World Rubber Market Structure and Stabilisation An Econometric Study C. Suan Tan 94 z . ' ' ' -- . 1~, WORLD BANK STAFF COMMODITY WORKING PAPER Number 10 World Rubber Market Structure and Stabilisation An Econometric Study C. Suan Tan The World Bank Washington, D.C., U.S.A. Copyright ( 1984 The International Bank for Reconstruction and Development / THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. First printing January 1984 All rights reserved Manufactured in the United States of America This is a document published informally by the World Bank. In order that the information contained in it can be presented with the least possible delay, the typescript has not been prepared in accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no responsibility for errors. The publication is supplied at a token charge to defray part of the cost of manufacture and distribution. The views and interpretations in this document are those of the author(s) and should not be attributed to the World Bank, to its affiliated organizations, or to any individual acting on their behalf. Any maps used have been prepared solely for the convenience of the readers; the denominations used and the boundaries shown do not imply, on the part of the World Bank and its affiliates, any judgment on the legal status of any territory or any endorsement or acceptance of such boundaries. The full range of World Bank publications, both free and for sale, is described in the Catalog of Publicationis; the continuing research program is outlined in Abstracts of Cuirrenit Studies. Both booklets are updated annually; the most recent edition of each is available without charge from the Publications Sales Unit, Department T, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from the European Office of the Bank, 66, avenue d'Iena, 75116 Paris, France. C. Suan Tan is an economist with the Economic Analysis and Projections Department of the World Bank. Library of Congress Cataloging in Pvblication Data Tan, C. Suan World rubber structure and stabilisation. (World Bank staff commodity working paper ; no. 10) Bibliography: p. 1. Rubber industry and trade--Mathematical models. I. Title. II. Series. HD9161.A2T29 1983 338.4'76782'0724 83-23351 ISBN 0-8213-0264-7 ISSN 0253-3537 ABSTRACT This study examines some problems in the market for natural rubber, one of the ten core commodities proposed for stabilisation under the UNCTAD Integrated Programme for Commodities, a;id the first for which an international agreement was reached. The first part of this study is concerned with the specification, estimation and validation of an econometric model of the world natural and synthetic rubbers market. The disaggregated annual model for 1956-1978 consists of two submodels, one for each rubber, and reflects their different industrial organisations. Other salient features of the model are the long lagged structures and the interaction between the submodels through relative rubber prices in the demand equations. The model validation shows that the secular decline in natural rubber price up to 1973 was due primarily to the substitution of natural rubber by the cheaper synthetic rubbers. The second part of this study concerns the application of the model to forecasting natural rubber prices and to analysing the implications of natural rubber market stabilisation along the lines of the International Natural. Rubber Agreement. The impact of national government interventions in world commodity markets is also illustrated by an examination of the impact of changing Malaysian export taxes. Ex post and ex ante simulations of buffer stock stabilisation showed the importance of the manner in which the buffer stock is operated. The results also show that stabilisation will have different effects for the producing and consuming countries, which raises the question of the funding of the buffer stocks. - iv ABSTRAIT L'auteur de la presente etude examine certains des problemes du march6 du caoutchouc naturel, qui est l'un des dix principaux produits dont le Programine integre pour les produits de base de la CNUCED vise a stabiliser le march6, et le premier qui ait fait lobjet d'un accord international. La premiere partie de 1'6tude traite de la specification, de l'estimation et du test de validit6 d'un modele 6conometrique du marche mondial du caoutchouc naturel et synth6tħ:.que. Le modele annuel pour la periode 1956-78 est d6compos6 en deux sous-modeles, un pour chaque type de caoutchouc; il reflete le fait que l'organisation industrielle est differente dans les deux cas. Les autres caracteristiques du modele sont les longs decalages incorpores dans les structures et l'interaction entre les sous-modeles due a l'introduction des prix relatifs du caoutchouc dans les equations de la demande. Le test de validit6 du modele montre que la baisse seculaire des cours du caoutchouc naturel jusqu'en 1973 a ete imputable avant tout au remplacement de ce produit par les caoutchoucs synthetiques meilleur marche. La deuxieme partie de 1'6tude concerne l'utilisation du modele pour les projections du prix du caoutchouc naturel et l'analyse des incidences de la stabilisation du march6 dans le cadre de l'Accord international sur le caoutchouc naturel. Elle illustre egalement les effets des interventions des pouvoirs publics sur les march6s mondiaux des produits de base en montrant quels ont 6te les r6sultats de la modification des taxes a 1'exportation en Malaisie. Des simulations ex post et ex ante des effets stabilisateurs du stock regulateur montrent l'importance de la maniere dont celui-ci est gere. I1 ressort 6galement des resultats que cette stabilisation aura des consequences d.iff6rentes pour les pays producteurs et les pays consommateurs, ce qui souleve la question du financement des stocks r6gulateurs. EXTRACTO En este estudio se examinan algunos problemas que existen en el mercado del caucho natural, uno de los diez productos basicos esenciales que se han propuesto para estabilizaci6n en virtud del Programa Integrado para los Productos Basicos de la UNCTAD y el priniero sobre el cual se ha alcanzado un acuerdo internacional. La primera parte de este estudio trata de la especificacion, estimaci6n y validaci6n de un modelo econom6trico del mercado mundial de caucho natural y caucho sintetico. El modelo anual desagregado para el periodo 1956-1978 consiste en dos submodelos, uno para cada tipo de caucho, y refleja sus distintas organizaciones industriales. Otras caracteristicas destacadas del modelo son las estructuras con prolongados desfases y la accion reciproca entre los subnodelos a traves de precios relativos del caucho en las ecuaciones de demanda. La validaci6n del modelo demuestra que la baja de los precios del caucho natural hasta 1973 se debi6 principalmente a la sustituci6n del caucho natural por cauchos sinteticos de menor costo. La segunda parte del estudio se refiere a la aplicaci6n del modelo al pron6stico de los precios del caucho natural y al analisis de las repercusiones de la estabilizaci6n del mercado de ese producto conforme al Convenio Internacional del Caucho Natural. El efecto de la intervenci6n de los gobiernos nacionales en los mercados mundiales de productos basicos queda ilustrado tambien por un examen de las consecuencias de una modificaci6n de los impuestos de exportaci6n de Malasia. Las simulaciones ex post y ex ante de una estabilizaci6n de las existencias reguladoras demostraron la importancia del modo en que estas funcionan. Los resultados sefialan ademas que la estabilizaci6n tendra efectos diferentes para los paises productores y los consumidores, lo que plantea la cuesti6n del financiamiento de las existencias reguladoras. ll (it l - vii - PREFACE This study of the world rubber market was undertaken by Ms. Choo Suan Tan during the period 1978-81, whil'e she was a post-graduate student in the Economics Department of the Research ',chool of Pacific Studies, The Australian National University. The manuscript was accepted in fulfilment of the requirements for a Ph.D degree. The world rubber model described herein has now been set up on the Division-s computer system and will be used for projections and analytical work related to the natural rubber market. Ms. Tan's study is being published in this form so that a description of the model will be available to those people interested in the techniques used by the World Bank in its forecasting and analytical work. As with other models used by the Division, the rubber model will be updated and revised to capture any subsequent changes in the world market. Any such extensions to the model will be described in Working Papers issued by the Division. Ronald C. Duncan Chief Commodity Studies and Projections Division ACKNOWLEDGE,MENTS This study was financed by a three-year Australian National IJniversity scholarship. Throughout the course of research I benefited from the advice of Dr. Colin Barlow, Dr. Ray Byron, Professor Peter Lloyd and Professor Jan Sandee, and the constant support of Professor Heinz Arndt and Professor Max Corden. To the ANU for the scholarship, and to my teachers for their friendships, I would like to express my gratitude. C. Suan Tan Commodity Studies and Projections Division -i i$11/ -3 In Co > tP . ' - ix TABLE OF CONTENTS Abstract iii Preface and Acknowledhmv-ents vii Table of Contents ix List of Tables xv List of Figures xix CHAPTER ONE: INTRODUCTION 1.1 Problems of the World Rubber Market 1 1.2 Backqround to the World Rubber Market 3 1.3 Falling Natural Rubber Market Share and Instability 5 1.4 Purpose of this Study 14 CHAPTER TWO: DEMAND FOR RUJBBERS 2.1 Introduction 18 2.2 Technical Features of Input Demand 20 2.3 Minimum Inputs Requirement of Tyre Droduction 2.4 Determinants of Input Substitution Beyond Minimum Requirements 31 2.5 Specification of inrut Demand Functions 38 2.6 Estimation of Input Demand Functions 44 CHAPTER THREE: SUPPLY OF RUBBERS 3.1 Introduction 56 3.2 Five Features of Natural Rubber Supply 56 3.3 General Determinants of Natural Rubber SunDly 61 3.4 Previous Econometric Studies of Perennial Crop Supply Response 68 3.5 Wickens and Greenfield's Model of Supoly Response 74 3.6 Estimation of Supply Response Equations 83 3.7 Oligopoly, Vertical Integration and Synthetic Rubber 89 Appendix 3.A: Estimates of Acreaqe Functions 92 CHAPTER FOUR: MALAYSIAN NATURAL RTJBBER EXPORT TAXATION 4.1 Introduction 95 4.2 Tenure of the Four-Component Exoort Tax 97 4.3 Implications of Price and Volume Based Taxes 101 4.4 Incidence of Exnort Tax 135 4.5 Empirical Estimates of Malaysian Sunply Response Under Export Taxation 111 4.5.1 Impact of Export Tax on Smallholder Supply But Not Acreage 112 4.5.2 Impact of Export Tax on Estate Supply and Acreage 117 4.6 Generalised Export Tax Functions 118 4.6.1 Generalised Export Tax Functions, 1956-1978 119 4.6.2 Generalised Export Tax Functions for 1980-1995 122 Appendix 4,A: Schedules of Natural Rubber Export Tax in Malaysia, 1956-1978 128 CHAPTER FIVE: 3EHAVIOUR OF RUBBER STOCKS AND PRICES 5-1. Introduction 132 5.2 Ownership Versus Location of Natural Rubber Stocks 132 5.3 Stocks Location and SDot Price Fcrmation 140 5.4 Spot Price Determination Under Stock Disequilibrium 145 5.5 Primary-Terminal Markets Interaction and Price Linkage 156 5.6 Synthetic Rubber Supply and Price Determination 158 CHAPTER SIX: MODEL STRUCTURE AND VALIDATION 6.1 Introduction 167 6.2 Data and Econometric Methods Used in Model Estimation 168 6.3 Causal Structure of the Model 171 6.4 Empirical Validation of the Model 179 6.5 Aftermath of the 1973 Oil Crisis 136E 6.6 Overview of Natural Rubber Market Instability, 1956-1978 194 Appendix 6.A: The Malaysian National. "Crash Programme" of 1974-1976 204 - xii - CHAPTER SEVEN: EXOGENOUS VARIABLES PROJECTIONS: 1980-1995 7.1 On Projecting Oil Price 214 7.1.1 Supply of Oil 216 7.1.2 Supply of Coal 218 7.1.3 Supply of Natural Gas 220 7.1.4 Supply of Hydro and Nuclear Enerqy 221 7.1.5 Supply of Alcohol Fuel 221 7.1.6 Supply of Other Energy Resources 222 7.2 Three Subperiods of Energy Sunnly 223 7.3 Demand for Energy 225 7.4 Time Paths for Oil Price: 1980-1995 227 7.5 Projecting Remaining Exogenous Variables 237 7.5.1 Economic Growth Rates and Price Indices 238 7.5.2 Activity Indices and Rubber Manufacturing 239 CHAPTER EIGHT: STABILISING THE NATURAL RUBBrP MPE7KFT 8.1 Introduction 243 8.2 Alleged Benefits from Price Stabilisation 245 8.3 Some Results of Theoretical Models 249 8.4 The International Rubber Agreement (INPA) 257 8.4.1 INRA Buffer Stock Price Bands 259 8.4.2 Price Band and Time Horizon 263 8.5 Towards a Viable Stabilisation Policy under the INRA 265 8.6 Some Aspects of the INRA Stabilisation Scheme Which Need to be Considered 269 - xiii - 8.7 Price Stabilisation Under Low Oil Price Scenario, 1982-1986: Prelimi.nary Comments 273 8.8 Price Stabilisation Under Low Oil Price Scenario, 1982-1986: Results 282 8.9 Distribution of Gains from Price Stabilisation 288 8.10 Conclusion 298 AuDendix 8.A Graphic Presentation of Price Stabilisation Effects, 1982-1986 299 CHAPTER NINE: PRICE STABILISATION FOR 1982-1991 9.1 Introduction 307 9.2 Stabilisation for 10 Years About Equidistant Price Bands 308 9.3 Stabilisation for 10 years About Non-Equidistant Price Bands 318 9.4 Ex Post Stabilisation for 1970-1980 332 9.5 Forecasts for Rubber Market Under High Oil Price Scenario 337 Appendix 9.A Graphic Presentation of Price Stabilisation Effects, 1982-1991 343 CHAPTER TEN: IMPACT OF MALAYSIAN EXPORT TAXATION 10.1 Introduction 358 10.2 Effects of Lower Malaysian Exoort Taxes 359 10.3 Effects of Zero Malaysian Export Taxation 364 10.4 Indirect Effects of Export Tax Variations on Market Instability 372 - xiv CHAPTER ELEVEN: SUMMARY AND CONCLUSION 11.1 Introduction 374 11.2 Empirical Findings for 1956-1978 374 11.3 Imnlications of Price Stabilisation, 1981-1991 377 11.4 Caveats for Successful INPA OPerations 381 11.5 A Final Perspective 382 BIBLIOGRAPHY 385 - xv - LIST OF TABLES AND FIGURES Tables Table 1.1: Production of Natural Rubber and Synthetic 6 Rubbers, 1956-1978 Table 1.2: Consumption of Natural Rubber and Synthetic 7 Rubbers, 1956-1978 Table 1.3: Distribution of Natural Rubber Consimmption, 9 1956-1978 Table 1.4: Natural Rubber Consumption by Sector in Major 11 Industrialised Countries, 1956-1978 Table 2.1: Comparison of the Properties of the 23 General-Purpose Rubbers Table 2.2: Input Mix for Cross-Ply Car Tyre 26 Table 2.3: Input Mix for Radial Car Tyre 27 Table 2.4: Input Mix for Cross-Ply Large Truck Tyre 28 Table 2.5: Estimates of Natural Rubber Demand Equations 49 Table 2.6: Estimates of Synthetic Rubber Demand Equations 50 Table 2.7: Summary of Relative Prices Used in Demand Equations 51 Table 2.8: Estimates of Short (Long) Run Demand Elasticities 54 With Respect to Relative Price of Natural Rubber to Synthetic Rubbers Table 3.1: Estimates of Supply Response Functions for 85 Natural Rubber Producing Contries, 1956-1978 Table 3.2: Short, Medium and Long Run Supply Elasticities 87 Table A3.1: Estimates of Investment Functions for the 93 Major Natural Rubber Producing Countries, 1956-1978 Table 4.1: Malaysian Supply Response Equations Under 113 Export Taxation, 1956-1978 Table 4.2: Malaysian Acreage Equations Under Export 114 Taxation,1956-1978 -- xvi - Table 4.3: Malaysian Supply Elasticities Under Gross 116 and Net Prices, 1970-1978 Table 4.4: Export Duty Structure Announced in December 1980 124 Table 4.A.1: Schedule I Export Duty 128 Table 4.A.2(a):Schedule II Tax (Anti-Inflation Cess) 129 Table 4.A.2(b):Surcharge (Anti-Inflation Cess) 129 Table 4.A.3: Schedule III Tax (Research Cess) 131 'Table 5.1: Natural Rubber Stocks and Spot Price Equations 146 Table 5.2: Natural Rubber Price Linkage Equations 157 Table 5.3: Synthetic Rubber Production and Price Equations 162 Table 5.4: Synthetic Rubber Price Linkage Equations 165 Table 6.1: Causal Structure of the 87-Equation Model 178 Table 6.2: Natural Rubber and Synthetic Rubbers Consumption 187 Shares, 1967-1980 Table 6.3: Rubber Prices, Production and Stocks 189 During 1973-1980 Table 6.4: Growth and Instability of Natural Rubber 199 Export Volume and Value Table 6A.1: Natural and Synthetic Rubber Prices, 1972-1974 206 Table 7.1: Share of Primary Energy Resources in China, 219 USSR and USA Table 7.2: Composition of World Energy Supply, 1956-1974 226 Table 7.3: Composition of World Energy Consumption, 228 1956-1974 Table 7.4: Price of Various Energy Resources 229 Table 7.5: Share of Crude Oil Supply in Developing 231 Countries, 1956-1974 Table 7.6: Estimated Cost of Synthetic Fuels 233 Table 7.7: Alternative Price Level for Oil, 1980-1995 236 - xvii - Table 7.8: Projected Low, Medium and High Rates of Growth 240 of Industrial Production, 1980-1995 Table 7.9: Estimates Used in Projecting Values of 242 Exogenous Variables Table 8.1: Summary of Price Stabilisation Effects, 290 1982-1996 Table 8.2: Summary of Price Stabilisation Effects on 292 Major Producers, 1982-1996 Table 8.3: Summary of Price Stabilisation Effects on 294 Major Consumers, 1982-1996 Table 8.4: Estimates of Buffer Stock Operational Costs 296 by Item, 1981-1986 Table 8.5: Buffer Stock Outlay and Cumulative Buffer 297 Stock Debt in Each Period, 1982-1986 Table 9.1: Summary of Effects of Price Stabilisation 312 with Equidistant Price Bands, 1982-1991 Table 9.2: Summary of Price Stabilisation Effects on Major 314 Producers, 1982-1991 (Case of Equidistant Price Bands) Table 9.3: Summary of Price Stabilisation Effects on Major 315 Consumers, 