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A STUDY OF IMPERFECT COMPETITION OF THE ASIAN DAIRY

MARKETS: THE IMPACTS OF DOHA ROUND AGRICULTURAL

NEGOTIATIONS AND FURTHER TRADE LIBERALIZATION

Tingjun Peng

A dissertation submitted in partial fulfillment of

the requirements for the degree of

Doctor o f Philosophy

(Agricultural and Applied Economics)

at the

UNIVERSITY OF WISCONSIN-MADISON

2006

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A dissertation entitled

A Study of Imperfect Competition of the Asian Dairy Markets: The Impacts of Doha Round Agricultural Negotiations

and Further Trade Liberalization

submitted to the Graduate School of the University of Wisconsin-Madison

in partial fulfillment of the requirements for the degree of Doctor of Philosophy

by Tingjun Peng

Date of Final Oral Examination: May 15,2006

Month & Year Degree to be awarded: December May August 2006

Approval Signatures of Dissertation Committee

Signature, Dean of Graduate School

r / t

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ABSTRACT

The objectives of this thesis are to address the knowledge gap between perfect competition

and imperfect competition in world dairy sector, and study the impacts of Doha round

agricultural negotiations on the Asian and/or world dairy markets. Using the conjectural

variation (CV) method, a model is built which allows any degree of market structure from

perfect competition to monopoly or monopsony. One spatial price arbitrage condition derived

from this model is estimated econometrically to test the existence of market power. Furthermore,

the differences between perfect competition and imperfect competition are evaluated in empirical

work in the context of Doha round negotiations on agriculture in the Asian and/or world dairy

markets by using the GAMS software. The separate impacts of implementing Doha round

commitments in 2009, Doha round boundary commitments in 2009 and full world liberalization

in 2009 are analyzed.

From a statistical point of view, it is found that the imperfect competition model is more

appropriate to explain China’s butter and skim milk powder (SMP) imports, Japan’s cheese,

butter and skim milk powder imports, and South East Asia’s skim milk powder imports. From

the empirical results, it is found that the impacts of imperfect competition are positively related

to trade distortions. That is, if there are more trade distortions, the impacts of imperfect

competition are more obvious, but if there are less trade distortions then the impacts of imperfect

competition become smaller. However, from the empirical results on market power, the use of

perfect competition assumptions to study world dairy sectors by current models is roughly

justified if imperfect competition only applies to a limited number of products in a few regions.

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The impacts of different degrees of trade liberalization on world dairy sectors are similar to

each other with different magnitudes. Full dairy sector liberalization has significant impacts on

Japan, Korea and SEA dairy markets, but the impacts on China and India dairy markets are

small. Japan, Korea and SEA dairy producers suffer most from trade policy reform while

consumers benefit. For India, the opposite situation arises as dairy producers gain from trade

policy reform while suffer a loss from domestic support policy reform. For China, both trade and

domestic support policy reform have minimal impacts on producer surplus and consumer

surplus. As major exporters, Australia and New Zealand producers gain from trade polices

reform while suffer from domestic support policy reform due to the elimination of milk

production quota. EU dairy producers suffer the biggest losses from world dairy trade

liberalization, especially from domestic support policy reform. Compared with other regions, the

impacts of world dairy trade liberalization on the U.S. dairy market is generally moderate in the

medium term context. Dairy producers mainly suffer from domestic support policy reform.

Canada’s dairy producers also suffer significant losses from full dairy sector liberalization, and

trade polices and domestic support polices provide similar protection to dairy producers. Overall,

full dairy sector liberalization has little impact on world aggregate welfare, but it changes the

location of production and redistributes welfare across different countries.

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Table of Contents

ABSTRACT............................................................................................................ i

TABLE OF CONTENTS..................................................................................... iii

LIST OF FIGURES.................................................. viii

LIST OF TABLES.............................................................................................. xi

LIST OF BOXES................................................................................................ xiii

ACKNOWLEDGMENTS.................................................................................. xiv

TABLE OF CONTENTS

CHAPTER 1 INTRODUCTION............................................................... 1

1.1 MOTIVATION .................................................................................................................1

1.2 REVIEW OF LITERATURE............................................................................................. 9

1.3 STRUCTURE OF THE DISSERTATION........................................................................14

CHAPTER 2 ASIAN DAIRY SITUATION.......................................................16

2.1 DAIRY POLICIES................................ 16

2.1.1 China.......................................................................... 16

2.1.1.1 Domestic support policies......................................................................................16

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2.1.1.2 Trade policies..........................................................................................................18

2.1.2 Japan.............................................................................................................................19

2.1.2.1 Domestic support policies.......................................................................................19

2.1.2.2 Trade policies......................................................................................................... 22

2.1.3 South Korea................................................................................................................. 23

2.1.3.1 Domestic support policies...................................................................................... 23

2.1.3.2 Trade policies.............................. 24

2.1.4 India..............................................................................................................................25

2.1.4.1 Domestic support policies...................................................................................... 25

2.1.4.2 Trade policies..........................................................................................................25

2.1.5 South East Asia ............................................................................................................26

2.1.6 Oceanic Countris ........... 27

2.1.7 EU ................................................................................................................................31

2.1.8 United States ...................................................................................................... 32

2.2 WTO COMMITMENTS AND IMPLIMENTATION................. 33

2.2.1 Market Access ..............................................................................................................34

2.2.2 Domestic Support ........................................................................................................39

2.2.3 Export Subsidy .............................................................................................................42

2.3 DAIRY PRODUCTS PRODUCTION, CONSUMPTION AND TRADE ..................... 43

2.3.1 China................... 45

2.3.2 Japan............................................. 50

2.3.3 Korea............................................................................................................................53

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2.3.4 India............................................................................................................................ 56

2.3.5 South East A sia........................................................................................................... 59

CHAPTER 3 CONCEPTUAL MODEL............................................................ 63

3.1 CURRENT MODELS TO STUDY WORLD DAIRY SECTOR..................................... 63

3.2 A SPATIAL EQUILIBRIUM MODEL TO STUDY PERFECT COMPETITION 68

3.3 A SPATIAL EQUILIBRIUM MODEL WITH IMPERFECT

COMPETITION.............. 71

3.4 APPLICATION TO THE ASIAN DAIRY MARKETS...........................;........................ .75

3.5 TEST OF MARKET POWER.......................................................................................... 81

3.6 SIMULATION PROCEDURE......................................................................................... 86

3.7 POLICIES MODELING............................. 87

3.7.1 Import Quota..................................... 88

3.7.2 Production Quota....................................................................................................... 95

3.7.3 Price Support Policies.................................................................................................. 96

3.8 PREDICTION.................................................................................................................. 97

3.9 DATA AND SOFTWARE........................................................ 99

Chapter 4 MARKET POWER...................................................................... 105

4.1 MEASUREMENT ERROR BIAS .................................................................................... 107

4.2 INSTRUMENTAL VARIABLES (IV )...............................................................................108

4.3 REDUCED FORM ............................................................................................................109

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4.4 IDENTIFICATION ........................................................................................................... I l l

4.5 GMM ESTIMATION....................................................................................................... 112

4.6 OVER-IDENTIFICATION TEST........................................................ 114

4.7 RESULTS..........................................................................................................................116

4.8 ROBUSTNESS............................................................................................. 125

4.9 DISCUSSION....................................................................................................................126

Chapter 5 THE IMPACTS OF TRADE LIBERALIZATION ON THE

ASIAN DAIRY MARKETS........................................................ 135

5.1 INTRODUCTION...................... 135

5.2 DOHA DEVELOPMENT AGENDA................................................................................137

5.3 POLICY SCENARIOS................. 149

5.4 SIMULATION RESULTS.................................................................................................157

5.4.1 Base Scenario.......................................................................................................... 157

5.4.1.1 Results................................................................................................................... 157

5.4.1.2 Sensitivity Analysis: perfect competition vs. imperfect competition....................159

5.4.2 The Short Term Impacts of Doha Development Agenda...........................................163

5.4.2.1 Central Doha Scenario ..........................................................................................163

