Working Paper Series FSWP An Empirical Test of the Rent-Shifting Hypothesis: The Case of State Trading Enterprises

Transcription

1 Working Paper Series FSWP An Empirial Test of the Rent-Shifting Hypothesis: The Case of State Trading Enterprises By Stephen F. Hamilton University of Arizona and Kyle W. Stiegert University of Wisonsin-Madison Abstrat: A entral result in the theoretial literature on strategi trade is the rent-shifting hypothesis, the idea that government s an employ trade poliy as a preommitment devie to transfer profit from foreign to domesti firms. To our knowledge, however, the rent-shifting hypothesis remains untested empirially. This paper onstruts a theory-based empirial test of rent-shifting behavior that relies on observations of government preommitment variables employed through State Trading Enterprises (STEs). The analysis applies data on the delayed produer payment struture of the Canadian Wheat Board (CWB) and examines its merits as a rent-shifting mehanism in the international durum market. The model fails to rejet the hypothesis that the CWB utilizes a pre-ommitment mehanism in the international durum market and several nonparametri tests onfirm that the observed transfer payments set by the CWB are onsistent with rent-shifting behavior in the pre-wto period. JEL lassifiation: F12; L13; L66 Key words: Profit shifting; vertial separation; new empirial industrial organization The authors are listed alphabetially; neither laims first authorship.

2 An Empirial Test of the Rent-Shifting Hypothesis: The Case of State Trading Enterprises 1. Introdution Beginning with the seminal work of Brander and Spener (1984, 1985), a large and growing literature has addressed what has beome known as the rent-shifting hypothesis, the possibility that government trade poliy an be used as a devie to transfer profits from foreign to domesti firms. The theoretial foundation for strategi trade poliy has subsequently developed in several important diretions. Brander and Spener (1988), Spener and Jones (1991, 1992), Fung (1995), Ishikawa and Lee (1997), and Ishikawa and Spener (1999)), among others, onsider the effet of vertial struture on strategi trade and haraterize how various inentive shemes and patterns of intermediate goods exhange bear on the optimal rent-shifting poliy design. Neary (1994) examines the relationship between the soial ost of publi funds, transnational differenes in prodution osts, and the optimal level of a domesti export subsidy. Dixit (1988) and Qiu (1995) onsider irumstanes under whih ountervailing duties by an importer provide suffiient deterrene to urtail the rent-shifting ativities of an exporting ountry. Goldberg (1995) and Karp and Perloff (1995) investigate the strategi trade impliations of limited government ommitment, and Bagwell and Staiger (1994), Maggi (1996) and Brainard and Martimort (1997) examine the effet of inomplete information on the optimal rent-shifting mehanism. In light of the onsiderable theoretial attention devoted to strategi trade poliy, it is somewhat surprising to note that the rent-shifting hypothesis remains untested empirially. 1 The goal of the present paper is to provide this link. The theoretial underpinnings of our approah are as follows. Aording to the rentshifting hypothesis (in any of its various forms), a mehanism must exist for a government to 1 Several papers have estimated mark-ups of prie over marginal ost in international markets (see, e.g., Aw (1992, 1993), Levinsohn (1993), Harrison (1994), and Goldberg and Knetter (1999)). However, these papers address the degree of international market ompetition, and not the related questions we examine here, whih are: (i) is there evidene of pre-ommitment in the international data, and (ii) given an estimated level of strutural ompetitiveness of the international market, is the relevant pre-ommitment parameter set at the optimal level to shift-rent? 2

3 establish some form of preommitment in the export market. 2 Through preommitment to a partiular trade poliy, the government an then use an appropriately designed mehanism to shift rent from foreign to domesti firms by effetively lowering the marginal ost of domesti prodution (e.g., with a unit subsidy). In quantity-setting games, the relative unit ost differential between domesti and foreign firms derived through suh a poliy leads to a ommensurate output differential that, in an optimally designed preommitment program, is exatly that whih would our in a Stakelberg leader-follower relationship between domesti and foreign industry groups. The empirial hallenge to an examination of the rent-shifting hypothesis is that the analysis must make a orresponding oneptual division; the presription of preommitment preludes market data from being viewed as the outome of a single-stage game. Consequently, we divide our empirial analysis into two setions that orrespond to eah of the two stages onsidered in the theory: a preommitment stage, in whih a government hooses the optimal rent-shifting transfer, and an output stage, in whih foreign and domesti marketing agents respond. Our empirial approah is developed through the use of two proedures, eah of whih onforms to an individual stage-game suggested by theory. In the first proedure, whih orresponds to the output stage-game, demand and ondut parameters are estimated in a segmented international market omprised of two exporting regions and one importer. The domesti export region, the region hypothesized to shift rent, is represented by a nationallysantioned marketing agent with exlusive ontrol of all domesti output, whereas a group of foreign marketing agents onduts independent marketing ativities in the remaining export region. We estimate the output stage in the tradition of existing models of asymmetri ost equilibria (see, e.g., Kahai, Kaserman and Mayo (1996); Berg and Kim (1998)), with one notable differene: government trade poliy is onsidered as a shift parameter in the domesti marginal ost funtion. In the seond proedure, whih orresponds to the preommitment stage of the 2 In quantity-setting games, this mehanism is typially an output (or investment) subsidy, although the treatment extends readily to various other trade instruments, suh as tariffs and import quotas. 3

