Leetmaa, Susan E.

English

Research Papers in Economics

*IATRC
INTERNATIONAL AGRICULTURAL
TRADE RESEARCH  CONSORTIUM
Economic Transition in Central and East Europe,
and the Former Soviet  Union:
Implications for International Agricultural Trade
Von Witzke,  H. and S. Tangermann,  eds.
1998
International Agricultural Trade  Research Consortium
Symposium Proceedings Issue
June 12-14,  1997
Berlin,  GermanyEFFECTS  OF  MARKET  REFORMS  IN THE  FORMER SOVIET  UNION
ON WORLD  GRAIN TRADE:
RESULTS  FROM  A MULTI-MARKET  WHEAT  TRADE  MODEL
Susan E. Leetmaa
US  Department of Agriculture, Washington, D.C.,  USA
This  segment  of  the  report  discusses  an  evaluation  of  market  reforms  that  was
undertaken using a multi-market wheat trade policy simulation  model.  The  results are
highly aggregated and serve two purposes.  First, the results provide  valuable  insights
into  the  effects  of  market  reforms  in  the  Former  Soviet  Union  (FSU)  on  market
relationships among  several important  wheat  exporters and  importers.  Second,  the
results  offer  a  benchmark  against  which  to  compare  results  obtained  from  less-
aggregate models.
The  Model
A multi-region wheat trade model  was constructed.  Wheat  is the chief commodity  of
interest  because of the  highly competitive nature of the world  wheat  market.  Since
wheat  has  been  shown  to  differ considerably  in  quality  and  use  characteristics  by
source,  we  modeled  wheat  as  a  differentiated  product  (Haley,  1995a).  The  model
includes net trade of wheat from six specific sources (Argentina, Australia,  Canada, the
European Union (EU),  Saudi Arabia,  and the United States) and wheat from  all  other
exporters.  The  model  was  specified  using the  Armington  framework  and  imposed
Hjort's  three stage  methodology  of wheat  demand.  Armington-type  models  explain
bilateral trade flows by assuming that commodities exported by different countries  are
not perfectly  homogeneous and  Hjort's  methodology provides a systematic framework
to utilize the Armington  analysis for wheat.
The model  is a static, partial equilibrium,  nonspatial  model, and  is characterized by an
economic structure that includes constant elasticity of supply and demand equations.
Supply and demand are functions of own and cross prices.  Net trade is the difference
between domestic supply and demand.  Domestic incentive prices depend on the  level
of consumer and producer support and on world  prices denominated in a local currency.
Price  transmission  elasticities regulate  the extent to which  changes  in world  prices
affect domestic prices.  World markets clear when net trade of a commodity across all
regions sums to zero.  The model, WHEAT,  is a 33-region,  11-commodity,  simulation
model  of world trade that has been parameterized with a 1992 database.  The model
yields results expected to occur in the medium term, or about 5-7 years for adjustment
to be complete.
Hjort's methodology separates wheat demand into three stages.  In the first stage, total
wheat  needs  are  determined,  as  are  imports  required  to  satisfy  the  quality
characteristics desired by users in the  importing country  (e.g.,  for milling, feed  uses).
This aggregate demand will  be called stage one demand.  In the second stage, the mix
of wheat  imports  by  class  that will  satisfy  stage  one  demand  is  determined.  Weak
separability  is assumed:  that is, the marginal  rates of substitution among wheat classes
201are independent of the determination  of stage one demand.  The goal  of the importer
is to  minimize the cost of fulfilling aggregate demand  for wheat.  The solution  to the
optimization problem shows the mix of wheats that will satisfy demand for wheat quality
characteristics.  In the third stage,  the importer determines the exporters to fulfill  class-
level  wheat  demand.  Weak  separability  is  again  assumed:  the  marginal  rate  of
substitution between suppliers of wheat is independent of quantities of other classes
of imported  wheat.  The  formal  goal  is the  maximization  of class  I importing  agent's
utility  given  the  choice  of  multi-sourced  class  I wheat  and  given  the  expenditure
constraint from stage two.  The solution  is the compensated demand that depends  on
the quantity of class I imports and the price of all within-class wheats.