5.4.2.2 Decomposing Central Doha scenario: market access, domestic support and export

subsidies............................................................ 169

5.4.3 The Long Term Impacts of Doha Development Agenda.............................................176

5.4.4 Comparing the Impacts of Individual Policies: Tariff, Quota, Export Subsidy, Trade

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Policies, Domestic Policies and Full Liberalization....................................................185

5.5 IMPACTS OF IMPERFECT COMPETITION UNDER DOHA SCENARIOS AND FULL

LIBERALIZATION.................................................. 198

5.6 DISCUSSION .................................................................................................................. 201

Chapter 6 CONCLUSIONS AND DISCUSSION........................................ 240

6.1 CONCLUSIONS.................................. 240

6.2 CONTRIBUTIONS OF THIS DISSERTATION ............................................................. 246

6.3 DISCUSSIONS AND SUGGESTIONS FOR FUTURE RESEARCH ............................ 247

REFERENCES.................................................................................................. 254

APPENDICES.................................................. 266

A. REGION DEFINITONS...................................................................................................... 266

B. COMMIDITY DEFINITIONS............................................................................................ 269

C. DATA SOURCES................................................................................................................ 272

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viii

LIST OF FIGURES

FIGURE 2.1 CHINA MILK PRODUCTION BY TYPE .............................................46

FIGURE 2.2 CHINA MILK PRODUCTION AND UTILIZATION....................................... 47

FIGURE 2.3 CHINA BUTTER PRODUCTION, CONSUMPTION AND TRADE.............. 48

FIGURE 2.4 CHINA CHEESE PRODUCTION, CONSUMPTION AND TRADE.............. 49

FIGURE 2.5 CHINA SMP PRODUCTION, CONSUMPTION AND TRADE....................... 50

FIGURE 2.6 JAPAN MILK PRODUCTION AND UTILIZATION....................................... 51

FIGURE 2.7 JAPAN BUTTER PRODUCTION, CONSUMPTION AND IMPORTS.......... 51

FIGURE 2.8 JAPAN CHEESE PRODUCTION, CONSUMPTION AND IMPORTS........... 52

FIGURE 2.9 JAPAN SMP PRODUCTION, CONSUMPTION AND IMPORTS................53

FIGURE 2.10 KOREA MILK PRODUCTION AND UTILIZATION ........................... 53

FIGURE 2.11 KOREA BUTTER PRODUCTION, CONSUMPTION AND IMPORTS.......54

FIGURE 2.12 KOREA CHEESE PRODUCTION, CONSUMPTION AND IMPORTS.......55

FIGURE 2.13 KOREA SMP PRODUCTION, CONSUMPTION AND IMPORTS............... 55

FIGURE 2.14 INDIA MILK PRODUCTION BY TYPE........................................................ 56

FIGURE 2.15 INDIA MILK PRODUCTION AND UTILIZATION..................................... 57

FIGURE 2.16 INDIA BUTTER PRODUCTION, CONSUMPTION AND IMPORTS......... 58

FIGURE 2.17 INDIA SMP PRODUCTION, CONSUMPTION AND IMPORTS................ 59

FIGURE 2.18 SEA MILK PRODUCTION BY TYPE. ................................................... 60

FIGURE 2.19 SEA MILK PRODUCTION AND UTILIZATION....................................... 60

FIGURE 2.20 SEA BUTTER CONSUMPTION AND IMPORTS....................................... 61

FIGURE 2.21 SEA CHEESE PRODUCTION, CONSUMPTION AND IMPORTS............62

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FIGURE 2.22 SEA SMP CONSUMPTION AND IMPORTS............................................... 62

FIGURE 3.1 THE IMPACTS OF IMPERFECT COMPETITION ON SUPPLY AND

DEMAND PRICES........................................................................................... 74

FIGURE 3.2 IMPACTS OF TRQS ON THE IMPORTING COUNTRY............................... 89

FIGURE 3.3 NONEQUIVALENCE OF IMPORT QUOTA AND TARIFFS: ECONOMIC

GROWTH............................................... 91

FIGURE 3.4 NONEQUIVALENCE OF IMPORT QUOTA AND TARIFFS: WORLD PRICE

INCREASES....................................................................................................... 93

FIGURE 3.5 TWO-TIER TARIFF-RATE QUOTA...............................................................94

FIGURE 3.6 SUPPLY CURVE WITH A PRODUCTION QUOTA...................................... 96

FIGURE 3.7 DEMAND CURVE WITH PRICE SUPPORT..................................................97

FIGURE 5.1 LINEAR REDUCTION MODALITY FOR EXPORT SUBSIDY.................. 155

FIGURE 5.2: AGGREGATE WELFARE IMPACTS (2009): WORLD................................. 214

FIGURE 5.3: AGGREGATE WELFARE IMPACTS (2009): CHINA................................... 214

FIGURE 5.4 AGGREGATE WELFARE IMPACTS (2009): JAPAN................ 215

FIGURE 5.5: AGGREGATE WELFARE IMPACTS (2009): INDIA.................................... 215

FIGURE 5.6: AGGREGATE WELFARE IMPACTS (2009): KOREA.................................. 216

FIGURE 5.7: AGGREGATE WELFARE IMPACTS (2009): SEA........................................ 216

FIGURE 5.8: AGGREGATE WELFARE IMPACTS (2009): E U ......................................... 217

FIGURE 5.9: AGGREGATE WELFARE IMPACTS (2009): AUSTRALIA........................ 217

FIGURE 5.10: AGGREGATE WELFARE IMPACTS (2009): NEW ZEALAND............... 218

FIGURE 5.11: AGGREGATE WELFARE IMPACTS (2009): U S ....................................... 218

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FIGURE 5.12: AGGREGATE WELFARE IMPACTS (2009): CANADA...........................219

