Agricultural Trade and Natural Resources: Discovering Critical Linkages 9781685852559

Table of contents :
Contents
List of Figures and Tables
Foreword
Acknowledgments
Contributors
Introduction
Part One - The Theoretical Framework
1. Natural Resource Concepts in Trade Analysis
2. International Trade Theory and Natural Resource Concepts
3. Economic Analysis of Agricultural Resources in an Open Economy: A Hybrid Model
Part Two - The Implications of Natural Resource Policies for Agricultural Trade
4. Implications of Environmental Regulations for Competitiveness in Agricultural Trade
5. Discussion: Linkages Between Soil Conservation Policy and Trade Policy
6. Effects of Natural Resource Policies on Agricultural Trade
7. Discussion: Developing a Framework for Analyzing Effects of Resource Policies on Trade
Part Three - The Implications of Trade Policy for Natural Resources
8. Trade Policies and the Use and Value of Natural Resources
9. Discussion: Conceptual and Empirical Needs for Integrating Resources and Trade Analysis
10. Issues in Commodity Trade: Implications for Natural Resources
11. Discussion: Policy Issues and Research Questions Relating to the Trade-Resources Interface
12. Technology, Natural Resources, and Commodity Trade
13. Bringing Together International and Resource Economists: Comment
Index
About the Book

Citation preview

AGRICULTURAL TRADE AND NATURAL RESOURCES

AGRICULTURAL TRADE AND NATURAL RESOURCES Discovering the Critical Linkages

edited by

John D. Sutton

Lynne Rienner Publishers • Boulder & London

Published in the United States of America in 1988 by Lynne Rienner Publishers, Inc. 948 North Street, Boulder, Colorado 80302 Published in the United Kingdom by Lynne Rienner Publishers, Inc. 3 Henrietta Street, Covent Garden, London WC2E 8LU ©1988 by Lynne Rienner Publishers, Inc. All rights reserved Library of Congress Catalog!ng-ln-Publication Data Agricultural trade and natural resources : discovering the critical linkages / edited by John D. Sutton, p. cm. Bibliography: p. Includes index. ISBN 1-55587-090-2 (lib. bdg.) 1. Produce trade—United States—Congresses. 2. Natural resources—United States—Congresses. 3. Agriculture and state— United States—Congresses 4. Natural resources—Government policy—United States—Congresses. 5. Produce trade—Congresses. 6. Natural resources—Congresses. I. Sutton, John D. HD9005.A2667 1988 382'.41'0973—dcl9

Printed and bound in the United States of America

The paper used in this publication meets the requirements of the American National Standard for Permanence of Paper for Printed Library Materials Z39.48-1984.

87-33288 CIP

Contents

List of Figures and Tables

vii

Foreword John E. Lee, Jr. and George E. Rossmiller

ix

Acknowledgments

xi

Contributors

xiii

Introduction John D. Sutton

1

Part One - The Theoretical Framework

7

1. Natural Resource Concepts in Trade Analysis Kathleen Segerson 2.

3.

International Trade Theory and Natural Resource Concepts Philip C. Abbott and Stephen L. Haley

35

Economic Analysis of Agricultural Resources in an Open Economy: A Hybrid Model John M. Antle and Richard E. Howitt

63

Part Two - The Implications of Natural Resource Policies for Agricultural Trade 4.

5.

6.

9

93

Implications of Environmental Regulations for Competitiveness in Agricultural Trade C. Ford Runge, James P. Houck, and Daniel W. Halbach

95

Discussion: Linkages Between Soil Conservation Policy and Trade Policy Clayton W. Ogg and John D. Sutton

118

Effects of Natural Resource Policies on Agricultural Trade Robert G. Chambers and Katherine Reichelderfer

126

v

VI

CONTENTS

7.

Discussion: Developing a Framework for Analyzing Effects of Resource Policies on Trade Nancy E. Schwartz and George E. Rossmiller

Part Three - The Implications of Trade Policy for Natural Resources 8. Trade Policies and the Use and Value of Natural Resources John D. Sutton and Alan J. Webb 9.

Discussion: Conceptual and Empirical Needs for Integrating Resources and Trade Analysis John C. Dunmore and James A. Langley

145 155

157

187

10. Issues in Commodity Trade: Implications for Natural Resources Andrew Schmitz, G. C. Van Kooten, and W. Hartley Furtan

195

11. Discussion: Policy Issues and Research Questions Relating to the Trade-Resources Interface Jerry Sharpies, Lyle P. Schertz, and Eduardo Segarra

217

12. Technology, Natural Resources, and Commodity Trade John M. Reilly and Tim T. Phipps

224

13. Bringing Together International and Resource Economists: Comment Bruce Gardner

236

Index

241

About the Book

247

List of Figures and Tables

Figures 2.1 2.2 3.1 4.1 4.2 4.3 4.A1 4.A2 4.A3 6.1 6.2 6.3 6.4 6.5 6.6 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8 8.9

Comparative Advantage in the Ricardian Model Comparative Advantage in the Heckscher-Ohlin Model The Trade-Production-Resources Linkages Induced Technological Innovation Minnesota Farmland Values and U.S. Value of Selected Commodity Exports Targeting Soils by Productivity and Environmental Sensitivity Regression #1 of Annual Percent Price Change in Soybeans, 1966/67-1984/85 Regression #1 of Annual Percent Price Change in Winter Wheat, 1966/67-1984/85 Regression #1 of Annual Percent Price Change in Corn, 1966 to 1984 Adjustment Path and Steady-State Values of Land Quality and Shadow Price of Quality Comparative Dynamics of a Change in Discount Rate How Exports Adjust Over Time to a Change in the Discount Rate Effects of Land Retirement and Investment on Land Quality Expected Price Trajectories Given Permanent Change in Price Level Comparative Dynamics of a Change in pj Impacts of a Change in World Product Demand on Factor Markets Impact of a Reduction in World Capital Supply on Factor Markets Value Product Curves to Determine Net Returns to Fixed and Variable Factors Cost Curves by Land Quality Relationship Between Wheat Prices and Land Prices Real U.S. Farmland Prices Real Canadian Farmland Prices Real Australian Farmland Prices Real French Farmland Prices vii

40 43 76 100 106 110 116 116 117 131 131 133 137 141 141 160 162 165 165 172 174 174 175 175

Vlll

8.10 8.11 8.12 8.13 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 10,9 10.10 10.11

10.12 10.13 11.1 11.2 12.1 13.1

LIST OF FIGURES AND TABLES

Real Argentine Farmland Prices Wheat Export Prices Wheat Producer Prices Real Long-Term Government Bond Rates Deficiency Payments in a Closed and Open Economy Deficiency Payments with Zero Welfare Cost Research and Development in an Open Economy Technological Transfer Multinationals and Resource Use Storage and Domestic Farm Policy Domestic Farm Policy and Gain from Trade European Community Wheat Sector Canadian Wheat Sector Gains from Trade Movement Along Production Possibilities Frontier When Both Product Prices Decline Dynamic Distortions Due to International Price Fluctuations Critical Investment in Water Resource Development Linkages Between Trade and Natural Resources Gains from Trade and Trade-Natural Resource Linkages Primary Economic Relationships Among Resources, Technology, and Agricultural Trade Commodity Exports with External Cost

176 179 181 182 198 199 200 201 202 204 204 206 206 207 208 209 214 218 220 226 238

Tables 4.A1 International Prices and Price Changes for Wheat, Corn, and Soybeans, Marketing Years 1965/66-1984/85 4.A2 Regression Series #1 (Excluding Outlier Data) 4. A3 Regression Series #2 (All Observations) 8.1 Determinants of Effects of Trade Policies on Agricultural Resources 8.2 Real Farmland Prices by Region, 1970-1984 8.3 Real Wheat Prices, 1970-1984 8.4 Correlation Between Annual Change in Real Farmland Prices and Real Wheat Prices, 1972/73-1982/83 8.5 Real Long-Term Government Interest Rates by Country, 1970-1984 10.1 Canada and U.S. Grain Harvests by Area and Yield, 1970-1984

113 114 115 168 177 178 179 182 211

Foreword

The expansion and contraction of U.S. agricultural exports, cropland area and intensity of cropland use, and dramatic fluctuations in farmland values, all since the early 1970s, together with growing awareness of environmental impacts of changes in land and water use, suggest strong ties between natural resources and international agricultural trade. The agricultural economics profession has devoted little attention, either conceptual or empirical, to understanding these ties. Agricultural trade theory and natural resource economics theory have developed largely separately and economists of both areas have had only limited professional interaction. Recognizing this shortcoming, the Resources and Technology Division (RTD) of the Economic Research Service and the National Center for Food and Agricultural Policy (NCFAP) of Resources for the Future co-sponsored the Workshop on Linkages Between Natural Resources and International Trade in Agricultural Commodities in Washington, D.C. on March 19-20, 1987. This book presents material prepared for and stemming from this workshop. The intensive interaction of workshop participants was in itself an important result. Debates were active and thought-provoking and participants' viewpoints were broadened beyond their areas of specialization. Many individuals contributed to this endeavor but three deserve special recognition. Katherine Reichelderfer, Associate Director of RTD, initially suggested holding a workshop and provided leadership throughout the planning process. Kenneth Farrell, then director of NCFAP, was responsible for the conceptual approach adopted. John Sutton, agricultural economist in RTD, was instrumental in planning and implementing the workshop as well as developing and editing this book. John E. Lee, Jr. Administrator, Economic Research Service U.S. Department of Agriculture George E. Rossrruller Director, National Centerfor Food and Agricultural Policy Resources for the Future ix

Acknowledgments

A great many people made significant contributions to the March 1987 Workshop on Linkages Between Natural Resources and International Trade and to subsequent publication of this book. Those involved in planning and supporting the Workshop were Malcolm Bale, Susan Capalbo, Velmar Davis, Robert Evenson, Kenneth Farrell, John Lee, Jr., John Miranowski, Phillip Paarlberg, Katherine Reichelderfer, Neill Schaller, Lyle Schertz, and Jerry Sharpies. Deborah Blue, Ann Ralosky, and Glennis Beaird provided continuous and highly competent secretarial and administrative support. In preparation for this book, many individuals provided technical reviews and frequently did so several times. In addition to the authors who often served in this capacity, I would like to extend special thanks to Carlos Arnade, Sandra Batie, Susan Capalbo, Barbara Chattin, Lee Christiansen, Larry Deaton, Mike Dicks, Clark Edwards, Karl Gertel, Michael LeBlanc, Michael Moore, Susan Offutt, John Scott, Harold Taylor, Thomas Vollrath, Gene Wunderlich, and Ed Young. Doug Parry and Jim Morrison are to be congratulated for producing the book's high quality graphics in a relatively short time. Finally, I wish to acknowledge Ivanetta Ingram-Thomas, a new and diligent ERS employee who quickly mastered a word processing system and typed and retyped a majority of the book's chapters. John D. Sutton

xi

Contributors

Philip C. Abbott is a professor of agricultural economics at Purdue University. His research focuses on international commodity trade. John M. Antle is an associate professor of agricultural economics at Montana State University. From 1984 to 1986, he conducted research on agricultural policy and natural resources at RFF. Robert G. Chambers is a professor of agricultural and resource economics at the University of Maryland. John C. Dunmore is associate director of the Agriculture and Trade Analysis Division (ATAD) of ERS. His research interests focus on agricultural and trade policies as determinants of comparative advantage. Bruce Gardner is a professor of agricultural policy in the Department of Agricultural and Resource Economics at the University of Maryland. Stephen L. Haley is an agricultural economist with ATAD/ERS. His research interests focus on the role of macroeconomic policy on agricultural trade and trade liberalization. W. Hartley Furtan is a professor of agricultural economics at the University of Saskatchewan, Saskatoon, Canada. Daniel W. Halbach is a research fellow in the Department of Agricultural and Applied Economics at the University of Minnesota. His research interests include international trade and environmental policy issues. James P. Houck is a professor of agricultural economics at the University of Minnesota. His major professional interests are agricultural prices, policy, and trade. Richard E. Howitt is a professor of agricultural economics at the University of California at Davis. His research interests focus on resource and environmental economics, quantitative methods, and econometrics. xiii

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James A. Langley is an agricultural economist with ATAD/ERS. His research interests are in the role of commodity programs in U.S. agriculture. John E. Lee, Jr. is the administrator of the Economic Research Service. Clayton W. Ogg is an agricultural economist with the Soil and Water Branch of the Resources and Technology Division (RTD) of ERS. His research interests focus on economic implications of soil conservation policy. Tim T. Phipps is a Fellow at the National Center for Food and Agricultural Policy (NCFAP), RFF. He specializes in agricultural land-use policy, environmental economics, and applied econometrics. Katherine Reichelderfer is associate director of RTD/ERS. Her research interests emphasize economic analysis of domestic natural resource policies. John M. Reilly is leader of the Land Values Section in the Land Branch of RTD/ERS. His current research includes investigation of factors influencing changes in farmland values and of natural resource impacts of technical change. George E. Rossmiller is director of the NCFAP/RFF. His areas of interest include agricultural policy, international trade, and macroeconomic linkages to both. C. Ford Runge is an associate professor of agricultural economics at the University of Minnesota. He has served on the staff of the House Committee on Agriculture and as Fellow of the American Association for the Advancement of Science. He is currently Special Assistant to the Deputy U.S. Trade Representative, Geneva. Lyle P. Schertz is editor of Choices magazine. His research interests focus on farm policy, international trade, and development. Andrew Schmitz is a professor of agricultural and resource economics at the University of California at Berkeley. He has published widely in the areas of international agricultural trade. Nancy E. Schwartz is an economist with ATAD/ERS. Her research interests include trade policy analysis, trade modeling, and macroeconomics. Eduardo Segarra is an agricultural economist with RTD/ERS. His research interests include the application of dynamic nonlinear models to natural resource, production, and trade issues.

CONTRIBUTORS

XV

Kathleen Segerson is an assistant professor in the Department of Economics at the University of Connecticut Her research interests include environmental and natural resource economics. Jerry Sharpies is an agricultural economist with ATAD/ERS. His research emphasizes international agricultural trade policy. He currently is ERS's exchange economist to the Australian Bureau of Agricultural Economics. John D. Sutton is an agricultural economist with RTD/ERS. His research interests focus on natural resource policy and relations between natural resources and agricultural commodity trade. G. C. Van Kooten is an associate professor of resource economics in the Department of Agricultural Economics, University of Saskatchewan, Saskatoon, Canada. His research interests include natural resource economics, welfare economics, and research methodology. Alan J. Webb is an agricultural economist with ATAD/ERS at the University of California at Davis. He has analyzed a variety of trade policy issue including U.S. competitiveness, export embargoes, surplus disposal programs, and trade implications of U.S. farm legislation.

Introduction John D. Sutton

The marked fluctuations in U.S. agricultural commodity trade over the past two decades have been accompanied by similarly significant changes in the use of natural resources (primarily arable land and water). The rise in land prices in the United States and in other major exporting nations in the 1970s and their financially distressing plunge in the 1980s are also related to changes in world market demand. Questions are increasingly being asked in the U.S. Congress, international lending institutions, and other countries regarding the natural resource and environmental implications of significant participation in world commodity markets (1, 2). Accurate answers first require understanding the complexities of agricultural trade, natural resources, and their relation to one another. This book advances our ability to construct a conceptual framework describing economic relations between trade and resources and to conduct research needed to clarify linkages that may be particularly important for policy and economic analysis. World agricultural trade expanded rapidly in the 1970s and early 1980s. Food grain imports by all nations (primarily wheat, rice, and wheat flour) rose from an average 62 million metric tons (MMT) in 1 9 6 6 - 1 9 7 0 to 119 M M T in 1 9 8 1 - 1 9 8 3 . Feed grain imports (primarily corn and barley) expanded from 44 M M T to 106 M M T over the same period (5). This expansion was driven by faster income growth in the developing world, a greater supply of loanable funds after the oil price rises of 1973 and 1979, decisions by the U S S R and China to put greater reliance on imports, and elimination of commodity export taxes by many nations, particularly in Latin America. U.S. agriculture directly benefited from this growth in world trade. Between crop years 1970/71 and 1980/81, our exports of wheat, com, rice, and soybeans rose 104 percent, 356 percent, 97 percent, and 67 percent,

1

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AGRICULTURAL TRADE AND NATURAL RESOURCES

respectively (8). Exports have become increasingly important to farm income, accounting for 25-30 percent of farm cash receipts over the past decade compared to 10-15 percent in the 1950s and 1960s (9). The growth in U.S. exports was accompanied by changes in the use and value of land, water, and other environmental resources. Nationally, cropland harvested for corn, wheat, and soybeans expanded 46 percent between 1972 and 1982 (8). Some regional changes, of course, were much greater. For example, cropland harvested for wheat in the Southern Plains States expanded 118 percent over this period.1 Nationally, nominal farmland prices quadrupled between 1971 and 1981 (7). More cropland came into production and was used more intensively. Per acre use of fertilizer doubled between 1965 and 1984. Application of irrigation water rose 15 percent nationally between 1970 and 1980 (12). Again, regional differences were large. In the Great Plains States, irrigation water use rose 35 percent, most of which came from groundwater withdrawals.1 Along with the increased use of land and water came heightened concerns that the environment was being degraded. National resource inventories and analyses indicated that much of the 20 million acres of pasture, range, and idle land that were converted to cropland between 1975 and 1981 was highly vulnerable to water and wind erosion. Concerns were voiced that along with exporting commodities the United States was also "exporting" its soil. An estimated 1.1 million acres of wetlands were converted annually to croplands from the mid-1970s to 1982 (3). These conversions very likely reduced fish and wildlife habitat, depleted the water recharge area necessary for natural flood control and filtration of pollutants, and diminished (for some) the potential for aesthetic enjoyment and recreation. Greater use of irrigation and increased application of agricultural chemicals led to greater concentration of salts, pesticides, and fertilizers in surface and groundwaters. Since the early 1980s, demand in world agricultural markets has been noticeably weaker. Lower rates of economic growth than in the 1970s and severe foreign debt problems for many developing countries, adoption of new technologies overseas, and a high exchange value for the U.S. dollar, have depressed demand for U.S. agricultural exports. In physical terms, U.S. wheat, corn, and soybean exports contracted 44 percent, 51 percent, and 2 percent, respectively, from 1981 to 1985 (10). As U.S. exports have declined in the 1980s, so has cropland area. From 1981 to 1986, harvested wheat, corn, and soybean acreages contracted 20 percent, 6 percent, and 6 percent, respectively (11). Over this period, nominal farmland values fell 27 percent. The declines in the more export-dependent regions, such as the Corn Belt and Northern Plains States, were much greater.1 Intensity of cropland use has only subsided somewhat. Although total fertilizer use dropped some 10 percent from 1982 to 1986, per acre rates have

JOHN D. SUTTON

3

changed little. For example, per acre nitrogen application rates for corn and wheat dropped less than 2 percent. Water withdrawals for crop irrigation decreased 9 percent from 1980 to 1985 (12). Corn and soybean production in both 1985 and 1986 were still above 1981 levels; wheat production, however, fell by one-fourth (8). Changes in resource use and value such as those experienced in the United States have also occurred in other major trading nations. In the 1970s, the European Community (EC) emerged as a net exporter of wheat and flour. Areas formerly considered too steep, infertile, or wet for crops were converted to cropland, some 4 million acres between 1972 and 1980 in the United Kingdom alone (1). As in the United States, the expansion and intensification of cropland use have been widely considered to have had generally negative effects on resource quantity and quality (decreased wildlife habitat, reduced recreational access to the countryside, drained wetlands, and contamination of drinking water with agricultural chemicals, to name a few). The notion that increased agricultural trade might have neutral or positive effects on natural resources does not appear to be as popularly held either in the EC or in the United States. Movements in EC farmland values since the early 1970s have been remarkably similar to those in the United States (4, 7). Among developing countries, international economic relations pose serious natural resource management issues because agricultural trade often is a major contributor to national product. Many of these countries are under tremendous economic pressures to exploit their resources regardless of longterm consequences (13). To earn foreign exchange necessary for debt payments, marginally productive lands are often converted to cropland. Much of the 11 million hectares of forest annually converted worldwide to cropland fall into the marginal category. Poorly designed irrigation systems lead to extensive soil waterlogging, salinization, and alkalization. The raising of beef cattle for export on pastures created from cleared tropical forests has been called "the single greatest cause of deforestation in much of Central America" (1, p. 27). Expansion and intensification of cultivated cropland in China has led that country to move from being an importer to exporter in key commodity markets. Some feel that China has achieved this only at a severe long-term cost to its natural resources (1). Although the broad relationship between agricultural trade and natural resources seems obvious, our understanding, as agricultural economists, of the nature and strength of specific, critical linkages between commodity trade, trade policies, natural resources and environmental quality is limited. This lack seriously constrains the ability to analyze and design policies that are effective and efficient in achieving their particular goals. In this book, the reader will see that while natural resource endowments are fundamental to trade theory, the theoretical approaches taken and problems addressed by trade economists are much different from those taken and addressed by resource

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AGRICULTURAL TRADE AND NATURAL RESOURCES

economists. And, until recently, resource economists have generally ignored resource implications of agricultural trade policies as well as effects that domestic resource problems and policy proposals may have on trade. The objective of this book is to initiate a dialogue between agricultural trade and resource economists such that their conceptual and theoretical differences may be recognized and implications for remaining with or narrowing these differences may become more clearly understood. The book should be of greatest interest to those concerned with the development and economic analysis of policies that directly affect agricultural commodity trade and/or use and value of natural resources. This would include professors, graduate and undergraduate students in the academic community, agricultural policy analysts at the national level in both the United States and other countries, and policy and project analysts with international lending institutions. The book is organized into three parts, each with several chapters. Each chapter is based on material prepared for or stemming from the Workshop on Linkages Between Natural Resources and International Trade in Agricultural Commodities. The Workshop was sponsored by the U.S.D.A. Economic Research Service and Resources for the Future and was held on March 19-20, 1987. Part One sets forth the broad theoretical setting in which natural resource and trade concepts are reflected in current theory and through which they might be more fully integrated. Chapter 1, written by an economist, Kathleen Segerson, is a review of natural resource models that allow for international trade and trade models that explicitly incorporate natural resources. The major focus of attention of subsequent chapters is on what she terms "infratemporal externalities." Chapter 2, written from the perspective of two trade economists, Philip C. Abbott and Stephen L. Haley, shows how natural resource concepts are dealt with in agricultural trade theory and suggests possible approaches (and limitations) to greater incorporation of resource concepts. John M. Antle and Richard E. Howitt, the authors of Chapter 3, combine a basic agricultural resources model and a basic trade model into a hybrid resources-trade model, and discuss the usefulness of exploring hypotheses suggested by versions of the hybrid. Parts Two and Three are still largely theoretical but move toward identifying important linkages through which natural resource policies potentially affect trade and vice versa. Where appropriate, empirical evidence is drawn upon to support or clarify concepts. Part Two deals with implications of resource policies for commodity trade. C. Ford Runge, James P. Houck, and Daniel W. Halbach, authors of Chapter 4, develop the argument that changes in commodity export demand cause changes in derived demands for resources and environmental quality and that consequent imposition of environmental regulations affects a country's

JOHN D. SUTTON

5

international competitiveness. They focus empirical attention on relative compatibility between soil conservation provisions and supply control provisions of the 1985 Food Security Act (FSA). In Chapter 5, Clayton W. Ogg and John D. Sutton further discuss trade implications of FSA soil conservation provisions. In Chapter 6, Robert G. Chambers and Katherine Reichelderfer also explore concepts suggested by Runge, Houck, and Halbach. They extend the standard Ricardo-Viner trade model to derive static and dynamic results for a range of natural resource and environmental policy approaches. They focus on differences between short-run and long-run impacts of resource policies on land quality. Chapter 7 is a discussion by Nancy E. Schwartz and George E. Rossmiller of issues involved in developing and implementing a framework to analyze effects of natural resources policies on a country's trade opportunities. Part Three reverses the perspective of Part Two by presenting the conceptual linkages through which trade policies may affect use and value of natural resources. In Chapter 8, John D. Sutton and Alan J. Webb trace effects of trade policy changes on inputs to agricultural production. They explore the linkages between world markets and resource values with an empirical analysis of relations between farmland values of five countries, world and domestic wheat prices, and price stabilization policies. Chapter 9 is a discussion by John C. Dunmore and James A. Langley of important conceptual and empirical needs for furthering our understanding of trade policy-natural resource linkages. It is largely based on ideas debated in the Workshop referred to earlier. In Chapter 10, Andrew Schmitz, G. C. Van Kooten, and W. Hartley Furtan deviate from traditional trade theory to highlight the crucial importance of trade and domestic distortions to analysis of interrelations between resources and trade. They view trade more from an industrial organization standpoint rather than from the context of standard general equilibrium models. In Chapter 11, Jerry Sharpies, Lyle Schertz, and Eduardo Segarra probe further into the trade-resource policy issues raised in the previous chapter as well as in the discussion group of which they were a part. In Chapter 12, John M. Reilly and Tim T. Phipps delve into additional conceptual and analytical complexities that incorporating technological change means for study of trade and resources. In Chapter 13, Bruce Gardner comments on the papers presented and ideas debated at the Workshop, on which the material in this book is based, with his own ideas on broadening perspectives of resource and international economists.

