Impact of NAFTA on U.S. and Mexican Sugar Markets

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Journal of Agricultural and Resource Economics 40(3): ISSN Copyright 2015 Western Agricultural Economics Association Impact of NAFTA on U.S. and Mexican Sugar Markets Troy G. Schmitz and
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Journal of Agricultural and Resource Economics 40(3): ISSN Copyright 2015 Western Agricultural Economics Association Impact of NAFTA on U.S. and Mexican Sugar Markets Troy G. Schmitz and Karen E. Lewis When NAFTA became fully implemented for sugar in 2008, Mexico became the leading sugar exporter into the United States, accounting for nearly 70% of U.S. imports in A partial equilibrium trade model was developed to estimate the welfare implications of NAFTA for U.S. and Mexican sugar markets from 2008 to While the net effect of NAFTA on U.S. welfare and Mexican sugar producers was positive, U.S. sugar producers suffered significant losses. The net Mexican welfare effect of NAFTA was significantly positive in 2011, negative in 2008, and slightly positive in and Key words: Mexico, NAFTA, producer surplus, sugar, trade policy, welfare economics Introduction On January 1, 1994, the North American Free Trade Agreement (NAFTA) went into effect for the United States, Mexico, and Canada, creating the world s largest free-trade area (U.S. Trade Representative, 2013). However, due to a Side Agreement on Sugar between Mexico and the United States (Jurenas, 2006; American Sugarbeet Growers Association, 2014), unrestricted free trade of sugar between the United States and Mexico did not begin until January 1, Prior to FY2008, Mexico exported a relatively small amount of sugar to the United States. From fiscal years (FY) , Mexican sugar exports to the United States averaged approximately 1.2 million metric tons raw value (MTRV), approximately 12% of total U.S. consumption. By FY2013, Mexican exports of sugar to the United States had reached 1.93 million MTRV, approximately 18% of total U.S. consumption (U.S. Department of Agriculture, Economic Research Service, 2013c). U.S. sugar prices were not initially depressed by increased Mexican exports of sugar in 2008 because of below-average sugar production in the United States and Mexico, which was caused by poor weather conditions (U.S. Department of Agriculture, Economic Research Service, 2013b; Roney, 2012; Knutson, Westhoff, and Sherwell, 2010). However, sugar prices started to decline in 2012, and the U.S. sugar price approached the U.S. loan rate by the end of Figure 1 provides Mexican sugar exports to the United States for FY2001 FY2013 as well as average U.S. and world sugar prices and U.S. raw sugarcane loan rates for the same time period. The evolution of an official U.S. sugar policy began with the Jones-Costigan Act of 1934 (Alvarez and Polopolus, 1998). Unlike many other commodities, the 2014 Farm Bill extended all sugar programs contained in the 2008 Farm Bill (American Sugar Alliance, 2014a). As outlined in the 2008 Farm Bill, U.S. sugar policy has three main components: (1) flexible domestic marketing allotments (regulating how much domestic production is allowed to be marketed in a given year), (2) Troy G. Schmitz is an associate professor in the W.P. Carey School of Business at Arizona State University. Karen E. Lewis is an assistant professor in the Department of Agricultural and Resource Economics at the University of Tennessee. The authors would like to thank the anonymous journal reviewers and editor Hayley Chouinard for their helpful comments and suggestions throughout the review process. The authors also thank the participants of the 2014 International Agricultural Trade Research Consortium for their helpful input and suggestions on this manuscript. Review coordinated by Hayley Chouinard. 388 September 2015 Journal of Agricultural and Resource Economics Figure 1. Mexican Sugar Exports to the United States (MTRV), U.S. Sugar Prices, U.S. Raw Loan Rate and World Sugar Prices: FY2001 FY2013 Notes: U.S. prices are Contract No. 14/16, duty fee paid New York; world prices are ICE Contract 11 nearby futures price. a government loan rate, and (3) tariff-rate quotas (TRQs) imposed on all countries except Mexico and Canada (U.S. Department of Agriculture, Economic Research Service, 2013b). The secretary of agriculture announces TRQs prior to the start of the fiscal year. Under the Uruguay Round Agreement on Agriculture, the United States must import a minimum quantity of 1.14 million MTRV under the TRQ (U. S. Department of Agriculture, Foreign Agricultural Service, 2012). 