4 theoretial model, we employ a subset of the output-stage results to haraterize the value of the trade poliy parameter assoiated with the optimal degree of rent-shifting. Two nonparametri statistial approahes (a Wiloxen signed-rank test and a bootstrap method) are subsequenty utilized to evaluate the relationship between the estimated optimal and observed transfer payments made between the domesti government and its marketing agent. The merits of this empirial approah are twofold. First, if the domesti government does in fat use a form of preommitment in the international market, then the observed trade poliy parameter an be used to derive an initial test of the rent-shifting hypothesis in the outputstage model. Namely, beause the reation of foreign marketing agents to a hange in the quantity of domesti exports is endogenous in the preommitment stage, this implies that the ondut parameter assoiated with the domesti marketing agent, itself, is pre-determined. Indeed, it is preisely this impliit funtional relationship that makes rent-shifting behavior possible. As we demonstrate in the empirial setion of the paper, this determinay leads to the following neessary ondition for rent-shifting behavior. When the ondut of the domesti marketing agent(s) is estimated as a free parameter in the output stage, trade poliy is an effetive rent-shifting mehanism only if the ondut parameter is of unit value. The seond merit to our approah is that the parameters estimated in the output stage also define the optimal level at whih the government preommitment variable should be set. Correspondingly, if the neessary ondition for rent-shifting behavior annot be rejeted in the output stage model, it is possible to alulate the optimal preommitment level and test whether the observed trade poliy parameter is set in a fashion onsistent with theory. We hoose to fous our empirial analysis on the delayed produer payment system of State Trading Enterprises (STEs). The behavior of STEs in international markets is well suited to our purpose in several regards. First, unlike the ase of rent-shifting arrangements between a government agent and private firm(s), whih may be ompliated by, among other things, strategi delegation issues and asymmetri information problems, STEs operate through a single marketing board with the exlusive ontrol of both the instrument for strategi trade (i.e., the unit 4

5 transfer prie) and the quantity traded. Seond, time-series data on STE ativities are publily available. Finally, apart from reasons of purely analytial onveniene, the behavior and praties of STEs are important in their own right. At least sine the Uruguay settlement of GATT, the role and behavior of STEs, whih have reported objetives that inlude protetion of domesti markets from world market influene and expansion of export market shares, have been a major onern in the emerging international ommitment to free trade (GAO, 1995). We apply our test of the rent-shifting hypothesis to the international durum market. International durum trade is an analytially onvenient subjet to study, as durum wheat is a relatively homogeneous ommodity with a limited number of global exporters. Over the pre- WTO period that omprises our data, moreover, the durum market is served by a single STE, the Canadian Wheat Board (CWB). 3 Our priniple finding is that the delayed produer payment struture implemented by the CWB in this period is onsistent with rent-shifting behavior. Further analysis of individual marketing years supplements this result, moreover, as the atual pre-payment disount implemented by the CWB and the estimated optimal rentshifting transfer annot be statistially differentiated in 17 of 24 sample years. The remainder of the paper is strutured as follows. Setion 2 provides bakground information that summarizes the urrent priing pratie of the CWB, with partiular attention direted towards the payment struture in the durum market. Setion 3 presents a theoretial framework that outlines the essential details of how a delayed produer payment system serves as a rent-shifting devie and derives the entral estimation equations we pursue in the empirial portion of the paper. Setion 4 outlines the empirial methodology. Setion 5 ontains the estimation results, and, in Setion 6, the paper onludes with a brief summary of our findings and suggestions for future work. 2. State Trading Enterprises, Vertial Separation, and Preommitment 3 The CWB is authorized under Canadian law to have near omplete autonomy over the marketing, storage, logistis, and priing of the nation s hard wheat, durum and barley exports. 5

6 In the Uruguay settlement of GATT, the urrent WTO member nations made signifiant ommitments toward freer trade through tariffiation of quotas, sheduled redutions in internal prodution and trade distortions, and tightened definitions of national autonomy in a new hard law framework. A major issue of onern in this settlement regarded STE ativity. In partiular, the question arose as to whether the programs instituted by STEs ould be tailored to irumvent the growing international ommitments toward free trade. In the post-uruguay period, the U.S. Congress ommissioned the General Aounting Offie to ondut two studies investigating and interpreting STE behavior (GAO, 1995; GAO, 1996). In these studies, STEs were shown to use poliy tools that have reasonably lear WTO ompliane rules, inluding prodution and import levies, prie supports, and export subsidies (GAO, 1996). The reports also ited several other STE ativities that are more problemati under WTO law, inluding export lienses, subsidies not tied marginally to a ommodity, aess to below-market borrowing rates, tax advantages, transportation subsidies, and delayed produer payments. The GAO (1996) study reognized delayed produer payments as a soure of priing flexibility, beause STEs initially set produer payments before final export marketing onditions are revealed. However, the report failed to draw attention to another important feature of the delayed payment system: almost exlusively, the initial payments for ommodities brokered by STEs are set at substantially below-market pries. The large body of literature on vertial separation suggests that similarly strutured payment systems between upstream and downstream firms are apable of generating the neessary preommitment mehanism to attain a Stakelberg leadership position (see, e.g., Bonanno and Vikers (1988), Lin (1988), Coughlin and Wernerfelt (1989), and Kühn (1997)). By setting a below-market prourement prie for a ommodity, a legally santioned STE is thus able to shift rent in the export market in muh the fashion that a downstream firm in a vertially strutured industry an strategially position itself 6

