| | The views represented herein are those of the authors, Colin A. Carter and R. M. A. Loyns, and we are responsible for the full contents of the report. Alberta Agriculture, Food and Rural Development provided financial and information resources to complete this work.
Conceptual overview
The most serious arguments commonly advanced in support of a single-desk seller for Canadian wheat relate to alleged market power of the CWB (Brooks, 1993, CWB, 1995). If some market power does exist the question naturally arises as to whether the benefits conferred to producers through CWB market power outweighs the costs due to the anti-competitive aspects of the CWB system.
Given that the effect of the CWB on prices received in the world market is probably minimal, the question then becomes what is the effect of the CWB on the performance of marketing functions within Canada. This issue is addressed in Section VII.
The difficulty with fully assessing CWB performance lies in estimating what farm gate returns would be in the absence of a compulsory CWB. We attempt to do this in Section VI.
There is remarkable similarity in the arguments put forward in defense of single desk selling around the world. Jacobsen, Scobie and Duncan (1995), in discussing statuatory marketing arrangements for New Zealand meat and wool, recognize that the argument for statutory power is essentially the proposition that commodity trade organized through private firms would result in lower prices than could be obtained with state imposed collusion-the terminology for this is "weak selling".
Establishing the existence of weak selling, and hence justification for a single desk, poses both conceptual and measurement problems. The inherent difficulty is that agricultural prices are both transient and have many dimensions. Further, given the variability of prices over time caused by fluctuating supply and demand in agricultural markets, weak selling is difficult to measure. As discussed in Section VI, the recent approach taken by the CWB (Kraft, Furtan, and Tyrchniewicz, 1996) has many associated problems.
A single "price" observed in the market at any one time has three elements:
- An underlying component reflecting current supply and demand and expectations of future supply and demand;
- Various margins around the underlying price reflecting quality, location, credit, delivery terms, diversification considerations, and loyalty, and;
- Any premium or discount that exists because of the market power of buyers or sellers.
Only the third element-market power-is of genuine interest in the debate over the single-desk in Canada. The state of world demand for grain and the output of competing suppliers, and thus the underlying price level, is outside the control of sellers in one country, however sellers are organized. Despite all the posturing by CWB officials and farm organizations on this score, the CWB has no real power to influence policies of competing nations.
There is no doubt that higher prices can be obtained by offering more marketing services. But the case for such value adding is not self evident. It depends on the benefits and costs of providing these services. Given the specialized nature of marketing services in the grain trade and the problems in deciding which services should be provided in diverse markets, prior reasoning suggests that these decisions are best left to private firms rather than performed by centralized selling authorities.
For example, small positive premiums reported by the CWB could be just as easily be explained by "over-servicing" of markets as through superior marketing expertise or market power exerted by the CWB. There may be a corresponding "under-servicing" by private grain traders marketing US wheat. It is worth noting that the customers of the CWB are commercial firms and government buying agencies who are free to source wheat from other countries. Why would they consistently pay the CWB more than necessary?
Theory of single desk
The theoretical case for single-desk selling is not unlike the "new trade theory" in economics (Baldwin, 1992), which suggests the possibility that government intervention in trade may be in the national interest. If this "theory" is operational and empirically relevant, then the benefits of free trade may be passé in certain markets. However, the empirical validity of the "new trade theory" is questionable because it is virtually impossible to formulate useful interventionist policies given the practical difficulties in modeling imperfect markets (Baldwin, 1992).
Policy makers cannot estimate import demand elasticities without great uncertainty and given these empirical difficulties, formulating optimal trade policies could do more harm than good. The Baldwin critique of the new trade theory clearly applies to the CWB’s price discrimination claims.
Canadian farmers are told that the single desk yields significant advantages through the opportunity to practice price discrimination. At the same time, foreign governments are told that the CWB is purely a marketing organization that does not price discriminate. What are the implications of this inconsistency?
It is also argued that the export demand for Canadian grain is inelastic in some markets, especially in Japan, because restrictions on market access and/or the existence of single importing agencies permit Canada to benefit from price discrimination. Competing exporters would bid away these benefits, according to the CWB.
Contemporary critics of the single desk have argued that any such gains from a single-desk could be maintained by licensing private firms selling to Japan.
