POLICY CHANGE, MARKET INTEGRATION AND TRADE FLOWS IN AGRICULTURAL MARKETS

• Sponsoring Institution: National Institute of Food and Agriculture
• Project Status: COMPLETE
• Funding Source: HATCH
• Reporting Frequency: Annual
• Accession No.: 0220441
• Project Start Date: Oct 1, 2009
• Project End Date: Sep 30, 2014
• Program Code: [(N/A)]- (N/A)

Recipient Organization
OHIO STATE UNIVERSITY
1680 MADISON AVENUE
WOOSTER,OH 44691

Performing Department
Agriculture, Environment and Development Economics

Non Technical Summary
The US and the European Union are the world's two major importers and exporters of agricultural products, both their trade and domestic agricultural policies having an important impact on world markets. For domestic agricultural policies, this influence can be significant when domestic farm support policies are linked or "coupled" to agricultural production decisions. In Europe, budgetary pressures and the need to meet World Trade Organization commitments have resulted in a major leap toward the decoupling of domestic farm support policies from production. Over the same time period, the US has made little progress towards decoupling its domestic farm- support policies. An important feature of European policy reform has been differential implementation among countries. Some discretion was allowed regarding the timing and degree of decoupling of domestic farm policy support, and differences among European countries were quite noticeable in key commodity sectors. This presents an important setting for investigating the impact of differential decoupling on agricultural commodity prices, production incentives, trade flows, both within Europe as well as on world markets. While our particular focus is on agricultural policy reform in Europe, what happens there is important globally. The European and US agricultural sectors are highly interdependent - European agricultural policies affect the US, and US agricultural policies affect Europe, and both affect world markets.

Animal Health Component

(N/A)

Research Effort Categories

Basic

(N/A)

Applied

(N/A)

Developmental

(N/A)

Classification

Knowledge Area (KA)	Subject of Investigation (SOI)	Field of Science (FOS)	Percent
606	6120	3010	100%

Knowledge Area
606 - International Trade and Development;

Subject Of Investigation
6120 - International economy and sectors thereof;

Field Of Science
3010 - Economics;

Keywords

decoupling agricultural policy

differential policy reform

market integration

trade flows

gravity model

Goals / Objectives
An important feature of recent reform of the European Union's (EU) Common Agricultural Policy (CAP) is that it has allowed for differential implementation among the EU's Member States. In this context, the current project addresses two separate but related questions with respect to the economic effects of differential policy implementation. First, based on analyzing the distribution of world, US and EU agricultural commodity prices, production incentives, and trade flows, how is the degree of EU and world market integration affected Second, how is the flow of commodity trade among EU Member States affected, and in turn what is the impact on the US agricultural sector, as well as the world market Within this setting, the key objectives of the project are four-fold: first, to use current econometric tools of analysis to assess market integration and how the functioning of markets is affected by decoupled agricultural support policies; second, to formulate a theoretically consistent gravity trade model; third, to statistically estimate and interpret the (policy) parameters of the gravity model; and, fourth, to assess the welfare implications of decoupling on regional EU, US, and world agricultural commodity markets.

Project Methods
This research contained in this project will be based on using two distinct methods of analysis: first, in our market integration work we will adopt a multivariate approach to cointegration and vector error correction (VECM) estimation. Within this framework we test for structural breaks in the data using the procedures proposed by Gregory and Hansen (1996). Two breaks are investigated: the policy break in 2003 following reform of the EU's Common Agricultural Policy (CAP), and also an export ban in August 2006 resulting from a major animal disease outbreak. We use our VECM estimates to assess the extent to which price signals are transmitted across markets and nature of the dynamics of the system to respond to external shocks. If markets are not integrated they do not share the same information set in the sense that they are driven by a single "pushing force" (Juselius, 2007). If price signals are not effectively passed-through, economic agents do not have complete information and welfare losses can result from the inefficient allocation of resources. Among other things, weak transmission of prices can be affected by trade or domestic policies. We seek to sort out the policy effects so that corrective action and appropriate responses can be taken to restore efficient outcomes. Hence, the results can aid in the design of regional policy. To our knowledge, this is the first application of these methods to the study of policy decoupling on market integration. Second, in our modeling of trade flows we will follow the recent gravity model contribution of Helpman, Melitz and Rubinstein (2008). Applying these procedures we will estimate a gravity trade model allowing for firm heterogeneity and self selection into export markets (Heckman, 1979). We will extend Helpman, Melitz and Rubinstein (HMR) by following recent analysis by Johnson (2009) and Santos Silva and Tenreyro (2009). Using monthly trade volume data for the EU15 from the Eurostat COMEX data base, we will apply Heckman two-stage and HMR's nonlinear least squares econometric estimation procedures. To our knowledge, this is the first empirical application of the HMR gravity model specification to agricultural commodity trade and the first effort to investigate how regional trade flows are affected by differential policy implementation.

