RETURNING MATERIALS: )V1£SI.J P1ace in book drop to LJBRAfiJES remove this checkout from w your record. FINES W'iH be charged if book is returned after the date stamped be10w. -::53 U L_ggg§ 063 THE STRUCTURE, CONDUCT, AND PERFORMANCE OF THE CCC EXPORT CREDIT SALES PROGRAM WITH A CASE STUDY OF THE ADDITIONALITY EFFECT OF CCC FINANCED COTTON EXPORTS TO KOREA By William I. Tierney, Jr. A DISSERTATION Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Agricultural Economics August, 1984 ‘- .1 s . " -/ c/ I m ABSTRACT THE STRUCTURE, CONDUCT, AND PERFORMANCE OF THE CCC EXPORT CREDIT SALES PROGRAM WITH A CASE STUDY OF THE ADDITIONALITY EFFECT OF CCC FINANCED COTTON EXPORTS TO KOREA By E William I. Tierney, Jr. The CCC Export Credit Sales Program was the most important export credit program ever offered by the USDA. The program provided financing for US agricultural exports on credit terms for as long as three years. The program was administered by the Office of the General Sales Manager (OGSM) within the USDA. This research attempts to evaluate and measure, when possible, the performance of the program with respect to it's objectives. This research adapted the structure, conduct, and performance model of industrial organization theory, and applied it to the problem of assessing the program's performance. The analysis of the program's structure begins with a description of the program's values, goals, and objectives, identifies the program's participants, outlines the problems associated with overlapping administrative Jurisdiction, and discusses the role of the program in overall agricultural export policy. This research explains the rationale for export credit programs with regard to of the current structure of international agricultural markets. This research describes the administrative functions of the OGSM. This research found that relations with other USDA departments and other federal agencies could influence program performance. Generally, the interest rate charged by the OGSM was-below comparable market rates, and constituted an implicit price subsidy. Previous attempts to measure the performance of export credit programs have suffered from a variety of shortcomings. Other export credit studies are discussed, and an alternative methodology is proposed. Performance must be measured against its explicit goal of increasing exports. However, this research also addresses the question of performance with respect to secondary political and economic effects. The ability of an export credit program to increase foreign sales is called additionality. This research attempts to measure the additionality of export credits for cotton sales to the Republic of Korea. A theoretical model is developed to describe the influence of CCC credits on a Korean textile firm's cotton purchasing behavior. This research uses a pre-existing model of the Korean economy to simulate the effects of a change in export credits. Changes in cotton imports, other agricultural trade, and all trade are documented. The cumulative increase in all Korean imports due to the export credits was 3.5 times the amount of the credits. TABLE OF CONTENTS Headings Page CHAPTER I Introduction 1 Objectives 5 Procedures 7 Organization 8 Endnotes 10 CHAPTER II The Structure of the Commodity Credit Corporation' 5 Export Credit Sales Program . . . . . . . . The Origin of the Structure, Conduct, and Performance Paradigm . . . . . . . . . The Need for an Institutional Analysis . . . . . . . . . Structure Values, Goals, and Objectives Objectives Goals Values . . . . . . . . . Participants . . . . Domestic Farmers Foreign Farmers Domestic Consumers Foreign Consumers i ll ll 13 14 1M 15 l5 l6 l6 l6 17 18 18 Domestic Exporters Foreign Importers Domestic Banks . . . . . . Foreign Banks The United States Government Foreign Governments . . . . . Other Participants Policy Makers Jurisdictional Boundaries External Effects . . . . . . Economies of Scale Preference Articulation The Program's Information and Feedback Systems . . . . . . . . . . . The Information System The Feedback System . The CCC Program in the Context of Overall Agricultural Export Policy Complementarity Among Programs The Credit Sales Program's Impact in Other Policy Areas Market Structure The Structure of International Commodity Markets . . . . . . The History of Credit Subsidy Agreements . . . . . The Structure of Domestic Commodity Markets . . . . . . . . . The Structure of Foreign Commodity Markets . . . . . . . . ii 19 21 21 22 23 23 2M 25 26 26 29 31 32 32 36 37 MO ”3 “3 AA “5 ”7 H8 Market Development in Countries with Government Importing Agencies The Cargo Preference Act and Countries with Government Importing Agencies Conclusion Endnotes CHAPTER III The Conduct of the Program's Policy Makers The Behavior of the OGSM Inter-Departmental Relations CCC-OGSM Relations with the State Department CCC-OGSM Relations with the Treasury Department Determining Interest Rates and Repayment Periods The Subsidy Effect . . . . . The Prime Rate Eurocurrency Rates . . . . Sales Registration, Confirmation, and Disbursement . . . Uncertainty and Its Influence of Program Decision Making . . . . . . . . . . . . Sources of Uncertainty Institutional Uncertainty Economic Uncertainty Flexibility as a Strategy for Dealing with Uncertainty Conclusion . . . . . . . . . . Endnotes . . . . . . . . . . iii '49 51 52 5A 59 59 6O 6O 62 65 65 66 67 71 73 73 73 7A 75 77 79 CHAPTER IV The Performance of the Program . . . . . . . . . 82 The Importance of Retaining a Pragmatic Perspective . . . . . . . . . . . . . 82 Impact Indicators .‘. . . . . . . . . . 83 Performance with Respect to the Program's Explicit Objectives . . . . . . . . . . . . 84 Previous Additionality Studies . . . . . . 84 The Elasticity Approach . . . . . . . . 85 The Probability Approach . . . . . . . . 87 Case Studies . . . . . . . . . . . . . . 89 The Simple Correlation Approach . . . . 91 An Alternative Methodology . . . . . . . . 95 Performance with Respect to the Program's Explicit Goals . . . . . . . . . . . . . . 96 Benefit Incidence - Exporter or Importer . . . . . . . . . . . . . 96 A Perfectly Compensating Subsidy . 97 An Overly Compensating Subsidy . . 98 An Unnecessary Subsidy . . . . . . 99 Benefits versus Costs - The View from the "New Supply-Side Economics" . . . . . 101 Performance with ReSpect to Secondary Economic and Political Impacts . . . . . . . . . . . 101 Secondary Domestic Impacts . . . . . . . 102 Comparative Advantage . . . . . . . 102 Increased Efficiency . . . . . 103 The Export Multiplier . . . . 104 Domestic Price Effects . . . . . . 104 Increase in the Federal Budget 104 Increase in Food Prices . . . 105 iv Increased Support of the Dollar . . . . . . . . . . . 105 Income Distribution . . . . . . . . 107 Secondary International Impacts . . . . 108 The Soviet Union . . . . . . . 109 China . . . . . . . . . . . . 109 Human Rights . . . . . . . . . 109 The Risk of Deterioration in the International Trade Climate . . . . . . . . . . 110 International Economic Impacts . . . . . 110 Export Credits as Aid . . . . . . . 111 Uneven Effects on LDC's . . . . . . 111 Performance with Respect to the Technical Efficienty of Program Administration . . . 112 Defaults and Debt Rescheduling . . . . . . 113 Attempts to be Self-Sustaining . . . . . . 114 Other Aspects of Administrative Performance 115 Interest Rate Adjustment . . . . . . . . 115 Interest Differentials on Letter of Credit . . . . . . . . . . . . . . . . 116 Conclusion . . . . . . . . . . . . . . . . . 117 Endnotes . . . . . . . . . . . . . . . . . . 119 CHAPTER V The Additionality Effect of CCC Credits for Cotton Exports to Korea . . . . . . . . . . . . . . . . 123 The Influence of CCC Credits on a Korean Textile Firm' 3 Cotton Import Purchasing Behavior . . . . . . . . . . . . . . . . 124 A Graphical Analysis . . . . . . . . . . . 124 Short-Run Effects . . . . . . . . . . . 124 Long-Run Effects . . . . . . . . . . . . 128 A Static, Neoclassical Model of the Influence of the CCC Credit on an Importing Firm' s Purchasing Behavior . . . . . . . . . . 132 Profit Maximization in a Multi- Product Firm 0 o o o o o o o o o o o o o o o o J-3Ll A Survey of the Korean Cotton Textile Industry 0 O I O I O O I O O O O O O O O O 1142 An Operational Model for Estimating the Additionality of CCC Cotton Export Credits. 148 Shocking the Model to Simulate Changes in CCC credit 0 O O O O O O O O O O O O O O 1149 Determining the Interest Subsidy Embodied in CCC Credit . . . . . . . . 150 Estimating the Interest Subsidy . . 150 Measuring the Interest Subsidy . . 154 Estimating Own Price and Cross Price Effects Decomposition of KASM Indices. 161 Simulation Results . . . . . . . . . . . . . 162 Cotton Imports . . . . . . . . . . . . . 163 The Direct Price Effect . . . . . . 163 The Induced Investment Effect . . . 164 Linkage Effects . . . . . . . . . . . . 166 Conclusion . . . . . . . . . . . . . . . . . 169 Endnotes . . . . . . . . . . . . . . . . . . 172 CHAPTER VI Summary and Proposals for Changes in the Program's Structure and Conduct . . . . . . . . . . . . . 174 Structural Proposals . . . . . . . . . . . . 176 Will the Program Have a Role in the Agricultural EXport Markets of the 1980' S O O O I I O O O O O O 176 Reducing Price and Income Instability . . . . . . . . . . 177 vi Market Penetration of High Value- Added Products . . . . . . . . 180 Use of the CCC Program for Diplomatic Purposes . . . . . . . . . . . 181 Negotiating Limits to Foreign Credit Competition . . . . . . . . . . . 183 The Nature and Extent of Foreign Credit Competition . . . . . . 184 A Two-Stage Strategy for Limiting Foreign Credit Competition . . 186 The Carrot and Stick Approach to Credit Negotiations . . . 186 Conduct Proposals . . . . . . . . . . . . . . . . 188 Planning: Indicative versus Mandatory . 188 Interest Rates: To Subsidize or not to Subsidize . . . . . . . . . . . . . . 191 Endnotes . . . . . . . . . . . . . . . . . . 194 APPENDIX A . . . . . . . . . . . . . . . . . . . . . . 197 vii Table Table Table Table Table Table Table Table Table Table Table Table Table Table Table Table II. III. IV. VI. VII. VIII. IX. XI. XII. XIII. XIV. XVI. LIST OF TABLES Value of U. S. Agricultural Exports Financed by the CCC O I O O O O O O O O O U.S. Exports of Cotton to the Republic of Korea . . . . . . . . . . . . . . . . Interest Rates Hypothetical Additionality Calculations Using Probability Approach . . . . . Supply and Demand for Cotton Yarn and 010th O O O O O O O O O O O 0 Cotton Spinning and Weaving Operation Rates 0 O I O O O O O O I O O O O 0 CCC Subsidy Relative to Commerical Terms Average Cotton Price: Cash, Commercially Financed and C00 Financed . . . . . Changes in Kasm Data Base for CCC Simulation Additionality Coefficients of the Price Effect of CCC Credits . . . . . . . . Additionality Coefficients of the Induced Investment Effect . . . . . . . . . . . The Value of Cotton Imports Due to the Induced Investment Effect . . Impact of CCC Cotton Credits on other Agricultural Imports . . . . Impact of CCC Credits on other Imports Kasm Output for With and Without CCC Credit Summary of Effects of CCC Cotton Credits viii 42 68 90 144 145 157 158 162 164 164 166 166 167 168 170 Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure 10. ll. 12. 13a 13b 14. 15. 16. 17. 18. LIST OF FIGURES An Illustration of SCP Relations Organizational Flow Chart of the CCC Credit Sales Program . . . . . . . . . . . . . Annual Carry-over Stocks of Selected Commodities and CCC Financing . Graphical Analysis of Limited Market Development with Government Importing Agencies . . . . . . . . . . . . Monthly Comparison of Interest Rate Export Credit Sales Program Processing of Sales from Registration to Payment Korea: Corn Portugal: Wheat Philippines: Wheat . . . . . . U.S. Export Market The Short Run Effects of the CCC Program . The Long Run Effects of the CCC Program Shifts Along the Firm's Long Run Cost Curve. Shift of the Firm's Long Run Cost Curve Wheat: Export Revenue as a Percentage of the Value of Production . . . . . Corn: Export Revenue as a Percentage of the Value of Production . . . . . . . Soybeans: Export Revenue as a Percentage of the Value of Produciton Major Linkages between the National Economy Model and Selected Other Models of the Korean Agricultural Sector System of Models . . . . . ix l2 27 34 50 64 72 93 94 94 100 125 130 131 133 178 178 179 198 CHAPTER I INTRODUCTION The Commodity Credit Corporation's Export Credit Sales Program provided financing for U.S. agricultural exports on credit terms for as long as three years. The Program established lines of credit for specific countries for the purchase of specific commodities. U.S. eXporters (or foreign importers) could draw upon these lines of credit when eXporting (importing) U.S. commodities. First established in 1956 and expanded in 1966, the Program had two objectives: 1) to maintain and develop markets; and 2) to increase commercial sales of U.S. agricultural commodities which were in need of export assistance. The Program was designed to do this while attempting to minimize the displacement of cash sales and commercial financing. The Export Credit Sales Program began on February 7, 1956. The initial emphasis was to allow the Department of Agriculture to dispose of government-owned stocks by financing export sales on a short term basis. Countries benefitting from the credit then were primarily Western European nations and Japan. In 1966, the Program was expanded and privately held stocks were made eligible for export financing. At the same time, the focus of the Program shifted from the disposal of surplus commodities to the purposeful development of overseas markets. With the restoration of the Japanese and European economies, the Program directed credit away from these cash markets towards 1 2 the emerging markets of Eastern Europe, North Africa, Latin America, and other areas. Budget allocations for the Program rose dramatically in the 1970's (see Table I) and, concurrent with the increase in its funding, the Program came under the increased scrutiny of other government agencies and Congressional authorities. A report released by the General Accounting Office in the Fall of 1979 raised some fundamental questions about the Program's structure, conduct and performance.1 The GAO's investigators cited studies which indicated that the gain in exports due to the Program were significantly less than the amount of CCC credit granted.2 Congressional critics also questioned the effectiveness of the Program and charged that greater efforts were needed to objectively evaluate Program performance.3 In FY 1980, the Program was discontinued and all credits ended on September 30, 1980. At the same time, the CCC moved to the sole use of credit guarantees as their primary tool for commercial export promotion. The termination of the Program may, however, prove to be temporary. Section 1201 of the Agriculture and Food Act of 1981 authorized the CCC to establish an Agriculture Export Revolving Fund. At present, funding has been approved for some eXport promotion effort but the exact form the effort will take has not yet been announced. TABLE I VALUE OF U.S. AGRICULTURAL EXPORTS FINANCED FY THE CCC (1,000 dollars) Total Cotton a Total Exports Cotton Exports Year Exports to Korea Exports to Korea 1956 1,406 - - — 1957 4,567 - 361 — 1958 11,873 - - - 1959 38.756 - - - 1960 794 - - - 1961 18,450 - - - 1962 32,808 - - - 1963 76,590 - - - 1964 118,443 3.590 39,770 1,134 1965 94,484 40 28,030 40 1966 216,768 447 16,168 476 1967 334,779 4,818 39.906 3.018 1968 144.929 6.250 51.759 5,708 1969 115,943 45,460 46,251 10,095 1970 211,346 36,986 48,222 22,186 1971 390,796 62,797 58,667 30,410 1972 371,612 65,175 79,003 40,011 1973 1,028,540 109,245 117,767 64,941 1974 297,900 48,400 63,400 ‘ 48,397 1975 248,600 60,200 97,400 59,495 1976 618,500 204,300 244,400 103,851 1977 755.300 128,400 98,500 78,117 1978 1,582,600 432,300 229,600 200,625 1979 - - - 272.657 a Fiscal Year, 1959-1963 Fiscal Year, 1963-1976 July 1 - June 30 Fiscal Year, 1977-.... October 1 - September 30 Sources: b ERS, U.S. Agricultural Exports Under Public Law 480, ERS-Foreign 395., October 1974, p. 238. & FAS, "Commercial Financing Under the CCC Credit Sales Program Reaches Record $1.6 Billion in Fiscal 1978," FATUS, January 1979, pp. 50-53. ERS, Ibid., p. 250. & FAS, Ibid. C d ERS, Ibid., p. 233. & FAS, Ibid. 8 OGSM, Printout of Country-Commodity tables (Korea-Raw Cotton7:7Computer printout using OGSM data base, Washington, D.C.: OGSM, USDA, May 31, 1980, pp. 49-53. Since the definition of fiscal years overlap for the nine month period October 1, 1976 to June 30, 1977 approximately 44,719 thousand dollars worth of CCC financed cotton exports to Korea are counted twice, once for fiscal year 1976 (July 1, 1976 — June 30, 1977) and once for fiscal year 1977 (October 1, 1976 - September 30, 1977). Objectives The primary objective of this study is to describe the Export Credit Sales Program's structure, conduct and performance. Emphasis will be placed on assessing Program performance and, in particular, evaluating the Program's export enhancing effects. The description of the Program's structure and conduct will be broad in scope but the analysis of performance will be more specific and will concentrate on measuring one aspect of performance in one unique case, CCC financed cotton exports to Korea. This study is an extension of the work done under a research grant funded by the Office of the General Sales Manager (OGSM) which administered the Program. This research addressed the theoretical and methodological problems associated with quantifying the eXport enhancing effects of the Program. These effects had been described by other researchers as the "additionality" effect and was defined as the increase in exports due to the export financing. The OGSM funded research analyzed the additionality effect in the context of a single country and a single commodity. At the request of the OGSM, the case study was cotton exports to the Republic of South Korea.“ The importance of the Program in promoting cotton exports to Korea was confirmed by the President of the American Cotton Shippers Association:5 "I was first struck, and forcibly so, with the importance of the CCC Credit in the preservation 6 of our 95-98% share of the Korean market when I went to Korea as a trade team leader in 1974. Nothing that has happened in the ensuing years has changed my belief in the great importance of CCC Credit in preserving this market for U.S. cotton. Representatives from the Spinners and Weavers Association of Korea, in emphasizing the importance of CCC Credit ... stated that numerous cotton producing countries have approached Korea in an effort to obtain an increased share of their market. In our opinion, without CCC Credit, it would only be a short time before the United States would end up with only 30-40% of the Korean market, just as we have roughly one-third of the Taiwan, Hong Kong and Japanese markets." The selection of Korea and cotton as a case study to assess the Program's additionality effect is an obvious choice for reasons other than just the Program's influence on relative market share. Over the nine years, 1970-78, Korea received a total of 1,207 million dollars of CCC credit and it ranked first among countries receiving credit during that period. Of these credits, 792 million dollars, approximately 66 percent, went for financing cotton exports.6 Over the five years, 1974—78, Korea was the United State's first or second largest market for cotton. Of the 733 million dollars of cotton exports financed by the CCC, 635 million (87 percent) 7 went to Korea. During this five year period, 44 percent of all U.S. cotton exports to Korea were CCC financed.8 During the course of the OGSM study, it became clear that this single measure of performance could not be fully evaluated unless it was linked with an understanding of the other dimensions of performance and an appreciation of the structural and behavioral factors which determined that performance. Were there other returns to the Program other 7 than just the increase in commodity exports? What aspects of Program administration seemed to impact favorably or unfavorably on performance? What kind of institutional constraints was the Program forced to operate under? These and other issues needed to be addressed and ordered before it was possible to put the Program's additionality effect in its proper perspective. Consequently, the specific objectives of this study are as follows: 1. Describe the institutional environment in which the CCC Export Credit Sales Program operated. This study will describe the linkages between the specific measures of the Program's performance with its structure and conduct. 2. Develop a theoretical framework to evaluate the economic returns to the credit sales. Specific emphasis will be placed on credit sales of cotton to Korea but the general applicability of the analysis will be demonstrated. 3. Describe and measure the increase in U.S. exports to Korea that can be attributed to CCC export credits for cotton. Procedures The research procedures employed in this study can be described as follows: 1. Develop an institutional model of the Program's structure, conduct and performance. The model will employ the appropriate neoclassical, institutional and organizational theories. 2. Review the Federal laws and administrative regulations which governed the Program and its operations. Survey the Congressional testimony of Program administrators and other qualified witnesses over the last five years, and review the published and unpublished reports and studies on the Program and similar export promotion programs (i.e. the Eximbank). 3. Interview officials and administrators of the OGSM, the Foreign Agriculture Service (FAS), the Economic Research Service (ERS), the Treasury Department, the 8 Eximbank, the World Bank, the Congressional Budget Office, and the Central Bank for Cooperatives. 4. Review the literature relevant to the theoretical and applied aspects of the economic theory of export promotion programs and their influence on international trade. ‘ 5. Develop a model to describe the influence of export credit sales on the importing country's purchasing behavior. 