In addition, the collapse of the former Soviet Union and economic changes in China have reduced the significance of single buying agencies in the world grain trade. Under the World Trade Organization (WTO), state trading organizations are an issue of disagreement and thus reform is expected even with regard to the Japanese Food Agency.
The theoretical rationale (Ryan, 1994; Booz, Allen and Hamilton, 1995; Canadian Wheat Board, 1995) that have been offered as justification for the Australian Wheat Board (AWB) and CWB (i.e., single-desk selling) includes the ability of single desk sellers to:
- Exploit market power through price discrimination and thus increase revenue;
- Provide farmers with a form of risk management through price pooling;
- Develop niche markets and new customers through market development;
- Negotiate price premiums with single-desk buyers, and;
- Exploit economies of scale associated with marketing.
Most of these potential benefits could be supplied as efficiently by the private grain trade. The market power argument is the only point that deserves serious consideration as the others are largely spurious.
The market power argument is based on the premise that the international grain market is imperfectly competitive, and that markets can be segmented (i.e., there is little or no arbitrage between markets). The AWB and CWB (Ryan, 1994; Canadian Wheat Board, 1995) argue that under these conditions they are able to price discriminate by charging relatively higher prices in those markets that are less price-elastic and lower prices in markets that are more price-elastic. If demand responds differently across these (separate) markets, then the alternative demand relationships can be exploited by the single-desk.
The AWB and CWB have recently argued (e.g., Ryan, 1994) that the U.S./EU wheat trade war has created the perfect price discrimination opportunity for State Trading Entreprises (STEs) and justifies their continuance. The U.S. and the EU have been running targeted export subsidy programs for about ten years now and these programs segment the world market into two pieces: the "subsidized" and "non-subsidized" markets. The law of one price is violated when comparing subsidized with non-subsidized prices. It is claimed by the AWB and CWB that the trade war has resulted in a whole "schedule" of prices across importing nations. In essence they argue the law of one price does not hold for sales within the subsidized markets.
Economic efficiency considerations
The CWB (1992) has previously argued that single-desk selling is important from an economic efficiency point of view. They suggested that inefficient resource allocation takes place where Canadian farmers use daily spot U.S. prices as a source of information and compare them with the CWB pooled price. Economic theory would predict just the opposite-namely that inefficiencies arising from a lack of price information and distorted market signals would adversely affect the allocation of resources and lower producer profits. For the purposes of examining this efficiency issue raised by the CWB, we have measured both technical and economic efficiency in agriculture for Alberta, Saskatchewan, and Manitoba for the years 1961 to 1992 (see Section VII).
We believe the excessive centralization of CWB control and lack of price information masks incentives for farm-level efficiency and leads to the misallocation of resources (i.e., economic inefficiency) in prairie agriculture. We, and others, have shown that price information is poor, and that CWB decisions affect cash flow and returns. Instead of maximizing profits, in the conventional sense, farmers end up balancing unknown risk and prices on CWB grains with measurable risks on non-board grains. In most cases farmers end up trying to meet some CWB set marketing quota, instead of maximizing profit.
On the prairies, there seems to be sufficient regulatory interference in marketing decisions to hypothesize that farm decisions on output levels and input usage are altered relative to a less regulated environment. These distortions reduce the farmer’s ability to maximize profits and use resources such as land, fertilizer, and machinery, in the most efficient way.
One could argue that under the CWB system, a farm could remain technically efficient but would most likely exhibit economic (allocative) inefficiency. Technical efficiency is defined as maximizing output subject to the available input technology. Farmers whose production is technically efficient produce on the "frontier" of the production function, which is specified by the observed best (or most efficient) practices. The farms which are technically inefficient produce less output given the same level of inputs, and therefore their input-output production combination falls below the "best practice" production frontier. Measuring technical efficiency in this way is independent of input and output prices, and instead, focuses on the technical aspects of farming such as non-price risk management, resource combinations, and non-price decision-making.
The usual way to show technical efficiency is by the production function (F) in Figure 2.1. It shows the technically correct (efficient) combination of inputs to produce various levels of output. It assumes up-to-date technology being used to the farmer’s best (technical) advantage. Allocative (economic) efficiency refers to the correct allocation of inputs and production of outputs, given input and output prices. Competitive input and output markets and profit maximization are usually required to ensure economic efficiency.
