A GENERAL EQUILIBRIUM ANALYSIS OF THE ECONOMIC IMPACT OF THE CANADIAN SOFTWOOD LUMBER TARIFF ON THE WASHINGTON ECONOMY

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1 A GENERAL EQUILIBRIUM ANALYSIS OF THE ECONOMIC IMPACT OF THE CANADIAN SOFTWOOD LUMBER TARIFF ON THE WASHINGTON ECONOMY Joydeep Ghosh, David W. Holland, Thomas Heckelei, Stephen Devadoss and Leroy Stodick Joydeep Ghosh is a research associate, David W Holland is a Professor in the School of Economic Sciences, Washington State University. Thomas Heckelei is a professor for Economic and Agricultural Policy, University of Bonn, Germany. Stephen Devadoss is a Professor and Leroy Stodick is a computer specialist in the Dept. of Agricultural Economics and Rural Sociology at the University of Idaho. We acknowledge the comments of John Gilbert (Utah State) during the study. We thank Tom Wahl (IMPACT Center, WSU) for providing data and financial support. 1

2 ABSTRACT A sixteen-sector computable general equilibrium model of the Washington economy was used to analyze the effects of the tariff on Canadian softwood lumber imposed in May Model results indicate that the tariff generates a 0.5 percent increase in Washington lumber output. Lumber imports from Canada decline by 26 percent, while the rest of the US lumber imports from Washington State increase by 5 percent. This illustrates an important distinction between national and regional trade policy analysis. At the state level, there are opportunities to substitute imports from the rest of the US for taxed foreign imports and thus moderate the negative economic impact of lumber tariff. Just as the lumber industry is advantaged by the tariff, the lumber using industries are damaged by the tariff. Counterfactual output reductions ranged between 0.5 percent and 1.5 percent in the downstream industries. On balance, once the Washington economy adjusts to a new equilibrium, the predicted change in gross state product is a very modest loss of roughly percent Keywords: Washington CGE model, lumber trade, Canadian lumber tariff, welfare change 2

3 A General Equilibrium Analysis of the Economic Impact of the Canadian Softwood Lumber Tariff on the Washington Economy Introduction The softwood lumber trade between the US and Canada, one of the largest forest products trade flows in the world, has been a contentious issue for many decades. There has been a long history of trade barriers affecting this industry. Studies have indicated that protectionist policies in both countries have imposed significant costs on businesses and consumers in the US and Canada. 1 US advocates of protectionism claim that Canadian producers enjoy subsidies in the form of below-market stumpage fees (payments to the government to harvest trees from public lands) that help them to produce lumber at lower costs than their US counterparts. However, such claims have been rejected by Canada. Although the dispute over Canadian lumber imports dates back many decades, it has heated up significantly since 1982, see Rahman and Devadoss (2002). Since that time three countervailing duty (CVD) cases have been initiated by the US Department of Commerce and the International Trade Commission. The cases revolved around the low stumpage fees charged by the Canadian federal and provincial governments. In the first CVD investigation (called Lumber 1), in 1983, the US Department of Commerce ruled that Canada s stumpage fees system did not subsidize Canadian lumber producers because it was not aimed at a particular industry or group of industries. The stumpage fees system benefited diverse industries lumber and wood products, veneer, plywood, building board, pulp and paper, and furniture manufacturing. Further, 3

4 the Department reported that a comparison of Canadian stumpage prices with US prices would be arbitrary and capricious in view of the wide differences between species composition; size, quality and density of timber; terrain and accessibility of the standing timber throughout the US and Canada. The Department concluded that Canadian prices did not vary significantly from US prices. In the second CVD investigation (Lumber 2), in 1986, the US Department of Commerce found that the Canadian stumpage fees were equivalent to a 15 percent subsidy. This change in position, relative to Lumber 1, was due to the way the Department analyzed the issue. The investigation was terminated when the US and Canada signed a memorandum of understanding (MOU) in the same year. The MOU stipulated that a 15 percent export tax would be imposed on all Canadian softwood lumber exports to the US. The Canadian provincial governments responded by making changes to their stumpage systems and transferring costs to the lumber industry. The US government responded by agreeing to a reduction in the export taxes. In 1991, Canada unilaterally terminated the MOU. The US government responded by imposing duties on Canadian lumber and then initiated a new CVD (Lumber 3). Lumber 3 was one of the first CVD cases after the US-Canada Free Trade Agreement (FTA) came into play. The dispute settlement mechanism of the FTA repeatedly overturned the findings of the US Department of Commerce and the International Trade Commission, and the two agencies repeatedly upheld their findings regarding the subsidies. This led to a bitter trade war between the two countries. Ultimately, the US agreed to refund more than $800 million in duties collected, and both countries agreed that future negotiations on the lumber trade issue would be resolved through dialogue. 4