6. Using an existing simulation model of the Korean economy, estimate the increase in all exports to Korea attributed to CCC financed cotton exports to Korea from 1971 thru 1975. Organization Chapter II of this study introduces the Structure, Conduct and Performance paradigm (SCP) and provides the rationale for applying the model to the Export Credit Sales Program. Following this is an analysis of the structural dimensions of the Program's institutional environment. Chapter III continues the SCP analysis with an overview of the three major aspects of the Program's conduct: 1) the administrative behavior of the Office of the General Sales Manager; and 2) uncertainty and its influence on administrative decision making. Chapter IV concludes the SCP model with a discussion of the theoretical and empirical basis for evaluating the many dimensions of the Program's performance. Several methodologies which have been used in the past to measure export additionality will be reviewed and critiqued. Chapter V presents a model to describe the impact that export credits have on the purchasing behavior of an 9 importing country. An alternative definition of eXport additionality is introduced and a methodology is developed and applied to the case of CCC financed cotton exports to Korea. A simulation model of the Korean economy is "shocked" in an appropriate manner to simulate the changes in economic activity wrought by an elimination of CCC cotton credits during the years 1971 thru 1975. Chapter VI summarizes the study, evaluates the possible role a similar program may have in the 1980's, and offers recommendations as to changes of Program structure and conduct which may lead to improved performance. CHAPTER I ENDNOTES lU.S., General Accounting Office, Stronger Emphasis on Market Development Needed in Agriculture's ExpOrt Credit Sales Program, lD—80-01 (October 26, 1979). 2 Ibid., pp. 3-4. 3U.S., Congress, Senate, Committee on Banking, Housing and Urban Affairs, Trends in Export Markets and . Competitiveness, Hearings befbre the Subcommittee on International Finance, 95th Cong., 2nd Session, 1978, p. 38. "William Tierney and Donald Mitchell, A Theoretical and Methodological Analysis of the Performance of the CCC's Export Credit Sales Program: A Case Study of Cotton Exports to Korea, Michigan State University, East Lansing, Michigan, May 1981. 5Walton Scott, Jr., President American Cotton Shippers Association, to George Shanklin, Assistant Sales Manager, U.S. Department of Agriculture, December 5, 1979, Federal Files, Washington, D.C. 6See Table I. 7U.S. Department of Agriculture, Office of the General Sales Manager, A Report on U.S. Exports for Four Marketing Years,1974-75 thru l977-78,’(November 1980): by R. L. Rudy, p. 107. 8U.S. Department of Agriculture, Foreign Agriculture Service U.S. Exports of Reported Agricultural Commodities "for 1974-74 thru 1978-79 Marketing Years, (19867, p. 191; and Office of the General Sales Manager, "Printout of Country-Commodity Table for Republic of Korea-Raw Cotton," (1980). pp. 49-53. 10 CHAPTER II THE STRUCTURE OF THE COMMODITY CREDIT CORPORATION'S EXPORT CREDIT SALES PROGRAM The Origin of the Structure, Conduct, and Performance Paradigm The Credit Sales Program has both eXplicit and implicit objectives. Furthermore, the Program is itself part of a larger strategy of the Department of Agriculture to achieve agricultural price stability and to promote equitable returns to agriculture. In the past, considerable confusion and debate has ensued when the Program's performance was evaluated. This was due, in part, to a lack of appreciation for the complexity of the institutional environment in which the Program operates. Our understanding of the Program would improve if we were to analyze it using the Structure- Conduct-Performance paradigm (SCP). Scherer, in his book Industrial Market Structure and Economic Performance, presents a hierarchial scheme of cause and effect relationships between the structure of a market (number of buyers and sellers, degree of vertical integration, etc.), the conduct of market participants (pricing behavior, advertising, etc.), and the performance of the market (productive and allocative efficiency, progress, etc.) (see Figure l).1 The SCP paradigm was first applied by investigators in the field of industrial organization but the model has found application in other areas of economic research. Specifically, J. D. Shaffer and A. A. Schmid have modified 11 12 .9 STRUCTURE lRE) {I CONDUCT )é-g L‘EERFORMANCE} Figure 1 An illustration of SCP Relations .L____- 13 Scherer's paradigm and used it in their studies of institutions and the consequences of institutional change. Their concern was with the relationships among the structure of the institution's environment, the conduct or behavior of members of society who are influenced by the institution, and the performance of these members which follows from this conduct. To paraphrase their paradigm, this study will use the following set of definitions: Structure. The predetermined characteristics of the institutional environment which constrain the choices and defines the opportunity set of society's members. Conduct. The choices, decisions, or strategies that society's members actually adopted given their constrained opportunity set. Performance. The consequences following the choices, decisions or strategies that were adopted. Performance is the matrix of all benefits and costs resulting from conduct.2 The interaction of these three parameters is held to be dynamic in nature and subject to probability distributions. Institutions can adapt or evolve over time due to changes in their structural determinants and in response to feedback with regard to their conduct and performance. The Need for an Institutional Analysis Previous studies of the Program measured the returns to the Program simply as the increase in exports of the commodity for which export credits were granted. Political 14 and military returns have been ignored. Returns to groups outside the United States are not measured. No mention has been made of the relative efficiency with which the Program achieves its objectives. Finally, Program costs have not been addressed. All of these areas need to be explored before the economic returns of the Program can be placed in their proper perspective. This chapter (and the following three chapters) will identify and briefly describe the key relationships which determine the Program's performance. Much of the content of these chapters should be regarded as preliminary research hypotheses. This study does not intend to test these hypotheses. It is useful to state them at this time and thereby provide a starting point for developing further research on these topics. The organization of tOpics which follows owes much to the Shaffer and Schmid rendition of the SCP paradigm. This study will follow their outline but will interject other paradigms where they are appropriate. Structure Values, Goals, and Objectives The first element of structure is the values, goals and objectives which presumably guide the Program's operations. Values, goals and objectives are related to one another in a hierarchial manner. To clarify terminology this study will employ the following set of definitions: A valgg is a meaning which we assign to our concepts of reality; specifically, a value concerns the sense of 15 'goodness' or 'badness' which we attach to a particular person, thing, or condition. A ggal is a condition, not yet established or obtained, which some individual or group is trying to obtain by taking appropriate action. An objective is an action deemed appropriate in attaining a goal. Objectives The current Program objectives are "to maintain and develop markets and to increase U.S. commercial sales of Agricultural commodities which are in need of export assistance."3 Consideration must also be given to whether the financing will: 1. permit U.S. exporters to meet foreign competition; 2. substitute commercial sales for PL 480 or other concessional programs; and 3. introduce a new use of the commodity to expand its consumption in the importing country. @212 The Program is itself part of a broader strategy that the USDA pursues in promoting exports. What this strategy is and how the Program fits in will be dealt with later. Suffice it to say that "one of the major goals of the Department of Agriculture has been to maintain or increase U.S. eXports of Agricultural commodities and so to continue 16 to improve farm income and to maintain the economic health of agriculturally dependent enterprises and communities ....Associated with this goal is the purpose of helping the development of poor countries...."u Values The values which provide the ethic behind the Program are believed to be the same as those which guide all agricultural policy. These values have often been aggregated under the rubric of 'rural fundamentalism.‘ Participants The second aspect of structure to be addressed is the identification of participants. Participants are those parties that either directly or indirectly effect or are effected by the Program. Domestic Farmers Since the Program's inception in 1956 until 1979, a total of 31 different commodities have been financed. However, three of these have collectively accounted for nearly 73 percent of all credits (wheat - 32%, corn - 22%, and cotton - 19%) while the top ten commodities have absorbed 97% of total Program credits.5 Production of these three major commodities can be characterized as being dispersed with individual producers having no market power. However, if organizations 17 representing these producers' interests have any influence at all on Program administrators, then they may be able to effect a transfer of income from the general public to the commodity producers. Those producers with the greatest stake in influencing the allocation of Program credits would be those that received the most in past periods (wheat, corn and cotton producers). Benefits, once granted and maintained over a period of time, are often perceived by the beneficiaries as an implicit property right. Producers of other commodities which have received no assistance or only small amounts of credit are probably unaware of the potential benefits which could be captured if they also were to coordinate their lobbying efforts. Foreign Farmers If the Program does not distort the relative prices of agricultural commodities, then no negative consequences for other commodity eXporting countries would be eXpected. However, foreign producers of commodities which receive credits may receive lower prices for their own exports. In addition, farmers of the importing countries (mostly LDC's) may also face depressed prices for their commodities that are either identical or close substitutes for the CCC financed imports. Such an effect has been documented by researchers evaluating some of the early PL 480 programs. To the extent that foreign producers are aware of their losses and to the degree that they can articulate their 18 dissatisfaction, they could petition their governments to intervene on their behalf and file a protest with the Program's administrators. Note the recent problems arising from the Sino-American trade agreement. The agreement included provisions for CCC credits. These credits, as well as other aspects of the arrangement, have provoked strong protests by both the Canadian and Australian governments. Domestic Consumers Although their interests are directly affected, it is unlikely that a unique consumer oriented voice is inter- jected into the Program's policy deliberations. Any program which subsidizes the export of commodities will decrease the supply available to domestic consumers and increase the prices they must pay. If the interests of consumers are represented at all, it is probably reflected in the lobbying efforts of those producers which use the exported commodities as intermediate goods. In the case of feed grains (wheat and corn) and oilseeds (soybeans) it is the livestock producers (beef, pork and poultry) who are in the best position to assess their losses (and indirectly, the losses that will be suffered by the consumer). Foreign Consumers Whereas domestic consumers may lose welfare, foreign consumers probably gain from the Program. In several cases investigated by the GAO, there is some question as to 19 whether or not cost savings are passed on to the final 7 consumer in the recipient countries. When the importing agency is subject to strict import and foreign exchange controls or is itself a government agency, then the opportunity exists for that government to siphon off benefits and use the revenue to support their domestic budget or to relieve a balance of payments deficit. If the credit savings is passed on to the end users, then the consumer, not the government, is the primary beneficiary of the Program. In those cases when the financed import is an intermediate input for a product with substantial export sales, then the beneficiaries may include consumers in other nations as well. In the case of cotton exports to Korea, over 60 percent of all cotton textile production is exported. Much of these exports is in the form of yarns and fabrics which are sold for further processing by firms in Hong Kong and Japan. So, if the cost savings are not interdicted by some Korean government authority, then those foreign consumers which benefit from the program may be a very large and heterogeneous group. Domestic Exporters The CCC purchases, for cash after delivery, U.S. exporter's accounts receivable arising from the export sale of eligible commodities to eligible countries. U.S. exporters can negotiate contracts with foreign buyer's contingent upon the availability of eXport credits.8 20 The decision as to commodity eligibility is determined by the USDA and announced monthly; however, the exporter can request that a line of credit be established for a particular country. While it is true that OGSM will respond to credit requests from foreign governments, foreign importers and from Agricultural Attaches; the GAO has found that many requests seemed to be initiated by domestic exporters. Exporters use the CCC credits as a sales incentive in their contract negotiations. In some cases, exporters have Closed deals based on cash or commercial financing and then have applied and been approved for CCC credits. In at least one case, exporters would have lost large contracts due to. cancellation if CCC credits had not been made available ex post.8‘5 At that time, nearly $143 million in cotton sales to Korea were financed after the fact, when adverse market conditions threatened to precipitate a wave of contract cancellations.9 The Program certainly has the potential to increase the exporters' total sales volume and possibly even increase their unit profit margins. If exporters had intimate knowledge of their competitors' prices and financing terms (if any), then it's possible that they could charge higher per unit prices for CCC financed contracts. In other words, the present value of a CCC financed contract, even at higher unit prices, might still be less than paying cash at competitive per unit prices. Sales volume would still be 21 larger than under cash terms (assuming a downward sloping demand curve in relation to cash and/or present value prices) and per unit profits would be greater. The exporter escapes all future financing costs by being able to sell his accounts receivable to the OGSM at the higher per unit prices and, thereby, may be able to extract some of the Program's benefits. Foreign Importers Whether importing for their own use or acting as a wholesaler, foreign importers obtain significant benefits from the Program. As previously noted, it is possible for an importer to make requests directly to the OGSM. Apparently, this is not usually done. Perhaps this is due to insufficient information, high transactions cost, past negative responses on the part of the OGSM or beCause they prefer to delegate the initiative to the exporter who then will act on their behalf. Even if the importer is a relatively passive party in the process of obtaining credit, they still stand to gain. Importers will finance imports as long as the net present value of financing costs is less than the present value of costs if cash were paid. Domestic Banks Domestic banks either issue bank obligations themselves or must confirm and advise on obligations issued by foreign banks. If the obligation is issued by a foreign bank, then 22 the advising U.S. bank must confirm at least 10 percent pro rate of the obligation. The bank obligations are in the form of irrevocable letters of credit. They are legally binding documents which certify the credit worthiness of the importers and serve as guarantees of payment should the importer default. In the event of default, the CCC will hold the issuing bank liable for payment without regard to risks. If the domestic bank advises on a foreign bank's letter, then their liability is reduced to 10 percent and is subject to commercial but not noncommercial risks (inability of a foreign bank to pay due to war, hostilities, etc.).10 When OGSM employees were questioned regarding the attitude of domestic banks toward the Program, they indicated that a protest was lodged only once. In most cases, they stated, domestic banks felt the Program was good for business and did not perceive it to be a competitor which displaces them.ll Foreign Banks Foreign banks may issue bank obligations but these must be confirmed by a U.S. bank or its overseas branch. Importers have an incentive to arrange for letters of credit with U.S. banks since a higher interest rate is charged on those loans guarantees by foreign banks. Usually the rate charged when foreign bank obligations are presented is one percentage point higher than the rate charged when a U.S. bank confirms the loan.12 23 The United States Government The Program has both domestic and international economic and political effects. The domestic economic effects on the farmer and consumer have already been mentioned. The international economic effect on foreign producers and consumers has also been discussed. The international political effect, however, does need further development. Considerable criticism has been leveled at the Program by GAO investigators who claimed that credits were granted for reasons other than market development. Most recently, the decision to grant credits to Korea, Poland, and China have been the subject of formal bilateral government-to-government negotiations (something the CCC has consistently tried to avoid).13 The problem with such negotiations is that broad foreign policy and defense considerations begin to influence the allocation of credits. Foreign Governments Direct government involvement in the Program is unavoidable in countries with either state trading or with strict import and exchange controls. In those cases where direct governmental negotiations are undertaken, the impact of governmental influence is even greater. Some of the benefits accrued by foreign governments have already been noted. The following is meant to augment the list: (1) participation in the Program results from a desire for closer ties with the U.S. (CCC credits is only part of a 24 package defining the relationship between the two governments); (2) government officials are looking for an additional source of revenue to support their budget or to relieve pressure on their balance of payments; (3) a desire to capture significant savings for domestic consumers (particularly if an important part of domestic policy is subsidized, low-cost food); and (4) use the credits as a lever in negotiating with other power blocks or other commodity eXporters. Of course, the Program has an indirect impact on the governments of those countries that are not receiving credits. The governments of those other exporting countries whose agricultural trade is being adversely effected may lodge a formal protest or initiate credit programs of their own to match the CCC Program. Other Participants Every commodity grown in the United States is a real or potential export. The Program's budget is fixed and disbursed each year to various commodities and countries as determined by CCC policy makers. Every dollar of credit committed to a commodity or country is one dollar less for all other commodities or countries. This is a crucial fact that must be kept in mind when determining the true 'cost' of the Program. In a very restricted sense, the cost of the Program is not the dollars which are disbursed but rather the return that is lost from not financing alternative 25 commodities or countries. In a broader sense it is the return which is foregone from not using the money to finance any other government loan program—-for instance, the Small Business or Federal Housing loan programs. Policy Makers The third dimension of structure is the identification of Program policy makers. Policy makers are those groups within the United States government who either legislate, monitor, advise or administer the Program. The Program Operates under two legislative mandates (the Commodity Credit Corporation Charter Act and the Food for Peace Act of l966).lu Its policies and regulations are outlined in two documents ("Financial Arrangements Required by CCC Under its Export Credit Sales Program," and "Regulations Covering Export Financing of Sales of Agricultural Commodities Under the Commodity Credit Corporation Export Credit Sales Program, GSM-S"). These regulations give the authority to designate eligible commodities to the President of the CCC (who is the Assistant Secretary for International Affairs and Commodity Programs) and a Vice-President of the CCC (who is the General Sales Manager). Other departments within the USDA advise them in this process. Determining country eligibility and the amounts of Specific country lines of credit is the responsibility of the CCC with the assistance of the Office of the General Sales Manager (OGSM). 26 Figure 2 is an organizational flow chart that sketches the chain of command and the relationships (vertical and horizontal) that exists among the various groups which influence the Program. The upper half of the chart illustrates the legislative mandates of the Program and the annual budgetary process. The bottom half depicts the nuts-and-bolts interactions between the groups when determining commodity and country eligibility. Jurisdictional Boundaries The fourth dimension of structure is the delineation of jurisdictional boundaries. Conflicts between the various policy making groups may arise either from the Program's external effects or because of potential economies of scale in administering the Program. External Effects "An external effect is a consequence of an act which currently is negligibly relevant to the...organization making the decision, given the existing jurisdictional boundaries."15 Although the Program's objectives are primarily economic, its potential effects have inspired other agencies within the government to try to bend the Program to suit their purposes. The OGSM and other Agriculture officials have resisted the intrusion of secondary economic and political objectives in the Program's policy making. While there are no statutory prohibitions 27 Emwwoum moamm uwumwo coo mfiu mo uwmso 3ofim HmGOHumNHcmwwo 095335 N GHDth caucus: no 30.33: I I I I I I .v E 333 new .093: 2332:; u . 