7 through use of an upstream prie restraint. 4 Moreover, in the ase of STEs, the final payment in a delayed produer payment system, whih is typially delivered in lump-sum fashion, provides an expliit method of transfer bak to the input supplier that rationalizes the system. The essene of the vertial separation argument, as it relates here, is as follows. Through an appropriately strutured system that employs below-market priing of an upstream produt with a linear ombination of lump-sum payments and equity sharing arrangements with the input supplier, a downstream firm an attain the requisite preommitment for Stakelberg leadership. The delayed payment system in a STE is of preisely this form: the STE typially pays upstream produers a below-market prie, then later provides lump-sum reimbursement after proeeds are generated in a downstream international market. Consequently, the delayed payment approah is apable of reating a redible marginal ost advantage for the STE in an international market, therein providing the neessary preommitment to shift rent. The delayed produer payment struture is equivalent in this regard to a poliy of diret export subsidization. In the partiular example we pursue here, the delayed payment system of the CWB, Canadian durum produers are required to market all output through the CWB both for domesti onsumption and for export. In eah year, the initial payment is announed by the CWB prior to harvest. Figure 1 highlights the details of this payment system for durum wheat. In the figure, the total height of eah bar is the prie reeived by Canadian produers in eah year, whih is the sum of initial, middle, and final payments provided by the CWB. The lower portion of eah bar is the initial payment paid to produers at the time they relinquish the grain, while the upper portion represents the sum of middle and final payments to produers after all revenue, net of ost, is determined. The salient feature of figure 1 is that the CWB onsistently delays payment for a substantial portion of the unit value of durum wheat. This deferred portion of the unit value represents a shift in ost between what is essentially a marginal ost and a fixed ost omponent 4 See Hamilton and Stiegert (2000) for an analysis of the antitrust impliations of suh vertial arrangements in international markets. 7

8 of the CWB. For the reasons mentioned above, whih we lay out more formally in the next setion, we take the level of this pre-payment disount, the differene between the initial payment and the resulting world market prie in eah year, to represent the preommitment parameter through whih a rent-shifting outome obtains. There are several irumstanes of durum trade that are partiularly well suited for a test of the rent-shifting hypothesis. First, the CWB is the major international player in the durum market. As the sole Canadian exporter for durum wheat, the CWB has maintained a 40-60% export market share over the past several deades (International Wheat Counil). Relative to the other ommodities sold under its auspie, moreover, whih inlude hard wheat and barley, the CWB hannels a larger share of its durum to export markets: for example, in the period, only 5-8% of the durum rop was sold domestially. Seond, unlike the international hard wheat and barley markets, in whih the Australian Wheat Board and Australian Barley Board operate their own delayed produer payment programs, the CWB does not ompete with other STE s in the durum market. Finally, only limited substitution is possible for durum in its primary end-uses of semolina flour and pasta formulas. These elements of the durum market allow us to implement a relatively straightforward empirial approah. 3. Theoretial Struture This setion provides a oneptual framework to identify the important features of the delayed produer payment system as a rent-shifting mehanism. Throughout, attention is onfined to irumstanes in whih a single STE operates in the international market, whih onforms with our empirial development of CWB behavior in the next setion. Consider a global export ommodity that is produed in two prodution regions, a domesti region, in whih operations are organized through a STE, and a foreign region omposed of n independent produers. Global prodution of the export ommodity is strutured in a vertial system omprised of an upstream input market in eah ountry and a single downstream international market. For analyti simpliity, upstream firms produe the input at 8

9 onstant unit osts of D and F in the domesti and foreign ountry, respetively, and eah downstream marketing agent serves as a pure intermediary in the prodution of the finished produt. 5 We further assume that the domesti STE has exlusive ontrol over all input purhases and has the authority to set the upstream market prie in a prourement ontrat, the details of whih are speified in some detail below. In the foreign region, downstream marketing agents are onstrained to purhase the input on the spot market, as would be the ase when legal restritions prevent the expliit ontrol of upstream market pries. For example, antitrust legislation in the U.S. limits the ability of a marketing agent to set the input prie through an upstream prie restraint. 6 Strategi interation between the marketing agents is modeled as a two-stage game. In the first stage, the preommitment stage, the STE selets an upstream transfer prie, w, for the produt. Partiipation by upstream produers in the market is mandatory at this prie. In the seond stage, the STE and the foreign marketing agents ompete in quantities in an international oligopoly market. At the onlusion of this output stage, proeeds aquired by the STE through international durum sales are returned in a lump-sum fashion to the upstream produers. 7 Let Q represent total output of the final good and denote the downstream inverse demand funtion as P(Q), whih is assumed throughout to be stritly dereasing and twie ontinuously differentiable. Downstream marketing osts are assumed to be linear in output and are heneforth subsumed into the market prie. Finally, we impose the stability ondition P'(Q) + QP''(Q) < 0, (1) whih, as demonstrated by Novshek (1985), ensures the existene of equilibrium. The model is solved using bakward indution. In the output stage, the STE seeks to Maxπ D ( q D,Q,w)= ( P(Q) w)q D, (2) q D 5 As will be made lear in a moment, this distintion between the input market and final produt market is motivated purely for expositional onveniene. 6 For a detailed disussion of U.S. antitrust law that governs transations in vertially strutured markets, see Perloff, Rubinfeld and Ruud (1996). 7 Beause the STE ats as a ooperative, the profit maximizing transfer prie is independent of the level of the lumpsum transfer; hene the size of the final transfer payment an be suppressed without loss of generality. 9