FIGURE 5.13: AGGREGATE WELFARE IMPACTS UNDER DIFFERENT SCENARIOS

(2009): WORLD........................................................................................... 232

FIGURE 5.14: AGGREGATE WELFARE IMPACTS UNDER DIFFERENT SCENARIOS

(2009): CHINA............................................................................................. 232

FIGURE 5.15: AGGREGATE WELFARE IMPACTS UNDER DIFFERENT SCENARIOS

(2009): JAPAN............................................................................................. 233

FIGURE 5.16: AGGREGATE WELFARE IMPACTS UNDER DIFFERENT SCENARIOS

(2009): INDIA............................................................................................... 233

FIGURE 5.17: AGGREGATE WELFARE IMPACTS UNDER DIFFERENT SCENARIOS

(2009): KOREA.............................................................................................234

FIGURE 5.18: AGGREGATE WELFARE IMPACTS UNDER DIFFERENT SCENARIOS

(2009): SEA...................... 234

FIGURE 5.19: AGGREGATE WELFARE IMPACTS UNDER DIFFERENT SCENARIOS

(2009): E U .................................................................................................... 235

FIGURE 5.20: AGGREGATE WELFARE IMPACTS UNDER DIFFERENT SCENARIOS

(2009): OCEANIA.............................................................. 235

FIGURE 5.21: AGGREGATE WELFARE IMPACTS UNDER DIFFERENT SCENARIOS

(2009): U S ...................................................................... 236

FIGURE 5.22: AGGREGATE WELFARE IMPACTS UNDER DIFFERENT SCENARIOS

(2009): CANADA....................................................................................... 236

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LIST OF TABLES

TABLE 2.1 CHINA’S TARIFF RATES ON DAIRY PRODUCTS........................................19

TABLE 2.2 ASIA COUNTRY’S DAIRY TARIFFS............................................................. 37

TABLE 2.3 TARIFF RATE QUOTA ADMINISTRATION FOR ASIA COUNTRIES....... 38

TABLE 3.1 NOTATIONS USED IN THE CONCEPTUAL MODEL.................................... 84

TABLE 4.1 MARKET POWER OF BUTTER....................................................................... 128

TABLE 4.2 MARKET POWER OF CHEESE......................... 129

TABLE 4.3 MARKET POWER OF SM P................................................................................131

TABLE 4.4 EFFECTS OF DIFFERENT IV ON MARKET POWER..................................132

TABLE 4.5 DEMAND ELASTICITIES FOR DIFFERENT DAIRY PRODUCTS............ 133

TABLE 4.5 THE LERNER INDEX FOR DIFFERENT DAIRY PRODUCTS IN DIFFERENT

MARKETS............................................................... 134

TABLE 5.1 CUTS IN DOMESTIC SUPPORT UNDER A TIERED FORMULA

WITH 75 PERCENT CUTS IN HIGH-SUPPORTING COUNTRIES .....145

TABLE 5.2A 2002-04 BASE SOLUTIONS........................................................................... 206

TABLE 5.2B 2002-04 DATA SIMULATIONS..................................................................... 207

TABLE 5.3 PERFECT COMPETITION VS. IMPERFECT COMPETITION: BASE........208

TABLE 5.4 IMPACTS OF DDA: CENTRAL DOHA SCENARIO .............................. 209

TABLE 5.5 IMPACTS OF DDA: DOHA DOMESTIC SUPPORT SCENARIO................210

TABLE 5.6 IMPACTS OF DDA: DOHA MARKET ACCESS SCENARIO....................... 211

TABLE 5.7 IMPACTS OF DDA: DOHA EXPORT SUBSIDY SCENARIO..................... 212

TABLE 5.8 WORLD TRADE VOLUME UNDER ALTERNATIVE DOHA SCENARIOS ....213

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.220

221

TABLE 5.11 IMPACTS OF DDA: DOHA MARKET ACCESS BOUNDARY SCENARIO...222

TABLE 5.12 IMPACTS OF DDA: DOHA EXPORT SUBSIDY BOUNDARY SCENARI0...223

TABLE 5.13 WORLD TRADE VOLUME UNDER ALTERNATIVE DOHA BOUNDARY

SCENARIOS.................................................................................................. 224

TABLE 5.14 WELFARE IMPACTS UNDER ALTERNATIVE DOHA BOUNDARY

SCENARIOS ..............................................................................................225

TABLE 5.15 IMPACTS ON MILK UNDER ALTERNATIVE SCENARIOS.................... 227

TABLE 5.16 IMPACTS ON CHEESE UNDER ALTERNATIVE SCENARIOS............... 228

TABLE 5.17 IMPACTS ON BUTTER UNDER ALTERNATIVE SCENARIOS............... 229

TABLE 5.18 IMPACTS ON SMP UNDER ALTERNATIVE SCENARIOS....................... 230

TABLE 5.19 FARM PRICE IMPACTS OF FULL DAIRY SECTOR LIBERALIZATION.^ 1

TABLE 5.20 PERFECT COMPETITION VS IMPERFECT COMPETITION: CENTRAL

DOHA SCENARIO........................................................................................... 237

TABLE 5.21 PERFECT COMPETITION VS IMPERFECT COMPETITION: CENTRAL

DOHA BOUNDARY SCENARIO/FULL LIBERALIZATION...................... 238

TABLE 5.22 COMPARISON OF MODEL SOLUTIONS AND ACTUAL DATA FOR 2004 ...239

TABLE 5.9 IMPACTS OF DDA: CENTRAL DOHA BOUNDARY SCENARIO .

TABLE 5.10 IMPACTS OF DDA: DOHA DOMESTIC SUPPORT BOUNDARY

SCENARIO............................................................. ..........................

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LIST OF BOXES

BOX 5.1 ALTERNATIVE APPROACHES TO REDUCING TARIFFS....................... !.......141

BOX 5.2 ELEMENTS OF THE DDA SCENARIO BASED ON JULY FRAMEWORK

AGREEMENT .................................................................................................145

BOX 5.3 MAJOR AGREEMENTS ON AGRICULTURE IN THE SIXTH MINISTERIAL

CONFERENCE.......................................................................................................... 148

BOX 5.4 DDA SCENARIO FOR SIMULATION...................................................................153

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ACKNOWLEDGMENTS

First of all, I would like to express my special appreciation to my advisor, Professor Thomas

Cox, for his great guidance, encouragement, understanding, tremendous patience and all-round

supports, without any of these, the completion of this dissertation is absolutely impossible. I also

want to thank Professor Thomas Cox for giving me father-kind caring during my study in U.S.. It

is him who makes my life in U.S. much more enjoyable. I am very thankful to Professor Jean-

Paul Chavas who amazingly responded to so many versions of my thesis. Talking to him has

always been refreshing and fruitful. I am very grateful to Professor Ian Coxhead for his insightful

comments on shaping the direction of this study. I also want thank him for providing me so many

background materials on the Doha round negotiations. It would be difficult to finish this study

without these materials. Professor Brian Gould has always shown his supports in spite of his

tight schedule. Professor Brian Yandell has also influenced my views of conducting this research.

To all of these helps, I am very thankful.

I thank all my other teachers at the University of Wisconsin-Madison, particularly Brad

Barham, Daniel Bromley, Kyle Stiegert, Guanming Shi, Michael Carter, Murray Clayton,

Douglas Bates, Robert Miller, Richard Johnson, Judith Grudzina and Kjell Doksum, from whom

I feel greatly benefited.

I thank Barbara Forrest for her administrative advice and helps during my 5-year study. She

is such a nice person to be always patient on any questions I raised. My appreciation also goes to

Davis Linda, Dawn Danz-Hale, Hilmanowski Nancy, Martin-Taylor Kathy, Munn Cindy, Olsen

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Carol, Reid Vemetta, Waters Eliza for their administrative helps, and Eric Dieckman for his

computer supports.

I thank Mr. Joseph Burke for helping me understanding the data configuration of the GAMS

model. I would also thank my other fellow students, especially Du Ying, Cai Xiaowei, Li Muqun,

Cheng Xu and Lin Hua for their friendship and encouragement.

This work, and my graduate studies, would be impossible without the financial assistance

from the Department of Agricultural and Applied Economics, University of Wisconsin-Madison

and the U.S. Department of Agriculture.

Finally, my wife is of great support throughout my studies. I thank my wife for waiting in

Beijing to allow me to pursue my “selfish” career ambition in the past five years. Without her

love I would be broken down during my study. This work is dedicated to my parents and my

parents in law, thanks to all of them for their understanding.

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Chapter 1 Introduction

Spatial equilibrium models have frequently been applied to study interregional trade

problems in agriculture including regional competition issues associated with the dairy sector

(e.g., Chavas, Cox and Jesse; McDowell et al). Originally developed by Enke and by Samulson

and then refined by Takayama and Judge, spatial price equilibrium models operate mostly under

the perfect competition assumption. However, the perfect competition assumption is

questionable for some products trade. For example, Kawaguchi et al (1997) in the study of

Japanese milk market pointed out that “The Coumot-Nash equilibrium solutions were the most

similar to actual observations, and the actual interregional milk movements could be explained

by assuming imperfectly competitive behavior”. Is the assumption of perfect competition for

Asian and/or world dairy markets justified? Can Asian and/or world dairy markets be explained

by imperfect competition or some other market structure? The objective of this study is to

develop a model of Asian dairy markets allowing for imperfectly competitive market structure.

More specifically, I want to build a model that can incorporate any degree of market power from

perfect competition to monopoly or monopsony. I want to explore the empirical relevance of

perfect and imperfect competition for Asian and/or world dairy markets. This is done by

studying the functioning of dairy markets in Asia and the exercise of market power, with

implications for Doha round negotiations on agriculture in Asian and/or world markets.

1.1 Motivation

With over 60% of world population, Asia’s dairy products consumption has increased

rapidly in recent years. Asia also produces large amounts of milk reaching 206 million MT in

2003, which accounts for 31% of world total milk production. From 1989 to 2003 its

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consumption of dairy products (simple summation) increased from 90.8 million MT to 177

million MT, with an annual average growth rate of 5%. Asia accounts for 36.5% world total dairy

products consumption in 2003. Butter is the largest product category consumed, with

consumption exceeding 3.5 million MT in 2003. The consumption of whole milk powder (WMP),

skimmed milk powder (SMP), condensed evaporated milk (CEM) and cheese all exceeded 600

thousand MT. Except lactose, all other products consumption exceeds 170 thousand MT. The

annual average growth rate of butter, cheese and dry whey exceeds 5% during this period.