Based  on Hjort's theoretical model, own and cross price elasticities can be derived.  The
necessary elements are an own price elasticity of demand (stage one), elasticities  of
substitution corresponding  to wheat classes (o,  stage  two) and  to wheat suppliers  of
particular classes (ao,  stage three), and consumption and/or import shares.  Calculation
of own and cross price elasticities are based on the Armington specification,  where:
11  =  demand elasticity for wheat
mfl  = own price demand elasticity of class I wheat
rih  = cross price demand elasticity of class I wheat with  respect  to class  h
wheat
Sh  = expenditure share of class h wheat imports.
The own price demand elasticity for class I wheat can be shown  to equal:
(1)  q, = -(1 -Si)  *  +  S,  *  9
The cross price demand  elasticity of class I wheat with respect to class h can be shown
to equal:
(2)  qih  (Sh  y  )
Within  each class of wheat additional own and cross price elasticities are defined  as
follows:
p,  = own price demand  elasticity of class I wheat from exporter j
.i,  m  =  cross  price  demand  elasticity  of  class  I wheat  from  exporter  j with
respect to exporter m
S m,  = expenditure share of class I wheat imports from supplier m.
Values  for  these  elasticities  can  be  calculated  based  on  equations  resembling
equations  1  and  2,  given  within-class  elasticities  of  substitution  between  wheat
suppliers and appropriate expenditure share data:
202
(3)  '/I  jj  -0_U1,j)*  +Ul,,j  *7711(rl  im  ,  S,,  * (r,  -q,,)
(5)  r;i,jm = Sm * qih where h_i
Data
Data  for supply,  trade  flows,  and  export prices were  obtained  from  the  International
Wheat Council  (IWC).  The 1992 crop year was selected as the base year due to the
availability of published data for world trade in that year.  The  IWC was  also the source
of data for transport costs and some subsidies for the United States and the  EU.  The
remainder  of the transport data were obtained from Maritime  Research  Inc.  The USDA
was  the  source  of  US  wheat  class  trade flow  data,  Export  Enhancement  Program
subsidies,  and US  food aid flows.
Elasticity values used for this study come from  (or are  based on)  numerous sources.
Supply  and  demand  elasticities  were  obtained  from  the  ERS  SWOPSIM  Global
Database (Sullivan,  Roningen, Leetmaa,  and Gray) and SWOPSIM  price transmission
elasticities were  used (Sullivan).  The  values  of the wheat  elasticities  by type  were
obtained from  Haley, Leetmaa,  and Webb,  and Haley (1995b).  These elasticities  are
based on a function of a country's end uses for the wheat.  The  elasticities also reflect
the  preferences  of,  and  the  constraints  faced  by,  those  who  make  wheat  import
decisions.  The values of the inferred between-class  elasticities  tend to be low (0.50),
and the between-supplier elasticities tend to be higher (3.0) (Haley,  Leetmaa, Webb).
Analysis
The objective of this analysis was to determine how potential changes  in the FSU wheat
market,  brought about by economic reform,  may alter U.S. competitiveness  in the world
wheat market.  Because the FSU  has not been a large player in the world market as of
late, we  elected to analyze other possible changes that might have  major impacts on
world  grain trade and compare them in relative magnitude to FSU  reform.
The WHEAT model  was used to analyze the potential affects of various scenarios  on
the world wheat market and on  U.S.  competitiveness.  The following  scenarios were
analyzed:
Large increase in FSU  wheat production due to successful economic reform;
Large increase in Chinese wheat imports;
Increase  in the ,,Asian Tigers'" income levels;
EU accession of the CEEs.
