Copyright is owned by the Author of the thesis. Permission is given for a copy to be downloaded by an individual for the purpose of research and private study only. The thesis may not be reproduced elsewhere without the pennission of the Author. ADOPTION OF BOVINE SOMATOTROPIN IN THE UNITED ST ATES AND IMPLICATIONS FOR INTERNATIONAL TRADE OF DAIRY PRODUCTS A thesis presented in partial fulfilment of the requirements for the degree of Masters of Agricultural Economics Massey University Palmerston North, New Zealand Joseph William Guthrie 1992 Abstract Advancements in biotechnology have led to some of the most important changes in agriculture in this century. The development of synthetic bovine Somatotropin, a hormone which increases milk production from dairy cows, may have a significant impact on the dairy industry in the near future. While bovine Somatotropin, or bST, has been widely studied, its potential impacts, both on milk production and on the economics of the dairy industry, remain controversial. At this time, bST has not been approved for use in any of the developed countries. It appears that, for a variety of reasons, the United States would be the most likely to approve bST in the near future. If bST is approved in the US, and widely adopted by American farmers, it could increase milk production in the US significantly, although the exact magnitude of its effects are difficult to determine at this time. Another important factor in determining US milk production is the US government's dairy policy. The policy for 1991-1995 is contained in the recently passed 1990 Farm Bill. The dairy provisions in the 1990 Farm Bill will maintain the current support price for milk at its current level, regardless of how large dairy surpluses become. Together, the increase in milk production from bST along with a guaranteed minimum support price could lead to significant surpluses of dairy products in the US by 1995. Since the US has traditionally sold its dairy surpluses on the international market at subsidised prices, or simply given them away as food aid, a large increase in US surpluses could have a great impact on the international dairy market. Furthermore, because the 1990 iv Farm Bill was only passed recently, no studies have yet been published which address the impact of bST under the current policy environment or what effect this would have on the world dairy market. The objective of this study is to empirically estimate the impact of bST on US production, and determine the implications- for international trade of dairy products. A five equation quarterly econometric model of the US dairy industry is used to forecast US production through 1995. Then the effects of bST use are incorporated into the model. The results show that if bST is adopted in the US as assumed, by 1995 surpluses of dairy products could rise to as much as 12 billion pounds. This surplus would be nearly as large as the record surpluses of the early 1980's, which caused unprecedented disturbances to the international dairy market. Thus, use of bST in the US could significantly increase the excess supply of dairy products in the world, and thereby lower prices, especially of butter and skim milk powder. New Zealand would be particularly vulnerable to any price reductions on the world dairy market. The European Community, which is the largest exporter of dairy products, may have to increase its own export subsidies to compete against the US. This, in itself could lead to even further turmoil in the world market. V Acknowledgements Several people have helped me considerably in completing this work. In particular, I would like to thank Dr. Doren Chadee, my advisor, for his assistance in the development and analysis of the model, and his unfailing support. I would also like to acknowledge the rest of the faculty and staff of the Department of Agricultural Economics and Business at Massey University, all of whom have assisted me in some way during the development of this thesis. I owe a special debt of gratitude to the New Zealand-United States Educational Foundation. Without their financial support, I would not have been able to study in New Zealand at all, much less write this thesis. In particular I would like to acknowledge Mr. Laurie Cox, the Executive Director of the foundation, for his support throughout the time I spent in New Zealand. Finally, I would like to thank my family and friends "back home." Although they were far away, they remained close. Their support and encouragment were a great help, and greatly appreciated. vi Contents Abstract Acknowledgements iv vi Chapter Page 1: Introduction . . . . . . . . . . . 1 1.1: Statement of the Problem 2 1.2: Objective 3 1.3: Methods 3 1.4: Outline of the Study 4 2: An overview of the us Dairy Industry, the World Dairy Policy Environment, and World Dairy Trade. s 5 7 7 7 2.1: Introduction 2.2: The US Dairy Industry and Dairy Policy 2.2a: Introduction 2.2b: Dairy Production in the US 2.2c: US Dairy Policy. . 8 2.2d: The Federal Milk Market Order Program. 9 2.2e: The Price Support Program .. 