However, Asia is unevenly developed. There are developed countries and regions such as

Japan, Singapore, South Korea, Hong Kong and Taiwan. There are developing countries with

fast economic growth rates such as China, India, Thailand, Malaysia and Indonesia. There are

also least developed countries such as Nepal. Due to different stages of economic development,

consumer’s taste and farming styles, countries play a unique role in this region’s dairy

consumption. More than 90% of Asian regional casein, dry whey, lactose and residual dairy

products (fluid and soft products) are consumed by China, Japan, Thailand, South Korea,

Singapore, Philippines, Malaysia, Indonesia and India. At least 80% of other dairy products are

consumed by the above 9 countries, and there are large differences in the consumption share

among these countries. Japan consumes about 70% of regional casein and lactose, 50% of cheese

and 30% of skimmed milk power in Asia. China consumes more than 30% of regional cheese,

dry whey and residual products. India consumes about 60% of regional butter. Malaysia

consumes about 20% of regional condensed evaporated milk.

Asia’s per capita dairy consumption is still low compared with Western developed countries.

Per capita dairy consumption in China, India, Indonesia, Japan, Malaysia, Philippines, South

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Korea, Thailand, and Vietnam averages 4.5 kg, 35.7 kg, 2.1 kg, 44.2 kg, 7.7 kg, 2.4 kg, 35.2 kg,

9.8 kg, and 1.8 kg per capita, respectively, in the last decade, in contrast with 105 kg per capita in

the EU-15, 120 kg per capita in Australia, and 113 kg per capita in the U.S (Dong, 2005). This

also means that there is huge potential for further growth and development of the Asian dairy

markets.

The Asian markets play a more important role in dairy products imports than exports. Most

countries do not have exports at all. Only a few countries (China and India) export some dairy

products to neighboring countries. In 2003, Asia’s imports of milk equivalent are 25.8% of the

world total; Asia’s imports of butter, cheese and SMP accounts for 19%, 14% and 42% of world

imports (FAO, 2003), respectively. Asia’s exports of milk equivalent only accounts for 2.9% of

the world total in 2003. From 1989-2003, the annual average growth rates of imports of cheese,

dry whey, SMP and RES are 6%, 13.7%, 2.7% and 14.3%, respectively; if we exclude Japan

from the Asian dairy markets, the annual average growth rates of imports of cheese, dry whey,

SMP and RES are 11%, 15%, 5% and 14%, respectively. This suggests that cheese and SMP

imports have increased a lot in Asian countries other than Japan. This is reasonable as Japan

experienced an economic recession during this period. In 2003, China’s import of butter, WMP,

dry whey and residuals accounts for 14%, 21%, 40% and 35% of the Asian market, respectively;

Japan imports a lot of cheese (71%), SMP (9.2%) and dry whey (11%); South East Asia imports

a lot of butter (78%), WMP (44%), SMP (77%) and dry whey (38%); Korea mainly imports

cheese (11%) and dry whey (10%); India does not import much dairy products, but it exports

several dairy products (butter, WMP, SMP).

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Most of the Asian dairy product imports are from New Zealand and Australia. For example,

according to cheng et al (2002), during 1996-1998, China’s import of concentrated milk from

New Zealand and Australia account for 34% and 11% of its total imports, respectively; the

import of butter and dairy spread from New Zealand and Australia account for 50% and 25%,

respectively; the import of cheese and curd from New Zealand and Australia account for 30%

and 22%, respectively. Australia is the leading exporter of natural cheese to Japan (Campo and

Beghin, 2005). On a volume basis it accounts for 39.7 percent in 2001. Together with second-

place New Zealand (26.5 percent) exports from these two nations in Oceania account for nearly

66.2 percent of all Japanese natural cheese imports. Japan imports butter mainly from New

Zealand (Campo and Beghin, 2005), which had a share of 60.5 percent on a volume basis in

2001. Australia ranks second with a share of 20.7 percent.

Why this is the case? Is it because New Zealand and Australia have comparative advantage

against other countries (like US, Canada, EU, etc)? Before 2001, the New Zealand Dairy Board

acted as the single desk (monopoly) exporter of New Zealand’s dairy products and handled about

30 percent of world dairy product exports. Under pressure from WTO, the October 2001 merger

of the New Zealand Dairy Group and Kiwi Cooperative formed Fonterra. The merged

cooperatives then absorbed the New Zealand Dairy Board (NZDB), and now processes over 95

percent of the milk produced in New Zealand and has purchased interests in Australian dairy

companies (Armentano et al, 2004). This merger achieved processing economies and realized

efficiencies in dairy products exports. This is because the merger is based, in part, on the

following considerations (Armentano et al, 2004): (1) it was reasoned that coordination of

industry activities throughout the value chain would be facilitated by merging the NZDB with

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the New Zealand Dairy Group and Kiwi Cooperative; (2) while the Board had efficient

procedures for allocating production orders for export sales with New Zealand’s cooperatives,

the NZDB was unable to optimize New Zealand’s dairy export product mix when it operated

separately from the cooperatives. Understandably, the cooperatives produced milk to further

their own interests rather than those of the entire New Zealand dairy industry under the old

structure; (3) to some extent, the NZDB had come to be regarded as an unnecessary layer

between foreign buyers and New Zealand’s domestic processors. Moreover, New Zealand’s big

cooperatives had developed the ability to export dairy products on their own. The merger was

also to gain market power. This is because one of the current strategies of Fonterra is to enable

firms to be effective developers of integrated strategies for the four key regional markets of

China, Eastern Europe, India, and the economic grouping of Chile, Brazil, and Argentina. This

strategy appears to involve getting ahead of competitors for serving these major growth markets.

This could give New Zealand first mover advantage in these markets and expand its market share.

In this case, an imperfect competition model may be more appropriate to explain dairy trade in

these markets.

Australia had a similar organization with the Australian Dairy Corporation (ADC), created in

1975. The ADC worked at enhancing the production and marketing of dairy products for greater

profit for milk producers, and acted as the single desk exporter of Australian dairy products. Its

role, however, was limited to exports to Japan of all dairy products and to cheese sales to the EU,

and it ceased operation on June 30,2002 (Seyoum, 2004). This role has been more or less taken

over by dairy companies such as Murray Goulbum Cooperatives and Bonlac Foods which have

emerged as major dairy exporters. In addition to this, Australia and New Zealand also provide

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technical assistance to Asian countries. For example, both Australia and New Zealand have a

large number of programs to promote dairy cooperation with the Chinese government and firms

(Cheng, 2000). The aim of these programs is to give them first mover advantage in China’s dairy

market, such as (1) build good relationship with China’s firms to have the priority to sign export

contracts; (2) expand market share and establish brand recognition through technical assistance.

Before the 1990s China’s milk yield per cow was very low and China imported a lot of dairy

cows from EU and North American during the 1980s. During the 1990s, Australia and New

Zealand governments provide technical assistance to China and promoted dairy cow exports to

China. Now Australia and New Zealand have become the main markets to export dairy cows to

China.

The international dairy market is characterized by the pursuit of an active role in international

trade by large dairy companies and multinational enterprises (Seyoum, 2004). Many of the

world’s key dairy businesses have been involved in major mergers and acquisitions in the past

decades. Between May 2000 and June 2001 there were 150 mergers and acquisitions throughout

the world in large dairy companies (Rabobank International (2001)). In its report, Rabobank

International indicated that in some product categories, globalization has already taken place:

Nestle and Unilever dominate ice cream; Danone, Yoplait and Nestle dominate yoghurt; and

Kraft focuses primarily on cheese.

According to Handy and Henderson (1994), most food manufacturing firms rely more on

foreign investment than on exports as their major strategies are to access foreign markets.

Dobson (2001) indicated that the global food processing market is dominated by big companies

in the U.S., EU and Japan and he argued that because the prospects for further trade

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liberalization of the world dairy markets are unlikely, foreign direct investment in new markets is

a potentially attractive alternative to exporting. Many large companies are now moving

aggressively into Asia. For example, so far, all the world's top 20 dairy brands have entered the

Chinese market and four of them have built production plants in the country, including

Switzerland's Nestle and Italy's Parmalat. As multinational companies have the ability to

maximize total profit over several countries’ markets, they can gain efficiencies in dairy product

production. This is different from a national or regional company which can only maximize its

total profit over one country’s market. Moreover, if the Asian dairy markets are dominated by

several big companies, there may exist market power. In this case, oligopolistic competition may

be appropriate to explain Asian dairy products trade.