5 The Softwood Lumber Agreement (SLA) was signed in 1996, and was implemented from April 1, 1996 through March 31, The SLA set export quotas for lumber from the Canadian provinces of British Columbia, Alberta, Ontario and Quebec. Under the agreement, the US agreed not to pursue CVD cases in the future. In general, there was dissatisfaction with the quota system on both sides of the border. The quota system resulted in higher prices in the US. Lumber users in the US urged the government to end the restrictions on Canadian imports. In February 2001, both countries agreed that the quota system would end after the SLA expired on March 31, The Department of Commerce imposed a 19.3 percent preliminary CVD in August, In October, 2001, a 12.6 percent anti-dumping duty was imposed. The combined duty rate was effective until December 15, In March 2002, the US Department of Commerce concluded that Canada subsidized its softwood lumber industry, and it was dumping products in the US at prices below production costs, and set the final duty amount to 29 percent. However, the final CVD rate was fixed at 18.8 percent, and the anti-dumping rate was fixed at 8.4 percent, thus resulting in a combined rate of 27.2 percent. The combined rate of 27.2 percent was effective May 22, The US is a major importer of Canadian lumber and nearly all US softwood lumber imports are from Canada. Approximately 40 percent of the US lumber demand is used in the construction of houses, 30 percent of the demand is used for remodeling (Marple s Business Newsletter, Oct.16, 2002), and the remaining 30 percent of the demand is from lumber-using industries like pulp and paper, wood preserving etc. US production of lumber remained stable between 2000 and 2002, while consumption increased in US production of softwood lumber was 35.8 billion board feet (bbf) in 2000, 33.8 bbf in 2001 and 35.3 bbf in 2002 (Western Wood Products Association). US consumption of softwood lumber was 53.9 bbf in the years 5

6 2000 and 2001, while the consumption was 56.3 bbf in The US imported 20.1 bbf of softwood lumber in 2001 (93 percent of the imports were from Canada), and 21 bbf in 2002 (91 percent of the imports were from Canada). The increase in consumption could be attributed to lower interest rates and lower lumber prices (see Fig. 1). As Figure 1 indicates, lumber prices have been falling since The tariff imposed in May, 2002 did not have the desired effect of lowering the volume of imports from Canada and increasing domestic lumber prices. Reports ( Tariff Misses Mark, The Spokesman Review, Nov.24, 2002) indicate that Canadian firms have increased production to lower unit costs, and have therefore been able to export large quantities of cheap lumber to the US. Washington is the second largest lumber-producing state in the US (Western Wood Products Association News Release, Sep.25, 2002). In 2000 the Washington lumber industry produced $2.79 billion (value of production) and employed 13,300 workers (Table 1). Lumber exports to other states and to foreign countries were $1.92 billion, while imports from other states and foreign sources were $346 million. The objective of this study was to examine the economy-wide effects of a 27.2 percent tariff on Canadian lumber on the Washington economy as well the effects of the downward movement in Canadian lumber price. We were interested in the economic impact on both Washington lumber producers and lumber users. A computable general equilibrium (CGE) model of the Washington economy was used to examine the effects of the tariff. CGE models are often used for analyzing the economy-wide effects of a tariff at the national level. We extend the same analytic framework, in this case, to the Washington state economy. A tariff not only affects the sector on which the tariff is imposed, but indirectly affects all the sectors that are linked to the sector on which the tariff is imposed. Only a CGE model is able to capture both the direct 6

7 and secondary effects of a tariff. As opposed to a regional input-output model with its assumption of fixed prices, the CGE model by measuring changes in production, prices and factor usage, household income and consumption, is able to estimate the regional welfare effect of the imposition of the tariff on Canadian softwood lumber. The next section presents a brief review of the literature, followed by a discussion of the theoretical model, a description of the empirical model, a review of the data used in the analyses, a discussion of the results of the analyses, and finally a summary of the conclusions. Literature review There are several studies that have analyzed the effects of the lumber trade dispute on the US economy. However, no study has examined the effects at the state level. Myneni, Dorfman and Ames analyzed the welfare impacts of the Canadian voluntary 15 percent lumber export tax and the 6.51 percent import tax, using a simultaneous equations model of the softwood lumber market. The study reported that US consumers experienced a loss of $147 million (1982 dollars) under the export tax policy, while they experienced a loss of $52 million with the US-levied import tax. US producers gained $109 million and $40 million under the export tax and the import tax policies, respectively. The net US impact of the 15 percent export tax was estimated to be -$38 million, while the net impact of the 6.51 percent import tax was estimated to be -$12 million. The Canadian net impact was positive under the export tax regime, while it was negative under the import tax regime. The study concluded that under both cases ( voluntary export tax and import duty), the US government pursued policies that benefited domestic producers at the expense of US lumber consumers. Lindsey, Groombridge and Lougani reported that between 1980 and 1985 the US price of lumber averaged just under $200 per 7

