Centre de Recherche en économie de l'Environnement, de l'Agroalimentaire, des Transport et de l'Énergie (CREATE) “Compositional Standards, Import Licences and Market Structure: The Case of Canadian Imports

Marie-Hélène Felt Carleton University, Ph.D candidate Bruno Larue Canada Research Chair in International Agri-food Trade CREATE, Université Laval Jean-Philippe Gervais Formerly Professor at North Carolina State University

IATRC, December 12, 2011 Background  New regulations with regards to cheese produced in Canada and imported:  Set a minimum % of the casein derived from fluid rather than from other milk products.  Constrains the whey protein to casein ratio of cheese not exceed that of milk.  Import licenses are needed in addition to import permits.  WTO notification in June 2007; Adoption by the Canadian Parliament in December 2007; Implementation in December 2008; Legal challenge-Superior Court in October 2009;-Appeal in February 2011; Supreme Court decision NOT to hear the case in November 2011.

The New Compositional Standards

Types of cheese Ratio casein from fluid milk / Ratio fixed by casein from all sources used new by the industry prior to the compositional imposition of compositional standards standards Pizza Mozzarella cheese 60% 63% Part Skim Pizza Mozzarella cheese

Cheddar and cheddar-type (Brick, Canadian 70% 83% Munster, Canadian Brick, Colby, Farmer’s, Jack, Monterey 100% Old (Monterey Jack), Mozzarella (Scamorza), Part skim Mozzarella, Part skim Pizza cheese, Pizza cheese,Skim Milk cheddar cheese and any other variety ,.

Specific speciality cheeses (Asiago, Baby Edam, Baby 80% 95% Gouda, Blue, Butterkäse, Bra, Brie, Caciocavallo, Camembert, , Edam, Elbo, Emmental, Swiss, , Feta, Fontina, , Gouda, Gournay, Gruyère, , Kasseri , Limburger , Maribo, Montasio , Muenster, Neufchâtel, Parmesan, Provolone , Romano, St. Jorge, Saint-Paulin, Samsoë, Tilsiter, , Harzkase)

Who complained?

Domestically: Saputo, Kraft, Parmalat, but not Agropur;

Internationally: Australia, the European Union , New Zealand, Switzerland and the United States….

but France has similar standards! The Canadian cheese industry…

 Operates under a supply management policy; 37% of Canada’s milk production is allocated to cheese manufacturing;

 Milk protein ingredients are imported;

 Is dominated by four large processors: Saputo, Kraft, Agropur and Parmalat, but there is a fringe of small specialty cheese manufacturers, especially in Quebec;

 Imports are regulated by a TRQ with 2/3 of the quota allocated to the EU;

 Importers need an import permit and an import licence and are subject to a « use it or lose it » clause.

Canada’s cheese imports

Canada cheese imports are subject to a TRQ of 20,412 tons since 1995.

HS 0406.10 HS 0406.20 HS 0406.30 HS 0406.40 HS 0406.90 Fresh Grated/Powdered Processed Blue Other HS 0406 1% of total cheese imports 6% of total cheese 6% of total 6% of total 81% of total Cream cheese (55%) imports cheese imports cheese imports cheese imports USA USA USA Switzerland France France Italy Italy France UK USA Italy Denmark Netherlands USA France Italy Switzerland Greece Germany Netherlands Germany Netherlands Netherlands France United Kingdom Denmark Italy Switzerland

Building on old ideas about TRQs and quantitative measures

 Larue, Gervais and Pouliot (2007, 2008) : TRQ setting under domestic price target and domestic monopoly;  Larue, Lapan and Gervais (2010) : TRQ as a « rent shifting » strategic policy instrument – Selling (dearly) domestic access;  Grossman (1980), Greaney (1996), Cunha and Santos (1996), Pouliot and Larue (2012): TRQs and other domestic content/market sharing agreements can have perverse effects/ « use it or lose it » vs sleeping on import licences;

Theoretical Modelling Strategy

Leontief cheese- qimin i m , i x making technology:

wwmx Cqii ii

Assumption: The standards bind on one or more firms and quality is unaffected Modelling theoretical strategy