33:9.— aqua: vi €323: Econ-535 :0 05.0 .Co: >. E... uuz luau-H.332— l-unoum 3 nuns-.35 95>... 2.30.5 U 333.500 33>»: 930.: 3.0qu 3238 yuan—Gum 1:03.: .I. .l I .I I I fluwumlgwuumw.‘ _ laud... .232...- v... Ago... . . ”Baku-9:. inguinal: 3 _ Aha—500 nozaqwlniuum . rlllllllllql III. Azmuov nouqnuz coanm 1.550 05 no .3qu 25333533 55.:— 1 u n u 7 74.. u I I J noun-3335 . ANTS—BI 30.5255 .33 I14 3223:: €238 . " ¢ had—.10 uni-non _ ---:4.---- .I I | ADJ—Incl...“ 9.5!. V _ lb: 933:?» uuu. _ . no 93300 non-«u. ...: if we 1:5. 5:. ptn-“ov “03.218... fl won 9.5.1: 936“ I. u . 7 no can 35!. onixmc unmanned-30 .. ...I-nuoum qunm uuvouu uuo annex—.032 «a 31.9. no 9.3551— 13 :3 have: 80 3 10.5.... noun-53:3 _ 1.35 5.25 «o 85.. .Tlllllbuaao Amngnxunn any guano o>uusuoum Auv Icon-name» dung no 2.309 A: :a 3:423.— 0-05 :3». 03:3. accessed :1 . o l A5623” tau.— >339. .Ihuugou no :12 101 can. 5.2a: 3V- -. 28 against such intrusions, the Program lacks any mandate gpher than to undertake market development and maintenance activities. What is at issue is not just a matter of bureaucratic territoriality. Should secondary considerations dominate the allocation of credits then the Program may become subject to the provisions of the Cargo Preference Act. A 1965 Justice Department opinion implied that "if the terms of sale are utilized...for the purpose of aiding or assisting a foreign nation or its economy the...Act would The Act requires that at least 50 percent of the financed commodities must be shipped in U.S. bottoms. Such a large increase in shipping costs (and therefore in total acquisition costs to the buyer) may wipe out any competitive advantage afforded by the financing. One other aspect of the Program is vulnerable to provisions of the Act. The Program's administrators must maintain the interest rate that they charge above the cost of money to the CCC. Great care must be taken to avoid the suggestion that the rates and terms are concessional and not 'commercial.' Besides the Justice Department, the International Monetary Fund (IMF), while not directly impinging upon the Program's jurisdiction, has nevertheless placed limits on its freedom of action. In 1978, the OGSM extended a $50 million line of credit to the Phillipines on repayment terms that were only 5 days short of a year (360 days). These odd terms were imposed in order to avoid violating a recent IMF 29 restriction on the Phillipines incurring any new 1 to 5 year debts.l7 Agencies and departments outside of Agriculture have had some success in influencing credit allocations on at least two occasions (Korea in 1978 and Poland in 1978).18 On these occasions, the OGSM lost much of its independence when CCC credits were made part of formal bilateral negotiations between the governments of these recipient countries and the U.S. Recently, CCC credits were made part of the recent four year Sino-American grains agreement. While the market development potential represented by such an agreement is clearly evident, some observers claim that the agreement (and any CCC credits that may be part of it) was intended to defuse domestic criticism arising from the earlier imposition of a Russian grain embargo. Others have argued that the agreement (and possibly the credits) were unnecessary and merely served to formalize a trend on the part of the Chinese to import more U.S. grains.19 Economies of Scale Other conflicts arising from the Program's jurisdictional boundaries concerns the possibility of attaining economies of scale in administering the Program. Certain agencies which 'cooperate' with the OGSM have research staffs or expertise that could facilitate the allocation of credits. Significant economies of scale are 30 possible if greater coordination between complementary agencies could be achieved. The General Sales Manager, the Foreign Agricultural Service (FAS), the Economics Statistics and Cooperative Service (now the ERS) and the Treasury have all agreed that the Program needs greater strategic planning. However, such planning efforts requires a staff which is far in excess of that which is available within the OGSM. In its report, the GAO made a strong recommendation that the OGSM work with the FAS and ERS in order that the OGSM could take advantage of the specialized research capabilities of these agencies.20 Recently, the OGSM has been made a part of the FAS and while cooperation between these two has been close in the past, it must now be closer still.21 It is unlikely, however, that the degree of cooperation envisioned by the GAO for the FAS-OGSM and ERS will ever be achieved. A 1977 GAO study attributed the lack of c00peration between the FAS and the ERS to philosophical and technical differences.22 PhiloSOphical barriers seemed to arise from differences in the two agencies research orientations. The FAS emphasizing the collection and analysis of current data while the ERS studies structural relationships and concentrated on getting the 'big picture.' Technical problems grew out of the FAS's responsibility to provide agribusiness with timely export forecasts. For this, they require immediate and direct market intelligence and an understanding of and good rapport with the agricultural 31 sector. The ERS, on the other hand, is reputed to have a more 'academic' orientation; is believed to be operating under less of a time constraint than the FAS; and is said to disparage the FAS's analytical capabilities.23 Preference Articulation The fifth aspect of structure to be addressed is the process by which preferences are articulated and communicated to Program policy makers. It must be kept in mind that the Program provides a service and that it is trying to maximize the welfare of its clients. How does the Program find out what its clients want when the service is neither bid for nor sold at market clearing prices? The OGSM believes they should respond to actual requests as they develop.2u This policy serves two purposes. First, it permits greater flexibility in responding to changes in market conditions. And second, it is a major preference articulation mechanism whereby the preferences of a select group of clients (voter—consumers) is transmitted to Program policy makers.25 The GAO, which strongly recommends the development of master market plans, seems to be advancing a philosophy that client preferences should be discovered analytically and that it is inappropriate to simply react passively to requests.26 However, if the purpose of the Program is to expand and maintain markets, who would have better or more timely information than the exporters who make their living 32 from reading and reacting to market developments? Furthermore, if it's the commodity exporters (and the producers) who are meant to benefit from the Program, then what better way to assure that they receiVe those benefits than to allocate credits in response to Eheir requests? The alternative is to allocate credits according to some predetermined distribution rule. The Program's effects on domestic consumers has already been described. There is no known formal mechanism for determining the domestic price (inflation) consequences of the Program. The creation of a consumer's affairs department within the USDA by the Carter administration was a step in the direction towards giving consumers a voice in all departmental policy making. What relations, if any, this office had with the OGSM is not known.27 The Program's Information and Feedback Systems The sixth dimension is that set of linkages which collects data needed for Program analysis. The feedback system is those mechanisms instituted to monitor Program performance. Occasionally, the official feedback system existing within the OGSM is augmented by evaluations that are unsolicited by the OGSM. The Information System Essentially, the data collected concerns three subjects. They are: (1) how much credit can be extended; 33 (2) what commodities are eligible; and (3) what countries are eligible. A secondary set of data is used to answer the question as to how much credit should be allocated to each commodity, to each country and/or to what countries for what commodities. Data used in determining commodity eligibility comes primarily from within the USDA. Eligible commodities are those deemed to be available in sufficient quantity for export and/or in need of export assistance. It is now known exactly what criteria are used when classifying commodities, however, carry-over stocks seem to be a significant factor (see Figure 3).28 A review draft of a USDA study, done in 1977, listed several criteria that they believed should be 29 The criteria are: used to determine eligible commodities. l. Commodities that are in ample supply as indicated by growing stocks. 1 2. Commodities not in serious surplus but for which someone in the U.S. is trying to create a foreign market (i.e., breeding stock or soy protein concentrates). 3. Commodities for which prior commitments have been made even though the original surplus condition has ceased. 4. Commodities for which traditional U.S. or foreign sources of credit will not finance (i.e. live cattle). 5. Commodities facing competition in foreign markets in which the Program's credits have an advantage over alternative credit sources. 34 uuwvouu 000 no auaHHo—v gdddfll 8H acuuou we con!— mcwcgu 33393 n Tug. 132—hon uo 30:25 @8255 ma 7: U i!!! :2: no 3225 8:3. 2: 3 800 no sauna-5 .833"! on no. ; - aquouo new 1 - 389: 1 ] as. an. i “A. 6“. «A. «A. «A. ~s. a“. as. as. , on. R. 2. mm. 3.. 2. as. as. cs. 3. 3. w a 3 u j w a 3 u w a 3 o J... 1.. a. E 1 1L [L IR IL F 1. r r: 8.03m 1.95 39 wGHUCmGHm 000 new mowuwpofiaoo L pouooamm mo mxooum po>07>pumu Hmacc< [IL IL m muawwm I. L. 35 The origin of data used in determining country eligibility is not known. This is the weakest link in the Program's information system and it is one for which the GAO took the OGSM to task. The GAO inferred that the OGSM did not know if the credits were needed or that the OGSM permitted credits to be issued for secondary economic and political objectives.3O They attributed this situation to several factors, one of which was what they perceived to be an inadequate information system. Some of the recommendations the GAO made, such as closer cooperation between the FAS-OGSM and the ERS and the use of market plans, have already been discussed. Other recommendations were: (1) collect better information from Agricultural Attaches on a systematic basis; and (2) collect information on competitor's credit terms. A Returning to the 1977 USDA study, it was found that they listed criteria for determining both country eligibility and need for financing.31 The criteria they recommend be applied in surveying a country's market development potential are: 1. Increased demand for eligible commodities supported by growth in the country's internal and external purchasing purchasing power and by suitable consumer and import policies. 2. Slow growth in domestic production of the targeted commodity even with domestic price incentives. 36 Sufficient capabilities for domestic processing and distribution of the targeted commodity. The existence of a U.S. comparative advantage (one in which only the additional weight of CCC credit is needed to make the U.S. a clearly superior source of supply). The existence of competition from other suppliers who offer preferential price or credit terms that could be offset by CCC credit. The criteria, suggested by the study, for determining a country's need for financing are: l. 2. Low per capital incomes. The country's external financial situation as determined by its credit branch with the IMF, drawings under special IMF credit facilities, its import coverage ratio, and recent changes or lack of change in its exchange rate. Ability to repay (the trend of its exports in the next few years). The country's debt service ratio. Political stability and government economic policies. The Feedback System The Program's feedback system includes both formal and informal components. The formal components are those arrangements made by the OGSM to check its own compliance with the regulations and to evaluate its performance with 37 respect to the Program's objectives. Overall, the GAO found that existing administrative procedures seemed sufficient to monitor the technical performance of the OGSM (in-house checks on compliance with regulations).32 However, when it came to self-assessment of the Program's effectiveness as an export promotion tool, the GAO found the OGSM performance 33 inadequate. The 1977 USDA study, mentioned earlier, found that the Program's ability to generate additional exports or to achieve other objectives had never been evaluated. This oversight was attributed to conceptual, methodological and data problems as well as "limited demand...from policy officials."3u The informal components of the Program's feedback system are those reports and evaluations which originate outside the OGSM. These include: (1) reports by the GAO; (2) hearings before Congressional bodies; (3) task force studies either within the USDA or multi-departmental; and (A) formal presentations made by exporters or by their organizations. The relative importance that the OGSM gives to these informal feedback mechanisms is hard to measure. It should be noted, however, that this research itself springs largely out of a desire of the OGSM to answer questions which were raised in the most recent GAO report. The CCC Program in the Context of Overall Agricultural Export Policy The seventh dimension of structure to be described is the relationship of the Export Credit Sales Program 38 vis—a-vis the other export programs which together comprise the total package of export policy mechanisms. The Program is only one of six major components making up the USDA's current export strategy.35 The other fiVe components are as follows: 1. Trade Negotiations carried on at both bilateral and multilateral levels. Bilateral agreements are generally used to capture a specific market for U.S. commodities. Multilateral agreements have the broader objective of attaining an improved trade climate. Foreign Market Intelligence includes all the activities within USDA that provide foreign market information to decision makers in both the government and private sectors. Market Development encompasses a wide variety of activities ranging from general trade servicing to point of sale promotion. Many of these programs are cooperative and they enable U.S. producers and interested domestic and foreign businessmen to work with the USDA in jointly developing foreign markets. Public Law N800, when enacted in 1954, was designed primarily to reduce domestic surpluses and to eXpand export markets. Beginning in 1966 and continuing into following years, the program has been amended to include humanitarian considerations, long-term agricultural and economic development in recipient countries, and the use of food aid as an instrument 39 of foreign policy. PL U80 shipments include grants and concessional sales and at one time, barter agree- ments (suspended in 1973). 5. Intermediate Credit and Non-Commercial Risk Assurance are two programs which directly complement the CCC Export Credit Sales Program. These three, as well as PL 480, all come under the purview of the CCC. The Intermediate Credit Program (enacted in 1978) authorizes the extension of credits for 3 to 10 years to finance: (1) the establishment of foreign commodity reserves; (2) the export of breeding animals; (3) the building of market infrastructure in importing 36 The countries; and (4) to meet credit competition. Non-Commercial Risk Assurance Program is an insurance program whereby the government underwrites commercial loans for the export of commodities against the risk of default due to the imposition of currency inconvertibility, government decree, war, etc.37 A program similar to the Non-Commercial Risk Assurance Program was proposed in June 1980. This program protects U.S. banks from defaults of private foreign banks against both non-commercial and commercial risks. "The new program was developed as an improvement over the [other] Program which tended to encourage participation by foreign-owned banks. By providing for commercial risks coverage, more private foreign banks will be able to participate in the 40 proposed program thus allowing a wider range of foreign buyers to participate in the program "38 Complementarity Among Programs There is a definite complementarity between the Export Credit Sales Program and the PL #80, Intermediate Credit and Non-Commercial Risk Assurance programs. Markets are developed first with one program, strengthened with another, then placed on a cash basis (or commercial financing) with other programs. Immediately following World War II and reaching a peak in l9u8-49, nearly 60 percent of all U.S. agricultural exports were financed under a variety of aid programs. By 1953, agricultural production in Japan and most European countries had recovered. However, import demand in these countries and in the merging LDC's remained high but was curtailed by a shortage of foreign exchange. PL #80, as originally enacted, permitted continued food aid but reduced the grant aspect and authorized recipient countries to pay for a portion of their food imports with their own nonconvertible currencies. With the continued growth of their economies and the restoration of convertibility, these countries were gradually weaned from PL 1480.39 However, many still suffered from severe balance of payments problems or else evidenced weak commercial demand for agricultural imports. The Export Credit Sales Program was conceived as a transitional device which would help re-establish Japan and 41 Western Europe as prime commercial markets.“0 Since then, the Program is applied most often to those countries which are commercial markets both which have balance of payments difficulties or when there is aggressive (but containable) competition from other suppliers. PL 480 is reserved for countries with more severe payment problems and serious food shortages. The complementary nature of these programs is exemplified in the history of U.S. cotton exports to Korea (see Table II). Mutual Security funds were the primary source of financing from 1950 to 1960; PL U80 from 1960 to 1970; and CCC credits from 1970 to the present. It's too early to tell how the Intermediate Credit Program will be used in relation to the Export Credit Sales Program. However, we do have some indication of how the OGSM would like to use the Non-Commercial Risk Assurance Program. On at least two occasions, in which the OGSM participated in formal bilateral negotiations, the Risk Assurance Program was offered along with CCC credits as a package deal. In both cases, the CCC credits were less than what the countries originally requested and the risk assurances were offered as the next best substitute for credits.”l These programs are not the only source of grants, credits or risk assurances for agricultural exports. The Export-Import bank, and independent agency of the government (established in 1934), also extends credits. Since 1963, the bank has also provided loan guarantees to private banks 42 TABLE II U.S. EXPORTS OF COTTON TO THE REPUBLIC OF KOREA (COMMERCIAL AND UNDER VARIOUS GOVERNMENT PROGRAMS) (1,000 Running Bales) Fiscal Mutual PL Year Security 480 CCC Commercial 54/55 168 - - 6 55/56 61 56 - - 56/57 200 ( ) - - 57/58 202 3 — - 58/59 216 - - 9 59/60 198 70 - 1 60/61 104 86 - - 61/62 1 234 - 15 62/63 - 267 - 14 63/64 - 229 10 16 64/65 - 243 ( ) 31 65/66 - 235 3 28 66/67 — 260 28 22 67/68 - 290 48 2 68/69 - 368 89 4 69/70 - 244 188 - 70/71 - 163 230 - 71/72 - 82 246 62 72/73 - 175 293 54 73/74 - 7 270 464 74/75 - - 200 341 75/76 - 55 808 216 76/77 — 28 217 439 77/78 - - 684 581 SOURCE: U.S., Department of Agriculture, Foreign Agricultural Service, The Market for U.S. Cotton in the Republic of KOrea, by R. 1 Less than 500 bales. . vans, , p. 5. 43 against commercial and non-commercial risk. While Ex—Im loans primarily finance capital goods, over $1.4 billion of loans and guarantees were made for agricultural exports from 1955-1973.”2 Nearly 88 percent of these loans went for cotton exports. The Credit Sales Program's Impact in Other Policy Areas The Program has an impact on the government's international financial policy and its importance was recognized by the Treasury Department in a letter addressed to the GAO in August, 1979. A similar letter from the State Department also acknowledged the economic and political contributions that the Program has made to the pursuit of foreign policy objectives.