1982-1991 (Case of Equidistant Price Bands) Table 9.4: Effects of Stabilislation with Equidistant Price 317 Bands on Malaysian Producers' Revenues, 1982-1991 Million US Dollars) Table 9.5: Estimates of Buffer Stock Operational Costs by 319 Item, 1981-1991 Table 9.6: Buffer Stock Outlay and Cumulative Buffer Stock 320 Debt in Each Period, 1982-1991 (Stabilisation With Equidistant Price Bands) Table 9.7: Natural Rubber Consumption Shares With and 321 Without Price Stabilisation With Equidistant Price Bands, 1982-1991 (Percentages) Table 9.8: Summary of Effects of Price Stabilisation With 325 Non-Equidistant Price Bands, 1982-1991 - xviii - Table 9.9: Buffer Stock Outlay and Cumulative Buffer Stock 328 Debt in Each Period, 1982-1991 (Stabilisation With Non-Equidistant Price Bands) Table 9.10: Summary of Price Stabilisation Effects on Major 329 Producers, 1982-1991 (With Non-Equidistant Price Bands) Table 9.11: Summary of Price Stabilisation Effects on Major 330 Consumers, 1982-1991 (With Non-Equidistant Price Bands) Table 9.12: Effects of Stabilisation with Non-Equidistant 331 Price Bands on Average Malaysian Producers' Revenue, 1982-1991 Table 9.13: Summary of Ex Post Price Stabilisation Effects, 334 1971-1980 Table 9.14: Summary of Ex Post Price Stabilisation Effects 336 on Major Producers, 1971-1980 Table 9.15: Effects of Ex Post Price Stabilisation on 338 Malaysian Average Producers' Revenue, 1982-1991 Table 9.16: Summary of Ex Post Price Stabilisation Effects 339 on Major Consumers, 1971-1980 Table 10.1: Comparison of Price Forecasts Under Alternative 361 Export Tax Rates, 1981-1985 Table 10.2: Effects of Alternati-Tre Export Tax Rates and Price 363 Stabilisation on Malaysian Estate Production, Export Earnings and Export Tax Revenues, 1982-1991 Table 10.3: Forecasts of Natural Rubber Price With and 365 Without Export Tax in Malaysia, 1981-1995 Table 10.4: Effects of Export Tax on Malaysian Estate, 366 Production, Export Earnings, Producers' Revenue and Export Tax Revenue, 1982-1991 Table 10.5: Effects of Malaysian Export Tax on Natural 368 Rubber Supply in Main Producing Countries, 1982-1991 Table 10.6: Effects of Malaysian Export Tax on World 369 Natural and Synthetic Rubbers Consumption, 1982-1991 - xix- Table 10.7: Effects of Malaysian Export Tax on Natural 371 Rubber Consumption in Main Consuming Countries, 1982-1991 Figures Figure 1.1: Natural Rubber and Synthetic Rubber Prices, 12 1956-1978 Figure 1.2: Total Natural Rubber Export Earnings of Main 13 Producing Countries, 1956-1978 Figure 2.1: Demand for Natural and Synthetic Rubbers by 19 Sector For Each Country Figure 2.2: Rubber Compositions of Car Tyre Treads 30 Figure 2.3: Comparison of Natural and Synthetic Rubber 35 Processing Figure 3.1: Variation of Yield with the Number of Years After 58 First Tapping Figure 3.2: Investment Planning and Production of 70 Perennial Crops Figure 4.1: Gencralised Export Tax Function for Smallholders, 120 1956-1978 Figure 4.2: Generalised Export Tax Functions for Estates, 121 1956-1978 Figure 4.3: Generalised Export Tax Function for Smallholders, 125 1980-1995 Figure 4.4: Generalised Export Tax Function for Estates, 126 1980-1995 Figure 6.1: Flowchart of the Interacting Flows in the 172 Estimated Model Figure 6.2(i): Time Paths of World Natural Rubber Supply, 180 1970-1978 Figure 6.2(ii): Tinme Paths of World Natural Rubber Consumption, 180 1970-1978 - xx - Figure 6.2(iii): Time Paths of London Spot Price for RSS1-grade 181 Natural Rubber, 1970-1978 Figure 6.2(iv): Time Paths of Average European Synthetic 181 Rubber Price, 1970-1978 Figure 6.2(v): Time Paths of World Synthetic Rubber 182 Supply, 1970-1978 Figure 6.2(vi): Time Paths of World Synthetic Rubber 182 Consumption, 1970-1978 Figure 6.2(vii): Time Paths of Natural Rubber Stocks in 183 Consuming Regions, 1970-1978 Figure 6.2(viii): Time Paths of Synthetic Rubber Stocks, 183 1970-1978 Figure 6.3: Time Paths of Average Monthly and Annual Natural 195 Rubber Prices in Singapore, 1953-1980 Figure 6.4: Natural Rubber Export Value Growth Rate Against 201 Export Volume Growth Rate, 1950-1976 Figure 6.5: Natural Rubber Export Value Growth Rate Against 202 Export Value Instability, 1950-1976 Figure 7.1: Time Paths of Oil Price Under Alternative 235 Scenarios, 1980-1995 Figure 8.1: Price Ranges Specified for Buffer Stocks 261 Operations Under the International Natural Rubber Agreement Figure 8.2(a): Forecasts of Natural Rubber Prices in London, 274 1981-1995 Figure 8.2(b): Forecasts of Average Synthetic Rubber Price 275 and Natural Rubber Prices in New York, 1981-1995 Figure 8.2(c): Forecasts of Natural Rubber Prices in Singapore, 276 1981-1995 Figure 8.2(d): Forecast Time Paths of Rubber Production and 277 Consumption, 1981-1995 Figure 8.3: Time Paths of Natural Rubber Price in Singapore 283 With and Without Market Intervention (No Prospective Buffer Stock Operations Allowed) - xxi - Figure 8.4: Time Paths of Natural Rubber in Singapore With 285 and Without Market Intervention (Prospective Buffer Stock Operations Allowed) Figure 8.5(a): Time Paths of World Natural Rubber Supply 289 Figure 8.5(b): Time Paths of World Natural Rubber Demand 289 Figure A8.1: Time Paths of Natural Rubber Supply and 300 Export Earnings, Africa Figure A8.2: Time Paths of Natural Rubber Supply and Export 300 Earnings, Brazil Figure A8.3: Time Paths of Natural Rubber Supply and Export 301 Earnings, Indonesia Figure A8.4: Time Paths of Natural Rubber Supply and Export 301 Earnings, Malaysia Figure A8.5: Time Paths of Natural Rubber Supply and Export 302 Earnings, Sri Lanka Figure A8.6: Time Paths of Natural Rubber Supply and Export 302 Earnings, Thailand Figure A8.7: Time Paths of Natural Rubber Consumption, France 303 Figure A8e8: Time Paths of Natural Rubber Consumption, West 303 Germany Figure A8.9: Time Paths of Natural Rubber Consumption, Italy 304 Figure A8.10: Time Paths of Natural Rubber Consumption, Japan 304 Figure A8.11: Time Paths of Natural Rubber Consumption, UK 305 Figure A8.12: Time Paths of Natural Rubber Consumption, USA 305 Figure A8.13: Time Paths of Natural Rubber Supply and 306 Producers' Revenue, Malaysian Estates Figure A8.14: Time Paths of Natural Rubber Supply and 306 Producers' Revenue, Malaysian Smallholders Figure 9.1: Price Stabilisation Without Prospective Buffer 309 Stock Purchases/Sales, 1982-1991 Figure 9.2: Price Stabilisation With Prospective Buffer Stock 311 Purchases/Sales, 1982-1991 (Equidistant Price Bands) - xxii - Figure 9.3(a): Time Paths of World Natural Rubber Supply 313 (Equidistant Price Bands) Figure 9.3(b): Time Paths of World Natural Rubber Demand 313 (Equidistant Price Bands) Figure 9.4: Price Stabilisation With Prospective Buffer Stocks 324 Purchases/Sales 1982-1991 (Non-Equidistant Price Bands) Figure 9.5(a): Time Paths of World Natural Rubber Supply (Non- 326 Equidistant Price Bands) Figure 9.5(b): Time Paths of World Natural Rubber Demand (Non- 326 Equidistant Price Bands) Figure 9.6: Time Paths of Natural Rubber Price With and 333 Without Buffer Stocks Stabilisation, 1970-1980 Figure 9.7(a): Forecasts of RSS1-grade Natural Rubber Prices 340 in Singapore Under Different Oil Price Scenarios, 1981-1995 Figure 9.7(b): Forecasts of Average Synthetic Rubbers Price and 341 Natural Rubber Price in New York, 1981-1995 (High Oil Price Scenario) Figure A9.l: Time Paths of Natural Rubber Supply and Export 344 Earnings, Africa (Equidistant Price Bands) Figure A9.2: Time Paths of Natural Rubber Supply and Export 344 Earnings, Brazil (Equidistant Price Bands) Figure A9.3: Time Paths of Natural Rubber Supply and Export 345 Earnings, Indonesia (Equidistant Price Bands) Figure A9.4: Time Paths of Natural Rubber Supply and Export 345 Earnings, Malaysia (Equidistant Price Bands) Figure A9.5: Time Paths of Natural Rubber Supply and Export 346 Earnings, Sri Lanka (Equidistant Price Bands) Figure A9.6: Time Paths of Natural Rubber Supply and Export 346 Earnings, Thailand (Equidistant Price Bands) Figure A9.7: Time Paths of Natural Rubber Consumption, 347 France (Equidistant Price Bands) Figure A9.8: Time Paths of Natural Rubber Consumption, 347 West Germany (Equidistant Price Bands) Figure A9.9: Time Paths of Natural Rubber Consumption, Italy 348 (Equidistant Price Bands) - xxiii - Figure A9.10: Time Paths of Natural Rubber Consumption, Japan 348 (Equidistant Price Bands) Figure A9.11: Time Paths of Natural Rubber Consumption, UK 349 (Equidistant Price Bands) Figure A9.12: Time Paths of Natural Rubber Consumption, USA 349 (Equidistant Price Bands) Figure A9.13: Time Paths of Natural Rubber Supply and Producers' 350 Revenue, Malaysian Estates (Equidistant Price Bands) Figure A9.14: Time Paths of Natural Rubber Supply and Producers' 350 Revenue, Malaysian Smallholders (Equidistant Price Bands) Figure A9.15: Time Paths of Natural Rubber Supply and Export 351 Earnings, Africa (Non-Equidistant Price Bands) Figure A9.16: Time Paths of Natural Rubber Supply and Export 351 Earnings, Brazil (Non-Equidistant Price Bands) Figure A9.17: Time Paths of Natural Rubber Supply and Export 352 Earnings, Indonesia (Non-Equidistant Price Bands) Figure A9.18: Time Paths of Natural Rubber Supply and Export 352 Earnings, Malaysia (Non-Equidistant Price Bands) Figure AS.19: Time Paths of Natural Rubber Supply and Export 353 Earnings, Sri Lanka (Non-Equidistant Price Bands) Figure A9.20: Time Paths of Natural Rubber Supply and Export 353 Earnings, Thailand (Non-Equidistant Price Bands) Figure A9.21: Time Paths of Natural Rubber Consumption, France 354 (Non-Equidistant Price Bands) Figure A9.22: Time Paths of Natural Rubber Consu.mption, 354 West Germany (Non-Equidistant Price Bands) Figure A9.23: Time Paths of Natural Rubber Cosumption, Italy 355 (Non-Equidistant Price Bands) Figure A9.24: Time Paths of Natural Rubber Consumption, Japan 355 (Non-Equidistant Price Bands) Figure A9.25: Time Paths of Natural Rubber Consumption, UK 356 (Non-Equidistant Price Bands) Figure A9.26: Time Paths of Natural Rubber Consumption, USA 356 (Non-Equidistant Price Bands) - xxiv - Figure A9.27: Time Paths of Natural Rubber Supply and Producers' 357 Revenue, Malaysian Estates (Non-Equidistant Price Bands) Figure A9.28: Time Paths of Natural Rubber Supply and Producers' 357 Revenue, Malaysian Smallholders (Non-Equidistant Price Bands) CHAPTER ONE INTRODUCTION 1.1 Problems of the World Rubber Market The question of price and export instability of primary commodities has occupied economists for a long time. More recently, the UNCTAD proposal for an Integrated Progranme for Commodities has caused renewed interest in this problem and precipitated further empirical and theoretical studies of this issue. The maintenance of interest in the problem of commodity market instability stems largely from the fact that many developing countries are known to be dependent on the export earnings of one or two commodities only. The problem of price and export instability is therefore particularly crucial for the major suppliers because of their reliance on commodity exports for foreign exchange earnings. Two types of problems caused by price and export instability may be distinguished. At the micro level, commodity instability affects employment and producers' earnings and investment in the commodity concerned. At the macro level, export earnings from primary commodities often form the main source of foreign exchange funds for imports of investment goods required for development purposes. The export instability therefore causes financial bottlenecks which hinder the implementation of overall development plans. Furthermore, it has Page 2 also been argued that the micro level problems caused by export instability are in fact greater than those suggested by the direct impact, because of the associated indirect input demand and multiplier effects on the rest of the economy and hence on overall investment. The problems of export instability are relevant to natural -ubber, production of which is concentrated in the South and Southeast Asian countries of Indonesia, Malaysia, Sri Lanka and Thailand. For all of these countries, natural rubber is a major source of export earnings and export tax revenue. Furthermore, as natural rubber production is particularly labour-intensive, the industry is also an important provider of employment. The problem of natural rubber market instability became more complicated after the sale in 1955 of the US government-owned synthetic rubber production capacities to the private sector. The subsequent dynamic growth of the synthetic rubber industry also led to increased competition between natural and synthetic rubbers. This increased competition between the two types of rubbers from 1956 to the first oil crisis in late 1973 was manifested in the continual decline of the long-run natural rubber price and natural rubber share of consumption. This study therefore sets out to examine the problems of the natural rubber market with the primary focus on market instability. An econometric model of the world market is estimated from data covering the 1956-1978 period. Such a model facilitates analysis of the market instability as well as the observed long-run decline in natural rubber price and consumption share during the historical Page 3 period. The model is used to forecast future natural rubber prices under a given oil price scenario; subsequently, price stabilisation schemes under the International Natural Rubber Agreement are evaluated. The model is also used for other purposes, such as the impact of national government market interventions. In this study the case of Malaysian export taxes on natural rubber is chosen. The incorporation of Malaysian export taxes on natural rubber in the model enables evaluation of the effects of variations in export tax rates on Malaysian production of rubber and world rubber price and hence on world production and consumption of rubber and market instability. This evaluation of Malaysian export taxes is an example of the effects on the world market of removing an existing intervention in the market by a national government. 1.2 Background to the World Rubber Market Natural rubber has been known as an industrial raw material since the last century. However, its importance to the modern industrial economy (via the tyre industry) has occurred only since the worldwide popularisation of road (private and commercial) and air transport, especially in the industrialised countries. A crucial aspect of the postwar transport industry's impressive growth is its interdependence with the rates of growth of natural rubber, oil and synthetic rubber industries. The long production gestation lag and accompanying Page 4 geographic concentration of natural rubber production, and the relatively high price for natural rubber, encouraged the rapid development of the synthetic rubber industry. Thus a study of the natural rubber market involves a study of the inter-relations between three commodities: natural rubber, oil and the synthetic rubbers. By the nature of agronomy, technology, location factors, market structures and economic behaviour, any exogenous shock to the natural rubber-oil-synthetic rubber system has tended, in general, to produce both positive and negative consequences for natural rubber due to substitution and income effects. This can be seen, for example, in the short-run effects of a change in oil price, an important variable in the competition between natural rubber and the oil-based synthetic rubbers. Ceteris paribus, higher oil price results on the one hand in increased natural rubber consumption (via substitution of synthetic rubber by natural rubber) while on the other hand higher oil price causes a fall in natural rubber consumption (through a decline in transport demand and hence tyre consumption). Similarly, the offsetting effects of technology on natural rubber consumption is illustrated by the introduction in the early 1960s of radial tyres, which have a higher natural rubber content per tyre than the conventional cross-ply tyres. Production of radial tyres in each period should result in increased natural rubber consumption. But 1 radial tyres are known to be longer lasting than cross-ply tyres. Under a given demand for tyres and a constant rate of tyre utilisation, the demand for natural rubber over time may decline if Although radial tyres have been quoted to be longer-wearing than cross-ply tyres by 30 to 80 percent, this feature is still being tested by the tyre industry for a more precise figure (Billet, 1981). Page 5 existing cross-ply tyres are gradually replaced by the longer-lasting radial tyres. The net effect of radial tyres on natural rubber consumption therefore depends on the trade-off between increased natural rubber consumption and the increased mileage per radial tyre. These examples illustrate the complex relationships influencing the two basic components of natural rubber demand: that of essential demand for natural rubber versus that of competitive demand between natural rubber and synthetic rubbers. The question therefore is whether the observed volatility of natural rubber price can be explained by the interaction of these two demand components with natural and synthetic rubber supply variations. 