Results
The collapse of the  Soviet Union  and the ensuing  introduction  of economic reforms
created much  uncertainty for farmers.  Due to financial upheaval, the State, the sole
purchaser of grains in Soviet times, became unable to pay farmers for their crops in a
timely manner and also eliminated input subsidies, which resulted in a decline in yields.
As market reforms progress, it is  likely that wheat yields will rebound.  If  FSU wheat
yields were to increase  to  1985-1994 average  FSU levels  (25.56 bushels/acre),  FSU
production would  increase by roughly 11  percent, allowing for an increase in net exports
203
(4)of almost 9 million tons (see Table 1).  However,  there would  be  little  change  in  U.S.
and Canadian  production and exports,  because FSU wheat does not directly compete
with their higher quality wheats.  The EU would  be the hardest  hit  of the major wheat
producers, since the FSU and the EU produce similar types and qualities  of wheat.  EU
production could be expected to decrease by nearly 2 percent, while exports could fall
by as much as  13.5 percent.  Though unlikely in the near term,  if the FSU was able to
increase  yields to  U.S.  (36.53  bu/acre)  or  French  levels  (92.52  bu/acre),  the  effect
would be far more dramatic.  If the FSU farmed  as intensively as the French, the  U.S.
and Canada would  suffer decreases  in net exports  of 9 and  14  percent respectively.
The  EU  would  be  most adversely  effected and  could stand  to  lose  as much  as 38
percent of their net exports.  If  the FSU  were to  produce wheat  as  efficiently  as  the
French,  they  would  rule  the  global wheat  markets  with  a  74  percent  share  of  net
exports.
According to Lester Brown,  China may soon  become an importer of massive quantities
of grain,  triggering an unprecedented rise  in world food prices.  Brown  estimates that
to meet the goal of 200 eggs per person per year by the year 2000 China would  require
an additional 24 million tons of grain.  We have analyzed the impact  of a  50 percent
increase in Chinese wheat demand (roughly 50 million tons) imposing current Russian
wheat yields, the higher historical  FSU yields, and U.S. wheat yields for the FSU (see
Table  2).  We  elected  not to analyze  increased  Chinese  demand  imposing  French
wheat yields on the FSU  because achieving such high yields would be highly unlikely
in the medium term,  if ever.
China imports  high protein wheat from Canada and the U.S. to blend with domestic and
imported wheat.  At present FSU  yields,  if Chinese demand for wheat would  increase
by  50  percent,  world  wheat  prices  would  increase  sufficiently  to  increase  FSU
production and net trade.  In terms of volume,  the largest gainer in the Chinese market
would  be the  U.S.,  followed by  Canada,  with the  largest percentage  gain.  If  FSU
reforms are successful and yields increase, the  FSU could  be the largest gainer from
increased demand by the Chinese.  FSU  wheat production could more than  double if
yields reach  U.S.  levels, making the FSU  the largest net exporter  in the world  wheat
markets.
In order to analyze the impact of CEE  integration into the EU,  some assumptions were
made about the terms of accession.  Because the CEEs produce a lower quality wheat
than the EU,  it was assumed that they would receive roughly 10  percent less than EU-
15 farmers for their wheat.  Also, it was assumed that EU  imports of generic wheat were
first filled by the CEEs.  It was also assumed that the EU  and CEE  GATT commitments
would be summed  to determine the EU-19 GATT commitments.
If,  or when, the EU  accepts the CEEs  as members of the  EU,  it appears that the U.S.
wheat market will not be greatly impacted.  U.S. production is expected to decline less
than one  percent, as  is their  net trade.  The  U.S.  will  maintain  its  market  share.
Canada,  which  produces  a  complementary  wheat  to  the  EU,  may  see  a minimal
increase in production and net trade, slightly increasing its market share.  The EU-15
will see a slight drop in production and a larger drop in net trade, but this will be offset
by the gain in CEE  production and net trade.  The  incentive of higher prices is expected
to increase CEE wheat production  by over 20 percent.  Consequently, the higher wheat
prices will also cause a large drop  in demand,  allowing for a sizeable  increase  in  CEE
net exports (approximately 20 million tons).  If we net out supposed intra-trade, the  net
204gain  in net trade for the EU-19  is expected to be only 4.1  million  metric tons (about 25
percent)  and the gain  in net trade for the CEEs to the rest of the world (excluding  other
EU  countries)  is expected to be roughly 5.8 million tons.