Note 1. The Southern Plains States are Oklahoma and Texas. The Northern Plains States are Montana, Nebraska, North Dakota, South Dakota, and Kansas. The Great Plains States are those of the southern and northern plains. The Corn Belt States are Iowa, Missouri, Illinois, Minnesota, and Indiana.

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References (1) (2) (3) (4) (5) (6) (7)

(8) (9) (10)

(11) (12) (13)

The Conservation Foundation. Agriculture and the Environment in a Changing World Economy. Washington, DC: The Conservation Foundation, 1986. The Economist. "A Greener Hue for Development Aid." March 28, 1987, p. 69. Heimlich, Ralph E., and Linda L. Langner. "Swampbusting in Perspective." Journal of Soil and Water Conservation 41(4): 219-224 (July-August 1986). Jorgensen, A. Walter. "Land Values and Appraisals." Denmark: Institute of Agricultural Economics, 1986. Mackie, Arthur B., Stephen Hiemstra, and Stacey Rosen. World Food Grain Trade, 1962-83. Stat. Bull. 734. Washington DC: U.S. Department of Agriculture, Economic Research Service, October 1985. McCalla, Alex F., and Timothy E. Josling. Agricultural Policies and World Markets. New York: Macmillan Publishing, 1985. Sutton, John D., and Alan J. Webb. "Trade Policies and the Use and Value of Natural Resources." In Agricultural Trade and Natural Resources: Discovering the Critical Linkages. John D. Sutton, ed. Boulder, CO: Lynne Reinner Publishing, 1988. U.S. Department of Agriculture. Agricultural Statistics 1986. Washington DC: U.S. Government Printing Office, 1986. U.S. Department of Agriculture, Economic Research Service. Embargoes, Surplus Disposal, and U.S. Agriculture. AER 564. Washington, DC: U.S. Government Printing Office, December 1986. U.S. Department of Agriculture, Economic Research Service, International Economics Division. FATUS: Foreign Agricultural Trade of the United States, Calendar Year 1986 Supplement. Washington, DC: U.S. Government Printing Office, May 1987. U.S. Department of Agriculture. Agricultural Resources: Cropland, Water, and Conservation Situation and Outlook Report. Washington EXT: U.S. Government Printing Office, October 1986. U.S. Department of Interior, Geological Survey. Estimated Use of Water in the U.S. in 1980. Circular 1001. Washington, DC: U.S. Government Printing Office, 1983. World Commission on Environment and Development. Our Common Future. Oxford: Oxford University Press, 1987.

1 The Theoretical Framework

CHAPTER

1

Natural Resource Concepts in Trade Analysis Kathleen

Segerson

Most of the theoretical and policy-oriented issues studied by resource economists fall under one of two headings. The first is the study of infratemporal externalities, most often as they relate to environmental pollution.1 In the context of agriculture, primary concerns are water pollution from applications of pesticides and fertilizers and other downstream effects of soil erosion. The second heading is the study of intertemporal resource management. Typically included under this category are models of forestry resources, fisheries, and mineral deposits. However, the same dynamic structure that characterizes these resources can also be applied to groundwater (7) and soil use (36). Although externalities and resource management are often viewed as two separate areas of study, in fact, conceptually they are closely related. The fundamental issue that arises from the dynamic nature of resource management—namely, the existence of "user costs" 2 —is simply an externality that occurs across time periods rather than within a given period. Thus, the notion of externalities, either intra- or intertemporal, underlies most issues of concern to resource economists. These externalities imply that market allocations may not be efficient, and some form of policy intervention might be warranted. As a result, the study of resource economics often involves normative analysis with close ties to welfare economics. Recently, economists began to recognize that both the positive and the normative sides of resource economics may be affected by the existence of international trade. Likewise, trade patterns and levels are affected by the use of natural resources. Examples can be found in the context of both environmental externalities and resource management. For example, government policies to correct environmental externalities can affect a country's apparent comparative advantage and thus its competitiveness in

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world markets, especially if similar corrective measures are not imposed by other countries. Thus, regulations that restrict or ban the use of certain practices or chemicals used in the agricultural sector might have an effect on the level of agricultural exports. Examples from resource management include the long-run productivity effects of groundwater depletion or soil erosion. Since both soil and groundwater (used for irrigation) can in some cases be viewed as exhaustible factors essential for agricultural production,3 the long-run loss of these factors could affect output and thus the level of agricultural exports. Even if such depletion effects are not a major national concern in the United States, 4 they may be occurring in other competitor countries (such as Argentina or Brazil). Since U.S. trade depends on production levels in these countries as well, depletion effects elsewhere can still affect U.S. trade. These examples illustrate that at least theoretically many issues in resource economics and international trade are closely linked. This chapter reviews some of the attempts that have been made to model those linkages theoretically. The models reviewed include standard natural resource models that have been extended to allow for international trade and trade models that explicitly incorporate natural resources. The discussion is separated into the two main areas already identified: infratemporal externalities and resource management models. The latter models are discussed in more detail since these are likely to be less familiar to those outside the field of resource economics.

Infratemporal Externalities and Trade There are at least two types of infratemporal externality that can affect international trade. The first type is a domestic externality, where the effect of the externality is only felt directly in the country in which it is generated. The second type is an international externality, where the effects are felt in other countries. We consider these two in turn.

Domestic

Externalities

Domestic externalities can be analyzed using the general theory of distortions and welfare advanced by Bhagwati (4). Blarel (5) discusses why, for both the pure production externality (where the output of one sector directly affects the output of another) and the factor use externality (where the use of an input by one sector affects the output of another), the resulting allocation is distorted. The externality causes the domestic marginal rate of substitution (MRS) to differ from the domestic marginal rate of transformation even though equality between MRS and the foreign rate of transformation is maintained. The result

KATHLEEN

SEGERSON

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is that production of the polluting sector is too high while that of the nonpolluting sector is too low. The underlying problem is that private comparative advantage, which reflects only private or internalized opportunity costs, differs from social comparative advantage, which reflects all opportunity costs, including those that are not internalized by private firms. As a result, the magnitudes of trade flows based on private comparative advantage and possibly even their directions are not socially optimal. This difference between private and social comparative advantage raises the possibility that environmental regulation or control would improve efficiency. Since a domestic externality does not spill over into other countries, the policy that is efficient from the perspective of the individual country will also be globally efficient. 5 If the polluting activity occurs in more than one country, then efficiency of course requires multilateral control. However, it is possible that one country would choose to impose controls unilaterally. Two important issues that arise in this context are then the cost of that unilateral action to the country that imposes controls and the benefits to its competitors that do not. In discussing unilateral pollution control measures, the U.S. Congress was sufficiently concerned about their potential cost in terms of international competitiveness that it legislated a comprehensive study of this issue [P.L. 92-500, Section 6. see (50)]. Other empirical studies of the trade effects of unilateral control include d'Arge and Kneese (11), Pearson (42), Koo (34), and Leonard (35). 6 The consensus seems to be that, although the cost of environmental controls could potentially influence trade patterns, those costs are not sufficiently large relative to overall production costs to alter trade flows substantially.7 Baumol (2) considered the benefits to be gained by competitor countries from the unilateral control actions of one of its trading partners. As expected, unilateral action causes the competitor country to become more specialized in the production of the polluting good. In addition, the price of the good is lower than it would have been if both countries had imposed controls. Baumol argued that in the short run this would improve the competitor's foreign exchange position if it were a net importer of the good. However, if it were a net exporter, the effect would depend on the other country's demand elasticity, since this elasticity determines whether the value of exports of the good increases or decreases as its price falls. Furthermore, in the long run the competitor's foreign accounts must balance regardless of its environmental policy. Thus, foregoing environmental control can have no lasting benefits in terms of its balance of payments. The only lasting effect would be the increased specialization in the production of the polluting good. A final issue relating to unilateral control of domestic externalities is the practice known as "exporting" pollution. Differences among countries in the severity of pollution control requirements and public concern for the

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AGRICULTURAL TRADE AND NATURAL RESOURCES

environment could potentially affect a firm's decision about where to locate its plants. A recent study by Leonard (35) concluded that overall there has not been a significant exodus of investment from the United States as a result of lower pollution standards elsewhere. 8 However, there is some evidence that differences in standards have affected plant location decisions for a few specific industries producing certain types of chemicals and processed minerals. Thus, there is still the possibility that unilateral environmental control could have some effect on world trade patterns and income and employment distribution. Earlier studies of this issue that reach basically the same conclusion include Koo (34) and Walter (52-54). International

Externalities

International externalities occur when the production of goods in one country causes external effects in another country. These spillover effects can be either direct or indirect. Direct spillovers exist when pollutants physically cross national boundaries. Examples include U.S.-Canadian acid rain and the impacts in Mexico of elevated salinity levels in the Colorado River. Direct externalities of this type are referred to as "transfrontier pollution." Indirect externalities exist when an external cost is imposed in one country by the consumption of a good produced in another country. For example, pesticide or fungicide residues in foods that are exported can cause external effects in the consuming country. As with domestic externalities, the existence of international externalities implies that private comparative advantage and social comparative advantage differ. Again the result is that the magnitudes and perhaps directions of trade flows are not socially efficient. Unlike the case of domestic externalities, however, when international spillovers exist the policy response that restores efficiency from the perspective of the polluting country will not guarantee global efficiency since in setting its policy the polluting country will consider only those external effects felt within its own borders. As a result, other affected countries might be forced to take action on their own to curb the external effects. Whether the international spillover is direct or indirect, the unilateral response of other countries can affect trade flows. Baumol (2) suggests that, when an externality results from consumption of an imported good, the importing country can use import tariffs to improve efficiency. Imposition of the tariff will increase the price of the good so that it more closely reflects marginal social costs. Demand will decrease and move closer to the socially efficient level. Thus, the import tariff can effectively internalize the externality through decreasing the level of imports of the offending good. Import tariffs can also be used to combat direct or transfrontier pollution. Although Kolm (33) suggests that the use of trade weapons is inappropriate

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as a means of combatting transfrontier pollution, Baumol and Oates (3, p. 231) conclude that "in the presence of transnational pollution with no collective regulation, zero tariff levels are generally not optimal." According to their analysis, the imposition of an import tariff could increase not only the welfare of the importing country but also global welfare. They argue that an import tariff on the good whose production is causing the pollution can serve as an imperfect substitute for the standard Pigouvian tax. To the extent that the tariff internalizes the social cost associated with production of the good, it could be an appropriate means for moving closer to a global optimum. If the country that is the victim of pollution does not import the good whose production creates the spillover, then the use of an import tariff on that good is obviously not a possible response. However, Segerson (44, 45) has argued that the victim country might still have sufficient leverage to use a tariff as a means of decreasing transfrontier pollution. If it imports a significant share of the production of some other good from the polluting country (or exports a good on which the polluting country is dependent), it can impose an import (or export) tariff on that good. Whether this provides the victim country with sufficient leverage over the polluting country depends on their trade relationship. In any case, if the victim country tries to use economic leverage to induce a reduction in transfrontier pollution, the effect will be felt through the trade flows between the two countries. In summary, the presence of infratemporal externalities, either domestic or international, can theoretically affect international trade flows. In the absence of efficient control policies, private and social measures of comparative advantage differ and thus market allocations are inefficient. If the externality is domestic in nature, unilateral attempts to correct the inefficiency and bring private and social comparative advantage into line could change the magnitudes of trade flows and in the extreme case even their direction. The same result is possible in the context of international externalities, whether direct or indirect, if the victim country's response includes the imposition of import (or export) tariffs. Whether these effects are quantitatively significant or not would of course depend on the severity of the externality.

Intertemporal Resource Use and Trade As noted previously, models of intertemporal resource use have been applied to a wide range of natural resources, including forestry resources, fisheries, minerals, groundwater, and soil. In most cases, the concern is with changes in the quantity of the resource over time, although in the cases of groundwater and soil an equally important issue is often change in quality.

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Both quantity and quality changes can be captured by the standard intertemporal resource use models, which capture the asset nature of natural resources. Before discussing the links between these models and international trade, a brief overview of that essential characteristic of all resource stocks is provided. Natural Resources as Assets The stock of a natural resource is in many ways similar to a stock of capital. Its level can be increased or decreased over time and it earns a rate of return. The main difference between resource stocks and produced stocks of capital is that the increase and/or decrease in the level of a resource stock and its rate of return are governed not only by economic factors and the decisions of economic agents but also by the biological or physical properties of the resource. Consider first the rate of change in capital versus resource stocks. For capital, the rate of change (dK/dt) is generally given by %-I-bK, dt where K is the level of the capital stock, / is the rate of investment, and b is the depreciation rate. The analogous equation for a resource stock S is f-=G(S)-/z, where G(S) is the net growth function 9 and h is the "harvest" or extraction of the stock. While the rate of increase in the capital stock (/) is usually a choice variable and the rate of decrease (depreciation) is exogenous, the reverse is true for the resource stock. The harvest is usually directly or indirectly under the control of the resource manager while the growth of the stock at any point in time is determined primarily by biological or physical constraints.10 If the stock of the resource does not grow naturally, that is, it is "nonrenewable" or "exhaustible," then G(S)=0. In this case, there is simply a fixed amount of the resource to be allocated over the time horizon. This allocation problem is often called the "cake-eating" problem. Obvious examples of resources of this type are minerals and oil. Although technically they replenish over time, the amount of growth that occurs over the relevant time horizon is so small that it can effectively be ignored. The same may be true of soil depth and groundwater quantity and quality, depending on the time horizon of interest Although soil is produced over time, the time horizon required for significant amounts to be produced often far exceeds the relevant planning horizon. Likewise, groundwater recharge and natural cleansing often

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occur only very slowly, making the quantity and/or quality of the resource effectively exhaustible. If the stock of the resource does replenish itself naturally, then the rate of growth often depends on the level of the stock. For example, the rate of increase in a fish population or the fish biomass generally depends on the size of the current population or biomass. Likewise, the amount that a tree grows in any given year depends on the size of the tree. If the resource of interest is a stock of clean air or water, then "growth" occurs as pollutants are dissipated over time. The rate at which this natural cleansing occurs can depend on the extent of pollution or, equivalently, the remaining stock of clean air or water. In all these cases, increments in the stock of the resource are primarily outside the control of the resource owner or manager. It is this feature that distinguishes natural resources from produced capital. Despite this difference, a natural resource stock can still be viewed as a stock of wealth or an asset since its use provides direct or indirect utility. As an asset, it can be either held or harvested and sold, and in equilibrium the rate of return on holding the resource stock must equal the rate of return earned by other assets. If this were not true, the resource owner would be better off liquidating his or her stock of the resource and investing the proceeds elsewhere. Thus, in the long run under perfect certainty, all assets including the resource asset must earn equal rates of return. This principle underlies all models of resource management that incorporate long run equilibrium. For example, Hotelling's (18) rule is an application of this principle to exhaustible resources. Since by definition the stock of an exhaustible resource does not grow naturally, holding onto the stock rather than selling it yields a rate of return only if the price of the resource net of extraction costs rises over time. The rate of return for an exhaustible resource is therefore (dp/dt)/p, where p is the net price. Hotelling's rule states that this rate of price increase must equal the rate of return on other assets. 11 Another application of the same principle is the Faustmann formula familiar in forestry models of optimal rotation periods (9). This formula states that the timber should be cut when the rate of return on holding the timber (i.e., not cutting) is equal to the rate of return on alternative assets. Unlike the case of exhaustible resources such as oil, holding timber can yield a positive rate of return even if the net price of timber is constant over time. With constant net prices, its rate of return has two components, one reflecting the gain due to the natural growth of the resource and the other reflecting the loss due to tying up the land (or, equivalently, delaying the start of a new rotation) for another period. These combine to determine the overall rate of return on the forestry asset Most of the models that have tried to integrate natural resources and international trade have incorporated one or both of these two essential

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features of the asset nature of natural resources, that is, the rate of change of the stock over time and/or the long-run equilibrium condition on the rate of return from holding the resource. 12 There have been two general approaches to this integration. The first adds trade possibilities to the standard closedeconomy model of resource use to determine whether the results obtained for the closed economy carry over to the open economy. These models focus on how the existence of trade affects resource allocation decisions within a given country, that is, they focus on domestic issues in an open economy. Alternatively, the second approach focuses on international trade issues. Natural resources are added to a standard trade model to determine how ihey are likely to affect trade and whether the standard theorems of international trade that were developed using models with only capital and labor carry over to economies that have natural resources. Within the context of these two general approaches, several issues have been raised. Four of these are reviewed here. They are the effect of trade on resource extraction and consumption, the conditions for long-run survival of a small economy dependent on imports of an essential resource, the interaction between resource-rich and resource-poor countries, and the effects of natural resources on trade flows. The many models that have been used to address these issues differ in several respects. It is useful to keep in mind some of the more obvious differences. 1. Partial Versus General Equilibrium. Some of the models include only the natural resource while others focus on the relations between the resource and other goods. 2. Small Versus Large Country/Single Country Versus Global Perspective. Many of the models view trade and resource use issues from the perspective of a single small country that takes the prices of traded goods as given. Others incorporate the interactions between countries in determining trade flows. 3. Consumption Good Versus Intermediate Input. The resource can be modeled as either a consumption good that provides utility directly or an input into the production of a final good. 4. Traded Versus Nontraded. In some cases, the resource is assumed to be directly traded. This is appropriate for resources such as oil, fish, timber, and minerals. In other cases, the resource is viewed as nontraded, and usually then as a nontraded factor of production. Examples where this is appropriate include groundwater quantity or quality and soil resources. In most of the models that view the resource as a factor of production and include at least two final goods, the resource is assumed to be perfectly mobile across sectors, although in some models use of the resource is confined to only one sector.