1.3 Falling Natural Rubber Market Share and Instability The two components of overall demand for natural rubber mean that this demand cannot be divorced from (a) the overall demand for elastomers and (b) the demand for synthetic rubbers. An overview of the interaction of the natural and synthetic rubber markets is therefore pertinent to an understanding of the natural rubber market. The salient features of this interaction will now be briefly discussed. Tables 1.1 and 1.2 show the volumes and distribution of world production and consumption of natural and synthetic rubbers respectively, for the period between 1956 and 1978. From the Tables, two features are seen to predominate: Page 6 Table 1.1: Production of Natural Rubber and Synthetic Rubbers, 1956-1978 (thousand tonnes) Year Natural Rubber Synthetic Rubbers Total 1956 1922.8 (60.9) 1230.4 (39.1) 3153.2 (100.0) 1960 2021.8 (51.4) 1910.1 (48.6) 3931.9 (100.0) 1965 2380.0 (43.7) 3060.7 (56.3) 5440.7 (100.0) 1970 3102.5 (34.4) 5892.5 (65.6) 8995.0 (100.0) 1975 3315.0 (32.5) 6855.0 (67.5) 10170.0 (100.0) 1978 3755.0 (29.7) 8850.0 (70.3) 12605.0 (100.0) Source: Rubber Statistical Bulletin, various issues. Note: Figures in parentheses denote percentages of the corresponding totals, Page 7 Table 1.2: Consumption of Natural Rubber and Synthetic Rubbers, 1956-1978 (thousand tonnes) Year Natural Rubber Synthetic Rubbers TOTAL 1956 1907.5 (62.3) 1153.2 (37.6) 3060.7 (100.0) 1960 2098.0 (53.4) 1826.3 (46.6) 3924.3 (100.0) 1965 2420.6 (44.4) 3020.1 (55.6) 5440.7 (100.0) 1970 2990.0 (34.6) 5635.0 (65.4) 8625.0 (100.0) 1975 3367.5 (32.3) 7027.5 (67.7) 10395.0 (100.0) 1978 3725.0 (29.8) 8755.0 (70.2) 12480.0 (100.0) Source: Rubber Statistical Bulletin, various issues. Note: Figures in parentheses denote percentages of the corresponding totals. Page 8 (i) Based on four- to five-year intervals, the rate of growth in world production and consumption of elastomers was fastest during the sixties, especially during the second half (1965-1970). (ii) In both production and consumption, the rate of growth for synthetic rubbers in each time interval was twice to five times as high as the corresponding rates for natural rubber. Obviously the dominant position of synthetic rubbers in the elastomer market was established during the sixties. This has also caused a reversal in the consumption shares of natural rubber and synthetic rubbers between 1956 and 1978. During this period, natural rubber's share of total elastomer consumption fell from 62.3 percent in 1956 to 29.8 percent in 1978; in contrast, synthetic rubbers' share rose from 37.6 percent to 70.2 percent. These consumption share figures, which approximate the respective rubber production shares, reinforce the argument that natural rubber demand should be analysed in the context of overall demand for elastomers. Since natural rubber is an industrial commodity in its end uses, a pertinent question is the extent to which demand are concentrated within the industrialised countries. Table 1.3 shows the distribution of natural rubber consumption between the main non-socialist industrial countries (of France, West Germany, Italy, Japan, UK and USA) and the rest-of-the-world. Although consumption in these countries dominate world natural rubber consumption, their shares have been declining, albeit gradually, from 58.2 percent in 1960 to 46.0 percent in 1978.2 A sectoral breakdown of natural rubber consumed As 1956 sectoral figures for Japan are not available, the figures here relate to the situation from 1960 onwards. Page 9 Table 1.3: Distribution of Natural Rubber Consumption, 1956-1978 (thousand tonnes) Major Year Industrialised Rest-of-the-World TOTAL Countries 1956 1190.3 (62.4) 717.0 (37.6) 1907.5 (100.0) 1960 1222.5 (58.2) 875.5 (41.8) 2098.0 (100.0) 1965 1278.5 (52.8) 1142.1 (47.2) 2420.6 (100.0) 1970 1518.4 (50.7) 1471.6 (49.3) 2990.0 (100.0) 1975 1593.0 (47.3) 1774.5 (52.7) 3367.5 (100.0) 1978 1716.7 (46.0) 2008.3 (54.0) 3725.0 (100.0) Source: Rubber Statistical Bulletin, various issues. Note: Figures in parentheses denote percentages of corresponding totals. Page 10 in the major industrial countries is presented in Table 1.4 and shows that natural rubber demand is concentrated largely in the transport sector whose share of consumption has grown from 58.8 percent in 1960 to 72.3 percent in 1978. Clearly this growth in transport sector demand is due to the growth of the road transport industry in the postwar period. Tables 1.3 and 1.4 thus emphasise the influence of industrial activity -- especially that of transport -- of the industrialised countries on the natural rubber market. The interaction between natural and synthetic rubbers and the influence of industrial (especially transport sector) activity on the elastomer market can be seen from the behaviour of elastomer prices. Figure 1.1 illustrate the time paths of natural and synthetic rubber prices during 1956 to 1978; these prices refer to c.i.f. New York price for RSS1-grade natural rubber and the unit export value for styrene-butadiene, the most widely used synthetic rubber. Figure 1.1 reveals three features: (a) the similarity in the price trends; (b) the well-defined falling trend in prices during 1960-1972 which has been shown to contain the period of fastest growth in elastomer production and consumption; (c) the rising trend in prices after the oil crisis of late 1973. What has such price behaviour meant, in terms of natural rubber export earnings of the producing countries? In Figure 1.2 the time paths of natural rubber earnings (in current US Dollars) of the four major natural rubber producing countries are presented. Except for Page 11 Table 1.4: Natural Rubber Consumption by Sector in Major Industrialised Countries, 1956-1978 (thousand tonnes) Year Transport Non-Transport TOTAL 1956 1190.3 (100.0) 1960 720.0 (58.8) 502.5 (41.2) 1222.5 (100.0) 1965 757.4 (59.2) 521.1 (40.8) 1278.5 (100.0) 1970 928.5 (61.1) 590.0 (38.9) 1518.4 (100.0) 1975 1082.4 (67.9) 510.5 (32.1) 1593.0 (100.0) 1978 1241.9 (72.3) 474.8 (27.7) 1716.7 (100.0) Source: Rubber Statistical Bulletin, various issues. Note: Figures in parentheses denote percentages of corresponding totals. Price of Rubber (US dollars per tonne) 1200 Natural Rubber (RSS1-grade, c.i.f.New York) o000o Synthetic Rubbers (Unit value of US exports of I0 styrene-butadiene) 800 400 0 Year 1956 1960 1964 1968 1972 1976 Figure 1.1: Natural Rubber and Synthetic Rubber Prices, 1956-1978 (D Page 13 AExport Revenue (Million Current US dollars) 1600 Malaysia 1400 1200_. 10001 800 In onesia 600 400 Th 'land 200 Sr anka 1956 1960 1964 1968 1972 1976 1980 Year Figure 1.2: Total Natural Rubber Export Earnings of Major Producing Countries, 1956-1978. Page 14 Indonesia, the distinct feature of the time paths is the approximately stationary trend in earnings during 1956-1972. In contrast, the trend during 1972-1978 was markedly rising. Thus although natural rubber production increased continuously throughout the sixties, the fall in price was such as to keep rubber export earnings relatively constant. In contrast, while production increased at a lower rate in the seventies, the rise in rubbe; prices resulted in significant increases in export earnings. This illustrates the importance of price in determining nominal and real producer incomes and natural rubber export receipts in the producer countries. 1.4 Purpose of this Study The above discussion has emphasised the derived demand for elastomers and the joint consumption of both natural and synthetic rubbers in this derived demand. Consequently, a balanced study of the natural rubber market and its future prospects also entails an understanding of the synthetic rubber industry. The immediate aim of this study is the estimation of an econometric model of the world natural and synthetic rubbers maarket to explain natural rubber price and consumption share over time. Such a model should reflect the lagged price effects on supply and demand. After the model has been validated it can then be used in various applications. In this study, the primary application of the model is to evaluate buffer stock price stabilisation by the International Page 15 Natural Rubber Agreement; the basis for this evaluation is the forecast of future rubber prices under a given oil price scenario. Since non-stochastic simulations are used, the sensitivity of stabilisation effects to stochastic and non-stochastic simulations will be evaluated by examining the effects of hypothetical price stabilisation during 1970-1980. In all these simulations, the evaluation of stabilisation effects on individual countries are facilitated by the highly disaggregated model. With the highlly disaggregated model, the impact of any national policy change on the rubber supply and demand of individual countries can also be examined. Since many of the natural rubber producing countries impose taxes on their natural rubber exports, the impact of Malaysian export tax variations on the rest of the world will also be assessed to illustrate the interrelations between variables within the system. All these simulations also provide information on the long-run behaviour of the natural rubber share of consumption. This thesis can be divided into two parts, the first of which concerns the various aspects of the market and the model specifications and estimations. The second part of the thesis concerns the application of the model to analyse the natural rubber price stabilisation and the effects of national government market interventions. In the first part, Chapter Two analyses the joint consumption of natural rubber and synthetic rubbers and emphasises the "habit persistence" aspect of the demand for elastomers. Chapter Three treats the question of supply of elastomers; the emphasis is to Page 16 contrast the markedly different gestation periods and industrial organisation in the production of the two types bf rubbers. Since primary producing countries typically tax their primary exports, Chapter Four examines the impact of export taxation on natural rubber supply response in Malaysia. Because of the derived nature of demand, and the geographical concentration of natural rubber production away from the main industrial consuming countries, Chapter Five examines the role of stocks and highlights the influence of stock location on price formation. These various components are synthesised in Chapter Six which shows that the world market for elastomers can be represented by a model consisting of two submodels: a natural rubber submodel featuring perfect competition and a synthetic rubber submodel featuring imperfection competition. The nexus between the natural rubber and synthetic rubbers submodels is provided by the consumption equations through which the natural rubber and synthetic rubber price effects are modelled. The validation of the model provides an understanding of the interaction between the long-term rubber market behaviour and the natural rubber market instability around the trend. The second half of this study begins with Chapter Seven which examines alternative oil price scenarios for 1980-1995. These scenarios provide the basis for projecting values of the exogenous variables in the model so that the model can be used to forecast natural rubber price under alternative scenarios. Chapter Eight begins with a discussion of the theoretical underpinnings of price stabilisation. It then goes on to discuss the clauses of the International Natural Rubber Agreement and to examine the conditions for a viable buffer stock price stabilisation policy. A 5-year buffer Page 17 stock stabilisation scheme for 1982-1986 under a low oil price scenario is then examined. Chapter Nine examines whether the distribution of gains is affected by (a) the period of a stabilisation agreement and (b) the use of equidistant or non-equidistant price bands. Forecasts of prices, production and consumption of rubbers under the high oil price scenario are also presented and the respective rubber consumption shares evaluated. Chapter Ten analyses the sensitivity of price forecasts, production and consumption of rubber to variations in Malaysian export tax rates; such export tax variations illustrate the effects of a market intervention by a national government and serve to verify the high degree of interdependence between variables in the rubber market. The simulations in Chapters Eight to Ten also emphasise the influence of lagged price effects and the issues which warrant consideration in any price stabilisation attempt. Finally, Chapter Eleven presents the main findings for the rubber market and summarises the problems of natural rubber stabilisation; further work along the lines of optimal stockpilirn ħrogrammes is then suggested. Page 18 CHAPTER TWO DEMAND FOR RUBBERS 2.1 Introduction In Chapter One it was explained why evaluation of stabilisation measures for the natural rubber market rests on the study of the interaction between the consumption and production of natural rubber and synthetic rubbers, and the price of oil. The three aspects of this interaction are (1) the substitutability, and hence competition, between natural and synthetic rubbers in the derived demand for elastomers; (2) the impact of oil price on synthetic rubber production costs and (3) the impact of oil price on general economic activity and hence on the demand for elastomers. The competition between natural rubber and the synthetic rubbers in the demand for rubber will be analysed in this chapter. The role of oil price (aspects (2) and (3)) will be discussed in subsequent chapters. The demand for rubber is derived from the demand for final goods; about 65 percent derives from the transport sector (mainly in the production of tyres and tubes) and the remaining 35 percent from the non-transport sector (from the production oJ: producer goods such as conveyor belts to consumer goods such as footwear and gloves). The two types of rubber jointly consumed in this derived demand are natural rubber and the synthetic rubbers. Figure 2.1 gives a flowchart of the various final goods demand, their translation into Original equip- ment demand for New cars NEW radial and r and cross-ply tyres vehicles Total , . + demnand for NEW St Replacement demand stock of car for NEW radial and man Natural o vehicl cross-ply tyres oubbers rubber 0 04t Demand for Replacement demand synthetic for RETREADED rubbers N radial and cross-ply tyres ,'6emand for 3~natural rubber I Demand for for SRs synthetic 4N ~'o Non-transDort.endDmd z emanI Demand J h industry --fr_for_N__ E j rubber goods g: L production rubbe z L-vI' |for SRs Figure 2.1: Demand for Natural and Synthetic Rubbers by Sector for each Country. D H Page 20 the derived demands for rubber and their subsequent decomposition into natural rubber and synthetic rubber demands. The process of natural rubber price formation is partially explained by the demand for rubbers and hence for natural rubber. As natural and synthetic rubbers are jointly consumed, the specification of these input demands can be jointly derived once their determinants are known; these determinants can be grouped according to whether they stem from technical, economic and political factors. Since the competition between the two types of rubber is dominated by the technical factors, the role of technology in the choice of rubbers demanded will be discussed first. 