Canada - U.S. Pesticide Regulation: An Economic Analysis

An Expert's View about Agriculture and Animal Husbandry in Canada

Posted on: 30 Mar 2010

An Economic Analysis of Price Discrimination. AAFC has monitored pesticide prices on both sides of the border for many years because pesticide pricing has been a perennial issue. Canadian farmers have more recently been concerned with pesticide availability.

CANADA ? U.S. PESTICIDE REGULATION: An ECONOMIC ANALYSIS of PRICE DISCRIMINATION by Cameron Short Policy Analysis Division Agriculture and Agri-Food Canada and David Freshwater Agricultural Economics University of KentuckyDecember 2004 CANADA ? U.S. PESTICIDE REGULATION: An ECONOMIC ANALYSIS of PRICE DISCRIMINATION December 2004 Strategic Research Agriculture and Agri-Food Canada Any policy views, whether explicitly stated, inferred or interpreted from the contents of this publication, should not be represented as reflecting the views of Agriculture and Agri-Food Canada (AAFC). AAFC does not control the availability of Internet web sites featured in this report. Therefore, it does not take responsibility for severed hyperlinks or discontinued web pages mentioned herein. Links to these web sites are provided solely for the convenience of users. AAFC does not endorse these sites, nor is it responsible for the accuracy, the currency or the reliability of the content. Users should be aware that information offered by sites other than those of the Government of Canada are not subject to the Official Languages Act. Electronic versions of Research and Analysis publications are available on the Internet at http:// www.agr.gc.ca/spb/rad-dra Publication 53261786B ISBN 0-662-38727-9 Catalogue A38-4/1-2004E-PDF Project 04-037-r Aussi disponible en français sous le titre : « Réglementation des pesticides au Canada et aux États-Unis : une analyse économique de la discrimination des prix » TABLE OF CONTENTS 3.4 Cross-border price patterns ....................... 11 Foreword ................................................... v 3.5 Implications for price discrimination .......... 13 Executive summary..................................... vii 4. Effect of eliminating price discrimination .. 15 1. The role of pesticides in farm production.. 1 4.1 Estimation of the consequences of price discrimination .......................................... 15 2. The regulatory process ........................... 3 4.2 Data on pesticide use ............................... 16 2.1 Evolution of the regulatory structure ......... 3 4.3 Linear results........................................... 17 2.2 Link between regulation and market power 4 4.4 Non-linear results..................................... 21 3. Pesticide availability and pricing issues..... 7 4.5 Conclusion ............................................... 24 3.1 Availability issues..................................... 7 REFERENCES ............................................. 25 3.2 Pricing issues .......................................... 9 3.3 The theory of price discrimination ............. 9 ANNEX ...................................................... 27 TABLE Table 1: Change in consumer surplus with marginal cost at 20% and 80% of the lower observed price, $US million ....................................................................................... ix Table 2: Impact of pesticides on production of major crops ...................................................... 2 Table 3: Comparison of average pesticide prices in Manitoba with North Dakota/Minnesota,1994-99 ................................................................................................................... 11 Table 4: Summary of regression results................................................................................... 12 Table 5: Herbicide price and quality data, 1997........................................................................ 17 Table 6: Linear model results for prices, quantities, consumer surplus (CS) and processor profits (percent change from base) ...................................................................................... 20 Table 7: Non-linear model results for prices, quantities, consumer surplus (CS) and processor profits (percent change)............................................................................................ 23 Table A1: Linear model calibration results.................................................................................. 27 CANADA ? U.S. PESTICIDE REGULATION iii An economic analysis of price discrimination TABLE OF CONTENTS ivTable A2: Linear model elimination of price discrimination results................................................ 28 Table A3: Non-linear model calibration results ........................................................................... 30 Table A4: Non-linear model elimination of price discrimination results ......................................... 31 FIGURE Figure 1: Equilibrium under price discrimination and uniform pricing........................................... 9 Figure 2: Smaller market not served with single price................................................................ 11 Figure 3: 95 percent confidence intervals for trifluralin, glyphosate and malathion for Canadian an U.S. locations ........................................................................................ 13 Figure 4: Effect of the elimination of price discrimination with linear demand functions................ 18 Figure 5: Effect of an increase in the value assumed for marginal cost........................................ 18 Figure 6: Comparison of the effect of the elimination of price discrimination with alternative assumed values for marginal cost .............................................................................. 19 Figure 7: Comparison of the effect of the elimination of price discrimination with linear and non-linear demand functions ..................................................................................... 22CANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination FOREWORD AAFC has monitored pesticide prices on both cation process and have begun work on a com- sides of the border for many years because pes- mon ?NAFTA label? that would be used in all ticide pricing has been a perennial issue. three countries. Canadian farmers have more recently been con- Patent protection and pesticide regulations con- cerned with pesticide availability. In May 2003, fer market power, which firms can use to recoup the Government of Canada committed $54.5 mil- the cost of product development and registra- lion over six years to provide faster registration, tion. This report first evaluates cross-border dif- which will improve the availability of minor-use ferences in pesticide pricing and availability, and reduced-risk pesticides and help Canadian taking into account this market structure, to producers. U.S. farmers, particularly in North determine whether current plans for regulatory Dakota, have complained that they face higher harmonization will likely result in harmonized prices than Canadian counterparts, which led to prices and availability. Secondly, it evaluates the a proposal to allow farmers to import pesticides consequences of effectively eliminating cross- for their own use from Canada. Although this border price discrimination for pesticides in legislation was not adopted, the issue of cross- terms of the impact on pesticide prices and use border differentials in pricing and availability is and the welfare of farmers on both sides of the an on-going irritant. border. The Pest Management Regulatory Agency in The international component of the Agricultural Canada and the American Environmental Protec- Policy Framework (APF) is designed to maximize tion Agency have been increasing regulatory international opportunities arising from progress cooperation through the NAFTA Technical on the domestic front. This report illustrates Working Group on Pesticides with the goal of a some of the most complex issues involved in our North American market for pesticides. They have relationship