“3 Although the Program incurs no cost over the life span of its loans, the burden on the domestic budget can be substantial in any one year. New loans made for more than a year contribute to outlays and do not generate revenue until later years.uu Of course, the Program fits into our overall trade policy and in that regard it has implications for our balance of payments, domestic unemployment and inflation. Market Structure The eighth and final dimension of institutional structure concerns the structure of commodity markets. Mention has been made of market structure in earlier portions of this paper but this study has not yet discussed 44 the full implications which market structure has for the Credit Sales Program. The subject is divided into three parts: (1) the structure of international commodity markets in general; (2) the structure of domestic commodity markets; and (3) the structure of commodity markets in specific foreign countries. The Structure of International Commodity Markets Many of the world's commodity markets are dominated by “5 The either a few large sellers or by a few large buyers. nature and degree of concentration in commodity markets has important consequences for the Credit Sales Program. One of the objectives of the Program is to help U.S. agriculture meet foreign competition, specifically credit competition. It is feared that if export credits are used improperly, the Program could actually stimulate international credit competition. In oligopolistic markets, competition, in any form, often inspires retaliation. Competing suppliers are usually sensitive to the marketing tactics of others.”6 If one of the suppliers initiates an aggressive marketing strategy, it is likely that the others will follow suit. Thus, any temporary gain in trade for the first supplier would later be lost.Ll7 In addition, each supplier would not be saddled with higher marketing costs]48 When the Intermediate Credit program was authorized in 1978, the law specifically warned 45 that "Intermediate credit financing...may not be used to encourage (international) credit competition."49 The problem is that the OGSM, in general, doesn't know what the credit terms offered by its competitors are. In 1978, the CCC authorized credits for 25 countries. Foreign credit information was available for only 8 of these countries. Of these, only 5 had data on interest rates and 51 repayment terms. The History of Credit Subsidy Agreements GATT does not presently deal with export subsidization through low interest, government provided credits. However, there have been gentlemen's agreements in the field. In 1934, the Berne Union was established to work "for the rational development of credit insurance in the. international field."52 In 1953, members of this group reached a set of understandings governing terms of trade loans. In 1960, the EEC proposed similar guidelines for its members. Among other principles, the 1953 Berne agreement introduced the rule of credit parity. Referred to as the 'matching principle,‘ it proposes that if any member offers more liberal terms than the rest of the other members may follow suit.53 This rule, while it may be politically expedient and needed to prevent an international credit race, is nevertheless theoretically unsound. Robert Baldwin notes that "The rule discriminates against capital abundant countries——like the United 46 States--that generally have lower domestic interest rates than capital-scarce countries..."54 Although capital funds are extremely fungible across international borders, interest differentials are not totally eliminated. Requiring the harmonization of interest rates for export credits would be the equivalent of "permitting countries to vary their export subsidies according to the degree that their wage rates exceed the [global] average."55 In 1963, the OECD established a permanent Trade Committee Group on Export Credit and Credit Guarantees. This agency serves as an information clearing house which reports on each country's handling of export credit and 56 terms they offer. The OECD Group also provides a forum for international negotiations to regulate various aspects of members' credit programs. The most recent agreement concluded under the auspices of the OECD Group occurred in February 1978. The International Arrangement on Officially Supported Export Credits established needed definitions and detailed provisions for notifying members of unilateral derogations from the new Arrangement. The Arrangement is a slight advance, at best, over the previous Consensus on Export Credits (itself a very weak agreement).57 With regard to these agreements' impact on the CCC Program, they do not apply to agricultural commodities, as well as to aircraft and nuclear plants.58 47 The Structure of Domestic Commodity Markets At the producer level the market structure for most eligible commodities is demonstrably competitive. However, as the commodities move from the farm gate to the docks the market structure of handlers and exporters becomes increasingly concentrated.59 The question which should be raised is whether and to what extent such concentration effects the Export Credit Sales Program? An answer to this question could only be made if the following areas were investigated: 1. What benefits has the OGSM earmarked for exporters and what benefits were meant to be distributed to producers? 2. How much of a price effect is transmitted down to the farm level from CCC financed exports and how long does it take? 3. What is the ownership of commodity stocks exported under the CCC Program (exporters', COOperatives' or stocks sold on commission for other parties)? 4. Is there a consistent pattern of CCC financing being managed by the same exporters year after year? 5. Are there systematic differences in the terms of contracts negotiated with and without CCC financing and how do the terms of CCC financed exports compare with eXports financed under other government programs (i.e. CCC cotton vs. Ex-Im cotton)? 48 6. Are there significant variations in the export marketing margins for those commodities whose exporting industries is less concentrated (i.e. exporters of breeding livestock and high protein concentrates vs. grain exporters)? The Structure of Foreign Commodity Markets The 1977 Agriculture study reported that less than 5 percent of all CCC credits are extended to private importing firms (the OGSM disputes this figure).60 The rest of the credits went to government agencies or importers that were subject to strict import and foreign exchange regulations. The OGSM agrees that substantial credits are allocated to government importing agencies or to importers under government control. The critical target in the OGSM's marketing strategy is the foreign purchasing agent. Whether the agent is government controlled or private, the OGSM extends financing in the hope of influencing that agent to purchase United States commodities instead of our competitor's.61 The GAO contested the wisdom of this strategy on the following grounds: 1. The market development effect of the credits would be greater if the benefits were passed down to the ultimate end-user. 49 2. If the credits were not passed on but 'siphoned off' to support the government's budget, the Program would then become subject to the Cargo Preference Act. Market Development in Countries with Government Importing Agencies Figure 4 provides a basis which can be used to analyze the GAO's objection. As illustrated, it is proposed that the effect of the credits in the short run would be both a shift in the demand curve from d to d' and a shift in the supply curve from S to Ssub’ Imports would increase from Q1 to Q3 if all financing benefits were passed on the end-user. Consumer surplus would increase by the area of lightly shaded region (ACEHDB). If only the benefit of increased credit availability were passed to the end-user (but not the subsidized interest rate) then imports would increase to only Q2 and consumer surplus by the area ABDC. Sales revenue to the exporter would decrease by the area Q2Q3HG. Given this set of demand and supply curves there, there would be a net loss of sales revenue and unless demand was perfectly inelastic there would always be an unequivocal loss in sales (by quantity). The area EHDC would be the reduction in consumer surplus. Of this loss, the area EGDC would be 'siphoned off' by the government. The remainder, the area GHD, is the familiar 'trade loss triangle' associated with import barriers. 50 P S w Pal) Sad) Figure 4 Graphical Analysis of Limited Market Development with Government Importing Agencies. 51 This analysis seems to support the GAO's objections. It appears that market development seems to be hampered when the full benefits of CCC financing are not passed on to the end-user. The Cargo Preference Act and Countries with Government Importing Agencies As is often the case in legal matters, every law, judgement, or opinion is subject to conflicting interpretations. The GAO reported that "the intrusion of economic support or political considerations into the CCC program decision process may jeopardize the program's exemption from the Cargo Preference Act."62 The State Department challenged this statement, declaring that the 'commercial' nature of the credits distinguishes the Program 63 This debate focused on an from concessional assistance. obscure opinion rendered by the Attorney General over 15 years before. For some reason, neither the OGSM, the GAO, nor the State Department sought further clarification from the Justice Department. Evidently, this issue cannot be resolved unless such clarification is obtained. 52 Conclusion The structure of the Program defines the environment in which the Program must operate. Performance can only be as good as is possible given the Program's structural constraints. It has been shown that the Program has both explicit and implicit goals, and that the operational objectives guiding the Program's administration are only tenuously linked to these goals. Perhaps the most important structural feature responsible for this weak link is the process by which, and for whom credit allocations are made. Given the examples of influence exercised by the State Department and the National Security Council, it seems that while these bodies have the power to effect the allocation process, they do not have to contribute to the Program's budget, nor must they bear responsibility for its shortcomings. Political and economic returns other than the increase in agricultural exports are captured by the Program. However, the enabling legislation makes no mention of these returns when defining the Program's mission. Consequently, the Program is shortchanged when evaluated solely on the basis of export promotion and market development. Justification for the Program's existence relies most heavily on the argument that the US would be at a 53 disadvantage if it abandoned such export incentives. While there seems to be some support for this line of reasoning, there is no guarantee that escalating retaliation by competitors would not eliminate all benefits. A framework for eliminating subsidized export credits for industrial goods is already in place. A serious effort should be made to duplicate this framework in the area of agricultural export credits. Multilateral movement away from highly subsidized credits would help move trade flows towards the ideal determined by comparative advantage. This would have the added benefit of reducing the participating countries' budget outlays and removing one more source of trade tension. CHAPTER II ENDNOTES lF.M. Scherer, Industrial Market Structure and Economic Performance, (Chicago: Rand McNally, 1970), pp. 1-7. 2James D. Shaffer and A. Allan Schmid, "Community Economics. A Framework for Analysis of Community Economic Problems," paper distributed in the course AEC 809 at Michigan State University, East Lansing, Michigan, September-December 1980 (Mimeographed), p. 6. 3Office of the General Sales Manager, Quarterly Report, April to June 1979, p. 9. ”U.S., Department of Agriculture, "CCC Credit and Market Development: Their Role in a USDA Export Strategy," interdepartmental review draft (July 1977), by O.P. Blaich et. al., p. 1. 5General Accounting Office, Emphasis on Market Development in Export Credit Program, pp. 3-4. 6See Lawrence Witt and Carl Eicher, The Effects of United States Agricultural Surplus Disposal Programs on Recipient Countries, Research Bulletin No. 27(East Lansing: Aggficultural Experiment Station, Michigan State University, 19 . 7General Accounting Office, Emphasis on Market DevelOpment in Export Credit Program, pp. 38-41. 8U.S. Department of Agriculture, Office of the General Sales Manager, Regulations Covering Export Financing of ' sales of Agricultural Commodities Under the Commodity Credit ggpporation (CCC) Export Credit Sales Program, GSM-SITMarch 7). 8'5General Accounting Office, Emphasis on Market Development in Export Credit Program, pp. 64-66. 9General Accounting Office, Emphasis on Market Development in Export Credit Program, p. 29. 10Office of the General Sales Manager, Regulations Covering Export Credit Sales Program, pp. 1-14. llFrom telephone conversations with OGSM personnel. 12General Accounting Office, Emphasis on Market Development in Export Credit Program, p. 11. 13 1”Ibid., p. 1. Ibid., p. 37. 54 55 15James D. Shaffer and A. Allen Schmid, "Community Economics," p. 9. 16General Accounting Office, Emphasis on Market DeveIOpment in Export Credit Program, p. 11. l7Ibid., pp. 40-41. 18Ibid., pp. 41-44. 19See "Chinese Grain Deal Isn't a Big Hit," Farm Journal, December 1980, p. 27; Dean Clark, "China Grain Deal?: USDA, Get Lost!," Grain and Feed Journals, 15 December 1980, pp. 22-23; "Four Year Grains Agreement with China...," Washington Farm letter, 24 October 1980, p. l; and R. Fraedrich, "Big China Deal Won't Make Farmers Rich," Farm Futures, December 1980, p. 42. 20General Accounting Office, Emphasis on Market Development in Export Credit Program, p. 18. 21The OGSM merged with the FAS and was reorganized as of 27 November 1979. 22U.S. General Accounting Office, Issues Surrounding the Management of Agricultural Exports, vol. 1, ID-76-87 (May 2, 1977), pp. 79l82. 23Ibid. 2”U.S. Department of Agriculture, Office of the General Sales Manager, "Statement of Action on GAO Final Report ID-80-01," interdepartmental correspondence (17 January 1980), pp. 1-2. 25For a theoretical discussion of preference articulation and organizational theory see Albert 0. Hirschman, Exit, Voice, and Loyalty. Responses to Decline in Firms, Organizations, and States (Cambridge: Harvard University Press, 19707T7 26General Accounting Office, Emphasis on Market Development in Export Credit Program, p. 14. 27Carol Foreman, in charge of this department during the Carter Administration, was a member of the CCC Board. 28An employee of the OGSM indicated that commodity eligibility is based on carry-over stocks. From a telephone conversation 19 December 1979. 29Department of Agriculture, "CCC Credit and Market Development," p. 48. 56 30General Accounting Office, Emphasis on Market Development in Export Credit Program, pp. 10, 29, and 41-44. 31Department of Agriculture, "CCC Credit and Market Development," pp. 15-19. 32General Accounting Office, EmphaSis on Market Development in Export Credit Program, p.v. 33Ibid., p. 25. 3“Department of Agriculture, "CCC Credit and Market Development," p. 56. 35Ibid., p. 3. 36General Accounting Office, Emphasis on Market Development in Export Credit Program, p. 44. 37Office of the General Sales Manager, Regulations of the Export Credit Sales Program, p. 38U.S. Department of Agriculture, Foreign Agricultural Service, Notice of Proposed Export Credit Guarantee Program (GSM-102) (9 June 1980), p. 3. 39U.S. Department of Agriculture, Economic Research Service, PL 480 Concessional Sales -- History, Procedures, Negotiating and Implementing Agreements, by Amelia Vellianitis-Fidas and Eileen Marsar Manfredi, FCrei n Agricultural Economic Report No. 142 (December 1977?, pp. 2-3. 240Department of Agriculture, "CCC Credit and Market Development," p. 32. ulGeneral Accounting Office, Emphasis on Market Development in Export Credit Program, pp. 42-43. ll2U.S. Department of Agriculture, Economic Research Service, U.S. Agricultural Exports Under Public Law 480, Foreign Agricultural Economic Report No. 395 (October 1974), p. vii. “3General Accounting Office, Emphasis on Market Development in Export Credit Program, pp. 86-91. uuDepartment of Agriculture, "CCC Credit and Market Development," p. 35. 45See, C.M. Alaouze, A.S. Watson, and W.H. Sturgess, "Oligopoly Pricing in Wheat," American Journal of Agricultural Economics, April 1978, pp. 173-185; Department of Agriculture, "CCC Credit and Market Development," p. 8; 57 U.S. Congress, Senate, Committee on Agriculture, Nutrition and Forestry, Hearings on S. 2385, 2504, 2405,2968, 3011, Hearings before the subcommittee on Foreign Agricultural Policy, 95th Cong., 2nd sess., 1978, p. 46; General Aficounting Office, Management of Agricultural Exports, p. 9 . . u6Department of Agriculture, "CCC Credit and Market Development," p. 8. “7Senate Committee on Agriculture, Nutrition, and Forefigry, Hearings on S. 2385, 2405, 2504, 2968,3011, p. O u8Department of Agriculture, "CCC Credit and Market Development," p. 8. ugGeneral Accounting Office, Emphasis on Market Development in Export Credit Program, p. 44. 50Ibid., pp. 19-20. 51Telephone conversation with personnel of the Office of the General Sales Manager. 52Robert Baldwin, Nontariff Distortions, p. 52. 53Ibid., p. 53. 5“Ibid., pp. 53-54. 55Ibid. 56Organization for Economic COOperation and Development, Trade Committee's Group on Export Credits and Credit Guarantees, The Credit Financing Systems in OECD Member Countries (1976), p. 5. 57U.S. Congress, Senate Committee on Banking, Housing, and Urban Affairs, Export Policy, Part 3, Forei n Government Policies and Programs to Support Exports, 95th ong., 2nd sess., 1978, p. 29. 58Department of Agriculture, "CCC Credit and Market Development," p. 53. 59General Accounting Office, Emphasis on Market Development in Export Credit Program, p. 5, and Idem., Management of Agricultural Exports, p. 95. 60Department of Agriculture, "CCC Credit and Market Development," p. 40. 58 61General Accounting Office, Emphasis on Market Development in Export Credit Program, pp. 46-47. 62 Ibid., p. 58. 63Ibid., p. 89. CHAPTER III THE CONDUCT OF THE PROGRAM'S POLICY MAKERS Conduct is the second component of the institutional model. Conduct is the link between an institution's structure and its performance. This discussion of conduct begins with a description of the behavior of the OGSM in its administration of the Export Credit Sales Program. Other observations will be made concerning the problem of decision making in uncertain situations. The Behavior of the OGSM The determination of country and commodity eligibility is the responsibility of the CCC Board with the assistance of the OGSM. A description of the process by which commodities and countries are designated was provided in the structural discussion of policymakers. Also outlined was the CCC's budget cycle and some of the behavior of the CCC vis-a—vis other policymaking groups when establishing country lines of credit (Jurisdictional Boundaries). The remaining topics dealing with the CCC—OGSM's behavior will focus on the inter-departmental relations of the CCC—OGSM, the determination of interest rates, and the technical aspects of the sales registration, confirmation and disbursement process. 59 6O Inter-Departmental Relations The CCC-OGSM has formal and informal relations with a variety of Executive departments, Congressional bodies and international or private organizations. While a closer look is needed at all these relationships, I would like to concentrate on the CCC-OGSM's relationships with the State Department and the Treasury Department. CCC-OGSM Relations With the State Department In its 1979 report, the GAO charged that the allocation of CCC credits were being influenced by secondary economic and political objectives. The inferred that the source of much of this influence was the State Department with some additional pressure brought to bear by other administration officials working through the National Advisory Council on International Monetary and Financial Policies (NAC).l Representatives of the State and Treasury Departments, as well as members from the Office of Management and Budget (OMB), are authorized by law to "review" all of the CCC's export sales financing agreements.2 Dr. Harrison, the General Sales Manager during the Carter Administration, reiterated in Congressional testimony the independent stance of the CCC. "Historically," he said, "the Department of Agriculture has done its own analysis and evaluation of the market impact of the credit program, and then has proposed to the National Advisory Council credit 61 programs." Furthermore, insisted Dr. Harrison, "The authority for determining and deciding what credits would, in fact, benefit or maximize exports has rested with Agriculture and will continue to rest with them."3 Seven months prior to Dr. Harrison's Congressional testimony, the State Department claimed that it had exercised, what was in essence, a 'veto' over the allocation of CCC credits in two separate cases. Richard Arellano, the Deputy Assistant Secretary of State for Latin American Economic Affairs, in a prepared statement on human rights and export promotion, stated that "Exports of agricultural goods under Commodity Credit Corporation loans have been less affected by human rights considerations relative to Ex-Im loans , since these loans are made on a commercial basis and are primarily to support U.S. farm sales. CCC credits have been denied on human rights grounds in two cases in the hemisphere (on wheat to Chile--$10 million in November 1977, $25 million in June 1978)."“ The issue of CCC credits and the human rights situation in Chile was broached by Senator Boren during the same hearings in which Dr. Harrison had testified. Senator Boren's questions were directed to Dr. Harrison's superior, Dr. Hathaway, then Assistant Secretary of Agriculture for Inter— national Affairs and Commodity Programs. Senator BOREN. I am trying to determine the real problem—-I would appreciate it, as much as you can, if you would answer this question with a yes or not. Is it completely a lack of funds for the extension of credit that is causing us not to extend credit? Dr. HATHAWAY. No, it is also a matter of judgement 62 as to whether the credit there would result in additional sales. Senator BOREN. Your answer is then that the human rights question has absolutely nothing whatsoever to do with the decisions on extending credit to Chile? Our Government is making decisions purely on economic grounds, and not at all, in any way, on political grounds, is that the answer? Dr. HATHAWAY. That is my basic position. We have been watching that market very carefully, but it was not evident at the time that we were making our decisions that it was necessary to use credit. The human rights provision, in fact, under law does not apply to the use of CCC credit, if I understand the law correctly. Senator BOREN. I understand. So it is no way impacting on the decisions? They are being made on the basis of markets? Dr. HATHAWAY. Market -- Senator BOREN. Market forcesg Dr. HATHAWAY. Market forces. Obviously, there is a great difference of opinion between the CCC-OGSM and the State Department as to why credits were not granted to Chile. CCC-OGSM Relations with the Treasury Department Relations between the CCC-OGSM and Treasury occur at several levels: (1) within the NAC; (2) during the annual budgetary process; and (3) in consultation concerning the credit worthiness and external financial position of prospective borrowing countries. However, it is the lack of other relations (or coordination) between these two groups that we would like to address. Specifically, the Eximbank and the CCC both extend credits for the export of agricultural commodities but there is no evidence of any coordination concerning their respective programs. Recently, there have been calls in Congress for a consolidation of all agricultural export credit programs 63 (under Agriculture) and assurances have been made by Exim officials to do so, but certain Exim developments seem to indicate otherwise. Senator Adali Stevenson, Jr. (Chairman of the Senate Subcommittee on International Finance, Committee of Banking, Housing and Urban Affairs) pointed out the inconsistency of having two agencies conducting separate agricultural export credit programs. "I suppose," he said, "with the same logic that has been suggested, Export-Import should support the export of agricultural commodities, it could be argued that the CCC should support the eXport of non-agricultural commodities."6 Senator Stevenson put the matter to the President and Chairman of the Eximbank, Mr. John Moore, who replied, "I believe that, to the extent the United States should engage in direct loans in support of agricultural commodities exports, they should be handled through other programs of the government...designed by the Department of Agriculture."7 While willing to concede to the CCC-OGSM agricultural credits, the Eximbank nevertheless expanded its operations to include other agricultural export activities. In 1978, Eximbank announced a new insurance program "allowing U.S. commercial banks to obtain short—term comprehensive insurance coverage to support bulk agricultural commodity exports sold on irrevocable letters of credit issued by foreign banks with ...8 repayment terms under one year... 64 32 5 2.... >0 3:: >u .2... >... 