2.2 Technical Features of Input Demand As mentioned before, the demand for rubber is concentrated in the transport sector, mainly in tyre and tube production. In contrast the remaining rubber is consumed by the non-transport sector in producing a conglomerate of final goods which cannot be aggregated because of their heterogeneity. However, the volume of rubber consumed by each type of non-transport final goods is relatively small. Thus this discussion of the role of technology in the choice of rubber will be restricted to the production of tyres and tubes. Basically, the substitutability between natural and synthetic rubbers in tyre and tube manufacturing stems from the development of Page 21 "general-purpose" synthetic rubbers having, in varying degrees, the properties of natural rubber. In joint use, these properties may be viewed as competing with and/or complementary to those of natural rubber. Apart from natural rubber, the general-purpose synthetic rubbers are styrene-butadiene(SBR) and the stereo-regular polybutadiene(BR) and polyisoprene(IR), the latter being known as "synthetic natural rubber" because its properties are very similar to those of natural rubber. Since the competition among the general-purpose synthetic rubbers is critical to the overall competition between natural and synthetic rubbers in tyre manufacturing, the nature of competition amongst the general-purpose rubbers within the tyre sector will now be discussed. The basic requirements of a tyre are its tyre strength, high speed and endurance; under these criteria, tyres can be made entirely from natural rubber as in some instances in the less-developed natural rubber producing countries. However technological progress in synthetic rubbers and tyre manufacturing has yielded tyres with improved properties, such as tyre wear resistance (treadwear), road adhesion (weather resistance), groove and sidewall cracking (resilience), heat durability and cold flexibility. To distinguish these two sets of criteria, Allen(1972) has termed the former as "product specifications" and the latter as "service performance". Strictly speaking, "product specifications" are essential requirements; "service performance" properties, though preferred are In addition there are special-purpose rubbers designed for specific end uses; these are polychloroprene, butyl, ethylene-propylene, co- and ter-polymers and the expensive specialty rubbers suach as silicones, acrylics, et cetera. Usages of the special-purpose rubbers have not been extensive for reasons of price or of inadequacy in physical properties. Page 22 not essential. However, from Table 2.1 which compares natural and synthetic rubbers' properties, it can be seen that it is on their ability to meet these "service performance" criteria that synthetic rubbers have made their inroads into the tyre industry. The development of blending technologies, especially for blending styrene-butadiene with polybutadiene has been instrumental in making these inroads. Because of the close substitutability between the various general-purpose rubbers, including natural rubber, the pattern of input-mix and volume of natural rubber consumption finally observed reflects a process of rubber input selection based on technical, economic and political considerations. In discussing the technical factors, a brief resume of the role of technological progress in the rubber industry is warranted. The effects of technological progress on rubber demand are two-faceted: qualitative effects which refer to physical properties versus quantitative effects wihich impact on production costs. The qualitative effects concern the physical properties attainable in individual or compounded rubber and new products, such qualitative technological progress having for example occurred in the mid-1950s with new processing techniques for styrene-butadiene and the development of polybutadiene and polyisoprene (which became commercially important by 1959). Subsequent displacement of natural rubber by synthetic rubbers was accelerated by the development of the blending technologies referred to above. Since the mid-1960s this trend has been counteracted by the development of the radial tyre which has a higher natural rubber content than the conventional cross-ply tyre. The quantitative effects of technological progress Table 2.1: Comparison of the Properties of the General-Purpose Rubbers Property Natural Polyisoprene Styrene- Polybutadiene Rubber Butadiene Treadwear 100 100 115 150 Resilience 100 100 75 95 Heat durability 100 100 150 150 Cold flexibility 100 100 90 120 Weather resistance 100 100 115 100 Source: D'Ianni, (1969). (D Pi Page 24 concern increased productivity and lower unit cost, in synthetic rubber production and the increased natural rubber content per tyre required by the radial tyres. The technical considerations in the choice of rubber inputs are therefore based on the availability of different rubber inputs, of blending technologies and of new products wrought through technological progress. Technically, the choice of natural or synthetic rubber inputs is dictated by the requirement that end-products meet the users' specifications. The development of blending technologies means that careful compounding of natural rubber with synthetic rubbers can yield almost any rubber with a predetermined set of properties. Conversely, for products requiring the general-purpose rubbers, there is a range of technical possibilities. This leads to the question of costs of mixing rubbers and of mix changes; the influences of economic and also of political factors will be discussed below. 2 An example of this is the cold-stream polymerisation of styrene-butadiene in the mid-1950s resulting in. lower-cost production. For details of other cost-reducing technological change, see Allen(1972) and Allen, Thomas and Sekhar(1974). Page 25 2.3 Minimum Input Requirement of Tyre Production Having briefly described the role of technological progress in rubber and rubber goods production, it is essential to discuss a technical constraint on the choice of rubber inputs observed in the tyre industry. The main inputs under consideration are natural rubber, styrene-butadiene, polybutadiene and polyisoprene. Three categories of output from the tyre industry may be distinguished; namely, tyres for passenger cars (hereafter referred to as cars), for commercial vehicles (hereafter referred to as trucks) and off-the-road tyres such as aeroplane tyres, tractor tyres and tyres for eartbnovers. Since off-the-road tyres consuLme only a relatively small share of the total rubber consumed in the tyre industry, this discussion will concentrate on car and truck tyres. Basically the rubber input mix for car and truck tyres differs because of their difference in size, product specifications and service performance. For each category (new or retreaded) of tyre, the availability of different types of tyres (crossply and radial), leads to further variations in input mix. The total demand for natural rubber for each category and type of tyre is the product of the total number of tyres produced and the natural rubber content-per-tyre, the latter being determined by the input mix applied. Tables 2.2, 2.3 and 2.4 present input mixes used in the various components of cross-ply and radial car tyres, and cross-ply tyres for large trucks, respectively. The Tables show that, for each type of tyre, several input mixes are feasible for each of their tyre components. Thus different input mixes are feasible for the tyre as a Page 26 Table 2.2: Input Mix for Cross-ply Car Tyre Components Percentage of Input Mix Total Rubber * Tread 35 75 SBR : 25 BR Carcass 37 60 NR : 40 SBR * 75 SBR : 25 BR or Side Wall-(a) Black Blend of NR/SBR/BR h e 14 -(b) White Blends of NR/SBR/BR with higher NR-con- tent than (a) but not exceeding 50 per cent Liner T Chlorobutyl and IR >6 14 Inner Tubes JMainly butyl * Usually made from same input material (Sin, 1979). Source: Anderson(1977) and Grosch(1969) Page 27 Table 2.3: Input Mix for Radial Car Tyre Components Percentage of Input Mix Tread 33 75 SBR 25 BR 30 SBR Carcass 21 70 NR 30 BR 30 SBR/BR blend Side Wall 18 55 NR : 25 SBR : 15 BR Liner 14 f NR - 30 per cent Chlorobutyl ? 70 percent (30 SBR Breaker 14 70 NR : 30 BR 30 SBR/BR blend All parts 100 40 NR e 60 SBR/BR blend Source: As for Table 2.2; Page 28 Table 2.4: Input Mix for Cross-ply Large Truck Tyre (Composition very diversified) Component Percentage of Input M Total Rubber Tread 30 75 NR : 25 BR 60 NR : 40 BR 40 NR : 10 SBR 50 BR 100 NR Subtread 10 50 NR : 50 BR 100 NR Shoulder Wedge 5 80 NR : 20 BR 45 NR : 55 BR 80 SBR: 20 BR 55 NR : 45 BR Side Uall 8.5 30 NR : 20 SBR : 50 BR 40 NR : 60 BR 100 NR 45 NR 25 SBR : 30 BR Carcass 46.5 65 NR 35 BR 80 NR : 10 SBR : 10 BR Source: Sin (1979). Page 29 whole from which it may be inferred that there exist minimum requirements of the various rubber inputs for each tyre component. This is substantiated in Figure 2.2 which presents histograms of natural rubber, styrene-butadiene and polybutadiene usage in car tyre treads; however, it should be emphasised that these histograms are based on analysis of tyre tread compounds used in over 200 car tyres produced in Europe and USA between 1964 and 1967 and are likely to be outdated by subsequent trends in tyre technology. An example of later trends is the widespread replacement of commercial vehicles by "mini-buses" in congested cities, as in Japan, so that the tyres required are smaller and can therefore use more synthetic rubbers than is permissible in tyres for heavy-duty commercial vehicles. Then the overall minimum requirement per type of input per tyre is the sum of minimum input requirements of the various tyre components. In order to examine the interaction between natural rubber and the various synthetic rubbers, the demand for the various elastomers per type of tyre should therefore be analysed together. Under a given technology, the substitutability between natural rubber and the various synthetic rubbers per tyre should, strictly speaking, refer only to the range of feasible inputs net of their minimum requirements. Hence while the minimum natural and synthetic rubber inputs per tyre are determined by the available technology and the service performance criterion, the substitutable shares of these inputs are determined by their relative prices. However, limits to substitution exist. These are imposed by the costs of technical adjustment and of the reallocation of labour input and/or of the alternative division of labour within the plant. The influence of Page 30 Styrene-butadiene Natural Rubber 40 100 20., 80 O ZDILE 20 40 60 80 100 60 >40 Polybutadiene 40 40- rX.4 20 20 20 40 60 80 100 20 40 60 80 1 Polymer (%) Figure 2.2: Rubber Compositions of Car Tyre Treads Source: Grosch.(1969). Page 31 relative prices, adjustment costs and other factors on the substitution between natural and synthetic rubbers will now be discussed. 2.4 Det2rminants of Input Substitution Beyond Minimum Requirements It has been shown above that the minimum input requirements in manufa.turing tyres and tubes delineate the range within which substitution between the different rubbers is technically feasible. Hence the overall input mix that is finally observed reflects the net effect of technical and economic determinants, since the observed input mix includes the share of inputs within the substitutable range. Of the economic factors, that of relative input prices may be differentiated from the non-price factors. These input prices directly affect input substitution via the relative price effect. The non-price factors, however, affect input substitution :.ess directly; on the whole they tend to discourage substitution by natural rubber even when the relative prices favour natural rubber consumption. The main determinants of competition within the general-purpose rubbers (especially between natural rubber and styrene-butadiene) are price and price stability. Price stability is important not only because manufacturing facilities cannot easily adapt to different blends of rubbers when relative prices change (because of technical adjustment costs) but also because the competitive situation of rubber goods manufacturing in the Western World (outside the Page 32 centrally-planned economies) does not on the whole yield high returns so that the industry is especially sensitive to raw material costs (Allen, 1972:164). The nature of the markets for rubber products also precludes frequent sharp changes in their selling prices.3 Furthermore, price instability also affects stock valuations. The nature of natural rubber price instability versus synthetic rubbers price stability will be discussed at length in Chapter Five on the price formation process in the two markets. For the present it suffices to mention that while natural rubber is traded internationally under perfect competition and openly in the world's major commodity exchanges, the same cannot be said of synthetic rubbers. Synthetic rubbers are neither traded openly nor on commodity exchanges; instead they are traded under list prices that are announced periodically so that price increases occur "in a predictable and orderly fashion" (Grilli, 1980); however, actual sales of synthetic rubbers are understood to be at discounts from the published prices (Allen, 1972), so that synthetic rubber prices actually do vary. If this is compared with the long-term contractual arrangement for the bulk of natural rubber consumed to be discussed at length in Chapters Four and Five, then the apparent contrast in price stability/instability may be overemphasised. In reality the prices actually paid by consumers for natural(synthetic) rubber(rubbers) may not be as unstable(stable) as their spot(list) price(prices) would suggest. For details on the workings of the international tyre industry, see Stanton (1979). Page 33 The location of rubber supply presents another factor in input choice and substitution. The consequence of the geographical concentration of natural rubber production in South and Southeast Asia is the long supply route to buyers which adds to transportation costs and causes buyer insecurity because of his vulnerability to possible shipping delays. Thus the consumer has to buy further forward which complicates his inventory policy. The sale of natural rubber is traditionally based on payments against documents; this means that the buyer must part with his money earlier than if he were to buy synthetic rubbers from sources closer to home. With speculative trading complicating the price behaviour of natural rubber as will be seen in Chapter Five, more trading acumen is therefore required of the buyer in natural rubber than in synthetic rubbers purchasing. Since synthetic rubbers are mainly produced in the industrial countries, the supply line from producer to manufacturer is shorter than that for natural rubber. Inventories can thus be kept at a lower level and quality complaints can also be dealt with more directly and quickly. The only problem with synthetic rubbers purchasing is their greater variety (both types and grades) and periodic shortages (due to occasional feedstock shortages and synthetic rubber supply adjustments) which the buyer has to consider for purchasing and, stocking. This is important since the function of a buyer is to anticipate changes in input mixes that may be necessary in view of expected long-term relative price movements. One description of the role of a buyer is that by Anderson: "As an individual, the commercial buyer of natural rubber for a medium to large rubber manufacturer does not play a significant part in making his company's choice between natural and synthetic rubber. He is a specialist engaged in daily Page 34 contact with the market and primarily concerned with the movement of prices and differentials of the many grades he has to buy and with the control of inventory, forward commitments, deliveries and claims. Even though he may also be involved in the purchase of equivalent synthetic rubbers hc is not normally aware of the equivalent cost of synthetic rubbErs in his company's products compared with natural rubber, wqlere substitution is technically possible. The rubber buyer is responsible for supplying information on the prices ruling for natural rubber grades and for the synthetic rubbers to his technical colleagues. It is they who are responsible for compounding to meet the product performance specifi.cations from the materials available at minimum overall costs, on which the choice of polymers depends. The buyer's role is then limited to obtaining supplies of the materials specified at minimum cost, and, of course, of keeping his company informed of the likely future price movements and changes in availability, particularly if these should call for development work leading to the use of more readily available or cheaper alternatives." Another factor influencing substitution between the two commodities is the processability of natural and synthetic rubbers. Figure 2.3 which compares the processing of natural rubber with synthetic rubbers shows that the latter can be used immediately it is received. In contrast, several preparatory steps are required of natural rubber before it is amenable for use in the Banbury Mixer where blending takes place before vulcanisation (or curing). The preparatory stages for natural rubber are: (a) Cleaning of the bales surfaces. This is because traditionally natural rubber arrives 'bare back'. Hence the bale surfaces must be cleaned of all extraneous dirt and foreign material which they have picked up en route to the factory, Anderson (1977); emphasis mine. Page 35 Figure 2.3: Comparison of Natural and Synthetic Rubber Processing Natural Rubber Synthetic Rubber Unload Car Unload Car Clean Bale Surface Hot Room Bale Cutter Plasticator Banbury Mixer Banbury Mixer Vulcanisation Source: Bekema (1969). Page 36 (b) Raw natural rubber is also susceptible to crystallisation at low ambient temperatures. Several days' conditioning at elevated temperatures are generally required prior to plastication. (c) The large bales of natural rubber must be cut into smaller pieces for efficient handling. (d) The Mooney viscosity of natural rubber must be reduced by multiple passes through the plasticator for mastication so as to attain optimum processibility before the natural rubber is delivered to the Banbury for mixing. Attempts to save some of these processing costs led to the production and export of crumb rubber, generally known as Standard Malaysian Rubber(SMR) and Constant Viscosity(CV) rubber in the mid-1960s. Crumb rubber has the advantage of low dirt content (which permits better processing, lower scrap and improved quaLity) and better scorch resistance while constant viscosity rubber eliminates much of the mastication required and its attendant degradation of physical properties. However, the tendencNr of raw natural rubber to crystallise at low ambient temperatures has yet to be overcome. From Figure 2.3, it can be seen that the various stages of processing relevant to the major part of the time period under study are not continuous, so that the intermediate output has to be stockpiled between each operation and transported onto the next; hence the operation is one of "batches". There is now a trend towards use of continuous processes where feasible, such as in mixing. Because of the various preparatory stages required in natural rubber Page 37 processing, more factory area and more inventory stations are required than in synthetic rubber processing, thus further increasing the cost of using natural rubber. Another factor influencing the choice of rubber is the question of accessibility to supply. Because of the geographical concentration of natural rubber production and the strategic nature of rubber in industry, the question of supply availability/accessibility is crucial. Furthermore there is, in some countries, a desire to be self-sufficient in rubbers, as in the centrally-planned economies. Once a synthetic rubber production capacity is established domestically, the synthetic rubbers become the preferred input. The choice of rubbers may also be influenced by a national policy of minimising foreign exchange expenditure. This is again particularly relevant to the centrally-planned economies which have gone into large-scale polyisoprene production especially. In summary, the industrial relationship between natural rubber and the synthetic rubbers is complex because of their similarities as well as differences. Regarding the status quo in the market structures of the two rubbers, D'Ianni has argued that the relationship between the highly interdependent rubbers is symbiotic. The choice of rubbers in this symbiotic situation is the outcome of an optimising process requiring constant revaluation of the cost and quality factors so that a "dynamic equilibrium is maintained with a balancing of costs, properties and performance as the critical criteria" since the cases "where blends are superior to either component alone outnumber those where only one is indicated" (D'Ianni, Page 38 1969:217). Any guideline for natural rubber supply management by a stabilisation agency thus hinges on an understanding of the interaction between the two rubber markets through their joint demand. 