HAVANA DAYDREAMING: A PARTIAL-EQUILIBRIUM SIMULATION OF INCREASING THE U.S.

SUGAR QUOTA FOR CUBA AND MEXICO

A Thesis Submitted to the Graduate Faculty of the Louisiana State University and Agricultural and Mechanical College in partial fulfillment of the requirements for the degree of Master of Science in The Department of Agricultural Economics and Agribusiness

by Daniel Ryan Petrolia B.A., Louisiana State University and A&M College, 1999 B.S., Louisiana State University and A&M College, 1999 August 2001

To my parents

ACKNOWLEDGEMENTS I would like to thank my advisor, Professor Lynn Kennedy, for his guidance and support throughout my program, and especially with the writing of this work. I would also like to express my gratitude to my committee members, Professor Steve Henning and Professor Rich Kazmierczak, for their assistance in developing my plan of study and in completing this thesis. Special thanks also to the entire faculty, staff, and fellow students of the Department of Agricultural Economics & Agribusiness, without which none of this would be possible. I would like to thank Mr. Bill Messina of the University of Florida for the wealth of information he provided me on Cuba, as well as the Middleton Library staff for their help in government document research. I should also express my appreciation for Mr. Jimmy Buffett, whose song A Havana Daydreamin@ both inspired this research and provided a catchy title. Lastly, I wish to thank my parents and family for their continued support in everything I do. You are the reason for my success.

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TABLE OF CONTENTS ACKNOWLEDGMENTS ............................................................................................. iii LIST OF TABLES ....................................................................................................... vii LIST OF FIGURES ..................................................................................................... viii ABSTRACT...................................................................................................................ix INTRODUCTION.......................................................................................................... 1 CHAPTER ONE: SUGAR PRODUCTION AND THE WORLD SUGAR MARKET SITUATION.............................. 4 World Sugar Production........................................................................................................ 4 Cuba............................................................................................................... 4 Mexico ......................................................................................................... 10 United States................................................................................................ 13 CHAPTER TWO: LITERATURE REVIEW ............................................................. 18 CHAPTER THREE: THEORETICAL AND EMPIRICAL FRAMEWORKS ................................................................................. 23 Theoretical Framework ............................................................................... 23 Empirical Framework .................................................................................. 26 Description of the ModPle Internationale Simplifi de Simulation ............. 26 Application of Empirical Model.................................................................. 28 CHAPTER FOUR: DATA.......................................................................................... 31 Prices and Quantities .......................................................................................... 31 Elasticities.................................................................................................... 31 CHAPTER FIVE: TRADE LIBERALIZATION SCENARIOS ................................ 40 Simulation Results: Prices, Supply, and Demand ...................................... 42 Simulation Results: Using Short-Run Elasticities ...................................... 43 Simulation Results: Using Long-Run Elasticities ...................................... 47 Comparison of Results ................................................................................ 48 CHAPTER SIX: WELFARE ANALYSIS AND POLICY OPTIONS.................................................................................................... 51 Welfare Analysis ......................................................................................... 51 Policy Options ............................................................................................. 55 iv

CONCLUSION ............................................................................................................ 61

BIBLIOGRAPHY ........................................................................................................ 67 VITA............................................................................................................................. 71

LIST OF TABLES Table 1.1 High-tier sugar tariffs of most countries compared to those of Mexico, in U.S. cents per pound ................ 14 Provisions of Uruguay Round agreement pertaining to sugar ........................................................................ 14 Provisions of the NAFTA pertaining to sugar...................................... 15 Production, supply, and distribution of sugar, FY 1999, in 1,000 MTRV ............................................ 32 U.S. sugar trade for FY 1999, in 1,000 MTRV.................................... 32 U.S., Mexican, and world refined sugar prices, FY 1999 .................... 33 Monthly U.S. Dollar exchange rates for Mexican Peso, FY 1999 ........................................................................ 34 Base-year quantity data used in MISS, in 1,000 MTRV....................... 34 U.S. own-price elasticities of sugar supply and demand ...................... 35 Own-price supply and demand elasticities for Cuba and Mexico ................................................................... 36 ROW beet sugar production by country, as percentage of world total, and weighted own-price supply elasticities, in 1,000 MTRV, FY 1999 ......................... 36 ROW cane sugar production, percentage of ROW total, and weighted own-price supply elasticities, by country, in 1,000 MTRV, FY 1999 ................................................ 37 ROW sugar consumption, percentage of ROW total, and weighted own-price elasticities of demand, by country, in 1,000 MTRV, FY 1999 ............................................ 38 Own-price supply and demand elasticities used in MISS ..................... 39 Scenarios simulated in MISS ................................................................ 42 vi

Table 1.2

Table 1.3 Table 4.1

Table 4.2 Table 4.3 Table 4.4

Table 4.5 Table 4.6 Table 4.7

Table 4.8

Table 4.9

Table 4.10

Table 4.11 Table 5.1

Table 5.2

Refined sugar price changes relative to the base, in 1,000 MTRV ............................................................ 43 U.S. supply and demand changes relative to the base, in 1,000 MTRV ............................................................ 44 Cuban supply and demand changes relative to the base, in 1,000 MTRV ............................................................ 45 ROW supply and demand changes relative to the base, in 1,000 MTRV ............................................................ 46 Results of U.S. sugar trade liberalization from Koo (2000), with percentage change from 1999 actual shown in parentheses ................................................................... 49 U.S. changes in consumer and producer surplus and net welfare gains ........................................................... 53

Table 5.3

Table 5.4

Table 5.5

Table 5.6

Table 6.1

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LIST OF FIGURES Figure 1.1 Quarterly Caribbean and U.S. raw sugar prices, 1985-2000, in U.S. cents per pound .................................................. 5 Effect of import quota on producer and consumer surplus of an importing country................................................ 52 Effect of import quota on producer and consumer surplus of an exporting country ................................................ 54 Effect of levying a sales tax on producer and consumer surplus .......................................................... 59

Figure 6.1

Figure 6.2

Figure 6.3

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ABSTRACT A world sugar model consisting of Cuba, Mexico, the United States, and an aggregated Rest of the World was developed in order to simulate increases in sugar imports by the United States from Cuba and Mexico due to the NAFTA and a reinstatement of Cuba as a sugar supplier. Results indicate that increased imports would generate up to $505 million in U.S. net welfare gains, benefiting sugar users while hurting producers. Policy options are then analyzed which could redistribute gains to compensate producers. The use of a consumer tax, which allows the supply price to fall to world levels, while retaining higher demand prices would result in more efficient production and trade based on comparative advantage, no net producer surplus change, increased consumer surplus, and no increased government expenditures. Results also indicate that world prices experience a minimal increase due to increased U.S. imports, indicating that the United States exhibits small- country effects on the world sugar market. These results contrast with previous studies which indicate that the United States would exhibit large-country effects on the world market, resulting in significant increases in the world sugar market price.

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INTRODUCTION With the signing of the North American Free Trade Agreement and its implementation on January 1, 1994, Canada, Mexico, and the United States took a step toward creating a common North American market. The NAFTA is not without opposition, however, and many see the agreement as the beginnings of a trade disaster. Another looming issue is the economic embargo on Cuba by the United States enacted by President Eisenhower in 1960. The embargo was not completely effective, however, due to the response of the Soviet Union to come to Castros aid for the duration of the Cold War. Today, with the Cold War over, the United States has opened trade routes with many former Soviet-bloc nations. Even those states still under communist regimes, namely China and Vietnam, have begun to establish trade relations with the United States. However, Cuba, only ninety miles from Florida, has not even been seriously considered as a trading partner for the near future. In fact, in 1992, more restrictions on trade with Cuba were enacted with the Torricelli Bill, which prohibits United States subsidiaries in third countries from trading with the island. In 1996, the HelmsBurton Bill was passed to further tighten restrictions. Both the NAFTA and impending trade with Cuba create an environment of uncertainty in U.S. ma rkets. Of major concern is the NAFTAs influence on U.S. and Mexican sugar production, demand, and prices. This concern also holds true for the case of Cuba, the worlds fifth- largest sugar exporter, and prior to the revolution of 1959, supplier of over one-third of total sugar requirements to the United States (Alvarez and Castellanos, 1995). Beginning in the year 2000, Mexico will be able to

export up to 250,000 metric tons to the U.S. market, and by the year 2008, will have unlimited access. Also, despite the Torricelli and Helms-Burton Bills, more recent actions by Congress indicate a move toward cooperation with Cuba. Such actions include the introduction of the Cuban Humanitarian Trade Act of 1999, introduced in the House, the Cuban Food and Medicine Security Act of 1999, introduced in the Senate, as well as the United States-Cuba Trade Act of 2000, introduced in both the House and Senate. Thus, it is evident that future trade relations with Cuba are slowly moving forward and, undoubtedly, sugar trade will play a substantial role in this process. The purpose of this study was to identify the status-quo of the sugar markets of Cuba, Mexico, and the United States, and attempt to simulate permutations to the status-quo and their subsequent effect on both domestic and international sugar markets. Factors identified included production, consumption, and their respective price elasticities, prices, and trade. Of primary importance, though, was the current policy situation for sugar in these states, which, ultimately determines much of the aforementioned factors. The work begins in Chapter One by discussing the current economic and political environment within Cuba and Mexico, and follows with a discussion of U.S. sugar policy, which drives the study. Chapter Two is a review of trade liberalization literature, segmented into domestic studies, which focus on the U.S. market, and international studies, which include other countries, and often, an aggregated rest of the world within the models. The theoretical and empirical frameworks are explained in Chapter Three, including a description of the MISS and its application. Chapter

Four covers all data used and their respective sources, while Chapter Five expounds on the specific scenarios simulated during the study and their respective results, including a comparison of results to a prior study. Chapter Six includes a discussion on welfare analysis and outlines some policy options that exist based on the results, followed by the conclusion.

CHAPTER ONE: SUGAR PRODUCTION AND THE WORLD SUGAR MARKET SITUATION World Sugar Production Benirschka et. al. (1996) provide an excellent discussion on sugar production and the world sugar market, which is summarized here. Sugarcane is a tall perennial grass that is produced in tropical and subtropical climate zones. It matures in twelve to sixteen months and each plant yields several crops, called ratoons. Once the cane is harvested, the sucrose begins to break down. In order to minimize transportation costs and sucrose losses, sugarcane mills are located close to the cane fields. The cane is then converted into raw sugar which is shipped to a refinery for further processing. Refineries, which operate throughout the year, remove the film of molasses and impurities that surround the sugar crystals (Benirschka et. al., 1996). Sugar beets are an annual crop grown in temperate climate zones. Because of disease problems, sugar beets are always grown in crop rotations. Like sugarcane, sugar beets are bulky and costly to transport, and thus, processing facilities tend to be close to the fields. Unlike sugarcane, beets are directly processed into refined sugar, and hence, raw sugar is a product of sugarcane only (Benirschka et. al., 1996). Raw and refined sugar are two distinct goods, and both are traded internationally. Sugar beet producing countries export only refined sugar, while sugarcane producers may export either raw, refined, or both (Benirschka et. al., 1996). In fiscal year 1999, cane sugar comprised 75% of total world sugar production. The top five sugar producers for that year were Brazil, the European Union, India, China, and the United States, respectively. The top five exporters were Brazil, the European

Union, Australia, Thailand, and Cuba, respective ly, while the top importers were Russia, the United States, the European Union, Japan, and Indonesia (Coalition for Sugar Reform, 2000). It should be noted that the European Union imports sugar due to obligations under the Lome Agreement, but is a net exporter (Benirschka et. al., 1996). In most years, over 70 percent of world sugar production is consumed domestically, implying that only a small proportion of world production is traded on the world market. Also, a significant share of this trade is the result of bilateral longterm agreements or on preferential terms such as the U.S. sugar quota or the E.U. Lome Agreement. Since only a small portion of world production is traded freely, small changes in production or government policies tend to have la rge effects on world sugar markets, and sugar prices are among the most unstable in international trade. Figure 1.1 shows quarterly Caribbean and U.S. sugar prices from 1985 to 2000, which illustrates the volatility in world prices. The Caribbean raw sugar price is usually Quarterly Caribbean and U.S. Raw Sugar Prices, 1985-2000
U.S. Cents/Pound
25 20 15 10 5 0
-1 00 -1 99 -1 98 -1 97 -1 96 -1 95 -1 94 -1 93 -1 92 -1 91 -1 90 -1 89 -1 88 -1 87 -1 86 -1 85
US Raw World Raw