1 TRQs are issued to forty countries, and their allocation is controlled by the Office of the U.S. Trade Representative (U.S. Department of Agriculture, Economic Research Service, 2013b). If a country wants to export sugar into the United States beyond the TRQ, it faces an over-quota tariff of $0.1536/pound for raw sugar. The over-quota tariff is almost always prohibitive. Since NAFTA was implemented, only negligible amounts of over-quota entries of sugar have entered the United States (U. S. Department of Agriculture, Foreign Agricultural Service, 2014). If the domestic sugar market is under-supplied on April 1 of the fiscal year, the secretary of agriculture may increase the TRQ (U.S. Department of Agriculture, Economic Research Service, 2013a). The USDA uses its World Agricultural Supply and Demand Estimates (WASDE) monthly report, which includes forecasts of U.S. sugar consumption and production and Mexican exports of sugar to the United States, to determine whether to increase the TRQ (U.S. Department of Agriculture, Economic Research Service, 2013a). The USDA s U.S. and Mexican sugar forecasts are a crucial component of proper implementation of U.S. sugar policy, especially considering that the goal of this policy is to maintain the price of sugar above the government loan rate, which is $0.1875/pound for raw sugarcane (U.S. Department of Agriculture, Economic Research Service, 2013a). Prior to full NAFTA implementation in 2008, Mexican exports of sugar to the United States were also limited through the TRQ. Legislation in the 2002 Farm Bill allowed Mexico to export a maximum of 250,000 MTRV of sugar into the United States annually under the TRQ (Jurenas, 2009; American Sugarbeet Growers Association, 2014). Under NAFTA, Mexico became eligible to export 1 TRQ is defined as the raw sugarcane TRQ. Schmitz and Lewis Impact of NAFTA on U.S. and Mexican Sugar Markets 389 Figure 2. Top Exporters of Sugar into the United States and U.S. Production (1,000 MTRV), FY2001 FY2013 an unrestricted, tariff-free amount of sugar into the United States (U.S. Department of Agriculture, Economic Research Service, 2013b). Figure 2 provides a detailed breakdown of U.S. sugar imports by country of origin for FY2001 FY2013 as well as total U.S. domestic production of sugar. The total combined TRQ for all forty countries whose sugar exports to the United States are restricted by the TRQ are also provided in figure 2 (shown below the TRQ line). Of the forty countries with restricted TRQs, Brazil, the Philippines, the Dominican Republic, Australia, and Guatemala were the top five exporters of sugar to the United States from FY2001 to FY2013. These countries plus Mexico accounted for 82% of all U.S. raw sugar imports in FY2013 (Mexico accounted for nearly 70% of total U.S. imports in that year). As shown in figure 2, annual U.S. sugar imports post-nafta implementation have been steadily higher than pre-implementation annual U.S. sugar imports (with the exception of FY2006). In FY2006 the USDA significantly increased the TRQ to allow additional imports of sugar into the United States as a result of the significant drop in U.S. domestic production caused by Hurricanes Katrina, Wilma and Rita (Haley, Jerardo, and Kelch, 2005). Overall, since full NAFTA implementation, the amount of sugar imported under the TRQ has fluctuated. In FY2008 and FY2009, imports allowed under the TRQ were set at levels slightly higher than minimum. In FY2010 FY2012, the TRQ was increased multiple times after the April 1 trigger date. And in FY2013, several TRQ countries did not fill their originally allotted TRQ (U.S. Department of Agriculture, Economic Research Service, 2013c). The decision to increase the TRQ can be controversial and political (Jurenas, 2010; Sweetener Users Association, 2011), relying heavily on USDA forecasts of U.S. production and consumption and Mexican exports of sugar to the United States. It was not until the 2008 Farm Bill that the USDA became required by law to publish a forecast of U.S. imports of Mexican sugar in its monthly WASDE (Lewis and Manfredo, 2012). Consequently, Lewis and Manfredo (2012) analyzed the performance of the USDA s U.S. sugar production and consumption forecasts from FY1993 through FY2011 and the USDA s Mexican sugar exports forecast in FY2010 (the first year it was published) and FY2011. Lewis and Manfredo (2012) determined that the USDA had done a respectable job of forecasting U.S. sugar production and consumption and Mexican exports of sugar to the United 390 September 2015 Journal of Agricultural and Resource Economics States. They also found that the accuracy of the USDA forecasts has stayed consistent over time, despite the full implementation of NAFTA. This paper analyzes NAFTA s impact on sugar producers and consumers in Mexico and the United States using a partial equilibrium sugar trade model (developed in this paper) for the United States, Mexico, and the forty other countries in the rest of the world (ROW) that export sugar to the United States under the TRQ. Literature Review Voluntary Export Restraints and the U.S. Sugar TRQ Certain theoretical welfare implications resulting from voluntary export restraints (VERs) are applicable to the counterfactual analysis performed in this paper. There exists an extensive literature on the welfare implications of VERs for both the importing and exporting country (e.g., Harris, 1985; Krishna, 1989). As Harris (1985) states, Economists working in the tradition of perfect competition tend to think of VERs