2.5 Specification of Input Demand Functions The --ompetition between natural and synthetic rubbers has been shown to stem from technical, economic and autarkic considerations. In specifying the input demand functions, the original intention was to build upon the findings by Behrman(1971). In analysing the competition between the two types of rubbers, Behrman first explained total rubber demand in terms of overall industrial activity and transport demand indices. The ratio of natural to synthetic rubber demand was then explained by total rubber demand and the relative price of natural to synthetic rubbers. Technical change in the synthetic rubber industry was represented by four technological indices which separately account for (1) the cold processing of styrene-butadiene, (2) the oil-extension of styrene-butadiene production, (3) the introduction of stereo-regular polybutadiene and polyisoprene and (4) the introduction of special-purpose rubbers. For the 1950-1966 period, Behrman obtained significant estimates when these four indices were incorporated in the relative rubber demand equation to account for input substitution due to the effects of relative prices and physical properties of the rubbers. Thus up to the mid-1960s, the elasticity of substitution may be decomposed into the technical (qualitative) and the price (quantitative) components. Page 39 By the mid-1960s the impact of the qualitative technical change in the form of new stereo-regular synthetic rubbers and their blending with styrene-butadiene to give synthetic rubbers of improved properties was well-established. Technical change in the ensuing period focussed on the specialty synthetic rubbers and on improving the tyre quality, the latter feature tending to lower the minimum inputs requirements of natural rubber. This trend may be attributed to the growth of the oil industry and the low stable oil prices, both of which facilitated the easy expansion of synthetic rubber production capacities. Thus it would have been interesting to examine the price elasticity of substitution net of these minimum inputs. However, since only European synthetic rubber list price data from mid-1960s on are available, it was decided to concentrate on the influence of minimum input requirements and relative input prices on rubber demand. Other factors relevant to input substitution and hence overall input demand, such as the relative lengths of supply routes, the differences in processability, the strategic issue of natural rubber supply availability and the corstraints on foreign exchange outflow is regrettably not incorporated into the present simplified study. These unincorporated factors are nevertheless pertinent to input demand choice and should be borne in mind since they are implicit in the determination of the final observed volumes of natural and synthetic rubbers consumed. Furthermore unless new and significant supplies of natural rubber emerge (such as from Brazil and Mexico), relevance of these factors are likely to persist into the foreseeable future. Consequently, in any complete evaluation of the market prospects for natural rubber, appropriate weights should be given to those factors Page 40 that have not been incorporated in the empirical estimation. Four assumptions about the rubber market are used in the specification of input demand functions. These assumptions concern the natural rubber and synthetic rubber markets, the nature of the two types of rubbers and the nature of production in the rubber goods industry. As indicated natural rubber is traded internationally as well as openly on commodity exchanges. In Chapter Three the atomistic nature of natural rubber supply will be discussed at length. It suffices here to mention that natural rubber is produced by estates and smallholders, the latter being the dominant producer group. The natural rubber market operates on conditions approximating the traditional model of profit-maximisation under perfect competition. In contrast to natural rubber, the synthetic rubber industry is vertically-integrated: backwards with the oil and petrochemical industry and forwards with the rubber goods industry. Since the oil and petrochemical industry and rubber goods industry are dominated by multinational corporations, the synthetic rubber industry is therefore related to these corporations. For reasons elaborated in Chapter Three (where the approach to modelling synthetic rubber supply is discussed) the assumption of profit-maximisation under monopolistic conditions for the synthetic rubber market will be adopted. On the whole natural rubber and synthetic rubbers are jointly consumed in rubber goods manufacturing. As with the transport-sector (the major demand sector) demand for general-purpose rubbers, it is Page 41 also assumed that the two types of rubbers are imperfect substitute inputs in rubber goods production. Arising from the highly competitive nature of the rubber goods industry the last assumption is that rubber goods are produced under cost-minimisation in a perfectly competitive market; A heuristic model of aggregate input demand in a one world economy and under the four assumptions can then be derived as follows. Let the production function for an aggregate group of rubber goods Q be (2.1) Q = f ( N, S, F, T ) where N is the natural rubber input in Q-production; S is the synthetic rubber input in Q-production; F is the fixed input in Q-production;5 T is the technology used in Q-production. Under cost-minimisation the input demand functions are then given by (2.2) CN = f1 ( PN/PS ,Q ,T ) (2.3) CS = f2 ( PN/PS ,Q ,T ) where CN and CS are the consumption of natural rubber and synthetic rubbers respectively. Since CN and CS are jointly consumed, these may be written as The inclusion of labour input as part of fixed input is not unrealistic in rubber goods manufacturing in view of the adjustment costs associated with labour input re-allocation that is discussed in section 2.3 above. Page 42 (2.4) CN = (CN/TR).(TR/Q).Q and (2.5) CS = (CS/TR).(TR/Q).Q where TR = CN + CS Then f1 and f2 gives (2.6) CN = f1(PN/PS, Q, T) , TR Q f1 (PN/PS, Q, T) + f2 (PN/PS, Q, T) f3 (PN/PS, Q, T) yQ On the assumption of minimum requirements, technology effect enters * through CN which is the minimum requirement level and the price ** effect enters only through CN , so that * ** (2.7) CN = (CN/TR) + (CN/TR) .yQ = f4(T) + f5(PN/PS) * YQ where (CN/TR) is the minimum requirement and T is the trend variable to proxy the technology which defines the minimum input requirement. Therefore (2.8) CN = a+ C1 (T) + f5 (PN/PS)} * YQ Similarly assumption of minimum input requirement (CS/TR) leads to Page 43 (2.9) CS = 0 + 51(T) + f6 (PN/PS)} . yQ Joint consumption of natural and synthetic rubbers is reflected by the following constraint across equations (2.8) and (2.9) (2.10) 0 + a (T) + f5(PN/PS) = 1 -{30 + 61(T) 6 Disaggregating the one world economy into individual countries, a set of input demand functions (2.8) and (2.9) would then apply to each country. Since different types of tyres have different minimum input requirements, a set of input demand functions (2.8) and (2.9) should be estimated for each type of tyre. However, data limitations prevent the estimation of these input demand functions, since data on rubber consumption in the major tyre producing countries, such as France, Italy and Japan, are differentiated only by transport and non-transport sector. While data for car, truck and off-the-road tyre production are separately available for the UK and the USA, these could not be used because data for their corresponding natural and synthetic rubber consumptions ar:e not available. Available data for the remaining industrial countries are even less detailed. A highly aggregated approach is thus adopted in estimating the input demands, concentrating only on the impact of lagged relative prices on the individual rubber demands. The consequence of this simplification is that the minimum input requirements cannot be substantiated empirically. Page 44 2.6 Estimation of Input Demand Functions The approach adopted in estimating the input demand functions was dictated by the data availability. Since the Rubber Statistical Bulletin (henceforth referred to as the Bulletin), a monthly publication of the London-based International Rubber Study Group(IRSG), provides the most comprehensive coverage of data pertaining to the world rubber market the basic data in this study are extracted from this source. The Bulletin provides separate data on natural and synthetic rubber consumption differentiated by transport and non-transport sectors, for tne major tyre producing countries only. For the remaining countries no sectoral breakdown of natural and synthetic rubber consumptioni is available. Although the Bulletin also provides data on the production of various types of tyres in the USA and UK, the corresponding data on natural and synthetic rubbers consumed by each type of tyre are again unavailable. The consuming countries are gr-ouped according to their data position into: (1) those countries for which sectoral rubber consumption data are available7 such as France, Italy, Japan, UK, USA and West Germany whose natural rubber consumption averages about half of the world's total natural rubber consumption; and (2) those countries for which sectoral rubber consumption data are not available, such as Australia, Brazil, Canada, China, COMECON, India and The Netherlands. To account for the balance rubber Page 45 consumption, a Rest-of-the-World consumption was introduced. For each consuming country the basic input demand equations are given by equation (2.2) and (2.3). For the transport sector demand function, the rubber goods refer to the number of tyres and tubes produced for each type of transport vehicle; for West Germany, quantity indices were used instead. For the non-transport sector demand the index of industrial production is used to reflect the level of activity in rubber goods manufacturing. As mentioned earlier, the degree of input substitutability (beyond their minimum requirements) in any period is constrained by technical considerations. Savings made on the input costs through substitution between inputs may be offset by adjustment costs to machinery and equipment and to the management. Substitution is also restrained by the known volatility of natural rubber price. Consequently in the short run natural rubber consumption does not respond to the full extent warranted by relative price changes per se. To incorporate this "habit persistence" effect, lagged relative prices are introduced so that the relative price (PN/PS) takes the form of 4 z (PN/PS)t_,, The natural rubber demand equation to be estimated is i=l then some form of 4 (2.11) CNR = f7 ( z (PN/PS)t-i Q, T i=1 Correspondingly, the synthetic rubber demand equation is then some form of Page 46 4 (2.12) CSR = f8 ( (PN/PS) t-iQ, T 1=1 Before estimating the input demand equations, the question of which rubber prices to use had to be decided upon. The criterion of using the natural rubber prices quoted in the market closest to the consuming country being dealt with was applied; for example, New York prices were used for USA and Canadian demand while London prices were used for West European demand. For synthetic rubber prices, the domestic list prices for styrene-butadiene (grades 1500 and 1712) and polybutadiene for the country concerned were used, such prices being available for the UK, France and Italy. Polyisoprene price is not used because of the data paucity. For consuming countries not having their own domestic list price quotations, the average European list prices were used instead. For the centrally-planned economies, lagged consumption were used instead of relative prices. In the Chinese case this is because apart from some domestic production of natural rubber they also obtain natural rubber from Sri Lanka under a Rice-Rubber (barter) exchange pact. In the Eastern European case, this is because of the increasing domestic production and thus consumption of synthetic rubbers, particularly polyisoprene, at prices that are not publicly known. For want of an appropriate activity variable for the rest-of-the-world consumption, a trend variable was used instead. The use of list prices for synthetic rubbers departs from the use of unit export/import values in some existing empirical studies of the 6 Although list prices are available for West Germany they were not used because the series for polybutadiene is incomplete. Page 47 7 rubber market. The reasons for using unit export/import values in previous studies and the preference in this study for list prices, as seen from the perspective of modelling synthetic rubber supply, will be discussed in Chapter Five. It will be recalled that an a priori reason favouring synthetic rubber consumption is its list price stability. However, the stability of prices actually paid for synthetic rubbers needs to be qualified. Prior to the 1973 oil crisis, the effective period for published list prices extended up to periods of eighteen months. The regularly published list prices with notification of its effective period therefore served as indicators of ceiling prices. Although price discounts are given, they are known only to the trading participants. The discounted prices therefore serve as indicators of floor prices to the synthetic rubber buyers. Thus given the list price for any synthetic rubber, the range within which the actual traded price will fall is known only to the buyers. It is in this sense that list prices incorporates a stability aspect. Actual traded prices of synthetic rubbers do fluctuate; however, in contrast to natural rubber price fluctuations, synthetic rubber price fluctuations lie within a relatively well-defined price band. The use of these list prices in the input demand functions is also an attempt to incorporate consumers' preference for synthetic rubber because of this stability and the predictable and orderly price increases relative to Studies using list prices are, for example, that by Behrman(1971) and by Man and Blandford(1980) whose study of the natural rubber market became available during this writing. In estimating the natural rubber demand functions, Man and Blandford used the New York spot price for RSS1 natural rubber and the New York Wholesale price for styrene-butadiene to form the relative price variable. Page 48 that of the market determined and less predictable natural rubber price. The use of list prices is an attempt to see if they will provide further insights about the competition between the two types of rubbers. This is relevant since in the event of continued escalation of oil price, the stability of list price would also be questioned. The demand equations were estimated in log-linear form using Almon polynomial lags (typically of second order) for the lagged relative prices. As data on synthetic rubber list prices are available only from 1963 the sample period begins from 1963 and ends at 1977 or 1978 depending on the individual countries' data position at the time of our data collection. The estimation results selected for subsequent simulation experiments are presented in Tables 2.5 and 2.6 with Table 2.7 providing a summary of the composition of relative prices referred to in the two aforementioned tables. As Tables 2.5 and and 2.6 reveal, the distributed price lags are fairly significant, thus suggesting that adjustment to changes in relative price extends over a period of three to four years. The variables used in Tables 2.5 and 2.6 are: CNRT - Consumption of Natural Rubber, Transport Sector CSRT - Consumption of Synthetic Rubbers, Transport Sector CNRNT - Consumption of Natural Rubber, Non-Transport Sector CSRNT - Consumption of Synthetic Rubbers, Non-Transport Sector QTY - Output of Tyres QTU - Output of Tubes Table 2.5: Fatites of Natural Rubber Denand Equat.ons \Explanatory Iariables C ontant qr1 qTu QTYC OTIV Qm IPI T CSR-Il CSR-2 CSR-3 (?U/PS) (PN/PS)-. (PN/PS)-2 (PN/PS)-3 (PN/PS)-.4 1 8sI 22 F UN Dependent\ V-riables CURT 0.7787 0.2861 0.6054 -0.0638 -0.1218 -0.1518 -0.1539 -0.1281 0.6193 0.9382 15.1689 1.8432 (0.9) (1.5) (4.2) (-1.2) (-1.7) (-1.9) (-2.1) (-2.3) (0.3) CUR -2.7438 1.0185 0.1733 1.1963 -0.8865 0.8630 9.4527 2.2426 (-2.4) (3.2) (0.8) (2.5) (-2.4) Prance CURT -4.1970 0.5046 .0.4369 -0.0435 -0.0694 -0.0794 -0.0733 -0.0511 0.3167 0.9928 166.1636 2.2703 (-7.4) (8.2) (8.6) (-0.6) (-0.8) (-0-8) (-0.9) (-1.0) (0.4) CURE! 1.8859 0.4982 -0.0456 0.0997 0.9090 56.5946 1.7279 (0.8) (1.7) (-2.7) (0.4) West Cerny CURT 2.3373 0.5293 -0.0102 -0.1542 -0.2179 -0.2012 -0.1041 0.6876 0.9218 20.6251 2.6667 (6.0) (7.6) (-0.1) (-1.2) (-1-6) (-1.6) (-0.9) (0.6) cHURl 2.S947 0.4019 -0.3445 -0.6727 -0.8537 -0.8875 -0.7740 3.5324 0.5435 2.0831 1.6574 (1.8) (1.1) (-1.2) (-2.0) (-2.3) (-2.7) (-2.8) (1.4) United lKingdom U.1td Kigd 8 -0.1109 -0.0977 -0.0615 -0.0624 -0.0403 0.3928 0.7735 4.0980 1.8181 CURT _5.908. 