Progress 10/01/09 to 09/30/14

Outputs
Target Audience: Academic audiences, public policy analysts, and lay audiences. Changes/Problems: Nothing Reported What opportunities for training and professional development has the project provided? Nothing Reported How have the results been disseminated to communities of interest? Results distributed through research seminars, working papers, journal articles and book chapters. What do you plan to do during the next reporting period to accomplish the goals? Nothing Reported

Impacts
What was accomplished under these goals? The first three objectives listed in “Major Goals of the Project” are directly addressed by the following publications (listed earlier in this report): Salhofer, et al., Prehn, et al., and Salhofer, et al.

Publications

• Type: Book Chapters Status: Published Year Published: 2014 Citation: Feichtinger, P., S. Salhofer, F. Sanabell, and S. R. Thompson. This Land is Your LandWho Benefits from Agricultural Subsidies? The Common Agricultural Policy in the 21st Century. Vienna, Austria, 2014: pp.67-82.
• Type: Journal Articles Status: Awaiting Publication Year Published: 2014 Citation: Prehn, S, B. Bruemmer and S.R. Thompson. Payment Decoupling and the Intra-European Calf Trade. European Review of Agricultural Economics.
• Type: Journal Articles Status: Under Review Year Published: 2014 Citation: Salhofer, K., H.A. Klaiber and S.R. Thompson. Capitalization of the SPS into Farmland Rental Rates under the 2013 CAP Reform. Agricultural Economics.
• Type: Journal Articles Status: Under Review Year Published: 2014 Citation: Hasan, S. and I.M. Sheldon, Credit Constraints, Technology Choice and Exports: A Firm Level Study for Latin American Countries, Review of Development Economics.
• Type: Journal Articles Status: Under Review Year Published: 2014 Citation: Tseng, E. and I.M. Sheldon, Food Processing Firms, Input Quality Upgrading and Trade, American Journal of Agricultural Economics.

Progress 01/01/13 to 09/30/13

Outputs
Target Audience: Target audiences for this research include academics, economists at NGOs, policy makers and farm organizations at the national and international levels. Changes/Problems: Nothing Reported What opportunities for training and professional development has the project provided? Graduate student working on impact of intellectual property rights on US seed exports has learned new skills in writing and presenting her research, and also responding to comments from peer researchers. How have the results been disseminated to communities of interest? Research output on seed technology transfer and trade presented to non-technical audiencesat national and international level. What do you plan to do during the next reporting period to accomplish the goals? Nothing Reported