8 thousand board feet, whereas between 1986 and 1998 the price averaged a little over $300. Thus, after the imposition of trade restrictions, average lumber prices rose by about $100 per thousand board feet in the United States. After controlling for other factors (strength of the economy, movements in the overall producer price index, and changes in timber supplies), the authors concluded that lumber prices were higher by between $50 to $80 per thousand board feet due to trade restrictions. From the perspective of US consumers, this represents a 20 to 35 percent tax on lumber consumption (as represented by both intermediate and final demand). Rahman and Devadoss studied the US-Canada lumber trade dispute from a historical perspective. The authors suggest that the welfare losses to US consumers and producers depend on the magnitude of price changes of lumber products due to the tariff, and on their demand and supply elasticities. The study concludes that aggregate welfare for the United States depends on the structure of the US market and the amount of tariff revenue it will generate. In related CGE studies, Wigle for example, reported that inclusion of transportation costs in a CGE model affected the predicted welfare effects of trade tariffs in Canada. Transportation costs reduced the benefits from free trade and tended to expand inter-regional trade at the expense of international trade, although the overall effect of transportation costs was very small. Kilkenny (1993 a, b) used CGE modeling to examine the effects of terminating agricultural subsidies in the United States. She reported that although agriculture and related sectors may contract with the termination of subsidies, other sectors in rural areas may benefit. Geographically immobile labor released from agriculture and related sectors could be absorbed into rural manufacturing. Further, declining costs of location-specific factors made rural areas more competitive in local, other domestic, and international markets. Waters, Holland and Haynes showed how a regional CGE models could be used to estimate the economic impact of 8

9 public resource supply constraints in Northeast Oregon. Several different policy scenarios were examined in the study. Elimination of federal range programs in Northeast Oregon caused the loss of 1371 regional jobs (2.3 percent of regional employment) and $29 million (1.6 percent) of regional household income. An 80 percent reduction in federal log supplies resulted in the loss of 3329 jobs (5.5 percent of regional employment) and $76 million (4.2 percent) of household income. The study reported that increases in tourism and high technology manufacturing, and growth in the population of retirees can largely offset employment and income losses stemming from reductions in supplies of public range or timber. Theoretical Analysis For expositional convenience we present the theoretical analysis in the framework of a two-sector economy (see Figure 2). Assume that the country does not influence world prices (the small country assumption), so that the terms of trade are fixed. In the pre-tariff situation, given the terms of trade (p = p B /p A ), represented by the slope of the line RR, the country s production and consumption points are E and E C respectively. The imports of good A are E CA E A and the exports of good B are E CB E B. When a tariff (t) is imposed on good A the domestic relative price p B /p A is no longer equal to the terms of trade, but lower, equal to, say slope of PP. Since domestic producers respond to the domestic relative price the production point shifts from E to H. International exchange takes place at the given terms of trade, and so the country can trade by moving from H (where it produces) along the straight line R*R*, parallel to RR, but the country will not end up at the tangency of I** to R*R* because consumers will also respond to the domestic relative price, and so equate the marginal rate of substitution to this price. Thus, moving along the straight line R*R* (which represents the 9

10 international exchange possibilities), we must therefore find a point where the marginal rate of substitution (slope of the indifference curve) is equal to the domestic relative price. This point is the point of tangency between the indifference curve I* and the line P*P*. The production effect consists of moving from point E to point H. The domestic output of the protected commodity increases by E A H A while the output of the other commodity decreases by E B H B. The consumption effect consists of the movement from E C to E* C. The domestic consumption of the protected commodity decreases by E CA E* CA, while the consumption of the other commodity increases by E CB E* CB. The effect on the volume of trade consists of an import effect and an export effect. Imports decrease by E CA E A E* CA H A, which is equal to the sum of E CA E* CA and E A H A (sum of consumption and production effects). Exports also decrease by E CB E B E* CB H B = E CB E* CB + E B H B (sum of consumption and production effects). The final effect is a reduction in the volume of trade. Since the country produces at H, the value of national output is represented by the position of PP and, national output in real terms, measured for example in terms of commodity A, is given by the intercept of PP on the vertical axis, that is by OP. We see that the value of national output corresponding to point H is Y H = p* A H A + p B H B where p* A = (1 + t)p A. The straight line PP represents all the combinations of A and B with the same values as the given Y H. Therefore, H A = -(p B /p* A ) H B + Y H /p* A, which is the equation of the straight line PP. The intercept of this line on the A axis is Y H /p* A, the value of national output in terms of A. The value of aggregate consumption expenditure is represented by the position of P*P* and measured in terms of A, by the intercept OP*. The difference between the value of aggregate consumption expenditure and the value of national output is the tariff revenue, because in the presence of a tariff, aggregate expenditure exceeds national output by an amount exactly equal to consumers outlay by way of the tariff. 10