Quarter

Figure 1.1. Quarterly Caribbean and U.S. raw sugar prices, 19852000, in U.S. cents per pound.

considered to be the world market price for sugar. One reason for volatile world prices could be the asymmetric supply response to price changes due to high fixed costs of production. An increase in sugar production in response to rising prices requires significant investment in processing facilities, which take time before becoming available. Once in place, however, they tend to be used at capacity to spread fixed costs. Therefore, when prices fall, production remains high. In short, sugar production is relatively price inelastic in the short run, implying that relatively small changes in demand can have significant price effects. Government policies may aggravate this instability by insulating domestic producers and consumers from world price fluctuations. Since price signals are not transmitted to domestic markets, domestic supply and demand are not responsive to changing world conditions. In addition to increasing world market instability, sugar policies can alter sugar production by stimulating production in countries that would produce less or no sugar in the absence of policy. Thus, production, consumption, and trade flows often reflect domestic sugar policies rather than comparative advantage (Benirschka et. al., 1996). Cuba Trade between the United States and Cuba has been non-existent since President Eisenhower enacted a complete economic embargo in late 1960, in response to Cubas nationalization of numerous American properties. It was believed that this action would strangle the Cuban economy and force Castro from power. However, this was largely avoided through aid from Moscow. The fall of the Soviet Union in the late 1980s crippled the Cuban economy, but it appears that a slow recovery has begun. The island has begun to take on more free-market characteristics, attracting

foreign investment through joint ventures, profit sharing, profit repatriation, and tax exemption. As a result, Australian, British, Canadian, Chilean, Mexican, and Spanish firms have expanded to Cuba. By the mid-1990s, the number of foreign firms operating in Cuba increased fourfold since 1987 to five hundred. Trade relations have also opened between Cuba and China, Italy, Jordan, North Korea, and Vietnam. The governments of Brazil, Chile, and Mexico have extended credit lines to Cuba. The tourism industry has also expanded as Australian, German, and Spanish firms have engaged in joint ventures with the Cuban government in this capacity (Leonard, 1999). Thus, it appears that the United States policy of economic strangulation of Cuba has been ineffective in unseating Castro, and may result in costing the United States economy a share of the quickly growing Cuban market. Prior to the embargo, the United States was a major importer of Cuban sugar, tobacco, and citrus fruits, while the United States supplied the island with machinery, spare parts, railroad harbor equipment, communications technology, and consumer goods. It is very likely that a resumption of trade today would bring about a very similar trade relationship (Leonard, 1999). However, some American agri-business leaders see little promise in Cuba. In 1995, Jim Thrift, spokesman for American Cyanamid, argued that Even if Cuba opened up for American business, wed wait a long time because of issues related to instability, credit, and collection. The countrys collapsed. However, Archer-Daniels-Midland CEO Dwayne Andreas, an early supporter of trade with the former Soviet Union, argued that open commerce is the most reliable way to bring democracy and prosperity to Cuba. Andreas cited seed, equipment, and fertilizer firms as major beneficiaries to open trade (Heuer, 1995).

Of course, most of the Cuban debate within the United States is economic at all, but rather, political. Positions are divided between two groups. The first group favors an intensification of the embargo. Alarmed by Cubas success in building trade and investment relationships with Canadian, European, and Latin-American partners, this group wants to give the embargo extra-territorial force. The second group, composed of more moderate opinions, believes that there is no need to intensify the embargo, and in some cases, favor easing it. Of all U.S. sanctions, the inclusion of food and medicine is unique to the Cuban embargo. The embargo against Cuba is even tighter than those against Iraq, Iran, and Serbia. Even some extremists find this both disproportionate and inhumane (Mead, 1995). Only a small number of Americans have any first-hand knowledge of Cuban conditions and views, and the result is a heated policy debate that does not provide much guidance. The degree of American hostility remains a central preoccupation in Havana, but Cuba is of marginal concern within the United States. A small but vitally interested pressure group still largely shapes United States policy towards Cuba. Before 1959, this pressure group was composed of American investors and expatriates in Cuba. Since the Cuban revolution, the group has been dominated by Cuban migrs. However, before and since Castro assumed power, American policy towards Cuba has been left to special- interest groups whose agendas were not always in the interests of either nation, and it is likely that they will continue to dominate CubanAmerican relations in the future (Mead, 1995). Lifting the United States embargo on Cuba will present many economic and political issues for both sides. Of great importance will be issues concerning the sugar

sector, given its dominant role in the Cuban economy, and the historical protection afforded American sugar producers through the United States sugar program. The main issue, when the embargo is finally lifted, will not be whether Cuban sugar will again be imported, but rather in what manner and to what degree. As Alvarez (1992) points out, Since sugar exports are the main source of Cuban foreign exchange, it is not unlikely that some type of provision may need to be made by the U.S. Congress for sugar imports from Cuba. The 1965 amendment to the Sugar Act reallocated the 50 percent Cuban share of American sugar requirements on a pro-rata basis to other quota-holding countries. Cuban sugar exports to the United States were 2.94 million metric tons in 1959. Also, 1.95 million MT had been exported to the United States when trade was suspended in July of 1960 (Alvarez, 1992). However, the average annual amount of sugar exported to the United States from Cuba during 1958 and 1959 represents twice the amount of total United States sugar imported today. This is due to increased domestic production and the advent of other caloric sweeteners (Alvarez and Castellanos, 1995). Thus, it is improbable that Cuba could be given its original quota level. In the case of Nicaragua, Panama, and South Afr ica, however, Congress reinstated sugar quotas withheld for political reasons at levels that reflected current United States import requirements (Alvarez and Castellanos, 1995). Cuban sugar production in fiscal year 1999 exceeded earlier expectations at an estimated 3.78 million metric tons, more than the original target of 3.6 million, which was the previous years production level. Despite the years higher crop, production remained well below the 7 million tons that Cuba experienced during the Cold War. The successful 1999 crop represents an important psychological boost for Cubas

sugar economy, which has been struggling to recover from drastic output declines due to over-harvesting and shortages of spare parts, fertilizer, and fuel. These problems are inherent in the present system, and thus, will not easily disappear. However, further gains are possible due to changes in management strategy, which have resulted in efforts to increase efficiency in all production aspects. Also, strict directives ha ve been issued which prohibit the cutting of young cane. In addition, some improvements may have occurred by utilizing only the more efficient mills and by reducing costs throughout the industry from field to mill. Even with increased production, though, revenue from sugar will fall as a result of low world market prices (F.O. Licht, 1999). Cuban consumption is estimated at 730,000 MTRV for fiscal year 2000, a ten thousand ton increase from the previous years estimates (USDA-ERS, 2000). Mexico The outlook for the Mexican economy continues to improve after the uncertainty caused by the economic crises in Russia, Asia, and Brazil during the latter part of 1998 and early 1999. The recent increase in oil prices combined with Mexicos conservative fiscal and monetary policies have led to considerable strength in the Mexican economy. Mexicos exports increased about 24.5 percent in nominal terms during the first six months of 2000, relative to those of the same period for 1999. Imports rose by about 25 percent during the same period. High oil prices and a robust U.S. economy are the primary reasons for these improvements. The United States remains, by far, the most important market for Mexicos exports (87 percent in

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1999), imports (74 percent), and its main source of foreign short- and long-term capital (FAS, 2000). Industry sources estimate sugar production for marketing year 2000 as 4.98 million metric tons raw value (MTRV), very close to 1999. This estimate is based on the relatively good weather experienced during the growing season, but also accounts for the drier-than- normal weather that reduced some yields. Presently, the sugar industry faces excess capacity and financial problems. With almost no sources of credit, cash flow problems, and high sugar inventories, sugarcane workers did not receive June and July wages for 2000. To help the industry and prevent unrest, Bancomext, working through FINASA (the Mexican Sugar Financing Bank) approved a financial assistance program. According to private sources, however, very few mills have benefited because the loans had to be paid back by November 30, 2000. In addition, the Mexican government decided to liquidate FINASA, which means that there will be no special access to credit for the sugar industry (FAS, 2000). However, a December 2000 proposal in the Mexican House of Representatives seeks to develop a national sugar agro- industry, in which the whole chain of productionplanting, industrialization, and tradingwould be of national interest. This law would also create a National Sugar Institute responsible for the development of policies, strategic planning for the sector, domestic reserves, financial strategies, prices, distribution, and trade (FAS, 2001). Sugar consumption for marketing year 2000 is estimated to continue at 4.4 million metric tons. The lack of growth is attributed to the increased use of alternative sweeteners. Private sources indicate that refined sugar consumption by the soft drink

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industry for 2000 was between 1 and 1.2 million metric tons. This industry also consumes between 200,000 and 250,000 metric tons of high- fructose corn syrup. The remainder of HFCS is used by the bakery, food processing, fruit and juice canning, and yogurt industries. As sugar becomes more expensive and HFCS prices fall (currently, tariffs on HFCS range between US$55 and US$175 per metric ton, in addition to the normal 4% ad-valorem duty), sweetener use could change dramatically. Sugar exports for marketing year 2000 are approximately 540,000 metric tons. Domestic sugar prices, although low, are higher than international prices. Thus, exports are a double-edged swordthey are necessary to reduce storage costs, but unprofitable due to low world prices (FAS, 2000). This could change, however, given the increased access to the U.S. market by the NAFTA. Mexico and the United States underwent difficult negotiations due to the ambiguous nature of the original NAFTA document and a side-letter allowing different quantities of Mexican sugar to enter the United States. As of October 2000, no agreement had been reached and Mexico had filed for a NAFTA dispute resolution panel. Mexican sugar producers, however, have requested that the government close the border to U.S. HFCS. On September 19, 2000, the USDA announced the fiscal year 2001 tariff-rate quota allocations for sugar, in which Mexico was allocated 105,788 metric tons, to comply with the NAFTA. Mexico believes it should have complete access for all of its excess sugar, which it estimates at over 500,000 metric tons.

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United States The 1996 U.S. sugar program continues to differ from the grains, rice, and cotton programs in that the USDA makes no income transfers to beet or cane growers. Instead, the incomes of producers are indirectly supported by limiting the amount of imported sugar through import quotas (Jurenas, 1999). The sugar programs provision of no net cost to the federal government also brought about the use of the import quota to support domestic prices and prevent loan forfeitures (Uri and Boyd, 1994). Quota allocations are given to quota- holding countries which allow the import of specific quantities of sugar produced in those nations at a first-tier, or low-tier, duty rate, which ranges from zero to 0.625 U.S. cents per pound. The USDA sets the TRQ at the beginning of the fiscal year, and the U.S. Trade Representative makes an initial amount available for allocation. Three of these TRQ allocations are made in January, March, and May if the ending fiscal year stocks-to- use ratio projection is below 15.5 percent. Consequently, if the ending fiscal year stocks-to-use ratio projection is above 15.5 percent, one or more of the allocations will be cancelled (Henneberry and Haley, 1998). Imports above the allocated tariff-rate quota from either the quota-holding countries or other countries are subject to a second-tier, or high- tier, duty. This hightier duty has historically been high enough to discourage the importation of sugar above the low-tier quota (Henneberry and Haley, 1998). However, the high-tier duty is subject to reductions under the Uruguay Round of the General Agreement on Tariffs and Trade. As Table 1.1 shows, the high- tier rate is decreasing fifteen percent over six years to 15.36 U.S. cents in 2000 (ASA, 1999).

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The U.S. market access commitment made during the Uruguay Round of the GATT guarantees that a minimum of 1.1394 million metric tons of foreign sugar be allowed to enter the United States annually (See Table 1.2). No provision limits the Table 1.1. High-tier sugar tariffs of most countries compared to those of Mexico, in U.S. cents per pound. U.S. High-Tier Tariffs for Raw and Refined Sugar Most Countries Mexico Raw Raw Refined Refined Cane Cane Base 18.08 19.08 16.00 16.95 1994 NA NA 15.60 16.53 1995 17.62 18.60 15.20 16.11 1996 17.17 18.12 14.80 15.69 1997 16.72 17.65 14.40 15.26 1998 16.27 17.17 14.00 14.84 1999 15.82 16.69 13.60 14.42 2000 15.36 16.21 12.09 12.81 2001 15.36 16.21 10.58 11.21 2002 15.36 16.21 9.07 9.61 2003 15.36 16.21 7.56 8.01 2004 15.36 16.21 6.04 6.41 2005 15.36 16.21 4.53 4.81 2006 15.36 16.21 3.02 3.20 2007 15.36 16.21 1.51 1.60 2008 15.36 16.21 0 0 Source: Lord (1994). ability of U.S. policymakers to allow additional sugar to enter, if necessary, to meet domestic demand (Jurenas, 1999).