with our most important trading approached harmonization through agreementspartner. on work sharing and the creation of a joint appli- CANADA ? U.S. PESTICIDE REGULATION v An economic analysis of price discrimination EXECUTIVE SUMMARY Pesticide regulation has important implications the costs of registration but the pass-though of both for the regulatory process in general and these benefits depends on whether the markets for agricultural conditions. Country-specific regu- for pesticides are competitive or not. The conse- lation of pesticides to preserve human health quences of regulatory change, therefore, could and environmental quality has the unintended include some unintended adverse consequences, consequence of creating a perfect mechanism to especially in Canada. prevent cross-border arbitrage and allow price 1 Patent protection is a barrier to entry and allows discrimination. Pesticide price differentials have patent holders to maximize returns by setting fueled interest by U.S. farmers to import Cana- prices above marginal costs. Many pesticides dian pesticides while Canadian farmers are con- currently benefit from patent protection. Pesti- cerned that some pesticides used by American cide regulation provides a further barrier to entry competitors may not be available in Canada. and, since pesticide registration is use-specific, a Concerns with pesticide market structure and means of market segmentation. Market segmen- regulation together with evidence for price dis- tation in turn allows cross-border price discrimi- crimination are summarized in this report, with nation that results in systematic price patterns in an analysis of the impacts of eliminating price different market segments?patterns unrelated discrimination for four specific pesticides. to costs specific to the market segment. In general, the design and management of the The existence of persistent price differentials for regulatory process in Canada and the U.S. has pesticides has been studied for some time not been concerned with either the impacts on [Carlson, McEwan and Deen, McEwan and Deen, pesticide manufacturers pricing strategies or the Taylor and Koo, Taylor and Gray]. It is shown effects on farmers profits and production oppor- here that price differentials for some pesticides tunities from differences in access. Regulatory are significantly different between Canada and cooperation in North America has been largelythe U.S. but there are no significant differences focused on the objective of harmonization under in pesticide prices in markets studied within each the assumption that this will provide uniform country. Furthermore, the prices of some pesti- benefits to all customers and possibly to manu- cides are systematically significantly higher in the facturers. The logic of this argument comes from U.S. while the prices of other pesticides are sys- an expectation that harmonization will reduce tematically higher than those in Canada. Although several alternative hypotheses were 1. There has been wide-spread attention recently to a very simi- considered, only price discrimination is consis- lar process that encourages imports of lower-priced prescrip- tion drugs from Canada by American consumers, thereby tent with the price patterns seen in these data. weakening a long-standing price structure that favored Cana- Given that price discrimination is a widely prac- dians. ticed pricing strategy, the conclusion that price CANADA ? U.S. PESTICIDE REGULATION vii An economic analysis of price discrimination EXECUTIVE SUMMARY viiidifferentials are indeed a result of price discrimi- were the same in both markets. The exercise nation is therefore warranted. was repeated with linear and a non-linear func- tional forms for the demand functions. Complaints of various farm groups that free trade should mean uniform prices at the retail In all cases, the equilibrium price without price level have resulted in some attempts to effect discrimination is found to be close to the changes to promote pesticide uniform prices. American price because of the larger size of that Most notably, Dorgan, Baucus and Conrad intro- market. Demand elasticities are greater than duced legislation in the U.S. Senate to allow unity for a monopolist and the equilibrium condi- farmers to import pesticides for their own use tion for price discrimination implies that demand from Canada. The objective of this legislation elasticities are higher in absolute terms in the appears to be supported by the regulatory market segment with the lower price. As a result, bodies responsible for pesticides in the NAFTA we see relatively large price changes (increases area whose joint objective is to create a single for Glyphosate, Fenoxaprop, Clopyralid, and market for pesticides in North America. decrease for Sethoxydim) for Canada and corres- ponding large changes in quantity demanded. However, the consequences of creating a single Under some, perhaps extreme, assumptions market do not appear to have been evaluated. In about functional form and marginal cost, de- this paper, the effects of eliminating market seg- mand in Canada is reduced to zero because the mentation of four pesticides (Glyphosate, resulting price exceeds the highest price Cana- Fenoxaprop, Clopyralid and Sethoxydim) sold in dian farmers would be willing to pay. Profits to both Canada and the U.S. are estimated. Results the manufacturer are always lower and total are given for both the change in price and quan- quantity produced is always lower for the non- tities of the pesticide sold in each country, for linear demand functions. total sales in both countries, profits of the pesti- cide manufacturer and the welfare of farmers Table 1 shows the welfare changes that result who use the pesticide (as measured by the con- from the elimination of price discrimination for sumer surplus areas under their demand curves) each of the three principal agents in the market. on both sides of the border. The models show that even though aggregate welfare from changing to a uniform price from The market equilibrium condition for a firm price discrimination, or vice versa, is small but facing downward sloping demand functions in the components that accrue to farmers in each two or more market segments can be used to country or to pesticide manufacturers can be calibrate demand functions for certain functional large. The distribution of winners and losers and forms using only observations of prices and their magnitudes are very consistent across quantities in each market and marginal cost. values assumed for marginal cost and the func- Estimates were made of prices and quantities of tional form used for the demand function. the four pesticides on both sides of the border. The price of Sethoxydim is higher in Canada On the other hand, total welfare changes are while the prices of the other three pesticides are relatively small and sensitive to assumptions higher in the U.S. Marginal costs are not known about marginal cost. The variation in total wel- but they must lie between zero and the lower of fare gains includes change in sign with the linear the prices observed in Canada and the U.S. demand function. Total welfare increases with Demand functions were therefore calibrated with the elimination of price discrimination except marginal costs varying in increments of 10% when the lower price market is eliminated alto- over the range 20 ? 