10 where π and denote the level of profit and output for the STE in the export market, D respetively, and w is the transfer prie set in the preommitment stage. Maximization of (2) with respet to q D q D yields the first-order neessary ondition: P( Q) + qd P' ( Q) w = 0. (3) Next, let q represent the output of foreign marketing agent i in the export market. F i Letting n denote the number of foreign agents, the aggregate output of foreign firms is q F = n q Fi i =1. For foreign marketing agent i, the objetive funtion in the output stage is whih yields the first-order ondition π Fi (q Fi,Q) = ( P(Q) F )q Fi, P(Q) + q Fi P'(Q) F = 0. (4) Equilibrium in the output stage is found by simultaneously solving the n+1 equations desribed in (3) and (4). To ahieve greater analyti tratability, the remainder of the paper onfines attention to the ase of symmetri foreign firms, q F i = ( 1/ n) q, i. In this ase, the above system of equations an be simplified by aggregating the n first-order onditions (4), whih yields the firstorder ondition for a representative marketing agent F P(Q) + (1/ n)q F P'(Q) F = 0. (5) The equilibrium export volume of the final good from domesti and foreign marketing agents, denoted q ( w, ), i = D F, and the total quantity sold in the export market, Qw (, ), are obtained i, by solving (3) and (5) simultaneously. In the preommitment stage, the STE selets the transfer prie, w, so as to Maxπ ( w) = P( Q( w, )) q ( w,. w D ( ) ) Letting w denote the solution to this problem, the upstream prie set by the STE in the optimal rent-shifting program is D w D = q D P'(Q ) q F (q D,Q ) < 0, (7) q D where q F (q D,Q ) = ( np'(q ) + q F P'' (Q ))(n [ +1) P'(Q ) + q F P''(Q )] 1 is the ratio of q D 10

11 omparative statis of (3) and (5) implied by the STE s hoie of w, and where the inequality in (7) holds by stability ondition (1). In expression (7), the profit-maximizing upstream prie set by the STE speifies that domesti upstream produers sell the input at a prie below marginal ost, whih inreases domesti market share in the international market in an analogous fashion as a domesti output subsidy. 4. Empirial Methodology In a standard empirial industrial organization model, the theoretial underpinning of the market equilibrium is a simultaneous-move game omprised of homogeneous firms (for a review, see Bresnahan (1989)). For our purposes, we extend this framework to onsider an international market equilibrium omposed of two exporting groups: the CWB and a omposite group of symmetri foreign marketing agents that operate without the servies of a STE. Our statistial approah begins with estimation of the output-stage model. For empirial purposes, we write the onjetural variations ounterparts to (3) and (5) with the use of ondut parameters. 8 The onjetural variations model arises by assuming eah firm views industry output Q as a funtion of it s own output q i, whih modifies (3) and (5) as P + q P' ( dq / dq ) w = 0, P + q oe P' ( dq / dq oe ) oe = 0, for the CWB and the omposite group of other exporters, respetively, whih we hereafter denote with the subsripts and oe. Noting that dq / dq i = dq i / dq i + dq i / dq i, where i refers to the ombined output of all marketing agents other than i, and letting m = w denote the markdown payment of the CWB, the onjetural variations ounterparts to (3) and (5) are P + q P' λ + m = 0, (3 ) P + q oe P' λ oe oe = 0, (5 ) where λ i = 1+ υ i is a ondut parameter and the variable υ i (dq i / dq i ), aordingly, is the so- 8 It is well understood that the ondut parameter framework has no valid dynami foundation. However, it provides a onvenient way to haraterize the spetrum of oligopoly outomes and it is ommonly used in empirial industrial organization studies. Genesove and Mullin (1998) provide a good disussion of the possibilities and limitations of the ondut parameter approah. 11