Table 1.2. Provisions of Uruguay Round agreement pertaining to sugar (ASA, 1999). Uruguay Round: Agreement on Agriculture Reduction Effect on U.S. Sugar Tariffs 36% average; High-tier tariff drops 15% over 6 years 15% minimum to 15.36 cents in 2000. Market Import restrictions reduced to TRQ has minimum of 1.1394 million MT Access ensure at least 3-5% (well in excess of 3-5% minimum). consumption from imports. Source : ASA (1999).

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Mexico faces different import rules under the NAFTA, implemented in January, 1994 (See Table 1.3). During the first six years, the United States reduced its high-tier tariff rate by fifteen percent (See Table 1.1). At the same time, Mexico was to align its tariff regime with that of the U.S. During the remaining nine years, U.S. and Mexican tariffs on bilateral sugar trade will be linearly reduced to zero. Mexicos duty- free quota from 1994-1999 was the greater of: 7,258 metric tons; the other Table 1.3. Provisions of the NAFTA pertaining to sugar (ASA, 1999). NAFTA Sugar Provisions Mexican Access to U.S. Provisions Years 1-6 (1994-1999) Mexico not surplus producer Greater of 7,258 MT or "other country" share of import quota. Mexico surplus producer 25,000 MT Years 7-14 (2000-2007) Mexico not surplus producer Greater of 7,258 MT or "other country" share of import quota. Mexico surplus producer 250,000 MT Sugar production minus sugar and HFCS Surplus producer definition consumption.

country share of the import quota under the current sugar program; or the quantity allowed under the definition of net surplus producer. In any of these years that Mexico reached net surplus producer status (production exceeding consumption, including corn sweeteners), duty- free access was provided, up to 25,000 metric tons. For years 2000-2008, that figure jumps to 250,000 metric tons. After the fifteen year transition period, there will be free trade in sugar between the two countries (USDAFAS, 1998). U.S. sugar production for fiscal year 2000 is estimated at a record 8.2 million MTRValmost 635,000 MT more than 1999. One reason for this increase is record

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area harvested, spurred by higher expected returns compared with substitute crops. Also, sugar yields in Louisiana, which now surpasses Florida in sugarcane acreage, have risen more than 34 percent since 1995 as more acreage is devoted to highyielding varieties (USDA-ERS, 2000). Total U.S. sugar production for fiscal year 2001 is presently projected at 7.75 MTRV, much lower than the previous year estimates. Beet sugar production for fiscal year 2001 is currently projected at 3.96 million MTRV, while cane sugar production is projected at 3.78 million MTRV. Production increases in Florida, Texas, and Puerto Rico are expected to more than offset declines in Louisiana and Hawaii. Although Louisiana sugarcane area harvested has increased 35,000 acres over last year, sugarcane production is estimated down 250,000 MT due to a continuing lack of adequate moisture. Hawaii cane sugar production for fiscal year 2001 is projected at 240,000 metric tons. One of the three remaining Hawaiian sugar companies ceased operations in November 2000, and another closed a processing facility. Sugar imports under the raw and refined sugar tariff- rate quotas (TRQs) are currently projected at 1.157 million MTRV. As of January 8, 2001, sugar imports under the TRQs have amounted to 288,215 MTRV, or about 25 percent of the amount projected to enter for the fiscal year. Sugar imports outside the sugar TRQ for fiscal year 2001 are projected to total 467,200 MTRV including 331,000 MTRV under the combined Refined Sugar Re-export Program, the Sugar-Containing Products Program, and the Polyhydric Alcohol Program. Sugar exports under the Refined Sugar Re-export Program for FY 2001 are projected at 158,750 MTRV. Total deliveries for the fiscal year are projected at 9.421 million MTRV. After subtracting deliveries made for the Sugar-Containing Products and

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Polyhydric Alcohol Programs and deliveries for livestock feeding, domestic food and beverage deliveries are projected at 9.276 million MTRV, about 2.3 percent higher than fiscal year 2000. Ending stocks are currently projected at 1.987 million MTRV, for an ending stocks-to-use ratio of 18.8 percent. Of the total, the Commodity Credit Corporation (CCC) owns 39.9 percent. The CCC acquired 720,004 MTRV in October 2000 as a result of loan forfeitures (USDA-ERS, 2001).

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CHAPTER TWO: LITERATURE REVIEW This literature review summarizes recent studies focusing on trade liberalization with respect to sugar. It is organized into two categories: domestic studies, which focus only on the U.S. sweetener sector, and international studies, which include other countries within the models. Sigua (1992) analyzed the effects of partial sugar trade reform on regional production, consumption, trade, and consumer welfare in the United States. Three less-protective trade policies were compared with the sugar loan rate program of 1989. These scenarios were simulated using the SWOPSIM model, and simulations were determined for the short, medium, and long run. Results indicated that the imposition of less- protective trade policies affected the sugarcane-producing regions more than that of sugar beets. Among beet regions, the Northwest and Far West experienced the most severe negative impacts from trade reform. With respect to sugarcane, Texas and Hawaii had the greatest negative response to raw sugar production. All scenarios implied positive consumer surplus due to reduced prices. Also, shifts in demand for raw sugar due to changes in HFCS use were small, suggesting that relaxing sugar policy did not discourage the substitution of HFCS for raw sugar. Haley (1998) models regional sugar processing and uses detailed sectoral analysis of sweeteners demand using an Almost Ideal Demand System approach. He assumes a total elimination of sugar policy to estimate the cost on the U.S. economy. He creates two scenarios: the first, a status quo with the domestic price of raw sugar kept at 18.42 cents per pound with imports adjusted to retain this price, and the

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second, a simulation where the domestic price equals the world price. His results show a fall in the domestic raw sugar price of 4.3 cents, a decrease in refined price of 3.6 cents, while fructose price falls by 1.2 cents per pound. Also, domestic cane production falls by 1.5 million tons, with beet production dropping by just over 900,000 tons. Imports increase by 5.1 million tons, where supply of raw sugar increases by 2.7 million tons. Also, fructose production drops by 660,000 tons. Finally, demand for sugar increases by over 1.5 million tons. Tanyeri- Abur et. al. (1993), look at effects of sugar policy changes from a total agricultural sector perspective using a base-year, comparative-statics approach. They model HFCS and sugar as substitutes in beverages, confectioneries, baking, and canning. Also included are import possibilities for raw sugar as well as domestic demand and export possibilities for refined sugar, gluten feed (produced from corn along with HFCS), and HFCS. Their results show that removing the sugar quota leads to sharply reduced sugar prices (about a 29% drop) and more than a 50% decline in raw sugar production. Raw sugar imports rise by more than five- fold. Additionally, HFCS price falls by 5% and production decreases by almost two-thirds of the baseline. Thus, quota elimination enhances raw sugar refining along with refined sugar consumption and processing, while greatly curtailing domestic sugar production. Also, HFCS loses its competitive position. Uri and Boyd (1994) examined the effect of the sugar tariff-rate quota program on the U.S. economy, using a computable general-equilibrium model. Their analysis suggests that a complete elimination of the sugar program would reduce output for all producing sectors by about $2.85 billion. For production sectors other than

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agricultural program crops, crude oil, and petroleum refining sectors, output would increase by about $2.98 billion. Also, there would be an increase of about $197 million and $121 million in the consumption of goods and services and in welfare, respectively. Additionally, government revenue would decrease by roughly $15 million. Devadoss et. al. (1995), used a non-spatial, partial-equilibrium world sugar trade model to analyze the trade creation and diversion effects of the NAFTA on U.S. sugar imports from Mexico. Their results show that the agreement will have a mild negative effect on U.S. suga rcane and sugarbeet production, with an average annual decrease of 0.02% and 0.7%, respectively. Also, the effect on sugar consumption in Mexico will be relatively small, although total caloric sweetener consumption will increase significantly. They attribute this to increased availability of high- fructose corn syrups (HFCS) from the U.S. market that will be substituted for sugar. They also predict an average increase in Mexican production of about 11.4%, caused by Mexicos opportunity to import improved U.S. technology, lower-priced inputs such as fertilizer, and the increased availability of U.S. capital to modernize Mexican production facilities. U.S. sugar demand would increase to about eleven million metric tons by 2007, as a result of price declines and income increases. They also predicted that in 1996 and 1997, the U.S. would reduce its imports from other countries by 5,690 MT and 4,750 MT, respectively. Actual figures show a much larger decrease in quota allocations (USDA-ERS, 1999). They also predict that Mexican imports will increase modestly beginning in 2000, and by 2005, Mexico will export the maximum amount of 250,000 MT to the United States. Consequently, other quota-holding

20

nations will see a more prominent decrease in market access during these latter stages due to the higher Mexican export quota. Benirschka and Koo (1997) used a dynamic partial equilibrium model of the world sugar market to study the effects of United States tariff- rate quota liberalization. A scenario increasing the import quota annually by 10 percent increases U.S. imports by 32 percent, while decreasing the U.S. import price by 16.3 percent of baseline projections. In response to lower prices, American production falls by 2.7 percent: beet production falls by 4.4 percent while cane declines by 0.6 percent. The Caribbean raw sugar price rises by 1.4 percent, while quota rent for exporters with United States quota allocations declines by 12.4 percent. The General Accounting Office (2000) estimated welfare gains and losses due to the U.S. sugar using Iowa State Universitys Center for Agricultural and Rural Development (CARD) world sweetener model. This model includes 29 sugarproducing nations, and was extended to include a more detailed, multi- market approach, including corn and feed, sugar, and HFCS. Results showed that the U.S. wholesale refined price falls 38.3% of the 1998 base, while the world refined price falls 21.8%. Sugarcane production falls only 1.7%, while sugar beet production falls 6.4%. These production results were undoubtedly a function of the supply elasticities used during the simulation, which were 0.05 and 0.10 for sugarcane and sugar beets, respectively. They also estimated that the U.S. sugar program cost domestic sweetener users $1.9 billion in 1998, while gains to sugarcane and sugar beet producers were about $1 billion.

21

Koo (2000) investigated the implications of a trade liberalization scenario in which the United States eliminates import restrictions while other countries maintain their respective sugar programs. Koo developed a global sugar policy simulation model to analyze major issues facing the U.S. sugar industry and the impacts of alternative trade liberalization policies in the United States and European Union. This model used a base and alternative scenarios approach, and disaggregated the world sugar market into three sectors composed of seventeen countries: beet sugar, cane sugar, and beet and cane sugar producing countries. Results show an increase in the Caribbean raw sugar price of about 36 percent, and a 28 percent decrease in the United States wholesale price for the 2001-2004 period. When the United States includes Cuba as a trading partner, the Caribbean raw price rises only 32 percent and the United States wholesale beet price falls 30.6 percent. This is primarily due to the fact that Cuba can supply large amounts of sugar to the United States at lower shipping costs.

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CHAPTER THREE: THEORETICAL AND EMPIRICAL FRAMEWORKS Theoretical Framework Consider the initial market model utilized by Mah et. al. (1988), Johnson et. al. (1992), and Kennedy (1994) in which N commodities are produced, consumed, and traded by K countries. Vectors of supply, demand, and excess demand are used to describe aggregate levels of production, consumption, and trade in each country. The supply sector in country k produces some combination of the N commodities in order to maximize producer rents, given prices, technology, and endowments. Aggregate production of the N commodities is describ ed by the vector of supply functions:

(3.1)

Sk (PSk ; ZSk ) = [S1k (PSk ; ZSk ), S2k (PSk ; ZSk ), , SNk (PSk ; ZSk )],

where P Sk = (PS1k, PS2k , , PSNk) is the vector of prices observed by the supply sector and ZSk is a vector of exogenous variables, such as technology, input prices, and endowments for the supply sector of country k. The vector of demand functions describes aggregate consumption of the N commodities:

(3.2)

Dk (PDk ; ZDk ) = [D1k (PDk ; ZDk ), D2k (PDk ; ZDk ), , DNk (PDk ; ZDk )],

where PDk = (PD1k, PD2k , , PDNk) is the vector of prices observed by the final demand sector and ZDk is a vector of exogenous variables for country k. The aggregate level of trade in the N commodities for country k is described by the excess demand functions:

23

(3.3)

Mk (PSk , PDk ; ZSk , ZDk ) = Dk (PDk ; ZDk ) - Sk (PSk ; ZSk )

where Mk = (M1k , M2k , , MNk) and Mik > 0 indicates net imports and Mik < 0 indicates net exports of commodity i for i = 1, 2, , N. The government of a country may intervene in the domestic market either through the use of price ( ) or supply/demand shift ( ) instruments. A price instrument, denoted as A Sik for producers and A Sik for consumers of commodity i in country k, affect the prices observed by the supply and final demand sectors. With the world price of commodity i represented as PW i , the domestic price functions for country k are:

(3.4)

PSik = PSik (ASik , PW i) and PDik = PDik (ADik , PW i)

for i = 1, 2, , N. Supply/demand shift instruments, denoted as A Sik for producers and ADik for consumers of good i in country k, are implicit elements of vectors ZSk and ZDk which shift supply and demand functions by modifying non-price elements of a producers or consumers decision- making process. Examples include input subsidies, acreage reduction schemes, and food stamps. To make these supply and demand shifters explicit, the vectors ZSk and ZDk are defined as follows:

(3.5)

ZSk = ZSk (A Sk , Z*Sk ) and ZDk = ZDk (ADk , Z*Dk ).