0.3697 0.8223 (-2.2) (2.0) (2.4) (-1.8) (-1.2) (-0.9) (-0.8) (-0.6) (0.3) C -3.3547 1.9255 -0.0650 -0.0155 -0.0770 -0.0068 0.8583 9.6933 1.3969 (-0.8) (1.9) (-4.3) (-0.1) (-0.6) (-0.1) United States CURT 3.3214 0.7878 0.1493 -0.0730 -0.0946 -0.1105 -0.1208 0.3990 0.9161 13.1017 1.1988 (4.7) (4.7) (1.3) (-0.5) (-0.5) (-0.6) (-0.6) (0.7) CHUll 6.1754 0.9131 -0.6963 -0.0555 -0.2800 0.7122 3.7122 1.9957 (3.5) (3.8) (2.4) (-0.2) (-1.1) JaPan CURT 1.6603 0.8177 -0.0223 -0.1492 -0.2105 -0.2061 -0.1361 0.7243 0.9498 33.0845 1.9291 (3.7) (7.8) (-0.1) (-0.6) (-0.8) (-0.9) (-0.8) (1.0) CIT 2.6197 0.6879 -0.0955 -0.2330 -0.3017 -0.2486 -0.0737 0.8568 0.9178 13.4074 1.3895 (3-1) (3.2) (-5.1) (-1.9) (-2.1) (-1.7) (-0.5) (0.5) CUR 0.0258 0.9966 -0.4370 -0.4850 -0.4411 -0.3055 -0.0781 1.7467 0.9437 29.3347 1.5571 (0.1) (3.7) (-3.5) (-2.9) (-2.2) (-1.6) (-0.5) (0.8) The Xetherlands CRt 1.2805 0.3011 0.0926 0.1055 0.0883 0.0413 -0.0358 0.3635 0.7107 3.6848 1.5164 (0.9) (1.7) (0.5) (0.3) (0.2) (0.1) (-0.1) (1.7) Uraxil CnU 0.0886 0.6640 -0.2426 -0.2733 -0.2719 -0.2381 1.0258 0.95i5 33.7948 1.5837 (0.1) (7.0) (-1.8) (-1.8) (-1-7) (-1.4) (0.6) India cm 3.5007 0.3688 -0.2664 -0.7037 -0.8889 -0.8218 -0.5025 3.1833 0.9716 58.9244 1.6549 (2.4) (1.3) (-2.2) (-3.7) (-4.1) (-4.1) (-3.4) (0.8) Australia CUR -4.2938 0.9786 -0.1679 -0.2956 -0.3175 -0.2237 -0.0438 1.0585 0.9054 16.7563 2.4105 (-3.6) (6.9) (-2.1) (-3.1 (-4.2) (-3.3) (-0.5) (0.3) CGCON CUR 0.6358 -0.1105 0.8927 0.1286 0.8031 10.8745 1.9755 (0.4) (-1.1) (2.2) (0.2) China CNR 1.9316 0.3062 i.1493 -0.8520 0.9543 55.7853 1.9936 (1.7) (0.4) (-2.3) 4.4170 0.0550 0.1520 0;0188 0.9859 233.699 1.9565 (5.1) (5.8) (0.8) (0.1) - --- 1~ 71 | .l i ts h. * f th, gb.oltt -I... of tbe- Al-o 1o0; 2. Except for EIP . all figures in par-ntheses are t-statistics for the correspnndlnk etiaates. 3. For 8 8 the figures io parentheses refer to standard deviations. i -i Table 2.6: Eatimates of Synthetic Rubber D-rand Equations \Explanatory a Conatant QTY QTU OTYC QTYV QTYT IPI T CSR-l1 CSR-2 CSR-3 (PN/PS) (PN/PS)-1 (PN/PS)-2 (PN/PS))-3 (PN/PS)-4 P_, R2 D Dependen Variables \ Italy CSRT -0.9760 0.6830 0.5273 -0.0672 0.0910 -0.0166 0.9743 37.8640 1.5801 (-1.3) (3.6) (4.2) (-1.4) (2.2) (-1.7) CSRNT -2.9226 1.1456 0.3115 0.1925 0.9846 235.0102 1.5666 (-3.3) (4.0) (1.73 (1.1) CSRT -5.6673 0.7445 0.3357 0.0607 0.1131 0.1399 0.1411 0.1167 0.5716 0.9755 47.6904 1.0841 (-4.2) (5.1) (2.8) (0.4) (0.5) (0.6) (0.7) (1.0) (0.9) CSRNT -3.6847 1.1637 -0.0531 0.8341 0.9830 328.3311 2.1288 (-2.5) (2.9) (-3.1) (11.1) Weat Ger-any CSRT 0.4306 0.7578 0.2577 -0.0563 0.1109 0.8456 12.3183 1.5169 (0.5) (3.1) (2.8) (-0.5) (1.0) CSRNT -4.5592 2.0924 0.3319 0.4107 0.4104 0.3309 0.1721 1.6559 0.9814 92.4299 2.5031 (-6.5) (13.0) (2.6) (2.7) (2.5) (2.3) (1.4) (0.6) United tingdom CSRT -6.0039 0.7741 0.3653 0.0540 0.0228 0.0333 0.9588 37.2498 2.6831 (-5.8) (9.4) (2.4) (1.3) (0.7) (0.7) CSRNT -5.8441 2.1954 0.0392 0.1196 0.9757 160.2768 1.7824 (-2.4) (3.9) (3.9) (1.1) United States CSRT 1.7084 0.7651 0.4125 0.1315 0.1196 0.1248 0.1470 0.5229 0.9769 57.7637 2.0597 (3.2) (6.5) (5.3) (2.4) (1.8) (1.6) (1.9) (0.3) CSRNT 0.6061 0.9571 0.0783 -0.2687 0.4253 0.9224 17.8248 2.1190 (0.7) (1.6) (0.2) (-0.6) (1.1) Japan CSRT -0.5716 1.2512 0.2074 0.1426 0.2640 0.3013 0.2544 0.1233 1.0857 0.9877 96.6440 2.3636 (-0.9) (14.5) (1.0) (1.2) (1.4) (1.4) (1.4) (0.9) (0.8) CSRNT 0.3558 0.6913 0.4708 -0.1163 -0.1027 0.8595 10.7018 1.6181 (0.3) (1.4) (1.3) (-0.3) (-0.3) Canada CSR -3.8275 1.8289 0.1540 0.3161 0.3540 0.2683 1.0925 0.9722 61.2938 2.3904 (-4.5) (11.6) (1.5) (2.8) (3.0) (2.3) (0.4) The Netherlands CSR -10.4465 2.2500 0.4634 1.0843 1.3503 1.2613 0.8174 4.9769 0.9131 15.7592 1.7194 (-2.6) (4.5) (0.9) (1.1) (1.1) (1.1) (0.9) (4.8) Brazil CSR -1.5290 O.9641 0.0471 0.9952 1243.8501 1.6275 (-1.8) (4.7) (2.4) India CSR -6.7448 1.9585 0.0575 0.9473 1.43R4 1.530Q 1.2249 5.1990 0.7766 5.2145 2.7679 (-2.1) (3.2) (0.2) (2.3) (2.q) (3.3) (3.3) (1.9) Aus tralia CSR -8.1189 1.3507 0.0001 -0.2912 0.3024 0.7371 4.9084 1.6452 (-2.2) (2.8) (0.1) (-1.1) (1.4) COMECON CSR -1.5442 1.0515 0.6711 -0.0922 -0.3525 0.9989 1532.6874 1.8992 (-4.2) (4.5) (2.0) (-0.2) (-1.4) Rest-of-the-World CSR 3.0615 0.0472 0.2276 0.2006 0.9480 60.7309 2.1577 (1.6) (1.2) (0.7) (0.6) NOTES: 1. is the sum of the absolute values of the Al..n lags; 2. Except for ZI, |, all figures in parentheses are t-statistics for the corresponding esAiates. 3. For ZIP 8 . the figures in parentheses refer to standard deviations. Page 5. Table 2.7: Summary of IRelative Prices Used in Demand Equations. Country/Demand PN/PSBR PN/PSBR PN/PSR PN/PSR1 Australia / CNR / Australia / CSR / Brazil / CNR / Brazil / CSR I Canada / CNR i Canada / CSR / West Germany / CNRT / West Germany / CSRT / India / CNR / India / CSR I Italy / CNRT / Italy / CSRT / Netherlands / CNR / Netherlands / CSR . UK /CNRT / UK /CSRT / USA / CNRT J USA / CSRT 1 Japan / CNRT / Japan / CSRT / Japan / CNRNT / France / CNRT 1 France / CSRT / West Germany CNRNT* West Germany / CSRNT / UK / CNRNT / UK / CSRNT / Notes: (1) PN represent the price of RSS3-grade natural rubber, except in the case of West German rubber consumption in the non-transport sector (marked with *) where the average of RSSl-and RSS3-pr:'ces were used. (2) PSBR represents the price of styrene-butadiene(SBR) grade 1712 (used mainly in tyre treads). (3) PSBR represents the simple average price of SBR grades 1500 and 1712. (4) PSR represents the simple average price of SBR grades 1500 and 1712 and polybutadiene(BR). (5) PSRI represents the simple average price of SBR grade 1712 and BR. Page 52 QTYC - Output of Tyres for Cars QTYV - Output of Tyres for Vehicles QTYT - Output of Tyres for Trucks IPI - Industrial Production Index T - Trend The trend variable used to proxy technological change was dropped from all equations for the transport sector; this is because inclusion of the trend variable generally gave poor, if not perverse estimates, possibly because technological change during the estimation period was relatively insignificant or was not time-related. A probable reason is the multicollinearity between the trend and Almon variables. Furthermore, because of the growth in rubber fabricating activities during the period, which is reflected either in the activity index or the volume of tyres and tubes produced, inclusion of trend term also causes multicollinearity. As discussed in Section 2.5 above, the key technological progress in the synthetic rubbers industry had occurred in the mid-1950s. By the mid-1960s, the industrial position of these general-purpose synthetic rubbers was firmly established. More recent technological progress focusses on the specialty synthetic rubbers; though this is important to automotive parts production, they are nevertheless only a small proportion of total synthetic rubber consumption by this sector. Likewise the technological progress manifested in the radial tyre occurred in the early sixties. By the late sixties the shift towards radial tyres was largely accomplished, especially in the European countries. Page 53 However, the impact of technological progress persisted in the non-transport sector where specialty synthetic rubbers are more important. The negative impact of this technological progress on natural rubber consumption in the non-transport sector was found for France, UK and Japan, but the corresponding expected positive impact of technological change on synthetic rubber consumption was substantiated for UK and Brazil only. For France and Japan the trend estimates had incorrect signs, possibly because the general-purpose synthetic rubber list prices were poor proxies for the prices of specialty synthetic rubbers used in these countries. In the Japanese case, the equation without the trend variable was selected. For France, the trend estimate was retained despite its incorrect sign since its omission severely affected the remaining estimates. Table 2.8 presents the short- and long-run estimates of elasticities of demand with respect to the respective relative prices used in the demand equations. The calculated estimates (synthetic rubber consumption in the Italian transport sector notwithstanding) generally substantiated the a priori arguments for low price elasticity of input demand, especially in the short-run. Tables 2.2, 2.3 and 2.4 revealed the range of input combinations that are used in the tyre industry. Since a breakdown of the aggregate synthetic rubber consumption data for the transport sector is not available, the precise synthetic rubbers input combinations used is not known. Thus the use of the simple average list price of the major types of synthetic rubbers may not correspond precisely to the synthetic rubber input combinations used. The non-availability of Table 2.8: Estimates of Short (Long) Run Demand Elasticities With Respect to Relative Price of Natural Rubber to Synthetic Rubbers Natural Rubber Synthetic Rubbers Country Transport Sector Non-Transport Transport Sector Non-Transport Sector Sector Italy -0.0638 (-0.6193) n.a. (n.a.) 0.0000 (-0.0423) n.a. (n.a.) France -0.0435 (-0.3467) n.a. (n.a.) 0.0607 (0.5715) n.a. (n.a.) West Germany -0.0102 (-0.6876) -0.3445 (-3.5324) 0.0000 (0.0546) 0.3319 (1.6559) United Kingdom -0.1109 (-0.3928) -0.0155 (-0.0993) 0.0540 (0.1101) 0.1196 (n.a.) United States -0.0730 (-0.3990) n.a. (n.a.) 0.1315 (0.5229) n.a. (n.a.) Japan -0.0223 (-0.7243) -0.2330 (-0.8568) 0.1426 (1.0857) n.a. (n.a.) Canada -0.4370 (-1.7467) 0.0000 (1.0925) Netherlands Estimates of wrong sign and insignificant 0.4634 (4.9767) Brazil -0.2426 (-1.0258) n.a. (n.a.) India -0.2664 (-3.1833) 0.0575 (1.5990) Australia -0.1679 (-1.0585) n.a. (n.a.) COMECON n.a. (n.a.) n.a. (n.a.) China n.a. (n.a.) Rest-of-the-World n.a. (n.a.) n.a. (n.a.) (D U, Page 55 prices for specialty synthetic rubbers used also lends bias to the price data used. Hence any intersectoral comparison of demand elasticities should be made cautiously since these elasticities should be interpreted as being indicative only of orders of magnitude. As list prices are regularly published in advance, the elasticities may however be interpreted as reflecting consumption behaviour that is influenced by the certainty of price bands within which the synthetic rubber prices will fluctuate and the uncertainty regarding the price band within which natural rubber prices will fluctuate. This feature, together with those factors causing "habit persistence" then makes the low demand elasticities inevitable. A priori the presence of a positive bias (over-estimation since elasticities is negative) and negative bias (under-estimation since elasticities is positive in value) in the natural and synthetic rubbers estimates respectively may be expected. Page 56 CHAPTER THREE THE SUPPLY OF RUBBERS 3.1 Introduction This chapter discusses the supply of rubbers, both natural and synthetic. For each type of rubber a supply function is specified on the basis of their production characteristics; estimates of the supply functions are then presented. Pt risk of imbalance in treatment oL the two types of rubbers, the lengthier discussion of natural rubber reflects the relative data abundance in the available literature on natural vis-a-vis synthetic rubbers. Whereas demand data limitations are manifest in the use of list prices instead of traded prices, the supply data limitations are manifest in the assumptions concerning synthetic rubber supply. 3.2 Five Features of Natural Rubber Supply Natural rubber is a perennial tree crop; amongst perennials, natural rubber has the atypical feature of broadly non-seasonal production and therefore of an indistinct harvesting period. To understand the determinants of natural rubber supply, the features Page 57 characterising its cultivation and production will be discussed first. The supply of natural rubber is characterised by five main features. These are (1) the long gestation period, (2) a long productive lifespan, (3) a yield profile resembling a flattened F-distribution curve, (4) non-seasonal production except for inclement weather and wintering effects which vary across locations and therefore have little aggregate influence and (5) a lengthy period before the impact of any agronomic technological progress can be felt. The gestation period refers to the period between initial input and first output; this period can range from five to twelve years depending on the type of clones and the quality of seedlings used, and the maintenance of the tree and its environs. This is then followed by a long productive lifespan - an extended period of output flowing from the initial production. For natural rubber, the productive lifespan ranges from 15 to 35 years, again depending on the types of clones and quality of seedlings used and the maintenance of the tree and environs dturing its productive lifespan. The resulting yield profile (depicting the yield of a rubber tree over its lifespan) generally tends to increase rapidly in the first few years after production commences; it then levels off for about 10 to 15 years before markedly diminishing yield sets in. Figure 3.1 presents some yield profiles for the period before markedly diminishing yield begins; profiles A, B and C are based on Malaysian data and profile D is based on Indonesian data. Profiles A and B, obtained from Allen(1972) refer to estate performince; profile A is for a group of modern high-yielding clones while B is for earlier high-yielders. The Page 58 Yield (kg/hectare/year) 2000 1500- A B 5000- / D O 1 . I .O 5 10 15 20 25 Years After First Tapping Figure 3.1: Variation of Yield with the Number of Years After First Tapping. Page 59 difference in rubber smallholder performance in Malaysia and Indonesia is seen by comparing profile C for Malaysia which was estimated by Smit (1978) and profile D for Indonesia (fox largely unselected material) which was estimated by Barlow and Muharminto (1981). There are two ways of viewing the question of seasonality in natural rubber production: (i) that of natural rubber production per se and (ii) that of natural rubber production vis-a-vis perennial crops production in general. The seasonality of natural rubber production per se is the outcome of wintering (leaf fall) during which period (about six weeks) the tapping of trees is halted. On a global level, wintering has little aggregate influence because wintering periods vary across locations. Since smallholder niatural rubber production plays a significant role in the natural rubber market, it is relevant to compare the seasonality of natural rubber vis-a-vis perennial crops production in general. Fruit-bearing perennial crops are seasonal in that their harvesting is bunched within one or two short periods within the year and output is less amenable to control by the producers. In contrast natural rubber output is available throughout most part of the year (barring inclement weather and wintering), its production being susceptible to control at any point in time. This is significant for smallholder producers, especially those using only family labour, since the problem of peak labour demand such as during the harvesting of fruit-bearing perennials therefore does not arise. In the very short-run, "-he decision to produce rubber depends on the decision to tap the tree or not. If the tree is to be tapped, the output flow can then be controlled by the tapping frequency and intensity and the use of chemical stimulants Page 60 (not fertilisers since fertiliser effects are only felt with a one- to three-year lag). The ability to halt production instantaneously (by not tapping) but inability to increase output instantaneously beyond the trees' potential output introduces an asymmetry into the short run production elasticity of natural rubber; such as, producers can only respond to price rises only if the tapping rate is below the maximum feasible rate. As the model used later in estimating supply response was derived on a annual basis, the asymmetry in supply response is not captured by the model specification. However, since the short-run is the sum of several vcry short-runs, the estimated short-run (annual) supply elasticities may be viewed as a the avergae of the very short-run supply elasticities that account for the asymmetry. This asymmetry is reinforced by the fact that more than 50 percent of the world's natural rubber production is in the hands of smallholder producers, many of whom use family labour in rubber tapping. The reactions of smallholder producers to price declines are known to vary in accordance with the degree of price fall. Under a relatively small price decline, the smallholders would tend to increase production so as to maintain their earnings from rubber. However, when the drop in price persists the smallholders are then inclined to abandon their rubber trees (temporarily at least) to turn to other more remunerative activities. Where the land value is relatively low, as in land-abundant Indonesia and Thailand, the smallholders would generally turn to alternative (cash or subsistence) crop cultivation. In less land-abundant situations as in Malaysia and Sri Lanka, the About two-thirds of the global 2.5 million people cultivating natural rubber are subsistence farmers and smallholders with less than 4 acres of natural rubber land (Anon., 1980a:1). Page 61 smallholders may increase production to maintain their income levels or else seek alternative employment to which they may be accessible. The problem of natural rubber price instability therefore carries wider economic implications.3 In contrast to technological change in manufacturing, the effects of technological progress in the natural rubber industry are felt relatively slowly. This is because experimentation in biological engineering and the subsequent diffusion and adoption of the new technologies takes place over a very long period. 