The conditions for profit maximization state that the marginal value product (mvp) for any variable input (e.g., fertilizer) must be set equal to the input’s price and that the marginal value product (mvp) per unit of input should be equal across different outputs. Marginal value product is the increment in the total value of output due to one additional input.
If a firm is operating at point E0 in Figure 2.1, this is below the best practices frontier production function (F) and E0 is inefficient. More output could be produced with the same level of inputs as at E0 by moving straight up to the frontier F. Point E2 is the production point that economists describe as a situation where both technical and allocative efficiency conditions are experienced. At this point, the slope of the production function (i.e., the input’s marginal product) is tangent to the isoprofit line pi1 and thus is equal to the ratio of the input price to the output price (r/p). Alternatively, if that same firm were operating at point E1 in Figure 2.1, then the firm has achieved technical but not allocative efficiency. Point E1 lies on a lower isoprofit line (pi2) and this point may characterize the situation for many farmers operating under the CWB.
As an illustration, consider a farmer operating at point E0 , which is below the "best practices" frontier. This could be explained by a lack of soil testing and under-fertilization. Through improved (technical) management practices the farmer could move up to point E1 in Figure 2.1, by conducting soil tests and adding some fertilizer. However, getting from E1 to E2 requires knowing all relative prices and correctly using them to make decisions and, in this example, it may require yet additional fertilizer.
We have this conceptual economic framework in mind when we discuss farm level efficiency issues later on in this report.
Cost and price pooling
A major part of single-desk selling of prairie grains is the pooling of costs and returns from wheat and barley sales. Pooling of costs and revenues is the genesis of many of the economic costs associated with the CWB. This section explains the mechanics of pooling, and identifies grain industry issues associated with pooling.
Pooling is a mechanism used by the CWB to average out revenues and costs, over time and place. It is the primary form of risk management used by the CWB. As a compulsory marketing agency with no options for marketing or pricing basis, the CWB offers this form of risk management on a take-it-or-leave-it basis. A farmer receives the same total payment (in nominal $) for a tonne of a particular category of grain, irrespective of when it is delivered, or to whom it is sold. Through CWB pooling growers receive the average price for the crop year, but they are completely exposed to inter-crop-year price risk.
Pooling is one component of the CWB’s marketing system that has remained relatively unchanged since the CWB came into existence in 1935, and was made compulsory for wheat in 1943. The system, the market, and farmer’s management needs have changed in this period. As a consequence, there are some significant economic costs associated with pooling.
How pooling works
Pools are just particular forms of accounts through which producer revenues and CWB costs of operation are channeled. The CWB operates four pools today. One covers all wheat excluding amber durum, a second covers amber durum, a third is for feed barley, and the fourth is for malting or designated barley. For the 1994-95 crop year, the amber durum wheat pool had 7 separate categories (usually referred to as grades), the ordinary wheat pool had 21 categories, the barley pool had 4, and the designated barley pool had 8. The increase in the number of categories within pools is probably the most significant change in pooling over time. The pooling period, or CWB crop year, extends from August 1 to July 31, of the following calendar year.
Initial prices are set for the reference grades of wheat (CWRS, CWAD, CWRW, CWSS)-and barley (Select CW, CW), basis in-store Vancouver and the St. Lawrence (formerly in-store Thunder Bay). These prices, set at the beginning of the crop year, are a minimum price guaranteed by the Canadian Government. Discounts and premiums to the reference grades for protein and quality, are determined by the CWB. These discounts and premiums are set relative to current and anticipated world market conditions, as well as the historic differentials between the various grades and protein levels. According to the CWB’s Grain Matters pool returns are calculated as follows:
The actual pool return that is established for any particular class, grade, or protein level of wheat is determined by the price relationships that exist in world markets over the course of the crop year (Grain Matters, December 1995).
