1. Introduction. Short research notes. Multicommodity substitution patterns in the international fats and oils market

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1 Short research notes 1. Introduction Multicommodity substitution patterns in the international fats and s market WALTER C. LABYS West Virginia University Decision making in international fats and s markets is extremely complex because of the high substitutability of a wide-range of fats and s originating under different production conditions. For example, soybean and cottonseed result from annual crop planting in temperate zones; palm and lauric (palm kernel and coconut ) stem from perennial tree crops in tropical areas; animal fats are by-products of livestock production; and marine s derive from fish. Yet the understanding of substitution between these s is of considerable importance to manufacturers who must blend these s and consequently hold inventories and to producers who must determine area expansion and restriction policies. Substitution among fats and s is normally examined on the demand side, where adjustments in product mix depend on the degree of saturation of the fatty acids contained in the s. The degree of saturation is generally reflected in their iodine numbers; high iodine numbers reflect a high proportion of unsaturated fatty acids and low iodine numbers the opposite. The group of fluid or soft s comprised of soybean, cottonseed, corn, groundnut and olive s are relatively unsaturated and compete in edible uses. Opposite these are the solid or hard s such as lauric s (coconut and palm kernel) which are more highly saturated and have both edible and inedible uses. Remaining are palm, lard and tallow which possess a saturation lying between the soft and the hard s. While palm, lard, and edible tallow are consumed edibly, grease and inedible tallow fall into the inedible category. Although the saturation characteristic once limited the range of substitution among s and fats, processing techniques such as hydrogenation now permit fluid s to Eur. R. agr. Eco. 4(1), pp

2 76 Walter C. Labys compete more fully with solid s. Economic analysis of intercommodity demand and substitution has taken place typically by building models for individual commodities, such as the soybean model by Houck, Ryan and Subotnik (1972), the lauric model by Labys (1973, 1975), the olive model by Al-Zand (1968), the palm model by Thiam (1972), and the tung model by Matthews and Womack (1970). The demand equations included in these models normally feature the prices of one or at most two other s and yield estimates of the corresponding cross-price elasticities. Up till now, such an approach has provided an incomplete picture of the full range of interchangeability existing among the more complete set of commodities. This note summarizes the results of estimating a more complete set of cross-price elasticities based on the demand system approach featured in the works of Brandow (1961), Zellner (1962), George and King (1971), and Court (1967), as recently reviewed by Phlips (1974). Inherent to the system approach is the premise that the demands for all commodities are interrelated. The complete demand system consists of individual demand equations where the demand for each included is regressed on the price of that, the prices of other s in the system, and total expenditures or income. System estimation depends on the incorporation of a priori restrictions on the equation parameters based on demand theory and requires only modest data inputs, in this case annual quantities and prices extending from Utilized here is an estimation procedure based on Zellner's (1962) method of 'seemingly unrelated regressions' and Court's (1967) adaptation thereof, as constructed by T. Akiyama. A more detailed paper regarding estimation results is available upon request. Demand systems have been estimated for the U.S., the European Economic Community (9 countries), and Japan to illustrate differences in substitution patterns among the three dominant fats and s consuming markets. Comparisons are also made with price elasticities previously estimated in individual fats and s studies. 2. The U.S. market Demand for s and fats in the U.S. centers around soybean, although cottonseed, lard, lauric, and edible tallow also occupy important positions. These five s together account for 76% of total consumption or