22 >0 :2 >6 £2 >6 :2 >u o2: >u 32 >0 ESE ::::: : ::E :: E d 5:: 55:5 55:: E:::: E:::: 55:. o .N~ .a .Emumoum mcnmm uwpouo uuomxm cw ucoanHo>mn umxumz :o manages—m I. .oofiwwo wcwucsoou< Hmuocmo “MQMDOm whOC¢OO I'll!!! l N >m3m. n.u a: . .s. to. a o. ... .. o. a. ...o. o. a 6‘ a I oo- oo— ~oo co co .I. a n 4.». .mn... . s cc... a cuts.” 1%” o\l\”@ s .. H: a ~ . . a . Q o... co 0'. oooo‘o co 0 h l\\ o. no . u no .. I! q... go o ll 0 o o. oo o. o. o o u no 0.0 ....- o. o. o ’1‘. so 6L. 0 o o. n:. m.:.w at u .. (s .. . o— oumm amoumucH J 3 mo comwumgaou hanucoz : m muswwm In. a. I 65 With the introduction by the CCC of its own Non-Commercial Risk Assurance and its new Export Guarantee Programs, there is no longer any rationale for maintaining similar programs within the Exim structure. Determining Interest Rates and Rppayment Periods Interest rates are determined monthly by the General Sales Manager in consultation with the CCC's Controller. Although the CCC has been charged with meeting foreign credit competition while minimizing its displacement of commercially financed or cash sales, neither of these factors have been the principle criteria in setting interest rates. Instead, the major concern of the OGSM is to maintain a 'commercial' rate and escape the provisions of the Cargo Preference Act (CPA).9 Loan maturities vary from 6 to 36 months, but 77 percent of the fiscal year 1978 credits were for the full 36 months.10 In recent years, the policy of the OGSM has been to set its loan rate at the midpoint between its borrowing rate and the U.S. prime rate (see Figure 5). While this formula may technically remove the program from the purview of the CPA, it was, nevertheless, a 'subsidized' rate that must invariably displace some commercial financing.11 The Subsidy Effect To determine the extent of the subsidy effect, one needs the relevant commercial interest rates and terms of repayment. 66 Any comparison of the CCC rate with the prime would be, at best inaccurate, and at worst, grossly misleading. It is doubtful whether the credit ratings on most CCC borrowers is of equal standing with the firms who are quoted the prime rate when borrowing from major United States banks. A more appropriate measure of the degree of subsidy would be to compare the CCC rate with the Eurodollar rates quoted to less-developed, semi-industrialized, and Eastern Bloc countries when they borrow in the Western capital markets. The Prime Rate The prime rate, as usually reported in financial publications, is the rate charged by leading New York banks to large borrowers of very high credit standings. The prime is usually the lowest possible cost of using short—term unsecured bank credit. A short-term loan is one in which the borrower has agreed to repay all interest and principal within a 12 month period. Unsecured means that there is no specific pledge of an asset in connection with the loan. Only the debtor's general promise to repay is offered to the creditor in the credit transaction. Current or short-term financing is often easier to obtain and available with less advance negotiations than other types of financing. Since payment to the creditor is due in a shorter period of time, the risk of lending is generally thought to be less for short—term loans than for loans of later maturity. Other factors being equal, higher interest must be charged for long-term than short-term maturities. The 67 OGSM implicitly recognizes this principle when it charges incrementally higher rates for loans with progressively longer maturities (in 1978, 7.75%: 6-12 months; 8.5%: over 12 months; and 9.42%: 36 months, see Table III). Eurocurrency Rates A 1977 Agriculture study stated that "Private U.S. and foreign bank loans for commodities are seldom longer than 180 days and the rates tend to approach the Eurodollar rate in international banking."12 An FAS internal study noted that "the maximum repayment period under the CCC program is 36 months. This is a longer repayment period than is generally available from commercial sources for comparable loans."l3 Both studies are half right. Loans are seldom made at a fixed rate of interest for longer than 180 days but they can be turned over continuously for terms longer than three years. Treasury and World Bank officials confirmed that the Eurocurrency rates were indeed the best barometer of rates that were commercially available for the 'typical' CCC 14 borrower. The Eurodollar interest rate is determined among major 15 The London Interbank Offered Rate (LIBOR) banks in London. has tended to follow the prime rate in the United States. This tendency was strengthened in January 1974 following the lifting of balance-of-payments restrictions by the United States. Variations between the two rates (prime and LIBOR) are due mainly to: (l) seasonal factors; (2) fluctuations in the dollar exchange rate; and (3) global events.l6 68 .osfiun may soon HoaoH ma mum“ wcaocma 000 oau sown3 CH whom» .oafiun on» cmsu uoswwn mu mum“ wcwocoa coo osu sofin3.cw mummy + .Aosaua mnu umzu Hoswfia muawoa owwuaoouwa m.H ou n. cowsuon maamsmsv mum“ wcwocma oEwuo oSu ou moumu Hams» wcfi%u mo hofiaog 3mg m oousufiumafi coo o£u whoa .mH uonMuaom mo mm m>Huomoom \M .mcmoH msuaoa omIo How moumu mafiuuoawu :fiwoo moans» 000 can wnma .om nous: mo mm C>Huoooom \M .mcmoH mauaoa NH uo>o was nucoa NHIo “cw mmumu wcfiuuoamu :Hwon moanmu 000 can uan .mH Monsoomm mo no mpwuoommm \W .mcmoa umo% m one pooh H .sucoa o How mouou wafiuuommu cawoo noflomu coo onu om¢a .mm Hooeoumwm mo mo o>auommmm \w mzmoa umohIm can nunoEINH now mmuwu wcwuuoaou Gamma moanmu coo w£u mmma .om um=w=< mo mm m>wuommwm \m .oofiumm awoouo mo Suwama so comma mums oomH .NH %um=unom Hausa oowumso moumm \M .umstS accouma one mum mGOHumwfiHno xcmn cwfiouOM co oowumso woumu I mcofiuwwfiano xcmo .m.D no omwuwno omonu who czosm mmumu m.ouo .¢Qm: .moua moaomu mo moaaoo xouox "oopsom qo.~H Nw.NH I I I I cam.ca Hn~.oa \M mnwa + wo.m Nq.m I I om.m mm.n Hmo.w mqq.n m.wmaH + Hw.o I om.m mm.“ I oa.~ omw.m omq.m \m puma + mm.o I I I mm.w oo.m oao.o Nom.m \m omma + nm.n I I I om.m om.w omw.o NOm.o mnaa + m~.oa I I I No.0H mm.a oom.w mmm.m \m.omma I wH.w mo.n I I I I «mo.n oom.o mmma I mH.m mH.o I I I I Nam.q oom.o whoa + mo.m mH.o I I I I m~w.o mmw.q Hmma + no.5 mm.o I I I I mna.m mH¢.m emma I mm.n mm.o I I I I nmm.o I momH I mm.o oo.o I I I I coo.m I woaa I om.m oo.m I I I I Nam.o I moma + mo.m wm.o I I I I ooa.m I \m.oo¢H I I I I I o.m o.q I I momH I I I I qm.q co.q I I coma I I I I N.o m.m I I momH comm onlo omImN «NIMH NH Hm>o NHIo mwaasouuom >u=wooue do oumm unsoomfin umow mafium mauve hanucoz so wouom wcaocog coo oumm ummumucH 000 can Amnma I mood mummy Hmoaoamu mo mowmum>< manaamv wMH.::— O- Iv-ln‘u- :nu:O.¢ 1‘8 . 322-300 I. an! wings - 28.35.25: :35 119—53 :13 o- :55... . 1::0.‘ 3:09 a as :2: 321.125 :6. 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o am no uommmm OH madman uOXsz_uHomxm .m.D m waHHz<=o o _ . _ _ m weHoozzoo .m.a mom ” nzm=u amen zpm ozoa n.2mHm mes ozoa< memHmm o-mH enemas . e-mfl cusses "I'CICIIII II I'll 0am 132 cost savings is of a long term nature, then they will adjust their capital investment plans and expand along a new curve LAC'. The next round of firm growth will be larger than what it would have been without long term cost savings (see Figure 14). General forward and backward linkage effects are distributed over time and diffuse in their impact.3 Korean employment and income is enhanced via the market development, foreign exchange and induced investment effects. The program not only induces additional cotton sales, but also creates additional demand for other U.S. exports via Korea's marginal propensities to import for U.S. products. The return to the U.S. from these long run effects can only be measured by taking into account the changes in the levels of Korean imports of all U.S. products (both manufactured goods as well as agricultural commodities). A Static, Neoclassical Model Of the Influence of the CCC Credit on an Importing Firm's Purchasing Behavior The demand for cotton is derived from the underlying demand for the outputs produced by the Korean cotton spinning and weaving industry (primarily yarns and fabrics). Because Of the variety of products using cotton as an input, an appropriate model of firm behavior would be the neoclassical theory of the multi-product firm. An interesting difference of opinion arises in the literature regarding the consequences to factor demand if the multi-product firm is able to switch fixed factors from 133 m>HDU umoo cam mcod m.EhHm Gnu mo umwnm SH ouswem mo>+-—i- < J 3> w present value of last period's interest and principal costs where wJ, TJ’IJ’ r are given and (t = 1, . . . , T3). Switching costs (S) are incurred when the firm transfers unspecialized fixed factors from one product line to another. This cost arises from the firm's need to physically move the factor, recalibrate, or change variable components on the fixed factor. This cost is dependent on both the previous use of the factor and its new use. Each fixed factor has an nxn matrix denoting the switching costs 137 associated with changing the factor from one product line to another. For the sake of simplicity, I have assumed that the switching cost matrix is symmetric. The elements of these matrices can be expressed as: (3) S = S(ylllsyll2a ' ° ° ’ylln3y2ll’ ° ° - :y21n3 3 yrnl’yrn2’ ’ ' ' ’yrnn)° Those costs which are invariant with respect to output during the production period are simply denoted as fixed costs (F). Total revenue (TR) from the sale of the (ql) output of the (n) product lines is earned in two markets, a domestic and an international market. The firm is assumed to be a perfect competitor in the world market and earns the world price (piw). It the domestic market is protected from international competition by a tariff (Tfi) then there is an incentive for domestic producers to form a cartel and exploit the relative advantage that they have in their home market. The profit maximizing solution would require the firm to act in a price discriminating manner and to equate marginal revenue in both markets. If this is the case, the firm produces a total output of (ql), sells (qld) on the domestic market and eXports the remainder (qix = q1 -qid) Domestic sales earn a price (pid) which is greater than the world price (piw) but less than the world price plus the tariff (piw+Tfi). An equation describing total revenue is as follows: (4) - W d d TR — E pl (q1 ) + p1 (q1 ) i=1 where d qi = qix + qi plw, pid, Tfi are given or pi = f(qid), and piw ; pid ; piw + Tfi- Profit can now be expressed as the difference between total revenue (TR) and total costs (TC) (5) n = TR - (v + S + F) n (6) 11 = Z : [piw 1 - J j=l i=1 31 J \_ Ij(1 _ (1 * 12)) + 1 ( Tj Tj ) s + + (Y . , Y ) + (1 + r)t 111 rnn r d m n C c J - x.. + Gk [ yk E yki ] + E 93 [ W3 1 k=1 i=1 '= i=1 —/) where (t = 1, , T.), J and (r = 1, . . . , k ), w d pi , pi , Wj’ Ij’ r, Tj’ F, and S(y111, . . . , yrnn) are given. 1&0 The Kuhn—Tucker saddlepoint theorem is required to describe the conditions needed for a maximum. The theorem is a generalization of the theory of constrained extrema and permits the introduction of some unique mathematical forms, such as: (l) inequality constraints; (2) non-negativity assumptions; and (3) non-linear objective functions. The fixed input constraint is expressed as an inequality to more closely approximate the true behavior of a firm. An implied assumption of the analysis is that at the point of profit maximization, all inputs must be positive or zero. Finally, according to Ferguson, "one cannot plausibly assume linear profit functions for a multi-product firm."7 If you did, then given a set of constraints, one product line would always yield a higher total profit and the firm would produce just that product to the exclusion_of others. For the Kuhn—Tucker saddlepoint theorem to hold, two assumptions must be met: (1) the objective function and the constraints must be differentiable; and (2) the objective function and the constraints must all be concave functions. These assumptions ensure that the conditions which guarantee a saddlepoint also guarantee the existence of a constrained extremum. Therefore, the necessary and sufficient conditions for a saddlepoint are as follows: (10) a) 8L < 0, (j=1,...,m), axji (i=1, ’n), b) aL ; o, ayki . r), 142 A Survey of the Korean Cotton Textile Industry The textile industry is one of the oldest and largest industries in Korea. The contribution of the textile industry to industrial production and employment is greater than that of any other industry. Its share of employment for the manufacturing sector has been steadily rising since, and in 1974 was 31.“ percent.8 Cotton and woolen yarns and fabrics have been the traditional mainstays of the textile industry. However, man-made fibers (MMF) have been displacing these traditional textile products. In part, this is due to the increasing demand for synthetic fibers and the emphasis placed by the Five-Year Plans on the construction of synthetic fiber plants.9 Modern textile manufacturing began in Korea in 1917 when the country was under Japanese suzerainty. The Korean war destroyed some 70 percent of the industry's plant, but it was rapidly rebuilt after the war, with the help of foreign aid. The four Five-Year Economic Development Plans have had a considerable influence on the composition and growth of the textile industry. At one stage, authorization for the construction of new spinning plants was withheld if the plant scale was below the minimum optimum scale of 50,000 spindles.lo The current and fourth Five-Year Plan (1977-81) initially implied that less emphasis would be given to textiles. While the Five-Year Plans have 143 influenced the industry's development, they have not dictated it and apparently, the Plans are flexible enough to respond to strong market signals. For example, during an unusual textile export boom in 1979, it was announced that the prior ceilings on expansion of facilities in the textile industry would be abolished.11 The industry has moved rapidly into the world market. Foreign demand now accounts for over 60 percent of total demand. In 1966, textiles earned Korea 26.3 percent of its total export revenues. In 1975, that figure had risen to 3M.5 percent. While the importance of cotton textiles relative to other fibers has declined, cotton textiles have nevertheless continued to eXpand (see Table V). Most cotton production is destined for overseas markets. In 1979, 86 percent of the cloth and 69 percent of the yarn produced was eXported. In recent years, yarn accounted for nearly half of the cotton exports and fabrics accounted for “6 percent. Made-up goods comprised only 5 percent of cotton products exports.12 In 1975, cotton textile exports accounted for 6 percent of all export revenues and 17.” percent of the export revenues earned by the textile sector. Nearly all of the yarn exported goes to Hong Kong and Japan while most of the fabrics go to Western Europe with significant amounts being exported to Hong Kong, Japan and the United States. Most of the fabric exported is a blend of cotton and other fibers.l3 144 TABLE V SUPPLY AND DEMAND FOR COTTON YARN AND CLOTH (yarn in kg. tons, cloth in km.) PRODUCTION EXPORTS DOMESTIC DEMAND Yarn Cloth Yarn Cloth Yarn Cloth 1961 44,190 183,555 - 3,977 44,190 179,578 1963 62,566 203,938 52 24,930 62,516 179,008 1966 69,799 171,685 837 81,117 68,962 90,568 1970 103,408 212,084 29,779 - 73,628 - 1974 159,015 231,113 95,098 201,056 63,917 30,058 1977 278,743 479,299 199,790 439,782 78,953 39,518 1978 330,164 559,705 229,954 491,097 100,210 68,608 1979 380,071 620,034 260,971 535,829 119,099 84,206 Sources: The Spinners and Weavers Association of Korea & textiles, and it is likely to retain Korea Development Bank (The Korean Reconstruction Bank, 1967), Industry in Korea 1967 (by the KRB) & Industry in Korea 1976 (by Seoul, Korea, 1967 & 1976. Korea is now the world's lowest 14 least the next several years. The the KDB). cost producer of cotton that distinction for at cotton textile industry has been steadily improving utilization rates and is now working at virtually full capacity (see Table VI). The industry's plants are characterized by large units of new machinery operated by an efficient labor force working at relatively low wages. Although the wage rates have been rising with the increase in other employment opportunities, productivity is also rising as the industry takes full advantage of the economies of large-scale operations. Production of cotton in Korea is insignificant (only 9 thousand bales in 1977 compared to 1,312 thousand bales 15 imported) and of low quality. Domestically produced 145 TABLE VI COTTON SPINNING AND WEAVING OPERATION RATES Spindles . Looms Operation Ratio Days Operation Ratio Days 1970 92.49 % 329 91.87 % 322 1971 93.02 336 83.92 329 1972 94.49 350 84.01 341 1973 95.35 354 79.19 302 1974 88.62 305 70.63 313 1975 89.60 336 84.31 342 1976 95.25 347 92.15 343 1977 96.28 334 95.72 342 1978 97.96 343 94.43 348 1979 96.99 342 94.61 347 Source: Spinners and Weavers Association of Korea. cotton is used primarily by rural households for their own needs. Since the Korean textile industry depends exclusively on imported cotton, the entire market demand for cotton (not just the excess demand) is the relevant demand for cotton imports. The international trade of cotton textiles has a long history of protectionism. Much of Korea's cotton exports are subject to bilateral agreements between the importing countries and themselves. These agreements were negotiated under the auspices of the international Multi-Fiber Arrangement (MFA) concluded under the General Agreement on Tariffs and Trade (GATT). One of the current provisions of the MFA is an overall growth rate of textile imports of at least six percent annually.16 Other limitations to trade include tariffs and exchange restrictions, subsidies to local industry, state trading; and quotas which are imposed 146 by countries that are not signatories to the MFA. Korea is able to get around some of these trade restrictions by exporting semi-finished cotton goods to Hong Kong. As a free port, Hong Kong places few restrictions on Korean cotton imports. Since Hong Kong has obtained relatively large import quota concessions from the United States and Western European countries, Korea has managed to bypass the small quotas on her products by exporting to Hong Kong who then re-exports Korean yarns and fabrics in a more finished form.17 The general upward trend in demand for Korean cotton textiles is due to two factors: 1. Low labor costs, new plant, government assistance and other factors has given Korea comparative advantage relative to other exporters. At the same time, the textile industry has begun to decline in several major importing countries. The importance of the former was recently illustrated when the Korean market share in some Asian yarn and fabric markets suddenly increased in 1978. The increase followed an earlier appreciation of Yen which forced Japanese mills to withdraw from these same markets.18 2. Increased textile demand on the world market which is due to the growth in population in some markets and to the rise in per capita income in others. The scope of future demand for Korean cotton textiles is also dependent on the Korean market shares of world 147 exports for yarn and fabrics. In 1976, Korea exported only 6 percent of the world's yarn exports and 3 percent of the fabric exports.19 There is considerable scope for further market expansion if the following conditions hold: 1. The competitive position of their traditional competitors continues to deteriorate. 2. The Koreans are successful in negotiating more generous trade concessions from the major importing countries. 3. A new rival does not challenge their position as low cost producer (the PRC, for instance). As previously noted, Korea relies entirely on imports to meet its industrial requirements for raw cotton. The U.S., over the last five years (1974-78), has been supplying 95-98 percent of these imports and the CCC has financed 44 percent of this trade. Over the 1976-78 cotton seasons 1 out of every 4.4 cotton bales exported by the U.S. went to Korea. In 1977, Korea was the world's third largest cotton importer accounting for 5.5 percent of the world's trade. In 1978, Korea's share had risen to 7 percent.20 The United States' dominance of the Korean cotton import market has been attributed to several factors: 1. The provision of financing under a variety of programs (Mutual Security, PL 480 and CCC). Mutual Security funds were the primary source of financing from 1950 to 1960; PL 480 from 1960 to 1970; and CCC from 1970 to the present. 2. The relative proximity of U.S. sources of supply. 148 3. The availability of large quantities of the various types of cotton fibers. 4. The trade intangibles such as close relationships between exporters and importers, good coordination of trade and extensive cotton promotion efforts on the part of U.S. suppliers.21 An Operational Model for Estimating the Additionality of CCC Cotton Export Credits In order to capture the short and long run returns to the U.S. (defined as the changes in the level of all exports to Korea), one should employ a dynamic model which will address the following issues: 1. The linkages of the textile sector with the general Korean economy. 2. Changes in the level of all imports resulting from changes in the general economy. 