24

The aggregate supply, demand, and excess demand equations, (3.1), (3.2), and (3.3), respectively, can be expressed as functions of world price, policy instruments, and exogenous variables by substituting the domestic price functions (3.4) and the function of explicit variables (3.5) to obtain:

(3.1*) Sk [PSk (ASk , PW ), ASk ; Z* Sk ], (3.2*) Dk [PDk (ADk , PW ), ADk; Z*Dk ], and (3.3*) Mk [PSk (ASk , PW ), PDk (ADk , PW ), ASk , ADk ; Z*Sk , Z*Dk ]

where PHk (AHk , PW ) = [PH1 (AH1 , P W ), PH2 (AH2 , PW ), , PHN (AHN, PW )] for H = S, D. World markets are competitive by assumption, and world prices adjust to clear world markets. Therefore:

(3.6)

Kk=1 Mk [PSk (ASk , PW ), PDk (ADk , PW ), ASk , ADk ; Z*Sk , Z*Dk ] = 0

where the right-hand side of (3.6) is an n x 1 null vector. World prices are defined as functions of the actions of individual countries. Thus, the world price vector is the function: (3.7) PW = PW (ASk , ADk , ASk , ADk ; Z*Sk , Z*Dk )

for k = 1, 2, , K.

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Empirical Framework The empirical framework is provided by the Modle Internationale Simplifi de Simulation (MISS), developed by Mah, Tavra, and Trochet (1988). It is a multiproduct, multi-regional, non-spatial, partial-equilibrium, world trade model, which simulates, in a comparative-static framework, the effects of various policy actions. Mah et al. (1988) used the MISS for an analysis of the interaction between European and United States policies. The model consisted of seven commodities and four regions: the European Union, the United States, a market-based rest of the world, and a centrally-planned rest of the world. Lynn Kennedy (1994) utilized the MISS to study policy decisions made during the Uruguay Round of GATT negotiations. This model consisted of seven commodities and three sectors: the European Union, the United States, and the rest of the world. Kennedy and Hughes (1998) again used the MISS to analyze welfare effects of agricultural trading blocs, by simulating a North American customs union. Description of the Modle Internationale Simplifi de Simulation The following is a descriptio n of the notation used in the empirical model. Upper case letters represent variables of amount, while lower case letters denote a percentage change in the respective quantity variable. A variable with a naught superscript indicates a base-year value.

i: k:

commodity index: i = 1, , N; in this case, N = 1 country index: k = 1, , K; in this case, K = 4

26

Sik , Dik : PSik , PDik : E*ik : Gik : PW i : PBik : Wk : TSik , TDik : Ck :

production final demand, respectively, for good i in country k for the base year domestic prices for production and final demand, respectively, for good i in country k matrices of supply elasticities with respect to output prices matrices of final demand elasticities with respect to consumer prices world price of good i border price of good i margin coefficient representing transportation costs, e.g., freight, insurance, etc., such that PBik = PW ik Wk protection coefficients for production and final demand, respectively, such that THik = PHik P Wik , for H = S, D currency exchange rate, represents number of currency units in country k which can be exchanged for one US Dollar initial world stock of good i quantity shifters for production and final demand, respectively, for good i in country k

Ii s ik , d ik :

The MISS uses several identities in order to derive the effects of policy changes on the sectors of production and final demand for the various countries. The model operates on the principle of Walrasian equilibrium. Any policy change undertaken by either country causes an adjustment in the world price levels, resulting in changes in supply and demand, and thus, a rebalancing of world trade. Initial equilibrium in the model is shown as (4.1) Sk Sik = Sk Dik + Sk Iik for all i = 1, , N.

27

Change in supply is shown as (4.2) sik = Sj (E*ik pSjk ) + s ik Change in final demand is shown as (4.3) qik = Sj Gik pDjk + ik for all i = 1,, N and k = 1,, K. for all i = 1,, N and k = 1,, K.

The domestic/world price linkage is shown by the equation (4.4) PHjk = PW j Ck THjk Wk or, in logarithmic terms, where Wk is fixed (4.5) PHjk = PW j + ck + tHjk for H = S, D.

Final equilibrium for the model, using the previous equations, is shown as (4.6) Ek Sik sik = Sk Dik dik for all i = 1, , N.

Application of Empirical Model The following discussion describes how the preceding empirical model was applied to the present problem. The model consists of four regions: Cuba, Mexico, the United States, and an aggr egated Rest of the World (hereafter referred to as ROW). In order to create a model in which cane sugar and beet sugar are perfect substitutes, only one commodity is specified within the model: refined sugar. The processes by which beet and cane become refined sugar are quite dissimilar and obviously more involved than this model specifies, and the reader is encouraged to consult the section on sugar production for more detail. However, this model assumes that the beet and cane sugar which is produced by the farmer eventually becomes refined sugar, and is sold to the consumer. Thus, by expressing beet and cane production in terms of sugar produced rather than beet or cane produced, the levels of supply can be directly compared to the levels of demand. Thus, the model assumes sugar is produced by the

28

farmer and sold directly to the consumer. However, to capture supply response differences between beet and cane production, two distinct production sectors, sugarbeet producers and sugarcane producers, are specified in each region which produce the same commodity. Of course, since Cuba and Mexico produce sugar from sugarcane alone, their respective levels of sugarbeet production are zero (Actually, Mexico has some sugarbeet production, but none has been reported since 1996). One demand sector is specified, which represents aggregate consumption of sugar by both industrial and non-industrial users. Since only one commodity is specified within the model, only one price is specified as well. This model makes use of the London Daily Price for refined sugar reported by USDA as the world refined sugar price. To model domestic price departure from world prices, protection coefficients are specified for each region. In the case of the United States, this coefficient is based on the U.S. wholesale refined beet sugar price, Midwest Markets, reported by Milling & Baking News and listed in the USDA ERS Sugar and Sweetener Situation and Outlook Reports (hereafter referred to as SSR). Since the United States utilizes an import quota to support domestic prices, protection coefficients for supply and demand are equal. This is also true of Mexico, which, beginning in the year 2000, is required under the NAFTA to implement a similar import control system. Mexicos protection coefficient is based on refined sugar prices reported in the USDA FAS GAIN Attache Reports (hereafter referred to as FAS). Cuba is assumed to respond to the world market price, and thus, has a protection coefficient of one. Exchange rates are specified within the model, and the U.S. Dollar is used as the base currency. Mexicos exchange rate is taken from monthly averages reported by the Federal Reserve. Since

29

Cubas exchange rate is not reported by the Federal Reserve, other sources were consulted. Benirschka et. al. (1996) expressed Cuban prices in U.S. Dollar terms rather than domestic currency. In addition, the online currency converter fxtop.com reports a Cuban exchange rate for U.S. Dollars of approximately one to one. Therefore, a one-to-one ratio was used concerning the exchange rate for Cuba. The rest-of-the-world region is also expressed in U.S. Dollar terms. For simplicity, transportation costs are assumed to be zero; therefore, each region has a margin coefficient of one. MISS does not specify beginning and ending stocks for each region. Rather, a general world stocks is specified, which accounts for world excess supply/demand in order to balance the model.

30

CHAPTER FOUR: DATA Prices and Quantities The data discussed above was taken from various sources, and is reported in the following tables. Table 4.1 contains production, supply, and distribution data for Cuba, Mexico, the United States, and the ROW, reported in SSR. Table 4.2 itemizes United States sugar trade, also taken from SSR. For this analysis, U.S. quota-exempt sugar for re-export is excluded from trade levels within the model since it is eventually re-imported and consumed domestically. Table 4.3 contains Mexican, United States, and world average monthly price levels for refined sugar. U.S. and world data were taken from SSR, while Mexican data were taken from FAS. Monthly levels are reported in local terms, while fiscal year averages are reported in both local terms and in US Dollars per metric ton. Table 4.4 contains average monthly exchange rates for the Mexican Peso reported by the Federal Reserve. Table 4.5 summarizes the quantity data used in the MISS. Elasticities The elasticities used in the empirical model were taken from outside sources. Table 4.6 summarizes various own-price elasticities reported for U.S. sugar supply and demand. They are categorized according to short-run, long-run, or term indefinite elasticities, as specified by the sources. Table 4.7 contains various own-price supply and demand elasticities for Cuba and Mexico. Table 4.8 contains ROW beet sugar production data reported by SSR and FAS, as well as own-price supply elasticites

31

Table 4.1. Production, supply, and distribution of sugar, FY 1999, in 1,000 MTRV. Production, Supply, and Distribution of Sugar, FY 1999 (1,000 MTRV)
Beginning Production Stocks United States Beet Cane Mexico Cuba ROW * Beet ** Cane ** Total 1,523 7,597 4,013 3,584 4,985 3,780 114,307 28,310 85,997 130,669 Imports 1,655 Exports 209 Domestic Consumption 9,079 Ending Stocks 1,487

670 290 23,309

0 0 34,265

590 3,200 31,921

4,400 720 110,158

665 150 28,341

25,792

35,920

35,920

124,357

30,643

All figures rounded to the nearest whole number * Calculated by subtracting US, Mexico, and Cuba from World Totals. Source: USDA Sugar and Sweetener S&O/SSS-228/May 2000 ** Taken from various FAS GAIN Reports.

Table 4.2. U.S. sugar trade for FY 1999, in 1,000 MTRV. U.S. Sugar Trade, Fiscal Year 1999 (1000 MTRV) Total Imports 1654.7 TRQ 1139.4 Canada, high-duty 165.1 Quota-exempt for re-export 339.3 Quota-exempt for polyhydric 10.9 alcohol Total Exports 209 Quota-exempt for re-export 209 Other 0 CCC disposal, for export 0 Source: USDA Sugar and Sweetener S&O/SSS-228/May 2000

reported by Tyers and Anderson (1992). Using the production levels, percentage shares of world production were calculated, and then used as weights for the respective elasticities to arrive at ROW own-price elasticities of supply. Table 4.9 accomplishes the same with respect to cane sugar production, while Table 4.10 does likewise with respect to ROW demand. Table 4.11 summarizes the own-price supply

32

and demand elasticities chosen for the model. Since sugarbeets and sugarcane do not compete for land, cross-price elasticities of supply were assumed to be zero. Also, since sugar is the only commodity within the model, there are no cross-price elasticities of demand.

Table 4.3. U.S., Mexican, and world refined sugar prices, FY 1999. U.S., Mexican, and World Refined Sugar Prices for Fiscal Year 1999 U.S. Wholesale Mexican Refined World Refined Cents/lb. Pesos/50 Kg. Cents/lb. Oct-98 26.90 244.41 10.00 Nov-98 27.00 250.01 10.78 Dec-98 27.00 245.77 10.97 Jan-99 27.20 250.22 10.99 Feb-99 27.13 251.28 10.50 Mar-99 27.00 241.93 9.85 Apr-99 27.00 239.00 8.79 May-99 27.00 233.35 9.13 Jun-99 27.00 242.83 9.93 Jul-99 27.00 251.83 9.47 Aug-99 27.00 243.62 9.04 Sep-99 27.00 239.71 8.28 FY 1999 27.02 244.50 9.81 US$/MT $595.52 $504.12 $216.21 Source: U.S. and World data taken from USDA ERS Sugar and Sweetener/SSS-229/September 2000. Mexican data taken from USDA FAS GAIN Report, Mexico Sugar Annual 2000.