3 Multicommodity substitution patterns 11 93% of edible consumption. Butter could have been added to the list, but has been omitted because of its relative isolation from the rest of the market due to government price intervention. Table 1 provides the direct and crossprice elasticities for each of the above s, together with the expenditure or income elasticities. 1 The given R 2 is the squared correlation of the actual quantity variable with that estimated from the equations, as suggested by Court (1967). With respect to the elasticities obtained, soybean consumption is negatively related to the prices of all other s. This implies gross complementarity in which soybean demand increases together with the demand for the other s. The direct price elasticity of is somewhat more elastic than values found in other studies over earlier periods as reported in Appendix A. 2 Table 1. Constrained demand matrix of s elasticities and cross-elasticities: U.S. Prices Consumption Soybean Cottonseed Lard Laurie Edible tallow Soybean (3.52) (1.64) (2.70) (0.34) (1.98) Cotton (0.90) (1.07) (1.26) (1.37) (0.35) Lard (1.83) (0.73) (0.63) (1.03) (0.41) 1. Numbers within parenthesis are t values. Significance here at the 5% level for equations reported is: 6 parameters, 1.78; and 5 parameters The Durbin-Watson statistic for five parameters with 18 observation is d L = 0.71 and dy , at the 5% level. The significance for 'R 2 ' is for 6 parameters and with 5 parameters Laurie (2.58) (1.67) (3.11) (4.21) (2.63) Edible tallow (0.59) (0.23) (0.60) (0.91) (0.27) Expenditures (3.43) (1.15) (2.85) (0.06) (1.56) R DW at the 5% level. 2. No attempt has been made to determine whether the elasticity estimates are significantly different from each other, mainly because of the incomparability of the time periods and the price series sometimes used.

4 78 Walter C. Labys The cottonseed and lard relations are the most difficult to explain. The cottonseed direct price elasticity of would appear to be reasonable since this is very close in substitution to soybean, as confirmed with the positive cross-elasticity of But a dummy variable had to be included in the equation to account for the downward shift in the consumption schedule since However, this adjustment still was not sufficiently strong to correct the negative income elasticity. Nor could the positive price elasticity for lard be corrected by adjusting for a shift in lard consumption. This same result obtained by Labys and Akiyama (1974) in a previous study could be corrected only by examining the interrelation between these s in individual end uses. The lauric s relation is more plausible. The direct price elasticity of compares favorably with the value of 0.22 obtained by Nyberg and of 0.16 obtained by Labys. The positive cross-elasticity of with lard implies competitiveness and the negative cross-elasticity of with soybean reflects complementarity. 3. The E.E.C. (9) market Whereas the consumption of s and fats is concentrated among five commodities in the U.S., it is more widely dispersed in the E.E.C. (9). Lauric, lard, soybean, and groundnut dominate the market, but palm, olive and fish are also important. The former importance of lauric attributed to its being the key ingredient for hardening margarine and shortening has now disappeared. The six most important s excepting olive account for 67% of total consumption or 79% of edible consumption. Olive has been omitted since it is rarely blended, being a premium with prices 2 or 3 times that of other s. The demand elasticities for the above system are reported in Table 2. There is some variation in the elasticities found as compared to Table 1, but this is to be expected because of differences in the pattern of end uses. As for the U.S., soybean now is the major commodity of this group, and this is reflected in its display of gross complementarity with the other s. The included direct price elasticity of is slightly higher than the import price elasticity reported by Houck et al. (1972) for this region. Groundnut with a direct price elasticity of is slightly higher than the value reported by METRA (1968) over an earlier period. Some substitutability with