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5. Renewable Versus Exhaustible Resources. Most of the models deal with the case of an exhaustible resource. This is generally the simplest case since the dynamics associated with natural growth are eliminated. A few models have incorporated renewable resources. Here, the analysis can be simplified by focusing on the steady state where harvest of the resource equals the net growth so that the level of the resource stock does not change over time. 6. Equilibrium Rate of Return. Some of the exhaustible resource models include the long-run equilibrium condition on the rate of return earned by holding the resource stock, namely, that the net price must rise at a rate equal to the return on other assets. Others set the resource price exogenously, holding it constant over time or allowing it to change at some exogenous rate. They do not require the asset market to be in long-run equilibrium. 7. Borrowing/Lending Possibilities. If perfect borrowing and lending on international markets is assumed, then maximization of the present value of the stream of output is a necessary condition for the maximization of discounted utility. Thus, the assumption of a perfect international capital market allows production decisions to be independent of preferences. If this assumption is not made, then the utility function and social rate of time preference enter the objective function and influence the optimal production path. These varying assumptions or modeling approaches explain some of the differences in the results that have been obtained from the models of natural resources and trade. Space constraints here do not permit a detailed review of which combinations of assumptions lead to which specific results. Instead, we simply review the issues that have been raised and the general nature of the results that have been obtained in the four areas to be covered. For a more detailed discussion of specific results and the assumptions necessary to obtain them, the reader is referred to the references cited. Optimal Depletion in an Open Economy A standard question for an economy with an exhaustible resource is how the stock of that resource should be used over time. In a closed economy, "use" refers to either extraction or consumption since in the absence of storage the levels of extraction and consumption of the resource are the same. This is true as well in an open economy if the resource is not traded. However, when the resource can be traded directly, consumption and extraction rates can differ. Thus, in an open economy with traded resources, the question of resource use has two parts: how much should be produced in each period and how much of what is produced should be consumed domestically or be exported. An underlying question is whether the factors that determine

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optimal use in a closed economy differ from those determining production and consumption in an open economy. In addition, much of the standard trade literature has focused on the efficiency aspects of free trade. However, the intertemporal externality created by harvesting a resource stock implies that market allocations under free trade may not be Pareto optimal in a world with natural resources. Thus, the standard welfare results of the trade literature may not be valid in models of resources and trade. The condition under which they would continue to be valid is another question of concern. Several authors have addressed one or more of the above questions. One of the earliest was Vousden (51). He constructed a model of a small open economy producing two tradable consumption goods—an exhaustible resource and a manufacturing good—and showed that the optimal depletion path and the pattern of specialization for the country depends on its exogenous (and assumed constant) terms of trade and the properties of its utility or social welfare function. Depending on whether the resource good is relatively cheap or expensive and how it is valued in consumption relative to the manufacturing good, the country would choose different sequences of production, consumption, and trade. The model used by Vousden (51) to analyze depletion and trade does not include capital (or any other assets), and the assumption of constant terms of trade implies that the rate of return on holding the resource asset is zero. Thus, the asset nature of the resource is not emphasized in his model. It is, however, considered by Dasgupta, Eastwood and Heal (12), who construct a model of an open economy with three assets—domestic capital, foreign capital, and an exhaustible resource. These three are used as inputs in the production of an aggregate output. The rate of return on foreign capital is assumed to be constant and exogenous, and in equilibrium the returns on the other two assets must equal it. As a result, even for a utility-maximizing society, both the optimal depletion policy and exports of the resource are independent of domestic preferences and the social rate of time preference. Optimal depletion is instead determined by the production function, the exogenous rate of return on foreign capital, and the initial resource and capital stocks, while exports depend on these factors plus the parameters of the foreign demand function. This result contrasts with that of Vousden (51), since Vousden did not include in his model the asset market equilibrium that drives this result. It is consistent with the standard trade model prediction that the production of an open economy will be independent of preferences and depend only on the production functions and world prices. However, the separability of production and consumption decisions in this model goes beyond that of the standard model since here not only production but also exports of the resource are independent of domestic preferences. This, of course, also contrasts with optimal depletion results in a closed economy where obviously domestic

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preferences influence production rates. The authors note, however, that the strong separability results obtained here would not hold if the rate of return on foreign capital were variable or if future demand were uncertain.13 The robustness of the separability result of Dasgupta, Eastwood, and Heal (12) has been questioned further by Moussavian (40). He shows that their result also does not hold if the economy produces a nontraded good. In this case, asset market equilibrium requires that the domestic rate of return on the resource equal the domestic interest rate, which differs from the exogenous foreign interest rate due to changes in the price of the nontraded good over time that generates domestic "inflation." Since the effects of these price changes depend on domestic preferences, resource production will in turn depend on those preferences. Thus, changes in the price of the nontraded good imply that separability no longer holds. Although they include both resources and produced capital as assets, the analyses of Dasgupta, Eastwood, and Heal (12) and of Moussavian (40) are concerned primarily with production and exports in the resource sector. Aarrestad (1), on the other hand, focuses on the interactions between resource use and capital accumulation decisions in an open economy. He analyzes how optimal savings decisions are influenced by conditions in the resource sector and how optimal depletion of the resource is affected by the capital market. He also identifies conditions under which interior solutions for the average savings ratio or per capita resource extraction would be optimal. Since in his model income is generated either from production using the capital stock or from extraction and sale of the resource in the world market, Aarrestad obtains the expected result that an increase in the country's initial capital stock will decrease extraction and thus exports of the resource, while the discovery of a resource will decrease the optimal savings rate. Although Aarrestad (1) treats both capital and the resource as assets in the sense that the levels of the stocks of both change over time, he does not require that the asset market be in long-run equilibrium. Withagen (55, Chap. 3) considered the question of whether long-run asset equilibrium conditions such as Hotelling's rule continue to hold when optimal extraction and savings are chosen simultaneously. He concludes that in an open economy the standard equilibrium rules may no longer be valid, depending on which world asset markets exist. This result is based on the small-country assumption that the price of the resource is exogenous (but not necessarily constant over time). The models of resources and trade have also been extended to allow for the possibility of interruptions in the supply of imports. 14 In the basic model, a country is assumed to have domestic supplies of an exhaustible resource, but domestic use of the resource comes from both domestic extraction and imports. The question is then how domestic extraction rates will be affected by uncertainty regarding the future availability of imports.

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Hillman and Long (17) show that the home country should respond to embargo possibilities with a more conservative domestic depletion policy. Thus, domestic production will be lower and imports higher due to the threat of trade disruptions. They also consider whether the market response to such threats will be socially optimal. Their conclusion is that firms anticipating market power after an embargo will tend to overexploit the resource since they would benefit from a reduction in the domestic stock of the resource available at the time of an embargo. This contrasts with the standard result in a closed economy, where monopoly power leads to a reduction in the current extraction rates (47). Crawford, Sobel, and Takahashi (10) also consider the effect of market power on optimal depletion rates when trade interruptions are possible. They assume that a country's terms of trade are determined by strategic bargaining. Once again, delaying extraction is the optimal response to embargo threats, in this case because it reduces the country's vulnerability and thus increases its bargaining power. All the above models of resources and trade assume that the resource is exhaustible. McRae (37), on the other hand, allows the resource to be renewable. Thus, even in the absence of exploitation, the stock changes over time. He shows that competitive producers who ignore the intertemporal externality created by user costs will not produce or trade at the socially optimal levels. Instead, they will either produce too much of the resource good and too little of the other import-competing good; or they will produce too little of both goods. The fact that competitive allocations differ from efficient allocations if all externalities are not internalized is of course consistent with standard results from a static model of a closed economy. It is also discussed by Kemp and Suzuki (32) and Vousden (51) for the case of exhaustible resources. The models reviewed in this section suggest that a country's domestic resource use decisions will differ when there is a possibility of international trade in the resource itself or a good produced using the resource. In general, extraction rates for an exhaustible resource will depend on conditions in international markets. The asset nature of resources implies that the rates of return on other assets in international markets can be particularly important. In addition, decisions regarding resource use and capital accumulation will be linked. Finally, if intertemporal externalities arising from the dynamic nature of resource use are ignored, then patterns of production and trade in both resources and other goods will not be Pareto optimal. Long-Run

"Survival"

In addition to the question of optimal depletion rates, the early literature on exhaustible resources in a closed economy also addressed the issue of

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survival. Could an economy that was dependent on an exhaustible resource survive in the long run, where "survival" is defined as the ability to maintain indefinitely a positive level of per capita consumption? This literature can be viewed as a response to the "limits to growth" argument, which holds that in the long run the finite nature of the world's natural resource base will place severe constraints on economic production and ultimately lead to drastic reductions in living standards due to resource depletion. Solow (46) determined the conditions on factor productivity, population growth, and technological change that were necessary to avoid this fate. He showed that, with constant population and constant-returns-to-scale Cobb-Douglas technology, even in the absence of technological progress, the economy can survive as long as capital's share of output exceeds the share going to the resource. Recently, similar questions regarding survival were asked in the context of an open economy that is entirely dependent on imports for its supplies of an essential resource. Using somewhat different models, Mitra, Majumdar, and Ray (39), Kemp and Long (28), and Ray (43) have all shown that Solow's result for a closed economy does not carry over to an open economy of this type. If a small, open economy has to import the essential resource, then in the long run it cannot survive without technological progress if its terms of trade are deteriorating exponentially, as would be expected under long-run asset market equilibrium. Since the value of exports and imports must balance in each period, when the relative price of the resource is increasing exponentially over time, exports of domestically produced goods (such as agricultural or manufacturing goods) must increase over time to pay for imports of the resource. This increase in exports cannot continue indefinitely unless sufficient technological progress exists to prevent consumption from being driven to zero. Thus, survival is not possible without technological progress. This result highlights the long-run vulnerability of a small country dependent on imports for an essential resource and the implications of that vulnerability for trade in other goods. For example, in the absence of sufficient technological change, small economies dependent on oil imports or imports of other mineral resources may be forced to export more and more of their agricultural output to cover the increasing cost of resource inputs. This would be done at the expense of domestic consumption, implying a reduction in their standard of living. Their increased exports would also increase supplies on the world market and thereby affect other exporters of the same agricultural good. Thus, the need to generate increasing amounts of foreign exchange to pay for imports of resources can in the long run be expected to have spillover effects on agricultural trade.

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Resource-Rich

Versus

Resource-Poor

Countries

The models of survival focus on the case of a small country that owns none of the resource and faces exogenous prices. They highlight the vulnerability of these countries. It is possible, however, that a resource-importing country (or a block of countries as a whole) could have some monopsony power in purchases of the resource and thus be able to influence resource prices through their trade policies.15 This section reviews models that have focused on possible monopoly/ monopsony power in resource trade. As in the survival models, these models assume that deposits of an exhaustible resource are unevenly distributed across the world. In the extreme case used for exposition, one country (or block of countries) is assumed to own all the resource but does not have the technology to use it to produce consumption goods, while the other country (or countries) has no deposits of the resource but does have the ability to produce consumption goods from the resource. Thus, both countries have some market power, the resource-rich country as a monopolist and the resource-poor country as a monopsonist. This extreme case is perhaps appropriate for some relationships between colonial and imperial countries. The question is then whether either country can, and if so should, exploit its market power to its own advantage. Among the earliest to address this issue were Kemp and Ohyama (31). Although they did not incorporate the exhaustibility of the resource into their model, they found that the resource-poor (imperial) country can and has an incentive to exploit the resource-rich (colonial) country, while the ability and incentive of the resource-rich country to exploit its resource-poor trading partner is limited. Kemp and Long (26) reached this same basic conclusion using a model that includes resource exhaustibility. The intuition behind this result is the following: Because the resource-rich country can do nothing with its output except sell it to the resource-poor country, it is vulnerable to exploitation. In particular, the resource-poor country can extract any rent associated with production of the resource. However, since the resource-rich country can either consume or export its output, it is less vulnerable to exploitation by its trading partner. Both Kemp and Long (26) and Brander and Djajic (6) note that the extreme exploitation of the resource-rich country obtained in these and similar models stems from the assumption that the exporting country cannot use the resource domestically to produce consumption goods. If the exporter has the option of using the resource productively itself, then the ability of the importing country to extract rent from it would be limited. Clearly, this case is more relevant in reality since, even if the exporter is currently incapable of using the resource domestically, exploitation by the importer will provide incentives for it to acquire or develop that capability. Thus,

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exploitation by importers is likely to lead eventually to increased processing of resources prior to export. The role of resource-rich and resource-poor countries was studied further by Chiarella (8), who extended the model of Kemp and Long (26) to include capital accumulation. He considered the optimal production and consumption plans of the exporting and importing countries under two different assumptions: first, that the exporting country trades only in the resource market and second, that it also trades in the capital market. His analysis highlights the asset nature of resources and the role of the existence of other asset markets (e.g., capital markets) in determining resource extraction. Kemp and Long (25) discuss the implications of asset market equilibrium in determining the optimal tariff to be imposed by a resourcepoor country seeking to exploit its resource-rich trading partner. They show that if the rate of return on the resource, that is, the rate of increase in its net price, is set equal to the interest rate, then the optimal ad valorem tariff rate is constant over time. They also raise the issue of dynamic consistency in the choice of the optimal tariff rate and show that, once the importing country has chosen and announced its optimal tariff policy, it will have an incentive to deviate from that choice in the future. The problem of dynamic consistency in the choice of an import tariff is discussed further by Karp (19). Karp's model is similar to that used by Kemp and Long (25), except that he views the resource importers as leaders in a Stackelberg game with the resource-exporting countries. He finds that the optimal tariff is sensitive to the specification of the functional forms for cost and demand, the type of market structure, and the type of tariff policy (open loop versus closed loop, unit versus ad valorem tariff). Finally, Kemp and Long (27, 30) use the Stackelberg equilibrium concept to study the effects of incomplete cartelization, that is, resource use decisions when some but not all of the resource-rich or resource-poor countries form a selling or buying cartel. They show that, for both export and import cartels, not only the included members but also the excluded members benefit from the formation of the cartel. Again, a problem of dynamic consistency arises since, when the stocks of the excluded members are exhausted and the cartel becomes a monopoly, it will have an incentive to deviate from its previously announced price path. The above models are representative of resources where deposits are concentrated in selected countries. They emphasize that the vulnerability of the resource-exporting countries to exploitation by resource importers depends on the alternatives available to them for use of the resource. If export is their only alternative, then vulnerability is high and resource-importing countries can extract rent from them and thus determine the worldwide distribution of income. However, if domestic use is possible or if the

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countries interact in markets other than the resource market, then the importing country's ability to exploit the exporter is limited. In addition, over time exploitation (or the threat of it) is likely to lead to the development of processing capacity by resource exporters. Finally, both resource-rich and resource-poor countries can generally benefit from exploiting their market power to some extent, even if their selling and buying cartels are incomplete. Trade Flows and

Resources

The literature on resource-rich versus resource-poor countries focuses on the market power generated by a substantial imbalance in the distribution of resource endowments. If resources are distributed more evenly (although not necessarily uniformly), market power will not exist and trading partners will simply be competitive countries, each having a given endowment of the resource and of other factors of production. This more closely resembles the situation captured by the standard trade models, the only difference being the endowment of the resource. Models of this type have been used to determine whether the results from the static models that include only inexhaustible factors such as capital and labor continue to hold when one of the factors of production is a natural resource. In particular, two questions have been raised. First, what patterns of production and specialization can be expected when resources are included and are they consistent with the Heckscher-Ohlin theory of international trade? Second, do the standard theorems of international trade, such as the Stolper-Samuelson and the Rybczynski theorems still hold in the presence of dynamic resource use? The early work by Vousden (51) addressed the first question regarding patterns of production and trade. He provided conditions determining the nature of a country's transition from incomplete specialization (producing both the resource good and a manufacturing good) to complete specialization in production of the manufacturing good once the resource is exhausted. The nature of the transition was shown to depend on the exogenous terms of trade and the properties of the country's social welfare function. Subsequently, several authors (16, 22, 30, 32, 55) concluded that an open economy with an exhaustible resource would always be completely specialized. More specifically, they found that if the resource-intensive good is ever produced, then production is initially specialized in production in the resource-intensive sector and later switches abruptly to the opposite specialization. This result is in contrast to the results of the static model, which predicts that production will generally be diversified. However, the pattern of complete specialization predicted here is consistent with the Heckscher-Ohlin theory in the sense that the country that is initially well endowed with the exhaustible resource will export the relatively resourceintensive good (30).

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The explanation for the prediction of complete specialization can be found in the features of the models used previously. Most of them are based on output maximization, which is justified for a utility-maximizing country by assuming that either (i) the social welfare function is linear or (ii) the country can borrow or lend in the international market at a fixed interest rate so that production and consumption decisions are separable over time. Tawada (48) has shown that if these assumptions are removed specialization will not always be complete. This result is also noted by Kemp and Long (30). Another determining factor is the assumption made regarding extraction costs. If nonlinear extraction costs are allowed, then again incomplete specialization over some time interval will occur (41). Finally, the complete specialization result is dependent on the assumption of constant prices embodied in the above models. As noted previously, constant prices are inconsistent with long-run asset market equilibrium when exhaustible resources and other assets exist. In order for the exhaustible resource to earn a rate of return equal to the rates on the other assets, the price of the resource must rise over time. Kemp and Long (29) analyze patterns of specialization when the price of the resource-intensive good is not constant but instead increases exponentially over time. In this case, complete specialization is possible but not assured. Furthermore, it is possible for the economy to specialize first in the production of other goods and then switch to resource-intensive production. Thus, the pattern of specialization cannot be predicted without knowing the level of the initial resource stock, the rate of increase in relative prices, the interest rate, and the parameters of the production function. An intuitive explanation of why constant prices and output maximization lead to complete specialization is suggested by Harris (16). It can be found in the asset nature of an exhaustible resource. If prices are constant and the value of output is maximized, then Hotelling's rule for asset market equilibrium implies that relative factor prices will be consistent with diversification at only one instant in time—namely, the point at which specialization switches from the resource-intensive good to the other good. This occurs even though the country's production possibility frontier is concave. Thus, the explanation for complete specialization in intertemporal models with natural resources differs from the standard explanation in static trade models. Regardless of whether specialization is complete or not, Kemp and Long (24, 30) have shown that the direction of trade will be consistent with the predictions of the Heckscher-Ohlin theory as determined by the relative resource endowments. However, here as in the static models the HeckscherOhlin predictions depend crucially on the assumption that all countries have identical preferences. Djajic (14) allowed preferences to vary across countries and showed that, if the asset market is in equilibrium, the direction of trade is

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independent of the magnitudes of resource endowments. Again, the explanation lies in the asset nature of the resource. In the long run, a country will only extract and sell its resource when the rate of increase in the price of the resource equals its domestic interest rate, which is assumed to reflect its rate of time preference.16 If rates of time preference differ across countries, then at any given time this condition can only hold for one of the countries. Thus, during any given interval only one of the countries will be induced to extract the resource. Furthermore, the country with the higher rate of time preference will extract (and thus export) the resource first, since the rate of price increase that induces it to extract and sell will be too high to induce the more patient country to liquidate its resource asset. Thus, when both countries own some of the resource, production and the direction of trade will be determined by the relative magnitudes of their rates of time preference rather than their relative resource endowments. 17 However, resource endowments do play a role in determining the length of time over which each country produces and exports the resource. The final question to be considered is whether the Stolper-Samuelson and Rybczynski theorems hold in a modified way for an economy with natural resources.18 Several authors have found that they do. For example, when the resource is exhaustible, an increase in the price of the resource-intensive good will increase the real resource price and decrease the rate of extraction, thereby increasing the interval of time over which the resource-intensive good is produced (16, 23, 30). Furthermore, an increase in the initial stock of the resource will cause an increase in production of the resource-intensive good and in the interval during which it is produced (16,22, 30). The extension of this latter result to the case of renewable resources was considered by Tawada (48, 49), who showed that it holds in modified form for this case as well. Finally, although the previous models are based on the assumption of constant prices, allowing exponentially increasing prices does not change the qualitative effects of an increase in the initial stock of the resource (29). The previous models then suggest that the fundamentals of the standard trade theorems derived from static models continue to hold when exhaustible or renewable resources are added as factors of production. However, because of the asset nature of resources, the potential for complete specialization exists even if the production possibility frontier is concave. The pattern of that specialization will depend on relative factor endowments if preferences are identical across countries. However, if rates of time preference differ, then those preferences will play an important role in determining the direction of trade flows. In other words, countries that are relatively well endowed with a given exhaustible resource will not necessarily produce and export resourceintensive goods if they are patient and choose to husband their resources while their less patient trading partners deplete their own domestic supplies.

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This result is not found in the static trade models that omit exhaustible resources.

Summary and Conclusion The theoretical linkages between natural resources and international trade are many and varied. Some of the standard results within each of these fields must be modified when the interactions between the two are considered, while others are more robust. Intratemporally, the existence of an externality associated with resource use implies a divergence between private and social comparative advantage. As a result, market-determined production and trade patterns are no longer Pareto optimal. The same is true if intertemporal externalities associated with user costs are not fully internalized. In this case, myopic (or static) comparative advantage differs from dynamic comparative advantage. Even if the intertemporal externality is fully internalized, the dynamic aspects of natural resource use can still affect international trade. In particular, they can (i) cause resource production and trade decisions to be closely linked to capital markets and thus create an additional link between capital markets and trade; (ii) force small countries that are dependent on imports of essential exhaustible resources to export more and more of their agricultural output to cover the increasing cost of resource inputs; (iii) lead resource-rich countries to increase the degree of processing of natural resources prior to export to avoid rent extraction by resource-poor importers; and (iv) increase the possibility of complete specialization due to relative resource endowments or differing rates of time preference. Although the literature reviewed in this chapter establishes the theoretical validity of these effects, a perhaps more important challenge that now faces applied economists is to determine if they are quantitatively important as well. The difficulty of this task should not be understated, since it requires data that are not readily available or easily collected. For example, study of the quantitative effects of infratemporal externalities requires that values be placed on many nonmarket goods, a problem that has plagued resource economists for decades. Likewise, quantification of the intertemporal effects of resource use on trade will generally require information on rates of time preference, initial resource stocks, present and future demands, and the relevant time horizon for analysis. In addition, if the resource stock is renewable, the dynamics of the biological or physical constraints governing growth of the stock must be captured as well. Finally, the impacts of uncertainty regarding, for example, future discoveries of additional resource deposits or inexhaustible substitutes for the resource must also be considered. These factors combine to make it extremely difficult to construct

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empirical models capable of reliably quantifying resource-trade linkages. Nonetheless, the construction of such models seems to be the most fruitful area for future research on this topic and the task does not seem to be hopeless. For example, for infratemporal externalities and agricultural trade, one might begin by developing a taxonomy of environmental externalities associated with agricultural production and classifying those externalities as domestic or international and, if international, as direct or indirect. For domestic externalities, numerous studies have been done that estimate the costs of implementing alternative agricultural production practices that reduce environmental pollution (e.g., reduced tillage methods or integrated pest management). These estimates could be used in models of agricultural commodity trade to provide some indication of the effect that mandatory regulation (or internalization of pollution externalities) would have on U.S. competitiveness in world agricultural markets. For direct international externalities (transfrontier pollution) such as increased salinity of the Colorado River, again the cost of reducing salinity could be estimated and used in a model of agricultural trade to determine the difference between private and social comparative advantage resulting from the externality. Although such models of the links between environmental resources and trade would be based only on the costs of reducing pollution and not on the associated benefits (which are typically much more difficult to measure), they would at least be a beginning in determining whether those links are quantitatively important. In terms of intertemporal resource use and agricultural trade, an empirical study might begin by identifying those resources that are important in agricultural production and essentially dynamic in nature. Obvious examples include groundwater quantity and quality, soil depth and productivity, and minerals used in fertilizers and energy inputs. To relate these inputs to the theoretical models reviewed here, they would have to be classified as traded/nontraded, mobile/immobile, and exhaustible/renewable, and the essential characteristics of each that determine the long-run return on preserving the resource would have to be identified. One could then look for empirical evidence supporting the predictions of some of the theoretical models. For example, for traded resources, does there exist any evidence that small countries dependent on imports of the resource have suffered from the need to export increasing amounts of agricultural or manufacturing production to pay for the increasing costs of resource inputs? If so, have those increased exports affected world trade flows? For developing countries that are resource rich, is there evidence that they are seeking to increase the amount of processing done prior to export to capture some of the resource rents that would otherwise be extracted by importers? If so, what effect has this had on trade flows and comparative advantage? Are there certain traded resources where disruptions of import supplies would have a serious impact

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on the U.S. agricultural sector? If so, have production policies in the United States reflected this vulnerability? Alternatively, for nontraded resources, one could ask whether observed trade patterns are consistent with Heckscher-Ohlin predictions when resource endowments such as groundwater supplies and soil productivity are considered. Is there empirical evidence that countries that might be expected to have high discount rates are mining their soil and water resources at a much faster rate than more patient countries and thus exporting goods whose production is intensive in the use of these resource (e.g., agricultural or forestry output)? Finally, regardless of whether the resource is traded or not, it may be possible to examine empirically whether resource use decisions reflect an internalization of the intertemporal externality or user cost. This would require an empirical test of the rate of return equilibrium condition for the resource to determine if firms view their resources as long-run assets. If they do not, then existing trade patterns are not necessarily Pareto optimal. By introducing alternative resource use scenarios into empirical models of comparative advantage, perhaps some indication of the quantitative difference between myopic (static) and dynamic comparative advantage could be obtained. Empirical work on questions such as these is necessary before a pronouncement can be made regarding the potential for interesting collaborative work between resource and trade economists. As always, the theory points us in a particular direction, but only the empirical work will tell us whether there is likely to be anything at the end of the trail.