10 2.2f: Dairy Policy Changes in the 1985 Farm Bill 11 2.2g: The 1990 Farm Bill and GATT Negotiations 13 2.3: The World Policy Environment 15 2.3a: Introduction 15 2.3b: Overview of the World Dairy Policy Environment vii 15 2.3c: Measuring Government Intervention ... 2.3d: Dairy Policy in the European Community 2.3e: Dairy Policy in New Zealand. 2.4: The World Dairy Trade Situation. 2.4a: Introduction 2.4b: An Overview of World Dairy Trade 2.4c: World Prices for Dairy Products .. 2.5: The US as a Dairy Exporter: A Review of the Literature 2.5a: Introduction 2.5b: Review of the Literature 2.6: Summary .... 3: An overview of BST and its Impacts 3.1: Introduction 3.2: An Overview of BST 16 18 20 21 21 21 23 24 24 25 26 28 28 28 3.2a: Introduction 28 3.2b: The Controversy Over BST 29 3.2c: Use of BST in the US 30 3.3: The Impacts of BST: A Review of the Literature 31 3.3a: Introduction 31 3.3b: An Overview of the Literature 32 3.3c: A Closer Look at the Assumptions 34 3.3d: BST and Optimal Government Policy 37 3 . 4 : Summary . . . . . . . . . . . . . 38 viii 4: A conceptual Model of BST and Its Impacts 40 4,1: Introduction 40 4,2: The Effects of Adopting a New Technology . . . . 40 4. 3: The Effect of a Support Price . 43 4,4: Export Subsidies . . . . 45 4.4a: Overview of Export Subsidies 45 4.4b: Small Nation Example 46 4.4c: Large Nation Example 48 4,5: Developing a Model of the Effects of BST 50 4.5a: Overview . . . . 50 4.5b: Models of the us Dairy Industry: A Review of the Literature 50 4.6: summary . . . . . . . . . . . 53 5: The Econometric Model and Empirical Results . 5.1: Introduction 55 55 5.2: The Dairy Simulation Model 55 5.2a: Overview of the Model 55 5.2b: Data Sources and Estimation Procedures 56 5.2b: Cow Inventory. . . . . . 60 5.2c: Results and Discussion 60 Milk Production per Cow 60 Total Milk Production 61 Commercial Disappearances of Milk 62 Real Farm Milk Price. 5.3: Model Validation. 5.4: Forecasting. 5 . 5 : Summary . . ix 62 63 64 68 6: 7: Incorporating BST into the Model 6.1: Introduction 6.2: Impacts of BST on Production 6.2a: The Response Rate 6.2b: The Adoption Rate. 69 69 70 70 71 6.2c: Calculating the Effect of BST on Production 73 6.3: Incorporating the Impacts of BST Into the Model. 74 6.3a: Percentage Increases in Total Production 74 6.3b: Increases in Total Milk Production 75 6.4: The Effects of BST on Excess Supply. . . 79 6.4a: Support Prices and Excess Supply 79 6.4b: Measuring Excess Supply. 80 6.4c: Estimating the Effect of BST on Excess Supply 6.5: Effects of the 1990 Farm Bill 6.5a: The Effect of the Support Price .. 6.5b: The Effect of Price Deductions 6.6: Effects on Other Dairy Exporting Nations 6.6a: The Effect of Subsidised Exports 6.6b: Effects on the World Price 6.7: Other Issues and Potential Developments 6 . 8 : summary . . . . . . . . . . . . . . . . summary, Conclusions, and Suggestions for Further Research . .... . 7.1: Summary of the Study 7.2: Conclusions 7.3: Suggestions for Further Research X 82 84 85 86 88 88 89 90 91 95 95 97 99 Literature cited 101 xi List of Tables Table 2-1: structural Changes in the us Dairy Industry, 1955-1989 Page 8 3-1: Parameters Assumed in Previous BST Studies 34 5-1: Econometric Equations of the Quarterly Dairy Model .. 58 5-2: variable Definitions for the Quarterly Dairy Model 59 5-3: Intra-Sample Simulation Performance 64 5-4: Predicted Values of Selected Variables (Without BST) 65 6-1: summary of Adoption Rates Assumed by the Scenarios 72 6-2: Percentage Increases in Total Milk Production as a Result of Using BST: Scenario 1 ..... 6-3: Percentage Increases in Total Milk Production as a Result of Using BST: Scenario 2 •••• 6-4: Total Milk Production (Billions of Pounds): Scenario 1 6-5: Total Milk Production (Billions of Pounds): Scenario 2 xii 74 74 76 77 List of Figures Figure 2-1: CCC Net Milk Removals, 1980-1990 2-2: US Milk Price Series. 2-3: Milk PSE's as a Percent of Producer Price in OECD Countries, 1988 Page 11 13 17 2-4: Leading Dairy Exporters, 1989 22 2-5: Prices of Dairy Products (at Rotterdam) 23 2-6: US Dairy Trade as a Percent of Domestic Production. 24 4-1: Effect of Adopting a New Technology 4-2: Effect of a Support Price As a New Technology is Adopted 4-3: Fixed Export Subsidy - Small country Example 4-4: Variable Export Subsidy - Large Country Example 5-1: Actual and Simulated Values of Selected Endogenous Variables 6-1: Total Production, Scenario 1 . . . . . 6-2: Total Production, Scenario 2 . 6-3: Dairy Excess Supply: Annual Totals 6-4: Excess Supply, Scenario 1 6-5: Excess Supply, Scenario 2 xiii 41 44 47 49 66 76 77 81 83 83 Chapter l Introduction some of the most important and far-reaching advances in agriculture in this century have been brought about as a result of the widespread adoption by farmers of the latest developments in biotechnology. One of the most widely discussed topics in biotechnology in recent years is the development of synthetic bovine Somatotropin, or bST. BST is a hormone which cattle produce naturally, but scientists have been able to produce synthetic bST, which has all the same effects. Dairy cows which are treated with daily injections of bST produce more milk with no apparent harm either to the cow's health or to the quality of the milk. Estimates of the amount of increase in milk production due to bST use vary, but bST may increase milk production by as much as 20%. At present, bST is still being tested, and has not been approved for use in any of the developed nations. It has never been shown to be a risk either to people or cattle, but its use remains controversial. Aside from heal th concerns, bST has sparked controversy because many believe it could fundamentally restructure the dairy industry wherever it is used. Of the major dairy producing nations, the us would appear to be the most likely country to approve bST in the near future, perhaps sometime in 1992. Even in the US, however, it remains quite controversial. Much is still unknown about bST. One debatable issue is how many farmers would adopt bST if it were approved. 