12 alled onjetural variation. In equations (3 ) and (5 ), the departure of λ i from unit value is a logially onsistent test of whether the Cournot-Nash model provides an aurate desription of the industry equilibrium. Under the rent-shifting hypothesis, the optimal markdown payment of the CWB in (3 ), denoted m, is defined by m = w in aordane with (7). Our approah essentially is to estimate equations (3 ) and (5 ). However, an eonometri problem arises in that rent-shifting behavior derives from a previous, preommitment period in whih the optimal markdown payment, m, is determined through the use of output-stage information. A two-step method orrets for this problem. In the first step, the value of m in (3 ) is taken as the observed markdown payment set by the CWB, whih we denote m, and prie and ost information is employed to estimate ondut parameters for the CWB and foreign marketing agents in the output-stage model. Beause m represents the atual markdown payment instituted by the CWB in eah sample year, moreover, this proedure yields unbiased estimates of the various market parameters. In the seond step, the estimated output-stage results are used to reover the optimal rent-shifting markdown in the preommitment stage and nonparametri statistial tests are applied to evaluate the relationship between the estimated optimal and observed markdown payments set by the CWB. The two-step approah outlined above has several advantages. First, if the CWB employs its delayed produer payment system to obtain an optimal rent-shifting position in the international market, as we hypothesize, then we should observe a zero onjeture for the CWB in the output stage (i.e., ν = 0). Indeed, if the CWB set its initial payment level aording to (7) in the preommitment period, the onjetural variation parameter is preisely the information that is subsumed into the optimal markdown payment, m. To derive this result more formally, it is helpful to integrate the two stages of the CWB problem into a single marketing problem, from whih we obtain the first-order ondition P + q P ( 1+ ν ) = 0. If the CWB does not employ delayed produer payments as a rent-shifting mehanism, so that information from the preommitment stage is ignored, the markdown payment m in (3 ) is a pure 12

13 monetary transfer that has no real eonomi effet on industry ompetitiveness. If the CWB operates an optimal rent-shifting program, however, then from (7), unit prodution osts relate to the prourement prie aording to = w + q P ν, whih implies P+ q P ( 1+ ν ) = P+ q P w = 0. Substituting in for the definition of the optimal markdown payment, m = w, yields P+ q P + whih is equivalent to (3 ) only when λ = 1. m = The determinay of the CWB onjeture under rent-shifting behavior provides a testable impliation in the output stage model. If CWB ondut is estimated as a free parameter in an output stage in whih the marginal ost of the CWB is shifted downward by the observed markdown payment, m, then, under the rent-shifting hypothesis, λ = 1 should obtain. If the hypothesis of leadership behavior is not rejeted in the output stage, a seond testable impliation derives in the preommitment stage model. In partiular, based on the relationship between the observed payment set by the CWB in the upstream durum market and the estimated optimal markdown payment alulated from (7), it is possible to assess whether m is onsistent with the profit-maximizing level of preommitment. Standard nonparametri statistial methods an then be applied to investigate the relationship between m and m. To omplete the speifiation of the empirial model, we onsider international demand for durum given by the isoelasti demand equation, 0 P = αq 1/ ε, where ε < 0 is the prie elastiity of demand. Substituting (3 ) and (5 ) in the alulation of (7) and making use of the fat that QP' P = 1 ε and QP'' P' = ( 1 ε) ε, the optimal markdown, m, is haraterized by m = w = S P ε + λ oe S oe (1 ε) ε (1+ λ oe )ε + λ oe S, (8) oe (1 ε) where S is the export market share of the CWB and S = q oe,i Q is the ombined market oe n i =1 ( ) share of other exporters. For given estimated values of the demand elastiity and the ondut parameter of the other exporters λ oe in the output stage of the model, expression (8) generates the estimated optimal markdown payment for eah marketing year. 13

14 5. Estimation and Results Our analysis begins with the estimation of the output-stage model. In the output stage, we onsider a three-region trade model in whih the CWB and the aggregate U.S.-E.U. other exporter region onstitute two distint net export regions and the rest of the world (ROW) are treated as net importers. All equations are expressed in log linear form, whih orrets for the perfet ollinearity problem of the linear Bresnahan model (see Perloff and Shen (1999)) and is onsistent with our speifiation of the demand relation (8). We desribe the demand and supply equations for the importing region (i.e. ROW) as follows: D S row 0 1 d 3 row 3 r 4( d r ) row = a = b 0 + a +b 1 P P d[-1] + a +b Y 2 AC + a P row[-1] + a +b 3 P P b[-1] P b + ε (9) a + ε (10) where S row and D row are prodution and onsumption of durum in the ROW region, respetively, P d is the international prie of durum, Y row is national inome in the ROW region, P r is the prie of a key a substitute produt (rie), AC row is durum areage planted, and P b is the prie of a prodution substitute (barley), and ε a and ε b are random disturbane terms. The [-1] subsripts refer to variables lagged one period, whih reflets the fat that durum supply deisions in a given year are determined prior to the marketing period, and hene depend on lagged values of pries and areage. 9 The exess demand relation for the ROW is haraterized by EDrow Drow S row, whih, making use of (9) and (10), we express in prie-dependent form as: 1 P d = ( a 1+ a 4 Pr ED row -a+ 0 b+ 0 b 1 P d[-1] -a 2 Y row -a 3 P r + b 2 AC row[-1] + b 3 P b[-1] )+ ε ab (11) Suppose the two net export regions, Canada and OE, selet quantities so as to equate pereived marginal revenue with marginal ost in (3 ) and (5 ). Confining attention to suh ases allows for simultaneous identifiation of the supply relationship and ondut parameter based on exogenous rotations of the exess demand urve through the interation term P d P r in (9). Moreover, beause the supply relation (10) does not depend on urrent year prie information, 9 The use of lagged areage is oneptually similar to the use of a lagged supply term but, by removing weather related output fators, better aptures the previous period s prodution ommitment. 14