Dairy industries around the world are among the most distorted agricultural sectors. In order

to resolve the issue of trade distortion and promote trade liberalization of dairy products, GATT

concluded the Uruguay Round Agreements in late 1993 after eight years of painstaking

negotiations. As a component of the agreement, the GATT/WTO Agreement on Agriculture

(AoA) requires all GATT members to make reduction commitments on domestic support and

export subsidy, and broaden market access. The commitment would be fulfilled by developed

countries at the end of 2000 and by developing countries at the end of 2004, with 1986-1988 as

the base period for reduction. The least developed countries are not required any reduction

commitment. For market access commitments, ten dairy products exports to Japan are subject to

Tariff Rate Quota (TRQ) administration, five to South Korea, two and one to Malaysia and

Indonesia, respectively. Japan and Korea’s TRQs are allocated on global basis. For whey and

skim milk powder for other purposes, Japan’s TRQs are allocated to producers and producer

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organizations of mixed feed or sellers. For skim milk powder, whole milk powder, and other

milk and cream, Korea’s TRQs are allocated according to the highest price bidders at quota

auctions held by the Livestock Products Marketing Organization. Indonesia acts as the single

desk buyer.

When TRQs are binding, the question of how TRQs are allocated among the importing firms

is the core of element of competition. In case of limited access to import rights, the assumption

of perfect competition might be rather unrealistic. McCorriston (1996, p.372) has shown import

quota can create oligopsony power: “the results confirm that perfect competition among license

holders should be rejected”. De Gorter (1999, p.9) explains the situation where “it is possible for

one group to purchase the entire portion of the right to import (domestic or foreign), and then

withhold part of the license to maximize revenue”.

Therefore, there is circumstantial evidence that the Asian and/or world dairy markets are

subject to imperfect competition. In this paper, I want to explore this possibility in the context of

new round (Doha Round) negotiations for further trade liberalization on agriculture. Doha Round

negotiations started in 2001 and are scheduled to finish this year. These negotiations aim at

substantial expansion of market access and reduction in domestic support and export subsidy.

During the negotiations, it is difficult to find a consensus formula for reducing agricultural tariffs.

Real progress on agriculture was not evident until the early hours of 1 August 2004 with a set of

decisions in the General Council (sometimes called the July 2004 package). The Sixth

Ministerial Conference in Hong Kong, China, in December 2005, reaffirmed the Declarations

and Decisions adopted at Doha, as well as the Decision adopted by the General Council on

1 August 2004, and committed to give effect to them. As mentioned above, the dairy industry is

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an infant industry in Asia when compared to Western countries. However, it has huge potential

for further growth and development. Three issues are of particular interest to this study. First,

how will the outcome of the Doha round negotiations affect its development? Second, do Asian

countries have market power for dairy trade? Third, if market power exists, how does it impact

Asian dairy industry? All answers to these questions would help us to better understand the

development of Asian and/or world dairy sector in the future.

1.2 Review o f Literature

Several issues of Asian dairy markets have been studied. Dong (2005) studied the role that

demographics, income and prices played in Asian dairy markets by using the FAPRI

international dairy model, and pointed out that both Asian dairy consumption and supply show

upward trends over the next decade. Asian dairy demand growth in the next decade is mostly

driven by income and population growth. Given a 1% additional growth in income, cheese

consumption will increase 0.45% and WMP consumption will increase 0.39%. With

technological change which increases yield per cow, Asian domestic milk output is expected to

increase, implying a possible decease in imports.

Cheng et al (2002) studied the impacts of China’s accession into WTO on its dairy industry

and argued that China’s dairy production will increase with China's accession into WTO; China's

accession into WTO will increase its dairy consumption; China will remain a net dairy importing

country from 2000 to 2015, as accession into WTO will boost up its net dairy imports.

Fuller et al (2005) studied China’s dairy production efficiency and found that the share of

output growth contributed by total factor productivity (TFP) was the lowest for milk production

when compared to almost all other livestock sectors (with the exception of backyard hog

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production). Although TFP growth has been relatively slow, the contribution of technology has

played an important role in the growth of China’s milk production. Most of China’s productivity

growth in the specialized and commercial dairy sectors has been due to the adoption of improved

genetics, milking processes and other management methods. There were very small gains due to

scale economies.

Cheng (2000) based on her investigation of dairy enterprises and production farms argued

that China’s dairy industry won’t be disadvantaged with China’s accession into WTO, and

China’s dairy industry won’t increasingly depend on world dairy markets.

China’s Rural Economy Research Center analyzed the factors restricting China’s dairy

industry development and pointed out that China’s dairy production, consumption, and dairy

products quality and varieties would increase rapidly in the following 10-15 years.

Wattiaux, Guo and Frank (2002) based on their study of dairy production systems and dairy

farms management systems, found that an increasing number of dairy cows are in the hands of

private entrepreneurs; The transition in production systems from large state-owned farms to

(currently smaller) private farms create challenges and uncertainties about the future of domestic

production in China. Chinese small privately-owned farms were as profitable as much larger

collective or state-owned farms. Large, well-managed Chinese farms have a net farm income

approximately three times lower than Wisconsin farms of similar size.

Pratt et al (2005) pointed out that the success stories of Pakistan and India show a high and

growing demand for dairy products; a growing supply resulting from increased numbers of

milking animals and growing contribution of technical change; increased feed availability,

development of feed markets, and market institutions linking demand and supply effectively.

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Conversely, Bangladesh and Sri Lanka face supply constraints related to production of quality

feed, animal stock composition and yields. These two countries also face lower demand for dairy

products, depend more on imports and at least in the case of Sri Lanka, powdered milk is more

popular than traditional products among consumers. In both countries, development of

manufacture and growth of human capital have increased the opportunity cost of rural labor,

which together with lack of technical options at the farm level, has discouraged diversification

and increased the share of livestock production in mixed production systems. In other cases, like

in Nepal, constraints appear to be more related to policy and promotion of inadequate market

institutions (such as the pricing and distribution system).

Lee et al (2005) pointed out that trade liberalization would cause significant increases in

Korean dairy imports (milk fat increase by 27%, non-fat-solid (NFS) by 18.1%), lower prices of

processed dairy products for Korean consumers (raw milk price falls by 27.8%, milk fat by

23.7%, NFS by 29.6%). Despite these large shifts in percentage terms, the quantity of raw milk

produced falls by only 4.9 percent. Even in the free trade scenario analyzed, the prices of farmer

supplied inputs, labor and capital, fall by a modest 3.1 percent and 2.4 percent.

Campo et al(2005) pointed out that Japan’s dairy consumption patterns have evolved with

increasing individual consumption of cheese and fluid milk. The individual consumption of

butter and milk powder has been stagnating as butter is not widely used in cooking and as fluid

milk has been substituted for milk powder. This increase in per capita consumption is linked to a

decline in real dairy prices, rising household incomes, and changes in taste/information. Japanese

dairy supply is still isolated from world markets because of prohibitive tariffs, high

transportation cost and the perishability of fluid milk. Processors have been disadvantaged by

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their low effective protection and by a lack of scale economies (dairy farm size is small and

inefficient).

Rakotoarisoa et al (2005) pointed out that India’s dairy products, especially SMP during the

1990s, has become more competitive. Domestic supply for WMP and raw milk are relatively

inelastic but increases in world WMP price would significantly increase both India’s WMP export

and wholesale price of milk. These gains extend if domestic WMP supply becomes more elastic.

These finding imply that reduction of distortions in the world dairy markets, especially in the EU

and the US, leading to higher world prices would make India’s dairy market more competitive.

Such reform would have significant impacts on fresh milk price, thereby, small milk farmers.

There are several papers using perfect competition models to study world dairy sector which can

be categorized as: (1) based on Computable General Equilibrium (CGE) Models: ABARE (2004),

CARD (2004), World Bank LINKAGE; (2) based on Partial Equilibrium Econometric (Time-Series

or Equilibrium Displacement) models: OECD Aglink, FAPRI, ERS/Penn State WTO Model:

Langley et al (2003); Abler et al (2001) and the Guelph Model: Lariviere and Meilke (1999); (3)

based on Partial Equilibrium Programming models: Toulouse EU Dairy Sector Model, Bouamra-

Mechemeche, Chavas, Cox and Requillart (2002,2004) and the University of Wisconsin World

Dairy Model (UW-WDM) Hedonic Spatial Equilibrium: Cox, Coleman, Chavas and Zhu (1999);

Cox and Zhu (2004); Zhu, Cox and Chavas (1999).