80% of the lower observed gether. However, with the non-linear demand price for each of the four pesticides. The demand function, total welfare decreases for Glyphosate, functions were then solved to maximize manu- Fenoxaprop and Clopyralid but increases with facturer returns under the condition that prices Sethoxydim.CANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination EXECUTIVE SUMMARYTABLE 1 Change in consumer surplus with marginal cost at 20% and 80% of the lower observed price ($US million) Canadian farmers U.S. farmers Pesticide company* 20% 80% 20% 80% 20% 80% LINEAR DEMAND Glyphosate -17.7 -5.4 47.6 0 -20.0 -10.7 Fenoxaprop -9.9 -3.2 23.5 0 -9.1 -6.5 Clopyralid -2.4 -1.1 4.5 7.4 -1.4 -4.2 Sethoxydim 9.0 10.9 -5.5 -3.0 -2.4 -5.3 NON-LINEAR DEMAND Glyphosate -20.5 -9.5 28.9 4.1 -9.8 -9.9 Fenoxaprop -11.1 -5.6 15.3 3.7 -4.6 -5.5 Clopyralid -2.7 -1.7 3.5 1.9 -0.8 -1.4 Sethoxydim 8.8 10.5 -7.0 -5.3 -1.6 -3.0 * In some instances, slightly higher values occur for values of marginal cost between 20 and 80%. Finally some conclusions may be drawn from this are not particularly strong, even under price particular example that may be applicable in discrimination, then removing the increment many of the other markets subject to price dis- of profit that comes from discrimination can crimination: alter longer run incentives to participate in specific markets. ? The standard assumption found in intermedi- ate microeconomic texts is that eliminating ? The specific nature of the demand functions price discrimination leads to increases in wel- has a great impact on the distribution of wel- fare is generally true only for linear demand fare gains and losses associated with functions, and only if the interests of individu- imposing a uniform price. Once a linear als in each market has equal weight in the demand function is abandoned it is unlikely social welfare function. that output will be invariant when moving from price discrimination to a uniform price. ? Since the new market price when discrimina- Even assuming social welfare functions that tion is eliminated is bounded by the two impose equal weights on individual welfare prices prevailing under discrimination, some being in place, it is still possible with some individuals will be net loses. For aggregate fairly simple functional forms to show price welfare to increase there has to be a larger discrimination is socially desirable. increase in welfare in the market that experi- ences the price decline than the sum of the The case of pesticides also has some interesting loss in welfare in the market where price implications of how the benefits of freer trade increases and the lost profit for producers. and regulatory harmonization may be distri- Importantly, moving from price discrimination buted. to a uniform price always results in both win- ? Clearly, free trade is not sufficient to create a ners and losers. single market for products like pesticides. It ? Because price discrimination is more profita- will always be in the producer?s interest to ble than charging a uniform price, there is a maintain market segmentation and price stronger incentive for firms to participate in products according to differences in demand the market. If in the long run profit margins elasticities so segmented markets for theseCANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimi ixnation EXECUTIVE SUMMARY xcommodities are likely to persist unless con- suggests that the social welfare implications of sumers have the right to import freely from change are complex, both in terms of short other countries in the free trade area. terms static effects on different groups and in terms of the longer run dynamics of the industry. ? Many of the benefits of regulatory harmoniza- There has always been a recognition that harmo- tion should reduce compliance costs and nization of pesticide regulation may not be other fixed costs. The benefits of these desirable. The main argument in the past has changes are likely to be captured by the been that there may be sound environmental manufacturer at least in the short run. The and public policy differences that require the benefit to the consumer will be in the form of markets be treated as distinct entities. Our work a wider range of suitable products available in also confirms that domestic policy interests can the market. Consumer benefits will be provide an additional reason for maintaining dis- realized only when greater competition from tinct markets if one party is a net loser. However a wider range of products results in more we also raise the possibility that price discrimina- elastic demand functions for each product. tion may provide a higher level of aggregate wel- fare than is the case if prices are set at a uniform At the most general level the implications of the level. analysis for pesticide policy are significant. ItCANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination SECTION 1 The role of pesticides in farm production Pesticides are a class of compounds used in agri- As a result, there would be some combination of culture to enhance the quality and/or quantity of a significant reduction in food production or desirable species of plants or animals. Pesticides expansion of land under cultivation (Oerke et al). control pests by either killing or weakening them, Expanding the area cultivated would bring its or by making the treated product unattractive to own problems in the form of lost species habitat the pest. Pests take the form of animals, insects, and increased levels of erosion. Finally, cultiva- plants, fungi and nematodes, but the defining tion practices would have to return to more feature of a pest is that it causes an adverse intensive use of plows, discs and harrows, all of effect upon some species of plant or animal that which require increased outlays on tractor fuel the farmer is trying to produce. and increased soil compaction. While natural forms of pesticides have been Pesticide expenditures are a relatively small employed since the very early stages of agricul- share of total input costs for most farmers. How- ture, pest management took on new significance ever they play a more significant role than their following World War II as advances in chemistry share of production costs would suggest. Fox and biology combined with the mechanization of and Weersink describe pesticides as part of a agriculture and the wide spread use of synthetic group of inputs that provide damage control. fertilizer to transform production technology. The Their value in the production process is indirect USDA estimates that 86 percent of the acreage in the sense that they limit the effect of adverse planted to five major crops (wheat, corn, cotton, conditions on the production process. This soybeans and fall potatoes) were treated at least means the marginal value of the damage control once with a herbicide (USDA 2000, p. 19). Of input depends upon the conditions that prevail. these crops, cotton made the most use of all In some circumstance, few pests, the marginal forms of pesticides and wheat the least. Other value product of pesticides is small. In other cir- USDA analysis shows that fruits and vegetables cumstance, many pests, it is high. Importantlyhave far higher per acre use rates and employ a decisions about pesticide application typically broader spectrum of pesticides (USDA 2001, have to be made without good information about p. 13). pest incidence. Table 2 demonstrates the importance of pesti- Another critical factor in the process is that appli- cides for the production of some major crops cation rates are not continuous. There are legal world wide. Crop production without pesticides maximum quantities of each pesticide that can would result in lower yields, greater field and be applied. Exceeding these levels can lead to post harvest losses and declines in the quality of legal problems for the farmer or applicator. In product that would lead to a reduced supply of their paper, Fox and Weersink suggest that there food and fiber and consequently higher prices. are often increasing returns from applying pesti- CANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination 1 SECTION 1 The role of pesticides in farm production 2cides up to some ceiling (either the maximum great bearing both on short run quality and allowable rate or a rate that achieves complete quantity of output and, in the long run, produc- control). This means that profit-maximizing tion technology available to farmers. This means farmers will often either apply the ceiling rate or that the price, and more importantly the availa- no pesticides (Fox and Weersink, p. 38). bility, of pesticides could greatly influence the economic position of much of the farm sector. In summary, although pesticide prices are