15 the estimated demand elastiity in the ROW region is idential to that of imported durum. For the OE region, net exports are speified in a similar fashion as above. However, an important distintion is that we onsider stoks holding ativities in the exess supply relation. The supply, demand and stoks equations for the OE region are speified as D oe = S oe = d 0 + d 1 a P d + 3 Y oe + 3 P r + 4 a( P d P r ) + ε (12) P d[-1] + d 2 AC oe[-1] + d 3 P b[-1] + d 4 BST oe + ε d (13) EST oe = e+ 0 e 1 e P d + 2 BST oe +ε e (14) where BST oe and EST oe denote beginning and ending stoks, respetively, and all other variables are defined as in the ase of the ROW above. In (14), ending stoks are modeled as a funtion of beginning stoks and the ontemporaneous prie of durum. Making use of (12)-(14), the following identity is used to alulate exess supply in the OE region (ES oe ): S + oe BST oe D oe + EST oe+ ES oe (15) The exess supply equation also inludes a shift term that aptures the equilibrium deviation of prie from marginal ost represented in (5 ), whih implies, upon gathering equations, that -1 P d = 1+ 4 P r + e 1 ( ES oe d 0 + e o -d1pd[-1]- d2ac oe[-1] - d3 P b +( e) 2 BST oe+ 2 Y oe + 3 Pr) 1 λ oe ESoe a 1+P + ε d, (16) r a 4 where λ oe is the ondut parameter for the OE, ε d is a random disturbane term, and all other variables are as previously defined. For the Canadian region, the supply, demand, stoks and exess supply equations are analogous to those of the OE region in (12)-(16), with one exeption. The marginal ost faing the wheat board in the output stage is redued by the observed markdown payment, m, as speified by (3 ). Proeeding as above yields the estimation equations D S = f 0 + f 1 Pd + f 3Y + f 3 Pr + f 4( Pd Pr ) EST = g 0 = h + g 0 1 P + h 1 d[-1] P d + g + h 2 2 AC BST [-1] + g h 3 P b[-1] + ε (17) f + g 4 BST + ε (18) + ε (19) g 15

16 P d+m = -1 ( ES f 1+ f + f 0 -g 0 + h- o g 1 P d[-1] - g 2 AC[ 1] - g 3 P b+(1+g 4 -h) 2 BST + f 2 Y + f 3 Pr) 4 P r + h 1 1 λ ES a 1 + a 4 P + ε fg. (20) r The data neessary to estimate the model are aquired as follows. International pries, areage, onsumption, prodution, trade, beginning and ending stoks for the various hard wheat ommodities are obtained from World Wheat Statistis. Per apita inome for eah region is alulated using GDP data reported in International Finanial Statistis and population data in the United Nations Population Database. Finally, the (real) international pries of barley and rie are obtained from North Amerian export values available in the United Nations Trade Database and deflated using the industrialized nations produer prie index reported in International Finanial Statistis. The system of equations above is estimated for the durum market over the pre-wto period Sine equations (9)-(20) represent a nonlinear simultaneous equation system, they are estimated using nonlinear 3-stage least squares (N3SLS). The exogenous variables in the system are used as instruments and onvergene is obtained from various groups of starting values. The estimation results are presented in table 1. The important feature to note in the table is that eah parameter estimate essential to our test of the rent-shifting hypothesis is of the orret sign and of a magnitude that onforms either with theory or to previous researh. In partiular, the oeffiients that jointly determine the world demand elastiity in the ROW region, a 1 and a 4, are both signifiant. Based on these values, the estimated demand elastiity in the durum export market (evaluated at the mean prie of rie) is and is signifiant at the 0.01 level. Using the observed prie of rie at eah data point, the elastiity of international durum demand varies in a range between 2.50 to 1.50 over the sample period. 11 The ROW 10 In light of the fat that the U.S. began investigating the trade impliations of STE behavior in 1995 (see GAO (1995); GAO (1996)), we onfine attention to prior years. 11 To our knowledge, there is no published researh that reports estimates of the import demand elastiity for durum over a omparable period of study. However, empirial evidene in hard wheat and ourse grain markets suggests 16