5 Multicommodity substitution patterns 79 Table 2. Constrained demand matrix of s elasticities and cross-elasticities: E.E.C. (9) Prices Consumption Soybean Groundnut Lard Laurie Fish Palm Soybean (1.98) (0.11) (0.75) (0.81) (0.25) (0.48) Groundnut (0.88) (2.61) (0.33) (1.28) (1.24) (0.60) Lard (1.63) (0.39) (2.91) (1.46) (0.79) (0.49) Laurie (171) (0.77) (0.15) (0.14) (1.41) (1.92) Fish (0.20) (0.38) (0.52) (0.82) (0.88) (0.85) Palm (0.68) (0.81) (152) (0.83) (1.06) (3.16) Expenditures (2.00) (0.27) (0.64) (1.81) (2.02) (2.13) lauric and palm is implied by the positive price cross-elasticity. This same interrelationship is symmetric with results found in the palm and lauric equations. As for the direct price elasticity of lauric, it is somewhat lower than that found in other studies, as given in Appendix A. 4. Japan After the U.S. and the E.E.C. (9), the largest consuming area for s and fats is Japan. Soybean consumed primarily in edible products is the most important. Beef tallow, lauric, fish, and whale (including sperm) of lesser importance are used mostly for inedible purposes. Since a small amount of soybean is also consumed for inedible purposes, it was decided to include that commodity with the other four in the empirical demand system. The results of estimating that system based on the period given in Table 3 reflect only limited success in estimation. The t values are all low and although this implies multicollinearity, it probably stems from the unavailability of fats and s price series for Japan. Price series used instead have been those derived from principal world markets. There are no previous R DW

6 80 Walter C. Labys Table 3 Prices Consumption Soybean Beef tallow Fish Laurie Whale Constrained demand matrix of s elasticities and cross-elasticities: Japan Soybean (1.07) (0.52) (0.31) (0.15) (0.14) Beef tallow (0.73) (0.54) (0.41) (0.28) (0.63) Fish (0.03) (0.12) (0.27) (0.15) (0.06) Laurie (0.23) (0.31) (0.32) (1.40) (0.43) Whale (0.12) (0.03) (0.03) (0.05) (0.50) Expenditures (2.35) (0.72) (0.12) (0.08) (0.32) studies available for comparing the estimated values, but the direct price elasticities found for soybean , fish 0.95, and lauric are reasonably close to those found for the other two regions. In terms of substitution patterns, soybean can be considered a gross complement with the other s, only the sign of the fish cross-price elasticity differing. Whale, fish and beef tallow reflect substitutability and this effect is symmetric in all three equations. 5. Conclusions The results obtained are obviously of a preliminary nature. Nevertheless, they do provide a more complete description of fats and s substitution patterns than previously existed. A principal empirical finding is that the demand for soybean is complementary with that of most other fats and s. To some extent, this is probably due to the relatively low price of soybean which assures that its demand will always rise with the demand for other fats and s. Although the result is not always symmetric with that of the signs of the cross-price elasticities obtained in other equations, this effect need not be symmetrical in the other equations and there is the difficulty that systems of demand equations are often in poor agreement with existing data. R DW

7 Multicommodity substitution patterns 81 Table 4. International elasticity comparisons Oils and fats Soybean Lauric Fish Tallow Soybean/Laurie Soybean/Lard Soybeayn/Tallow Laurie/Fish U.S E.E.C. (9) Direct price elasticities Cross-price elasticities Japan Table 4 provides a comparison of the direct and cross-price elasticities in the three regions. The results show that the demand for soybean is more elastic in the E.E.C. (9) and in Japan than in the United States. The same could be said of the demand for lauric in Japan. Soybean also has a high rate of adoption along with other fats and s in the E.E.C. and Japan. Both the direct and cross-price elasticities of tallow differ for Japan from the U.S., but this is due to demand in the former referring principally to inedible uses, while for the latter it refers to edible uses.

8 Appendix Table A. Direct price elasticities estimated in various studies (annual data) Oils Cottonseed Fish Grease Groundnut Lard Laurie Palm Soybean Direct price elasticities 1 United States A B C D E F G (2.15) (2.15) (2.65) 1. Values in parenthesis are / values where available. 2. Demand in Western Europe. 3. Demand in E.E.C. (6). 4. Demand in developed countries (2.0) (3.14) (2.25) (2.70) H K (2.66) World C 2 F (3.02) (4.11) E I J (0.74) (2.91) (1.61) (3.0) (5.59) (3.37) (2.0) (5.14) oo