Impacts
What was accomplished under these goals? 1. Exchange rate uncertainty was found to negatively affectUSexports of fresh fruit and vegetables. Specifically, statistical methodswere applied to analyzing the relationship between USexports of fresh fruit and fresh vegetables tomajor markets over the period 1976-2006, drawing on several measures of long-run exchange rate uncertainty. The results suggest thatUS fruit and vegetable exporters may be quite significantly exposed to exchange rate risk, for which there are no cheaply available hedging-instruments. As global integration of markets increase, traders may become more exposed to uncertainty beyond movements in prices, which has potential implications for the structure of federal funding of farm programs. In terms of project objectives, panel econometric techniques were used to estimate arobust version of the gravity trade model includingtwo measures of exchange rate movement: astandard rolling standard deviation index, and an index that takes account of exporters' expectations concerningexchange rates. The results of thisanalysis indicate that exchange rate uncertainty has had a statistically significant effect on US bilateral trade in fresh fruit and vegetables. 2. Intellectual property rights such as those provided under the WTO's TRIPs Agreement were shown to havehad a positive effect onUS exports of seeds that embody proprietary technology.Specifically, statistical methods were applied to analyzing the relationship between US exports of seeds to a sample of 134 countries over the period 1985-2010. The results of the research are important as they shed light on a critical policy debate concerning diffusion of technology to developing countries -doe intellectual propertyprotection such as plant breeders' rightshave a positive or a detrimental effect on technology exports? In terms of project objectives, time-series panel econometric methods were used to estimate a robust version of the gravity trade model including measures of intellectual property rights such as membership of the International Union for the Protection of New Varieties of Plants as well as TRIPs. The results of this analysis indicate that protection of intellectual property rights,and in particular membershiop of TRIPs,has had a statistically significant impact on US seed exports. A keyfeature of this research has been the use of appropriate statistical methods to take account of zero entriesin theseed export data. 3.The availability ofvoluntary product standards such as through the International Organization for Standardization (ISO), has been shownto provide firms with a meansof convincing consumers in export marketsof product quality, independent of any action by local regulators. Thisresult is important in light of the increased demand by consumers for mutliple characteristics in food products, including, among other things,that they are fair traded and organic products. The results of the analysisalso explain why there has been growth in the implemenation of private industry standards over and above minimum standards set by government. In terms of project objectives, this research extends the work on heterogeneous firms and productivity, by allowing for goods where claimed quality cannot beverified, even after consumption.The analysis will help inform future empirical analysis by explaining why firm size, sunk costs and export participation are correlated with the adoption of voluntary standards. 4.The markets for GM corn, cotton, and soybeans have been found to be characterized by significant endogenousfixed costs associated wth R&D investment. Given the increased concerns over concentration in agricultural biotechnology, regulators and policymakers alike will find these results of particular interest. Whereas increased levels of concentration are often associated with anticompetitive behavior in an industry, the presence of endogenous fixed costs and the nature of technology competition in agricultural biotechnology imply a certain level of concentration is to be expected in this sector. Specifically, R&D activity is concentrated within three to four firms across GM corn, cotton, and soybeans and the ratios of concentration have been changing little over the past 20 years. In terms of project objectives, the theoretical lower bound to R&D concentration and empirically testable hypotheses for an industry characterized by endogenous fixed costs (EFC)have beenderived. Using data on field trial applications of GM crops, the lower bound to R&D concentration in the agricultural biotechnology sector was estimated. The empirical results imply that the markets for GM corn, cotton, and soybean seeds are characterized by endogenous fiixed costs with predicted lower bounds to the one-firm R&D concentration ratio for an infinitely-sized market of 54.8%, 47.3%, and 78.6%, respectively. No evidence has been found that adjusting for merger and acquisition activity significantly increases the lower bounds.Moreover, the empirical model leaves open the possibility that the introduction of second and third generation GM varieties, the opening of foreign markets to GM crops, future exogenous shocks to technology, or reductions in regulatory cost could lead to additional entry, exit, or consolidation in the industry.

Publications

• Type: Journal Articles Status: Published Year Published: 2013 Citation: I. M. Sheldon, S. Khadka Mishra, D. Pick and S. Thompson, Exchange Rate Uncertainty and US Bilateral Fresh Fruit and Fresh Vegetable Trade: An Application of the Gravity Model, Applied Economics, 45(15): 2067-2082, 2013.
• Type: Journal Articles Status: Under Review Year Published: 2013 Citation: B. Anderson and I.M. Sheldon, R&D Concentration under Exogenous Fixed Costs: Evidence from the Agricultural Biotechnology Industry, submitted to Journal of Industrial Economics.
• Type: Journal Articles Status: Under Review Year Published: 2013 Citation: W. McGuire and I.M. Sheldon, Voluntary Standards and International Trade: A Heterogeneous Firms Approach, submitted to Journal of International Economics.
• Type: Conference Papers and Presentations Status: Published Year Published: 2013 Citation: M. Zhou and I.M. Sheldon, "The Role of Intellectual Property Rights in Seed Technology Transfer through Trade: Evidence from US Field Crop Exports" Working Paper, Andersons Program in International Trade, May 2013
• Type: Conference Papers and Presentations Status: Published Year Published: 2013 Citation: M. Zhou and I.M. Sheldon, The Role of Intellectual Property Rights in Seed Technology Transfer through Trade: Evidence from US Field Crop Exports, IATRC Public Trade Policy Research and Analysis Symposium, Productivity and Its Impacts on Global Trade, Seville, Spain, June 2013.
• Type: Conference Papers and Presentations Status: Published Year Published: 2013 Citation: M. Zhou and I.M. Sheldon, The Role of Intellectual Property Rights in Seed Technology Transfer through Trade: Evidence from US Field Crop Exports, Agricultural and Applied Economics Association Annual Conference, Washington DC, August 2013.