33

Table 4.4. Monthly U.S. Dollar exchange rates for Mexican Peso, FY 1999. Monthly US Dollar Exchange Rates for Mexican Peso, FY 1999 US $1 = X Mexican Pesos October 1998 10.16 November 1998 9.97 December 1998 9.91 January 1999 10.13 February 1999 10.01 March 1999 9.73 April 1999 9.43 May 1999 9.40 June 1999 9.52 July 1999 9.37 August 1999 9.40 September 1999 9.34 FY 1999 Mean 9.70 Source : Federal Reserve Statistical Release, www.federalreserve.gov

Table 4.5. Base-year quantity data used in MISS, in 1,000 MTRV. Base-Year Quantity Data Used in MISS, 1,000 MTRV US Beet Supply Cane Supply Sugar Demand 4013 3584 9079 Mexico 0 4985 4400 Cuba 0 3780 720 ROW 28310 85997 110158

World Stocks * 6312 * MISS does not consider beginning and ending stocks. Rather, it uses 'world stocks' to balance the model. Source : USDA Sugar and Sweetener S&O/SSS-228/May & September 2000.

34

Table 4.6. U.S. own-price elasticities of sugar supply and demand. U.S. Own-Price Elasticities
Sugar Supply Beet Sugar Short-Run Elasticities Tyers and Anderson (1992) Lopez (1990) Lopez (1989) Sudaryanto (1987) * Leong (1985) * Long-Run Elasticities Tyers and Anderson (1992) Lopez (1990) Lopez (1989) Sudaryanto (1987) * Leong (1985) * Term-Indefinite Elasticities Devadoss et. al. (1995) Uri (1993) ** Tyers and Anderson (1992) Sigua (1992) # Gardiner et. al. (1989) Leu and Knutson (1987) *** Vroomen (1984) **** Cane Sugar Aggregate Sugar 0.07 0.246 0.479 0.7 0.103 0.231 0.17 0.16 0.28 0.354 1.201 2.29 0.254 0.579 0.74 0.32 0.054 0.89 -0.412 -0.597 -0.141 -0.1 Demand Sugar

0.215

-0.042 -0.5 -0.2 0.5 -0.24 -0.15 -0.114

0.51

0.297

0.28

0.135

* Taken from Sigua (1992) ** Taken from Uri and Boyd (1994) *** Taken from Tanyeri- Abur et. al. (1993) **** Taken from Messina and Seale (1993) # Average of reported regional elasticities

35

Table 4.7. Own-price supply and demand elasticities for Cuba and Mexico. Own-Price Supply and Demand Elasticities for Cuba and Mexico
Supply SR Cuba Tyers and Anderson (1992) Mexico Devadoss et.al. (1995) Tyers and Anderson (1992) (LR) Gardiner et. al. (1989) 0.13 LR 0.68 Termindefinite Demand

-1.4

0.891 0.15 0.45 0.2

-0.019 -0.85 -0.6

Table 4.8. ROW beet sugar production by country, as percentage of world total, and weighted own-price supply elasticities, in 1,000 MTRV, FY 1999. FY 1999 ROW Beet Sugar Production and Weighted Supply Elasticities , 1,000 MTRV
Country/Region Canada EU * Portugal & Spain Other W. Europe E. Europe Former Soviet Union Egypt Pakistan China Japan ROW Total Production 93 16222 1321 190 3897 3983 220 11 1693 680 28310 % of World Total 0.33% 57.30% 4.67% 0.67% 13.77% 14.07% 0.78% 0.04% 5.98% 2.40% 100.00% Price Elasticities of Supply SR LR LR Weighted Weighted 0.1 0.0003 0.5 0.0016 0.1 0.0573 0.5 0.2865 0.14 0.0065 0.7 0.0327 0.16 0.0011 0.32 0.0021 0.05 0.0069 0.08 0.0110 0.11 0.0155 0.21 0.0295 0.1 0.0008 0.32 0.0025 0.1 0.00004 0.13 0.0001 0.15 0.0090 0.88 0.0526 0.1 0.0024 0.5 0.0120 0.0998 0.4307 SR

Source: Production data taken from USDA ERS Sugar and Sweetener S&O/SSS-229/May 2000. Data for countries producing both beet and cane taken from various USDA FAS GAIN Reports. Elasticities taken from Tyers and Anderson (1992).

36

Table 4.9. ROW cane sugar production, percentage of ROW total, and weighted own-price supply elasticities, by country, in 1,000 MTRV, FY 1999. FY 1999 ROW Cane Sugar Production and Weighted Own-Price Elasticities, 1,000 MTRV
Country/Region Argentina Brazil Other Latin America Caribbean Central America Other South America EU * Spain & Portugal Egypt S. Africa, Republic of Nigeria Sub-Saharan Africa N. Africa & Middle East N. Africa Middle East Bangladesh China Japan India Indonesia Pakistan Philippines Taiwan Thailand Other Asia Australia & Oceania ROW Total Production 1830 18300 8929 794 3195 4940 263 12 960 2808 16 3909 5087 1120 3967 165 7276 172 17436 1492 3780 1630 312 5386 919 5315 85997 % of ROW Total 2.13% 21.28% 10.38% 0.92% 3.72% 5.74% 0.31% 0.01% 1.12% 3.27% 0.02% 4.55% 5.92% 1.30% 4.61% 0.19% 8.46% 0.20% 20.28% 1.73% 4.40% 1.90% 0.36% 6.26% 1.07% 6.18% 100.00% SR 0.39 0.4 0.4 Supply Elasticities SR LR LR Weighted Weighted 0.0083 0.69 0.0147 0.0851 0.8 0.1702 0.0415 0.59 0.0613

0.1 0.14 0.1 0.1 0.17 0.17 0.1

0.0003 0.00002 0.0011 0.0033 0.00003 0.0077 0.0059

0.5 0.7 0.32 0.3 0.51 0.51 0.2

0.0015 0.0001 0.0036 0.0098 0.0001 0.0232 0.0118

0.25 0.15 0.1 0.12 0.3 0.1 0.13 0.2 0.35 0.1 0.1

0.0005 0.0127 0.0002 0.0243 0.0052 0.0044 0.0025 0.0007 0.0219 0.0011 0.0062 0.2330

0.51 0.88 0.5 0.46 0.59 0.13 0.68 0.4 1.5 0.2 0.5

0.0010 0.0745 0.0010 0.0933 0.0102 0.0057 0.0129 0.0015 0.0939 0.0021 0.0309 0.6233

Source: Production data taken from USDA ERS Sugar and Sweetener S&O/SSS-229/May 2000. Data for countries producing both beet and cane taken from various USDA FAS GAIN Attache Reports. Elasticities taken from Tyers and Anderson (1992).

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Table 4.10. ROW sugar consumption, percentage of ROW total, and weighted own-price elasticities of demand, by country, in 1,000 MTRV, FY 1999. FY 1999 ROW Sugar Consumption and Weighted Own-Price Elasticities of Demand
Country/Region Canada Argentina Brazil Other Latin America Caribbean Central America Other South America EU * Spain & Portugal Other W. Europe E. Europe Former Soviet Union Egypt Nigeria N. Africa & Middle East N. Africa Middle East S. Africa, Republic of Sub-Saharan Africa Bangladesh China India Indonesia Japan Korea Pakistan Philippines Taiwan Thailand Other Asia Australia & Oceania Total Consumption 1240 1520 9100 6530 674 1404 4452 12648 1709 542 4383 9560 1950 675 10403 2955 7448 1375 4048 460 9000 16977 2800 2313 1118 3210 1900 495 1825 3057 1320 110158 % of ROW Total 1.13% 1.38% 8.26% 5.93% 0.61% 1.28% 4.04% 11.48% 1.55% 0.49% 3.98% 8.68% 1.77% 0.61% 9.44% 2.68% 6.76% 1.25% 3.68% 0.42% 8.17% 15.41% 2.54% 2.10% 1.02% 2.91% 1.73% 0.45% 1.66% 2.78% 1.20% 100.00% Price Elasticities of Demand Reported Weighted -0.08 -0.0009 -0.6 -0.0083 -0.6 -0.0496 -0.6 -0.0356

-0.12 -0.24 -0.12 -0.8 -0.1 -0.8 -0.8 -0.5

-0.0138 -0.0037 -0.0006 -0.0318 -0.0087 -0.0142 -0.0049 -0.0472

-0.6 -0.8 -1 -1.5 -0.8 -1.2 -0.05 -0.8 -1 -1.4 -0.8 -0.7 -1 -0.18

-0.0075 -0.0294 -0.0042 -0.1226 -0.1233 -0.0305 -0.0010 -0.0081 -0.0291 -0.0241 -0.0036 -0.0116 -0.0278 -0.0022 -0.6442

Source: Consumption data taken from USDA ERS Sugar and Sweetener S&O/SSS-228/May 2000 and USDA FAS EU Attach Report, April 10, 2000. Elasticities taken from Tyers and Anderson (1992).

38

Table 4.11. Own-price supply and demand elasticities used in MISS. Own-Price Supply and Demand Elasticities Used in MISS Short-Run Elasticities Long-Run Elasticities Supply US Mexico Cuba ROW US Mexico Cuba ROW Beet 0.34 0.10 0.86 0.43 Cane 0.14 0.18 0.13 0.23 0.40 0.67 0.68 0.62 Demand US Mexico Cuba ROW US Mexico Cuba ROW Sugar -0.14 -0.73 -1.40 -0.64 -0.50 -0.73 -1.40 -0.64

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CHAPTER FIVE: TRADE LIBERALIZATION SCENARIOS Changes in import quotas are carried out in the MISS by specifying a percentage increase or decrease relative to a countrys base net-export level. Since current sugar policies utilize specific quantities, a percentage change was determined that corresponded to specific quantity levels. Eight trade liberalization scenarios were developed in which the United States import quota was gradually increased relative to the base year. These scenarios are carried out to simulate increased imports of sugar to the United States from both Mexico and Cuba. It should be noted that the levels of sugar imported under the tariffrate quota program, excluding Mexico, are held constant throughout all simulations. Since the MISS is a non-spatial model, the origin of the commodity is unknown. However, since sugar is a fungible commodity, it can be assumed that the effects on the U.S. market due to liberalization will be the same, regardless of origin. The world price is not sensitive to origin, either, due to the fungibility characterisitic. Any quantity of sugar diverted from the world market, ceteris paribus, would have the same effect on the world market, regardless of whether that sugar was from Cuba or any other nation. For example, suppose the United States increases domestic sugar supply by importing 1 million MT from Cuba. That means that 1 million MT of sugar is diverted from the world market, and the would-be buyer of the Cuban sugar must look to other sources, like Australia, for 1 million MT of sugar. Alternatively, suppose the United States increases domestic supply by importing 1 million MT of sugar from Australia. Again, 1 million MT of sugar is diverted from the world

40

market, and the would-be buyer of Australian sugar must turn to a different source, like Cuba, for 1 million MT of sugar. Either way, that sugar which is diverted from the world market is, theoretically, replaced by the would-be exporter. Another approach is to consider that the United States increases supply by importing 1 million MT of sugar from Cuba. Thus, 1 million MT is diverted from the world market, and, ceteris paribus, the world price rises and the U.S. domestic price falls. Alternatively, if the United States had imported the sugar from Australia, 1 million MT of sugar would have still been diverted from the world market, resulting in the same world and domestic price adjustments. Therefore, regardless of who is assumed to have exported sugar to an importing country, the supply, demand, and price effects are the same. The only difference is who gains from access to the higher-priced market, and this can simply be calculated outside of the model by multiplying the assumed quantity of sugar exported from a country by the simulated domestic price, to arrive at country-specific gains/losses. Table 5.1 summarizes the scenarios used for the study. Scenario 1 simulates Mexican accession into the U.S. market of 250,000 MTRV of refined sugar. Since the base year contains Mexicos previously allocated 25,000 MTRV, Scenario 1 imposes a quota increase of 225,000 MTRV. Scenario 2 simulates Mexicos accession of 250,000 MTRV, plus a quota allocation of 25,000 MTRV to Cuba. Scenarios 3 and 4 gradually increase Cubas allocation to 100,000, and 250,000 MTRV, respectively, holding constant Mexicos access of 250,000 MTRV. Scenario 5 simulates Mexico, under an unlimited access status, exporting 500,000 MTRV to the United States, while