9 Multicommodity substitution patterns 83 Source and explanatory notes for Table A A. Computed by inverting price flexibilities, M. A. Jacobson, Basic competitive price relationships among major food fats and s (Unpublished Ph.D. dissertation, Purdue University, 1968) p. 62. B. Computed for G. W. Kromer, The U.S. coconut situation: Fats and s situation. Washington, D.C.: U.S. Department of Agriculture Economic Research Service, April C. Computed for A. V. Nyberg, The Philippine coconut industry (Unpublished Ph.D. dissertation, Cornell University, 1968) p D. Computed for A. E. Drake and V. I. West, Econometric analysis of the edible fats and s economy, Bulletin 695 (Urbana: University of Illinois Agricultural Experiment Station, June 1963) p. 33. E. Computed for The equivalent elasticity value for export demand is J. P. Houck, M. E. Ryan and A. Subotnik, Soybeans and their products (Minneapolis: University of Minnesota Press, 1972) p. 86. F. Computed for W. C. Labys, Dynamic commodity models: Specification, estimation and simulation (Lexington: Heath Lexington Books, 1973), p. 32. G. Computed for J. P. Houck and J. S. Mann, Domestic and foreign demand for U.S. soybeans and soybean products, Techn. Bull. No. 256 (St. Paul: University of Minnesota Agricultural Experiment Station, 1968) p. 20. H. Computed for R. J. Vandenborre, Economic analysis of relationships in the international vegetable and meal sector. Bulletin 106 (Urbana: University of Illinois Agricultural Experiment Station, 1970) p. 43. I. Computed from linearized coefficients based on a nonlinear price relationship, A. E. Recto, An analysis of the international demand for Philippine coconut products (Unpublished Ph.D. dissertation, University of Minnesota, 1971) p J. Computed by inverting price flexibilities, D. Bachelet, Analyse economitrique du marche des oleagineux tropicaux. Prepared by METRA International for the E.E.C., Brussels, K. Computed for J. P. Houck, Demand and price analysis for the U.S. soybean market, Tech. Bull. No St. Paul: University of Minnesota Agricultural Experiment Station, 1963.

10 84 Walter C. Labys REFERENCES Al-Zand, O. A. (1968). Olive trade and trade policies in the Mediterranean region. Unpublished Ph.D. Dissertation, St Paul: University of Minnesota. Brandow, G. E. (1961). Interrelationships among demands for farm products and implications for control of market supply. Pa. Agric. Exp. Sta. Bull., No University Park. Court, R. H. (1967). Utility maximization and the demand for New Zealand meats. Econometrica, 35: George, P. S., and King, G. A. (1971). Consumer demand for food commodities in the United States with projections for 1980, Giannini Foundation Monograph No 26. University of California at Berkeley. Houck, J. P., Ryan, M. E., and Subotnik, A. (1972). Soybeans and their products. Minneapolis: University of Minnesota Press. Labys, W. C. (1973). Dynamic commodity models: Specification, estimation and simulation. Lexington, Mass.: Heath. - (1975). Dynamics of the international lauric s market. In W. C. Labys (Ed.), Quantitative models of commodity markets. Cambridge, Mass.: Ballinger. and Akiyama, T. (1974). Measuring multicommodity substitution patterns with a demand system approach. Geneva: Graduate Institute of International Studies. Mimeo. Matthews, J. L., and Womack, A. W. (1970). An economic appraisal of the U.S. tung economy. Southern J. agr. Eco., METRA (1968). Analyse econometrique du marche des oleagineux tropicaux. Prepared by METRA International for the E.E.C., Brussels. Nyberg, A. V. (1968). The Philippine coconut industry. Ph.D. thesis, Cornell University. Phlips, A. (1974). Applied consumption analysis. Amsterdam: North-Holland. Thiam, T. B. (1972). The palm industry of Malaysia. Ph.D. thesis, Raleigh: North Carolina State University. Zellner, A. (1962). An efficient method of estimating seemingly unrelated regressions and tests for aggregation bias. J. Amer. stat. assoc, 57: