In this post, Ivan Luketina is presenting the results of his research work. He is answering very important question, i.e. why does New Zealand export sawn timber and logs to different markets? If you want to get known the response for this peculiar question, continue reading…
New Zealand’s Forest Product Exports
New Zealand’s forestry production is increasing rapidly. Planting rates increased in the 1970’s and 80’s, which was followed by a large spike in planting during the early 1990’s. This has seen New Zealand’s harvest increase from under 20 million cubic metres to over 30 million cubic metres in just 5 years from 2009 to 2014. Annual harvests are steady at around 30 million cubic metres, but the early 1990 planting boom is getting closer to harvest. The expected increase in harvest which has already begun is referred to as the ‘wall of wood’. We may see another 5 million or more cubic metres added to annual harvest within the next five years.
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The increase has been almost entirely accommodated by an increase in log exports. While domestic processing has remained relatively level, there has been a constant increase in the volume of logs being exported, mostly to China. Nearly 60% of the harvest is now exported as logs, 10 years ago it was less than 30%. Log exports represent a lost opportunity for New Zealand processors. When logs are sawn overseas, the jobs and added value are exported, as is the residue for downstream processing.
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Logs and sawn timber markets for New Zealand are split. Most markets accept either logs or sawn timber, only a few take a mix of both. Log markets are very concentrated, over 95% of logs go to just three markets, nearly 70% goes to China alone. Sawn timber markets are much different, they are diverse, no market takes more than 22% of logs, and it takes 21 different countries to make up the top 95% of exports.
To understand why log markets are taking off, while sawn timber remains stagnant, it is important to understand the differences between these markets. The aim of this study is to understand why New Zealand exports logs to some markets and sawn timber to others, and what the characteristics of those markets are that lead to this behaviour.
The Differences Between Markets
Initial investigation showed some obvious differences between the markets, and some potential influences where the effect is not clear. In some countries massive tariff escalation between logs and sawn timber showed a clear bias towards importing logs. Many countries take this approach to protect their domestic industry from competition. Countries like India, where the sawn timber tariff has been up to 26% in recent years, have strict laws protecting small scale processors. Processing industries are often protected through non-tariff barriers (NTBs) that seek to lower the imports of processed goods, in favour of importing the raw material. There are also competitive effects, with other suppliers, and with the domestic industry in the importing market. Some other suppliers protect domestic processing through export tariffs, or laws that restrict log exports. Meanwhile it is often stated that New Zealand processors struggle to compete with processing in countries where the labour costs are much lower.
Analytical Framework
To analyse the issue an econometric model of export demand was used to estimate the impact that these different barriers are having on sawn timber exports. A standard demand model was used, where demand for the product is explained by real GDP and real prices. Import tariffs that are given as an ad-valorum rate are added to the price to give a better representation of the import cost. A panel model of New Zealand’s sawn timber export markets is used so that New Zealand’s export market can be modelled fully. A double-logarithmic formula is used to show the elasticities of demand for the variables. Different variables were then added to this formula, to estimate the impacts of things like competitor presence in the market, tariff wedges between the raw material and the finished good, and the effect that wages have. This model was also then applied to New Zealand’s export log markets to show where the differences are between sawn timber and log markets.
The formula used is shown below:
L signifies the natural log
EV is the export volume
GDP is the real GDP in the local currency unit
IPR is the import price, (cost, insurance, freight) with (T) the tariff applied to it
i and t are variables for time and country
Results
The demand model used is a good fit, with positive signs for income (GDP) and negative for price, meaning that there was a downward sloping demand curve, as expected. This is shown in both the log and sawn timber export models.
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There were also significant results for modelling the tariff wedge and the size of the softwood harvest in the importing market. The softwood harvest cause a negative impact for demand for imports sawn timber and in logs. The tariff wedge (the sawn timber tariff minus the log tariff) was negative for sawn timber, but there was no significant effect for logs.
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Other variables tested such as competition effects and wage rates did no show significant impacts. Wage rates are likely to be overcome through higher levels of automation and lower reliance on labour. This result is not surprising, given that New Zealand’s larger sawn timber markets are in South East Asia, where labour costs are very low.
Table 1 Sawn timber model results
Table 2 Log model results
* The tariff wedge co-efficient is misleading. As tariffs are expressed as a percentage of the import price, a logarithmic value cannot be taken, this means that in the model 1 + the tariff rate had to be used, meaning that the elasticity is inaccurate. The model would treat a 100% increase in the tariff wedge from 10% to 20% as just a 9% increase from 1.1 to 1.2. Once this is considered the actual elasticity of demand with respect to tariff wedges is -0.45 for sawn timber.
Policy Implications
As the tariff wedge has a significant negative impact on sawn timber demand, but not log demand, it is clear that tariff escalation is one of the driving factors between the markets for sawn timber and for logs. Where these tariffs are present, New Zealand exports are being driven towards importing logs rather than sawn timber. This is a good justification for New Zealand to continue its work in implementing free trade agreements and lowering tariffs for its exports.
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Different NTBs were tested in the model but were not found to be significant, these include some NTB’s described in the UN TRAINS database, as well as others such as the Corruption Perception Index. NTBs are hard to estimate, and hard to track. This means that it is hard to measure their effect. As there is a quantifiable difference shown for tariffs, if a tariff could be shown to be having a measurable impact on sawn timber imports and not log imports, this framework would be appropriate for analysing the difference. Some NTBs can be applied to this framework. In China there is a difference between the value added tax (VAT) for sawn timber and the VAT for logs. This is directly relatable to the tariff wedge, and when analysed as a tariff wedge using the demand model the effect is quantifiable. The difference in VAT in China, which is set to be increased, is estimated to be suppressing sawn timber export volume by up to 20%.
Free Trade Agreement Analysis
Given the ability to use this model to analyse the impact of tariffs and tariff wedges, it is a good tool for estimating the effectiveness or potential impact of free trade agreements.
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New Zealand signed the China Free Trade agreement in 2008, and amongst other changes, tariffs on logs were dropped from 8% to 0%, while the tariff for sawn timber was dropped from 14% to 0%. This meant that the tariff wedge was also eliminated. The effect for sawn timber exporters can be estimated through running the model with, and without tariffs included for the years since 2008.
The difference is estimated to have been major. Sawn timber exports have increased by about $64 million per year compared to the alternative. This has been worth over $400 million in exports since the agreement was signed. This is a 1.5% increase in export value of all forest products for New Zealand and an 8% increase in the value of sawn timber exports.
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This framework can also be applied to analyse the impact of other free trade agreements, and the potential for free trade agreements under negotiation as well.
Author of the post:
Ivan Luketina
Student – University of Canterbury
ivan.luketina@mpi.govt.nz