Progress 01/01/12 to 12/31/12

Outputs
OUTPUTS: Investigations were made of the effects of policy reform on agricultural market integration and trade flows in the European livestock sector. Economic analysis has been completed on the impact of exchange rate uncertainty on trade in agricultural commodities such as fresh fruit and vegetables. Research has also been conducted on the impact of food standards on international trade, with a specific focus on technology transfer from developed economies to developing economies. The results have been disseminated throughout the academic community. This has been accomplished through scientific journals and unpublished working papers. Audiences impacted include academics, policy makers, and farm organizations. PARTICIPANTS: At Ohio State, Stan Thompson (PI) collaborated with Ian Sheldon (PI) TARGET AUDIENCES: Target audiences for this research include academics, policy makers and farm organizations at the national and international levels. PROJECT MODIFICATIONS: Nothing significant to report during this reporting period.

Impacts
Innovative data analysis methods were used to evaluate the market effects of alternative policy change scenarios. These effects were incorporated into a general framework to assess the welfare effects of policy change. An ex post evaluation of the 2003 Fischler Reforms to the EU Common Agricultural Policy (CAP) lead to several important findings. First, the decoupling of support payments from production reduced market prices, yet EU livestock markets remained economically integrated. Second, allowing Member States (MS) to differentially implement the decoupling reforms resulted in differential production incentives; hence, trade flows of livestock products were altered. Third, the Reforms were a step towards greater compliance with WTO commitments. Finally, the methods developed and used contributed greatly to the economic evaluation literature. Empirical analysis of the connection between exchange rate uncertainty and trade in fresh fruit and vegetables was revised, the key result being that fresh fruit trade is clearly negatively affected by exchange rates as compared to fresh vegetable trade. A developed-developing country trade model was also developed focusing on the impact of higher WTO-compliant food standards in the developed economies, specifically relating to pesticide residues. The results show that technology transfer from developed to developing economies can have help alleviate barriers to food exports by developing countries. Further analysis was conducted on whether developed country food standards stimulate innovation in the devloping economies as per the Poretr hypothesis.

Publications

• Ihle, R. B. Bruemmer and S.R. Thompson. "Structural Change in the European Calf Markets: Decoupling and Blue Tongue Disease." European Review of Agricultural Economics. 39 (2012): 157-180.
• Sheldon, I.M. "North-South Trade and Standards: What Can General Equilibrium Analysis Tell Us" World Trade Review, 11(2012):376-389.
• Sheldon, I.M., S. Khadka, D. Pick and S.R. Thompson. "Exchange Rate Uncertainty and U.S. Bilateral Fresh Fruit and Vegetable Trade: An Application of the Gravity Model." forthcoming in Applied Economics, 45 (2013): 2067-2082. Electronic version published in 2012.

Progress 01/01/11 to 12/31/11

Outputs
OUTPUTS: Investigations were made of the effects of policy reform on agricultural market integration and trade flows in the European livestock sector. Economic analysis has also been conducted of the impact of exchange rate uncertainty on trade in agricultural commodities such as fresh fruit and vegetables. In addition, analysis of tariff escalation in the food marketing system has been completed. The results of this research have been disseminated throughout the academic community. This has been accomplished through scientific journals and unpublished working papers. Audiences impacted include academics, policy makers, and farm organizations. PARTICIPANTS: At Ohio State, Stan Thompson (PI) collaborated with Ian Sheldon (PI). TARGET AUDIENCES: Target audiences for this research include academics, policy makers and farm organizations at the national and international levels. PROJECT MODIFICATIONS: Nothing significant to report during this reporting period.