Assuming that Russian yields reach pre-FSU  levels, the FSU is not likely to  benefit from
EU  enlargement.  Though the results suggest that  FSU  production  will  increase,  the
increase is due to the exogenous supply shock accounting for the higher yields,  not a
price change.  The decrease  in world  price,  brought about  by the  increase  in  supply
from the CEE  countries spurs increased FSU  wheat demand,  resulting  in a  decrease
in net trade of roughly 3.4 million tons.
If the  incomes of the  so-called ,,Asian  Tigers"  continue to  increase,  the demand  for
wheat,  especially  as  a  feed,  could  increase  as  well.  Using  SWOPSIM  (Sullivan,
Roningen,  Leetmaa,  and  Gray)  income elasticities for wheat,  we estimate  that a  7.2
percent increase in income  in the high growth Asian countries (South  Korea,  Taiwan,
Malaysia,  Philippines, Thailand,  and Indonesia) and a  15  percent  increase  in  income
in China will have little impact on U.S. wheat exports.  However, the EU  could suffer a
fairly sizeable decrease in net exports, while the FSU  could increase their net exports.
Were the FSU  able to  increase their yields to pre-reform  levels,  they could  possibly
increase their net exports by as nearly 12  million tons.
Table  5 compares  base market shares of net exports to the shares  estimated  in  our
simulations.  In  all scenarios except for CEE  integration to the EU, the FSU would gain
in market  share.  In the scenarios where the 1992 base yields were assumed, the  FSU
either remains a net importer of wheat, or captures only a small  portion of market share.
If  yields  were  to  increase  to  historical  (1986-1994  average)  levels,  the  FSU  could
become a  major player in the global wheat market (though this is unlikely in the near
future).  If efficiency were  increased and  FSU  yields boosted  to French,  or even  U.S.
levels, the FSU  could become the largest net exporter on the world market, surpassing
even the  U.S.
Conclusion
Though the  FSU has imposed some economic reforms  on their agricultural sector, the
reform  process is far from complete.  Our analysis suggests that if the sector continues
to operate as it has since the break-up of the Soviet Union, the U.S. has little to fear in
the world wheat market.  However,  if the FSU  allows for complete privatization of the
sector,  leading  to  efficiency  gains  in production,  it is possible  that  the  FSU  could
become a major exporter of wheat.
205References
Armington,  P.C.  "A Theory of Demand for Products Distinguished  by Place of
Production."  International Monetary Fund Staff Papers. 16(1969): 159-178.
Haley, S.  Product Differentiation in Wheat Trade  Modeling. Technical  Bulletin  No.
1838.  Washington,  DC:  USDA,  Economic Research  Service,  June  1995
Haley, S.  Personal communication.  1995 and  1996.
Haley,  S.L.,  S.E.  Leetmaa,  and A.J. Webb.  ,,Wheat Cleaning and  its  Effect  of U.S.
Wheat  Exports".  International Agricultural Trade Research Consortium
Working Paper.  Number 93-9,  October 1993.
Hjort,  K.C.  "Class and Source Substitutability in the Demand for  Imported  Wheat,"
unpublished Ph.D.  dissertation,  Dept.Agr.  Econ.,  Purdue University,  May,
1988.
International  Wheat Council.  World Grain Statistics 1991.  London:  IWC,  1992.
Maritime  Research,  Inc.  Parlin,  NJ.
Sullivan,  J.  Price Transmission Elasticities in the Trade Liberalization (TLIB)
Database.  Staff Report  No. AGES-9034.  Washington,  DC:  USDA,  Economic
Research Service,  1990.
Sullivan,  J., V.O. Roningen,  S.E.  Leetmaa,  and D. Gray.  A  1989 Global Database
for the Static  World Policy Simulation (SWOPSIM)  Modeling Framework.
Staff Report AGES  92-15.  Washington,  DC:  USDA,  Economic Research Service,
1992.
206Table  1:  Absolute and  percentage  changes  in production and  net trade  with
FSU  increasing yields to former,  US,  and  French  levels.
Russian  Yields  U.S.  Yields  French  Yields
Production  Net Trade  Production  Net Trade  Production  Net Trade
US  105.1  109.6  -888  -713  -3981.8  -3180.6
(0.18%)  (0.32%)  (-1.5%)  (-2.1%)  (-6.8%)  (-9.1%)
Canada  218  190.9  -585  -620  -2781  -2856.2
(0.93%)  (0.95%)  (-2.5%)  (-3.1%)  (-11.8%)  (-14.2%)
EU  -971.6  -2139.6  -21825  -3159.9  -5253.9  -6096.3
(-1.95%)  (-13.5%)  (-4.4%)  (-20%)  (-10.6%)  (-38.6)
FSU  food  2948.6  1881.2  16136.4  13096.5  77958.5  62425.6
(10%)  (169%)  (54.5%)  (1177.5%)  (263.4%)  (5612.6%)
FSU  feed  5475.9  8885  27360.3  32923.1  139634.3  149260.2
(11.9%)  (888500%)  (59.5%)  (329231 %)  (303.6%)  (149260%)
Table  2: Changes  in Wheat  Production and  Net trade with a 50 Percent
Increase in Chinese Wheat  Demand.
_____~Current  Yields  Historical Yields  U.S.  Yields
__________Production[  Net Trade  Production[  Net Trade  Production[ Net Trade
U.S.  1725.1  1556.8  1445.6  1320.7  -579.4  -380.6
(3.0%)  (4.5%)  (2.5%)  (3.8%)  (1.0%)  (-1.1 %)
Canada  .1470.7  1488.5  1230.3  1247.0  -335.5  -337.8
(6.3%)  (7.4%)  (5.2%)  (6.2%)  (-1.4%)  (-1.7%)
E U  -157.3  -715.5  -532.8  -1042  -2796.7  -3177.4
(-0.3%)  (-4.5%)  (-1.0%)  (-6.6%)  (-5.6%)  (-20.1 %)
FSU  869.3  2875  8897  11282  80071.3  82188.6
(1.1 %)  (258.5%)  (11.8%)  (1014%)  (105.9%)  (7389%)
207Table 3: Changes  to World Wheat  Trade  with EU  Accession  of the CEEs.
Change  in Production  Change  in  Net Trade
U.S.  -466  (-0.8%)  -287.5  (-0.8%)
Canada  131.6  (0.56%)  105.3  (0.52%)
EU  -680  (-1.4%)  -1589.5  (-10.1%)
CEE  5216.3  (22.5%)  5729.7  (4702%)
FSU  7794.4  (10.3%)  -3437.4  (-450%)
Table  4: Change  in production and  Net Trade  with an 7.2 percent Increase in
,,Asian Tigers" Income.
Base Yields  Historical  FSU Yields
Production  Net Trade  Production  Net Trade
U.S.  567.1  512.5  314.6  303.3
(1.0%)  (1.5%)  (0.5%)  (0.9%)
Canada  593  572.5  372.4  351.2
(2.5%)  (2.9%)  (1.6%)  (1.8%)
EU  -558.1  -1708  -910  -1988
(-1.1%)  (-10.8%)  (-1.8%)  (-12.6%)
FSU  491.4  3607.5  8488.8  11910.9
(0.7%)  (324.3%)  (11.2%)  (1071%)
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Effects of Market Reforms in the Former Soviet Union on World Grain Trade: Results From A Multi-Market Wheat Trade Model

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