Notes 1 . T h e term "infratemporal" externality refers to an externality that is primarily static in nature, that is, where the actions of one individual have an effect on another only within the current time period. What constitutes the "current" time period depends on how often decisions are made. For example, if decisions are made once a month, then the current time period is the current month. Alternatively, if they are made only once a year, it is the current year. The infratemporal or static view of pollution externalities is appropriate when pollutants dissipate within the current time period and thus do not accumulate over time periods. However, if the pollutants are persistent, the externality that is generated will be "intertemporal," that is, it will occur across time periods. 2. The term "user cost" refers to the cost imposed on the future by using one more unit of the resource in the present. For example, the user cost associated with using one more barrel of oil today is the foregone present value of the net benefits that would have resulted from using that barrel (optimally) in the future. 3. Both soil depth and groundwater have the ability to regenerate over

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time. However, in many cases the rate of regeneration is so slow relative to the rate of use that for planning purposes it can essentially be ignored. See further discussion later. 4. These effects may be very important in certain regions of the United States where soils are very fragile or agricultural production is heavily dependent on irrigation from a limited groundwater supply. 5. If the externality imposes costs on other countries, then the individual country's choice of a control policy will not be globally efficient since it will not generally consider the external effects in other countries when making that choice. See discussion. 6. For a more complete list of previous work in this area, see the references in Leonard (35). 7. It s h o u l d be n o t e d that these studies deal m a i n l y with the m a n u f a c t u r i n g sector. Virtually no empirical work on the e f f e c t s on environmental control of agricultural trade appears to have been done. Blarel (5) presents some simulations of a general equilibrium model designed to capture the relation between environmental externalities and agricultural trade. However, because of data limitations, the results are mainly illustrative. 8. A previous survey by Koo (34) indicated, however, that interregional shifts due to differing standards and attitudes could be substantial. 9. Net growth includes gross increases in the stock and natural decreases such as mortality or dissipation. In this sense, it includes "depreciation" not associated with use. 10. It is possible that the stock of a resource could be augmented by investment. For example, investment in exploration activity might augment the available stock of a mineral resource, while investments in soil conditioning could increase the stock of soil productivity. However, the physical characteristics of the resource still dominate its growth potential. 11. More generally, the rule can be stated in terms of the net value of the resource. For example, when both resources and capital are used as intermediate inputs in production, the rule takes the form dMP^M MP(R) ' where MP(AT) is the marginal product of capital and MP(/?) is the marginal product of the resource. See, for example, Dasgupta and Heal (13). Note that Hotelling's rule is a long-run equilibrium condition under perfect certainty. For a test of its validity, see Miller and Upton (38). 12. Exceptions to this are the models concerned primarily with land resources where dynamic allocation issues are not important. These models are not reviewed here. 13. T h e implications of uncertainty regarding the initial size of the resource stock are discussed by Kemp (20, Chap. 24). 14. A l t h o u g h this r e s e a r c h was m o t i v a t e d by concerns o v e r the possibility of disruptions in world oil supplies, it is also relevant to other exhaustible resources. A good example in the U.S. context is potash, which is an i m p o r t a n t ingredient in fertilizers used in the agricultural sector. Disruptions in future imports of potash could have a serious effect on fertilizer supplies and thus on agricultural output. Although such disruptions are not likely in the near future, the literature that deals with the effects of possible trade disruptions may still be of some interest. 15. Again an example is offered by U.S. imports of potash. The United

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States produces less than half of the potash it uses and nearly all its imports come from Canada. As noted above, these imports are a key input into fertilizers used in the U.S. agricultural sector. Thus, at first glance, Canada might apear to have some monopoly power over the United States in the potash market. However, Canada is also dependent on the United States as a market for its potash production. Although Canada could diversify its export markets, it could do so only at a considerable cost to itself since selling to a more distant market would imply much greater transportation costs and thus a considerable decrease in FOB prices. As a result, the United States might be viewed as having some monopsonistic power over Canada in purchases of potash. 16. This assumes that international trade in assets does not occur. 17. A similar result was found by Findlay (15) using an "Austrian" model, where the production of an intermediate good takes time while a final good is produced instantaneously. He found that the more patient country would export the time-intensive intermediate good and import the finished good. 18. For a statement of these theorems in the absence of exhaustible resource, see Chapter 2 in this volume. Another theorem of interest, the factor price equalization theorem, has also been addressed by some but with less success. See, for example, Kemp and Long (30) and Harris (16).

References (1)

Aarrestad, Jostein. "Optimal Savings and Exhaustible Resource Extraction in an Open Economy." Journal of Economic Theory 19: 163-179 (1978). (2) Baumol, William J. Environmental Protection, International Spill-over and Trade, (Wicksell Lecture). Stockholm: Almquist and Wiksell, 1971. (3) Baumol, William J., and Warren E. Oates. The Theory of Environmental Policy: Externalities, Public Outlays and the Quality of Life. Englewood Cliffs, NJ: Prentice-Hall, 1975. (4) Bhagwati, J. N. "The Generalized Theory of Distortions and Welfare." In Trade, Balance of Payments and Growth. J. N. Bhagwati, et al., eds. Amsterdam: North-Holland, 1971. (5) Blarel, Benoit. "Economic Effects of Externalities on International Agricultural Trade: A Methodological Investigation." Ph.D. dissertation, University of Wisconsin, 1985. (6) Brander, J., and S. Djajic. "Rent-Extracting Tariffs and the Management of Exhaustible Resources." Canadian Journal of Economics 16: 288-298 (1983). (7) Burt, O. R. "Temporal Allocation of Groundwater." Water Resources Research 3(1): 45-56 (1976). (8) Chiarella, Carl. "Trade Between Resource-Poor and Resource-Rich Economies as a Differential Game." Essay 19 in Kemp and Long (21). (9) Clark, Colin W. Mathematical Bioeconomics: The Optimal Management of Renewable Resources. New York: John Wiley & Sons, 1976. (10) Crawford, Vincent P., Joel Sobel, and Ichiro Takahashi. "Bargaining, Strategic Reserves, and International Trade in Exhaustible Resources." American Journal of Agricultural Economics 66(4): 472-480 (November 1984). (11) d'Arge, Ralph C., and Allen V. Kneese. "Environmental Quality and

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International Trade." International Organization 26(2): 419-465 (Spring 1972). Dasgupta, Partha, Robert Eastwood, and Geoffrey Heal. "Resource Management in a Trading Economy." Quarterly Journal of Economics 92: 297-306 (May 1978). Dasgupta, P., and G. M. Heal. "The Optimal Depletion of Exhaustible Resources." Review of Economic Studies: Symposium, pp. 3-28 (1974). Djajic, Slobodan. "Exhaustible Resources and the Dynamics of Comparative Advantage." Journal of International Economics 17: 55-71 (1984). Findlay, Ronald. "An 'Austrian' Model of International Trade and Interest Rate Equalization." Journal of Political Economy 86(6): 989-1007 (1978). Harris, Richard. "Trade and Depletable Resources: The Small Open Economy." Canadian Journal of Economics 14(4): 649-664 (November 1981). Hillman, Arye L., and Ngo Van Long. "Pricing and Depletion of an Exhaustible Resource when There Is Anticipation of Trade Disruption." Quarterly Journal of Economics 98: 215-233 (May 1983). Hotelling, H. "The Economics of Exhaustible Resources." Journal of Political Economy 39: 137-175 (1931). Karp, Larry. "Optimality and Consistency in a Differential Game with Non-renewable Resources." Journal of Economic Dynamics and Control, 8(1): 73-97 (October 1984). Kemp, Murray C. Three Topics in the Theory of International Trade. Amsterdam: North-Holland, 1976. Kemp, M. C., and N. V. Long, eds. Exhaustible Resources, Optimality and Trade. Amsterdam: North-Holland, 1980. Kemp, M. C., and N. V. Long. "International Trade with an Exhaustible Resource: A Theorem of Rybczynski Type." Essay 13 in Kemp and Long (21).

(23) Kemp, M. C., and N. V. Long. "Exhaustible Resources and the StolperSamuelson-Rybczynski Theorems." Essay 14 in Kemp and Long (21). (24) Kemp, M. C., and N. V. Long. "Exhaustible Resources and the Heckscher-Ohlin Theorem." Essay 15 in Kemp and Long (21). (25) Kemp, M. C., and N. V. Long. "Optimal Tariffs and Exhaustible Resources." Essay 16 in Kemp and Long (21). (26) Kemp, M. C., and N. V. Long. "The Interaction of Resource-Rich and Resource-Poor Economies." Essay 17 in Kemp and Long (21). (27) Kemp, M. C., and N. V. Long. "International Monopoly-Monopsony Power over Exhaustible Resources." Essay 18 in Kemp and Long (21). (28) Kemp, M. C., and N. V. Long. "Conditions for the Survival of a Small Resource-Importing Economy." Journal of International Economics 13: 135-142 (1982). (29) Kemp, M. C., and N. V. Long. "Rybczynski's Theorem in a Context of Exhaustible Resources: The Case of Time-Contingent Prices." International Economic Review 23(3): 699-710 (October 1982). (30) Kemp, M. C., and N. V. Long. "The Role of Natural Resources in Trade Models." In Handbook of International Economics, vol. 1. R. W. Jones and P. B. Kenen, eds. Amsterdam: North-Holland, 1984. (31) Kemp, M. C., and M. Ohyama. "On the Sharing of Trade Gains by Resource-Poor and Resource-Rich Countries." Journal of International

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Economics 8: 93-115 (1978). (32) Kemp, M. C., and H. Suzuki. "International Trade with a Wasting but Possibly Replenishable Resource." International Economic Review 16(3): 712-732 (October 1975). (33) Kolm, S. Ch. "Guidelines for the Guidelines on the Question of Physical International Externalities." In Organization for Economic Cooperation (OECD), Problems in Transfrontier Pollution. Paris: OECD, 1974. (34) Koo, A. Y. C. Environmental Repercussions on Trade and Investment. Geneva: International Labour Organization, 1979. (35) Leonard, H. Jeffrey. Are Environmental Regulations Driving US. Industry Overseas? Washington, DC: The Conservation Foundation, 1984. (36) McConnell, K. E. "An Economic Model of Soil Conservation." American Journal of Agricultural Economics 65: 83-89 (1983). (37) McRae, James J. "Optimal and Competitive Use of Replenishable Natural Resources by Open Economies." Journal of International Economics 8: 29-54 (1978). (38) Miller, M. H., and C. W. Upton. "A Test of the Hotelling Valuation Principle." Journal of Political Economy 93(1): 1-25 (February 1985). (39) Mitra, Tapan, Mukul Majumdar, and Debraj Ray. "Feasible Alternatives Under Deteriorating Terms of Trade." Journal of International Economics 13: 105-134 (1982). (40) Moussavian, M. "Growth Rates with an Exhaustible Resource and Home Goods." Journal of International Economics 18: 281-299 (1985). (41) Ono, Hiroshi. "Note on International Trade with Exhaustible Resources: A Theorem of Rybczynski Type." International Economic Review 23(1): 165-170 (February 1982). (42) Pearson, C. Implications for the Trade and Investment of Developing Countries of United States Environmental Control. Geneva: United Nations Committee on Trade and Development, 1976. (43) Ray, Debraj. "Survival, Growth and Technical Progress in an Open Economy Facing Deteriorating Terms of Trade." International Economic Review 25(2): 275-295 (June 1984). (44) Segerson, K. "Unilateral Transfrontier Pollution and Economic Interdependence: A Methodological Study." Ph.D. dissertation, Cornell University, 1984. (45) Segerson, K. "Unilateral Transfrontier Pollution: The Role of Economic Interdependence." Land Economics 61(1): 83-87 (February 1985). (46) Solow, R. M. "Intergenerational Equity and Exhaustible Resources." Review of Economic Studies: Symposium, pp. 29—46 (1974). (47) Stiglitz, J. E. "Monopoly and the Rate of Extraction of Exhaustible Resources." American Economic Review 66(4): 655-661 (1976). (48) Tawada, M. "A Note on International Trade with a Renewable Resource." International Economic Review 23(1): 157-163 (February 1982). (49) Tawada, M. "International Trade with a Replenishable Resource: The Steady State Analysis." Economic Studies Quarterly 35(1): 39-45 (April 1984). (50) U.S. Department of Commerce. The Effects of Pollution Abatement on International Trade. Washington, DC: U.S. Government Printing Office, 1973. (51) Vousden, N. "International Trade and Exhaustible Resources: A Theoretical Model." International Economic Review 15(1): 149-161 (February 1974).

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(52) Walter, Ingo. "Environmental Control and Patterns of International Trade and Investment: An Emerging Policy Issue." Banca Nazionale Del Tavoro Quarterly Review 100: 82-106 (1972). (53) Walter, Ingo. International Economics of Pollution. New York: Halstead Press, 1975. (54) Walter, Ingo, ed. Studies in International Environmental Economics. New York: John Wiley & Sons, 1976. (55) Withagen, C. Economic Theory and International Trade in Natural Exhaustible Resources. Berlin: Springer-Verlag, 1985.

CHAPTER

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International Trade Theory and Natural Resource Concepts Philip C. Abbott, Stephen L. Haley

The fortunes of the U.S. agricultural sector have been closely linked to international agricultural markets during the previous two decades. During the 1970s, U.S. agricultural exports expanded rapidly, drawing resources into production and raising prices of agricultural commodities, factors of production, and especially land. In the early 1980s, the export boom subsided, commodity prices have declined, resources are being taken out of production, and land prices have fallen dramatically. Adjustments to the changing economic environment have been strongly conditioned by U.S. farm policies and programs. Among these are policies that have established floors for agricultural prices, discouraging adjustments to the changing export market by artificially maintaining domestic and international incentives to produce, and policies aimed at restoring U.S. export markets in order to bolster farm incomes. Resource usage and resource pricing have been determined in large part by how these policies operate in the international marketplace. Several resource and trade economists have expressed concern over the problems in resource allocation engendered by expanding exports and from the distortions introduced by U.S. farm policy. Doering, Schmitz, and Miranowski (19) have argued that the social costs of agricultural exports may be well in excess of the benefits realized. Farm program costs leading to large differences between production costs and international prices are the largest source of this divergence, but they also identify externalities, such as soil erosion and silting, as costs which need to be considered. Schmitz, Sigurdson, and Doering (56) have further argued that export promotion is unlikely to restore the gains from trade lost because of distortions in the international market. Heady (28), Reichelderfer (54), and others have also expressed concern over fluctuating export markets and the effects of farm

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programs on adjustments in resource allocations to those changes. Recent evaluations of U.S. agricultural policy in an open economy stress that land prices have been particularly sensitive to export market performance. Work on the overlap between issues of concern to natural resource economists and to specialists in international agricultural trade has been limited; yet issues in that overlap are of considerable importance to U.S. agriculture. In order for there to be greater collaboration in these two areas, there is a need for each group to understand the underlying paradigms and theories of the other specialty. There is also a need to examine common issues and approaches and to consider how the concerns of each specialty fit into the paradigm of the other. The purpose of this chapter is to look at one side of this overlap—how natural resources have been addressed in the framework and analysis of international trade economists. Our review of the international trade literature and discussions with natural resource economists suggest that the approaches of these two areas are not as divergent as initially suspected. Particularly in the theoretical literature, the use of a general equilibrium framework is common to both. The greatest differences lie in the use of closed-economy assumptions in most natural resource work, as opposed to the small-country assumption— relating domestic and international prices and linking supply-demand imbalances to trade—in international economics. Greater differences arise in empirical work, where practicality often necessitates the use of focused partial equilibrium models. With the emergence of computable general equilibrium models, even this distinction will diminish. Trade theory has probably been using general equilibrium frameworks longer, but many of the propositions derived from the standard Heckscher-Ohlin framework are simply characteristic of a general equilibrium model and would carry over to a closed economy model.

Resource Issues and Trade Theory Issues of central concern to agricultural trade specialists are also important to natural resource economists, though possibly seen from a somewhat different perspective. The competitiveness/comparative advantage question is the one that most easily highlights this overlap.1 International trade economists are concerned with the commodity composition of trade, what factors dictate that composition, and the magnitude of imports and exports. Natural resource economists are concerned with the optimal allocation of resources, now in an open economy. Both are concerned with the effects of policies on the realization of comparative advantage—hence, the optimal allocation of resources. The starting point for this review and discussion of trade theory relevant

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to the concerns of natural resource economists are the approaches taken to the analysis of comparative advantage. This focus is also useful to the presentation of much of the content of modem international trade theory. That theory emphasizes the relations between natural resource endowments and international trade patterns. Several additional issues are of concern to natural resource economists. The extent to which trade theory considers these issues needs to be examined. Foremost among these is the effect of externalities (identified as distortions in the international trade literature). The Heckscher-Ohlin framework is most adept in a distortion-free world, but trade economists have considered the implications of "second-best" policies in a distorted economy. Those distortions of greatest concern to international trade theorists—tariffs, quotas, and factor mobility—are not necessarily the most important to resource economists. They see production externalities (e.g., soil erosion) as important concerns. Nevertheless, lessons may be learned from the introduction of distortions into trade theory. A second area of concern is dynamic adjustment. It is now widely recognized among trade economists, however, that the Heckscher-Ohlin framework is a static construct more appropriate to long-run adjustment. Technological change has been an important consideration of trade theorists, but it has been handled in a somewhat simplistic manner. Only in the area of petroleum trade where depletable natural resources are examined is the richness of dynamic specifications of natural resource economists evident. Ricardo-Viner models offer a framework for incorporating such issues. Setting intertemporal discount rates is a problem faced by natural resource economists that arises from the concern with dynamic adjustments in a distorted world. Such issues have been of less concern to international trade theorists, who find that models of distorted economies enable few theoretical generalizations. The third major concern of resource economists specifically interested in agricultural commodities is the special role of land. How land prices are formed is a key issue in today's debate on agricultural policy. The supplydemand models of land allocation used by resource economists and the notion of land rents developed by Ricardo are likely to lead to different perspectives on the role of this resource. Such discrepancies can probably be reconciled through modern general equilibrium theory, however. While land has been introduced into the models of some trade theorists, most resource economists are likely to be disappointed with the simplistic treatment of land in this framework. Trade theorists have recognized the special problems of agriculture but have often chosen to focus on manufactures trade as a consequence. Leontiefs classic test of the HeckscherOhlin theorem specifically excludes agricultural trade. Agricultural trade specialists have recently been concerned with the

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relevance of these theories and the role of land in establishing comparative advantage. Anderson (2) and Abbott and Thompson (1) examine agricultural comparative advantage using the Ricardo-Viner framework first proposed by Jones (30). Haley and Abbott (26) have extended this analysis, looking more closely at the role of land quality and investment in agricultural resources. As is evident in that work, and in much of the work following the Leontief paradox, empirical investigations are forced to come to grips with the conceptual questions often glossed over in a theoretical investigation. Treatment of land of differing qualities is such an issue: it has received scant attention in trade theory. Our review of trade theory and empirical work on agricultural trade emphasizes the role of land in existing work. That work, however, takes a much more aggregate, macroeconomic view of the world than is common among resource economists. The problems of differing production units with varying endowments of land of differing characteristics, or with differing degrees of production externalities, represent a frontier in the overlap of these two disciplines which is likely to be difficult to address.

Organization of Trade Theory Discussion and Implementation Issues The remainder of this presentation includes a review and evaluation of existing approaches to trade theory and of empirical work relevant to the concerns of agricultural resource economists interested in addressing issues in an open-economy context. The next section uses the issue of comparative advantage to present alternative approaches to trade theory. The Ricardian theory of comparative advantage, the Heckscher-Ohlin model, the RicardoViner models, and Krueger's "hybrid" combination of these models are considered in turn. Implications of extending the older two factor models to a world of many factors (resources) are specifically addressed. The role of distortions in trade theory, especially those of interest to resource economists, are then evaluated. Empirical investigations of trade economists, including work following the Leontief paradox, and the recent tests of trade propositions in computable general equilibrium models are examined. Development planning models as implementations of Ricardo-Viner theory are also considered. Explicit attention is then given to the work of agricultural trade economists. The role of technological change is explicitly considered in that section, where the issues relevant to agricultural technology are most apparent. Agricultural sector models as partial implementations of the Ricardo-Viner framework are also considered. The project evaluation literature has also come to grips with some of the issues in the overlap of these areas. Its relation to trade theory has been considered

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explicitly, so that topic is reviewed here. Implications for future work incorporating agricultural resource issues into international trade models are then presented.

Comparative Advantage Theory A fundamental concern of trade theorists has been why trade arises and, when it does, what determines the commodity composition of that trade. Ricardo's theory of comparative advantage provides the framework within which this dilemma may be addressed. It remains a useful paradigm for explaining the direction and composition of trade. Of interest to resource economists is the role of natural resources in that theory, and agricultural economists are specifically concerned with land endowments (or other resources, such as water or soil quality) and the commodity composition of agricultural trade. Ricardian Theory According to Ricardian theory, trade arises because of commodity price differentials, which would arise under autarky.2 Because production relations (costs) differ among countries, international prices differ from those autarky prices. A country seeking to maximize national income would specialize in the production and export of those commodities for which the autarkic relative price is less than the international price ratio. Figure 2.1 illustrates this situation for the two-good world typical of Ricardian theory, where Leontief fixed coefficient production functions are also assumed. Under autarky, both goods 1 and 2 are produced and the relative price corresponds to the relative use of variable resources—the slope of the production possibility frontier (PPF). With free trade, the country specializes in production of good 2, which it exports. National income at international prices exceeds income under autarky, as U1 exceeds U° and consumption of both goods increases. This familiar gain from trade argument arises whenever autarky prices and international prices differ, or whenever production functions differ if there are two regions in the world. Slopes, or relative costs, and not absolute resource costs are the key factors in determining the composition of trade. Extension of the Ricardian framework to a many-product, many-input framework, and specifically to account for land (or possibly other resources), is straightforward (6). Determination of production patterns (Xj) may be cast in a linear programming framework, where the objective is national income maximization at border (international) prices (P,): (2.1)

max X ^ i Xj •

40

AGRICULTURAL TRADE AND NATURAL RESOURCES

Figure 2.1

Comparative Advantage in the Ricardian Model Good 1

This maximization is subject to fixed resource endowments (B,) and a Leontief production structure: (2.2)

i = 1

,n.