11 The tariff raises the domestic price of the imported commodity and also increases the returns to the factor used intensively in the production of the imported commodity (Stopler- Samuelson effect). A tariff has implications in terms of welfare also. We can see that the new consumption point E C * lies on a lower indifference curve relative to the pre-tariff situation. Alternatively, we can see that the value of real national output in terms of A was OR in the pretariff situation, while the value of real national output is OP after the tariff is imposed. Thus, a tariff reduces welfare. Model CGE models are multi-sector models of the economy. They are based on Walrasian general equilibrium models of market-clearing on both the product and the factor markets. CGE models have been extensively used to analyze tax and trade policies. As in any neo-classical model, producers are assumed to be profit maximizers, and in typical CGE methodology they can sell their output either on the domestic market or on the export market, based on relative prices. Households maximize utility by consuming a mix of domestic and imported goods. The composition of domestic supply depends on the relative prices of domestic products and imports. Households are modeled as a representative agent assumed to have Stone-Geary preferences and industries are modeled as representative producers assumed to have CES production technologies. There is endogenous determination of equilibrium prices (commodity prices, factor prices and the exchange rate) to clear the product, factor, and foreign exchange markets. 2 Specific functional forms are used to capture the behavior of economic agents. The parameters of these functional forms are obtained by calibration to a dataset (usually a Social 11

12 Accounting Matrix a matrix showing income and expenditure flows in an economy) for a given year. The benchmark year is considered to be in equilibrium for calibration purposes. A sixteen-sector model of the Washington economy was created using the year 2000 SAM (social accounting matrix) of Washington. The model equations are available upon request from the authors. Like many other CGE models, a Leontief-cum-constant elasticity of substitution (CES) type production function was used to model producer behavior. This production function for a given industry has the following features fixed proportions of intermediate inputs, but CES technology and capital/labor substitution for primary factors for a given industry. The Leontief part of the production function ensures weak separability between primary (labor and capital) and intermediate factors. We assume capital is sector specific, but labor is mobile across sectors. The demand for factors is derived from the first-order conditions of profit maximization taking into account the value-added or net price. A Stone-Geary utility function (which produces a Linear Expenditure System) was used to model consumer behavior. CGE models of trade allow for imperfect substitution between domestic goods and foreign goods. The Armington function is used to capture the substitution possibilities between domestic goods and imported goods for households. In other words, the Armington aggregate is a composite good consisting of domestic and imported goods. The Armington function is of the CES type. The higher the value of the Armington elasticity, the higher is the substitution between domestic and imported goods. Since this is a regional model, we have used the Armington function at two levels in the first stage we allow for substitution between domestic goods (produced in Washington) and imported goods; in the second stage we differentiate between domestic imports (imports from rest of the United States) and foreign imports (imports 12

13 from rest of the world), and allow substitution to take place between them. The foreign exchange rate is assumed flexible. The current account is fixed (at the benchmark year level), so that the foreign exchange rate fluctuates to maintain the current account balance. Government expenditure and investment are exogenous in the model. As mentioned before, there is endogenous determination of prices to clear all the markets. Initially, consumer prices of domestic goods and imports, the world price of exports, factor prices, and the exchange rate are all set equal to one. The price of foreign imports (from rest of the world) is assumed exogenous, that is, the world price is given. In this setting we can therefore make the small country assumption and consider the terms of trade to be fixed. The consumer price index is set to be the numeraire. The export supply function, derived from the constant elasticity of transformation (CET) function, specifies the value of exports based on the ratio of domestic and export prices. The CET function defines the production possibilities available to a given industry assuming exported products are differentiated from domestic products produced by a given industry. The import price is a function of the world price, the import tariff and the exchange rate (foreign). Import demand is the first-order condition obtained from the cost minimization problem of buying a given amount of the composite good. The composite supply (Armington aggregate) is a function of the price of imports and the price of regionally produced goods. The regional import composite is a function of the price of imports from domestic and foreign sources. The regional export composite is a function of the price of exports to domestic and foreign sources. Household income is obtained by netting out investment, government expenditure and current account balance from total state income. 13