a small share of total production costs, they have a TABLE 2 Impact of pesticides on production of major crops Estimated % decline in Theoretically Actual % increase in production production Crop attainable production land to restore without crop without crop production (avg. 1990-98) actual output protection protection Rice (mt) 1047 509 184 64% 280 Wheat (mt) 831 548 400 27% 140 Barley (mt) 244 172 129 25% 130 Maize grain (mt) 729 449 295 34% 150 Potato (mt) 464 273 123 55% 220 Soybeans (mt) 152 103 63 39% 160 Cotton (kt) 84.1 52.4 13.9 74% 380 Coffee (kt) 9.8 5.9 3.0 49% 200 Source: E-C Oerke, H-W. Dehne, F. Schonbeck, and A. Weber. Crop Production and Crop Protection Estimated Losses in Major Food and Cash Crops. Amsterdam: Elsevier Science B. V. [1994]CANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination SECTION 2 The regulatory process Pesticides have significant costs inherent in their human well-being, wildlife and natural habitat. use. Because they are toxic by design, they can Both governments use essentially the same proc- harm non-target species, including applicators, ess to register pesticides for each allowable use, bystanders and wildlife. Pesticide residues can except that Canada still requires efficacy testing. become embedded in food products with possi- Consequently, the impacts of pesticide regulation ble harmful effects for consumers. There has on farm profitability and the competitive position therefore been an increasingly important regula- of agriculture are at best secondary elements in tory role governing the use of pesticides. the decision process of both countries. The concern in this paper is with the regulation While both Canada and the U.S. have each oper- of which pesticides are deemed acceptable to ated independent regulatory systems, there has use and their allowable uses. Pesticides are regu- been a longstanding process of collaboration at lated first by patent law which establishes the the agency level. As the scientific basis of regula- property rights of the inventors of each new pes- tion increased it became obvious that there was ticide product and then by regulations which, in considerable potential to share scientific exper- effect, licenses each allowable use of a pesticide. tise and divide the analytical portion of the regu- An allowable use includes the crop on which it latory function between the two countries. In may be used, application rates and other restric- turn this led to the establishment of common tions on how it may be used. The product label is data packages to facilitate the regulatory closely proscribed by regulators in each country process. It should be noted that this did not so that it provides each pesticide applicator with mean that interpretation of the data results was the information necessary to comply with the always the same. One of the more notable regulation. examples of divergent interpretations was the decision by Canada in the early 1980s to ban the 2.1 Evolution of the regulatory structure herbicide Alachlor due to a fear of possible carci-nogenic effects, while the U.S. drew the conclu- There have been significant changes in the regu- sion that Alachlor was safe from the same data lation of pesticides over the last fifty years, (Shapiro et al.). including a shift in the focus of regulation form efficacy to safety and a change in the primary The introduction of NAFTA led to the formation regulatory agency from departments of agricul- of the NAFTA Technical Working Group (TWG) ture to agencies more focused on human and 2 environmental safety. Both the U.S. Environ- 2. Freshwater and Short and Freshwater provide an overview of mental Protection Agency (EPA) and the Pest recent regulatory changes in Canada and the U.S. and the role Management Regulatory Agency (PMRA) of of NAFTA and a discussion of stakeholder interests in the evo- Health Canada are charged with protecting lution of the system. CANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination 3 SECTION 2 The regulatory process 4on Pesticides to provide a forum to better inte- target species could still make some uses possi- grate regulation of pesticides. The TWG includes ble in one country but not in another. representatives of the Comisión Intersecretarial 2.2 The link between regulation and market para el Control del Proceso y Uso de Plagicidas y power Sustancias Tóxicas Mexico as well as the EPA and PMRA. A main focus of the TWG is to ensure As indicated above, regulatory approval is a that common scientific standards are followed, costly process similar, from an economic point of coordinate the analysis of registration data and view, to the research needed to invent the pesti- resolve potential trade irritants such as differ- cide. In addition to establishing patent rights, the ences in maximum residue limits (MRLs). The pesticide manufacturer has to undertake scien- TWG has clearly articulated goals of harmoniza- tific studies to demonstrate the safety of each tion and working toward creating a North Ameri- proposed allowable use of the pesticide. Besides can market for pesticides in which ?growers in all the compliance costs of undertaking these stud- three countries can access the same pest control ies and preparing the submissions for regulatory tools.? It has approached harmonization through approval, there are not inconsequential applica- agreements on work sharing and the creation of tion fees and additional costs imposed in the a joint application process that includes a com- time required to obtain approval. The registra- mon data submission and format and a coordi- tion of a pesticide for a particular use is an intel- nated review process. The working group has lectual property of the manufacturer registering begun work on a common ?NAFTA label? that the pesticide. If a pesticide is no longer eligible would be used in all three countries. for patent protection, other manufacturers must independently incur much the same cost to Joint submissions may provide a significant step obtain the right to sell the product for each use. in reducing the cost of approval for new pesti- Rights to sell a pesticide for a specific use are cides. Pesticide manufacturers have the option of therefore, another barrier to entry over and submitting proposals for allowable uses to indi- above patent protection. vidual governments or jointly. A company may still wish to pursue individual submissions in both Some pesticides have been removed from use in countries if they would like to market a com- response to our greater understanding of their pound differently with regard to concentration, unintended consequences. Other pesticides are application method, etc. Assembling the data less effective because species evolution in the required for registration for three packages is target pests has resulted in greater resistance. both time consuming and expensive. Besides However, the search for effective but safe pest reduced compliance costs, joint submissions are control products has become more difficult over expected to be given higher priority, reducing time due to governments setting more stringent the time required to obtain a decision. Work limits on acceptable risks and the simple fact that sharing offers the potential of considerable cost we have made most of the easy discoveries. saving on the part of the regulatory agencies. Each nation takes a piece of the data in a given In the last decade, both Canada and the U.S. registration package and performs an evaluation implemented major legislative changes in pesti- that will be accepted by the other parties. cide regulation. In the U.S., the Food Quality Protection Act (FQPA) of 1996 significantly With a common label, issues of own use importa- changed the way pesticides were regulated. The tion could largely be resolved. Because the single major elements of FQPA were: the repeal of the label would be legal in each country, there would Delaney Clause to allow the presence of carcino- be no reason to prevent a farmer from crossing genic compounds in food if the level of presence the border to purchase a specific chemical. Note is considered to pose no risk; the creation of a that a common label does not have to mean that new standard for assessing exposure ? the risk all uses or application rates must be standard. cup? that looks at all pathways of human expo- While a farmer in one country could purchase a sure to classes of compounds instead of focusing product that had a common label, it could only on exposure on a compound by compound basis; be used for those purposes, and at those rates, explicit attention to the possibility that infants that were legal within that country. In particular, and children may have more adverse conse- differences in environmental impacts on non- quences from a given level of exposure thanCANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination SECTION 2 The regulatory processadults; creation of a relatively short time-line for sides of the border. The demand for each allowa- reassessing the registration status of all licensed ble use will depend on competition from good pesticides using current standards and the elimi- alternative pesticides and these vary from coun- nation of economic benefit as a factor in the try to country. For example, Carlson, McEwan registration decision. The Pest Control Products and Deen report that only half of 54 herbicides Act that received Royal Assent in December 2002 approved for wheat in Canada and the U.S. are makes many of the same changes in Canadian registered for wheat in both countries. Two of pesticide regulation. the most significant herbicides used for wheat in the U.S are not registered in Canada and five of One consequence of the FQPA has been a focus the most significant pesticides registered in on two broad classes of compounds, organo- Canada are not registered in the U.S. They have phosphates and carbomates that are widely used similar findings on registration for other types of ingredients in insecticides used on major field pesticides and other crops. crops, fruits and vegetables. In many cases, there are no obvious substitutes for insecticides Resulting differences in demand have implica- based upon these materials and there is a con- tions for the optimal marketing strategies on cern that if these products are de-licensed there either side of the border. Naturally it will be most could be significant impacts on production. profitable to register a pesticide in a market seg- ment where demand is stronger and where sub- The development of pesticides has become an stitutes are less satisfactory. increasingly expensive process and the number of firms engaged in agricultural biotechnology Other factors may contribute to differences in has declined significantly in recent years (King, demand elasticity on either side of the border. p. 1). Patent protection and the registration The different crop mix and even potential non- process provide an incentive for firms to engage agricultural uses may also be important to the in the risky and expensive process of developing overall demand for each pesticide in each coun- new compounds. Brown and Gruben (p. 18) try. Government support programs differ across show that property rights provide a strong incen- the border in terms of the crops eligible for sup- tive to restrict supply in a way that extends the port, the amount of support provided and how useful life of the compound. However such pro- support is coupled to farming. Differences in tection clearly creates monopoly power for pesti- other input prices (labour, land, interest rates, cide producers and it is important that efforts to fuel, etc.) and taxes may affect demand elasticity examine the industry recognize the existence of and therefore the optimal pricing policy. this monopoly power. The regulatory system also provides a means of The analysis of Fox and Weersink suggests that segmenting markets. Preventing arbitrage pesticide producers should have considerable among different allowable uses in Canada, for pricing power, especially where there are few example, is not really possible so there may be a close substitute compounds. The cost of switch- single market for each pesticide within each ing to alternative non-chemical control technolo- country. But even products which are licensed in gies (for example, crop rotations or more tillage both countries can not be imported by pesticide operations) may be high. Similarly King?s argu- users because they do not have the labels speci- ment that concentration is increasing in the agri- fying the allowable use in the importing country. cultural biotechnology industry suggests that Cross-border arbitrage is not possible, so pesti- competition may be lower than it was in the cide manufacturers can follow different pricing past. policies in each country. An optimal marketing strategy would recognize cross-border differ- In addition to creating a basis for market power, ences in demand and the opportunity presented the regulatory system provides an incentive for by market segmentation to set prices in each cross-border market segmentation. The demand market that equated marginal revenue with mar- for a pesticide will be the sum of the demands ginal cost. for each registered use of that pesticide on bothCANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination 5 SECTION 3 Pesticide availability and pricing issues Since farmers in Canada and the U.S. remain A considerable portion of the costs getting a new competitors in North American or world markets product to market are related to demonstrating there is considerable concern that the playing that it can be safely used for each potential use. field is level for critical inputs such as pesticides. More rigorous requirements also raise the costs From their perspective, the two critical issues are of registering new pesticides. The importance of first, access to the same spectrum of pesticides the regulatory cost is perhaps best illustrated by as farmers in competing countries and second, the case of ?minor uses?. Governments in both equivalent prices for those products. Canada and the U.S. maintain programs to subsi- dize the registration of pesticides for markets too 3.1 Availability issues small to generate enough profits to cover the cost of registering the pesticide, such as ?minor Several factors combine to restrict access to use? markets. effective pesticides on both sides of the border. Some well-established pesticides may become To some extent minor use status is a relative less effective because of adaptation of pests. Our concept. For example, much of the fruit and understanding and ability to anticipate possible vegetable production in the U.S. involves a minor negative consequences of pesticide use have use of pesticides relative to row and field crops become more sophisticated while our tolerance like corn and wheat. But fruit and vegetable pro- to risk and adverse environmental impacts has duction in the U.S. still represents a large decreased. Regulatory changes therefore tend to enough market that it is worth the support of reduce the options available. Old products are chemical manufacturers. By contrast, fruit and re-tested to ensure they meet current standards vegetable production in Canada is both a minor and it is more difficult to register new products. market, relative to row and field crops, and small The recent introduction of the notion of the ?risk enough that the volume of sales may not be cup? in which pesticides are grouped into classes enough to warrant registering a compound forwith maximum exposure levels for the entire use in Canada even if it is available in the U.S. class is one such change that has important con- for the same crop. sequences for pesticide availability. Aside from the compliance costs incurred directly Pesticide manufacturers continue to submit both by the manufacturer, several different types of new compounds and new uses for registration fees or taxes may be assessed that affect the but as the costs of developing new compounds market. From the point of view of the manufac- may be increasing. It may be more difficult to turer, these costs might be divided into three discover new pesticides today because the easy general types: discoveries have already been made and our ? tariffs, sales taxes and other charges that are lower tolerances of adverse impacts. proportional to the quantity sold and/or price, CANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination 7 SECTION 3 Pesticide availability and pricing issues 8? annual fees and compliance costs such as Harmonization however, may only benefit the those for maintaining registration, and pesticide user indirectly. If there were a large number of manufacturers producing the same ? one time charges and compliance costs such pesticide, competition among them would force as those associated with establishing patent down the price so that all the benefits from rights or the right to sell a pesticide for a par- reducing annual fees would eventually go to the ticular use. pesticide user. If fees were such that manufac- It will be profitable to place a pesticide in a par- turers enjoyed high profits in a particular market, ticular market segment, i, if additional manufacturers would have an incen- tive to obtain the rights to sell the pesticide ?dt ?dt [1] , PV = ?E ? A e + pi (t)q (t)e > 0 i i ? it i i ? forcing down the price to a level where fees dis- t couraged additional market entrants. In such a where E are one-time (type 1, above), costs, A i it market, lower registration costs should result in are annual registration costs in period t (type 2, lower market prices of pesticides. below), q (t ) is quantity so pi (t)ld and is prof- i i 3 its per unit both as a function of time. The However, if the right to sell a particular pesticide expenditures E and A are needed to create and i it is held by a single owner of the intellectual pro- maintain intellectual property rights to sell a pes- perty rights and the pesticide has some unique ticide in market segment i. They are a barrier to advantages, the demand function will be down- entry though clearly not as effective as patent ward sloping. There will be no incentive to rights. The effect of tariffs and taxes would also change prices just because harmonization has tend to reduce the profits that can be generated reduced E and A . It is only in the long run when i it from a particular market segment because they lower fees have resulted in the development of reduce demand or price from the perspective of better substitute pesticides that the demand the pesticide manufacturer. It will be profitable function will become more elastic and the bene- to establish patent rights to a pesticide if the fits of harmonization will be felt at the farm level. sum of the benefits across all market segments is positive i.e., Furthermore, when the owner of the right to sell the pesticide is able to maintain different prices ? dt ? dt [2] PV = ? E ? A e + pi .( t ) q ( t )e > 0 i i ? it i i ? in different market segments he/she may be t better off. His/her operating profits will be maxi- This is the amount that must be set against the mized if the marginal revenue is equal to the research and product development costs marginal cost in each market segment. incurred to invent a new pesticide. The same pesticide sold in both Canada and the The minor use programs increase pesticide avail- U.S. for the same use can differ in several impor- ability by reducing E for the pesticide manufac- i tant respects. The pesticide may be sold at dif- turers. One of the motivations for regulatory ferent product concentrations, which has harmonization has to be to generally reduce the important implications for application. In all burden posed by regulation on pesticide manu- cases, the pesticides will have label as prescribed facturers and users. Harmonization should lead by the regulation in each country. A pesticide can to lower values for E and A and therefore make i it be thought of as consisting of a bundle made up it more attractive to register a pesticide in a par- of the compound itself and the label, which dic- ticular market segment. The manufacturer tates the crops that the compound can be used potentially benefits from harmonization two on, the maximum allowable application rate and ways: through lower costs for the each market the conditions under which the product can be segment he/she serves and the possibly that it applied. Products from another country are typi- will be profitable to sell the product in additional cally not allowed to be used because their label market segments. does not reflect an identical set of the regula- tions. Thus in a strict sense, because the label 3. Of course a more complicated version would consider negative differs from country to country, the product also impacts on other pesticides and related products ? such as differs. seed varieties -- already established by the manufacturer. The number and effectiveness of competing pesticides registered in each market segment will affect potential market size.CANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination SECTION 3 Pesticide availability and pricing issuesBecause of these differences farmers cannot in some significant way or because of price dis- import pesticides from across the border in North crimination. Different prices themselves do not America even for their own use. Pesticides avail- necessarily imply price discrimination is being able on one side of the border may not be avail- practiced. In simple terms price discrimination able on the other or may be available for exists only if the same product, net of shipping different uses. The regulation therefore clearly costs and embedded taxes, is sold at different prevents cross-border arbitrage and establishes prices in two markets (Tirole, p. 133). We will market segmentation. return to this point in the conclusion because it is central for policy decisions about pesticide regu- 3.2 Pricing issues lation. Ongoing differences in pesticide prices between 3.3 The theory of price discrimination Canada and the U.S. have resulted in a number of studies to monitor price differentials and to Price discrimination is typically discussed in inter- examine the impact on producers in various mediate microeconomics texts as part of the countries (Taylor and Koo; Taylor and Gray; development of monopoly behavior. Essentially Carlson, McEwan and Deen; McEwan and Deen). price discrimination is profitable when the firm The magnitude of the difference and the per- can identify distinct market segments which have ceived economic impact has led to legislation different demand curves. By equating marginal being introduced in the U.S. Senate to allow revenue and marginal cost in each market the farmers to import pesticides for their own use monopolist increases profits above the level that from Canada if prices are lower (Dorgan, Baucus is achieved by simply summing the individual and Conrad). While there is considerable interest demand curves and using the aggregate mar- in the relative prices of herbicides by farmers ginal revenue curve (Figure 1). In these discus- and politicians, there has not been a large body sions, because price discrimination results in the of research conducted to assess why pesticide transfer of more consumer surplus to producers prices differ. (i.e. profits are higher under price discrimina- tion), there is a presumption that price discrimi- Higher prices in one market could result from nation is undesirable. real cost differences in serving the two markets, because the products sold in each market differ FIGURE 1 Equilibrium under price discrimination and uniform pricing A potentially interesting consequence of working the marginal revenue curve, as is shown in with what is essentially a kinked demand curve is Figure 1. This provides an additional source of that at the kink marginal revenue becomes dis- price indeterminacy for a profit maximizing firm. continuous. In addition, depending on the spe- These issues are discussed in the literature on cific shapes of the demand curves, it is possible oligopoly pricing, but the consensus in that that marginal cost intersects both segments of literature is that the there are no a