3.3 General Determinants of Natural Rubber Suply The supply of perennials hinges on their long gestation and productive lifespan, which features are fundamental to understanding investment and production behaviour in the industry. This is because the time horizon for natural rubber producers must, pari passu with the lifespan of rubber trees, be longer than that for producers of annual crops. Upon planting the tree becomes a capital asset for the planter/producer. Consequently, w1ecision-making in planting and/or replanting perennials becomes a problem in capital theory where the This is especially relevant to the situation in Peninsular Malaysia in recent years because of the good transport facilities and the availability of industrial employment. For details see Bauer (1948), MacBean (1966) and Radhakrishnan (1974). For details on the R and D process in natural rubber cultivation see Ng and Pee (1977). Page 62 objectLve is to maximise the present value of the discounted future stream of net returns from the rubber investment. In the case of smallholder rubber, this is complicated by the simultaneous presence of cash and subsistence "intercrops" cultivation from which substantial values are derived. Indeed in the more land-abundant rubber producing countries, rubber planting alone may not be justified on present value grounds. However, given the data constraints, the theoretical developments of perennial crop response have in the main taken into consideration alternative competitive crops rather than such complementary intercropping. Theoretically, the relevant time horizon should also determine the time periods corresponding to the short- and long-runs. At the producer level the short-run, by the Marshallian-Cournot definition, is that time period during which the productive capacity of a producer is fixed. This means that short-run supply variations are restricted only to variations in the use of the variable factors in combination with the fixed productive capacity. At the industry level, the short-run is restricted by the condition of no new producers entering the market. For perennial crops, the productive capacity at any time period is represented by the existing stock of mature trees. Barring very short time periods, distinction between short- and long-runs for perernnial crops is hazardous because of the continuously changing stock of mature trees, especially because smallholders in land-abundant countries may switch between cultivation of natural rubber and other crops. This in turn stems from the fact that the Page 63 rubber producer, unlike the typical manufacturer (or at least the version in theory) has many units of capital (namely trees). The problem is further aggravated in the case of natural ruabber since there is no distinct harvesting period. To illustrate the difficulty of distinguishing short- and long-run supply responsiveness consider rubber production at any time period t. For any such period, the supply function for rubber is (3.1) Q g( PN, PC, PI, A(m), T, W, . ) where Q is output; PN is the price of natural rubber; PC is the price index of products competing for inputs used in natural rubber production; PI is the vector of prices of factor inputs; A(m) is the mature acreage; T is the state of technology; W is the weather/rainfall variable (this affects the yield or trees as well as stock of trdes via damaging trees). It is more helpful to write output Qt from any given mature acreage A%'m) in any given period as T= where At is the mature acreage that is being tapped (tha~t is, the t number of trees tapped) and Yt is the actual average yield per tapped acre. Page 64 For any time period t, the mature acreage A(m)t may be considered to proxy the existing stock (number) of mature trees and hence the productive capacity. By the Marshallian-Cournot criterion, the short-run is the period during which A(m)t is fixed. This raises the problem of distinguishing the short- from long-runs, since A(m)t may be constantly changing as new mature acreages (from new planting and/or replanting) come into production whilst old mature acreages (removed and/or abandoned) go out of production. It was mentioned earlier that the gestation period is determined by the types of clones and quality of seedlings used. Abstracting from the qualitative difference in clones and seedlings used, A(m)t at any time period t may be expressed as n n (3.3) A(m)t = A(m) t- + N t-i + Rt-i - Lt t=5 i=5 for 5 < n < 12 where n is the gestation period of natural rubbers; n Z Nt i is the sum of surviving new plantings undertaken during i=5 the period (t-5, t-n) that has come into production in the current period; n Z R . is the sum of surviving replantings undertaken during i=5 the period (t-5,t-n) that has come into production in the current period, and L is the loss of mature trees in period t due to disease t or age; It should be mentioned that the terms Nt. and R allow for the situation -ti a stand of trees,though of the same age,may differ in Page 65 maturity and therefore enter the production phase at different points in time. This difference in growth rates which leads to time difference in production initiation of the trees of the same age is particularly important in Indonesian and Thai rubber production. The change in mature acreage between any two periods is then given by (3.4) AA(m)t A(m)t A(mt- n n - Nt . + E R - L i=5 i-5 t Given the non-seasonality of rubber versus seasonality of other fruit-bearing perennial crop production, mature trees would therefore be constantly coming into production in accordance with the prior planting and replanting schedules. Thus, except for very short time periods, A(m)t would be changing continuously; hence annual production reflects the sum of both short- and long-run supply responsiveness since production in any period t is the result of (a) short-run response to price changes and (b) long-run response to planting decisions taken (t-i) periods ago for i=5, 6.........., 12; In summary, short-run supply response relates to actual output while long-run supply response relates to potential output. I am grateful to Dr. Barlow for this point. Page 66 Even supposing that the time period was specified such that A(m)t is constant, the data requirements for determining movements in A(m)t accurately is enormous as it entails knowledge of the number of trees planted and removed at each point of time within the gestation period. Assuming a sufficiently short time period to warrant fixed productive capacity A(m)t in each t, the short-run supply response can then be effected by varying the yield. The short-run determinants of variations in yield are: (a) the tapping frequency F. In general the selected frequency is used throughout the productive lifespan of a tree, thus defining a long-run tapping "system" applicable to each tree. For short-run responsiveness, the producer must be able and willing to vary the tapping frequency in response to natural rubber price fluctuations. (b) the tapping intensity I. This refers to the length of the tapping cut. In general, the tapping frequency and intensity are jointly determined. (c) the number of trees tapped per acre N(1). This reflects the density of planting and the 'reserve' of untapped trees. (d) the number of trees tapped per worker N(2). The argument for the inclusion of this variable is that early morning tapping is important in extracting maximal latex from the tree. Thus savings in labour costs by a bigger tapping task per tapper may be offset by lower overall unit yield; that is, the unit yield is negatively For details of tapping systems, see Barlow (1978:135-140) and Pee and Arope (1976:81-83). Page 67 related to the task size. However the significance of tapping task has not been empirically substantiated. (e) the application of chemical stimulants M. In the short-run, yield can be raised bv use of stimulants. The disadvantage of this is that continuous usage over a longer period causes residual effects on 7 subsequent yields. However, M is more important as a long-run substitute for labour through reduction of the tapping frequency F. Hence the yield function may be written as (3.5) Y = g2( F, I, N(1), N(2), V, G, S, M, H,....) where (apart from the variables defined above): V is the varietal composition of the stand of trees (this is correlated with weather (W) since biological engineering has led to the development of different clones to suit areas having different weather conditions); G is the age composition of the stand of trees; S is the quality of the soil and elevation; H is the condition of the trees (dependent on overall maintenance of the trees and their environs and the application of chemical fertilisers). See Barlow (1978:140-148) and Pee and Arope (1976:83-85). Page 68 3.4 Previous Econometric Studies of Perennial Crop Supply Response Up to the early 1970s, attempts at estimating supply response for perennial crops have been guided by the long gestation period and productive lifespan features of perennials, and recognition of the critical role of expectational variables in perennial crop production. The essence of these attempts concentrated on specifying systems of functional relationships that would explain (a) potential output and (b) actual output. The relationship used for potential output essentially accounts for the longer-run planting behaviour and is generally a Planting-Price relationship that translates the desired stock to actual stock of trees. For actual output, the relationship used essentially accounts for the shorter-run production behaviour and is generally a Price-Output (Harvesting) relationship. In general the Nerlovian framework of partial adjustment and adaptive expectations was applied to translate the desired and expected variables to observable (measurable) variables. Thus while recognising the existing stock of trees as a source of capital, these attempts failed to integrate the planting process with capital accumulation, and the harvesting process with (optimal) capacity utilisation. As the major models developed up to the early 1970s have been surveyed by Lim (1975), it suffices here to relate the essence of these models to the issues and problems of investment in perennial crops, 8 See Nerlove (1956, 1958). Page 69 The stages from planning investment to actual production of perennial crops are summarised in Figure 3.2 by the Desired and Realised panels. The intermediate stages are in general essential to all perennial crop cultivation. Two key points in the analysis are the start and close of the stages illustrated which concern (a) the forces that motivate a producer to plant; (b) the relationship between area planted and actual output attained. The flow chart shows that the cornerstone in perennial crops analysis lies in linking desired and actual output. This linkage is realised via a sequence of intermediate stages leading to the adjustment of the existing stock of trees to the desired stock. The range of factors viz. expectations, institutional and financial constraints, agronomic practices and metereological conditions, and their interactionscan then be identified from the sequential stages. Thus a basis for analysing perennial crop cultivation is the specification of a functional relationship between an "actual" and a "desired" variable. For analytical consistency, the basic relationship is complemented by other functional relationships representing the relevant intermediate stages. The flexibility in the choice of any pair of desired-actual variables for focussing the basic functional relationship is illustrated by the variety of pairing (by the dotted lines) in the flow chart. Each dotted line delineates the desired-actual variables pair basic to the respective models for perennial crops. Figure 3.2: Investment Planning and Production of Perennial Crops Page 70 Expectations about Future Demand and Supply; Subsistence and Cash Intercropping I_ Actual Output \ Prices of natural Desired Output rubber & competing - < Xproducts; input prices Potential (planned) Output Variental compos- ition of existing N Types of Clones; stand of trees; Expected Yield; of' \ CTree Maintenance; \t \t/ Fertilisers usage; \-' \ Tapped/untapped tree \ b lance. -e\ h\ Desired Stock of (1966) Actual Stock of Tree Trees Expected Price; " Expected cost of 6 'isease, age natural rubber w- Disease, age, production; Age weather damag of existing stock \ f' of trees; < A new ~~v- . s> Desired new T\ Actual new planting & plantings & replantings replantings Expected yield of Expected Price; Age existing stock of composition of trees \existing tzees; Expected output balance per tree; Desired Total | Actual Total Plantings Plantings , ' Institutiona ZFinancial. DESIRED REALISED Key Sequence of intermediate stages between planning investment in natural rubber and production of natural rubber and their corresponding determinants. Functional relationships forming the essence of various models of perennial crop supply. Page 71 Summary of Some Perennial Crop Models The basic (functional) and complementary relationships used in the various perennial crop models are briefly reviewed in chronological order below. In Bateman's (1965) model the basic relationship used is that between actual planting (planted area) and producer's price expectations (based on expectations about future demand and supply). Nerlove's adaptive expectations scheme was used to transform the expected price into determinants of planting. Actual planting is then related to observed prices and actual output becomes a function of actual planting, price and natural factors (viz. rain, humidity). Behrman's (1968) model is based on a planting equation relating actual to the desired stock of trees. As the flow chart indicates, this is complemented by an equation relating the desired stock of trees to the expected prices. Ady's (1968) model is essentially a capital stock model based on the assumption that the existing (surviving) stock of trees is an important determinant of further planting. That is, the actual tree stock influences desired new plantings. This basic relationship is complemented by equations relating actual to poter4tial output and hence potential output to existing tree stock. Arak (1968) focussed her interest on the determination of changes in the tree stock. It is basically a stock-adjustment model, relating the actual new plantings to the desired stock of trees. The remaining equations in the moQel completing the adjustment mechanism are: Page 72 (a) an equation relating the rate of new planting and replanting to the proportion of old to young trees and expectations about the labour cost (due to the near-monopsonistic market for labour in the Sao Paulo coffee sector which she was studying); (b) an equation accounting for the cost of tree removals and (c) an equation accounting for tree abandonment. The model by French and Matthews (1971) is the most detailed of this group of models. The two basic relationships concern the adequacy of the existing tree stock in producing the desired output and the adjustment of new plantings towards the desired stock of trees. The remaining equations in the model then caters for (a)the acreage removed each year; (b)the transformation of unobservable expectations variables to observable variables and (c)variations in yield. The above discussion shows that in examining the responsiveness of perennial crops it -s necessary to distinguish between: (a) the level of production in each period (reflecting the harvesting decision) and (b) the number of trees planted in each period (reflecting the investment decision). The short- and long-run supply responsiveness may then be defined by Page 73 (a) and (b) respectively since (a) reflects the influence of price on supply under fixed productive capacity, while (b) represents the stock adjustment process towards the desired productive capacity. The perennial crop supply models mentioned so far have assumed that the investment and harvesting decisions are mainly determined by expected prices. The supply function is derived from three basic * e equations involving desired output (q t) and expected prices (Pt (3.6) q = a + fpe t A(qt ) O X<1 (.) e e = e 0<0< 1 (3.8) pe -Pet_l = ( 0(t-1 Pt_0l which is Nerlove's supply response model, where * denotes long-run equilibrium or desired output and e denotes expected value. Solving equations (3.6) - (3.8) gives the supply function as (3.9) qt + ~ex(pt-1) + [(1-0) + (l-X)]qt 1 - [(1-0) (1-X)] q t-2 As Wickens and Greenfield (1973) indicated in their study of the world coffee market, the above approach suffers from the disadvantages of Page 74 (a) having the model based on ad hoc behavioural relationships with (b) the equations representing behavioural relationships failing to distinguish between the investment and harvesting decisions. Consequently, the derived supply function does not adequately capture the lagged response of the perennial crop supply to past investment. 