14 On the factor side of the economy, labor is mobile across sectors and there is a marketclearing wage rate for the economy. Capital is assumed to be fixed for all sectors. The model thus captures the fixed resource endowment of the Washington economy and represents economic adjustments in the relatively short-run given the assumption of fixed sector specific capital. The GAMS software (using the PATH solver) is used to construct and solve this model, a simultaneous system of non-linear equations. The model is initially solved to replicate the base year SAM by appropriately calibrating the parameters of the model. 3 Empirical estimates of the Armington elasticities were used in this model (typically the range was between 0.5 and 1.75). The CET elasticities were set equal to 2 for the traded sectors, and 0.5 for the non-traded sectors. Data The year 2000 social accounting matrix (SAM) of the state of Washington from the IMPLAN (Impact Analysis for Planning) database is used for this analysis. There are 528 industries in the IMPLAN database. For this study a 16-sector model of the Washington economy is constructed. The sectors that are most likely to be affected by the tariff, directly or indirectly, have been kept at the most disaggregated level. The industries that are not closely related to wood products and are likely to have negligible effects, are aggregated into broader multi-sector composites. The sector aggregation scheme for the model is identified in Appendix A. 14

15 Results Two simulations were conducted for the purpose of this study. The first simulation was done to examine the effects of the 27.2 percent import tariff assuming no change in baseline Canadian (world) prices. The baseline Canadian price is set to one. The second simulation was to see the combined effects of a lower Canadian lumber price (from Table 2 we know that the world price of lumber is considerably lower than the US price) and the 27.2 percent import tariff. The 2002 Canadian price of lumber net of the tax was calculated to be equal to 68 percent of the 2000 price. The import price of lumber from Canada was $234 per thousand board feet in 2000, while it was $202 per thousand board feet in the year 2002, implying that the import price in 2002 was approximately 86 percent of the price in 2000 (base year). Therefore, the import price including the 27.2 percent tariff is equal to 0.86 (in relative terms) in 2002, which gives the Canadian price net of tariff to be equal to 0.68 in 2000 prices 4. The baseline Canadian price is set to 0.68 in this second scenario. I. Effects of the 27.2 percent lumber import tariff Three different scenarios are run using different sets of Armington elasticities. In scenario 1, the Armington elasticity (1.43) is taken from the literature (Bilgic et al., 2001). 5 The Armington elasticity for the lumber sector is set equal to 0.5 in scenario 2 and 5.0 in scenario 3, and empirical Armington estimates are used for all other sectors. Since the Armington elasticities play a crucial role in determining the ease of substitution between domestically-produced goods and imports, a sensitivity analysis for low and high elasticity values is conducted in scenarios 2 and 3. Table 1 indicates that Washington lumber output increases due to the tariff, in scenarios 1 and 3. There is a 0.5 percent increase in output in scenario 1, while there is a 1.35 percent 15

16 increase in output in scenario 3. There is a decrease of about 0.04 percent in scenario 2. Due to the relatively higher values of the Armington elasticities in scenarios 1 and 3, the tariff has a larger impact on the level of output in these two scenarios. The tariff increases the price of foreign lumber relative to domestically-produced lumber, thus causing an increase in demand for domestically-produced lumber. Total imports (the Armington aggregate ) of lumber decrease in all three scenarios. Total imports decrease by 5.41 percent in scenario 1, by 2.48 percent in scenario 2, and declined by 9.7 percent in scenario 3. Imports from Canada (virtually all lumber imports are from Canada) experience a relatively larger impact due to the tariff. Foreign imports decrease by 26.7 percent in scenario 1, by percent in scenario 2, and by percent in scenario 3. The tariff increases the foreign price of lumber relative to the rest of the US price. Therefore, imports from rest of the US increase in all three scenarios. Imports from rest of the US increase from a low of 0.86 percent increase in scenario 2 to a high of percent in scenario 3. The Armington aggregate (Table 1) represents the mix of Washington-produced lumber and imported lumber that is consumed in Washington. Employment in lumber production increases in scenarios 1 and 3. About 106 jobs are created in scenario 1, 9 jobs are lost in scenario 2 and 274 jobs are created in scenario 3. Incorporation of the Armington function in trade-focused CGE models allows for cross-hauling i.e., imports and exports of the same good. The tariff increases the composite price (price faced by the Washington consumer) of lumber by approximately 2-3 percent across the scenarios, which translates into a roughly $6-10 increase in the consumer price of lumber. The composite price is a mix of the Washington price (domestic price) and the importable price (which in turn is a mix of the foreign importable price and the rest of the US importable price). The increase in the composite price is attributed to the increase in the Washington producer price and the 16