17 ross-prie elastiity with rie, estimated at the mean durum prie, is positive, whih onforms to expetations that rie and durum are substitutes in onsumption. Inome parameters for Canada and the OE indiate that durum is a normal good. Most of the remaining parameters from the supply equations and stoks equations either onform to expetations or are not statistially signifiant. The prie of barley, whih is inluded in the model as a prodution substitute for durum, is statistially signifiant in all three regions, but of the wrong sign in the ROW region. This finding may be due to the fat that barley is a substitute in Canadian and OE growing regions, but less important to the diverse growing regions haraterized by the ROW. The parameters for beginning stoks in the ending stoks equations are positive and statistially signifiant in both export regions, with magnitudes that indiate more pronouned stoks adjustments in the U.S. than in Canada. In eah ase, stoks holding behavior is positively related to the world export prie, whih indiates that both regions may attempt to influene the world market prie for durum through grain storage. The ondut parameters, both for the CWB (λ = 1.05) and for the OE region (λ oe = 0.74 ), are statistially signifiant, whih provides some indiation that the world durum market is nonompetitive. Making use of the output stage estimation results, moreover, the hypothesis that λ =1 annot be rejeted. 12 Hene, we fail to rejet the hypothesis in the output stage model that the CWB shifts rent through its delayed produer payment program. The estimated ondut of the CWB in the output stage provides a neessary, but not a suffiient, ondition for rent-shifting behavior. 13 Consequently, we next turn to the question of whether the observed CWB markdown payments are onsistent with the optimal employment of a rent-shifting mehanism in the preommitment stage. Figure 2 ompares (in perentage terms) the observed markdown in the durum market, m, with the estimated optimal markdown payment over the period, m. The observed that the import demand elastiities reported here are quite reasonable (see, e.g., Paarlberg and Abbott (1986), Tyers and Anderson (1988), and Devadoss and Meyers (1990)). 12 In ontrast, a similar test on the ondut parameter for the OE region rejets the hypothesis of unit value at the 0.05 level. 13 Indeed, a unit ondut parameter is also onsistent with stati, one-shot Cournot-Nash ompetition. 17

18 markdown payment in eah period is taken to be the differene between the initial prourement prie and the global market prie for durum, while the estimated optimal markdown is based on the relevant output-stage oeffiients that omprise equation (8). Other than notable exeptions that our in the years 1980, 1987, 1990, and 1995, the estimated optimal markdown prie seems to trak fairly losely with the observed markdown payments implemented by the CWB. This provides some asual evidene that the markdown payments set by the CWB are set at the optimal level to shift rent. Before proeeding with a more formal analysis of the preommitment stage, we first assess the extent to whih the orrespondene between m and m provides evidene to support the optimality of payments in a rent-shifting program. It is important to note that the alulation of the optimal markdown payment in (8) relies on the use of estimated oeffiients in the outputstage model (a 1, a 4 and λ oe ), where eah of these parameters, in turn, is onditional on the vetor of observed markdown payments, m. For this reason, it is neessary to address the extent to whih m is onditioned by m through the output-stage oeffiients before inferenes are drawn regarding the optimality of the observed markdown payments. To evaluate this issue, we alulate the sensitivity of m to various perturbations in In partiular, we re-estimate the output-stage model following several perentage magnitude adjustments in m. The ondut parameter and oeffiients that determine the demand elastiity are extremely robust in response to eah of these perturbations. For the largest magnitude hange, a 20% inrease in m, the parameters relevant to our alulation of m, a 1, a 4 and λ oe, derease in absolute value terms by 1.38%, 1.66% and 0.01%, respetively. The ar elastiity of m. m with respet to m is for eah magnitude of the hange, with a range that varies between and aross individual data points (due to variation in output levels). These results indiate that the alulated value of m is not highly onditional on m in our sample An anonymous referee suggested an alternative way to address this issue. To the extent that an estimated optimal markdown payment is onditional on the observed markdown payment, suboptimal behavior may appear to be optimal in the preommitment stage omparison (type II error). To evaluate this possibility, we uniformly inrease eah observed markdown payment by $5 (a mean inrease of 19.2%) and re-estimate the output-stage model. The alulated values of the optimal markdown payments differ only marginally from those reported in table 2 and, 18

19 The observed and estimated optimal markdown payments are reported in table 2. The differene between the values of m and m in eah sample year provides the basis for our statistial assessment of the rent-shifting hypothesis in the preommitment stage. On average, the observed markdown payment set by the CWB is $26.03, whereas the estimated optimal markdown is $24.14 in the sample period. Beause we have limited knowledge of the underlying distributional properties of m, we apply two nonparametri tehniques to evaluate the hypothesis that m = m. The first tehnique employs a standard nonparametri bootstrap proedure on the system of equations to generate a onfidene interval about m, whih allows the hypothesis of equal markdown payments to be examined in eah sample year. 15 The bootstrap is implemented by generating OLS parameter estimates of the redued form system and sampling (with replaement) from the errors of the redued form equations to reate 1000 simulated pseudo-samples of the endogenous variables. The simulated endogenous variables are then introdued into the strutural system to generate the vetor of strutural parameter estimates neessary to alulate m in eah sample year. For eah marketing year, the third olumn of table 2 reports the bootstrap p-value for a test of equal oeffiients, m = m. In 1980 and 1990, the observed markdown payment implemented by the CWB is either zero or near zero, whih indiates that a rent-shifting markdown payment was not implemented. Of the remaining sample years in whih a positive markdown is observed, the results fail to rejet the hypothesis of equal oeffiients at the 0.05 level in 17 of 22 ases. Thus, in the majority of years in the sample the markdown payment instituted by the CWB is not statistially different from the optimal rent-shifting markdown at the bootstrapped sample means. In four of the five remaining years in whih the hypothesis of equal oeffiient is rejeted, the observed markdown set by the CWB exeeded the level neessary to aquire the optimal rent-shifting advantage in the durum market. Eah of these ases orresponds with a strong leadership signal, although an exessive markdown payment is orrespondingly, the hypothesis that the suboptimal payment level are optimal is rejeted on the basis of the Wiloxen signed-rank test (desribed in detail below). 15 See Efron and Tibshirani (1993) for a general disussion of this approah. 19