The ay represent resource requirements and, in the case of the two-good, onefactor world, determine the slope of the PPF. Unlike Ricardian theory, in which a country specializes in production of a single good, inclusion of several resources leads to incomplete specialization. Nevertheless, with many goods and factors, complementary slackness leads toward specialization in a few goods rather than production of all goods. Each constraint tends to determine the production of a good that uses that resource efficiently. If land (or types of land of differing qualities) is a binding constraint, production (and possibly export) of a good using land relatively efficiently will be determined by that constraint. Ricardo recognized the consequence of the fixity of land in this framework. He observed that a rent accrues to land, placing a value on its scarcity. He was concerned, as was Malthus, that as population expanded, this rent would increase and food production would become more costly. This concept of rents accruing to fixed resources is how land will typically be valued in the modern Ricardo-Viner models of trade. As seen previously, this

PHILIP C. ABBOTT & STEPHEN L. HALEY

41

concept of land rent is determined in a manner comparable to calculation of opportunity costs for a linear programming model. Imports and exports are then determined by utility maximizing consumers, who also face international prices (P) and have to spend the maximum national income derived from the producer problem. Hence, the consumer problem is max U(C),

(2.3)

where C = ( C i , . . . ,C„), a vector of consumption of each good. A foreign exchange budget constraint relates consumption to production (2.4)

ZPj(Cj-X¿)

0 for m C X.

Equilibrium requires that Walras' law be satisfied, that is, all excess supplies sum to zero: (3.20)

XESm=0. mCM

Goods flow from the set of exporting countries X to the set of importing countries I. Define the exports from country i to country j as ES,y. Then total exports from country i are (3.21)

ES,= £ES;,, ¡a and total imports by country j are

i C X,

(3.22)

j C I.

ES, = l E S y , icx

This basic competitive equilibrium model implies that each country will be a net importer or exporter of the traded good as a function of its domestic equilibrium relative to the world equilibrium price. The model can be made more realistic by introducing simple modifications, such as transportation costs and policy interventions, which in turn alter each country's competitive position vis-à-vis the international market. Policy interventions could include price setting as well as quantitative restrictions on trade flows. Multiple traded goods can be introduced by adding additional systems of excess supply equations into the model, with appropriate modifications for possible cross-supply and cross-demand elasticities in each country. Further

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modifications of the basic competitive model are required to deal with phenomena such as nonhomogeneous goods and noncompetitive behavior by exporting or importing countries. In the case of natural resource policies that are directed at the output market, the simple multimarket model can be used directly to analyze impacts on prices, trade flows, and aggregate welfare in a straightforward manner. However, many natural resource issues involve factor markets and cannot be analyzed in terms of the product market. As we saw in the previous section, purchased inputs often interact with the resource stock and influence its evolution over time. In addition, many purchased inputs are in fact traded goods themselves. Because these purchased agricultural inputs, such as agricultural chemicals, often interact in significant ways with resources, their trade can play a significant role in a country's resource problems. Thus, we need to consider trade in both outputs and inputs. This situation can be contrasted with the conventional trade models, which assume factors are immobile across national boundaries. Observe that the simple model outlined in Equations (3.19)—(3.21) contains only output prices and quantities; essentially, all other variables, such as resource prices, are held constant. To make this simple, static model more useful for analysis of resource issues, it needs to be generalized to incorporate explicitly the interaction between factor and product markets. The first step in introducing factor markets into the basic trade model is to formulate an aggregate representation of the supply side of the traded-goodproducing industry. More generally, the supply side of the economy could be disaggregated into traded goods and nontraded goods sectors, and these in turn could be disaggregated into their component industries. In the case of a single sector, define the short-run supply of the competitive industry in terms of its profit function (3.23)

n = JC[/V,Z,S] ,

where n measures returns to fixed factors of production S and z as a function of product price P and factor prices w. If we apply Hotelling's lemma, the industry product supply and factor demand functions are (3.24) and (3.25) Note that r represents purchased inputs that are variable in the short run, z is purchased capital or other factors fixed in the short run, and S is the resource stock, also fixed in the short run.

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73

Examining equation system (3.24) and (3.25), we can see that since resource stocks play a role in agricultural production, they affect supply and demand functions for the industry. Consequently, they will figure into the industry's functioning in international markets. But this model does not determine the value of those resource stocks or how they evolve over time; they are simply taken as given. The evolution of the stock over time is determined by the resource model described in the previous section. The two models need to be merged into a hybrid model to determine jointly both the state of the industry's trade in international markets and the state of its resource stocks. This task is taken up in the following section. It may be reasonable to assume, at least in the short run, that domestic factor supply functions are perfectly inelastic, in which case the above system of factor demand functions determines the equilibrium factor prices as a function of given factor supplies f. If we assume factors are not traded, a factor market equilibrium condition can then be defined as (3.26)

r=

r*[P,w,z£].

In contrast, if factors were supplied perfectly elastically to the industry, then the factor price w would be exogenous to the sector and the quantity supplied would be endogenous. Combining the above product supply and factor demand functions with domestic product demand functions, we can represent each country's traded goods sector and resource markets in terms of the country's excess supply functions and resource market equilibrium condition: (3.27)

E S m = ES m [/>,w m ,z m ,SJ ,

m C M

and (3.28)

rm = rdm[P,wmjm,Sn]

,

mC

M .

Note that P is not subscripted to denote that it is determined in the international market. Other variables are country specific. It should be emphasized that the basic concepts of international trade theory are embedded in this simple model. The system of excess supply functions embeds the country's technology and resource endowments and thus reflects its comparative advantage. Therefore, in an undistorted world market in equilibrium, a country that is a net exporter of an agricultural commodity must have comparative advantage in that commodity. Another point to be emphasized is that, in the general equilibrium theory of trade, it is not important to distinguish between trade in commodities and trade in factors of production. If factors are immobile, trade in commodities substitutes for trade in factors. However, in the present context it is

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AGRICULTURAL TRADE AND NATURAL RESOURCES

important to distinguish between trade in factors and products if they do not have the same effects on the resource stock. Consider, for example, the case of factors such as pesticides or fertilizers, which generate externalities in the form of pollution, and the pollution is not traded with the output. In this case, trade in output and trade in factors is not equivalent, since the two cases have different effects on the resource stock. A country that produces with pesticides must bear the associated pollution, whereas a country that trades in pesticides forces the pesticide-importing country to bear the pollution when it uses the pesticide. The essential difference between this model and the simpler model above with only product markets is that changes in factor markets have an impact on product markets, and vice versa. Thus, policies implemented through factor markets can be analyzed in terms of their effects on trade flows and world market equilibrium prices. A further logical generalization of the simple trade model would be to endogenize both sides of factor markets, by introducing a factor supply function rather than assuming that factors are in fixed supply. In addition, we can allow variable factors (such as seed, fertilizer, and pesticides) to be traded in international markets. In the case where the agricultural industry of a country is "small" relative to the world factor markets, so that the sector is a price taker in factor markets, the factor supply function is perfectly elastic at the going world market price. As in the case of the product market, the country will be a net supplier or net demander of the traded factors as a function of its domestic supply and demand in relation to the world price. To keep the model simple, assume that the domestic factor supplies are fixed, and that the agricultural sector can obtain variable purchased inputs on the world market at going market prices. At the same time, factor owners can sell either to the domestic industry or to the international markets. Thus, the country has a factor excess supply function (3.29)

¥K. m \r m J > ,w,z m £^ = r m — r d m [ P , w j m £ m ] ,

mC

M ,

and a product excess supply function (3.30)

E S m = ES m [/ 3 ,w,z m y S m ] ,

m C M .

Note that in Equation (3.28), domestic factor prices w m clear the factor markets; in (3.29) and (3.30) the world factor price w is relevant. At the world price w, domestic factor demand is given by the industry's derived demand function in (3.25). If that quantity is less than the country's fixed supply the country exports factors; if that quantity is greater than its domestic supply, it is a factor importer. The model with traded factors consists of equations (3.29) and (3.30).

JOHN M. ANTLE & RICHARD E. HOWITT

75

Several observations may be made about this generalized model. First, it is obviously a more complex model: in general, there may be interactions between all the relevant variables in both product and factor markets. Second, this general model is much more data intensive, requiring price and quantity data from product as well as factor markets. Third, depending on the structure of the product and factor markets, an econometric version of the model may be a fully integrated simultaneous system with both P and w endogenous (e.g., if the country is a price maker in both the product and factor markets), or recursive with P exogenous and w endogenous (e.g., if the country is a price taker in the product market), or "seemingly unrelated" if both prices are exogenous.

Hybrid Resource-Trade Models It is apparent from the resources model discussed above that the dynamics of the resource stock both affects and is affected by the agricultural production process. The resulting production dynamics translate into dynamic product supply and factor demand functions, which in turn introduce dynamics into the product supply functions and the factor market equilibrium conditions for the industry. The trade model discussed in the previous section shows that resource stocks affect product supply and factor demand, and thus the sector's excess supply functions in the international market. Since the trade model takes the resource stocks as given, it can be thought of as the short-run model of the industry in the case where firms do not take into account the effects their production decisions have on the resource stock. This would be the case, for example, when the resource is common property and the effects of individual production decisions on the stock represent an externality. In attempting to model the link between agricultural resources and trade in agricultural commodities, it is important to recognize that the two models have in common the agricultural production process. The trade model represents the link from trade to production, through the excess supply functions; the resource model provides the link from the production process to the resource stock, through the production technology and the equation of motion of the resource stock. Thus, any hybrid resource-trade (HRT) model must exploit the central role that the agricultural production process plays in the linkages between natural resources and trade in agricultural commodities. 4 This linkage is illustrated in Figure 3.1. The figure also shows how various issues can be addressed in the context of a hybrid model. Trade policy affects the resource-trade linkage through the interaction of trade and production and thus can be analyzed and modeled through the trade portion of the hybrid model. Resource policy affects the resource-trade linkage through the

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AGRICULTURAL TRADE AND NATURAL RESOURCES

Figure 3.1

The Trade-Production-Resources Linkages

production-resource interaction and thus can be analyzed through the resource part of the hybrid model. Similarly, other important phenomena such as dynamics, externalities, irreversibilities in investment, and price and production uncertainty can be introduced into the analysis through the production process. An important problem that arises in attempting to develop an HRT model is related to aggregation. The resource model represents an individual firm, whereas the trade model represents an industry. This means that important aggregation problems arise in any attempt to merge the two models. One must be careful to address the validity of the microeconomic assumptions underlying the production model when it is applied to industry analysis and data. In addition, the problems of the measurement of an aggregate capital stock must be addressed in attempting to measure the aggregate resource stock. Aggregation may disguise important distributional issues that are better analyzed at the firm or regional levels. Several versions of a hybrid model can be derived, depending on the status of the resource stock in the model. Socially Optimal

HRT

When producers internalize the effects of their decisions on the resource stock, the dynamic product supply and factor demand functions (3.17) and (3.18) can be combined with the product demand and factor supply functions to obtain dynamic versions of equations (3.29) and (3.30):

JOHN M. ANTLE & RICHARD E. HOWITT

(3.31)

ESMI( = ES„JSM(,

ZMI„

XmT,

P«\

77

W«>, M«, W« „(0, N « M R MI ].

In addition, the dynamic model contains the solution (3.16) for the resource allocations. This model gives the socially optimal behavior of the industry, which takes into account the effects of its production on resource stocks. HRTfor Externalities Not Internalized If the relation between firm decisions and the resource stock represents an externality that is not internalized by firms, in the short run, firms solve the static profit maximization problem discussed previously. The link between the resource model and the trade model is the presence of the resource stock in the profit function (3.23). Combining a time-subscripted version of the trade model [Equations (3.29) and (3.30)] with the equation of motion for the resource stock [Equation (3.3)], one obtains a version of the HRT for the case in which the industry does not internalize its effects on the resource. The shadow value X, for the resource stock that is generated by firms' production decisions in a given production period t can be obtained from the profit function, by adding time subscripts to the profits function, (3.23), and differentiating it with respect to the resource stock: ,,

3K[/ > „W„Z„S,] — aj ,

- A,.

If the resource stock were privately owned by agricultural firms, then in longrun equilibrium this shadow value is equal to the long-run equilibrium price of the stock St.5 Thus, the long-run equilibrium stock can be found by equating X, to the long-run equilibrium price, and solving (3.33) for S,. If the resource stock is a common property resource, which agricultural producers do not have to own to use, they rationally view the price as zero. Thus, if society attaches a positive value to a common property resource, there will be a tendency for producers to overuse it from society's point of view. HRTfor a Regulated Externality The shadow value to society of the resource stock is obtained by solving the resource model with the externality taken into account [Equation (3.13)]. If policies are designed [such as a user tax equal to X, in (3.13)] to force firms to internalize the cost of degrading the resource, then firms' decisions will lead

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AGRICULTURAL TRADE AND NATURAL RESOURCES

to the socially optimal resource stock at each point in time. This represents a case of optimal regulation of the externality, and the resulting production decisions are the same as the dynamic model's solution, Equation (3.16). Substituting Equation (3.16) into the profit function (3.23) and then deriving the product supply and factor demand functions and the excess supply functions for output and traded inputs, we again obtain the socially optimal solution (3.31) and (3.32). Regulation need not achieve the social optimum, however. Indeed, there are numerous examples of regulatory failure, due either to the lack of information by the regulatory agency, conflicts of interest between J h e regulators and society. In the case of suboptimal regulation, a time path X(t) is imposed on producers by the regulatory agency. Solving for the sequence S, using (3.33), and then substituting into the profit function to obtain a system of excess supply functions for output and inputs, one obtains another version of the HRT. In this case, however, there is no presumption that the solution is identical to the socially optimal solution (3.31) and (3.32). The preceding discussion shows that the HRT model can be formulated in various ways, depending on the particular problem of interest. These models provide a means by which a variety of interrelations between domestic agriculture, international trade, and natural resource stocks could be quantified and studied. For example, consider the price support policy of a dominant exporting country such as the United States, which leads to higher world prices. An HRT would show the effects of such a policy on the product supply, factor demand, and resource stocks in an open agricultural economy. Similarly, policies that affect the supply of traded factors of production would be transmitted internationally. In the following sections we further discuss some applications of the HRT. Empirical implementation of each of the versions of the HRT would involve particular modeling and data requirements. The most demanding would be the optimal HRT model. Implementation of this model would require data for the basic production model, as well as the data necessary to quantify the resource stock and its equation of motion. Thus, the biological relations governing the resource stock and the interactions between production decisions and the resource stock would need to be quantified. Once those relations were quantified, the optimal solution would be obtained by solving the appropriate dynamic optimization problem. This may be feasible for a nonstochastic version of the model, as presented previously; however, with the introduction of uncertainty and expectations, as discussed later, the solution of the problem may be computationally burdensome. Implementation of the HRT for the case of externalities that are not internalized is less demanding. Given production data needed for quantification of a restricted profit function model, the product supply and factor demand functions can be estimated. Such aggregate production models have been

JOHN M. ANTLE & RICHARD E. HOWITT

79

developed in the literature [see (8), for a survey of recent models]. Combined with information on the product demand and factor supply relations, the product and factor excess supply functions can be derived, conditional on the resource stock in each time period. By quantifying the resource stock and its equation of motion, the model can be closed. In this version of the HRT, since the socially optimal solution is not followed, the dynamic production problem need not be solved. The HRT for the optimally regulated externality would require the same data and modeling procedures as the socially optimal case discussed previously, since the two models are essentially the same. However, if analysis of some other (i.e., suboptimal) regulatory scheme were desired, one could simply impose that regulatory scheme on the unregulated model. For example, quantitative restrictions on the utilization of agricultural land, which come about through acreage diversion programs, could be evaluated in terms of their effects on the resource stock and on international trade.

Externalities A variety of factors related to natural resources induce externalities and the resulting failure of competitive markets to allocate resources efficiently. Perhaps the most intensively studied externalities are associated with common property resources such as air, water, and pest resistance. Typically, these externalities are integrally related to the dynamics of the resource stock and thus can be studied using the HRT model. In addition to these conventional externality problems, international trade may generate externalities associated with the specialization of production. This latter class of externalities is discussed in detail in the following section on uncertainty. Externalities associated with agricultural resources generally involve social costs associated with agricultural production activities. Consequently, policy remedies to agricultural resource problems typically involve restrictions of production and thus of trade. Therefore, resource policy prescriptions typically will be in direct conflict with the spirit of international trade theory, which stresses the gains from free trade, as well as with trade policies aimed at trade promotion. On the other hand, protectionist policies are likely to play the role of second-best resource policies in the presence of production-related externalities. Implementation of an empirical HRT model would provide estimates of the magnitude of the social costs and benefits of trade policies, taking into account externalities associated with utilization of agricultural resources. Externalities associated with traded goods create important institutional and trade policy problems that can be studied using an HRT model. For example, consider the case of a country producing a commodity that degrades

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AGRICULTURAL TRADE AND NATURAL RESOURCES

a common-property resource within a country. In a closed economy, the optimal externality policy would involve an intervention in the output market to restrict production to the point at which the marginal social benefit of consuming the product equaled the marginal social cost of producing it, including the resource cost of the externality. In an open economy, the policy problem involves the actions of all trading partners. If all countries acted jointly to maximize welfare defined as the collective sum of producer and consumer surplus across countries, the policy problem is analogous to the analysis of the single-market problem of the closed economy, with the world market supply and demand functions replacing the closed-economy supply and demand functions. However, such a policy scenario is unlikely in the real world, and each country is likely to have to deal with its externalities on a unilateral basis. In this case, a "small" exporting country is faced with the difficulty that foreign consumers benefit from being able to obtain the product at a world price that does not take into account the cost of the externality borne by the citizens of the producing country. Conversely, the small importing country is able to increase consumption of the traded good, while decreasing its production and thus reducing its domestic externality problems. Unless compensation is forthcoming from the importing countries (which is unlikely), the producing country's only options are to bear the full cost of the externalities in a free-trade policy or to restrict its production and exports and thus reduce the extent of externalities it must bear. The existence of traded factors of production also introduces new complexities into trade policy analysis as well as domestic policy analysis. Again an example can illustrate the kind of problems that may arise. Consider the policy of restricting agricultural chemical use, as in the case of pesticide registration in the United States. If a restriction on the use of a pesticide in the United States led to more pesticide being available in international factor markets, at a lower price, other countries would use more of the pesticide. The increased use abroad could offset some of the environmental improvements that were intended to be obtained by the restriction in the United States. Moreover, if pesticide restrictions in the United States raise production costs in the United States, and thus reduce supply, the product price may rise in international markets. This product price increase shifts production from the United States to other parts of the world where pesticides are not restricted, again thwarting the policy goals of the U.S. restriction. And finally, if as a result of this policy the United States imports more of the products that use the restricted pesticide, the problem of pesticide residues on imported food replaces the problem of residues on domestically produced food. These examples suggest that the empirical implementation of an HRT for analysis of many important classes of problems will involve the same sorts of difficulties confronted by all attempts to model international markets.

JOHN M. ANTLE & RICHARD E. HOWITT

81

First and foremost, the data requirements may be extremely high if one needs to know how world markets respond to domestic policy changes. In order to analyze optimal international policies to deal with production externalities, one would need to be able to quantify the externalities generated in all trading countries. Such an undertaking clearly is not possible now and may never be. However, it may be feasible to quantify the relevant externalities in some cases for one or a small number of countries and to utilize an HRT to evaluate the effects of trade on those countries' agricultural resources.

Irreversible Investment Investment in agricultural assets is predominantly irreversible. Many resource assets such as land fertility, soil conservation, and drainage are clearly fixed in location and can only be reversed by the process of degradation and decay. The capital market for agricultural resources is restricted further by the very low proportion held by publically traded companies. Agricultural technology is often embodied in crop- and location-specific capital and leads to liquidation difficulties if the industry is overcapitalized. This characteristic may result in behavior similar to the case of truly irreversible investments. The phenomenon of irreversibility may be relevant to the analysis of agricultural trade policy in the context of recent U.S. agricultural policy. The U.S. policy has had the effect of supporting world commodity prices. Policy changes (to lower support prices) appear to be undertaken with the expectation that the supply response in other countries to price decreases will be as elastic as the response to price increases was. The discussion of investment irreversibility in this section suggests that when U.S. policy induces investments that bring new acreage into production, especially marginal land with little economic value in other uses, the supply response to price decreases is likely to be low and may be positive in the short run. In addition to investments in agricultural land, investments in agricultural technology and human capital are largely irreversible. Once made, these investments are maintained, regardless of prices. This fact again suggests that when one large actor in the world commodity markets, such as the United States, encourages such investments through its price support or other policies, the result may be a fundamental change in the supply response of other countries trading the commodity. This section examines the effect of agricultural investment irreversibility on production supply response under conditions of unanticipated changes in output prices. Two principal hypotheses result from the theory. First, the supply function under expanding output is more elastic than the contracting output supply. Second, given substantial changes in price expectations and an inelastic cross-supply elasticity with other crops, disequilibrium in asset

82

AGRICULTURAL TRADE AND NATURAL RESOURCES

values can cause negatively sloped supply functions in the short run. The difference between supply elasticities of an expanding and contracting industry has been noted and estimated for some time. Tweeten and Quance (32) estimated a 60 percent reduction in short-run aggregate elasticity. Johnson and Quance (17) also emphasized the asymmetry between expanding and contracting agricultural supply. Chambers and Vasavada (10) used the Fuss putty-clay technology test for fixity of assets in agriculture. They tested three inputs: capital, labor, and intermediate materials. Land was also included as an input but was assumed to be fixed ex post. The aggregate empirical results found no evidence of fixity in capital, labor, and materials. Vasavada and Chambers (33) used an adjustment cost model and did find evidence of asset fixity in the sense that land, labor, and capital stocks adjust slowly to price changes. However, their data rejected nonsymmetric factor demand elasticities and thus rejected the hypothesis of irreversibility. Therefore, these aggregate results do not support the contention of irreversibility of land or capital but do not address the hypothesis of irreversibility in natural resources or their allocation to particular crops. Nor have studies based on disaggregate data been conducted to test any of these hypotheses. We are not aware of a published analysis that shows how supply response may be related to the dynamic disequilibrium of agricultural assets owing to their irreversible nature. Analysis of the theoretical basis of supply expansion and contraction will define hypotheses that can be tested using more reliable disaggregate data to determine the interrelationship between resource policy and the excess supply elasticity of a given crop. The resource production model in Section 2 is restricted to consider only two types of crops, a cash crop (1) and a cover (conservation) crop (2).Allocating land to the cash crop decreases the stock of fertility, that is, dgt(*)/dsu < 0. whereas allocation to the cover crop increases the stock of fertility, that is, dg,(»)/ds2, > 0. The effect of increased land fertility increases output of the cash crop, dfu(»)/dsu > 0, but the cover crop's yield is not increased by increases in fertility. If the Hamiltonian (3.6) is augmented by Lagrangian constraints in each time period for the nonnegativity of land allocations s„ (i = 1,2) and investment vit, and an upper bound v, on the rate of investment, the firstorder conditions (3.7) and (3.9) are modified by the appropriate Lagrange multipliers and Kuhn-Tucker conditions. Let the Lagrange multipliers for land allocations be Y, 0,

i"

m"

< 0,

< 0,

m(0)

and

=

0,

/(0) = 0.