as being similar to a quota, except that the quota rents are captured by the foreign exporters in the form of higher profits. This presumes of course that entry into the exporting industry is somehow limited. If this is the case, then welfare of the foreign country can improve due to the imposition of VERs because of the transfer of the quota rents to the foreign country. (p. 800) Allen, Dodge, and Schmitz (1983) explain that voluntary exports restraints are voluntary because the exporting country has the choice between curtailing its exports or having them reduced by the importing country through protectionist measures such as tariffs. Faced with this choice, an exporting country often voluntarily chooses to limit exports to the exporting country. This result holds because the exporting country can capture tariff equivalent revenues. (p. 291) In the case of VERs on substitute goods within the framework of perfect competition, the importing country suffers welfare losses because producers are protected at the expense of consumers. Furthermore, as long as the export supply curve is upward-sloping and exporters receive the higher price caused by the import restriction (which holds true in the case of U.S. sugar policy), VERs can, in some cases, lead to welfare gains to producers in the exporting country. For example, Allen, Dodge, and Schmitz (1983) found that as a result of the 1964 U.S. Meat Import Law, producers who exported beef to the United States realized welfare gains of $8.25 million per year from VERs. In another example, Picketts, Schmitz, and Schmitz (1991) found that Canadian potash producers gained $108.4 million after they voluntarily agreed to restrict potash exports to the United States as a result of a 1987 countervailing duty case filed by the United States. In the case of U.S. sugar trade with Mexico, the very act of restricting U.S. sugar imports from Mexico to TRQ levels that existed prior to 2008 in our counterfactual scenario yields similar theoretical results as a Mexican VER. Over our examined time frame (FY2008 FY2013), the TRQ imposed on sugar exporters by the United States takes the form of a zero in-quota tariff and an overquota tariff that is almost always prohibitive. Furthermore, the U.S. TRQ is based on a historical allocation; thus, foreign exporters do not have to pay for a quota license and are therefore able to capture the quota rent (Skully, 2001). Hence, in years when the over-quota tariff is prohibitive, U.S. sugar import restrictions take the form of what Anderson and Neary (1992) term pure VERs, where all quota rents are awarded to producers in the exporting country. 2 Our results illustrate that 2 In the case of Mexico, the sugar mills that export sugar into the United States receive the quota rent. There are fifty-one Mexican sugar mills, nine of which are owned by the Mexican government (U.S. Congress, 2015). Thus, the quota rent is divided between the Mexican government and the privately owned sugar mills. Schmitz and Lewis Impact of NAFTA on U.S. and Mexican Sugar Markets 391 it would have been possible for Mexico to realize welfare gains if free trade in sugar between the United States and Mexico, from FY2008 through FY2013, had instead been replaced with a binding TRQ that behaved, at least theoretically, like a pure VER. Previous Literature on U.S. Trade Policy in Sugar Previous research has analyzed numerous aspects of the U.S. sugar market and U.S. sugar policy, ranging from the cost of U.S. sugar policy to the impact of various changes to current U.S. sugar policy (e.g., Babcock and Schmitz, 1986; Leu, Schmitz, and Knutson, 1987; Koo, 2002; Schmitz et al., 2002; Beghin et al., 2003; Petrolia and Kennedy, 2003; Elobeid and Beghin, 2006; Beghin and Elobeid, 2015). Previous research has also analyzed the ex ante impact of NAFTA on the U.S. sugar market (e.g., Sano, House, and Spreen, 2004; Abler et al., 2008; Kennedy and Schmitz, 2009; Knutson, Westhoff, and Sherwell, 2010). Sano, House, and Spreen (2004) created a model that forecasted four possible scenarios of the volume of U.S. sugar imports for FY2002 FY2015. They concluded that the Mexican sugar industry benefited little in the past ten years of the NAFTA regime and may not expect much in the future either (pg. 18). Abler et al. (2008) used the Center for Agricultural and Rural Development international sugar model to project that the average U.S. raw price of sugar for FY2008 FY2015 would be lower than the U.S. sugar loan rate in many scenarios as a result of full NAFTA implementation. This would have made it very unlikely for U.S. sugar policy to be able to continue operating at no cost to taxpayers. Therefore, based on fears that unrestricted, tariff-free sugar exported from Mexico into the United States would cause existing U.S. sugar policy to no longer operate at no net cost to taxpayers, Abler et al. (2008) proposed and examined a new U.S. sugar policy based on standard commodity programs found in the 2002 Farm Bill, such as direct payments, which they projected for the average of FY2008 