Further:
...A pooled payment ensures that the price spread between grades are representative of the market price spread over the course of the selling period... Many people think that a pooled price is the average price for all sales of a particular grade in the crop year. It isn’t. (Grain Matters, September-October 1990)
Pooling is sometimes mistakenly viewed as an averaging of CWB sales prices for a specific grade of grain over a given crop year. (Grain Matters, December 1995)
One reason given by the CWB for the method it uses to determine the pooled price for any particular grade and quality of wheat is:
If the CWB pooled returns by grade, you could end up with a situation where lower grade grain might receive greater returns than higher grade grain. This could happen if the lower grade grain were sold during the crop year at times of peak prices while the higher grade happened to be sold when market prices were at their lowest levels. (Grain Matters, December 1995).
Obviously there is a great deal of power, latitude and discretion involved in determining prices and price relatives within these pools. There is no information released publically to allow assessment of how these decisions were made in a particular year, or to determine how final prices compare to other measures of market prices.
Depending on the philosophy of the Minister in charge of the CWB, initial payments have been announced as early as March and as late as the beginning of the crop year. Table 2.1 shows the dates when initials were announced from the 1982-83 to the 1992-93 crop year.
Adjustments to initial payments are made when the pools show substantial surpluses due to upward trends in prices.
Table 2.1. Announcements of CWB Initial Payments
Crop Year | Date Initials Announced |
| 1992-93 | July 27, 1992 |
| 1991-92 | July 25, 1991 |
| 1990-91 | May 01, 1990 |
| 1989-90 | April 26, 1989 |
| 1988-89 | July , 1988 |
| 1987-88 | July , 1987 |
| 1986-87 | April 08, 1986 |
| 1985-86 | March 28, 1985 |
| 1984-85 | April 13, 1984 |
| 1983-84 | April 05, 1983 |
| 1982-83 | March 21, 1982 |
Source: Manitoba Markets, Manitoba Agriculture, Various Years.
Note: With PRO forecasts, initial payments have moved to July announcements.
Sometime after the end of the crop year the pools are closed. Closing dates are thought to vary. In one hotly disputed case (1986), the crop year was left open and lower quality wheat sales reduced the potential final payment on higher quality wheat (see Section VII for a discussion of this "long long" weekend). Interim payments are made on occasion, sometime between closing the pool and making the final payment. The final payment for each grade, type and protein level (if the pool shows a surplus) is determined by the CWB and paid to farmers in early January. In recent years the pace of distributing pool surpluses has been somewhat accelerated.
Issues related to pooling
There are many important economic issues related to pooling in general, and specifically in the case of CWB pooling. The major ones are listed and briefly discussed.
- Equity versus Economic Efficiency
- Cross-Subsidization
- Information and Market Signals
- Price Transparency
- Pooling of Risk
- Aggregation and Transparency of Marketing Costs
- Pooling and the Livestock Industry.
- Effects on Farm Management Decisions.
Equity of treatment versus economic efficiency
A driving force for much of CWB activity is equity in treatment of producers. This motivation for regulation has produced equal prices over a pooling year, equal access to the grain handling and transport system through quotas, and permit books to monitor the process. We have also seen that the system has evolved in the direction of less concern for equality, and modified notions of equity (equal access over a year, equal chance to sign contracts) because this objective often conflicts with economic reality and the need to market grain more efficiently. There are also significant cases where equal in "volume or nominal" terms is far from equal in "economic" terms.
Equity has given way as it should to efficiency. The issue here is when, or how fast, should that occur. That is a question that appears much more appropriately dealt with by governments than a monolithic organization whose primary function and operating tools are in grain marketing. Alternatively, the market is a vehicle for making this trade off.
Cross subsidization
This economic term refers to any transfer of revenue or cost from one group to another that does not reflect value of product or service. Cross subsidization occurs through taxation and subsidy programs run by government. Uncompetitive markets can produce private sector cross subsidization. Pools, by their very nature, imply some measure of cross subsidization, and pools operated over long periods with limited information flow, like those of the CWB, will always be suspect. Cross subsidization occurs in the pool accounts among grades and categories due to the CWB’s mechanism of assigning "representative price spreads" that are deemed by the CWB to be "proper". It also occurs among producers through shipping costs. Producers pay the shipping costs to the nearest port, not necessarily the cost to the port where the grain is destined. It also occurs among producers who, due to the quota and contract systems, receive differential treatment on deliveries.
The CWB have attempted to minimize "cross haul" costs through introduction of Freight Adjustment Factors. It is an arbitrary mechanism and therefore we are not sure if cost pooling is now between pools as well as within pools. Freight Adjustment Factors are new since August 1995.