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AGRICULTURAL TRADE AND NATURAL RESOURCES

The assumption that m' < 0 reflects the presumption that more intensive use of the land resource tends to diminish land quality, albeit at a decreasing rate (m" s.t. X = m(vi)

-rv L -/)dt; + /(/)

and

X0 = X .

Here 8 is the time rate of discount for farmers and r is the instantaneous price of the variable factor of production. Producers of the nonagricultural commodity maximize J 0 V 9 '(P/2-'-V 2 )dt, where 9 is the time rate of discount of nonagricultural producers. However, it is easy to show that a full employment, temporary equilibrium associated with the above maximization problems can be arrived at equivalently by solving3 (6.1)

max J 0 > - ' (p/j + p / 2 - 7)dt; s.t. m(vj) + /(/) = X,

vj + v 2 = v,

and

X0 = ^ .

where v is the total endowment of the input that is traded between sectors. The current-value Hamiltonian associated with Equation (6.1) is h = Pifi + p / 2 - 1 + H(w(vi) + /(/)),

ROBERT G. CHAMBERS AND KATHERINE REICHELDERFER

129

where (i is the current-value co-state variable. By the maximum principle, the optimal trajectories for the states and controls are found as the solution to (6.2)

(v,, T) = arg max h ,

X = — max h ,

LI = 8 u - — max h , dX

e^'uCO = 0.

In what follows, let the maximum value of the current-value Hamiltonian be denoted H = max h . The Hamiltonian is concave in A= XL and affine in (i. Hence, by the usual results in optimization theory, H is convex in (i and concave in A (as well as X). Let V](n, X,pi,p2, A) and /(|i, X,pup2) be the elements of the vector in the first equality in (6.2). By straightforward arguments one can then easily establish dv,


aL

0,

0,

0,

d V) dp i d Vj dp2 dv2 = -dv i .

Moreover, d I d* 3/ dl 3/ „ J — > 0 and — = — = — = — = 0 . dp. dA, dL dpi dp2 These results are straightforward and need little intuitive interpretation except to note that the zero restrictions on the partial derivatives of / are a direct consequence of the additively separable equation of motion for X. Equations (6.3) and (6.4) are useful primarily in carrying out comparative dynamic experiments. The first task is to ascertain the dynamic properties of the system as it is characterized by Equations (6.1) through (6.4). Note that, using (6.2), one can characterize the dynamic properties of the system both in and out of the steady state if a stable convergent adjustment path exists. 4 The steady-state solution to (6.1) is given by the following system of equations:

(6.4)

(6.5)

vj — = 0 dji.

and

8\i -

r) W - — = 0. dA,

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AGRICULTURAL TRADE AND NATURAL RESOURCES

That is, the system is in a steady state when the change in the optimal value Hamiltonian caused by a change in the state just equals the discounted current-value co-state. Under the assumptions already made, one can depict the dynamic behavior of the system by the phase diagram in Figure 6.1. The curve labeled |i = 0 is the long-run demand for land quality written in shadowprice dependent form [i.e., the second equation in (6.5)]. The curve labeled X = 0 is the long-run supply of land quality [i.e., the first equation in (6.5)]. The steady-state values of X and (I are labeled X°° and n°°, while the stable adjustment path is the heavy-arrowed curve. Comparative Dynamics of a Change in the Farmer's Discount Rate To infer how a change in 8 affects the steady-state value of X and (i, note that (6.5) implies after some obvious manipulation that d\T ¿8

il ¿ 2 / / / 3 | i dX ^ A

and dX~ |I d 2 H / d \ i 2 dò ~ A ~

'

where

Thus, increasing the discount rate of farmers lowers long-run land quality and the shadow price of land quality. This is illustrated in Figure 6.2. Increasing the discount rate effectively lowers the shadow price that farmers would pay for future units of land quality in the long run because it drives down the discounted value of the marginal productivity of land. This is illustrated by the long-run demand for quality shifting down as illustrated in Figure 6.2. To consider the comparative dynamics of the adjustment, consider that, in the very short run, one cannot change land quality. So, if the system was originally in the steady state (jx~, X°°), the system initially moves to point J on the new stable path. Thus, in the very short run, utilization of v in the agricultural sector rises and production of the agricultural commodity rises. Production of the nonagricultural commodity falls. Given fixed international prices, exports of the agricultural commodity then rise (3). At the same time, however, investment in land quality falls. Because of the more intensive use of the existing stock of land and the fall in land investment, land quality starts to fall and, as it does, the shadow value of land quality starts to rise.

ROBERT G. CHAMBERS AND KATHERINE REICHELDERFER

Figure 6.1

Adjustment Path and Steady-State Values of Land Quality and Shadow Price of Quality Shadow Price cf

Figure 6.2

Comparative Dynamics of a Change in Discount Rate Shadow Price of

131

132

AGRICULTURAL TRADE AND NATURAL RESOURCES

But as shown, land quality continues to decline throughout the adjustment period. This, along with the increase in the shadow value of land quality, depresses agricultural production. Thus, we have the phenomenon that increasing 8 first increases agricultural production and exports but then leads to a gradual decline in production and exports as the soil is gradually depleted. So over time we can depict the adjustment trajectory of agricultural exports by something like Figure 6.3. In the original steady state, let agricultural exports be given by X^. The immediate response to the rise in the discount rate is for production and exports to expand: exports jump to X,. But after the short-run adjustment, exports start to decline with agricultural production as a result of the deteriorating land quality. On the other hand, the country tends to import first more then less of the nonagricultural commodity. And as time wears on, exports will approach a new steady-state level. Whether or not the new steady-state export level is above depends on whether long-run production rises or falls. Although the long-run effect is indeterminant since -

^dfi dò dv!

(.

av-

3vi d\i dò

d\

N

8/i LdX j + dA

dò

intuition suggests that the tendency of the change in variable input utilization associated with the long-run change in the co-state will be dominated by other effects and I oo dyl ——< 0. dò

Resource Preservation A need for preservation arises when the value that society places on a resource in one use (e.g., land in wilderness) is greater than the value of the resource in its privately determined use. The objective of a preservation policy is to prevent the resource from being employed in its private use. It is practically applied to resources for which the private use results in irreversible loss of an amenity. The intent is to prevent permanently the amenity loss. A typical policy instrument is a targeted quota on the affected resource. Land preservation policy, for example, can affect agricultural production in one of two ways, depending on whether agriculture is the higher or lower land use at issue. Preservation of land in a lower use than agriculture constrains agricultural production possibilities. Preservation of land in agricultural uses induces changes in factor proportions. Wilderness preservation and the Endangered Species Act are examples of

ROBERT G. CHAMBERS AND {CATHERINE REICHELDERFER

133

Figure 6.3

How Exports Adjust Over Time to a Change in the Discount Rate

policies that effectively reduce the total endowment of land available for agricultural production. Unless land is a scarce factor, there may not be any measurable impacts of such policies. However, if demand is sufficient to induce high levels of production, land preservation outside the agricultural sector becomes a constraint. The imposed scarcity of land under these circumstances will, in the short run, diminish derived demand for variable inputs. In the longer run, land scarcity may or may not induce productivity improvement, particularly if nonland factors mitigate initial effects on the cost of production. Some of these ideas can be illustrated using the model. As is demonstrated, the long-run demand and supply for land quality are determined by a number of factors including relative commodity prices, producer discount rates, and the endowment of fixed inputs. Now consider a policy that seeks to preserve environmental quality by retiring land from production. From expression (6.5)

1 / d2// d2H _ dL ~ A and

&H \ 3L dX ~ dX dL 3 n dl J 2

&H

134

AGRICULTURAL TRADE AND NATURAL RESOURCES

d\~

i

aL ~ A

ry//

La^ 2

/

_

y//

A

J

3X 3L

3L J '

For the purpose of discussion, presume that the flexibility of demand for land given fixed X is greater than - 1 or, more formally,

&4 [b

dA)

Permanently retiring fragile land from production is equivalent to reducing the physical endowment of land. In the very short run, when it is impossible to augment land quality, the first response to such a policy is forced by the fact that land retirement reduces the marginal productivity of the variable factor devoted to agricultural production. More of v is devoted to the production of y2, which therefore rises while production of ^ falls. Decreasing L tends (under the assumptions already spelled out) to reduce the long-run demand for quality. This happens because each existing unit of quality has less physical land to interact with and this diminishes the marginal productivity of the quality factor. On the other hand, the long-run supply curve of land quality shifts to the right as L declines because the decline in L tends to decrease the utilization of v in agricultural production. But decreasing the utilization of the variable factor of production, ceteris paribus, means that the scale of operation starts to decline and, as this happens, the quality of the land remaining in production tends to rise. In the long run, therefore, it is not clear whether land quality will either rise or fall. What is clear, however, is that the shadow value of land quality falls. So in the very long run we find that investment in land quality declines unambiguously. And if long-run land quality either falls or only increases slightly, we find that utilization of v in agriculture, and therefore agricultural production, also declines. But what about the process of adjustment: that is, what happens to the dynamic adjustments of the system? Our results suggest that if the decrease in L tends to increase average land quality, then the shadow price of quality adjusts less in the short run than it does in the long run. But if a decrease in L decreases land quality in the long run, then the shadow price of quality adjusts in the short run by overshooting the long-run adjustment. As a consequence, the short-run adjustment in agricultural production and production of the nonagricultural good also overshoot their long-run adjustment. Nonagricultural production uses more in the short run than is required for long-run equilibrium while agricultural production declines more in the short run than is required for long-run equilibrium. Now what are the consequences of these simple general equilibrium results for trade, and particularly trade in agricultural products? Under our

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135

assumptions, demand for the agricultural and nonagricultural products remains unaffected. And it appears likely, as simple intuition would suggest, that policies that preserve land outside the agricultural sector by themselves diminish agricultural trade and agricultural income while enhancing nonagricultural trade and income. But as pointed out, exceptions to these results are possible. Policies such as farmland or greenbelt preservation 5 represent the opposite side of the coin by creating an artificial abundance of land in the agricultural sector. Basically, therefore, their results mirror those derived for land preservation outside agriculture. Theoretically, these policies could also encourage technological advance with respect to land's agricultural productivity and lower marginal costs of production, and thus improve the competitive position for trade.

Resource Conservation Conservation policies are designed to make private use rates of nonrenewable or slowly renewable resources consistent with the rates dictated by societal preferences. With respect to agriculture, this objective is most likely to apply to soil and water resources. Common conservation policy approaches include quotas, bribes, and taxes, all three of which are currently operative for soil conservation programs in the United States. As the following examples demonstrate, each approach has unique implications for production. One way to reduce soil erosion rates is to invest in structures (e.g., terraces) that retain soil on the land (i.e., invest in land quality). Structural investments improve the quality and present value of the land by preventing future loss of productivity associated with soil depth. (Investment in time t yields improvement in periods t + 1 through t + n.) The Agricultural Conservation Program (ACP) and related programs provide cost-share subsidies to farmers who invest in conservation structures. Thus, they raise the productivity of land. Contrast this with a taxation approach. The Conservation Compliance (CC) and "sodbuster" provisions of the 1985 Food Security Act penalize farmers who cultivate highly erodible land without investing in soil conservation measures. The penalty is in the form of loss of eligibility for commodity, credit, and other farm program benefits—a tax at a level that varies as program benefits vary. At the farm level, the effect of conservation compliance depends on producer response to the tax. Acceptance of the tax in lieu of making conservation investments increases marginal costs of production by the unit value of the tax. Avoidance of the tax requires unsubsidized investments, which also increase production costs but have the longer-term advantage of maintaining productivity of land.

136

AGRICULTURAL TRADE AND NATURAL RESOURCES

As an alternative to inducing in situ soil conservation practices, various quota mechanisms can be implemented to withdraw from production those lands from which soil erosion is most likely to occur. This, in effect, is the approach taken in implementing the Conservation Reserve Program (CRP). Although a bribe in the form of an income-supplementing rental payment is paid to encourage 10 year retirement of highly erodible cropland, the ultimate effect will be a 40 million acre reduction in land availability for agricultural production over the 10 year period. At the same time, the average quality, productivity, and value of land remaining in production are increased, especially if we assume, as Runge and Houck suggest, that low-productivity/ high-environmental-sensitivity land is targeted for retirement. The net effect on production in the short term depends on the extent to which the marginal value of land in production rises relative to marginal cost. The effect of subsidized investment in conservation structures is fairly straightforward. This strategy shifts the long-run supply curve for land quality to the right (from LS to LS* in Figure 6.4). The shadow value of land quality Qi) decreases, thus encouraging both greater use of the variable input (v), which degrades land, and continued investment (/) in maintaining land quality. The net effect is an increased long-term devotion of v to agriculture, with v2 declining, and a consequential rise in production and exports of the agricultural good. The short-run effects of subsidized investment in land-conserving structures is particularly interesting because it is characterized by overshooting of the shadow value of land quality. Therefore, subsidies to conservation structures also lead to short-run overshooting of agricultural production and exports. The effect of tax-induced private investment in land quality, via CC and sodbuster policies, has a similar long-run effect. However, intermediate adjustments shift more of the variable input into the nonagricultural sector as the value of taxes and/or investment lowers the marginal value of v t in time t. Over successive time periods, investment increases the shadow price of land quality and draws v back into agriculture. The long-run effects of the CRP are more ambiguous. They are equivalent to the effects of preserving land outside the agricultural sector. As our earlier discussion of land preservation suggests, long-term land retirement schemes, including the CRP, are likely to diminish agricultural trade. But, if the concurrent shifts in long-run supply and demand for land quality that follow from CRP implementation result in a significant increase in future land quality, this particular quota could induce increases in the scale of operation in the agricultural sector. This later result may be more likely for the CRP than for land exclusion from agriculture for two reasons. First, land retirement through the CRP is differentiated by land quality; higher-quality land remains in production while lower-quality land is retired. Second, land retirement through the CRP is based on a bribe that will prevent farm

ROBERT G. CHAMBERS AND KATHERINE REICHELDERFER

137

Figure 6.4

Effects of Land Retirement and Investment on Land Quality Shadow Price of of Quality (/u)

income from falling as much as it would otherwise. Indeed, if expectations are perfectly rational, it should not fall at all. If conservation policy decisions were only based on their impacts on agricultural trade, the preferred approach is subsidization of investments in future land quality. The advantage of this approach is that it improves longrun trade opportunities. Conservation compliance and the CRP, on the other hand, negate some of the gains from trade that are expected to arise from adjustments in loan rates and target prices. However, the long-run effects of the CRP on trade are not clear. These will depend on a range of factors, including the relative prices of production factors and agricultural vis-à-vis nonagricultural goods, the elasticities of supply and demand for land quality, and the degree to which land quality supply and demand schedules shift over time in response to price changes. While the CRP may interfere with trade possibilities in the short run, it may, under certain conditions, improve the long-run competitive position of U.S. agricultural trade.

Environmental Regulation Here, we examine policies that affect variable inputs through attempts to internalize the externalities arising from those inputs' use. Agricultural production externalities affecting environmental quality pose a particularly difficult policy problem in that they are nonpoint sources of pollution. The

138

AGRICULTURAL TRADE AND NATURAL RESOURCES

potentially polluting inputs (e.g., fertilizers, pesticides) create an externality (e.g., water pollution, chronic toxicity) only if the sum of their residual from numerous points of use in production results in some critical concentration at a single point of collection. The nonpoint source and stochastic characteristics of agricultural pollutants preclude direct taxation or variable quotas on input quantity as feasible policy instruments. Thus, the most common policy tools for environmental regulation affecting agriculture take the form of input use prohibition (quota) or management practice incentives (taxes and subsidies). If the use of a variable input is judged to pose societal risks that exceed its value in production, the typical policy response has been to prohibit or restrict its use. Such is the case, for example, in pesticide regulation. The effects of pesticide regulation in the United States arc well documented. Withdrawal of a pesticide from the market results in an increase in unit production costs (owing to greater relative expense or lesser relative effectiveness of alternatives) and a leftward shift in the aggregate supply functions for outputs utilizing the affected material. Because a given pesticide may be specific to certain crops and/or regions, secondary adjustments in output mix and output prices can also occur (7). The net welfare effects of a pesticide's withdrawal are negative in the commodity market, with decreases in consumer surplus offsetting increases in producer surplus (5), but are positive or neutral if gains in societal welfare associated with reduced risk are considered (4). As increasing numbers and types of pesticides have become subject to regulation, the rate of development of new pesticide materials has decreased significantly (3). This reflects an induced disinvestment in pesticide technology and implies that the marginal cost of pesticides will continue to increase. At the same time, however, strides are being made in the technological advance of substitutes for pesticides (labor and information). Management practice incentives are a preferred approach for achieving agricultural pollution abatement objectives when trade-offs (between private marginal value and social marginal cost) are possible (6). The effect of taxing management practices that lead to environmental externalities is similar to that of a quota on the polluting input. Marginal costs increase, aggregate supply shifts leftward, and, over time, innovations are induced that decrease reliance on the taxed practice. (The effect of management practice subsidies is similar to that of input subsidies, discussed in the next section.)

Input Subsidies And Resource Development So far, we have looked only at resource policies that reduce the availability (and increase the cost) of fixed and variable factors. These are implemented either as a way of producing a superior good (environmental quality) or in

ROBERT G. CHAMBERS AND KATHERINE REICHELDERFER

139

response to the lengthy social time horizon of high-income countries. Input subsidies and resource development schemes are also important resource policies that are more likely (though not exclusively) to be implemented in countries with less fully developed agricultural sectors. Input subsidies have exactly the opposite effect of input quotas and taxes. Subsidization of variable input cost reduces marginal cost and encourages the input's use in production. The effect of subsidizing input use in agricultural production can easily be analyzed in our model. As the model is cast, subsidizing an input's use in agricultural production is fully equivalent to raising the price of agricultural products relative to the price of the nonagricultural commodity. Using expression (6.5), we obtain 4r \ f &H d2H &H &H V dP\ ~ A l^M. dpi dX2 ~ dX dX dpx J sr_ i r y / / ?h dp\ ~ ¿ L a ^ 2 dxdpi

+

/ s - d2H \ m n ^ 3|i3x J a ^ a p J

Before discussing these results, note that if instead of assuming static output prices we had instead assumed perfect foresight or some other extreme form of rational expectations, these results would characterize how the steady state changes in response to a permanent price-level change that occurs in the initial period. So, for example, if the original expected price trajectory were as illustrated in Figure 6.5, the comparative dynamic experiment we are talking about is illustrated by an upward, parallel shift in the price trajectory. First consider that the long-run demand curve is the solution to d

H

F

Hence, increasing px shifts the long-run demand curve to the right as it increases the value marginal productivity of any level of quality. Formally, cP-HfdX api à i •> o api i t = o " 8 _ a 2 / / / 3 x a i i and d2mx api > 0 &H/dX2 bpx (1 = 0 " ax_

140

AGRICULTURAL TRADE AND NATURAL RESOURCES

where the second inequality follows by the concavity of H in X. Similar arguments show that the long-run supply curve shifts back to the left. These changes are illustrated in Figure 6.6 where the analysis starts from the original steady state |i~). As drawn, the new steady state involves a lower-quality level. The system initially jumps to point A on the new stable path so that the short-run effects of the price rise can be inferred from 3vi" 3/>i where d\\Jdp\ is given by the vertical distance \i"A. The long-run effects are portrayed by analyzing the expressions 3v t ~

3v t ~

3V]- 3(1"

3V!" dX°°

dpi

dpi

3(1 3pi

3A. 3pi

where in Figure 6.5: 9p i

and

l

Subsidizing the use of the input in agriculture increases the long-run demand for land quality since land quality has a positive effect on agricultural output. At the same time, however, the long-run supply of land quality decreases because the incentives to use the variable input are also incentives to overuse the existing land stock, and degradation results. Again, the long-run effect on land quality is ambiguous but the shadow value of land quality rises unambiguously. Thus, the long-run effect of input subsidies is similar to augmenting the stock of physical land in agriculture. The dynamics of the adjustment process are as follows. In the very short run, subsidizing the utilization of the variable input in agriculture bids that input toward agriculture: agricultural production and incomes rise accordingly. And in the first instance, land quality will begin to decline with the more intensive use of existing farmland. However, subsidizing the use of the variable input in agricultural production raises the shadow price of land quality as each unit of quality-adjusted land now has more of the variable input to cooperate with in production. The increased shadow price of land quality calls forth more investment in land quality. In the long run, however, the overall effect is unclear. Because the shadow price of land quality has risen, some of the incentive to expand agricultural production caused by the input subsidization is mitigated by the now higher price of land quality, which encourages farmers to use less intensive cultivation practices. Although the ultimate sign and magnitude of the effect are not clear, the

ROBERT G. CHAMBERS AND KATHERINE REICHELDERFER

Figure 6.5

Expected Price Trajectories Given Permanent Change in Price Level Pi

Figure 6.6

Comparative Dynamics of a Change in p. Shadow

P r i c e of

141

142

AGRICULTURAL TRADE AND NATURAL RESOURCES

intuitive result is straightforward. Subsidizing utilization of the variable input in agriculture suddenly makes quality-adjusted land a more valuable commodity while raising the market base forces a return to using the variable resource in agriculture. But more intensive cultivation practices simultaneously degrade land quality, and thus farmers are simultaneously being pushed in two different directions by the subsidy policy. An interesting case of agricultural input subsidization in the United States is our irrigation water pricing policy. By making water abundant and keeping its price below its opportunity cost, the practice of irrigation has rapidly developed. However, by subsidizing water's use in agriculture, a condition of water scarcity in municipal and industrial sectors has been created in the American West. The consequences for agriculture of increasing intersectoral competition for water will eventually include the rising cost of irrigation water. But the ultimate effect on trade of agricultural water price subsidization is, as explained, ambiguous. At present, initial market signals of rising water cost are stimulating the adoption of more efficient, watersaving irrigation technologies (2). As the rise in the price of irrigation water accelerates, we might expect to see the shadow price of irrigated land decrease, with associated reductions in irrigated acreage and commodity supply. On the other hand, if shifts back to dryland production improve the quality of land over time, incentives will also exist for intensive use of formerly irrigated areas, thus leading to greater use of substitutes for water in expanding production and trade.