3. The sensitivity of the Korean cotton textile industry to CCC credit in relation to: (1) their present and future demand for U.S. raw cotton (ii) the growth in the industry's capital investments Developing such a model would certainly be beyond the capability and resources of a research effort such as this, unless a large portion of the model already existed in an operational form. The Operational model this study will employ is the Korean Agricultural Sector Model (KASM). KASM is actually a system of models which interact with one another as 149 components of an integrated system. The components can be run separately or in combination for subsector analyses. The five components of KASM are: 1. Population and Migration 2. Crop Technology Change Demand-Price-Foreign Trade Farm Resource Allocation and Production U'IJZ'LA) National Economy Only the latter three components would be employed in an additionality study. The use of these three components allow us to expand our definition of additionality to include changes in the level of all imports and to isolate the effect of just one year's credit on the level of current and future imports. The heart of our prOposed methodology is the National Economy Model (NECON). A description of this model and its linkages with the Production and Demand Models is found in Appendix A. Shocking the Model to Simulate Changes in CCC Credit One of the 16 sectors of NECON is the textile sector. This sector can be 'shocked' and the effect of a change in CCC credit can be simulated. Three sets of data need to be adjusted to approximate a change in CCC credits. The model is set to run using actual historical data from 1970-75. The model uses the historical price indices for world prices and domestic prices. Export demand for each sector is also set at its historical levels. 150 If CCC credit had not been available at that time then the world price that cotton importers would have to pay would be higher. Production costs in turn would be higher. Domestic consumers would buy less at higher prices and export demand may fall as well. Per unit profits for the textile sector would decline as would the textile sector's contribution to aggregate employment and income. As GNP would decline, so to would the consumption and import of food and nonfood consumer and investment goods. Assuming constant market shares, the value of U.S. exports to Korea would also decline. Determining the Interest Subsidy Embodied in CCC Credits If CCC interest rates are below commercial market rates, then the Program is providing the buyer with an implicit interest subsidy. The alternatiVe commercial interest rate for export financing is best determined by looking at the Eurocurrency market. In order to determine if an interest subsidy existed for 000 cotton credits to Korea, this study compared those rates against the rates charged to Korean firms who obtained financing on the Euromarket. Estimating the Interest Subsidy The interest subsidy is the positive difference between the CCC rate and the LIBOR rate charged to Korean firms plus an interest premium. The LIBOR rate is assumed to be a given reference rate that applies to all loans, but the 151 premium is believed to be dependent on characteristics of the obligor and other factors. World Bank records of transactions in international capital markets were examined to determine the prevailing commercial interest rate. The data covered loans contracted by Korean firms or government agencies from 1972 to 1980. The data identified the borrower, the type of loan, the loan's purpose, date of the loan, amount, interest rate and terms. The data also distinguished between several classes of firms (utilities, transport, financial institutions, and general industrial firms). Fixing the base LIBOR rate, the next step in estimating the interest subsidy was to discover the determinants of the premium. Was the interest premium charged the same for all firms or was it determined by the type of_the firm, the amount of the loan, the base LIBOR rate or other factors? The premium was regressed against a variety of structural and functional specifications. A single equation was chosen based on its overall statistical properties and economic logic. This equation was then used to estimate the premium that would have been charged to Korean textile firms had they financed their cotton imports on the Eurocurrency market. This estimated premium plus the base LIBOR rate prevailing at the time of the CCC loan was then compared against the CCC rate to determine the implicit interest subsidy. 152 The final structural form chosen to estimate the premium and its structural coefficients are: Premium = 1.24161 - .45364E-03(Maturity) + .0162619 (2.58) (1.78) (2.12) (l/Amount) - .243584E-03(Time) - .845641E-03 (2.53) (5.07) (LIBOR Reference Rate) OLSQ 54 months of data Estimation Procedure Number of Observations F- Statistic - 27.42 Durbin—Watson Statistic - 1.82 R—Squared - .69 ( ) - t-statistic The independent variables are not self evident and require some explanation. It should be kept in mind that the premium is both a service charge and a discriminatory charge based on the particular risk associated with the loan. Since Eurocurrency loans are roll-over loans, there is no risk to the lender that he will not be able to pass on higher interest costs should they rise during the life of the loan. Risk is associated with the borrower, not the possibility of higher interests rates should the loan be for an extended period of time. Writing the loan, assessing the borrower's credit worthiness, arranging a syndicate to float the loan, etc., are all expenses incurred by the lending institution above and beyond the cost of money (just like closing costs are added on to the cost of financing a mortgage). The cost of writing the loan, however, is not a lump sum charge at the time of closing, but rather is charged as a percent of the principal over the life of the loan. The cost of writing a 153 loan has a large fixed cost component, independent of whether the loan is large or small, for 1 year or 5 years. The forms, processing, and details that must be worked out are often the same. 0n the other hand, certain economies may be captured by the lender if the loan is for a large amount. Assuming that the lending institution has a fixed pool of lendable funds, managing a few large loans may be less expensive than managing many small loans. Premiums should, therefore, be inversely related to the maturity of the loan as well as to the amount of the loan. For example, if 80 percent of the service component of the premium is fixed, that fixed charge as a percent of the principal should be smaller the longer the life of the loan. In addition, the service costs, which are largely invariant with respect to the size of the loan, should be smaller the larger the principal amount becomes. For example, if the fixed cost component of the premium is 1 million dollars over the life of the loan, this would be 10 percent of a 10 million dollar loan but only 1 percent of a 100 million dollar loan. The premium also reflects the lender's judgement as to the risk associated with a particular loan. At low LIBOR rates, more firms may be encouraged to seek financing and apply for loans, Consequently, the incidence of risk increases as the population of loan applicants increases. At high interest rates, only the most credit-worthy firms apply as only they have internal rates of return high enough 154 to support the interest payments. A high interest rate acts as an environmental selection device keeping the less credit-worthy firms from applying. Consequently, that component of the premium which is a discriminatory risk charge should go down as the base LIBOR rate goes up. Premiums may also be influenced by the passage of time. Time may work in two ways. First, as the market develops and more banks do business with Korean firms, the competition for that business may increase over time. Since the base LIBOR is determined by the market, the only room for competition is in the service fees charged by the banks. Also, as time passed and the same firms came back again and again to borrow on the market, their credit history improved and banks may have lowered their risk charges. This hypothesis seems to be supported by the negative sign on the time coefficient. Measuring the Interest Subsidy A Korean textile firm importing U.S. cotton could choose to pay cash, finance the purchase at market rates, or finance using CCC credit. The firm would be expected to finance the purchase if the net present cost (NPC) of financing is less than the cash cost. When the firm's opportunity cost of capital exceeds the interest rate, then the firm would finance rather than pay cash. The subsidy implicit in a C00 loan is realized when the interest charged by the CCC over the life of the loan is 155 less than the cost of financing at commercial rates. The subsidy (s) is the difference between the NPC of commercial financing (NPCcf) and the NPC of CCC financing (NPCccc)' A subsidy ratio (S) can be calculated as the ratio of the subsidy to the face value of the loan (L). The formal expression for this ratio is: s = (NPCcf — NPCCCC)/L where: t n = ' - * NPCcf L +E: EFL (P 1)] 1&5) l j=1 i=1 (1 + 9i) n NPCCCC= L + E: [L - (P*i)] ICCC i Icf(j) = the commercial interest rate in (t) ICCC = the CCC interest rate (fixed over the life of the loan) t = commercial loan maturity in roll-over dates n = the number of times interest and principal payments are made (for commercial loans in each period (t); for CCC loans over the life of the loan) P = equal principal payments such that P*n = L q = the firm's opportunity cost of capital (its 156 discount rate) This expression has several advantages which make it useful when doing commercial policy analysis. 1. The ratio expresses the subsidy as a percent of the total loan. For example, if the subsidy ratio is .05, the subsidy is 5 cents on each dollar loaned. 2. The partial differentials of S with respect to each argument (Icf(t)’I ,q,i,t) are measures of the ccc sensitivity of the subsidy to changes in these variables. 3. As the subsidy becomes larger or smaller relative to the changes in these variables, it is reasonable to assume that the Program becomes more or less effective as a tool of commercial policy. Without detailed knowledge of the debtor's profit function, we cannot determine empirically the "true" value for q. However, a surrogate measure can be employed in its place. Past studies of the subsidy effect of EXIM loans used the market rate of interest.22 Consequently, the interest rate charged by Korean banks was used to approximate textile firms' opportunity cost of capital. Values for Icf and t were obtained from the World Bank data on Euro-credit transactions. From 1971 to 1975 the CCC financed the purchase of $329,898,000 worth of cotton exports to Korea. The subsidy provided by the CCC relative to commercial terms was 157 $20,054,000. For the entire 5 year period the subsidy ratio (S) was .061, or 6 percent of the value of the credits. TABLE VII CCC SUBSIDY RELATIVE TO COMMERCIAL TERMS ($1,000) Calendar Amount of Subsidy Subsidy Year CCC Credits ($) Ratio (%) 1971 41,084 3,340 8.1 1972 37,016 6,930 18.7 1973 69,812 6,421 9.2 1974 31,185 0 0.0 1975 150,801 3,375 2.2 The World Bank data showed few loans made for the import of raw materials. In 1972 and 1973 the net present cost of commercial financing exceeded the cash purchase cost. Consequently, one is lead to believe that Korean . textile firms did not use commercial financing because: (1) it was too expensive relative to cash; (2) international banks would not agree to provide long-term financing for raw material imports; or (3) the Korean government rationed scarce foreign exchange. If we accept the assumption that commercial financing was not available then the credit subsidy would be the full difference between the net present cost of CCC financing and cash. Given this assumption, cotton imported under CCC financing resulted in a net present cost savings of $36,146,000 and was the equivalent of an 11% reduction in the average bale price. 158 TABLE VIII AVERAGE COTTON PRICE: CASH, COMMERCIALLY FINANCED AND CCC FINANCED Calendar Cash - CCC Year Cash Commercial CCC Equivalent Price Cut ($7Bale) (%) 1971 146 141 129 11.7 1972 178 201 144 18.7 1973 162 164 147 9.2 1974 294 272 272 7.2 1975 302 277 270 10.4 Estimating Own Price and Cross Price Effects Imports Imports of raw cotton were regressed against the price of cotton and other variables. The final structural form chosen was: Cotton = -308159O + .590647E+10(l/Time) - -l47.l61 Imports (.81) (.79) (1.61) (Cotton Price) + 181.932 (Cotton Yarn Price) (1.87) + .2387 (# Cotton Spindles in Industry) (3.08) Estimation Procedure - OLSQ Number of Observations - 21 years of data F-STatistic - 94.56 Durbin-Watson Statistic - 2.2 R-Squared - .96 ( ) The own-price elasticity is relatively inelastic at -.35. A t-statistic literature review did not reveal any other published estimates of Korea's cotton price elasticity. The estimate, while it appears reasonable, is weakened due to the 159 relatively low t-statistic which indicates that the estimate is significant at the .14 level. Other problems associated with the estimate are multicollinarity between cotton and cotton yarn prices as well as the assumption that elasticity is stable through time. From 1970 to 1975 nearly all of the fiber materials used by the Korean textile industry were imported. Synthetic yarn and wool imports supplied the bulk of the fiber requirements for the woolen and synthetic textile industries. Industry studies suggest that there is a high degree of substitutability of one fiber for another23. The industry has to be flexible with regard to production processes in order to adapt to abrupt changes in tastes, technology and input costs. In order to capture these substitution effects, wool and synthetic yarn production were regressed against the price of cotton and other variables. The final structural forms chosen were: Wool = —3475.84 + 3459.49(Wool Yarn Prices) + 24.55(Cotton Imports (.49) (1.72) (5.90) Price) Regression Procedure OLSQ Number of Observations - 16 years of data F-Statistic 17.42 Durbin-Watson Statistic 1.43 R-Squared - .73 ( ) t—statistic and Synthetic = -.173209E+08 — 32.579(Synthetic Fiber Yarn (4.38) (1.45) Price) + 22.02(Raw Wool Price) + 271.87 (1.32) (7.06) Cotton Price) + 8788.54 (Time) (4.36) Regression Procedure - OLSQ Number of Observations - 16 years of data 160 F-Statistic 264.78 Durbin-Watson Statistic 1.79 R-Squared - .99 ( ) t-statistic No meaningful structural equations could be fitted to synthetic fiber imports.24 Consequently, cotton price was regressed against the domestic production of synthetic yarn. An input/output coefficient was estimated for synthetic fiber input/yarn output. Synthetic fiber imports were assumed to change in a proportional manner. Finished Textile Production and Textile Exports An increase in the import price of cotton should have several effects. The own-price effect would reduce the quantity of cotton imported. This, in turn, would reduce the quantity of finished cotton textiles produced and exported. Cross-price effects would lead to an increase in the import of wool and synthetic fibers. .More woolens and synthetics won't take up all the slack left by a reduction in cotton textile production, total fiber imports would fall and total textile production and exports would decline. Input/output coefficients were estimated for each of the three textile sectors. The coefficients were assumed to be constant from the period 1970-75. Changes in fiber imports resulted in proportional changes in the output of finished textiles. The average ratio of exports to total production was assumed to remain constant. 161 Decomposition of KASM Indices Three indices of KASM were changed to reflect the changes wrought in the textile industry by a lack of CCC financing for cotton imports. The first index changed was the import price index for the textile sector (VPWI-lO). KASM's designers originally obtained the index from the Korean Foreign Trade Statistics Yearbook. The index was duplicated using the original data but decomposed into various components. The index was then recalculated to reflect the change in cotton import prices. The value weights for the various fibers were adjusted since the total value of cotton, wool and synthetic fiber imports had also changed. The second KASM index to be adjusted was the domestic producer price index for the textile sector (P-lO). The index was obtained from Korean economic statistical yearbooks and was decomposed into its subsectoral components. Changes in fiber imports required proportional changes in the composition and quantity of finished textile outputs. Detailed knowledge of textile subsector cost functions were not available, consequently constant costs were assumed to prevail over the range of output changes in cotton, woolen, and synthetic textile production. The textile producer price index was modified based solely on the changes in cotton fiber costs, the composition of fiber inputs, and the composition of finished textile products. The final index to be modified was the absolute level of eXport demand for the textile sector (VXD-lO). As 162 stated, the ratio of exports to total production was assumed to remain constant under both sets of cotton import prices. In other words, if 50% of cotton yarn production was exported in 1973 given CCC financing, the 50% of the reduced cotton yarn production would be exported even if CCC financing were not available. No changes in world prices were made under the assumption that changes in the level of Korean exports could not effect world prices. TABLE IX CHANGES IN KASM DATA BASE FOR CCC SIMULATION Item 1970 1971 1972 1973 1974 1975 VPWI-lO CCC Credit 1.000 .877 .795 .575 .800 .900 No CCC 1.000 .965 .875 .633 .880 .990 VXD-10* CCC Credit 341 448 560 1022 1036 1144 No CCC 306 403 504 919 932 1030 P-10 CCC Credit 1.000 .928 .888 .876 .753 .649 No CCC 1.000 1.021 .977 .964 .828 .714 *Million won/year Simulation Results The KASM model was run from 1971 to 1975 under the two scenarios of with and without CCC credit. Although only three components of the model were linked 163 (Demand-Price-Foreign Trade, Farm Resource Allocation and Production, and National Economy components) considerable economic information was generated. Only that information pertaining to the textile sector, agricultural imports and overall measures of economic performance will be discussed. Cotton Imports U.S. cotton exports to Korea decreased due to the direct price effect of CCC credit and due to the induced investment effect. The first effect acts in the current time period and the second acts in preceding time periods and is cumulative in nature. Because of its cumulative nature the latter's total impact on cotton exports exceeded the immediate price effect of the credits. The Direct Price Effect Without CCC credits net exports of U.S. cotton to Korea would have decreased $14,359,000 during the five years 1971-1975. Exports declined because the Koreans no longer enjoyed the implicit price discount that was embodied in the credits. The discount was the difference between the net present cost of financing at CCC terms and the cost of paying cash in the current time period. When the "additionality" of the credits is measured as the increase in the value of exports (due to the credits) as a percent of the amount of the credits, the influence of the Program is relatively minor (Table X). The low additionality coefficients of the credits can be attributed to the low price elasticiity of demand for cotton imports (about -.35). 164 TABLE X ADDITIONALITY COEFFICIENTS OF THE PRICE EFFECT OF CCC CREDITS 1971 1972 1973 1974 1975 TOTAL 2.52% 4.53% 2.75% 4.30% 5.59% 4.36% The Induced Investment Effect The induced investment effect is considerably greater than the price effect. CCC credits reduced the net present cost of cotton imports and this savings represented a transfer of income to the Korean textile industry. From 1971-1975 this transfer amounted to over $36,146,000. From 1972 thru 1975, total textile sector imports increased by more than the amount of the changes in cotton, wool and synthetic fiber imports. The value of those changes is due solely to the direct price effect of the credits. Without those credits the rate of investment in the textile sector fell so that by 1975, gross investment under the no-credit model was 33% less than investment in the with-credit model (see Table XI). TABLE XI ADDITIONALITY COEFFICIENTS OF THE INDUCED INVESTMENT EFFECT 1971 1972 1973 1974 1975 Total 0.00% 10.24% 2.25% 45.38% 33.06% 21.03% 165 The induced investment effect of the income transfer embodied in the credits contributed to the expansion of the textile industry and indirectly increased cotton imports in succeeding years. The total amount of cotton imports attributed to the induced investment effect was $69,364,000. The total effect is probably several times larger due to the cumulative nature of the investment-return process whereby investments made during 1972-1975 influenced output and consequently cotton demand well after 1975. This estimate of the induced investment effect must be qualified. The investment elasticities used by the KASM model were not estimated directly but were loosely derived from a variety of sources. In fact, the KASM documentation describes the source of the investment parameters as "tentative estimates." Combined, the price and induced investment effects of CCC loans increased U.S. cotton exports by $83,763,000. The total additionality of the credits during the period 1971-75 would therefore be 25.39%. Since the model was set to run from 1971-1975 only, it is not possible to document the induced investment returns after 1975. However, given the geometric expansion of cotton imports it is likely that total additionality (price and investment) is two to three times greater than the base additionality effect of 83.7 million dollars. 