17 importable price of lumber. The moderate consumer price change is a function of the substitution of both lumber imports from the rest of the US and Washington lumber for Canadian lumber imports in the consumer market. An important objective of the study was to see the effects of the tariff on other sectors of the economy. Table 2 indicates that the sectors that use lumber as an input experience a decrease in output due to the higher price of lumber as a result of the imposition of the tariff. In the case of millwork, output decreases from a low of 0.82 percent in scenario 2 to a high of 0.90 percent in scenario 3. In case of other wood, output decreases by percent across the scenarios. In the case of wood-preserving, output decreases by percent across the scenarios. In the case of pulp and paper, there is an output decrease of 0.30 percent (low) in scenario 2, and a decrease of 0.44 percent (high) in scenario 3. As Table 3 indicates, the tariff causes economy-wide repercussions. Remember that the regional economy is modeled in accordance with standard neoclassical assumptions in that endowment of capital and labor are assumed fixed at the economy level. Labor is assumed mobile and the labor market clears with a flexible wage. Capital is sector specific. There is a small decline in the wage rate in scenarios 1 and 2, while the wage rate remains unchanged in scenario 3. State GDP falls by percent in scenario 1, and falls by percent in scenario 2. As theory would predict, there is a loss in the utility level. Utility decreases by percent across the scenarios. II. Effects of the 27.2 percent lumber import tariff, and the lower Canadian lumber price This simulation was done to see the effects of a lower Canadian price of lumber in combination with the 27.2 percent lumber tariff on the Washington economy. The reason for 17

18 using a lower price was because of the actual decline in the Canadian lumber price in 2002, relative to the import price in the base year (2000). As Table 4 indicates Washington lumber output decreases by 0.32 percent and 1.42 percent in scenarios 1 and 3 respectively. This is mainly due to the substitution of imported lumber for Washington-produced lumber. There is a slight increase (0.02 percent) in output in scenario 2. This is because the possibility of substitution between Washington-produced lumber and imported lumber is less in scenario 2 because of the lower values of the Armington elasticity. Total imports (the Armington aggregate) increase in all three scenarios, ranging from a 1.43 percent increase in scenario 2 to a percent increase in scenario 3. Imports from Canada increase by percent in scenario 1, by 7.03 percent in scenario 2, and by percent in scenario 3. Imports from rest of the US decline in all three scenarios, ranging from a 0.47 percent decrease in scenario 2 to a percent decrease in scenario 3. Imports from Canada increase and imports from rest of the US decrease because of the lower price of Canadian lumber even after the tariff is imposed. The decrease in lumber output in Washington results in lower employment opportunities in the sector, in scenarios 1 and 3. There is a loss of 67 jobs in scenario 1, a gain of 4 jobs in scenario 2 and a loss of 286 jobs in scenario 3. There is a fall in the composite price (price faced by the Washington consumer) of lumber in all three scenarios. The composite price falls by 2-3 percent, which roughly translates into a $6-10 decrease in the consumer price of lumber. Table 5 indicates that the outputs of sectors that use lumber as an input increased. The lower price of lumber thus benefits sectors that use lumber as an input. In the case of millwork, output increases by percent across the scenarios. In the case of other wood, output increases by percent across the scenarios. The wood preserving sector increases 18

19 output by percent across the scenarios the while pulp and paper sector increases output by percent across the scenarios. As Table 8 indicates there is negligible, but positive impact on the wage rate, in all three scenarios. The state GDP increases in scenarios 1 and 2 by about percent, while it remains virtually unchanged in scenario 3. The utility level rises in all three scenarios. There is a percent increase in utility in scenarios 1 and 2, while it rises 0.01 percent in scenario 3. Summary and conclusions The objective of the paper was to use a CGE model of the Washington economy and examine the industry specific and economy-wide effects of the 27.2 percent tariff (imposed by the United States in May, 2002) on Canadian softwood lumber. A sixteen-sector computable general equilibrium (CGE) model of Washington was used to quantify the effects of the tariff. In general, the results are consistent with what economic theory would predict. Two simulations were undertaken to examine the effects of the tariff. Each simulation was carried out using three different sets of Armington elasticities. The Armington elasticity determines the degree of substitution between Washington lumber and imported lumber. Different values of the Armington elasticity will thus lead to differential impacts on the Washington economy. Considering the tariff alone, imports from Canada decline in all three scenarios, however there is considerable variation across the scenarios. The Armington aggregate (which represents the mix of domestically-produced lumber and imported lumber) declines in all three scenarios. The tariff has a positive impact on employment in the lumber sector new jobs are created in the lumber sector in scenario 1, 9 jobs are lost in scenario 2, and 274 jobs are created in 19

20 scenario 3. However, the sectors that use lumber as an input experience a fall in output and employment, in all three scenarios, due to the higher price of lumber. There is a small decline in the market clearing wage. The composite price (price faced by the Washington consumer) of lumber increases by roughly $6-10 per thousand board feet across the scenarios. Lumber producers in Washington benefit from a higher price, but state GDP falls in scenarios 1 and 2, while household utility falls in all three scenarios. However, the losses in household income and state GDP are small. The second simulation was done to see the effect of a lower world price (Canadian price) of lumber in combination with the 27.2 percent import tariff on lumber. The Canadian relative price of lumber was set to 0.68, based on the price decrease between the base year (2000) and As in the first simulation, three different sets of Armington elasticities were used to model three different scenarios. Lumber output decreases when empirical estimates and elastic values of the Armington elasticity are used. The decrease in lumber output is due to the substitution of cheaper imports for Washington lumber. Imports from Canada increase by relatively large amounts relative to the baseline in all three scenarios. The Armington aggregate increases in all three scenarios. There is a negative impact on employment in the lumber sector in scenarios 1 and 3. The number of jobs lost is 67 in scenario 1, while the number of jobs lost in scenario 3 is 286. Four new jobs are created in scenario 2. From a policy perspective it means that there is a rise in unemployment in the lumber sector in scenarios 1 and 3. However, there is an output and employment increase for all the sectors that use lumber as an input, in all three scenarios. This is due to the lower composite price of lumber. State GDP rises in scenarios 1 and 2, while household utility rises in all three scenarios. 20

21 The tariff on Canadian lumber imports is shown to negatively impact the Washington economy. In a previous study (Lindsey et al., 2000), the predicted change of the composite price of lumber (price faced by the Washington consumer) was larger than in our study. In Lindsey s study (at the national level) the predicted price change due to trade restrictions was a $50-80 lumber price increase per thousand board feet, while in this study the predicted change in the Washington lumber price (composite price) is a price increase of $6-10 per thousand board feet. One reason, in addition to the differences in tariff levels, for the difference is that this state-level analysis takes into account the possibility of substitution between foreign imports and imports from rest of the United States. Specifically, in Washington, lower foreign (Canadian) lumber imports are accompanied by a higher level of lumber imports from rest of the United States. From this perspective, it can be seen that the Washington economy has somewhat greater flexibility in dealing with the damaging effect of the Canadian lumber tariff than is the case for the US economy and this is one factor accounting for the relatively modest predicted lumber price increases in our model and the modest decline in gross state product. Of course we are assuming that price of lumber from the rest of the US would be relatively unaffected by the tariff. The degree to which that is true is an empirical question. If the rest of the U.S lumber price is driven up by the tariff, the flexibility of the Washington economy to adjust to the tariff is reduced and the economic loss to the Washington economy would be increased. 21

22 Endnotes 1 The issue is further clouded by the fact that several large U.S. based timber and wood products companies, for example Weyerhaeuser, also own and control important timber and wood products companies in Canada. 2 Several alternative treatments are possible regarding the current account balance. The foreign exchange rate is assumed fixed and the current account balance changes. Alternatively, the current account balanced is assumed fixed and the foreign exchange rate adjusts. 3 Most of the parameters of the model can be calibrated, however, the Armington elasticities, the constant elasticity of transformation (CET) elasticities (counterparts of the Armington elasticities on the export side), the elasticity of substitution in production, the household income elasticity, and the export demand elasticity are obtained from the literature. 4 PW L ( ) = 0.86, where PW L is the world price of lumber. 5 See Appendix A for empirical estimates of the Armington elasticity. 22

23 References Bilgic, A., S. King, A. Lusby and D. F. Schreiner. Estimates of US regional commodity trade elasticities of substitution. Paper presented at the 32 nd Annual Meeting of the Midcontinent Regional Science Association in Duluth, MN, Gandolfo, G. International Trade Theory and Policy. Berlin, Heidelberg and New York: Springer-Verlag, IMPLAN Professional Manual (Second Edition). Stillwater MN: IMPLAN Group Inc, Kilkenny, M. Rural/Urban effects of terminating subsidies. American Journal of Agricultural Economics. 75 (1993 a): Kilkenny, M. Agricultural liberalization in segmented or integrated markets, with scale economies. Journal of Economic Integration. 8 (1993 b): Lindsey, B., M. A. Groombridge and P. Lougani. Nailing the homeowner: The economic impact of trade protection of the softwood lumber industry. Center for Trade Policy Studies Paper, Cato Institute, Marple s Business Newsletter, Oct. 16, Myneni, G., J. H. Dorfman and G. C. W. Ames. Welfare impacts of the Canada-US softwood lumber trade dispute: Beggar thy consumer trade policy. Canadian Journal of Agricultural Economics. 42 (1994): Rahman, O. Sm. and S. Devadoss. Economics of US-Canada Softwood Lumber Dispute: A Historic Perspective. Journal of International Law and Trade Policy, 3(1), pp , Sadoulet, E. and A. de Janvry. Quantitative Development Policy Analysis. Baltimore and London: The Johns Hopkins University Press,

24 The Spokesman Review, Nov.24, Waters, E. C., D. W. Holland and R. W. Haynes. The Economic Impact of Public Resource Supply Constraints in Northeast Oregon. Technical Report, US Department of Agriculture, Forest Service, Pacific Northwest Research Station, Portland, Oregon, Wigle, R. M. Transportation costs in regional models of foreign trade: An application to Canada-US trade. Journal of Regional Science. 32 (1992): (World Trade Atlas) (Randomlengths website) (Western Wood Products Association website) 24

25 Figure 1: Softwood lumber prices ($ per thousand board feet) Domestic price Import price (from Canada) Source: Randomlengths and World Trade Atlas 25

26 Figure 2: The general equilibrium effects of a tariff A R R* E CA P* E* CA P E C E C * I** I* I*** H A H P* E A E P R* O E CB E* CB H B E B R B 26

27 Table 1: Effects of the 27.2 percent import tariff on the lumber sector (1) Counterfactual (empirical Armington Elasticities=1.43) (2) Counterfactual (Armington elasticity = 0.5) (3) Counterfactual (Armington elasticity = 5.0) Benchmark Variable value Output Washington consumption (absorption) Total imports Foreign imports Imports from rest of the US Armington aggregate Employment 13,336 13,442 13,327 13,610 Total exports Foreign exports Exports to rest of the US Washington price ($) Importable price ($) Foreign importable price ($) Rest of the US importable price ($) Composite price (Armington aggregate) ($) Composite export price ($) Foreign export price ($) Rest of the US export price ($) Washington producer price ($)

28 Table 2: Output effects of the 27.2 percent tariff on the downstream sectors Sector output Benchmark value (1) Counter- Factual (empirical Armington Elasticities) (2) Counterfactual (Armington elasticity = 0.5) (3) Counterfactual (Armington elasticity = 5.0) Millwork Other wood 1, Wood preserving Pulp and paper 3, , , ,

29 Table 3: Effects of the 27.2 percent tariff on the economy Variable Benchmark value (1) Counter- Factual (empirical Armington Elasticities) (2) Counterfactual (Armington elasticity = 0.5) (3) Counterfactual (Armington elasticity = 5.0) Wage rate ($) State GDP ($ m.) 214, , , , Utility ($ m.) 146, , , ,

30 Table 4: Effects of the 27.2 percent import tariff on the lumber sector with the Canadian lumber price set equal to 0.68 (1) Counterfactual (empirical Armington elasticity) (2) Counterfactual (Armington elasticity = 0.5) (3) Counterfactual (Armington elasticity = 5.0) Benchmark Variable value Output 2, , , , Washington consumption (absorption) Total imports Foreign imports Imports from rest of the US Armington aggregate 1, , , , Employment 13,336 13,269 13,340 13,050 Total exports 1, , , , Foreign exports Exports to rest of the US 1, , , , Washington price ($) Importable price ($) Foreign importable price ($) Rest of the US importable price ($) Composite price (Armington aggregate) ($) Composite export price ($) Foreign export price ($) Rest of the US export price ($) Washington producer price ($)

31 Table 5: Output effects on other sectors of the economy of the 27.2 percent lumber tariff with the Canadian lumber price set equal to 0.68 Sector output Benchmark value (1) Counter- Factual (empirical Armington elasticities) (2) Counterfactual (Armington elasticity = 0.5) (3) Counterfactual (Armington elasticity = 5.0) Millwork Other wood 1, , , , Wood preserving Pulp and paper 3, , , ,

32 Table 6: Effects of the 27.2 percent tariff with the Canadian lumber price set equal to 0.68 Variable Benchmark value (1) Counter- Factual (empirical Armington elasticities) (2) Counter-factual (Armington elasticity = 0.5) (3) Counter-factual (Armington elasticity = 5.0) Wage rate ($) State GDP ($ m.) 214, , , , Utility ($ m.) 146, , , ,

33 APPENDIX A Empirical estimates (Bilgic et al., 2001) of the Armington elasticity Sector Armington elasticity estimate 1. Agriculture Forest products Residential construction Commercial construction Other construction Maintenance Logging Lumber Millwork Other wood Wood preserving Pulp and paper Mining Food Manufacturing Services