Summary and Conclusions In the simplest sense, we acknowledge that land preservation outside agriculture, conservation taxes and quotas, and environmental regulation will shift short-run supply schedules to the left and elicit initially adverse effects on agricultural trade, while input and management practice subsidies and resource development will have the opposite short-run effects. However, changes in land quality and value and consequential intersectoral adjustments make long-run effects less easy to predict. In particular, the intertemporal Ricardo-Viner model employed to address resource policy-trade linkages underscores the importance of the quality of land, agriculture's fixed factor, in determining long-run intersectoral production patterns. Land and a variety of intersectorally mobile variable inputs complement each other in agricultural production. The long-run demand for and supply of land quality interact to determine an equilibrium shadow price of land quality. This shadow price is critical in that it determines the allocation of fixed and variable inputs in agricultural production. Policy-induced changes in the shadow price of land quality

ROBERT G. CHAMBERS AND KATHERINE REICHELDERFER

143

directly affect the marginal value of the variable inputs that complement land. In turn, changes in the relative value of nonland inputs induce changes in the intersectoral distribution of those variable inputs' employment. If the variable inputs or their factors of production are bid out of agriculture, the agricultural sector's scale of operation diminishes over time, with overadjustments likely to occur in the process. The interesting finding is that it is not obvious how the shadow price of land quality responds to resource policies that induce changes in agricultural factor proportions. Direct improvements in land quality shift the long-run supply of land quality and increase the shadow price. But, if greater quantities of the variable input are employed to complement the higher valued land, subsequent backward shifts in the supply schedule for land quality occur as land degradation results. Also, policies that reduce the physical supply of land or otherwise affect the long-run demand for land quality induce shifts in demand concurrent with shifts in supply of land quality. Thus, the ultimate shadow price effect is indeterminant, as are the direction and magnitude of long-run impacts of resource policies affecting the demand for land quality. These findings support the suggestion by Runge and Houck that conservation schemes can be designed to enhance long-term land productivity and reduce externalities while maintaining or even improving agricultural trade possibilities. However, our conceptual results also imply that such designs would pose some hefty analytical problems. Primary research needs include estimation of long-run supply and demand for land quality and the responsiveness of these schedules to changes in the supply and use of both land and variable inputs in agricultural production. On a more theoretical level, an improved analytical framework is needed. The model itself is a slight extension of the usual Ricardo-Viner model in that it allows one input to grow or be depleted. The obvious way to extend the model is to allow more than one input endowment to change in this fashion. For example, one could start by introducing an equation of motion for one of the elements of N. The more such equations of motion are introduced, the more the model is capable of portraying long-run behavior. However, extending the model even in this modest fashion increases the computational problems associated with the model significantly. For example, suppose that agricultural producers and nonagricultural producers do have different time rates of discount. If the model is truly dynamic, then the single Hamiltonian approach used has to be modified to ensure that the model is always consistent with temporary equilibrium. Perhaps the most difficult generalization of the model is to extend it to the large-country case. Because the model is dynamic, this greatly complicates the specification of an expectations model if producers know anything about the underlying demand structure.

144

AGRICULTURAL TRADE AND NATURAL RESOURCES

Notes 1.The aggregate land endowment L obviously consists of many different soil types. If we index soil types by the continuous variable 4> and let the amount of land of soil type be denoted /(. « F8 , -'S»3 « p

Sv - i r ^ o o f ^ o o o o a v o o o o ^ o r - p ^oorfda^rifS^'OiriaJri'rivci

o

y.

•3P e §

u 00

t- fcj T3 • H

SP a 2 -S ? 2 * «8 S A- 2U C§ « O ** H •SM u< u I 8 6 . v. G l (S S

q t ^ o o o i c o ^ q ^ o q o j ^ r ) ^ ^

3

S2i

"(S.S

o ^

ai

S.IT-C

u

l ' S - ^ ß I" m. a " " " ? 8 - 1 « S

'S P , o«—csmTj-vnsor-ooovO'—'fSm^?-

C • T . I ' I L "Uli S I S s i n

f a l l

i

l l ?

JOHN D. SUTTON & ALAN J. WEBB

Figure 8.11

Wheat Export Prices

1970

1975

1980

1/ USS/MT (Deflated) 2 / C$/MT (Deflated) 3 / AS/MT (Deflated) 4 / FS/MT (Deflated). Prices lor 1983 and 1984 were not available. 5 / USS/MT (deflated)

Table 8.4. Correlation Between Annual Change in Real Farmland Prices and Real Wheat Prices,» 1972/73-1982/83 Region

Producer Prices

Export Prices

Buenos Aires

-0.39 b

-0.05b

New South Wales Western Australia

-0.04° 0.22

0.05= 0.16

Saskatchewan Manitoba

0.67 0.72

0.45 0.56

Picardie Centre

0.91 d 0.84 d

0.50^ 0.66 d

North Dakota Oklahoma

0.96 0.79

0.82 0.82

»Wheat prices are a 3-year moving average. 1972/73-1981/82. Land price data were not available after 1982. c 1976/77—1982/83. Land price data were not available before 1976. d 1972/73-1980/81. Export price data were not available for 1982-1984.

b

179

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AGRICULTURAL TRADE AND NATURAL RESOURCES

In short, the U.S. agricultural sector has, until recently, been a "shockabsorber" for world wheat markets. French policy, which has the opposite effect, has effectively insulated its producers from short-term world fluctuations in wheat prices but not from the long-term decline in real prices. Canada and Australia act as if they are price takers and both have central marketing boards. Canada tries only to smooth intrayear price variability. Australia bases its prices to growers on different formulations of world price averages and has changed formulas frequently as it tried to reduce variability. Argentina, also a price taker, did not attempt to stabilize prices. Frequent changes in Argentine export taxes on wheat and import tariffs on purchased inputs have reduced the linkage between world market prices and net returns to wheat production in Argentina. Wheat Prices Received by Producers Real producer prices showed similar movements in three countries—the United States, Canada, and Australia—from the early 1970s to 1984 (see Figure 8.12 and Table 8.3). 7 Prices jumped sharply between 1972 and 1974, almost declined to previous levels by 1977-78, rose slightly through 1980, and thereafter declined. French producers did not experience the upward price shock of the early 1970s but instead experienced a gradual loss in real price throughout the 15 year period. Argentine prices appear to have oscillated more strongly than in other countries. Producers did not enjoy a strong real price rise until 1977-1978. In the regions of three countries—the United States, Canada, and France—movements in producer prices and in land prices were more closely associated with one another than were export prices and land prices (see Table 8.4). This result would be consistent with the idea that those active in real estate markets would be more aware of the prices that farmers receive for their crops than of world prices. In the regions of Argentina and Australia, the associations between land prices and either world or producer prices were very weak. This suggests that factors causing movement in land and commodity prices might have been markedly different. Discount Rates The long-term government bond rate less the percent change in the country's Consumer Price Index is used as a proxy for the rate at which the future flow of net returns is discounted to the present. By Equation (8.2), as the rate falls, discounted returns and hence land prices would rise. Because of the integration of world financial markets, a similar pattern of interest rate movement is to be expected among nations of the world (see Figure 8.13 and Table 8.5). In general, real discount rates fell quickly during the years 1971-1974.

JOHN D. SUTTON & ALAN J. WEBB

181

Figure 8.12

Wheat Producer Prices

1/ USS/MT (Deflated) 3 / CS/MT (Deflated) 5 / 1960 Pesos/MT

2 / A $ / M T (Deflated) 4 / 10 F J / M T (Deflated)

These years generally corresponded to the abrupt jump in farmland prices discussed previously. Although rates began rising from the negative levels reached in 1974, they remained very low (often negative or below 1 percent) and it was not until 1980-1981 that they reached the levels of a decade earlier. Such low rates put upward pressure on farmland prices. By 1981, however, real discount rates in each country had established what turned out to be part of a general upward movement. This upward trend, in contrast, put downward pressure on land prices. In brief, we have seen in this section that the rising-falling movement in real farmland prices from the early 1970s to the mid-1980s occurred in each of the major wheat-exporting nations except Argentina. This price behavior seems to have a direct association with real wheat prices and an inverse association with real long-term interest rates. The degree of association differed considerably between the five countries and nine wheat regions. Recognizing the desirability of protecting producers' net returns from the volatility of world prices, each country but Argentina enacted stabilization policies appropriate to its role and circumstances in the world wheat market. These policies may be one reason that real domestic land prices were sometimes more closely associated to real producer prices than to real world prices. In general, the association suggested by the movements in

182

AGRICULTURAL TRADE AND NATURAL RESOURCES

Figure 613

Real Long-Term Government Bond Rates

Table 8.5. Real Long-Term Government Interest Rates by Country, 1970-1984» Country United States Year

(%)

1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984

0.71 1.44 2.31 -0.01 -3.91 -2.19 0.98 1.15 0.95 -1.97 -2.10 3.33 6.83 8.11 8.16

Australia

Canada

(%)

France

(%) 2.86 0.89 0.04 -2.26 -5.99 -5.32 -3.29 -2.04 1.14 0.68 1.45 4.35 4.21 4.26 9.77

4.55 4.14 2.38 -0.09 -2.13 -1.57 1.57 0.78 0.23 1.20 2.23 2.82 3.41 6.01 8.43

2.23 2.24 1.12 0.88 -3.23 -2.24 -0.44 0.21 -0.13 -1.22 -0.34 2.31 3.68 4.00 5.00

(%)

»Calculated by subtracting the percent change in the Consumer Price Index from the longterm government bond rate in International Financial Statistics, International Monetary Fund, various issues, Washington, DC. A data series could not be obtained for Argentina.

JOHN D. SUTTON & ALAN J. WEBB

183

world wheat prices, producer prices, long-term interest rates, and land prices appears consistent with the theoretical framework summarized in Figure 8.5.

Future Impacts of Trade Policies in Natural Resource Markets The conceptual framework developed herein helps one to identify key parameters whose values affect the functioning of natural resource markets. We have compared the values of some of these parameters for selected countries and have also discussed how changes in world wheat prices may be reflected in changes in domestic land prices. Having also presented in a very broad sense the factors and policies that have shaped resource allocation in recent years, we can now take a more forward look and address the issue of how trade policy is likely to affect natural resource use and value in the next 5-10 years. Former USDA Assistant Secretary Robert Thompson recently observed that "we are in the midst of a far-reaching restructuring of the [agricultural] sector. Complicating this is the limited ability of the world market to react to swings in global supply and demand without having the sharp price adjustments transmitted to the countries linked to the market" (15). This restructuring is not unique to the United States. The European Community, since the inception of the CAP, has not permitted any direct linkage between world and domestic producer prices. But the ascension of Spain and Portugal to the Community has broadened the number of countries subject to the CAP and promises to exacerbate the glut of agricultural products on world markets. The United States, with the passage of the 1985 Food Security Act, has taken strong steps to maintain agricultural incomes through higher deficiency payments while increasing exports with lower loan rates and higher export subsidies. Acreage reduction programs are designed to reduce surplus productive capacity, soil erosion, and destruction of wetlands. To the extent that the Act will maintain the present value of returns to land, it will tend to slow the decline in land values. With the United States and an expanded EC both taking steps that will insulate large numbers of producers from resource adjustments implied by low world market prices, Canada has been compelled to move as well. In December 1986, Canada's Agriculture Minister John Wise announced a billion dollar assistance program to grain producers in an effort to reduce the negative impact of the U.S.-EC subsidy war on Canadian farmers. A growing number of the major players in world agricultural markets are choosing to intervene in their own domestic markets to prevent the resource

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adjustments implied by depressed world agricultural prices. These actions tend to maintain or increase the supplies to the world market, depressing prices even further. As a result, the allocation of natural resources in agriculture is increasingly being determined by government policies—not by the market. Research is needed to help us understand these resource distortions and the net costs they imply for each country and for the world trading environment. To do this, we need better information on the factors that determine product supply response and resource use in agriculture—for the major agricultural trading countries. Initial research efforts might include the following: 1. Effects of domestic policies, market structure, and level of development on natural resource (both those with market and nonmarket values) around the world. The discussion surrounding Table 8.1 set forth some tentative hypotheses but much more work needs to be done to determine what forces are important and what weights to attach to them. 2. Identification of key economic, legal, and sociocultural institutions that have significant control over change in land and water use and distribution of net returns to these resources is needed. 3. An examination of the relation between the use and value of land visà-vis other inputs is needed. For example, are land and capital complements or substitutes in the United States? in Australia? in Thailand? What does the degree of substitutability mean for natural resources as world markets change? 4. An investigation of the role resource returns play in motivating agricultural policies is important. For example, to what extent is the decline in land values generating a constituency for higher price supports in the United States and in other countries? If there is a strong connection, what policy alternatives could attack the symptoms without causing major world price distortions? Ultimately, knowledge of the magnitude of the policy-induced distortions on agricultural resources and the loss of productivity and social welfare that have been the result is needed. Perhaps the most important—and at the same time the most difficult—task is to determine the effect of these resource distortions on the dynamics of the growth and development of agriculture vis-à-vis nonagricultural sectors. As the role of the market in determining the allocation of resources and products declines, inefficiencies arise, which—if sustained over a period of years—spread out across countries, commodities and sectors draining the global economy of the productivity upon which the prosperity of the past 35 years has been based.

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Notes Co-authors, listed alphabetically, are agricultural economists, Economic Research Service, USDA. Ray Olsson, Department of Agricultural Economics, University of California, Davis, assisted in preparation of figures and tables. 1. The equilibrium relation can be generalized for p product markets and r factor markets so that (MR,)(MPP,,) MR, MFC^~ MQ ~ where i = 1, . . . , p and j = 1, . . . , r. 2. Runge, Houck, and Halbach (Chapter 4 in this book) show how, in the absence of working markets for environmental products, some countries experience development of nonmarket institutions, which in essence establish societal values (positive and negative) for these products. 3. The erosion of real support prices in France coupled with the growing U.S. subsidies argue for including the United States and France in the same category. 4. Land prices were not available for New South Wales before 1976 or for the French regions before 1972. Land price data are available in (14). 5. World wheat prices are export prices at major ports. They are United States: Gulf ports, FOB, hard red winter, ordinary protein; Australia: standard white, FOR, Canberra; Canada: Thunder Bay, FOB, standard wheat; Argentina: Buenos Aires, FOB. Prices are quoted in national currencies—except those of Argentina, which were available only in U.S.S/metric ton—and deflated by each country's CPI (14). 6. Use of a 3 year moving average (f-1, t, f+1) reflects the hypothesis that annual change in land prices is based not only on net returns in the current year (/), but in the previous year (f-1), as well as expectations of returns one year into the future (i+1). 7. Prices received by producers are: United States: average price received including direct and indirect payments based on degree of participation in commodity programs; Australia: net average return paid to growers, in Canberra; Canada: final price realized by farmers for No.l Canadian hard red spring; France: producers' prices for common wheat; Argentina: wholesale price received by producer. All prices are expressed in national currencies, deflated by each country's CPI (15).

References (1) (2) (3) (4)

Burt, Oscar R. "Econometric Modeling of the Capitalization Formula for Farmland Prices." American Journal of Agricultural Economics 68(1): 1026 (February 1986). Gertel, Karl. Differing Effects of Farm Commodity Programs on Land Returns and Land Values. AER-544. Washington, DC: U.S. Department of Agriculture, Economic Research Service, November 1985. Heimlich, Ralph. Sodbusting: Land Use Change and Farm Programs, AIB No. 536. Washington, DC: U.S. Department of Agriculture, Economic Research Service, June 1985. Heimlich, Ralph, and Linda Langner. Swampbusting: Wetland Conversion

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(11)

(12)

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and Farm Programs. AER-551. Washington, DC: U.S. Department of Agriculture, Economic Research Service, August 1986, Jorgensen, A. Walter. "Land Values and Appraisals." Denmark: Institute of Agricultural Economics, 1986. Just, Richard E., David Zilbermand, and Gordon C. Rausser. "The Role of Governmental Policy in Agricultural Land Appreciation and Wealth Accumulation." University of California-Berkeley, Department of Agriculture and Resource Economics, March 1982. Marshall, Alfred. Principles of Economics. London: MacMillan, 1952. McCalla, Alex F., and Timothy E. Josling. Agricultural Policies and World Markets. New York: Macmillan Publishing, 1985. Melichar, Emanuel. "Farm Wealth: Origins, Impact, and Implication for Public Policy." Cornell University, Department of Agricultural Economics, October 26, 1983. Nielsen, Elizabeth G., and Linda K. Lee. "Potential Groundwater Contamination from Agricultural Chemicals: A National Perspective." Agricultural Resources, Inputs: Situation and Outlook Report. AR-5. Washington, DC: U.S. Department of Agriculture, Economic Research Service, January 1987, pp. 23-32. Ogg, Clayton. "Cropland Use Changes and Soil Erosion: Economic Analysis of the National Resource Inventories." In Agricultural Soil Losses: Process, Policies, and Prospectives. John M. Hardin and Gigi M. Berardi, eds. Boulder, CO: Westview Press, in press. Petit, Michel. "The Role of Land in the Economic Development of Industrialized Market Economies." Paper for International Workshop on Agricultural Real Estate and Land Prices. Universidad Menendez Pelayo, Seville, Spain, September 1986. Reinsel, Robert. Capitalization of Farm Program Benefits Into Land Values. ERS-506. Washington, DC: U.S. Department of Agriculture, Economic Research Service, October 1972. Sutton, John D. "Relationship Between Wheat Policies and Farmland Values of Major Exporting Countries." U.S. Department of Agriculture, Economic Research Service, draft September 1987. Thompson, Robert L. "Global Trends in Supply and Demand. Remarks at the USDA Agricultural Outlook Conference." In Agricultural Outlook. U.S. Department of Agriculture, January-February 1987, p. 2. U.S. Department of Agriculture, Economic Research Service. The Current Financial Condition of Farmers and Farm Lenders. AIB No. 490, March 1985. U.S. Department of Agriculture, Economic Research Service. Cropland Use and Supply: Outlook and Situation Report. CUS-1. September 1984. Webb, Alan J. "Protection in Agricultural Markets." Staff Report, AGESU.S. Department of Agriculture, Economic Research Service, September 1984.

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Discussion: Conceptual and Empirical Needs for Integrating Resources and Trade Analysis John C. Dunmore, James A. Langley

Chapter 8 emphasized the role of agricultural trade policies in affecting the use and value of natural resources—in particular, land. A simple conceptual flow from trade policy and its effects on the use and value of natural resources arose from that chapter and work group debates on the nature and strength of specific linkages: trade (trade policy) — > demand for agricultural commodities —adjustments in agricultural production — > derived demand for resource use and value — > associated environmental issues. This paper provides a broad overview of issues related to these linkages.

Trade Policies The policies of the various government sectors permeate the domestic and world markets. Policies such as export subsidies or taxes, import quotas, and nonprice trade barriers have relatively obvious trade impacts. Domestic programs and measures, which have trade effects, are also included in the set of agricultural trade policies. Domestic programs such as relatively high U.S. loan rates acting as implicit export taxes, U.S. deficiency payments (in the absence of large acreage reduction programs) acting like an export subsidy, or subsidized investment in infrastructure are less obvious trade policies, yet still impact on the terms of trade between nations. A different mix of direct and indirect trade policies occur in each country. A concerted effort is needed to measure distortions created by different trade policies. A fundamental step to success is developing a credible standard price equivalent measure of the distortions. An example of a standard price measure is the producer subsidy equivalent (2). In concept, a producer subsidy equivalent (PSE) is an estimate of the financial compensation payable to the 187

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farmers of a country so as to leave them equally well off as if all government agricultural support policies and programs of that country were removed. In other words, a P S E tries to determine what level of simple monetary subsidy/tax would be the equivalent of each existing program in terms of achieving the same level of income transfer to producers. A complication in using PSEs to measure distortions created by different trade policies is that there is not necessarily a one-for-one relation between income transfers to producers and trade distortions. This is especially true for indirect trade policies, such as target prices or support prices. For example, domestic agricultural producers may receive significant income transfers from their government. However, if only a negligible portion of those producers' products reach the world market, then the PSE measure would not accurately reflect the trade-distorting impacts of those income transfers. Other distortion measures look at the price gap between domestic prices and "world" prices. Measures of price gaps more directly address the pricedistorting behavior of domestic policies, but there are still problems of defining an appropriate "world" reference price for each commodity, determining the specific impact on world prices resulting from each domestic program, and so on. If a standard measure of the distortion effect of policies could be decided on—whether a P S E , price gap, or some combination of these—research should then focus on more accurately measuring supply response/production adjustment. Another area meriting research in the trade policy/production adjustment linkage is the notion of irreversibility of supply response or asset fixity. There is a need for research to be focused not only on the United States but on the rest of the world as well. For example, what can be said about the adjustment process or supply response in a country when trade policy is pushing commodity prices up versus down?

Trade (Trade Policy) and the Demand for Agricultural Commodities Discussion of the policy-demand for agricultural commodities linkage points out the importance of elasticity estimates. As a profession, our understanding of the price elasticity of export demand for U.S. agricultural products is woefully lacking. Without accurate measures, we cannot estimate, for example, changes in quantity exported in response to a change in our export price. Unfortunately, we do not know enough empirically about the behavior of demand elasticities over time or how far importers as well as foreign competitors adjust to U.S. and other countries' price and policy adjustments. An improved understanding of the price elasticity of export demand is a critical component to evaluating alternative marketing strategies and/or food and agricultural policies.