priori reasonsCANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination 9 SECTION 3 Pesticide availability and pricing issues 10for specifying a kink at a given point on the purchased. In practice volume discounts are less demand curve for an oligopolist (Ferguson, controversial than non-uniform prices for the p. 347; Tirole, pp. 243-244). By contrast, in the same quantity. case of distinct national demands that are aggre- Most analysis of price discrimination employs gated into a single market, the existence of a linear demand curves. While the use of linear kink is almost certain and its location on the curves is typically a benign assumption, in the aggregate demand curve is well defined. This case of price discrimination it leads to some suggests that pricing strategy is likely to be com- interesting anomalies. First, if both markets are plex over a significant range of outputs if price served when price discrimination is not adopted, discrimination is eliminated. then price discrimination results in no change in Empirically, the monopolist requires estimates of aggregate output. The distribution of output is elasticity of demand in each market and knowl- simply shifted with the more elastic demand seg- edge of the firm?s marginal cost to establish price ment receiving a lower price and larger share levels. If this information is available then the than under a uniform price. Second, if both mar- profit maximizing equilibrium condition is given kets have a common vertical intercept, such as by: the first unit sold in each market is sold at the same price, then price discrimination has no ? ? ? ? 1 1 [3] . effect (Hadar, p. 88). In this case both the profit MC MR ? ? ? ?= = p 1? = MR = p 1? 1 1 2 2 ? ? ? ? ? ? ? 1 ? ? 2 ? maximizing price and the quantity are invariant under price discrimination and under the single where MC is marginal cost, MR , p and n are i i i aggregate market. marginal revenue, price, and point demand elas- ticity respectively in country i. This implies that a A somewhat more sophisticated study of the higher price will be charged in the country with effects of price discrimination has been sug- the less elastic demand and the price would only gested by Varian (1985). He notes that where be the same if by chance the demand elasticity is there are significant differences in the size of the the same. Since elasticities depend both on the two markets it is possible that without price dis- slope of the curve and a specific price quantity crimination the smaller market will not be combination on the curve, this is an unusual served. This results if the profit maximizing price event. in the aggregate market is above the intercept, or reservation price, in the small market Discussions of price discrimination normally (Figure 2). Higher demand in the large market adopt Pigou?s three part classification (Phlips, with a a single and lower price is not sufficient to pp. 11-14). First degree price discrimination offset the lost sales in the small market. Varian assumes that the firm has complete knowledge concludes that a necessary condition for price of each individual?s demand schedule and can discrimination to be welfare enhancing is that prevent each customer from reselling the com- output has to be higher under price discrimina- modity. This allows each unit to be sold at a tion than under a single price. unique price and exhausts all consumer surplus. Second degree price discrimination assumes the Tirole concludes that the welfare effects of third firm can sell units of output at different prices to degree price discrimination are ambiguous customers in the same market. The firm is able (2001, p. 139). Consumers in low elasticity of to separate customers into groups and charge demand markets lose, but consumers in higher each group a different price that reflects the elasticity markets and producers benefit. Thus, minimum value to members of that group. Third even if output remains unchanged, price discri- degree price discrimination exists when the firm mination can be socially beneficial if the welfare can separate the markets for its products but has gains exceed the welfare losses. Further, Tirole no specific information about the nature of the notes that in cases where the government is not demand by any individual within a market seg- neutral in terms of distributional issues, it is ment. For the most part pesticides fall into the possible that the aggregate social welfare gains category of third degree discrimination. However from discrimination are positive if low income there is the possibility for second degree customers have high price elasticity and high discrimination to exist if prices vary by volume income customers have low price elasticity, soCANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination SECTION 3 Pesticide availability and pricing issuesthat welfare losses to the high income group are make a case against price discrimination on the more than offset by gains by the low income basis of income distribution. (Tirole, 2001, group. Thus it is clear that one cannot a priori pp. 139-140). FIGURE 2 Smaller market not served with single price 3.4 Cross-border price patterns centration of the effective ingredient, and then adjusted using the prevailing exchange rate. Agriculture and Agri-Food Canada fund two Carlson, McEwan and Deen report average prices studies each year that collect price data in loca- for the period 1993-97 for 32 pesticides as sum- tions close to the border (Thomson Corporation, marized in Table 3. For eight of the 32 the McEwan). The Thomson study collects retail difference between average prices is less than price data in Manitoba and North Dakota and 5 percent of the average price in both countries. Minnesota for wheat, canola and other cereal Prices were lower in Canada for 16 of the 32 and herbicides. McEwan collects similar herbicide this was especially likely to be the case for herbi- data in Ontario, Michigan, Ohio, Illinois and cides. Prices were lower in the U.S. for eight pes- Indiana for corn and soybean products. Taylor ticides, seven of which are ?other pesticides.? In and Koo and Taylor and Gray provide a recent general one can conclude that some prices are comparison of price differentials between North systematically higher in Canada than the U.S., Dakota and adjoining Canadian provinces. others are significantly lower, while others are roughly the same. The prices are standardized for units and con- TABLE 3 Comparison of average pesticide prices in Manitoba with North Dakota/Minnesota, 1994-99 Price situation Herbicides Other pesticides Total Less expensive in Canada 11 5 16 No difference* 628 Less expensive in the U.S. 7 Total 18 14 32 * Difference is less than 5% of the average price in both regions. Source: Gerald Carlson, John Deal, Ken McEwan and Bill Deen. ?Pesticide Price Differentials Between Canada and the U.S. 1999.? p. 14. McEwan collected price information for up to five Ontario, eleven times a year. Similar information retail outlets in eleven Canadian locations in was collected from seven U.S. locations in theCANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination 11 SECTION 3 Pesticide availability and pricing issues 12North-Central states. He performed exchange while Figure 3 shows expected prices for three rate and unit of measure adjustments to the representative compounds for a specific time American data before giving it to us. We period in each market surveyed. Each bar in the regressed deflated prices against a system of figure shows the 95 percent confidence interval trend and dummy variables for location to deter- with the black horizontal bar showing the mine mean and variance by location. The esti- expected price. mated equations are summarized in Table 4 TABLE 4 Summary of Regression Results Variable/Statistic Trifluralin Glyphosate Malathion Range of location coefficients: Canada -0.43 ? 0.33 -0.35 ? 0.44 -0.69 ? 0.92 (5 of 11) (5 of 11) (9 of 11) U.S. -0.73 ? 0.72 -0.82 ? 0.80 -0.60 ? 