41

Table 5.1. Scenarios simulated in MISS. Scenarios Simulated in MISS U.S. Import Quantity Allocated (MT) Scenario Cuba Mexico Total Base 0 25,000 25,000 1 0 250,000 250,000 2 25,000 250,000 275,000 3 100,000 250,000 350,000 4 250,000 250,000 500,000 5 100,000 500,000 600,000 6 250,000 500,000 750,000 7 500,000 500,000 1,000,000 8 750,000 750,000 1,500,000

Cuba is allocated 100,000 MTRV. In Scenario 6, Cubas allocation is increased to 250,000 MTRV, and in Scenarios 7 and 8, both Cuba and Mexico are allocated 500,000 and 750,000 MTRV each, respectively. Simulation Results: Prices, Supply, and Demand Table 5.2 summarizes U.S. and world refined sugar price changes relative to the base in cents per pound, dollars per metric ton, and percentage terms, using both short- and long-run supply elasticities. Table 5.3 summarizes U.S. supply and demand changes relative to the base, in both metric tons and percentage terms . Further, Table 5.4 summarizes Cuban supply and demand changes relative to the base, in both metric tons and percentage terms. Since ROW quantities and percentage changes are of minimal concern, they are not discussed, but are reported in Table 5.5. The following discussion addresses each scenario, and its effect on prices, production, and consumption. Again, all percentage changes discussed are relative to the base. Since no policy changes are simulated for Mexico, and since Mexicos domestic price is protected from the world market, they experience no production or

42

consumption changes throughout all simulations. Mexicos increase in imports to the United States is a case of trade diversion, rather than trade creation. Counterintuitively, this could be viewed as the removal of trade diversion resulting from the initial U.S. policy. Table 5.2. Refined sugar price changes relative to the base, in 1,000 MTRV . Refined Sugar Price Changes Relative to the Base (1,000 MTRV)
United States Refined Sugar Price Using Short-Run Elasticities Using Long-Run Elasticities U.S. Quota Scenario % Level Cents/lb. $/MT Cents/lb. $/MT % Change Change Base 25 26.98 594.58 26.98 594.58 1 250 25.10 553.19 -6.96% 26.00 572.99 -3.63% 2 275 24.90 548.74 -7.71% 25.89 570.62 -4.03% 3 350 24.31 535.83 -9.88% 25.57 563.60 -5.21% 4 500 23.15 510.27 -14.18% 24.93 549.45 -7.59% 5 600 22.42 494.09 -16.90% 24.51 540.23 -9.14% 6 750 21.35 470.55 -20.86% 23.89 526.50 -11.45% 7 1000 19.67 433.39 -27.11% 22.86 503.84 -15.26% 8 1500 16.66 367.15 -38.25% 20.88 460.14 -22.61% World Refined Sugar Price Using Short-Run Elasticities Using Long-Run Elasticities % Cents/lb. $/MT Cents/lb. $/MT % Change Change 9.81 216.21 9.81 216.21 9.83 216.73 0.24% 9.83 216.55 0.16% 9.84 216.79 0.27% 9.83 216.60 0.18% 9.84 216.95 0.34% 9.83 216.71 0.23% 9.86 217.29 0.50% 9.84 216.95 0.34% 9.87 217.53 0.61% 9.85 217.10 0.41% 9.89 217.87 0.77% 9.86 217.34 0.52% 9.91 218.46 1.04% 9.88 217.73 0.70% 9.96 219.62 1.58% 9.91 218.51 1.06%

Scenario Base 1 2 3 4 5 6 7 8

U.S. Quota Level 25 250 275 350 500 600 750 1000 1500

Simulation Results: Using Short -Run Elasticities Scenario 1 simulates Mexicos accession into the U.S. sugar market of 250,000 metric tons. The U.S. refined sugar price falls 6.96% relative to the base, to 25.1 cents

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per pound. The world refined price rises slightly, by 0.24%, to 9.83 /lb. U.S. beet production drops by 2.42%, while cane production falls by 1%. U.S. demand rises by 1.02%, to 9.17 million MT. Cuba experiences mild changes due to the rise in world price, increasing cane production by 0.03%, while demand falls by 0.34%. Table 5.3. U.S. supply and demand changes relative to the base, in 1,000 MTRV. United States Supply and Demand Changes Relative to the Base (1,000 MTRV)
Scenario Base 1 2 3 4 5 6 7 8 Quota Level 25 250 275 350 500 600 750 1000 1500 Using Short-Run Elasticities Beet % Cane % Supply Change Supply Change 4013.00 3584.00 3915.89 -2.42% 3548.16 -1.00% 3905.05 -2.69% 3543.86 -1.12% 3873.35 -3.48% 3532.03 -1.45% 3809.54 -5.07% 3508.02 -2.12% 3768.21 -6.10% 3492.25 -2.56% 3706.01 -7.65% 3468.60 -3.22% 3604.08 -10.19% 3428.81 -4.33% 3406.23 -15.12% 3349.96 -6.53% Using Long-Run Elasticities Beet % Cane % Supply Change Supply Change 4013.00 3584.00 3887.39 -3.13% 3531.32 -1.47% 3873.35 -3.48% 3525.58 -1.63% 3832.42 -4.50% 3508.02 -2.12% 3749.75 -6.56% 3472.54 -3.11% 3695.57 -7.91% 3449.24 -3.76% 3614.51 -9.93% 3413.76 -4.75% 3480.47 -13.27% 3354.27 -6.41% 3219.23 -19.78% 3234.92 -9.74% Demand % Change 9079.00 9171.61 9181.59 9212.46 9275.11 9317.78 9381.33 9490.28 9712.71 1.02% 1.13% 1.47% 2.16% 2.63% 3.33% 4.53% 6.98%

Scenario Base 1 2 3 4 5 6 7 8

Quota Level 25 250 275 350 500 600 750 1000 1500

Demand % Change 9079.00 9126.21 9131.66 9147.09 9179.78 9201.57 9235.16 9292.36 9410.38 0.52% 0.58% 0.75% 1.11% 1.35% 1.72% 2.35% 3.65%

Scenarios 2, 3, and 4 hold constant Mexicos quota of 250,000 MT, and allocate 25,000, 100,000, and 250,000 MT, respectively, to Cuba. Scenario 2 results in a 7.71% drop in the U.S. price to 24.9 /lb. World price rises only 0.27% to 9.84 /lb. U.S. production falls by 2.69% for beets, and 1.12% for cane, while demand

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rises by 1.13%, to 9.18 million MT. Cuba increases supply by 0.04%, and demand falls by 0.38%. Scenario 3 results in a 9.88% drop in U.S. price, while the world price rises slightly to 9.84 /lb. U.S. production falls 3.48% for beets and 1.45% for cane, while demand rises 1.47%. Cuban production remains at 0.04% higher than the base, while consumption falls 0.47%. During Scenario 4, the U.S. price falls 14.18%, to 23.15 /lb., while the world price rises to 9.86 /lb. U.S. production falls 5.07% for beets, and 2.21% for cane, while demand rises 2.16%. Cuban supply rises by 0.06%, while demand falls by 0.7%. Table 5.4. Cuban supply and demand changes relative to the base, in 1,000 MTRV. Cuban Supply and Demand Changes Relative to the Base (1,000 MT)
Scenario Base 1 2 3 4 5 6 7 8 Using Short-Run Elasticities U.S Quota Cane Supply % Change Demand For Cuba 0 3780.00 720 0 3781.13 0.03% 717.55 25 3781.51 0.04% 717.26 100 3781.51 0.04% 716.62 250 3782.27 0.06% 714.96 100 3783.02 0.08% 713.88 250 3783.78 0.10% 712.30 500 3784.91 0.13% 709.63 750 3787.56 0.20% 704.38 Using Long-Run Elasticities Scenario Base 1 2 3 4 5 6 7 8 U.S. Quota Cane Supply % Change For Cuba 0 3780.00 0 3784.16 0.11% 25 3784.54 0.12% 100 3786.05 0.16% 250 3788.69 0.23% 100 3790.58 0.28% 250 3793.23 0.35% 500 3798.14 0.48% 750 3807.22 0.72% Demand 720.00 718.42 718.20 717.70 716.62 715.90 714.82 713.02 709.42 % Change -0.22% -0.25% -0.32% -0.47% -0.57% -0.72% -0.97% -1.47% % Change -0.34% -0.38% -0.47% -0.70% -0.85% -1.07% -1.44% -2.17%

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Table 5.5. ROW supply and demand changes relative to the base, in 1,000 MTRV. ROW Supply and Demand Changes Relative to the Base (1,000 MTRV)
Using Short-Run Elasticities Scenario Base 1 2 3 4 5 6 7 8 U.S. Quota Level 25 250 275 350 500 600 750 1000 1500 Beet Supply 28310.00 28315.00 28318.49 28318.49 28324.15 28326.99 28332.65 28338.31 28355.30 % Change 0.02% 0.03% 0.03% 0.05% 0.06% 0.08% 0.10% 0.16% Cane Supply 85997.00 86048.60 86048.60 86065.80 86091.59 86117.40 86151.80 86203.39 86306.59 % Demand Change 0.06% 0.06% 0.08% 0.11% 0.14% 0.18% 0.24% 0.36% 110158.00 109992.76 109970.74 109915.66 109805.50 109728.38 109618.22 109430.96 109056.42 % Change -0.15% -0.17% -0.22% -0.32% -0.39% -0.49% -0.66% -1.00%

Using Long-Run Supply Elasticities Scenario Base 1 2 3 4 5 6 7 8 U.S. Quota Level 25 250 275 350 500 600 750 1000 1500 Beet Supply 28310.00 28329.82 28332.65 28338.31 28352.46 28360.96 28372.28 28394.93 28437.39 % Change 0.07% 0.08% 0.10% 0.15% 0.18% 0.22% 0.30% 0.45% Cane Supply 85997.00 86083.00 86091.59 86117.40 86177.59 86211.99 86272.19 86366.79 86564.58 % Demand Change 0.10% 0.11% 0.14% 0.21% 0.25% 0.32% 0.43% 0.66% 110158.00 110047.84 110025.82 109992.64 109915.66 109871.58 109794.48 109662.28 109419.94 % Change -0.10% -0.12% -0.15% -0.22% -0.26% -0.33% -0.45% -0.67%

Scenarios 5, 6, and 7 simulate Mexico, under an unlimited access status, exporting 500,000 MT to the United States. Also, Cuba is given a quota of 100,000 MT, 250,000 MT, and 500,000 MT, respectively. During scenario 5, U.S. price decreases 16.9%, and world price increases 0.61%. U.S. beet supply falls 6.1%, while cane supply falls 2.56%. Demand rises 2.63%, to 9.32 million MT. Cuban supply rises 0.08%, while demand falls 0.85%. During Scenario 6, U.S. price falls 20.86%, while world price rises 0.77%. U.S. production drops 7.65% for beets, and 3.22% for

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cane, while consumption rises 3.33%. Cuban production rises 0.1%, while demand falls 1.07%. During Scenario 7, U.S. price decreases 27.11%, and world price increases 1.04%. U.S. beet supply falls 10.19%, while cane supply falls 4.33%. Demand rises 4.53%, to 9.49 million MT. Cuban supply rises 0.13%, while demand falls 1.44%. Scenario 8 simulates Mexico, under unlimited access status, exporting 750,000 MT to the U.S., while Cuba receives a quota of 750,000 MT. U.S. price falls 38.25%, to 16.66 /lb., while the world price rises 1.58%, to 9.96 /lb. U.S. production falls 15.12% for beets, and 6.53% for cane, while demand rises 6.98%, to 9.71 million MT. Cuban production increases 0.2%, while consumption falls 2.17%. Simulation Results: Using Long-Run Elasticities The use of long-run elasticities result in similar, but more modest, changes in prices and demand. Production changes, however, are more dramatic. During Scenario 1, the U.S. refined sugar price falls 3.63% relative to the base, to 26 /lb. The world refined price rises slightly, by 0.16%, to 9.83 /lb. U.S. beet production drops by 3.13%, and cane production falls by 1.47%, while U.S. demand rises by 0.52%. Cuba increases cane production by 0.11%, while demand falls by 0.22%. During Scenario 2, U.S. price drops 4.03% to 25.89 /lb. World price rises only 0.18% to 9.83 /lb. U.S. production falls by 3.48% for beets, and 1.63% for cane, while demand rises by 0.58%. Cuba increases supply by 0.12%, and demand falls by 0.25%. Scenario 3 results in a 5.21% drop in U.S. price, while the world price rises 0.23%. U.S. production falls 4.5% for beets and 2.12% for cane, while demand