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Gardiner and Dixit recently reviewed estimates of the price elasticity of export demand (1). They found that the adjustment period, government policies, domestic structure of trading countries, and a country's market share were considered highly influential to determining the level of elasticity. They found little consensus: parameter estimates varied widely—from very inelastic to very elastic. They concluded that using data from the 1960s and 1970s may in fact not be appropriate for estimates of current elasticities. Yet, because of the importance of elasticity estimates for policy analysis and because of the inherent dynamics involved in defining them, it is important that they be continually updated if they are to reflect accurately the response of other countries to changes in U.S. commodity prices. We must point out that this one research recommendation alone would entail an enormous commitment of staff and funds to update data bases, account for policy changes, and estimate supply demand and price transmission elasticities of trading countries. There is an obvious need to improve our ability to quantify, in greater detail, the adjustments that take place and affect elasticities for importing and exporting countries as policies are altered. There is a need for a better understanding and quantification of the production and resource adjustments in major trading countries to changes in U.S. prices. The elasticity of U.S. export demand is simply a summary in one parameter of the reactions of both importing and exporting countries to a price change. Another area raised for research emphasis was that of price transmission. Our understanding about how and to what degree world price movements are transmitted to the domestic economies is limited. There is also a relatively low understanding of how price transmission changes over time. Production Adjustment and the Derived Demand for Resource Use and Value A major factor that undergirds the role of production adjustment in the conceptual linkage is the time dimension (short run versus long run). The basic notion of the time dimension is that trade policies are distortions that send out economic signals to producers. The magnitude of those signals and response of producers to those signals differ over time. In the short run, policies may influence the value and use of resources through factor substitution. Over the longer term, these distortions send signals which alter investment patterns in primary factors, that can change factor productivity and serve to alter the comparative advantage of a country. There are many examples of nations "creating" a comparative advantage through investment over time. Consider the case of steel production in Japan.

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Because there are no significant iron ore deposits in Japan, Japan would not fit the traditional view of comparative advantage based on natural resource endowments. Yet, through investment in shipping and port facilities to import raw materials, implementation of efficient production techniques, and aggressive sales practices, Japan developed a comparative advantage in steel production. Several researchable issues can be identified regarding the production adjustment-derived demand linkage. First, conceptual and empirical work is needed to determine the effect of domestic macroeconomic and trade policies on the level of uncertainty or volatility in the U.S. agricultural sector. A second researchable issue is the effect of uncertainty/volatility on investment decisions and on resource use and value in the more uncertain trade environment. In other words, there is a need to identify the contribution of government policies or the changing trade environment to an increasingly uncertain environment facing producers. One example is the impact of land price variability on the use of other resources. It is believed that land price variability does not determine commodity supply, but it may affect the use of other resources. More research is needed to quantify these effects.

Production Adjustment and Environmental Issues The area of production adjustment versus environmental quality holds promise for future research. There is still room for much formal conceptual and empirical estimation of the use value of land, water, and wildlife resources in agricultural production and for society as a whole. For example, some claim that the United States is exporting its soils. However, how does the soil loss resulting from the 35 percent of the U.S. feed grain crop that is exported differ conceptually or empirically from the soil loss resulting from the 65 percent of the U.S. feed grain crop that is used domestically? The simple answer lies in the difference in erosion rates on different classes of land. However, not all production for export occurs on marginal land, just as not all production for the domestic market occurs on the best quality land. The commodity and sectoral composition of net exports or merchandise and services for the United States and other countries broadly reflects the factors that determine comparative advantage—that is, the relative abundance of land, certain other natural resources, human and physical capital, and the availability of advanced technology. How would explicit accounting of the full social value of clean water, wildlife habitat, and other environmental goods affect the comparative advantage paradigm?

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Modeling Trade Policy-Natural Resource Linkages An issue in modeling the linkages between trade policy and natural resources is the appropriate level of modeling detail. An important aspect is developing empirical relationships regarding the extent to which different domestic commodity programs affect production adjustment and resource use. The impacts of any trade policy that affects domestic farmers may be tempered by domestic commodity programs. For example, a lower world price may be sending signals to domestic farmers around the world to reduce production. However, domestic price supports, income transfers, and so on may offset the world price signal by continuing to encourage farmers to maintain higher production levels at home. A change in commodity programs can result in changes in relative factor intensity in the production process and in relative returns to various factors. For example, what impact would a decoupling versus mandatory supply control program have on land use and value? It makes a difference in terms of resource use and value which land is taken out of production. A typical mandatory control program would require all producers to reduce their acreage a sufficient amount to raise domestic commodity prices to 70-90 percent of parity. Decoupling in its various forms attempts to "decouple" government program benefits from the current system of basing payments on historical crop acreage levels. Mandatory control options are often supported on grounds of preserving the current structure of agriculture. A pure decoupling option would preserve the most efficient producers. There is no clear-cut consensus as to what type of farm operation might prove to be most efficient in the absence of government programs. A significant difference between mandatory controls and decoupling is in their effects on asset values. Producer benefits of mandatory controls are likely capitalized into land values, creating an additional barrier to entry into the farm sector. If it is true that government program benefits (a positive sum) have been capitalized into land values, then removing those programs under a pure decoupling scheme would cause the value of land and other fixed assets to decline in the short run. Conclusive empirical evidence is not available on these important issues of incidence of benefits and costs, efficiency of production adjustments, environmental impacts, and so on. Greater knowledge of elasticities of factor substitution under alternative commodity price scenarios would shed much light on potential resource adjustments occuring from changes in commodity programs. A second factor in the modeling production adjustment-resource use and value linkage was the need for greater regional detail in resource models. With greater regional detail, one can look at the effect of policy changes on

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production adjustments in various regions or types of farms. When speaking of regional detail in models, it is important to indicate that many regional models possess great detail in terms of production practices. However, what is often lacking is equivalent detail on government program parameters and on factors affecting producer response to those programs. Regional impacts are an increasingly important aspect since trade issues have a highly regional impact, which may be seen as marginal at the aggregate level. For example, U.S.-Canada free trade is a case where the impact of removing trade barriers would not fall evenly on each region of the country. Perhaps the ultimate empirical approach for the analysis of trade and natural resource linkages would be to refine existing world trade models to account explicitly for all the factors affecting the appropriate linkages among both exporting and importing nations. This type of model would contain empirical relations for both the domestic economies of major competing nations and for international trade, price formation, and natural resource linkages. A "proper" conceptual framework for the model would need to be an international, long-term, dynamic, multicommodity-specific, computable general equilibrium model of both agricultural and nonagricultural production and trade. However, major drawbacks exist for developing such a model, not the least of which is the impossibility of such a modeling task. Questions arise as to how appropriate computable general equilibrium models are for picking up short-term distortions and resource use. CGE models are not very useful in forecasting or in discovering the structural parameters of the underlying system. Besides, such a model would involve substantial resource commitments in developing and refining model structures, significant efforts at collecting and "creating" more data, development of new empirical relation, and increased time commitments of the individuals involved. The more elaborate the model structure, the more likely one is to run into serious data deficiencies, which would greatly frustrate the effort. The impossibility of developing a single computable model to analyze the linkage between trade and natural resources does not preclude the importance of having information on the major relation outlined. A far more feasible method would be to approach the modeling effort in a partial equilibrium sense. A suggested outline for such a partial approach would be to conduct analyses on the following topics: 1. Decisionmaking at the firm level (short and long term): -Derived demand for factor inputs -Resource allocation and opportunity costs -Commodity supply -Firm-level equilibrium 2. Aggregation to the sector level (short and long term): -Aggregate derived demand for factor inputs -Domestic demand

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-Domestic supply -Market structure -Price Formation -Sector-level equilibrium 3. Aggregation to the economy level (short and long term): -Opportunity costs for factor inputs for competing uses -Factor intensities and resource allocation between sectors -Stage of development -Macroeconomic factors -Economy-level equilibrium 4. Aggregation to the international level (short and long term): -Factor intensity of exports -International macroeconomic influences -Tradable versus nontradable factors of production -Impacts of other-country policies on domestic resource use -International-level equilibrium An initial step in explaining the market behavior of competing nations and the resulting impacts on natural resources could be to estimate a set of excess supply and demand equations for the relevant commodities. From a theoretical standpoint, an excess supply (demand) curve shows the level of potential exports (imports) each country is willing to offer (purchase) at a given world equilibrium price. Estimates of the responsiveness of agricultural exports, combined with quantitative measures of trade patterns, factor intensity of exports and imports, and domestic supply response, could provide a useful compromise to a full-blown effort to model empirically world commodity and resource markets.

Conclusion More work needs to be done to create a conceptual and empirical layout of the linkages between trade and the use and value of natural resources. The most fruitful avenues of research seem to be developing empirical estimates of the individual linkages. The outline presented here offers a broad approach to identifying some of these linkages. It does not appear necessary to link trade policies and the use and value of natural resources in every research investigation. However, there appears to be benefits for trade researchers to pay more attention to factor market interactions and for resource economists to pay more attention to trade policy and trade sector interactions.

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References (1)

(2)

Gardiner, Walter H., and Praveen M. Dixit. Price Elasticity of Export Demand: Concepts and Estimates. For. Agr. Econ. Rep. No. 228. Washington, DC: U.S. Department of Agriculture, Economic Research Service, February 1987. U.S. Department of Agriculture, Economic Research Service, International Economics Division and National Economics Division. Government Intervention in Agriculture: Measurement, Evaluation, and Implications for Trade Negotiations. For. Agr. Econ. Rep. No. 229, April 1987.

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issues in Commodity Trade: Implications for Natural Resources Andrew Schmitz, G. C. Van Kooten, W. Hartley Furtan

Theories of international trade and resource economics have been present in the economic literature for quite some time. In fact, rudiments of trade theory had already been developed by Adam Smith. As pointed out in some of the earlier chapters, Ricardo certainly had a well-developed theory of international trade. The most modern theory of trade, in spite of its many limitations, continues to be the Ohlin theory, which is based on natural resource endowments. This theory states that a country will export those commodities produced intensively with the country's abundant factor. The various theories and the propositions derived from this theory have been pointed out in Chapter 2 by Abbott and Haley. These authors also point out many of the limitations accompanying the Ohlin theory and the ones predating that development Resource economics developed independently from international trade theory. In the area of resource economics, concepts such as renewable and nonrenewable resources and stocks and flows were developed along with concepts such as externality. In addition, the entire area of cost-benefit analysis was essentially developed in the context of resource economics. In fact, it would seem strange that these two fields of knowledge were developed separately, even though, as pointed out already, the basic theories of international trade are based on aspects of natural resource endowment. In Chapter 4 by Runge, Houck, and Halbach, agricultural trade is linked to land and water quality. The authors document the relation between the export demand for agricultural commodities and the use of water and other inputs in the production process. In particular, they show that the change in the relative prices of inputs, such as water, can induce new innovations in the production process that also affect the environment In addition, Chapter 4 stresses the importance of international trade to U.S. land values and supports 195

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the various empirical studies that argue that international trade is a major component affecting the rapid rise and fall of U.S. farm land values. They relate to the well-known Stolper-Samuelson theorem of international trade, which shows that, if land is the abundant factor and the United States exports land-intensive goods, a substantial increase in the demand for farm products would increase the real returns to the land input. An interesting aspect of Chapter 4 is that it illustrates the impact on intensity of land use and other factors owing to expansion and contraction of international trade. When demand shifts substantially to the right, farmers will generally also produce on submarginal land, and, when demand slackens, partly because of government programs, they will attempt to intensify their production on good quality land. The reference by Runge, Houck, and Halbach to the factor price equalization theory is interesting, particularly concerning the comparison between Europe and the United States. However, as we point out later, there are additional factors that question the validity of the factor price equalization theorem, other than environmental concerns. For example, since product prices are not equalized, one would not expect land values to be equalized. In addition, because of the numerous factor market distortions that exist due to, for example, input subsidies, the factor price equalization theorem is not likely to hold. In Chapter 3 on resource policy in an open economy, Antle and Howitt illustrate how natural resources and international trade are interrelated at many points in economic theory and policy. Among other models, they discuss the spatial price equilibrium framework, which has been used extensively in empirical analyses in international trade, especially for agricultural products. The authors emphasize that investment in agricultural assets is predominantly irreversible. Many resource assets such as land fertility, soil conservation, and drainage are clearly fixed in location and can only be reversed by the process of degradation and decay. They also examine the effect of agricultural investment irreversibility on production supply response, where changes in output price expectations substantially change supply. They derive two hypotheses from the theory. Under expanding output, the supply function is more elastic than when output is contracting. Given substantial changes in price expectations and given elastic cross-price elasticities of supply with other crops, low equilibrium prices and high asset values can cause negatively sloped supply functions in the short run. In this chapter, we build on previous arguments as we both extend some of the analyses presented and present some additional issues of relevance to resource economics and international trade. For example, we emphasize the literature on the international gains from trade, which often gets neglected in partial equilibrium models and in discussions of U.S. farm and trade policy, although it does form a core part of general equilibrium trade theory. In

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addition, we reemphasize the nature of agricultural resources; we emphasize their fixity and that they cannot be transferred, for example, into the manufacturing sector. One of the limitations of the Ohlin theory is that it is a two-factor model and land is excluded. We also highlight the role of international trade distortions and domestic policy distortions in analyzing the question of resource economics and trade. For example, much of the trade literature incorporates stocks as a means of dealing with price stabilization. However, in the real world, stocks are a result of many factors other than stabilization policies. In the United States, stocks are largely the result of loan rates that have no relation to target prices. Further, trade theory essentially says nothing about marketing intermediaries. In other words, trade theory consists of production possibilities surfaces, indifference maps, and so on, but actors buying and selling commodities are not present. In fact, the entire discussion in the earlier chapters ignores the approach that some have taken toward international trade, which is to view trade more from the theory of an industrial organization standpoint rather than in the context of standard general equilibrium trade models. We present eight areas that are of interest concerning linkages between natural resources and agricultural trade. These areas include resource mobility, research and development, the impacts of international trade, and agricultural trade in the context of domestic and trade policy. The role of trade distortions is highlighted.

Deficiency Payments in the Context of Trade Deficiency payments have been discussed in the economic literature at least since the early 1940s, but generally the reference is to a closed economy. The so-called Brannon plan is illustrated in Figure 10.1. If the domestic supply curve is Sc and domestic demand is Dd, then supporting price at Ps causes a welfare loss of abc, where P¡flbPc is the amount of the government subsidy to producers. Now consider a model that incorporates trade. Suppose, in Figure 10.1, that Dd is the total demand and that D' is the domestic demand. In this case, a price support of Ps causes a much greater welfare loss (the cross-hatched area) as part of the subsidy to producers is transferred to importers. The subsidy causes price to drop from P* to Pc and importers gain fcbe. The welfare cost of the producer deficiency payment is abefc. Thus, given the support price Ps, the cost of the deficiency payment increases as the volume of trade increases. Hence, a country with a large agricultural export sector loses more from a deficiency payment scheme then does a country with a small export sector. In other words, there is "international trade slippage" owing to a price support and subsidy. Because of the many price distortions in international trade, exporters are

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Figure 10.1

Deficiency Payments in a Closed and Open Economy

responding to market prices. Competing exporters are responding to market prices through deficiency payments of their own (e.g., the Canadian $1 billion deficiency payment in response to the 1985 Farm Bill). In evaluating the cost, it is no longer appropriate to begin the analysis by assuming free trade (price P* in Figure 10.1). For example, consider the price Pc that exists because of the distorted demand D*—a trade distortion. If the government intervenes to restore price to P* with a deficiency payment of P*cxy, then a welfare cost of chezx results. In the case where deficiency payments are used to bring producer prices up to world levels, the true economic cost of the program, expressed as a percentage of treasury costs, may be greater or less than the cost of supporting price above the free-market price P* where a deficiency payment is used to restore price and quantity to the free trade level. The welfare costs are larger than the measure given by the traditional welfare triangle. As before, this is because a deficiency payment not only generates a subsidy to domestic producers but also provides a subsidy to importers as well. Now consider the model in Figure 10.2 where supply and demand take on different characteristics. The domestic supply is SJ>d and the combined domestic and foreign demand is Dw. At the free trade price P, exports are d

c

a

b

Q2

Q,

Quantity

aggregate demand now becomes DQDJ. The loss to producers is PabPw, while consumers gain PcdPw. The largest share of producer rent, namely cdba, is transferred to importers. In this case, a deficiency payment of PabPw to restore rents to the free trade level does not involve a welfare cost, since the producer gain PabPw equals the size of the deficiency payment. The deficiency payment does not provide an added income transfer to importers. The model in Figure 10.2 is more appropriate for a country such as Canada than is Figure 10.1 because Canada is a price taker in wheat and supply appears to be highly price inelastic. As the model shows, the billon dollar deficiency payment in 1986/87 represented an income transfer from taxpayers to producers with little or no welfare cost. In this case, the income transfer from Canada to importers occurred as a result of trade distortions, which dropped prices from P to Pw.

Research and Development and Technology Transfers The introduction of trade into research and development (R&D) changes the magnitude of the rates of return to R&D. In Figure 10.3, Td is total demand

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Figure 10.3

Research and Development in an Open Economy Price

sd

\ a

^ ' V c bV

X

Dd

Q

Q,

Quantity

and Dd is domestic demand. Without R&D, the price and quantity are P and Q, respectively. The new supply curve owing to R&D is Sj. In this case, the rate of return to R&D is not as great as would be the case if Td were also the domestic demand curve. The reason is that, from the standard method of calculation, one has to substract area (abdc) which is a gain to foreign consumers from the R&D activity. 1 In this model, the greater the exports, the smaller is the rate of return from R&D. In terms of technology transfers, sizable resources are spent (e.g., expenditures at CIMMYT for the development of high-yielding wheat varieties) by the United States and Canada in other countries to foster an increase in agricultural products, often in areas where Canadian and U.S. exports compete. This is illustrated in Figure 10.4. In the model, the comparative advantage of the United States and Canada in agricultural production is diminished by the direct transfer of technology, which tends to make the production surfaces similar (e.g., shifts to the dashed production surfaces). 2 Instead, technology should be transferred, in a way that shifts the production surfaces of less developed countries from to X2X2. An example often cited is the impact of technologies in plant breeding at CIMMYT, which, in essence, made former importing countries, such as India, self-sufficient in wheat. The technology transfer occurred not only in

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Figure 10.4

Technological Transfer Manufacturing

plant breeding but also in the use of accompanying inputs, such as irrigation, equipment, fertilizers and farm chemicals.

Farm Policy and Multinationals Trade models generally have little to say about the role of national and multinational agricultural trading firms and input suppliers. In the following model, farm policy is incorporated along with activities of such firms. In the upper part of Figure 10.5, the supply of wheat is S and D is demand. In the lower part of Figure 10.5, the supply curve for services of multinationals is Ss. At one extreme, the multinationals would price at P and pay producers a price P2. They would provide Q* of services at price P* (lower part of Figure 10.5). However, a preferred position for the multinational might be to lobby Congress to introduce a support price Ps that would increase output beyond the competitive level and thus increase the level of services provided by the multinationals to Q** at price P**. If price instability is also introduced, the multinationals could charge a price above P**, which, in essence, would generate a rate of return to expenditures on information search. This ties in with the Runge-Houck-Halbach analysis concerning the

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Figure 10.5

Multinationals and Resource Use

Quantity (a)

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derived demand for input. As they show, as exports expand, the derived demand for inputs, including fertilizers and chemicals, also expands. Since multinationals are also in the input-supplying business (e.g., selling chemicals and fertilizers), they will lobby to keep output high. It is clear from the model that, if is the loan rate and government or producer stocks are S, multinationals would lobby for lowering the loan rate since they could increase their supply of services. In trade theory, there is generally an optimal stocks policy to be adopted in response to price instability. Stocks increase, for example, during periods of good weather and are depleted in periods of bad weather [see the survey in 5]. Policy instruments such as price supports and loan rates are largely ignored. Consider Figure 10.6 where stocks in one period are S0 at price Pu corresponding to S\ and are released in the following period when supply is S. This is the standard model where the only instrument is a price stabilization rule. However, suppose a different model is used where Se is the expected supply curve or planning curve and Ps is the support price. If Pu is the loan rate, then stocks exceed S0. In this case, stocks are not due to price stabilization policy but, rather, a high price support level relative to the loan rate. Under normal weather conditions, stocks would accumulate given Ps and Pu. Thus, stocks in this model will become excessive rather than selfliquidating as is the case where the model consists only of S, S', and D, with Pu the stabilized price brought about by stockholding. Gains from Trade The general equilibrium gains from trade models can be translated into a supply and demand analysis over many markets. While the issue of gains from trade has been discussed theoretically, relatively little has been done on empirical estimation, especially in highly distorted commodity markets. Some general equilibrium analysis has now been done using the computable general equilibrium approach. Consider Figure 10.7 where the gains from trade discussion is incorporated with government policy instruments. The excess supply curve for wheat is Es and the excess demand curve is Ed. The gains from trade to the exporter are given by area Pab. This gain can be offset, however, by a government subsidy. Suppose the excess demand curve shifts to EJ owing to distortions abroad, and the exporter responds with subsidies to shift Es to Es'. The free-trade output is not affected, but the gains from trade are now only equal to the government subsidy—that is, Pab = Pacd. Consider a different example. If a price support of Ps is accompanied by acreage controls that keep output at Q, then the government subsidy of P^ecd exceeds the gains from trade of Pab.

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Figure 10.6

Storage and Domestic Farm Policy

Figure 10.7

Domestic Farm Policy and Gains from Trade

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Agricultural Trade and Distortions The factor price equalization theorem states that all countries will have equal factor prices both relatively and absolutely. Consider the current distorted market situation. Suppose we have two countries, the European Economic Community (EEC) and Canada, both producing and exporting wheat. The situation is depicted in Figures 10.8 and 10.9. If the EC sets the price of wheat at the free-trade price, Pc in Figure 10.8, then the land rent to EC producers will be area (P c da). In Canada, this will result in an excess demand for wheat Ed, with rents to Canadian producers of Pczj (Figure 10.9). Now, if the EC raises the domestic price of wheat to producers (Pw) and protects the domestic market through tariffs, the rents will be area (abPw). The quantity of land used for wheat production in the EC need not have changed, but EC farmers will use more fertilizer. The increased land rents will provide an incentive for R&D in the EC, resulting in a supply shift from 5 1 to S 2 , which further increases the rents by area abc. The EC will export a quantity of wheat QCQ**, thereby shifting the Ed curve in Canada to £