FY2015. They concluded that the replacement of the current sugar program by a standard commodity program would increase the costs of the program for the U.S. taxpayers but would lower costs for the U.S. sugar users (pg. 100). Kennedy and Schmitz (2009) examined the impact of U.S. production control policies in response to increased exports of sugar entering into the United States due to NAFTA. Using data from FY2005, they first examined how increased U.S. sugar import quotas would impact U.S. consumer and producer welfare and how they would impact U.S. welfare if U.S. producers used supply management practices. They reached the conclusion that U.S. sugar production control policies can lessen the impact of increased sugar imports into the United States to a certain extent, but U.S. supply management would eventually fail to compensate for increased sugar import quotas. To analyze the potential impact of NAFTA on the U.S. and Mexican sweetener industries, Knutson, Westhoff, and Sherwell (2010) utilized the Food and Agriculture Policy Research Institute (FAPRI) U.S. and Mexican sweetener baseline models to project sugar and high-fructose corn syrup (HFCS) supply and demand conditions in the United States and Mexico for FY2010 FY2019. Their projections indicated that NAFTA would not negatively impact the U.S. sugar industry as anticipated and that dire predictions of U.S. producer interests would not materialize (Knutson, Westhoff, and Sherwell, 2010, pg. 1). While Sano, House, and Spreen (2004), Abler et al. (2008), Kennedy and Schmitz (2009), and Knutson, Westhoff, and Sherwell (2010) examined the potential impact of full NAFTA implementation ex ante, they did not include an ex post analysis, because full implementation of NAFTA for sugar had not yet occurred. We contribute to the existing literature on the impact of NAFTA on the trade of sugar between the United States and Mexico by being the first, to our knowledge, to empirically estimate the ex post impact of full NAFTA implementation on U.S. and Mexican producers and consumers by using actual data for FY2008 FY2013, during which NAFTA was fully implemented. 392 September 2015 Journal of Agricultural and Resource Economics Methodology We determine the ex post impact of full NAFTA implementation of U.S. trade in sugar on U.S. and Mexican producers and consumers by making extensive use of the concept of economic surplus (e.g., producer surplus, consumer surplus, and total welfare), which is frequently used in applied welfare economics to analyze the impact of policy changes involving international trade (e.g., Just, Hueth, and Schmitz, 2004; Schmitz, Schmitz, and Dumas, 1997; Schmitz, 2002). We capture the major aspects of current U.S. and Mexican sugar trade policy using a stylized partial-equilibrium trade model, which incorporates Mexico s unrestricted access to the U.S. sugar market starting in 2008 when NAFTA became fully implemented and takes into account the TRQs issued by the U.S. government to forty sugar exporting countries (ROW). The ROW TRQs were completely filled in FY2008 FY2012 but not in FY2013; thus, our model incorporates both scenarios. Once developed, the model is calibrated for each individual year, FY2008 FY2013, in order to estimate realized economic welfare in the United States and Mexico. The parameters of the model are then used to capture the welfare implications of a counterfactual scenario in which Mexico is initially restricted to 250,000 MTRV (Mexico s pre-2008 TRQ allocation) of sugar exports to the United States. Theoretical Model A model of sugar trade is provided in figure 3. The United States imports sugar from the forty ROW TRQ countries and from Mexico. Mexico is a net exporter of sugar and, since full implementation of NAFTA in 2008, has exported all but a negligible amount of its sugar exports to the United States (U.S. Department of Agriculture, Economic Research Service, 2013c). Most of the ROW countries (such as Brazil) have associated production and shipping costs that are typically lower than Mexico s, while some have associated costs that are higher than Mexico s in some years (dependent on global market conditions). 3 While exports by the ROW to the United States are restricted by import quotas under the TRQ, the within-quota tariff is essentially zero, which implies that the ROW countries usually receive a price for U.S. sugar exports that is much higher than the world price. The ROW is allowed to export sugar to the United States beyond the quota, but the over-quota tariff is effectively prohibitive. No significant amount of sugar was exported to the United States beyond its TRQ from FY2008 through FY2013. The United States is a large-country importer of sugar, while Mexico and the ROW are largecountry exporters. In the left panel of figure 3, the U.S. supply and demand curves are S u and D u, respectively. The U.S. excess demand curve is ED u (in the middle panel of the diagram), which equals the horizontal difference between D u and S u. In the right pane
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