However, none of the above approach explores the differences between perfect competition and

imperfect competition for Asian and/or world dairy markets. Is the perfect competition model

justified to study Asian and/or world dairy markets? There are several trade books studying the

impacts of imperfect competition.

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Helpman and Krugman (1989) pointed out that the theory of trade policy under imperfect

competition is full of paradoxes. For example, a tariff or import quota may reduce the output of the

protected industry, an import subsidy may improve the terms of trade, and export subsidy may raise

the subsidized firm’s profits by more than the subsidy itself, protection can raise the profits of

foreign as well as domestic firms, and a tariff can reduce internal prices. The basic reason for this

prevalence of unusual is that under imperfect competition firms react to more aspects of their

situation than they do under perfect competition. Instead of simply setting marginal cost equal to the

price, firms set it equal to perceived marginal revenue.

Krugman (1994) pointed out that, in the context of oligopoly competition and decreasing cost,

protecting the domestic firm in one market increases domestic sales, lowers foreign sales in all

markets, and increases the incentive for domestic RandD at foreign expense. This in turn translates

into a shift in relative production cost, which leads to increased domestic sales even in unprotected

markets.

Krishna (1989) pointed out that in the case of duopoly competition a quota can easily raise the

profits of both firms.

There are several papers that incorporate imperfect competition in spatial equilibrium models.

Nelson and McCarl developed a Cournot and conjectural variation model which could depict certain

forms of imperfect market structures, but they did not apply them empirically. Kawaguchi, Suzuki,

and Kaiser used the conjectural variation approach, similar to that used by Nelson and McCarl, and

applied it to the Japanese domestic milk market. But Kawaguchi et al. study exporters’ market

power and ignore potential importers’ market power. This is unrealistic because demand (imports)

more important than supply (exports) for trade flow in dairy products. Chen, McCarl, Chang and

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Hsu developed an imperfect competition model that can study any kind of market structure

specification allowing competitive behavior spanning from perfect competition to monopoly or

monopsony. They also considered both exporters’ and importers’ market power by applying the

model to world rice trade. But they focus only on the trade side and do not consider the domestic

supply/demand change associated with a change in countries’ exports/imports.

In this dissertation, I will develop a model to combine domestic supply/demand and

imports/exports into one unified system to study the importers and exporters’ market power by

allowing any degree of market structure from perfect competition to monopoly or monopsony, and

investigate which model is more appropriate for Asian and/or world dairy markets, with

implications for the impacts of Doha round negotiations.

1.3 Structure o f the Dissertation

The objectives of this dissertation are to better understand the Asian dairy situation, examine

whether or not there is market power for Asian dairy products trade, explore the differences

between perfect and imperfect competition for Asian dairy products trade, and investigate the

implications in the context of Doha round negotiations. I use five chapters to achieve this. Chapter 2

presents the status quo Asian dairy situation. I first review dairy policies (domestic support policies

and trade policies) for major Asian countries and their exporters (New Zealand, Australia, EU and

U.S.). I then study Asian countries WTO commitments and implementation from the perspective of

market access, domestic support and export subsidies. Lastly, I study Asian countries major dairy

products (butter, cheese and skim milk powder) production, consumption and trade in recent years.

Chapter 3 develops a model to combine domestic supply/demand and imports/exports into one

unified system to study the importers and exporters’ market power by allowing any degree of

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market structure from perfect competition to monopoly or monopsony. I first briefly introduce the

pros and cons of existing models to study world dairy markets, and then built an imperfect

competition model extending previous models of perfect competition (The UW-Madison World

Dairy Model (UW-WDM)).

Chapter 4 is used to study the market power of Asian countries and their major exporters for

dairy products trade. In this chapter I estimate an econometric model which can reveal and test

whether or not market power for importers and/or exporters in dairy products trade exists. It relies

on the spatial price arbitrage conditions derived under imperfect competition in chapter 3.

Chapter 5 studies the impacts of Doha round negotiations on the Asian dairy markets. First, I

introduce the Doha development agenda and its major achievements. Second, I set several

alternative scenarios based on the August 2004 Framework Agreement to study the potential

impacts of Doha round negotiations on Asian dairy markets. One scenario is the BASE scenario

which I use the average data from 2002-04.1 calibrate the endogenously generated dairy products

prices, production, consumption with 5-10% of the actual data for this period. Using this BASE

scenario, I explore the differences between perfect and imperfect competition for Asian and/or

world dairy markets. The results of other scenarios are compared to this BASE scenario to see their

individual impacts on dairy products prices, production, consumption and welfare. Third, I further

explore the difference between perfect and imperfect competition in the context of Doha round

negotiations and full dairy sector liberalization. Lastly, I discuss the needs for further research.

Further conclusions and discussions are developed in chapter 6. In particular, I discuss the

contributions, limitations and future tasks of this search.

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Chapter 2 Asian Dairy Situation

As Asian countries experience different stages of economic development, their dairy policies,

dairy product trade, production and consumption are consequently different from each other. In

this chapter, we review major Asian countries dairy policies, their WTO commitments, and dairy

products trade, production and consumption. In addition to major Asian countries, we also take a

look at their major exporters, i.e., EU, Australia, New Zealand and U.S.

2.1 Dairy policies

2.1.1 China

2.1.1.1 Domestic Supporting Policies

The dairy industry is regarded as an important industry by the government as it has a direct

impact on the nutrition and health of its people, and is identified as a key industry for state

support in the policy documents of the State Council. At the end of the 1990s, when there was a

surplus in the supply of pork and poultry, the market for dairy products remained rather stable.

At this time, the government was determined to improve the structure of the agriculture and

husbandry industry. In 1999, the Ministry of Agriculture (MOA) made it clear that China "put

more emphasis on the production of dairy products, stabalize the supply of pork and poultry, and

raise the output of herbivorous animals." In the 1990s, preferential policies were introduced to

promote foreign investment in the dairy industry and many international dairy enterprises have

established joint ventures in various parts of China. As a result, the quality of management,

operation, as well as marketing of dairy products has significantly improved. In its “Tenth-Five

Year” country economic development blueprint (2001-2005), dairy is identified as an important

industry. It has implemented “school student milk program” to provide subsidized milk for

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school students at selected cities. The program is expected to expand to other cities all over the

country.

To promote the development of the dairy industry, China reformed its dairy feed provision

and dairy products pricing policies in recent years. For feed provision policies, during the

transition from the planned economy to market economy (early 1990s), China implemented a

policy of fixed provision of grain. As a measure to ensure enough high quality feeds (including

feed grain, bran and oil meals) for the dairy industry, dairy farms and dairy farmers in suburbs

could exchange "feeds for milk". Three kilograms of milk could be exchanged for one kilogram

high quality feed at a subsidized price. In some places, high quality feeds were provided at a

subsidized price according to the number of milk cows. The measure aimed at providing price

subsidies (payment from local government) to farmers when the cost of raw milk production

exceeded the price of milk set by the state. Since the mid 1990s, with the development of the

market economy, China cancelled the fixed grain provision policy, liberalized the price of milk,

and abolished the measure of "milk for feeds".

For dairy products price policies, under the planned economic system, the price of milk was

set by the price bureau at provincial and local administrative levels and strictly controlled by the

state. From 1950s to the beginning of 1980s, the price of milk had been fixed at a certain level.

In some places the price was reduced in absolute terms to benefit the consumers. Such a price

system delayed the development of the dairy industry because most of the cities had to limit milk

consumption by issuing milk coupons. In the 1980s, restrictions on dairy products and feed were

lifted in a number of cities. In major cities such as Beijing, Tianjin and Shanghai, however, the

prices of dairy products are still controlled by the local government. As the market economy

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develops, the competitive mechanism of "good quality at a good price" was introduced in the

dairy industry. Many dairy enterprises now conduct strict inspection in the purchase and sale of

milk. They implement a pricing-according-to-quality system to encourage farmers to sell quality

milk and help avoid adulteration.