0.82 (6 of 7) (5 of 7) (6 of 7) Trend in Canada -0.016 -0.017 0.044 (-10.5) (-9.3) (29.7) U.S. trend differential -0.021 -0.007 -0.024 (-7.7) (-2.5) (-10.6) Constant 12.88 12.66 7.25 (311.2) (273.6) (196.6) U.S. Canada differential 0.41 4.45 -0.76 (9.9) (96.0) (-20.7) R-squared adjusted 0.31 0.92 0.68 Mean dependant variable 12.13 11.27 8.23 Regression standard error 0.91 1.28 0.90 T-Statistics are reported in parentheses. For the location coefficients, the number significantly different from zero at the 95 percent confidence level is given The top element of Figure 3, Trifluralin, shows a Companies might be expected to recover the pattern of mean and variance that is highly cost of registration in their wholesale prices and homogeneous within each country and across avoid cross-subsidizing registration costs in one the border. There is very little evidence of country with revenues from another. In addition, differences in retail cost structure in any of the each country provides patent protection for a locations for Trifluralin. The second and third defined length of time, which creates an incen- elements of the figure show very different results tive for chemical companies to attempt to obtained for Glyphosate and Malathion. Glypho- recover their investment costs within the patent sate is much more expensive in the U.S., while life so they have adequate revenue to remain in Malathion is significantly more expensive in business on an ongoing basis. The registration Canada. The homogenous price pattern within process takes place within this patent window, each country combined with the significant dif- and as regulators in Canada have already recog- ference between countries implies that we are nized that the process takes longer in Canada, not just seeing the effects of retail level pheno- there is a shorter period of time available to the mena, but rather the effects of a systematic company to recoup its costs, and hence a higher pricing policy followed by the manufacturer, such price is required. While these may be factors in as simple price discrimination. pricing policy, the contrasting results for Glypho- sate and Malathion suggest that demand factors Other more complicated marketing strategies are important at least for some pesticides. could also result in the price patterns observed.CANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination SECTION 3 Pesticide availability and pricing issuesFIGURE 3 95 percent confidence intervals for trifluration, glyphosate and malathion for Canadian and U.S. locations 3.5 Implications for price discrimination levels of competition among products, or dif- ferent retail structures. Price discrimination is one explanation for cross- border price differences but there are several If regulatory procedures are more onerous in alternative explanations to consider. These one country than the other, then one would include some combination of differences in regu- expect that price differences would be higher in latory structure, different market size, different the country with the more expensive regulatoryCANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination 13 SECTION 3 Pesticide availability and pricing issues 14structure. This explanation should lead to a pat- as having its largest influence on the slope of the tern of prices being consistently higher on one demand curve. For products where there are side of the border. limited alternative, ceteris paribus, one would expect a steeper demand curve. But as long as Market size may be important for the following pesticide manufacturers face a downward reasons. If a product is used on multiple crops, sloping demand function they have the opportu- or on crops that have large acreages, then econ- nity and incentive to follow monopolistic pricing omies of scale and size in production and distri- strategy such as price discrimination. bution may exist that explain price differences. Similarly, while fixed costs should not enter There is an expectation that producers of pesti- pricing decisions in the short run, the high costs cides will be able to recover fixed costs of of developing and registering a compound have product development and registration through to be recovered over a relatively short period if charging prices above marginal cost. Patents are the manufacturer is to remain in the pesticide extended to the companies so that they can business. Consequently larger markets allow recover the research costs. Pesticide manufac- these fixed costs to be ?spread? over a larger turers can be expected to recover the fixed costs base of output. Market size effects can be of product registration in the same way. Firms roughly thought of as influencing the how far can only set price above marginal costs when from the origin the demand curve for a product competition is controlled and they are therefore lies. However, such an explanation implies that facing a downward sloping demand function, in prices would be systematically lower in the mar- which case they maximize profits by setting price ket with the greater volume of sales. so that marginal revenue equals marginal cost. If each country had a different retail structure Price discrimination is a simple extension of this with different levels of mark-up or different pricing practice to segmented markets. It is a pricing strategies this could lead to different viable strategy if markets can be segmented and price regimes. Differences in the relative influ- if the relative demand levels differ enough to ence of cooperatives market share, as opposed make discrimination a higher profit alternative to investor-owned firms or factors that influence than adopting a uniform price. Pesticide regula- the level of retail competition could also play a tions clearly have the effect of providing cross- role in explaining price differences. In this situa- border segmentation. Price discrimination is also tion, prices should systematically differ being a regular business practice?the various forms of consistently higher on one side of the border or volume discounts are a ubiquitous example. It in certain markets on either side of the border. also has a long history in Canadian agriculture with evidence of price discrimination in the farm Competition effects are the second major dimen- machinery market first reported in the 1960s sion that can explain price differences. Competi- (Green).The only restriction on price discrimina- tion can be thought of in several ways. The first tion in Canadian law circumscribes its use among 4 is that for some compounds multiple manufac- purchasing competitors. Canadian competition turers make the same active ingredient. In these law cannot protect farmers from price discrimi- cases each manufacturer has very limited ability nation among producers in different countries. In to alter prices without a significant decline in fact, it would be surprising to find that chemical sales. Even when a product remains ?on patent? companies did not also practice price discrimina- so no other product has the same active ingredi- tion wherever possible. ent there can be significant competition. Other producers may have other compounds that pro- vide essentially the same level of crop protection, 4. Consumer and Corporate Affairs Canada Bureau of Competi- or farmers can adopt alternative control strate- tion Policy. ?Price Discrimination Enforcement Guidelines?, gies such as increased cultivation. In a rough available http://strategis.ic.gc.ca/SSG/ct011403.html sense one can think of the degree of competitionCANADA ? U.S. PESTICIDE REGULATION An economic analysis of price discrimination SECTION 4 Effect of eliminating price discrimination In this section we estimate what would be the it is not clear, a priori, how much the choice of effects of eliminating cross-border price discrimi- functional form will influence the modeled nation for pesticides. It is not clear that this is behavior of the pesticide manufacturer. In the possible since it is in the pesticide manufacturers? non-linear models we have used a two parame- interest to maintain segmented markets. The
Posted: 30 March 2010

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