These sources of cross subsidization are inherent in a pooling system like that operated by the CWB. The Board, not the market and individual decision making, determines the outcome of most of these important economic variables for CWB grains.
Information and market signals
The system of pooling prairie grain has a critical impact on market information- on grain producers, on livestock producers, other buyers, and the competition.
The CWB is extremely protective of its basic information, claiming that information is a major source of its market power. That argument may be true for its market power over the farmers it serves because if market information is nonexistent, no market performance analysis can be conducted. It is doubtful that grain traders and buyers in international markets have many real secrets for any significant period of time.
Consequently the real losers in this closed system are prairie grain producers and livestock feeders. Market signals indicating the value of farmers’ grain and, in turn, the value of farmers’ inputs, do not get through to Canadian producers. Among the information and market signals required are, the estimated prices for all grains, forecasts of macro supply and demand conditions, and an assessment of relevant delivery opportunities, timing and costs (Cramer and Wailes, 1993).
Major production and marketing decisions are made around the seeding period, but the modern commercial farmer is involved in an on-going and continuous process of assessing input and product market opportunities. This requires a high degree of market information (both micro and macro) based on comprehensive and credible market intelligence (Loyns et al. 1987).
Price and market information from the CWB that could genuinely be used by farmers has, historically, been almost nonexistent. In 1993, the CWB began announcing Pool Return Outlooks or PROs which are updated monthly. However, the PROs are not particularly useful to farmers.
The CWB is expected to come under increased scrutiny under the new World Trade Organization, because of the perception that the CWB engages in non-transparent and unfair trade practices.
Price transparency
In the context of public policy or agency analysis, transparency refers to the ability of citizens, participants, or analysts to see and know how the system operates and how decisions are made. From the comments on price information, it is clear that price transparency does not exist in CWB operation. This is a problem for producers in decision making; it is a problem for other participants in the system; and it has become a major trade irritant to many of Canada's trading partners. Price transparency was a major issue in the deliberations of the Canada/U.S. Joint Commission on Grains.
Pooling of risk
When the CWB pools revenues over the crop year and among individual sales it is in effect pooling the risk associated with seasonal price fluctuations, some locational price differentials, and perhaps some qualiti-tative difference. "Advocates of pooling like to point out that pooling of grain revenues is a means of risk management for producers" (Grain Matters, Dec. 1995). Opponents of pooling suggest that practical alternatives to this method of risk management exist, and that compulsory average risk management may not be suited to the needs of many individual producers. The CWB has embarked on use of futures trading in the past three years. It is unclear how the CWB uses these instruments because there is no public information available, and because a senior Board economist argued that their analysis of futures trading potential had shown that CWB positions were too large for the available wheat futures markets. This is technically incorrect because there are no limits on futures positions for hedgers.
Pooling of marketing costs
These issues are much the same as price and revenue concerns in pooling. There are transparency, cross subsidization and information/market signals problems associated with CWB cost pooling. Perhaps the greatest source of cost pooling distortion has been the pooling of Seaway costs. The basis point of eastern shipments has been shifted from Thunder Bay to the Seaway. For a period beginning sometime in the early 1980’s, the cost pooling method resulted in eastern prairie growers being overpaid. Seaway costs are now out of the pools, and the Freight Adjustment Factor method of accounting for eastern and other shipments appears to arbitrarily penalize some producers for being in the wrong location on the prairies in relation to assumed port contraints at Pacific ports.
Pooling and the livestock industry
Pooling, initial price levels, lack of price transparency and price signals, and sometimes barley assembly strategy by the CWB, all impact livestock producers across, and outside, the prairies. There are periods when feed barley may be underpriced and periods when it may be overpriced because of CWB signals or the lack of them (Rosaasen and Lokken, 1986). In 1984, Storey, Coffin and Rosaasen argued that if pooling did not exist, feed grain prices would be higher in Alberta than in Manitoba (also see Rosaasen, Coffin and Storey, 1983).
While there is evidence that livestock producers may gain in some cases from these market distortions, and lose in others, the real issue is one of uncertainty-what is barley really worth?