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rises 0.75%. Cuban production rises 0.16%, while consumption falls 0.32%. During Scenario 4, the U.S. price falls 7.59%, to 24.93 /lb., while the world price rises to 9.84 /lb. U.S. production falls 6.56% for beets, and 3.11% for cane, while demand rises 1.11%. Cuban supply rises by 0.23%, while demand falls by 0.47%. During scenario 5, U.S. price decreases 9.14%, and world price increases 0.41%. U.S. beet supply falls 7.91%, while cane supply falls 3.76%. Demand rises 1.35%, to 9.2 million MT. Cuban supply rises 0.28%, while demand falls 0.57%. During Scenario 6, U.S. price falls 11.45%, while world price rises 0.52%. U.S. production drops 9.93% for beets, and 4.75% for cane, while consumption rises 1.72%. Cuban production rises 0.35%, while demand falls 0.72%. During Scenario 7, U.S. price decreases 15.26%, and world price increases 0.7%. U.S. beet supply falls 13.27%, while cane supply falls 6.41%. Demand rises 2.35%, to 9.29 million MT. Cuban supply rises 0.48%, while demand falls 0.97%. Under Scenario 8, U.S. price falls 22.61%, to 20.88 /lb., while the world price rises 1.06%, to 9.91 /lb. U.S. production falls 19.78% for beets, and 9.74% for cane, while demand rises 3.65%, to 9.41 million MT. Cuban production increases 0.72%, while consumption falls 1.47%. Comparison of Results Let us compare the results of the present work to those of Won Koo (2000), contained in Table 5.7. Using an econometric approach, Koo (2000) forecasts the U.S. wholesale sugar price to increase 6.1% from the base-year 1999 price of 23.28

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Table 5.6. Results of U.S. sugar trade liberalization from Koo (2000), with percentage change from 1999 actual shown in parentheses. Results from Koo (2000)
1999 Actual Production (1,000 MT) Beet Sugar Cane Sugar Consumption (1,000 MT) Imports (1,000 MT) U.S. Wholesale Price (/lb.) 4577.3 3428.1 10083.1 2190.9 23.28 2004 with Liberalization in the U.S. Base Without Cuba With Cuba 4768.2 (4.2%) 3536.8 (3.2%) 10518.8 (4.3%) 2308.8 (5.4%) 24.7 (6.1%) 3733 (-18.4%) 2956 (-13.8%) 11426 (13.3%) 4722 (115.5%) 16.75 (-28%) 3668 (-19.9%) 3216 (-6.2%) 11494 (14%) 4948 (125.8%) 16.17 (-30.5%)

cents per pound during the 2000-2004 period. Under elimination of import restrictions and the sugar loan program, he indicates a 28% price decrease relative to the base year. With Cuba as a trading partner, the decrease is 30.5%. These results fall between those of the present studys short-run and long-run elasticity results (see Table 5.2). A direct comparison of world prices cannot be made, since Koo only reports the Caribbean raw price, while the present study reports only the world refined price. However, Koo does report significant world price increases as high as 36.7% with liberalization, while the current study reports only mild price increases. The world refined price increases only 1.58% under short-run elasticities, and even less under long-run elasticities, in the most liberalized scenario. Of course, the present study utilizes the world refined price and aggregates beet and cane sugar into one category, thus representing a larger market which is less price sensitive to supply and demand changes. In addition, under Koos simulation, the United States completely eliminates import restrictions and the sugar loan program, which is a much more drastic scenario than the gradual reductions simulated here. Another possibility for the disparity is the structure of the model. The present study treats all sugar produced outside of Cuba, Mexico, and the United States as one large aggregated market, and

49

bases its price changes accordingly, whereas Koo may base his price changes on a small, residual market. Koo lends credence to this possibility in his opening statement that Less than 30 percent of world sugar production is traded internationally. Nonetheless, these results have very important implications. Koos results indicate that as the U.S. liberalizes trade, the world price rises significantly, making the U.S. market less attractive to exporters. The present study, however, indicates that even with significant sugar liberalization, the world price remains almost unchanged; although the United States is the second- largest importer of sugar (CSR, 2000), it acts as a small- country with regard to the world sugar market. Therefore, exporters still have a great incentive to export to the United States, which means continued outside pressure on the United States to further open trade.

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CHAPTER SIX: WELFARE ANALYSIS AND POLICY OPTIONS Welfare Analysis A common method of measuring efficiency gains in economics is through analysis of consumer and producer surplus. Figure 6.1 illustrates the effects of a price change on consumer and producer surplus within an importing country. Price P0 represents the initial domestic price. Note that the initial price is not at the intersection of the demand and supply curves, as this country is an importer, and thus, the intersection represents the autarkic price. The quantity imported is represented by QD0 QS0 . Consumer surplus consists of the area above the price line and to the left of the demand curve. Producer surplus consists of the area below the price line and to the left of the supply curve. As the import quota is inc reased, the quantity imported increases to QD1 QS1 , and there is a price decrease from P0 to P1 . Now, consumer surplus has increased, gaining areas A, B, C, and D. Producer surplus, however, has decreased, losing area A. Nevertheless, there is a net welfare gain equal to the sum of areas B, C, and D (area A just changes hands from the producer to the consumer), which were unavailable under price P0 . Therefore, there are efficiency gains due to increased trade, and although consumers win and producers lose, the economy, taken aggregately, is better off than it was before increasing the quota. This approach was utilized to analyze efficiency gains in the present study. Table 6.1 summarizes consumer and producer surplus and net welfare gains relative to the base for the United States domestic sugar market for the eight scenarios,

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P0 A P1 B C D

QS1

QS0 Q D0

QD1

Figure 6.1. Effect of import quota on producer and consumer surplus of an importing country.

using both short- and long-run supply elasticities. Using short-run elasticities, as imports progressively increase from Scenario 1 to Scenario 8, consumer surplus increases relative to the base, from $377.7 million to $2.137 billion, respectively. Producer surplus, however, decreases relative to the base, ranging from $312 million to $1.632 billion. There is a net welfare gain for all scenarios, ranging from $66 million in Scenario 1, to $504.7 million in Scenario 8. Long-run elasticities produced similar, yet more mild, results. Cons umer surplus gains ranged from $196.5 million to $1.243 billion, while producer surplus losses ranged from $162 million to $945 million. Again, there were net welfare gains, ranging from $34 million in Scenario 1, to $298 million in Scenario 8. In short, any move toward liberalization results in producer surplus losses, consumer surplus gains, and a net welfare gain for the

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Table 6.1. U.S. changes in consumer and producer surplus and net welfare gains.
United States Changes in Consumer and Producer Surplus and Net Welfare Gains Using Short-Run Elasticities Quantities (MTRV) Surplus Changes US$/MT Beet Cane Demand Consumer Producer 4,013,000 3,584,000 9,079,000 594.58 3,915,890 3,548,160 9,171,610 553.19 $377,696,374 -$311,688,430 3,905,050 3,543,860 9,181,590 548.74 $418,532,723 -$344,852,257 3,873,350 3,532,030 9,212,460 535.83 $537,311,638 -$440,694,913 3,809,540 3,508,020 9,275,110 510.27 $773,717,507 -$628,723,277 3,768,210 3,492,250 9,317,780 494.09 $924,346,211 -$746,513,078 3,706,010 3,468,600 9,381,330 470.55 $1,144,817,365 -$916,061,394 3,604,080 3,428,810 9,490,280 433.39 $1,496,591,122 -$1,179,095,985 3,406,230 3,349,960 9,712,710 367.15 $2,136,899,303 -$1,632,173,001 Using Long-Run Elasticities Quantities (MTRV) Surplus Changes US$/MT Beet Cane Demand Consumer Producer 4,013,000 3,584,000 9,079,000 594.58 3,887,390 3,531,320 9,126,210 572.99 $196,525,242 -$162,094,589 3,873,350 3,525,580 9,131,660 570.62 $218,163,707 -$179,651,241 3,832,420 3,508,020 9,147,090 563.60 $282,322,134 -$231,380,946 3,749,750 3,472,540 9,179,780 549.45 $412,009,371 -$334,397,279 3,695,570 3,449,240 9,201,570 540.23 $496,774,490 -$400,608,687 3,614,510 3,413,760 9,235,160 526.50 $623,414,006 -$497,844,191 3,480,470 3,354,270 9,292,360 503.84 $833,508,603 -$654,768,044 3,219,230 3,234,920 9,410,380 460.14 $1,242,856,124 -$944,518,303

Scenario Base 1 2 3 4 5 6 7 8 53 Scenario Base 1 2 3 4 5 6 7 8

Net Gain $66,007,944 $73,680,466 $96,616,725 $144,994,230 $177,833,133 $228,755,971 $317,495,137 $504,726,302

Net Gain $34,430,653 $38,512,465 $50,941,189 $77,612,092 $96,165,803 $125,569,816 $178,740,559 $298,337,821

economy. With regard to Cuba, welfare analysis is less straightforward because this model utilizes the refined sugar price, when it is more likely that Cuba would export raw cane sugar to the United States. Hence, any welfare change estimates using the refined price would tend to overstate gains to the island. Alternatively, the assumption could be made that the raw price changes by the same percentage as the refined price, but this would introduce much greater room for error in such estimates. We can, however, illustrate graphically, the gains that would accrue to Cuba in more general terms. Looking at Figure 6.2, since Cuban consumers are assumed to pay the world price for sugar, they consume up to QD, and consumer surplus is represented by areas A and B. Without the

P
A

Demand

Supply

PUS

PW E

G F QD QS1 QW

QS QUS

QD

Figure 6.2. Effect of import quota on producer and consumer surplus of an exporting country.

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U.S. quota, Cuban producers would produce up to Q S, receiving the world price, exports would equal QS QD, and producer surplus would be represented by areas E, F, G, and H. With the quota, however, Cuba diverts exports equal to the quota from the world market to the U.S. market, and receives the U.S. price for that quantity. Thus, excess supply is segmented in two parts: that which is exported to the world market at the world market price, Q S1 QD, and that which is exported to the United States at U.S. market price, QS Q S1 . The arrows below the graph indicate the same. Without the quota, producer surplus was the area below the world price line and to the left of the supply curve. With the quota, producers now receive a higher price for that quantity sent to the United States, and producer surplus increases by an amount equal to area D, because the U.S. price now comprises the upper boundary for that quantity. Of course, the U.S. price represented on the graph would be lower than the price prevailing prior to the allocation of the quota, but this prior price is irrelevant to Cubans, since they never experience it. Also, this analysis assumes that the world price does not change as Cuba diverts exports to the United States (the results from the present study suggest the same). However, we can observe from the graph that if the U.S. domestic price falls due to liberalization and the world price rises (the two prices would approach each other), rectangle D would decrease in area, indicating the decreasing incentive to for an exporter to sell to the United States. A similar analysis would also apply to Mexico. Policy Options Table 6.1 makes evident the welfare gains achieved through liberalization. It is not a simple task, however, to make these gains a reality. The main obstacle is the current political economy of the U.S. sugar market. The playing field in which this

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political game takes place gives a distinct home- field advantage to producers. While U.S. sugar producers comprise only a small fraction of the populace, they have a distinct advantage in terms of political clout. Not only do sugar producers lobby for sugar price protection, corn producers also have a stake in the price of sugar, since high sugar prices translate into increased HFCS demand. Conversely, there is no great lobbying force for sugar consumers. Also, sugar, like food in general, makes up only a small fraction of disposable income for most American consumers. Therefore, a small change in the price of sugar has little effect on the quantity demanded. This is evidenced by the inelastic price elasticities of demand reported by most studies (see Table 4.6). Thus, while a price decrease brought on by increased imports favors consumers and increases the net welfare of the economy, little public sentiment exists to promote this outcome. On the other hand, a price decrease hurts producers, and being a small interest group, they are easily able to come together and lobby against such measures. Producers also have on their side the argument of food security, which basically states that too much dependence on foreign markets makes the domestic market susceptible to outside actions. In a worstcase scenario, the domestic market could be without any sugar at all. Therefore, while liberalization appears to be the optimal move based on the economic theory of welfare analysis, such an outcome is difficult to achieve in the political realm. We must, therefore, approach the issue of gains and losses more carefully. Various policy options are available which can aid in capturing some or all of these welfare gains. However, given WTO agreements, many policy options are considered as trade distorting, and hence, illegal. Accordingly, only those policies that would fall into the green box, those policies which are the least trade distorting, or the