20 learly sub-optimal in ontext of the stati theoretial struture that frames our approah. Only in 1995, the final sample year in our study, is the observed markdown payment both signifiantly different than zero and below the estimated optimal markdown. 16 We next examine the orrespondene between the estimated and observed markdown payments in the entire sample range. The overall agreement between m and m in the entire sample range is entral to our analysis of the preommitment stage, partiularly when one onsiders that the final world prie is to some extent unertain at the time the initial payment is announed. 17 In any given year, exogenous shoks (e.g., output shoks due to weather events) an potentially our between the time the initial and final payments are made that influene the performane of the rent-shifting poliy. Provided that the exogenous shoks are unorrelated, however, extending the analysis to the entire sample range dampens the influene of suh events, even in a small time series suh as ours. To address the general relationship between the observed and estimated optimal markdown payments over the sample period, we employ a Wiloxen signed-rank test (see Wilox (1987)). The Wiloxen test, whih relies on sequentially ranked differenes of the median values of m and m is used to generate a z-sore for the hypothesis that m = m. 18 The result of this test is reported with its orresponding p-value at the bottom of table 2. With 24 pairs of observations of the ranked data, we fail to rejet the hypothesis that the estimated optimal and observed markdown payments oinide over the sample period. Thus, the results of the Wiloxen signed-rank test suggest that the prourement priing struture of the CWB in the preommitment stage is indeed onsistent with the rent-shifting hypothesis Although we do not wish to press the point here, it is interesting to note that the 1995 marketing year also orresponds to the first year of the U.S. Congressional investigation into STE behavior (GAO 1995, 1996). 17 To obtain unbiased parameter estimates in the output stage model, however, it is neessary to onsider the markdown payment as the observed deviation from the atual market prie, not the expeted market prie. 18 If eah differene is from some symmetri distribution, of ourse, then any inferene about the median also applies to the mean. 19 We also performed two other tests on the relationship of m and m : a simple t-test of the means and Spearman s oeffiient of rank orrelation, neither of whih differed signifiantly from the Wiloxen test results. 20

21 Several features may explain why our sample involves a higher observed markdown on average than the estimated optimal markdown payment. First, the delayed produer payment system may provide anillary benefits not onsidered in our analysis, suh as a soure of interestfree short-term loans to manage day-to-day operations of the CWB. Seond, the CWB ontrols both the transfer prie and the quantity marketed for export, whih allows greater latitude for strategi behavior than that whih is onsidered here. Finally, our estimates of the output stage parameters are based on information from the entire sample period, whereas the CWB operates on a year-by-year marketing basis. On the whole, while one should be alert to the possibility of data problems, our findings seem remarkably onsistent with the hypothesis that the delayed payment system of the CWB serves as a rent-shifting mehanism in the international durum market. 5. Conluding Remarks The purpose of this paper was to derive and implement a general test of rent-shifting behavior in international markets. Our examination of the international durum market, in whih the CWB ats as the sole exporter for Canada, failed to rejet the hypothesis that the priing struture employed by the CWB is targeted at the optimal level to shift rent. The empirial approah we developed here to test the rent-shifting hypothesis provides a general methodology for the examination of multi-stage games in non-ompetitive markets. The empirial analysis was onduted using two proedures that orrespond, in parallel fashion, with eah of the two stages of the theory. In the first proedure, the output stage of the model was estimated using ondut parameters to desribe equilibrium market behavior in an environment that onsidered the strategi manipulation of a poliy parameter in the domesti marginal ost relation. A testable impliation resulted for these output stage estimation results. Namely, it was demonstrated that a neessary, though not a suffiient, ondition for rent-shifting behavior is a unit value for the estimated ondut parameter of the domesti marketing agent. Applied to the role of the CWB in the international durum market, this hypothesis ould not be rejeted. The 21

22 seond proedure relied on information from the preommitment stage that permits several nonparametri statistial tests to be employed to evaluate the hypothesis that the observed markdown is onsistent with the optimal rent-shifting markdown. Based on these tests, the hypothesis that the delayed produer payment system of the CWB is onsistent with the optimal rent-shifting poliy in the sample period ould not be rejeted. As the trend ontinues towards greater integration of international markets, extension of these findings to other markets (and other trade poliy parameters) is essential. Evidene of similar rent-shifting poliies in other export markets, whether instituted by governments through delayed produer payments and export subsidization programs or by private market mehanisms suh as union-management ontrats, upstream equity-sharing relations, and strategi delegation, would provide further validation for the results reported here. Suh orroborative evidene is important as international free-trade agreements ontinue to be restrutured along the lines suggested by theory. 22

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