2.1.1.2 Trade Policy

Before the economic reform, China had closed its doors to the outside world. At that time,

China's dairy products were also of relatively low quality. Its policy was to resist imports and all

possible forms of international assistance. With the introduction of the economic reform, China

began to import dairy products from other countries to produce reconstituted milk. At the same

time, China began to accept international assistance from World Food Program (WFP)/Food and

Agriculture Organization (FAO) and EU in developing the dairy industry. The latter has helped

advance dairy processing technology and promoted the development of the industry as a whole.

Both China's market access and foreign investment policies in the dairy industry are lenient

and favorable. Now, China only has tariff measures and no quota limitation on dairy product

imports. The purpose of tariffs are to protect local products from competing head-to-head with

cheaper foreign imports. In recent years, in order to comply with the requirements of GATT and

later WTO, China’s import tariffs have been adjusted to lower levels. China’s commitment of

tariffs during its accession into WTO is shown in table 2.1.

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Table 2.1 China’s Tariff Rates (%) on Dairy Products

Description of goods TariffNo. Import duty rate in 1999

Binding tariff rate in 2004

Milk and cream, of a fat content, by weight, not exceeding 1% Milk and cream, of a fat content, by weight, exceeding 1%, but not exceeding 6%

04011000

04012000

Milk and cream, of a fat content, by weight, exceeding 6% Milk and cream in powder, granules or other

04013000 25 20

solid forms, of a fat content, by weight, not exceeding 1.5% Milk and cream, not containing sugar, in powder,

04021000 25 25

granules or other solid forms, of a fat content, by weight, exceeding 1.5% Milk and cream in powder, granules or other

04022100 25 25

solid forms, of fat content, by weight, exceeding 1,5%

04022900 25 25

Milk and cream not containing added sugar or other sweetening matter 04029100 50 40

Other milk and cream 04029900 50 25 Yogurt Other buttermilk, curdled milk and cream,

04031000 50 10

whether or not containing added sugar or other sweetening matter or flavored additives Whey and modified whey, whether or not

04039000 50 20

concentrated or containing added sweetening matter

04041000 6 6

Other whey and modified whey 04049000 50 20 Butter 04051000 50 30 Dairy spread 04052000 50 35 Other fat derived from milk 04059000 50 30 Fresh (unripened or uncured) cheese, including whey cheese, and curd 04061000 50 12

Grated or powdered cheese, of all kinds 04062000 50 12 Processed cheese, not grated or powdered 04063000 50 12 Blue-veined cheese 04064000 50 30 Other cheese 04069000 50 30 Source: The Schedule o f Management o f Imp-export o f P.R.C.- Tariff and Other Measures, MOFTEC, 1999.

2.1.2 Japan

2.1.2.1 Domestic Support Policies

Before 2001, Japanese dairy policy was composed of three basic programs: price supports for

milk used for manufactured dairy products, classified pricing and revenue pooling through

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2 0

prefectural milk marketing boards, and import quotas (Suzuki and Kaiser, 1994). Japan’s

government has set production ceilings in order to prevent market surpluses and price instability

since 1965. Dairy producers voluntarily organized a planned production system in 1979. Annual

production allowances based on demand were determined by the Japan Dairy Council, and were

allotted to each prefecture (nine in total). In turn, the authorities on the prefecture-level, set

production quotas for individual agricultural cooperatives and dairy farmers within the prefecture.

According to Campo and Beghin (2005), allocation formulas varied among the different

prefecture councils. Until 1995, production quotas were under the control of the national and

prefectural councils. In 1996, however, a system allowing individual dairy farmers to adjust

production quotas among themselves was instituted.

Deficiency payments based on the difference between the average cost of producing one

kilogram of milk (the guaranteed price) and the price dairy producers receive for the same

quantity (the standard transaction price) were determined annually (Campo and Beghin, 2005).

Therefore, the price the dairy producers received was the guaranteed price (standard transaction

price paid by the milk processors plus the deficiency payments paid by the government). Also

before 2001, fluid milk prices were determined by negotiations between each marketing board

and the processors that it supplied (Campo and Beghin, 2005). Given the manufacturing milk

price, prefectural marketing boards usually obtained fluid milk premiums through their market

power (Suzuki and Kaiser, 1994).

The recent trend has seen steady price declines for fluid milk that progressed independently

of production costs to dairy farmers (Japan Dairy Council). The current dairy policy has been in

place since 2001. The production quota is still in effect and is determined as before. All

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2 1

government-regulated prices were abolished including (Campo and Beghin, 2005): (1) the

guaranteed manufacturing milk price for fanners; (2) the standard transactions price for

manufactures. The difference between guaranteed price and the standard transactions price used

to be paid to farmers as deficiency payments. According to Suzuki and Kaiser (2005), in the new

system, only the amount of the former deficiency payment, almost ¥ 10/kg, is maintained as a

fixed payment. The fixed payment level is reviewed every year considering the demand/supply

situation and farmers’ production costs. Now, the private market determines the manufacturing

milk prices. Regardless of the market price level, farmers receive the market price plus the fixed

payment.

However, the new policy has a built in security measure in case of a sudden price decline and

operates along the lines of a revenue insurance program. According to Campo and Beghin (2005),

a fund has been established that is charged by deductions of ¥0.4/kg of milk that is delivered and

by an additional ¥1.2/kg of milk quota for which farmers are getting subsidies. These funds are

then matched by government money. If the price for manufactured milk is below the past three-

year average, farmers can receive the 70 or 80% of the difference between the current price and

the past three-year average from the fund. Overall, it seems that the policy changes have been

cosmetic rather than of a fundamental nature. The essence of the policy is that it is paid by

consumers through market prices that are much higher than their international equivalents

(Campo and Beghin, 2005).

According to the OECD, the market price support (MPS) component indicates the producer

support obtained through market price distortions. In Japanese dairy production the MPS has

been about 90% of the producer support estimate (PSE) between 1986 and 2003, with very little

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2 2

change during this period. Still according to the OECD, consumer prices have been almost as

high as the price received by producers during the same period and this suggests that Japanese

dairy policy is mostly paid by consumers rather than by taxpayers. The level of support, as

measured by the PSE per unit of production in nominal terms, has been falling from ¥91,000/mt

in 1986 to a bit less than ¥66,000/mt, hence quite a substantial decrease, especially in real terms,

although the intervention level remains extremely high (Campo and Beghin, 2005).

2.1.2.2 Trade Policies

Japan’s domestic dairy market is highly protected. The imports of dairy products such as

milk powder, condensed milk, buttermilk powder, whey, and butter are managed by the

Livestock Industry Promotion Corporation, a state trading enterprise (STE). Ten dairy product

imports are subject to tariff rate quota (TRQ) administration, including skim milk powder, whey

and butter (see section 2.2.1 for details).

Japan distinguishes broadly between natural and processed cheeses (Campo and Beghin,

2005). Natural cheese includes soft cheeses (i.e. Camember or Mozzarella), semi hard (i.e.

Gouda), hard (i.e. Emmental and Gruyere) and extra hard cheeses (i.e. Parmesan). Processed

cheese is made out of one or more varieties of natural cheese. Today, most imported cheese

consists of natural cheese. According to Campo and Beghin (2005), on natural cheese imports

intended for direct consumption, Japan levies import tariffs ranging between 22.4 to 40 percent.

Natural cheese destined as an ingredient for processed cheese is imported through the “pooled

quota” and enters Japan duty free up to 2.5 times Japanese domestic natural cheese production

used for processed cheese. The over-quota tariff of 35% is applied to imports exceeding that

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volume. Importers must apply to the Ministry of Agriculture, Forestry and Fisheries (MAFF) for

the in-quota duty rate (Campo and Beghin, 2005).

To stabilize Japanese butter prices, all butter imports pass through a single importer channel,

the Agriculture and Livestock Industry Corporation (ALIC) (JETRO, 2002a). The state trading

importing regime of the ALIC basically ensures that a much higher domestic fluid milk price can

be maintained. Though it is possible to import butter through the “Pooled Quota” at the in-quota

rate of 35 percent, it is limited to butter for specific uses (for display at international trade fairs

and for airplanes on international flights etc.) (JETRO, 2002a). In order to apply for the primary

duty rate, importers must apply to MAFF and obtain a TRQ certificate. Ad valorem equivalents

for over quota rates for the butter TRQs range between 465.5 (Janet Nuzum) to 592 percent

(OECD). Clearly these rates are prohibitive in addition to the import monopoly by the ALIC

(Campo and Beghin, 2005).