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blue box, which indicate policies that are somewhat distorting, but not illegal by WTO standards, will be considered here. For exa mple, payments tied to production, marketing loans, etc., will not be considered. It is also important to mention that current sugar price support operates at no cost to the federal government, thus any policy option that would require budgetary expenditures would be more difficult to implement, given current trends in budget reduction, especially with regard to agriculture. The first option for policy makers would be to remain passive, and not get involved in producer compensation. Basically, producers would absorb the loss in surplus, and cut back on production. This approach would lead to the greatest net welfare gains. Of course, given the political power of sugar lobbyists, this approach is not likely. Table 6.1 makes evident the most obvious, but also, the most abstract, policy option. This option would entail transfer payments from consumers to producers equal to the producer surplus loss. This would result in a Pareto optimal condition, where producers are not harmed, and consumers are still better off by an amount equal to the net welfare gain. How this surplus is extracted from consumers, however, is more complicated. Another issue is deciding which entities on the production side receive the payment, and what percentage of such a payment. Thus, while this option may result in a Pareto outcome, putting it into action is more complicated. The alternative to the previous option is a fixed payment by the government to producers equal to the loss in producer surplus. In this case, consumers would reap the full benefits of the lower price, capturing all consumer surplus gains reported in Table 6.1. What this introduces, however, are budgetary costs, and as stated earlier, make this option less politically palatable. Under Scenario 2, for example, policy makers would

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need to allocate $3.45 million to compensate producers. Under Scenario 8, that figure would jump to $1.63 billion. Another approach, which has been mentioned in the past, most recently by Skully (1998), is to auction sugar quotas to exporters. Currently, sugar quotas under the TariffRate Quota scheme are given away, such that the exporting countries receive all of the revenue from selling in the U.S. market. Under such a scheme, the revenue from the auction could be used to compensate producers for surplus losses. As Skully argues, the revenue generated would equal the difference between the domestic and world price times the amount of the quota auctioned. This scheme simultaneously bases imports on efficient production by exporting countries, rather than on politics. This is due to the assumption that exporters will not rationally bid more than the difference between the U.S. domestic price and their marginal cost. The major drawback to this option is the possibility that the revenue from such auctions may not be sufficient to compensate producers, depending on domestic and world prices, production, and consumption. Also, many of the current quotas are used as political tools. Thus, adopting this scheme would rob policy makers of some political leverage. These quotas provide additional surplus to exporters, as illustrated in Figure 6.2. Thus, were the United States to pursue some policy for rebuilding the Cuban sugar market, a quota auction would remove much of the benefits that would accrue to Cuba. Finally, this auction probably would not apply to Mexico, since Mexicos access is stipulated within the context of the NAFTA. Alternatively, given the apathetic nature of consumers with regard to sugar prices, the government could levy a tax on sugar consumption and use the revenue to compensate producers. Normally, a tax is considered to create dead-weight losses, but in

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this case, the resulting price would still be lower than the current price, although still higher than the price under free trade. Figure 6.3 shows such a policy. P0 represents the domestic price before increased imports, and P1 , afterwards. If, when the government

P0 A P1 + t P1 C D B

QSt

QD t

QD1

Figure 6.3. Effect of levying a sales tax on producer and consumer surplus. increases imports, it simultaneously imposes a sales tax, t, on all sugar consumed, then producers lose areas A and C, consumers gain areas A and B, and government revenue increases by areas C and D. The government then uses the revenue to compensate producers. To ensure that producers are fully compensated, the tax t must be set high enough that area D equals area A. To visualize this, imagine raising the price line representing P1 + t until A decreases in area and D increases in area. When area A equals area D, then producers will be fully compensated by the transfer payment. The benefits of such a program are that the government experiences no net increase in expenditure, since the tax is used to compensate producers. Also, although a tax is levied on consumption, consumers still experience a lower price, P1 + t, than that under reduced

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exports, P0 , and gain surplus equal to areas A and B. Thus, this approach results in net welfare gains. Also, as long as the payment is not tied to production, such a policy would allow for production decisions to be made based on market prices rather than artificial prices determined by the current program. Thus, inefficient producers would no longer have an incentive to produce. The downside of such an approach is the reduction in quantity demanded equal to QD1 - QDt, due to the higher consumer price. In addition, there would be some administrative costs associated with tax collection and direct payment distribution.

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CONCLUSION This study illustrates the economic gains possible through liberalization of sugar trade. However, while the use of a partial-equilibrium framework allows for an adequate analysis of the sugar market, it ignores gains and losses outside of the sugar market. For example, communities and businesses dependent on sugar production could be significantly damaged due to such changes in supply. If such actions as those mentioned here were undertaken, policymakers may wish to consider such effects and devise some program to allow for a smoother transition away from sugar production. Again, such a program may entail further government expenditures. Another issue is that domestic sugar prices, if sufficiently depressed, could lead to increased loan forfeitures, which also means increased government spending, both on the loans and on storage for the forfeited sugar. The current loan rate for beets is 22.9 cents per pound, and according to the present studys results under short-run elasticities, a quota increase of 600,000 MT would be sufficient to trigger these loans. Therefore, policy makers must be mindful of such effects when considering liberalization. Other short-term policy tools, such as sugar buyout programs, would likely occur more frequently if the quota was increased without any other changes to sugar policy. Again, such programs increase government expenditures not only for the buyout itself, but also of sugar storage, which is usually the most costly aspect of such programs. Of equal concern is the increased price volatility and uncertainty that would be introduced as a result of increased trade liberalization. As Figure 1.1 makes evident, the world sugar price is not only significantly lower, but also much more volatile than U.S. prices. Hence, if it is the goal of policymakers to not only sustain higher prices, but also

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to promote price certainty, moves toward liberalization could seriously undermine such policies. Also, if policies such as target prices were undertaken, price volatility would translate into uncertain and volatile government spending levels, since such expenditures are based on the difference between current market price levels and the target price. Further, the results of this study show that even with liberalization, the world price remains almost unchanged. This adds doubt to the argument that as the United States liberalizes trade, exporters will have less of an incentive to export because the world price would rise dramatically, lessening the gap between domestic and world prices. On the contrary, the world price remains relatively low, and unless the domestic price is allowed to equal world levels, the incentive to export to the United States will remain intact. The effect sugar liberalization will have on the HFCS market is controversial. Sugar and HFCS are substitutes in beverages, confectionaries, baking, and canning (Tanyeri-Abur et. al., 1993). As the price of sugar falls, however, users will not shift a certain percentage of their HFCS use to sugar. Instead, they will continue to use HFCS until the sugar price falls below that of HFCS, and there would then be a complete shift in demand from HFCS to sugar. However, there are some costs associated with switching from HFCS to sugar, and these costs would determine how quickly such a change took place. The 2000 GAO report, however, argues that the possibilities for substitution between sugar and HFCS are more limited than in the past due to technological advances which have created a more specialized sweetener market. They hold that even if the sugar program were eliminated, the impact on HFCS prices wo uld be limited, and that HFCS producers would not need to lower prices to remain competitive.

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An interesting conclusion that is not obvious from the present studys results is that there are gains that accrue to the domestic production side. What makes this not readily apparent is that in this study, refiners and industrial users of sugar are considered to be on the demand side, since they are the ones that pay the raw cane price and the wholesale beet price, respectively, on the market. Thus, while low raw sugar prices mean low returns for domestic cane producers, they also mean low input prices for raw sugar refiners, and hence, a lower price at which refined sugar can be sold to industrial users, such as bakers and beverage producers, who use refined sugar as a factor of production. Thus, while growers are forced to decrease production due to lower prices, refiners and industrial users may be able to increase production due to lower input costs. Therefore, while the producer surplus results presented in Table 6.1 indicate losses to the production side, there are gains to the supply side which are not readily apparent. This slight difference in assessing the situation, considering refiners as consumers rather than as producers, makes a dramatic difference when arguing that sugar trade liberalization hurts producers. Raw sugar liberalization hurts growers, but benefits everyone else along the supply chain. Refined sugar liberalization, on the other hand, negatively impacts growers and refiners, since imported refined sugar comes in direct competition with domestically refined sugar. Therefore, it is uncertain what effects Mexico will have on the domestic market, since Mexico is able to export either raw or refined sugar under the NAFTA. How much of Mexicos current 250,000 MT quota will be composed of refined sugar in the coming years is yet to be determined. According to data provided by the U.S. International Trade Commission, Mexican refined sugar and refined-sugar-containing products exported to the United States has remained below 30,000 MT from 1997-2000

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(this includes all products under Harmonized Tariff Schedule codes 17019105001701995000) (USITC, 2001). Of course, the year 2000 was the first of the annual 250,000 MT allocation. Whether this quantity will change depends on several factors, including Mexicos ability to increase and sustain investment in sugar production, and the ability to increase refining capacity. In either case, future research should attempt to quantify these potential gains by refiners and sugar users, and possibly devise some scheme in which these gains could be shared with growers, who would experience losses due to lower prices. Moss and Schmitz (2000) begin to analyze such possibilities in the sugar industry under vertical integration. Also, research attempting to forecast the composition of Mexicos future exports as raw or refined sugar would also be of great interest to both policy makers and the sugar industry. It should be noted that there are some distortions in the estimated welfare changes reported here. Only one price, the wholesale beet price, was used to represent the U.S. market. However, the domestic raw cane price is typically a few cents per pound less than the wholesale price, and thus, producer surplus losses may be somewhat overstated. Conversely, a significant portion of sugar is bought at the retail price, which is typically 12-16 cents per pound greater than the wholesale price. Hence, estimated consumer gains due to trade liberalization may be too conservative. However, such deviations should not be looked upon as critical, since they would not change the direction of the welfare changes, and only affect the magnitude of the estimates somewhat. As tariffs on Mexican sugar imports fall, there will be greater incentive for Mexico to send its surplus to the United States. As the NAFTA stipulates, TRQs for other countries will be cut, if necessary, to offset imports of Mexican sugar. What this

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means in terms of trade relations with the rest of the world remains to be seen. However, it can be expected that those countries whose sugar is displaced by that of Mexico will seek some type of reconciliation, be it countervailing duties imposed on the United States or some future negotiations allowing more foreign sugar into the United States. Also, the very use of the TRQ as a quantitative limit to imports will come under severe pressure as trade barriers are lowered and eventually dissolved for Mexico. In the extreme case, only Mexican sugar wo uld be imported into the United States, with all other TRQs being cancelled. In addition, after the transition period, Mexican sugar will be free to flow into the domestic market at will. Hence, U.S. sugar policy may very well become ineffective as a means of supporting prices through import quotas. With regard to Cuba, any move toward trade would certainly aid in restoring economic stability to the island. Certainly, since sugar is a major player in the Cuban economy, allowing them a fraction of total U.S. sugar imports, at U.S. prices, would give their sugar industry an immediate boost. This could lead to increased investment by both domestic and foreign sources, and improved production and refining capacity. It is likely that such investments in Cuban sugar infrastructure would also translate into gains for U.S. equipment, fertilizer, and seed firms. While this study makes evident the specific gains from liberalizing sugar trade, it alludes to a broader and more critical issue. While strong opposition remains with regard to resuming trade with Cuba, the United States must be mindful not to allow itself to be a victim of its own policies. While the objective of the embargo is to limit Cuba economically, other countries, as mentioned in Chapter One, are not following suit, but are beginning to invest in Cuba. With Cuba in such close proximity to the United States

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and with so many opportunities for investment and development, the United States should seriously consider its political objectives with respect to the island and weigh these against its long-term economic objectives. With sugar being such a major player in the Cuban economy, it may serve as the easiest means for the United States to reacquaint itself with the island, and get a foothold in the development boom that is likely to transpire in a post-Castro Cuba.

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BIBLIOGRAPHY

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VITA

Daniel Ryan Petrolia was born on November 9, 1977, in New Orleans, Louisiana. He was raised in rural Tickfaw, Louisiana, and attended school in nearby Independence. Dan graduated from Independence High School in May of 1995, and enrolled at Louisiana State University that fall as a member of the Honors College. Dan received a bachelors degree in political science and another bachelors degree in animal, dairy, and poultry sciences in May of 1999. Dan remained at L.S.U. for his masters degree in agricultural economics, and will graduate in August of 2001. Dan will begin his doctoral program in September of 2001, in the University of Minnesotas Department of Applied Economics, as a USDA National Needs Fellow.

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