Impacts
Innovative data analysis methods were used to evaluate the market effects of alternative policy change scenarios. These effects were incorporated into a general framework to assess the welfare effects of policy change. An ex post evaluation of the 2003 Fischler Reforms to the EU Common Agricultural Policy (CAP) lead to several important findings. First, the decoupling of support payments from production reduced market prices, yet EU livestock markets remained economically integrated. Second, allowing Member States (MS) to differentially implement the decoupling reforms resulted in differential production incentives; hence, trade flows of livestock products were altered. Third, while markets remained integrated, the outbreak of the animal disease Blue Tongue induced a significant change in the spatial structure of animal prices. Fourth, the Reforms were a step towards greater compliance with WTO commitments. Finally, the methods developed and used contributed greatly to the economic evaluation literature. A model was also completed to analyze the issue of a simultaneous reduction in tariffs at different stages of the food marketing system. Although tariff reduction formulae have been widely employed as part of the trade negotiating process, their advocacy has often been ad hoc. This analysis shows that rules promoting tariff de-escalation ensure either parity in terms of the changes in profits between domestic upstream and downstream firms, or avoid the burden of adjustment falling on exporters if there were tariff escalation. In addition, empirical analysis of the connection between exchange rate uncertainty and trade in fresh fruit and vegetables has been completed, the results indicating that in a globally integrated world market, there is need for development of cheap and readily available risk-reduction instruments.

Publications

• Ihle, R., B. Bruemmer and S.R. Thompson. (2011). "Structural Change in European Calf Markets: Decoupling and the Blue Tongue Disease." European Review of Agricultural Economics, 38 (3):1-23.
• McCorriston, S. and I. Sheldon (2011). "Tariff (De-) Escalation with Successive Oligopoly." Review of Development Economics, 14(4): 587-600.
• Sheldon, I., S. Khadka Mishra, D. Pick and S. Thompson. (2012). "Exchange Rate Uncertainty and U.S. Bilateral Fresh Fruit and Vegetable Trade: An Application of the Gravity Model." Applied Economics - forthcoming.
• Prehn, S, B. Bruemmer and S.R. Thompson. "Payment Decoupling and the Intra- European Calf Trade." American Journal of Agricultural Economics. (Third revision requested December, 2011).

Progress 01/01/10 to 12/31/10

Outputs
OUTPUTS: Investigations were made of the effects of policy reform on agricultural market integration and trade flows in the European livestock sector. Economic analysis has also been conducted of tariff escalation in the food marketing system. The results of this research have been disseminated throughout the academic community. This has been accomplished through scientific journals and unpublished working papers. Audiences impacted include academics, policy makers, and farm organizations. PARTICIPANTS: At Ohio State, Stan Thompson (PI) collaborated with Ian Sheldon (PI). TARGET AUDIENCES: Target audiences for this research include academics, policy makers and farm organizations at the national and international levels. PROJECT MODIFICATIONS: Nothing significant to report during this reporting period.

Impacts
Innovative data analysis methods were used to evaluate the market effects of alternative policy change scenarios. These effects were incorporated into a general framework to assess the welfare effects of policy change. An ex post evaluation of the 2003 Fischler Reforms to the EU Common Agricultural Policy (CAP) lead to several important findings. First, the decoupling of support payments from production reduced market prices, yet EU livestock markets remained economically integrated. Second, allowing Member States (MS) to differentially implement the decoupling reforms resulted in differential production incentives; hence, trade flows of livestock products were altered. Third, the Reforms were a step towards greater compliance with WTO commitments. Finally, the methods developed and used contributed greatly to the economic evaluation literature. A model was also developed to analyze the issue of a simultaneous reduction in tariffs at different stages of the food marketing system. Although tariff reduction formulae have been widely employed as part of the trade negotiating process, their advocacy has often been ad hoc. This analysis shows that rules promoting tariff de-escalation ensure either parity in terms of the changes in profits between domestic upstream and downstream firms, or avoid the burden of adjustment falling on exporters if there were tariff escalation.

Publications

• Thompson, S. R., Y. Bae and M. Kniepert (2010). Agricultural Policy Regime Change Assessment: Austrian Accession to the European Union. Empirical Economics 39:292-302.
• McCorriston, S. and I. Sheldon (2011). Tariff (De-) Escalation with Successive Oligopoly. Review of Development Economics - forthcoming.
• Bruemmer, B., S. Prehn and S. R. Thompson.Payment Decoupling and the Intra-European Calf Trade. Am. J. Agr. Econ. First submission December 2010.
• Bruemmer, B., R. Ihle and S.R. Thompson. Regional Market Integration in the EU Beef and Veal Sector: Policy Decoupling and Export Restrictions. Eur. Rev. Agr. Econ. First submission March 2010. Revision requested and resubmitted December 2010.