2 This would depend most likely on other currently unknown factors such as how much bST would cost, how much it increased milk production per cow, the price the producer received for milk, and other factors. Another controversial issue is how well consumers would respond to milk that had been produced from bST-treated cows. 1.1: statement of the Problem Although several studies have estimated the economic impact that bST would have if it were adopted in the US, these studies are found to be lacking in what this author feels are two vital concerns. One is the change in the policy environment since these studies were written. The other is their lack of analysis of the effects that bST could have in making the US a larger exporter of dairy products, and the effects that increased exports by the US would have on international dairy trade. Previous studies were based to a large extent on the assumption that the dairy policies in the US from the late 1980's would continue into the 1990's. However, since these studies were completed, the 1990 Farm Bill, which will guide US dairy policy from 1991 through 1995, was passed and went into effect. It altered the dairy price support system that had been in place since the passage of the 1985 Farm Bill. Thus, these previous studies haave become somewhat outdated. Furthermore, most studies which analyse bST' s effects on the us dairy industry do not carry that analysis over to an examination of the impacts it would have on the international dairy market. One study which did concluded that bST may play 3 a part in making the US a larger exporter of dairy products. It was based, however, on the same assumptions that were discussed above, that the 1985 Farm Bill policies would be continued in the 1990 Farm Bill. Therefore, that study's conclusions may not accurately show the most probable effects of the use of bST in the us on the international dairy market. There is, therefore, a lack of information on the effects that the adoption of bST will have on the US dairy industry, and the implications for international trade of dairy products. Since the effects of bST use could be very significant, an indepth analysis is needed to estimate the effects that bST could have if it is adopted in the us under the current policy environment. This analysis could then be used to determine the implications for the international dairy market. 1.2: Objective This study will estimate the effects that adoption of bST in the US will have on the US dairy industry and the implications for international dairy trade. The purpose is to gain a better understanding of the effects of bST, and of the us dairy industry under the current policy environment, in order to forecast with a greater deal of confidence what the effects of bST use will be. 1.3: Methods The general procedures followed in the study include the specification and estimation of an econometric model of the US dairy industry. The econometric model is then simulated to generate forecasts of the endogenous variables for the 1991-1995 4 period. Based on these forecasts, several scenarios of the use of bST under various assumptions are developed in order to analyse the empirical impacts of bST on the US dairy industry, and the resulting impacts of the excess supplies from the US that could be traded on the world market. 1.4 outline of the study The next chapter in this study discusses the us dairy industry and the current dairy policies in the US. It then gives an overview of the policy environment around the world, with particular emphasis on the leading dairy exporters, the EC and New Zealand. That chapter then explains the current situation in world dairy trade, and how the us could emerge as a larger exporter. Chapter 3 discusses the impacts of bST, and reviews the literature of the economic impact of the adoption of bST in the US. Chapter 4 gives a conceptual model of the effects of bST in the US. Chapter 5 explains the model that was used to estimate the supply, demand, and prices for dairy products in the US and shows the empirical results that were obtained. It also shows how the model was validated, and the results of using the model to forecast over the 1991-1995 period. Chapter 6 shows how the adoption of bST was incorporated into the model, and discusses the implications for international dairy trade. Chapter 7 gives a summary of the study, the conclusions that can be drawn from it, and suggestions for further reserch.