2.1.3 South Korea

2.1.3.1 Domestic Support Policies

Korean dairy production is heavily supported by the government. The producer support

equivalent (PSE) for Korean dairy was 68 percent in 2003 (OECD, 2004). In addition to high

tariffs and tight tariff rate quotas, the government also provided a variety of domestic support

measures. According to Lee et al (2005), most importantly, the government requires that raw

milk be purchased from farmers at prices above the competitive market price. These prices are

set in reference to the production costs, so that, on average, farmers are guaranteed a positive net

margin. Further, although farm efficiency has improved, the guaranteed price has never been

adjusted downward.

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Given the high prices relative to production costs, management of dairy stocks has long been

a problem for the Korean government, especially after 1998 when the authorities raised the raw

milk price by 18.4%. According to Lee et al (2005), the result was a stockpile that grew from 8

percent of production in 2000 to 12 percent in 2002. To curtail milk production, the government

provided compensation to slaughter dairy cows, but the program was largely ineffective. With

mounting financial burden, the Dairy Committee began an informal two-tier price policy, which

pays farmers a price lower than the government-set base price for the raw milk that exceeds the

farmer’s “normal” production (based on previous years’ production). As a result, several large

producer cooperatives have left the Dairy Committee, reducing its raw milk market share more

than 70 percent to about 26 percent, making the Committee ineffective as a policy administrator

(Lee et al, 2005). Policy is unsettled and adjustments are under way. These include introduction

of formal marketing quotas and a gradual decline in the price of above-quota production (Cho et

al., 2002).

2.1.3.2 Trade Policies

Until 1994, Korea maintained strict import quotas for most dairy products. Under the

Uruguay Round WTO agreement, Korea formally opened the dairy market, providing minimum

access (MMA) quotas, relatively low within-quota tariff rates, and very high over-quota tariff

rates (Lee et al, 2005). Currently, five dairy product exports to Korea subject to TRQ

administration, which include skim milk powder, whole milk powder, whey powder and butter

(see section 2.2.1 for details). During the 10-year Uruguay round implementation period (1995-

2004), over-quota tariff rates fell each year, but the lower within-quota tariffs did not fall (Lee et

al, 2005). The tariff rates vary significantly across products. For example, according to Lee et al

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(2005), skim milk powder has a tight quota for which the lower tariff of 40 percent and an over

quota tariff of 176 percent apply (in 2004). Butter has an 89 percent over-quota tariff. At the

other end of the spectrum, formulated butter (which is about 70 percent milk fat) has a single

tariff of 8 percent. Cheese imports have a single tariff of 36 percent.

2.1.4 India

2.1.4.1 Domestic Support Policies

According to Rakotoarisoa and Gulati (2005), Indian dairy policies have always been aimed

at protecting the interests of both dairy farmers grouped in cooperatives as well as consumers

from the distorted world dairy markets. The dairy sector has attracted the attention of the

government, both from the point of view of rising demand, and as a means to provide

supplementary employment and income opportunities in the rural areas. Support for dairy sector

in India is included in the government expenditures in ‘dairying and animal husbandry’ but

constitutes less than one percent of government total agricultural subsidies. The support for milk

production in India is marked by three Operation Flood (OF) programs. Expenditures in the form

of subsidies of the first Operation Flood (OF-I) were included under the plan expenditures for the

period following 1970-71, the year OF-I started. The OF-II began in 1978-79 the overlapping

period of two years, 1978-79 and 1979-80. The OF-III started in 1987-88 and ended in 1996.

2.1.4.2 Trade Policies

Before 1990, India’s domestic dairy products production was heavily protected by import

restrictions, which include import quota and ‘canalization’ of imports of dairy products by the

Indian Dairy Corporation (IDC) (Rakotoarisoa and Gulati, 2005). But in the early 1990s, India’s

government initiated major trade policy reforms, which favored increasing privatization and

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liberalization of all sectors including the dairy sector. Current trade policies of India for 2002-

2007 are outlined in the ‘Export-Import’ or ‘Exim’ policies of 2002 (Rakotoarisoa and Gulati,

2005), which asked for the removals of restrictions on imports and exports of products including

all dairy products. Such policies were aimed at expanding dairy supply and trade.

2.1.5 South East Asia (SEA)

Southeast Asia countries do not produce sufficient fresh fluid milk to satisfy their fresh milk

needs. Although their governments have provided some supports, such as providing technical

assistance and financial support, those programs do not have expected results (Dong, 2005). For

example, the Malaysian government established and operated numerous large dairy enterprises

and a system of centralized milk collection centers (Dong, 2005). In the later 1990s, 60 percent

of milk produced was collected and sold through official milk collection centers, and about 65

percent of milk from the official milk collection centers was used by domestic dairy

manufacturers (Zhang et al, 2003). In addition, the Malaysian government supports the domestic

dairy industry by direct investment in farms, school milk programs, and restrictions on entry of

imported dairy products (Zhang et al, 2003). To develop the domestic dairy industry, the

Philippines National Dairy Authority has set up Herd Build-Up and Save-the-Herd Programs in

recent years to allow for the importation of bulls and cows from Australia, New Zealand, and

some Pacific Island states (Dong, 2005). The imported herds are adapted to the local climate and

bred with local cows and carabaos for milking purposes (USDA, 2002b). The infusion of the

imported dairy animals has resulted in marginal increases in local milk production. Moreover,

the Non Fat Dry Milk grant provided by the USDA has helped the purchase of imported dairy

cattle and the establishment of three new dairy zones which are expected to boost milk

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production (USDA, 2003c). In addition, a national school milk program was launched to create

the demand for locally produced milk and consequently stimulates the development of local

dairy industry (Dong, 2005). The Royal Thai Government has promoted raw milk production

through the price guarantees for raw milk, an import quota allocation for NFD and a school milk

program (Dong, 2005).

For trade polices, although Indonesia and Malaysia apply TRQs for some dairy products

imports SEA has relatively lower import tariffs than other Asian countries (see section 2.2.1 for

details).

2.1.6 Oceanic Countries

New Zealand is the only major milk producing country that has almost no government

intervention in dairy sector (Johnston, 1985) and it currently supplies dairy goods at world prices.

However, the New Zealand government does provide research and outreach support to the dairy

industry. According to Armentano et al (2004), Dairy InSight and the national government are

the primary sources of funding for dairy production RandD and dairy industry education. Dairy

InSight is a mandatory check-off program created in mid-2002. All dairy farmers contribute to

Dairy InSight through a mandatory levy of NZ$0,034 per kg milk solids. The levy is to be

reviewed every six years and voted on by dairy producers in a continuance referendum. Funding

is used for RandD, technology transfer, industry promotion (not milk promotion), education and

training, and research on animal health. Federal government funding is principally provided

through the Foundation for Research, Science and Technology (FRST). FRST supports research

within specified broad areas. Pertinent to dairy in 2002-03 were “Sustainable Development and

Biological Industries.” AgResearch (one of several Crown Research Institutes) is a major

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beneficiary of FRST funding, receiving NZ$54.4 million of its total 2002*03 budget of NZ$129

million from FRST. Most of AgResearch’s other funding is from commercial sources. It

specializes in basic research and commercialization of laboratory findings.

Before 2001, the New Zealand Dairy Board acted as the single desk (monopoly) exporter of

New Zealand’s dairy products and handled about 30 percent of world dairy product exports.

Under pressure from WTO, the October 2001 merger of the New Zealand Dairy Group and Kiwi

Cooperative formed Fonterra. The merged cooperatives then absorbed the New Zealand Dairy

Board and processes over 95 percent of the milk produced in New Zealand and has purchased

interests in Australian dairy companies. Fonterra is also the world’s largest exporter of dairy

products, exporting 95 percent of its two million metric tons of production to approximately 140

countries (Armentano et al, 2004). The merger is to achieve processing economies and realize