Consumers have quasi-linear 22 preferences: UZAXAXXXXX1 1 2 20.5 1 2 1 2

There are 3 types of firms: m1 firms produce type 1 cheese , m2 firms that produce type 2 cheese and n importing firms that have a « use it or lose it » quota constraint. Domestic firms have Cournot conjectures and know that import licences will be filled

AABA jAm1 1( 1 1) qn 1 1 q 1 mq 2 2 nQc 1 0

AABA jAmqn2 2 1 11 q 1 ( m 2 1) qnQc 2 2 0

BABA jAArrm(1 2 )( 1 2 ) 1 (1 ) qn 1 (21)(1 ) qm 1 2 (1 ) qn 2 ((1 )1) Q

Analytical solutions are messy and not insightful, but comparative statics give simple and neat results. Theoretical results:

 Proposition 1: If the compositional standard binds only on foreign producers of type 1 cheese, consumption of type 1(2) cheese falls (increases), and total quantity of domestic cheese produced can decrease/stay the

same/increase as mm12

If output expansion occurs in the less competitive segment and the contraction occurs in the most competitive segment, then the standard that binds only on imports actually triggers an overall reduction in domestic cheese production. Theoretical results:

Proposition 2: The standard can decrease/keep constant/increase the domestic demand for milk if :

mB11 B m12 m 1 mB22

The standard can backfire on dairy farmers even when it binds only on foreigners! Theoretical results

 Proposition 3: The value of trade can increase/stay constant/decrease in response to the imposition of a compositional standard that binds only on type 1 cheese

exporters. If rr 12 , the value of trade can only increase with rr a standard-induced increase in r1. If 12 , then the value of trade increases, stay the same or decreases as B r B 1 . where B qr11 1 1 B 0 rr12 rq11 Theoretical results:

 Proposition 4: If the compositional standard binds only on domestic type 1 cheese manufacturers, then: type 1 cheese consumption decreases, type 2 cheese consumption and milk demand can decrease/stay constant/increase and domestic cheese production decreases. n  For type 2 cheese consumption, the result hinges on: m2

 For milk demand, the result depends on: 1 2n m2 1 n n 1

m22 n n Theoretical results:

 Proposition 5: The value of trade can increase/stay the same/decrease if the standard binds only on domestic type 1 cheese manufacturers as . rr12

Empirical Methodology

 Structural change test on import unit values;  Problem: the compositional standards were implemented recently;  Andrews (2003) S-test is designed to find a break near the end of the sample;  Bai and Perron (1998, 2003): breaks are endogenously determined. Structural change in unit values of Canadian cheese imports by HS6 category from all sources: Bai and Perron Andrews structural break test structural break test Test results: All Cheese type Origin Endogenous estimation Estimation period resulting potential break date of break date(s) on the from Bai and Perron break test from June 2007 to full initial sample May 2011 are tested December Italy 2001**(2,3,4,5) Jan 2002 –May 2011 March 2010** December 2001*(1) Nov 2009-June Jan 1997 –May 2011 040610 2010** Fresh cheese (1) June 2007, Oct May 2010*** United States (2) 2007*** February 2010** Jan 1997 –May 2010 May 2007,July- Sept 2007, Nov 2007** 040620 Grated-Powdered United States Stability Jan 1997 –May 2011 Stability cheese France Stability Jan 1997 –May 2011 Stability September 040630 2002***(2,3,4,5) Switzerland Oct 2002-May 2011 Oct-Nov 2010* Processed cheese February 2002 and September 2002**(1) United States Stability Jan 1997 –May 2011 February 2009* 040640 Denmark Stability Jan 1997 –May 2011 March-May 2008* Blue-veined cheese France Stability Jan 1997 –May 2011 Stability France Stability Jan 1997 –May 2011 Stability Feb-April 2011** 040690 Italy Stability Jan 1997 –May 2011 Nov 2010-Jan Other cheese 2011* Switzerland Stability Jan 1997 –May 2011 Stability

Conclusion

 The standards ‘ effects depend on domestic industry’s structure and substitution demand parameter. The « use-it or lose it » changes the reaction functions of firms and can induce peculiar effects;  EU’s share of the Canadian market is protected ; growth in exports volume is limited, but compositional/quality upgrading effects are beneficial to the EU;  Milk protein ingredients imports from NZ are down.  Consequences on R&D effort and future innovation? Thank You! Merci !

Bruno Larue Canada Research Chair in International Agri-food Trade