In addition it is not uncommon for livestock producers to have problems physically procuring supplies. It does not require much market intelligence to infer that these livestock producer problems have a grain producer analogue. There are many ways to describe these problems but they all boil down to lack of information, lack of transparency, lack of arbitrage, and market inefficiency. Livestock and grain producers bear these costs.
Farm management and pooling
Little has been written on the relationship between CWB operations and farm management/farmer decision making. Loyns, Martin, Ashmead, and McQuorkodale(1987) and, Rosaasen and Lokken (1986) have identified some general aspects of market regulation on decision making. The operation of the CWB and its pooling regime impact directly and significantly on how farmers make their management decisions, for both board and nonboard grains, as well as how farm operations perform. There are also impacts of the CWB on livestock producer's decision making and performance. The most significant impacts are through three CWB instruments: the permit book, deliveries regimes (quotas and contracts), and the pricing regime.
The permit book, in the context of CWB grains is the right to farm. If farm management is viewed as a risk management operation, accepting a permit book and producing CWB grains is an assignment of a major portion of risk management to an external agent with major power to influence price and sales. Much of the remainder of risk management within the farm has to be built around CWB decision making because the producer can only react to, not influence, CWB decisions. In essence, "signing up" with the CWB significantly limits economic choice in terms of risk management, financial management and marketing management. Obviously, the CWB does manage some of the risk for farmers- that is one of the rationales for the existence of the CWB. However, giving up portions of risk management to others creates some new risks; that is the nature of risk management. As well, the risk management provided by the CWB is not necessarily consistent with, and may be contradictory to, individual farmer needs. Objectives at the CWB level may be totally different than those at the individual farm level. This is the difference between acting for the group and acting in one's own economic interest.
The issue identified here is choice-economic choice-and its relationship to farm management decision making. The choice issue has received considerable attention recently in CWB documents (Grain Matters, Dec. 1995) and by Alberta Pool (Back-grounder, Oct. 1995). But these discussions try to pit choice against economic benefit in the matter of whether or not producers should continue to support the CWB. There are matters of philosophy, values, preferences and choice involved in any democratic decision making process. But these are not the issues involved here. We are talking about the dollars and cents choices that have to be made to operate a successful commercial farm in the 1990s. They are influenced by CWB operations which are completely outside the influence of the farm manager.
Pooling of returns substantially alters and delays cash flows for the farmer. Externally directed, unpre-dictable cash flow generates a measure of uncertainty in farm finance and usually will result in increased credit costs (or foregone interest) revenue. These considerations have income tax implications.
Pooling also raises the issue for individual farmers of whether they are paid for what they actually produce and sell. We assume there is no need to justify the validity of this criterion as a measure of market performance. There are two aspects of this issue: how well is the sales agency matching supply with demand, and is there cross subsidization among producers? The manner in which pools are designed and operated involves considerable administrative, not market, decision making. Examples of questionable sales and cross subsidization presented in this report demonstrate that this issue is real.
Finally, there is a regional dimension of CWB impacts on farmer decision making and resource allocation. We know that administrative decisions of the CWB, not the market, determine product flows within and between groups of commodities, and between regions. Different delivery patterns, given flat annual prices, result in different real prices and different market signals regionally. A producer with a large debt load operating in an area that is late to enjoy the benefits of open quota will likely choose a different cropping pattern than a producer in the same area with little debt; this same producer will likely operate differently than a producer in a different area who is confident of relatively large, early quota/contract calls.
These are matters of CWB pooling and assembly logistics that influence individual farmer decision making. Regional and commodity production decisions may be affected. If they are, overall economic efficiency is reduced. The purpose of this discussion is to develop implications of CWB operations on farmer decision making-the micro-economics picture. Obviously if there are microeconomic distortions, these will be aggregated up to the overall market level.
Conclusions
- Making the case for significant selling benefits from the exercise of market power in world wheat markets is difficult.
- Making the case for significant farmer benefits from a single desk must deal with the domestic costs associated with SDS.
- The pooling regime associated with SDS on prairie grains generates several market inefficiencies.
- The costs generated by SDS relate to lack of competition, poor market signals, lack of arbitrage, lack of transparency, cross subsidization and over regulation.
- There are significant negative impacts of SDS on farm management decision making and on livestock producers, and overall resource allocation.
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