk by 17 points and 117 points, respectively. The reduction in dry and condensed milk net imports is explained by new exports to Quebec, New York and SNE. s a result, the Western Ontario dry and condensed plant is replaced by a larger plant in Eastern Ontario. Significant decreases in the value of Ontario farm milk and plant milk components also occurred in the Free Trade simulation. Maps 9 and 10 and Table 1 illustrated the implications for calculated milk values. Map 9. Supply Shadow Prices: Canadian Dollars per Hectoliter Novakovic, Doyon and Bishop 219 Map 10. Processing Shadow Prices: Canadian Dollars per Hectoliter Table 1. Changes in Shadow Prices for Supply, Butterfat and SNF for Various Dairy Products Relative to the Base Scenario
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