166 TABLE XII THE VALUE OF COTTON IMPORTS DUE TO THE INDUCED INVESTMENT EFFECT ($1,000) 1971 1972 1973 1974 1975 Total 0 3,789 1,574 14,152 49,849 69,364 Linkage Effects Because of the pivotal role that the textile sector played in the Korean economy, any factor increasing textile production would have secondary impacts in other sectors of the economy. No attempt was made to identify which sectors were effected but agricultural imports and total imports were examined. The linkage effects were simulated by KASM using a 1970 input—output model of the Korean economy which was developed by the Bank of Korea. Input demand functions in the trade component of the model were derived by time series regressions. TABLE XIII IMPACT OF CCC COTTON CREDITS ON OTHER AGRICULTURAL IMPORTS ( $1.000 ) Commodity 1971 1972 1973 1974 1975 Total Rice 0 -60 —864 -2071 —924 -3,919 Wheat 0 -134 —75 -291 -233 -1,466 0th. Grains 0 -28 -2 -57 -169 -256 All Imports 0 +822 —6617 —4195 -1920 -11,910 167 From 1971 thru 1975 Korean agricultural imports declined $11,910,000 when 000 credit was eliminated. Rice was the commodity suffering the largest decline. Much of the decline in agricultural imports can be attributed to the income elasticity of demand for those commodities. Reduced output of the textile sector alone probably would not have been sufficient to reduce import demands for these commodities. However, as a result of the linkages the textile production resulted in a significant decline in the output of other sectors and the economy as a whole. By 1975, gross domestic product (GDP) in Korea had declined as much as 7.2% relative to the GDP generated with credits (see Table XV). This loss of GDP in turn led to a reduction in per capita incomes, thereby reducing the import and consumption of these food commodities. Other imports besides food and textile fibers were reduced when CCC credits were eliminated. From 1971 thru 1975 imports other than cotton and agricultural commodities decreased over 1 billion dollars. TABLE XIV IMPACT OF CCC CREDITS ON OTHER IMPORTS ( $1,000 ) 1971 1972 1973 1974 1975 Total 0 73,085 105,174 292,659 586,501 1,057,419 168 The U.S.‘s share of these imports was not estimated but whatever the U.S. share is, when combined with the increase in cotton and agricultural imports, would probably be 1 to 3 times the $329,898,000 worth of C00 cotton credits extended. If the probable impacts of the credits after 1975 are taken into account, then the total additionality of the credits could be from 3 to 5 times the value of the credits. TABLE XV KASM OUTPUT FOR WITH AND WITHOUT CCC CREDIT 1971 1972 1973 1974 1975 (Percent Change) Textile Sector Output —4.2 -9.3 -l4.5 -24.5 -33.0 Investment 0 -6.8 -16.4 —24.9 -41.4 Capacity - Utilization -4.2 -l9.8 -14.8 -24.9 -33.4 Labor Dmnd. -4.2 -19.7 -l4.5 -24.5 -32.9 Import Dmnd. -3.7 -18.8 -13.6 —23.2 -32.1 Export Dmnd. -7.8 -18.7 —20.0 -32.1 -37.8 Total Economy GDP -.3 -l.3 —2.1 -3.4 -7.2 Investment 0 —.4 -1.2 -2.8 -6.1 Labor Dmnd. -.3 -2.2 -2.0 -4.4 -8.6 Import Dmnd. - 5 -3.1 -3.6 -6.9 -l4.3 Export Dmnd. -1.9 -4.2 -6. -ll.2 -l9.6 169 Conclusion Economic theory suggests the CCC Program would increase exports by relieving the importer's credit constraint and by providing an implicit interest subsidy. The provision of export credit combined with an interest subsidy has the same effect as a price discount in that they might reduce the net present cost of the purchase to less than the current cash cost. A comparison of CCC interest rates with Euromarket rates confirms that CCC rates were lower than commercial rates. In addition, it was determined that export financing on the Eurocurrency market was either unavailable or not used for agricultural or raw material imports. Consequently, the direct effect of CCC credits was equal to an 11 percent discount in cotton prices. An implicit 11 percent price discount had the following effects: 1) it increased cotton imports; 2) it increased textile production and textile exports, and 3) it increased the rate of capital eXpansion in the textile industry. Over the five year period 1971-1975, the increase in cotton imports due to the induced investment effect of the credits was considerably greater than the own-price effect of the price discount. The Korean textile industry is an important engine of economic growth and employment. The induced investment effect of the credits on the textile industry were multiplied throughout the economy and promoted additional agricultural imports. Non-agricultural imports increased in 170 response to these multiplier effects. The cumulative increase in all imports due to the CCC cotton credits was 3.5 times the amount of the credits. TABLE XVI SUMMARY OF EFFECTS OF CCC COTTON CREDITS ($1,000) 1975 1972 1973 1974 1975 Total Cotton Imports 1,035 5,467 3,497 15,491 58,273 83,763 Other Agricultural Imports 0 -822 6,617 4,195 1,920 11,910 Other Imports 0 73,085 105,174 292,659 586,501 1,057,419 The empirical results of the KASM model simulation must be received with caution as they are subject to an unspecified margin of error. The cotton textile industry, nor the textile industry itself were modeled separately due to a lack of detailed industry data. The textile sector described within the input-output model of the national economy can be "shocked" only by manipulating three aggregate price indices of textile import prices, domestic producer prices, and export demand. Furthermore, the KASM model was designed primarily to evaluate agricultural policies, not to simulate minute changes in the import price of specific textile fibers. In this regard, perhaps the 171 most serious shortcoming of the model is the "tentative" nature of the investment elasticities used when estimating the induced investment effect of the export credits. It was the investment effect of the credits which proved to be far greater than the immediate price effect and therefore assessing the overall returns to the Program is heavily dependent on the accuracy of those investment elasticities. CHAPTER V ENDNOTES 1See, Robert Schwartz, "An Economic Model of Trade Credit," Journal of Financial and Quantitative Analysis, September 1974, 9(4), pp.v643-657. 2U.S., Department of Agriculture, Office of the General Sales Manager, Quarterly Report of the General Sales Manager (January 1979), p. 10. 3For a discussion of the measurement of these linkages, see LeRoy P. Jones, "The Measurement of Hirschmanian Linkages," Development Discussion Paper No. 6 (October 1975), Harvard Institute for International Development. "C.E. Ferguson, The Neoclassical Theory of Production and Distribution, (Cambridge, The University Press, 1971), pp. 201-211. 5See, Ralph Pfouts, "The Theory of Cost and Production in the Multi-Product Firm," Econometrica, 1961, XXIX, pp. 650-8; Thomas H. Naylor, "A Kuhn-Tucker Model of the Multi-Product, Multi-Output Firm," Southern Economic Journal, April 1965, 31, pp. 324-30, Joseph P. Hughes, "Factor Demand in a Multi-Product Firm," Southern Economic Journal, October 1978, 45, pp. 494-501. 6The firm could have access to commercial credit supplied by traditional financial institutions. However, unlike inter-firm trade credit which can only be used to purchase a specific type of input, commercial credit can be used to purchase all inputs to simplify the presentation we have omitted cash and commercial credit as separate constraining factors. If included they would simply add two more Lagranian multipliers to the finan expression of the firm's objective function. 7C.E. Ferguson, Theory of Production, pp. 201—211. 8The Korea DevelOpment Bank, Industry in Korea 1976, (Seoul: The Korea Development Bank, 1976) , p. 239. 9Ibid., p. 240. 10The Korean Reconstruction Bank, Industry in Korea 1967, (Seoul: The Samhwa Printing Co., Ltd., 1967), p. 111. llU.S. Department of Agriculture, Foreign Agriculture Service, The Market for U.S. Cotton in the Republic of Korea, by R. E. Evans, FAS Marketing Series (1980), FAS M-29i9 P. 9. 12Ibid., pp. 2. 172 173 13Ibid., p. 1—2. 1”Ibid, p. 16. 15Ibid., p. 3. l6U.S.I.T.C., The History and Status of the Multi-Fiber Agreement, USITC Pub. No. 850 (Washington, D.C.: United States Internation TRade Commission, 1979). 17Foreign Agricultural Service, Market for U.S. Cotton in Korea, p. 14. 18Ibid., p. 9. 19Ibid, p. 2. 2OU.N., Food and Agriculture Organization, Trade Yearbook 1978, (New York: F.A.O., 1979). 21Foreign Agricultural Service, Market for U.S. Cotton in Korea, pp. 6-9. 22The Library of Congress, Congressional Research Service, "Impact of Eximbank on U.S. Exports" (April 25, 1978), by Jane Gravelle. 23Korea Federation of Textile Industry, Textile Industry in Korea,1979-l980, Korea Federation of Textile Industry (Seoul, Korea, 1980). 2"The own-price elasticity of cotton imports is estimated to be -.35. The cross-price elasticity of wool imports to cotton price is +.83 and synthetic yarn production's cross-price elasticity is +.92. The price of wool was not included in the wool import equation due to problems of multi-collinearity with the price of cotton. Since the Objective of the wool import equation was to measure the cross-price relationship, not wool's own price elasticity, the wool price was delated from the equation in favor of cotton. CHAPTER VI SUMMARY AND PROPOSALS FOR CHANGES IN THE PROGRAM'S STRUCTURE AND CONDUCT The CCC Export Credit Sales Program had, for many years, been an important part of the USDA's strategy to develop overseas markets and to enhance exports. Despite the long history and importance of the Program, very little formal research has been done to assess the performance of the Program. The original focus of this study had been to rectify this situation and to quantify the Program's impact on exports by conducting a case study of CCC financed cotton exports to the Republic of Korea. During the course of that research it became evident that there were other aspects of Program performance that were not being addressed. Additionality, while a major component of performance, was an incomplete and inadequate way of evaluating the Program. However, it was clear that simply identifying the other measures of Program performance was not enough. How were these various effects related? What were the determinants of performance? Were there any strategies which could be employed that would improve Program performance? How might different strategies influence the various measures of performance? Additionality and other impact indicators are the end products of the CCC Program's Structure and the Conduct of the Program's participants. This study has attempted to outline the salient features of the Program's Structure, to 174 175 describe the Conduct of the Program's administrators, and to identify other valid measures of performance. This study has then described and estimated the influence of 000 credits in the case of CCC financed cotton credits to Korea. This study suggests that substantial returns were accrued by the U.S. from its extension of cotton export credits to Korea. The contention that similar returns from other export credits are possible is supported by the recent research of a joint USDA-MSU study. Using the MSU AGMODEL, researchers found that a 4 percent subsidy on 10 year export loans could provide an additional 1.028 billion dollars in export earnings during 1982-83. Although the Program had been discontinued by the Reagan administration, Congress resurrected the Program under the guise of the Agricultural Export Revolving Fund. The Revolving Fund Program has not yet been funded but when it is, this Program will inherit many of problems of the old Export Credit Sales Program. OGSM-USDA administrators have a unique opportunity to take a fresh look at the whole idea of export credit programs. Now is the time to begin an investigation of possible changes in both the Structure and the Conduct of export credit programs that could lead to improved program performance. This chapter offers some concluding observations on the role of export credit programs and suggests some changes to future programs' Structure and Conduct. These proposals are offered as a research menu and are not meant as a final institutional 176 diagnosis and prescription. Prescriptions cannot be made until these proposals are evaluated with additional data and more precise analysis. The proposals are divided between those that concern program Structure and those that deal with program Conduct. Structural Proposals Will the Program Have a Role in the Agricultural Export Markets of the 1980's? Our existing international agricultural policies were designed to reduce the chronic surpluses of the Post-War era. At that time, exports (even at concessional terms) were considered a more efficient use of agricultural resources than any other competing uses. However, beginning in the early and mid-1970's and continuing on until today, many analysts believe that fundamental changes have transformed international markets and that these changes, in turn require a restructuring of our trade policies and programs. Domestic and international conditions suggest that our trade must now COpe with markets characterized by a trend toward tightening supplies and increasing variability in production (and consequently in prices). Presently, the United States supplies approximately one-half of the world's agricultural trade volume and this represents almost 10 percent Of the world's consumption (other than our own). A recent agriculture study estimates that by the end of the eighties "the U.S. share of world trade could rise to 177 three—fifths, and our exports could constitute as much as 13 percent of the world's food consumption."1 Given these conditions one might assume that eXport promotion programs in general would be unnecessary. This is possible, particularly given the new administration's philosophy of reducing the government's role in the nation's political economy. However, that does not mean that there are no sound economic reasons for maintaining and even expanding the Program. Reducing Price and Income Instabilipy If higher prices are to be accompanied by increased variability, then there may be a resultant need for an appropriate policy intervention. Evidence of the trend toward increasing variability was overwhelming during the seventies. The instability in prices led to unstable export revenues and fluctuations in farm incomes (see Figures 15, 16 and 17). With exports comprising an ever-increasing share of total farm income we find that total exposure to market risk is also increasing. Producer strategies to COpe with risk impose additional costs (and losses in output) in that producers must forego some returns arising from use of specialized machinery, single cropping systems, use of debt capital, and the introduction of new technology.2 The primary policy response proposed to deal with price instability has been the institution of a global reserve program. While reserve schemes may have comparative 178 Figure 15 WHEAT: EXPORT REVENUE AS A PERCENTAGE. OF THE VALUE OF PRODUCTION PERCENT 80 7o_ — 60 - _. SO - - . _4 4O - - 3O ~v .. 20 " ' - 10 [‘1 I 11 1951 1955 1960 1965 1970 1975 (31.1) (42.3) (62.9) (47.5) (58.9) EUMBEIS IN PARENTHESES SNOW THE EXPORT REVENUE AS A PERCENTAGE C‘ M VALUE 0‘ PROOUCYION (OR IN! PRECEOING 5 YEARS. 1980 Source: Figure 16 CORN: EXPORT REVENUE AS A PERCENTAGE OF THE VALUE OF PRODUCTION PERCENT 35 3O -4 25 -w' 20 -* 15 ‘1 10 -i 5 .4 O l l I l l 1951 1955 1960 1965 1970 1975 1980 (3.9) (6.6) (13.8) (12.6) (19.2) NUMBERS 1N PARENMESES SHOW THE (90!! REVENL‘! AS A PERCENTAGE OP (HE VALUE OP PRODUCTION FOR 1115 PRECEOING 5 MS. U.S., Department of Agriculture, "Implications of Increased Reliance on International Markets, by Ronald L. Heekhof, ESCS Agriculture Economic Report 438 (November 1979). 179 Figure 17 SOYBEANS: EXPORT REVENUE As A PERCENTAGE OF THE VALUE OF PRODUCTION PERCENT 80 7O 60 50 4o 30 20 l l l 10 19511955 1960 1965 1970 1975 1980 (20.0) (39.4) (51.6) (55.2) (58.8) NUMBERS 1N PAIENTHESES SHOW EXPORT REVENUE AS A PERCENTAGE 0' THE VALUE OP PRODUCTION 303 THE PRECEDING 5 YEARS. 180 advantage in ameliorating price swings there is still a role for the CCC Export Credit Program. The Agricultural Trade Act of 1978, among other things, authorized the CCC to finance the "establish-[ment] in importing countries [facilitates] for...storing...imported agricultural n3 commodities.. In addition to financing foreign storage facilities the CCC could (if authorized) finance the purchase of large commodity stocks. In years when world prices are depressed, the CCC could offer special, low-interest financing to encourage importing countries to 'buy ahead'. These stocks could not be released until a specified time period has passed. The program would be similar to the domestic reserve program already run by the CCC in that the importer would have the option of abrogating the financing agreement and releasing his stocks prior to the expiration of the storage period buy only at the expense of paying off the loan at some higher rate of interest (a penalty). This program would have the combined effect of strengthening any global reserve program and also increasing demand for U.S. agricultural exports by providing importers with an incentive to purchase in advance during periods of low prices. Market Penetration for High Value—Added Products Two contrasting positions have been identified in regard to the 'cost' of producing for the export market. On the one hand we are assured that "U.S. agricultural exports 181 could be much greater than they are...[and]Vast Opportunities exist for expanded production at very nearly constant costs."Ll On the other hand we are warned that exports in the volume likely in the 1980's will have high additional costs with broad social and economic consequences.5 If the latter is the true situation, then this may require a shift in the relative emphasis that an export credit program places on the various commodities it finances. For example, the Program might focus more on financing those commodities "that minimize pressure on our resource base and food-price inflation but maximize the value added to the product and the benefits for the farm sector and the general economy."6 An internal FAS study suggests that such "high value added" products have not been traditionally exported and that they would benefit the most from increased credit availability.7 If adopted, this strategy may require credit agreements to finance exports for a period of years rather than on an annual case-by-case basis. The OGSM has recognized the importance of making credit available from one year to the next (though it cannot currently engage in multiyear credit agreements).8 Use of the CCC Program for Diplomatic Purposes In 1977, the Congressional Research Service issued a report on the use of United States food resources for 9 diplomatic purposes. Food, they stated, is a real or 182 potential source of power which the state can employ in the pursuit of its foreign policy objectives. The requisite conditions to successfully exercise food power based on market control are rather stringent and have not been very successful in the past. However, For an exporting country to have food power based of foodaid [and food imports financed by low-interest loans can be considered a form of food aid], it is enough that it have surplus food that it is willing to transfer on concessional terms... Don Paarlberg, retired Professor of Agricultural Economics at Purdue University, described the relative success that the United States had in at least two cases when it attempted to exercise diplomatic power based on food aid. The Offer of food aid, he said, was instrumental in getting the Egyptians to negotiate with the Israelis. However, an attempt by the Johnson administration to pressure India (using food aid) into supporting our Vietnam Policy backfired.ll Considerable criticism has been made of the use of food as a tool of foreign policy. Some of this criticism has been based on humanitarian grounds but much of it was based on the efficacy and the cost of using food, rather than other methods, to achieve foreign policy objectives. Most of the objectives were summed up in the aforementioned CRS report:12 1. Lack of effective market control. 2. Failure to extract specific policy Changes from other countries. 183 3. Unfavorable impacts on our domestic agriculture. 4. To use food power effectively would require a major restructuring of the role of government in agriculture. During the course of Congressional hearings on or related to the CCC Export Credit Program, the nearly unanimous opinion of Congressmen and witnesses was that the use of CCC credits for foreign policy purposes was ineffective and expensive. Mr. John W. Curry, President of the National Corn Growers Association, estimated that corn exports alone would expand by 53 percent if CCC credit were 13 Mr. Robert provided to all non-market economies. Kohlmeyer of Cargill Inc., further endorsed this view. He identified the Eastern European countries as being particularly responsive to credit availability and he predicted significant increases in commodity imports if CCC credit were extended.lu NegotiatingpLimits to Foreign Credit Competition Over the last 20 years, American trade policy has tended to emphasize free trade in agricultural products and the removal of barriers to agricultural trade. In 1979, the Senate Subcommittee on International Finance, reported that "Reductions in foreign import barriers and export subsidies is the major avenue through which U.S. agricultural exports could be increased."15 The United States, however, runs the risk of escalating the level of export subsidies if its own 184 Export Credit Program exceeds the 'par' level which has evolved over time for such subsidies. A 1977 Agriculture study reported that "most export markets are basically oligopolistic."16 In such a market, competition, in any form, often inspires retaliation. If one supplier initiates an aggressive marketing strategy it is likely that others will follow suit. The expansion of the CCC Program to include intermediate credits (up to 10 years) was strongly opposed by the State Department on these grounds. The State Department argued that the program "would be breaking new ground and that our competitors would almost certainly respond by changing their own credit "17 programs to protect their market shares. Congress seemed to heed the State Department's warning, not by rejecting the program but by including the provision that "intermediate credit financing under this subsection may not be used to encourage intermediate credit competition."18 The Nature and Extent of Foreign Credit Competition Two contrasting positions exist as to the nature and extent of foreign agricultural credit competition. First, there is the State Department. While the agricultural export systems of these three countries Canada, Australia, and Argentina differ from ours, they essentially rely upon commercial bank credits with Government guarantees. More important, one of the three countries normally Offers credit terms for agricultural commodities of more than 3 years and generally speaking they provide less favorable terms. There have been one or two exceptions to this in recent years but the underlying reason for these exceptions were--appea§§ to have been more political than commercial. 185 When pressed to document their position the State Department representative that testified before the Senate Subcommittee on Foreign Agricultural Policy waffled a bit and finally admitted that they had "NO information in advance and very little information after the fact..."20 What data they eventually were able to produce was sketchy, outdated, and of little use in determining an appropriate credit strategy of our own. The opposing view is usually championed by the Department of Agriculture. Representatives of Agriculture reported to the same Subcommittee that-- 1. The Canadian wheat board finances its operations with bank credits guaranteed by the government. 2. The Australian wheat board receives credit through the reserve bank of Australia. 3. Individual member countries of the European Community offer long-term credit and low interest rates and financing is also supplied through private banks operating under a government subsidy scheme. 4. Brazil has used an indirect eXport subsidy by providing funds at preferential interest rates to eXporters in proportion to their exports of soybean products. Exporters can then relend the funds on the Brazilian money market at substantially higher rates and use the differential to reduce their export prices.21 The United States is the only major exporter that regularly announces the particulars of its credit program 186 (commodity and country eligibility, amount of the credits, interest rates, and maturities). Even if the Program administrators had nothing buy good intentions and sought only to offer credit at the 'going subsidized rate' it is impossible to find out what that rate is.22 A Two-Stage Strategy for Limiting Foreign Credit Competition Because the CCC-OGSM administrators are operating in the dark they must strive to obtain better information on competitors' credit terms. This information is apparently not forthcoming via the traditional channels. What is needed is an international reporting agreement similar to the one recently concluded governing the reporting of officially supported capital goods export credits. This would be the first step in a two—stage strategy for limiting foreign credit competition. Once everyone's cards are on the table, so to speak, the necessary conditions for the second stage would have been met. The Department of Agriculture has identified the next stage in its 1977 study when it noted that "No individual competitor dares to withdraw unilaterally from the use Of aggressive methods for fear that others will not and so cause him to lose his market share." They concluded correctly that "The only way out is through a collective effort."23 The Carrot and Stick Approach to Credit Negotiations. A 1978 OECD study on officially supported export credits for capital goods estimated that these programs were costing 187 OECD governments $2 billion annually in lost revenues.2u By 1980, the annual cost of these subsidies rose to between three to five billion (due primarily to the higher interest rates government's had to pay finance their programs.)25 No similar study of agricultural eXport credit costs is possible due to the lack of information. However, it is likely that the total subsidy cost to agricultural eXporting countries is considerable.26 The Eximbank had initiated a 'carrot and stick' approach in its relations with its credit competitors. The 'carrot' is that the United States stands ready to raise the minimum rate that it charges if its competitors are willing to follow its lead. The minimum allowable rates would be determined by a formula which would tie each country's rate to its government's cost of money. This would retain some weighted parity among countries' programs yet reduce the subsidy cost for all. Eventually, the minimum allowable rate would rise through a gradual process until it approximated the prevailing commercial rates.27 The 'stick' is that the United States is equally prepared to make "aggressive use of the substantial resources...committed to [the Eximbank 1... [and ]to match, on a selective basis, the type of predatory financing [which it believes would lead to an escalation Of the international 28 credit 'war']." There are no economic reasons why such a approach could not be employed in achieving a similar 188 reduction in total world agricultural export credit subsidies.29 Conduct Proposals Planning: Indicative versus Mandatory Both the 1977 Agriculture study and the 1979 GAO rcport made strong recommendations for greater planning within the Program and for the establishment of country-commodity export priorities.3O In 1978 and again in 1979, the General Sales Manager came out in support of the general idea of 31 In 1978 the beginnings of a planning 32 market planning. group was assembled within FAS for just this purpose. However, by the time the GAO report came out only a few country plans had been produced and the GAO attributed this poor showing to several factors-- 1. lack of commitment by CCC-OGSM administrators to a "structured approach for establishing...priorities and market share goals...;"33 2. insufficient coordination among agriculture agencies (specifically FAS and E88); and 3. hiring limitations which had kept the FAS planning group at only 60 percent of its authorized strength. The GAO argued that the 'structured approach' (mandatory) to planning is needed to prevent the Program's effort from "being dispersed to low priority countries with "34 less need for credit than others. Furthermore, the plans would provide a yardstick against which Program performance 189 could be measured. Finally, the plans could be used by the CCC-OGSM administrators to defend the Program against the unwarranted influence of secondary economic and political considerations. The OGSM replied to the GAO's planning strategy in January 1980.35 We continue to feel that surveying our worldwide network of Agricultural Attaches, and responding to actual requests for credit will provide a more flexible and effective framework for planning than setting specific market-share targets. This is not to say that the OGSM has abandoned its formal planning efforts. ...country analysis, buttressed with country analyses prepared by AID, E808 and further supported by Long Range Strategic Marketing Plans being prepared by FAS, will ensure a more exhaustive examination of individual countries and commodities when allocating budgeting funds for CCC credit. Whatever the degree of SOphistication achieved by these plans, the OGSM insists that the plans he of an indicative character and not mandatory schedules that must be followed in all cases. Mandatory 'Plans' could achieve some of the benefits that the GAO claims for them. Without a doubt the more systematic and extensive one's data and analysis the better one's understanding of market factors. A formal joint planning effort among Agriculture agencies would be more efficient and may capture some economies of scale. Judging from the OGSM's statements there does not seem to be any fundamental disagreements on these points. 190 The usefulness of making the 'Plan' the primary criterion of performance is quite another matter. Any target identified by the Plan would be dependent upon the assumption of certain values for a multitude of independent variables. Many other variables which effect the targets must be omitted from the analysis either because there is little or no data on them or because their independent influence on the target cannot be determined. What if one of these omitted variables should change during the planned period and the OGSM proceeds with the Plan as ordered but fails to attain its target (it doesn't even come close)? Does this mean that the Program was poorly administered? If the Plan is used as the yardstick of Program performance one of two things will happen. First, the Plan will be pared down to something that has the maximum possible likelihood of success. No risk will be accepted but the plan will be fulfilled. Or second, the target impact indicators chosen will be those that have a high probability of yielding good scores (lots of smoke but little fire). For example, if volume of sales is the target impact indicator chosen, then the OGSM could up its score by simply lowering the interest rate it charges (nearly give the stuff away at zero interest). If net economic returns is the target impact indicator, then the OGSM may tend to underestimate the Program's cost (bury the subsidy in paperwork or subterfuge) and inflate the Program's benefits 191 (create a very favorable eXport multiplier for employment and national income effects). The remaining benefit of mandatory planning is that the Plan can be used to fend off attempts by others to use the Program for other than strictly commercial purposes. Even if it is possible and proper that the Program should serve only very limited commercial objectives, hiding behind a Plan will not prevent it from being subverted for other purposes. Instead of the day-to-day struggle between the CCC-OGSM and other power cliques all their efforts will be concentrated into capturing the Plan. Interest Rates--To subsidize or not to Subsidize Effective as of September 19, 1979, the CCC instituted a new policy of tying their rates to the prime lending rate (usually between .5 to 1.5 percentage pOints higher than the prime). This was a significant departure from the earlier policy of pegging the rate to the mid-point between the prime and the CCC's cost of money. The new rates undoubtedly reduced if not eliminated the 'grant' component embodied in the loans (although there may still be some element of a subsidy if the rates are lower than alternative commercial rates charged the 'typical' CCC importer). With the diminishing of the implicit subsidy, the Program's ability to influence importer's purchasing patterns likewise diminished. As the Program's rates and terms approached those prevailing in the commercial 192 market, there was not only less of a distinction between CCC financing and commercial financing but also less of a justification for maintaining a separate government financing program. One of the strongest arguments used in support of the Eximbank Program has been that it corrected specific imperfections in the long-term financing market for capital goods exports. The reasoning was that most semi-industrialized and Third World countries required fixed-rate, long-term financing before it could afford to import 'big ticket' capital goods. Furthermore, if this type of financing were not forthcoming, many capital goods imports would not be made. They would not be made even at a reduced scale (and probably at higher rates and shorter terms) since the 'big ticket' imports were indivisible and it would be inefficient to shift to a smaller scale of an imported capital good.36 I have been unable to find any reference to a similar argument in support of the CCC Program. While it is true that the CCC Offers fixed rates for up to 36 months, no one has claimed that this was needed because there were capital market imperfections; that agricultural imports are indivisible; that significant economies of scale exist as to the value (volume) of commodity shipments; or that importers would cease buying if CCC financing were not available. Consequently if none of these conditions exists and if the CCC continued to operate the Program on a strictly 193 'commercial' basis, then importers would have perceived the Program as just another source of financing and the United States as merely another source of supply. The Program would have served only to marginally increase the total supply of credit available to finance agricultural exports and I doubt whether this will be sufficient justification to maintain the Program (particularly not during the present administration). An alternative policy with regard to interest rates would be to set lending rates (whether above or below the CCC's cost of money) at that level which would 'maximize' the returns to the Program. What arguments to include in the Program's Objective function are another matter which has been addressed elsewhere in this paper. Suffice it to say that there has been considerable support (particularly from exporters) for the idea of operating the Program solely to increase agricultural exports. CHAPTER VI ENDNOTES lU.S., Department of Agriculture, "A Time to Choose: Summary Report on the Structure of Agriculture" (January 1981), p. 139. 2U.S., Department of Agriculture, "Implications of Increased Reliance on International Markets," by Ronald L. Meekhof, ESCS Agriculture Economic Report 438 (November 1979): pp. 261-262. 3General Accounting Office, Emphasis on Market Development in Export Credit Program, p. 44. "U.S., Congress, Senate, Committee on Banking, Housing, and Urban Affairs, U.S. Export Policy, A Report submitted by the Subcommittee on International Finance, 96th Cong., lst sess., p. 14. 5 6 Ibid. 7Foreign Agricultural Service, "New Orientation to FAS Market Development Activities," p. 14. 8Office of the General Sales Manager, "Statement of Action on GAO Report," pp. 3-4. Department of Agriculture, "A Time to Choose," p. 139. 9Congressional Research Service, Use of Food Resources for Diplomatic Purposes. An Examination of the Issues, a committee print prepared fOr the Committee on International Relations, U.S. House of Representatives (Washington, D.C.: U.S. Government Printing Office, January 1979). 10 Ibid. llBob Tamarkin, "Food - Myth and reality," Forbes (February 2, 1981), p. 52. 12Congressional Research Service, Use of Food Resources for Diplomatic Purposes, p. 2. 13Senate, Committee on Banking, Housing, and Urban Affairs, Part 5, Agricultural Export Policies, pp. 24—25. 14 Ibid., p. 52. 15Senate, U.S. Export Policy, A Report, p. 16. 16Department of Agriculture, "CCC Credit and Market Development," p. 8. 194 195 17Senate, Committee on Agriculture, Nutrition, and Forestry, Hearings on S. 2385, 2405, 2504, 2968, 3011, p' 1470 18General Accounting Office, Emphasis on Market Development in Export Credit Program, p. 44. 19Senate, Committee on Agriculture, Nutrition, and Forestry, Hearings on S. 2385,2504, 2968, 3011, pp. 46-47. 20 Ibid., p. 47. 21Senate, U.S. Export Polioy, A Report, pp. 15-16. 22OGSM personnel reported in a telephone conversation that the OGSM has gone to considerable expense on cables in attempt to collect information on competito rates, total amounts, eligible commodities-countries, etc. Neither they nor the U.S. Agricultural Attaches had much success. 23Department of Agriculture, "CCC Credit and Market Development," p. 8. 2"Senate, Committee on Banking, Housing, and Urban Affairs, Part 4, Export-Import Bank Authorization and Related Issues, p. 84. 25Senate, Committee on Banking, Housin , and Urban Affairs, Competitive Export Financing, p. 1 7. 26For a description of a methodology which could be employed in estimating global cost see Axel Wallen, "Arrangement on Guidelines for Officially Supported Export Credits: Implications for the Arrangement of Operational Alternatives to the Present Matrix (Paris: Trade Directorate, OECD, April 24, 1980). 27Senate, Committee on Banking, Housing, and Urban Affairs, Export-Import Bank Programs and Budget, p. 85. 28Senate, Committee on Banking, Housing, and Urban Affairs, Competitive Export Financing, p. 180. 29That is not to say that there are not political reasons to avoid such an approach. Agricultural trade has a tradition of being the most intractable item on the agenda of every multilateral trade negotiation since the so-called Dillon Round was initiated by GATT in 1961. 30General Accounting Office, Emphasis on Market Development in Export Credit Program, p. 14, and see Department of Agriculture, "CCC Credit and Market Development." 196 31General Accounting Office, Emphasis on Market Development in Export Credit Program, p. 18. 32Ibid., p. 17. 33Ibid., p. 18. For a description of one analytical technique for performing a constant-market-share analysis that decomposes a country's change in exports due to (1) a general increase in world trade, (2( commodity composition, (3) market distribution, and (4) a residual competitive effect see 0. Michael Aho and Richard D. Carney's paper presented in Senate, Committee on Banking, Housing, and Urban Affairs, Part 2, Trends in Exports and Competitiveness, pp. 138-I51. 3"General Accounting Office, Emphasis on Market Development in Export Credit Program, p. 14. 35Office of the General Sales Manager, "Statement of Action on GAO Report," p. 2. 36Senate, Committee on Banking, Housing, and Urban Affairs, Part 4, Export-Import Bank Authorization and Related Issues, pp. 444-445. APPENDIX 197 APPENDIX A NECON Model Description The National Economy Model is a recursive input-output model of the Korean economy. The model has 16 sectors which are an aggregation of a 52 sector input-output model estimated by the Bank of Korea in 1970. The recursion takes place via the linkages with the demand and production models. These interactions and the model's inputs and outputs are shown in Figure 18. NECON is an unconstrained production model that is essentially demand driven. For this reason we will describe the derivation of demand in some detail. Consumption Functions Both food and nonfood consumption functions were estimated using a Cobb-Douglas equation of the form: ( )E MPC. (DEPij .SN(t) _ HAPCD(t) (GDPP t (1) PCDMim ‘ “i' (‘17? i(—C'17'—)G inI‘MP—ciTT) 31 where: PCDM = per capita consumption at constant relative consumer prices (won/person-year) MPC = consumer price index (1970 = 1.00) APCD = total nonfood consumption expenditures at constant relative consumer prices (won/person-year) GDPP = per capita gross domestic product (won/person—year) 198 mHOOOE mo Emummm Houoom HONDUHDOHHw< Cmouox can mo maopofi Honuo wouooaom cam Hoooz hEOCOOM Hmcofluoz OLD GOOBDOQ mowmxcfla MOnmz ma ouswflm 2:9:0 .25 22.5.2.5 , A 2.3.555 5...... .55538m 30:5. 8.5 25.5 2:585 .53.“. 2:58: 0:2. 52:... 8.x. 2.38.5 2585 55.52 35:. 5:3. no.2 .8... 5.38350 0.3:“. .5833... 23:; 5.3.22.5 .55... 22 55:88 5.2:”. 52:555. 35:55:52 < 35:0 .525: .5... 58258. 25.32 _ 4 I 5.552.. 32:. x .5... 5.5. 3.... too“. 93 2:...— 5.3.5.5.. 5.5. 35.5593 3.5 250:. 5.35550 poo... .5352 8.3.52 3.2.55: 5.38550 5352 < 2.2... 5.05“. 62......553 199 SN = elasticity expansion parameter 1, J = index commodities, k, j = l, 2,..., NNC NNC = number of commodities Food consumption is calculated in the demand model while nonfood consumption is generated within NECON. Separate estimates of consumption functions were obtained for farm and nonfarm populations. Total consumption for each commodity group is then the sum of consumption by these two groups 2 (2) CDMi(t) = MPCi(t) [CDPMi(t) + Z PCDMik(t)POPk(t)] where: CDM = consumption demand at current relative consumer prices (won/year) MPC = consumer price index CDPM = public consumption demand at constant relative consumer prices (won/year) POP = farm and nonfarm population (persons) 1 indexes all sectors, 1 = l, 2,..., NS NS = number of sectors (currently 16) Consumer goods imports are computed by first deflating CDM to constant relative prices (CDMi/MPci), then determining imports at constant relative prices (CMC CDMi/MPCi), and finally adjusting to current relative 1 world prices with PWLDi. (3) CMi(t) = PWLDi(t)CMCi(t)CDMi(t)/MPci(t) 200 where: CM = consumer goods imports at current relative world prices (won/year) PWLD = world price index CMC = consumer goods import coefficient (proportion) Domestic consumption demand at current relative producer prices is used in the production component of NECON as part of final domestic demand. It is a function of domestic consumption at current relative consumer prices (CDMi-CMi) and trade and transportation margins. CDMi(t) - CMi(t) (4) DCD.(t) = 1 1 + TDMGCi P12(t) + TPMGC. P13(t) FE???" 1 FZTET‘ for i # 12 or 13, where: DCD = domestic consumption demand at current relative producer prices (won/year) TDMGC, TPMCG consumer goods, trade and transportation margins, respectively, at constant relative producer prices (constant won of margin/constant won of consumption) P = producer price index (see price component discussion) The remaining two elements of final demand are government consumption and eXport demand. Both of these would be set to their historical levels. The latter, export demand, would be subject to adjustment to reflect the effect of changes in CCC credit. 201 Investment NECON also computes net and gross investment, demands for investment goods and investment goods imports as required by the production component and for national accounting. The proportional rate of change of private net investment is a function of the proportional rates of change of profits per unit output and capacity utilization. PPULi(t) - PPULi(t-DT) (5) IVPRi(t) = IVPRi(t-DT> [1 + “”311 PPULi(t-DT) CULi(t) - CULi(t-DT):| + CEIi CULi(t-DT) where: IVPR = private net investment at constant relative investor prices (won/year) PPUL = exponential average of recent past profits per unit output (proportion-—won of profits/won of output) PEI = profitability elasticity of investment CUL = exponential average of recent past capacity utilization rates (proportion/year—-won per year of output/won of capital stock) 1 = indexes nonagricultural sectors, 1 = 2, 3,...,NS A matrix BN is used to convert from investment in a sector to demands for investment goods, where BNij is demand for investment good 1 per unit investment in sector j. BN is computed in nominal terms based on 1970 incremental 202 capital-output ratios and current relative producer price indices. ICORijPi(t) (6) BNi.(t) = NS for i, j=1, 2, ..., NS 3 z ICORijk(t) k=1 where ICORiJ is the incremental capital-output ratio, i.e., demand for investment good 1 per unit change in output of sector j. Investment goods demands at current relative investor prices are: (7) IDi(t) = BNil6(t) [GIV16(t) - PIG16(t)RESCON(t)] NS + 2 EN . t GIV.(t 21 “H J) J j#16 Imports of investment goods at current relative world prices and demand for domestically produced investment goods are computed in a similar fashion as are consumer goods demands. (8) IMi(t) = IMCi(t)IDi(t)PWLDi(t)/MPIi(t) IDi(t) - IMi(t) (9) DIDi(t) = 1 + TDMGIip12(t) + TPMGIip13(t) pi(t) pi(t) for i # 12, 13 and NS p12(t) (10) DID12(t) = §=1DIDj(t)TDMGIj'EETET— j#12 NS p13(t) j#13 (11) DID13(t) = Z DIDj(t)TPMGIj 53(57— 203 where: ID = demand for investment goods at current relative investor prices (won/year) IM = investment goods imports at current relative world prices (won/year) MPI = market price index for investment goods IMP investment goods import coefficients PWLD = world price index DID = domestic investment goods demand at current relative producer prices (won/year) TDMGI, TPMGI = trade and transportation margins, respectively, for investment goods (constant won of margin/constant won of investment goods) P = producer price index (see_price component discussion) Production Based on final domestic demand, the production component computes output at current relative producer prices and unit value added for each sector. In matrix notation, out put is 1 (12) OUT(t) = [I - AD