3.5 Wickens and Greenfield's Model of Supply Response In estimating the supply response equations for natural rubber, the Wickens and Greenfield model for perennial crop production was applied. The model is an improvement over earlier models in its explicit treatment of the tree stock as capital and in constraining the harvesting decision by the existing productive capacity. The supply function is derived from a formal optimising model similar to the investment model developed by Jorgenson (1965). The model also has the attractive features of (a) incorporating the yield profile of the crop in question and (b) distinguishing the short-term from the long-term impacts of price on supply. The model consists of three basic structural relationships reflecting the supply behaviour in both the short- and long-run. The supply response function to be estimated is derived as the reduced form solution of the three-equation system. Consequently both the short- and long-run supply response (adjustment) coefficients are embedded in the nonlinear coefficients of the reduced form equation. The abortive attempt at a similar line of analysis by Cheong (1971) in his Ph.D. thesis ought to be mentioned. Page 75 The three structural relationships are: (1) the Vintage Production Function which reflects the constraint of potential output on supply; (2) the Investment Function which reflects the long gestation lag in perennial crop potential supply; (3) the Harvesting Function which reflects the short-run harvesting decision (to tap the rubber tree or not and the rate of extraction). Since in this analysis of world natural rubber supply, the Wickens and Greenfield model is adopted without modification (except for the minor disregard of the biennial cycle for coffee production that was incorporated in their harvesting equation), only the three basic structural equations are discussed in brief. The Vintage Production Function The Vintage Production Function gives the potential proc.uiction n (3.10) d E 6 (i, t)It- i-0 n i=O I t-i l where qp is the production potential (of maximal output); t An application of the model to natural rubber has been made by Dowling(1977), but only to natural rubber production in Thailand. Page 76 It-i is the number of trees planted i years ago which have survived to year t and 6(i, t) is the average yield of the It i trees. In terms of Figure 3.1, the Vintage Production function relates -potential output to actual total planting in the previous periods. Since the production function only refers to yield and plantings, several assumptions regarding land and labour inputs are implicit. Takinq the number of trees to be capital, the land and labour are assumed to be the other essential but non-substitutable inputs which are used in fixed proportions with capital. Hence the planting densities (capital/land ratio) and tapping task per labourer (capital/labour ratio) are assumed fixed. Where cash and subsistence intercropping are widespread, this assumption would not hold since the capital/labour ratio then tends to vary with the price of output. Land and labour are also assumed to be in unlimited supply so that there are no constraints on attaining the desired investment or fully utilising the capital thereafter. The Investment Function Since rubber trees are characterised by long gestation periods and productive lifespan, the decision to plant (invest in) rubber trees is based on the expected discounted income stream from the investment. As cash and subsistence Lntercropping are disregarded in Page 77 the Wickens and Greenfield model, the investment function is derived from a formal optimising model assuming no such intercropping exist. Let V be the expected discounted net revenue; r be the rate of discount; Pe be the expected unit price for iaatural rubber; se be the expected unit cost of harvesting natural rubber t when all potential output qp is harvested; Ft be the fixed cost in year t; f (It) be the planting costs, with f (It) > 0, fJjI ) > 0 It be the number of trees in year t. Then 00 (3.11) V = Z(l+r) [(P- S ) - F - f(I) t=O t tttlt V is maximised by choosing suitable tirme paths for qp and It The t t Lagrangean is 00 (3.12) L V + X (qP - S i t( t i-O i t-i) i=o from which the necessary (first-order) conditions for a maximum are Page 78 (3.13.i) 6L/6cit = (l+rt * (pt - Se) + 0 00 (3.13.ii) 6L/6It = -(1+r) . 1f /61t - Z X6 = 0 00 (3.13.iii) SLp_ -= 6j~- I 0 t 1iO i t-i The rate of investment obtained from (3.13.ii) is 03 (31)6 6-i e e (3.14) 6f1/61t = E (1+rj ( t+i - s +e)6 that is, investment is undertaken up to the point where the marginal cost of investing in one or more tree equals the expected discounted net revenue to be obtained from the future production of that tree. The assumption that f 1(It) is convex is used to determine the rate of investment; that is, the rate of planting to attain the desired number of trees. If f 1(It) is a quadratic function of It then the Investment Function derived from 6F/6It is (3.15.i) it 3+ l Re 0 let where Page 79 co e i i e e (3.15.ii) Rt = (l+r) Se+(Pt+j ) i=O To find proxies for the investment function variables, note e that Rt which is a function of expected prices can instead be represented by a distributed lag of past rubber prices. Assuming a Koyck scheme for the distributed price lags, the investment function becomes n a (.6It= + E W3itP WJ. =~ 0 < X < 1 i=0 = + (PN) + AI a o t t-1 where I - I is the actual number of tress planted in t t period t. and PN is the price of natural rubber. Assuming that treeslosses due to disease, removal and abandonment are relatively small, and using the change in planted acreage to proxy new plantings, the investment function may be approximated by (3.17) AAt =0 + (PN)t + X(AA The investment function can be written more generally as T i+ -(N +~ (3.18) t- S (Nt-I At-i-1 = X (1 - XD) + 3(l-AD) (PN i) 0 - Page 80 with D first-differencing operator and since t-i Xit- = (l-D)Iti The Harvesting Function The harvesting decision function is to explain the short-run supply behaviour. In the short-run the upper limit in production is given by the production capacity, which is the potential output of the existing stock of trees. Whether the potential output is fully exploited in each period depends on the profitability of doing so. It is assumed that this is determined by the recent behaviour of natural rubber prices so that actual production will be some function of the potential output and a short distributed lag of natural rubber prices. A short distributed lag of prices is used in the harvesting function because harvesting (that is, tapping) takes place when the rubber trees are already in existence. The decision to harvest the existing trees is therefore based on expected price which is formed from the actual prices in the recent past. The Harvesting Function is then given by: Page 81 m (3.19) qt + aqp + ib bPt1 0 1 t ~ i=0 - The Reduced Form Supply Equation The reduced form supply equation is then obtained by substituting the potential output equation (3.10) and investment equation (3.18) in the short-run supply equation (3.19). This gives n * (3.20) q (1-D) = c.(1-D) + Zi S.0 ti+ i=O m + (l-D) Z biPt-i i=0 Expanding (3.20) and collecting terms, equation (3.20) becomes n (3.21) t Constant + tP + Xq 1=0 I1 - t-1 where T. = cY66 + b i=0 1 1 0 0 = clf + bi Xbi-l i=1, 2, .., m = Xb i-l i=m+l = f6 i=m+2, ..., n. Page 82 In equation (3.21) the lagged supply term qt l is related to the dynamics of the investment function whilst the nonlinear price coefficients are related to short-run price response and long-term adjustment to the yield profiles. It can be noted from the composite term T. that: (i) in the current period, output response is determined by the short-run price coefficient b0; (ii) in the medium-term (i < m) output response is determined by the yield 6. and price coefficients bi. (iii) for i = m+1, T. is influenced by the yield 6. and price coefficients b m (iv) for the longer-run, T. is proportional to the yield 6.; Thus the nonlinear coefficients show the dominance of price in the short- to medium-term supply response and of yield in the longer-term response. In the medium-term, Ti is influenced by the short- to medium-term adjustment and the relative size of the coefficients 6i and bi while in the long -run T. is directly proportional to the yield profile.11 Since yrield of rubber trees levels off after about four to five years after the first tapping (depending on the type of trees, care and maintenance), the reduced form expression can be simplified by first differencing so as to shorten the lag. Then A problem with this approach is that the relationship between 'm' and the gestation period for natural rubber production cannot be directly established. Page 83 k* (3.22) qt Tpipt-i + (1+A)qt l Xq t-2 1=0 where T, = T. l + b (i=O) I- 1 00 0 i- + (b b -X(b i- bi-2) (i=1,2 . . . ,k) -T (i=k + 1) 3.6 Estimation of Supply Response Equations The supply response equation (3.22) was estimated separately for the chief natural rubber producing countries of Africa, Brazil, Indonesia, Malaysia, Sri Lanka and Thailand. To account for the balance world production (mainly in Burma, China, Indochina, Papua New Guinea and the Philippines), a Rest-of-the-World supply equation was also estimated. The natural rubber market price quotations used in the estimation were chosen so as to reflect the orientation of the producing countries to the rubber trading centres geographically nearest to them. Thus the Singapore f.o.b. price quotations were used in estimating the supply equations for India, Indonesia, Malaysia, Sri Lanka, Thailand and the Rest-of-the-World; for Africa and Brazil the London and New York price quotations were used 12 For an empirical evaluation of the acreage function as a proxy for investment function, see Appendix 3.A. Page 84 respectively. To reflect the yield profiles of rubber trees, third and fourth order polynomials were alternatively tried in the Almon scheme specified Lor the distributed price lags; the flexibility of the Almon scheme provides a means of determining the most appropriate lag lengths for price in each case. The estimation results presented in Table 3.1 indicate fairly good fits overall with the distributed price lags generally behaving in accordance with the expected pattern. (For a discussion of the computation of the various test-statistics associated with the Almon lag scheme, see Trivedi and Pagan (1976).' However, in the choice of market price quotations that for Brazil appeared unsatisfactory; although estimation with New York price quotations gave a good fit, the resulting Durbin-Watson statistic was unduly high. Re-estimation with Singapore prices improved the Durbir-Watson statistic; for Brazil, the supply response equation using Singapore prices was selected for inclusion in the model. The estimates for the distributed price lags generally followed the expected pattern; that is, the price coefficients have positive values over the periods at the tail-ends and are negative in value over the interim lagged periods. This is in accordance with the nonlinear price coefficients composition given in equation (3.19). Since the average tree is tapped in the sixth to seventh year, the nonlinear price coefficients can be expected to resume positive values around the sixth or seventh lag. In general the price estimates conform with this expectation. In cases where positive values are resumed at much later lags, two non-mutually exclusive reasons may be Table 3.1: Esti-ates of Supply Response Functions for Natural Rubber Producing Counr -es, 1956-1978 QN-1 QN-2 PN PN-l PN-2 P-3 PN-4 Ph-5 p86 PN-7 FN-8 PN-g PN-io PN-.. PN-12 PN-13 PS-14 F1 5-I| R2 F DU 1) Africa 0.2384 -0.0041 0.1224 0.0819 0.0176 -0.0505 -0.1068 -0.1404 -0.1447 -0.1179 -0.0619 0.0160 0.1047 0.1884 0.2467 0.2549 O.t839 1.8385 0.7308 1.6292 2.2498 (0.7) (-0.01) (2.0) (1.2) (0.3) (-1.4) (-1.7) (-1.3) (-1.1) (-0.9) (-0.5) (-0.5) (0.2) (3.5) (2.3) (1.8) (1.5) (1.4) (0.2) 2) Brazil 1.1348 -0.3324 -0.0042 -0.0030 0.0042 0.0024 -0.0002 -0.0022 -0.0026 -0.0015 0.0008 0.0028 0.0027 -0.0022 0.0288 0.8031 3.3991 2.4386 (4.2) (-1.5) (-2.1) (2.9) (3.3) (2.4) (-0.1) (-1.2) (-1.6) (-1.6) (0.8) (1.7) (2.0) (-0.8) (0.0) 3) India -0-9147 -0.2570 -0.0448 0.0465 0.0924 0.1046 0.0933 0.0679 0.0362 0.0047 -0.0210 -0.0369 -0.0400 -0.0288 -0.0028 0.0370 0.0885 0.7454 0.9503 6.3684 2.0888 (-3.0) (-0.8) (-0.9) (1.8) (2.6) (2.5) (2.1) (1.5) (0.9) (0.1) (-0.7) (-1.4) (-1.3) (-0.7) (-0.1) (0.9) (1.8) (0.1) 4) Indonesia a) Eatates 0.5600 -0.5702 0.0698 0.0375 0.0079 -0.0158 -0.0314 -0.0379 -0.0352 -0.0243 -0.0072 0.0129 0.0319 0.0446 0.0447 0.0249 0.4259 0.9612 8.2677 3.0969 (2.5) (-2.1) (4.6) (2.6) (0.9) (-2.4) (-2.6) (-2.2) (-0.9) (-1.5) (-0.8) (4.3) (2.9) (2.4) (2.2) (1.8) (0.04) b) Small- -0.3435 0.3909 0.1429 0.0260 -0.0239 -0.0310 -0.0152 0.0081 0.0280 0.0379 0.0359 0.0245 0.0105 0.0054 0.0251 0.0897 0.5040 0.9404 5.2634 2.1867 holders (-1.9) (2.4) (3.2) (0.9) (-1-5) (-1.4) (-0.4) (0.2) (0-5) (0.9) (1.4) (1.8) (0.3) (0.1) (0-5) (3.3) (0.1) 5) Malaysia a) Estates -0.6394 -0.4430 0.1089 0.1748 0.1462 0.0666 -0.0287 -0.1123 -0.1650 -0.1756 -0.1409 -0.0658 0.0367 0.1457 0.2321 0.2588 0.1809 2.0387 0.9676 9.9597 2.9826 (-3.6) (-3.6) (2.9) (8.5) (6.8) (2.4) (-0.9) (-3.4) (-5.3) (-6.7) (-7.3) (-3.9) (1.6) (4.9) (7.2) (8.6) (4.0) (0.1) h) Small- 0.1107 0.9384 0.2119 -0.0440 -0.1524 -0.1624 -0.1153 -0.0446 0.0237 0.0714 0.0881 0-0708 0.0247 1.0093 0.9939 162.5128 1.6734 holderx (0.8) (7.4) (8-1) (-2.4) (-7.7) (-8.9) (-6.0) (-2.3) (1.5) (5.0) (4.7) (3.8) (1.0) (0.2) 6) Sri Laolka -1.2176 -0.3369 0.0626 0.0431 0.0197 -0.0024 -0.0194 -0.0288 -0.0295 -0.0214 -0.0060 0.0140 0.0347 0.0509 0.0559 0.0420 0.4304 0.8219 3.6906 1.8589 (-3.7) (-1.1) (4.9) (4.6) (2.8) (-0.4) (-2.8) (-3.4) (-3.4) (-3.0) (-1.5) (4.8) (4.6) (4.3) (4.1) (3.9) (0.04) 7) Thailand -0.4658 -0.0564 0.0987 0.1210 0.0942 0.0413 -0.0188 -0.0714 -0.1062 -0.1170 -0.1019 -0.0633 -0.0076 0.0543 0.1074 0.1324 0.1059 1.2414 0.9942 172.3124 1.7741 (-3.6) (-0.6) (12.0) (12.1) (12.1) (10.6) (-5.1) (-9.7) (-10.6) (-10.9) (-11.2) (-11.4) (-7.3) (10.6) (11.1) (11.2) (11.2) (0.02) 8) Rest-of- -0.9450 -0.5152 0.0678 0.0889 0.0742 0.0405 0.0012 0.0332 -0.0553 -0.0608 -0.0484 -0.0200 0.0196 0.0623 0.0971 0.1098 0.7791 0.7919 1,9032 1.9653 the-World (-2.3) (-1.3) (1.6) (3.4) (3.1) (1.4) (0.03) (-0.8) (-1.4) (-1.9) (-2.4) (-1.2) (0.7) (1.7) (2.5) (2.3) (0.1) NOTES: QNLi is the atural rubber output lagged i periods., i - 1,2; / PN-j is the natural rubber prize per tenn lagged i periods., i - 1,2 14; El P-i is the s- of the absolute values of the Al.on lags; I Except for Zl 8-tI, all figures in pareotheses are t-statistics for the corresponding estisutes. For Z| B-11, the figures refer to standard deviations. Page 86 given; either (a) the tapping of trees was initiated at a later stage or (b) the trees were protected from over-exploitation in the initial tapping years. For the Malaysian estate supply equation where price coefficients resumed positive values only in the tenth lag, (b) would seem to be the relevant reason. To obtain supply elasticities from the estimates presented in Table 3.1, the price coefficient Ti in the reduced form equation (3.21) must first be derived from the T* estimates in Table 3.1. 1 This is done by using the relationship between T. and Ti given in equation (3.22). The supply elasticity 11 for each period is then calculated from Ti and average price (P) and output(Q) during the sample period; that is s i = T i(P/Q) for i = 0,1,2, ..., 14; Once the supply elasticity for each period is known, the supply elasticities over different lengths of time periods is obtained by summing the elasticities of the various periods. The short-run is here defined as covering the current period (i=0); the medium-run covers the current and first three lagged periods (i=0,1,2,3) while the long-run includes current and all lagged periods (i=0,1,2,..... 14). Table 3.2 presents the estimated short-, medium- and long-run supply elasticities. On the whole the supply elasticities are found to increase as the lagged periods lengthen, except for Africa, Brazil and smallholder production in Malaysia. Page 87 Table 3.2: Short-, Medium- and Long-Run Supply Elasticities Country Short-Run Medium-Run Long-Run Africa 0.1809 1.0642 0.2808 Brazil (-0.2807) 0.2005 1.3969 India 0.1175 2.7915 37.3776 Indonesia Estates 0.4945 3.6423 5.6559 Smallholders 0.3586 1.4324 6.6673 Malaysia Estates 0.3007 3.6422 8.9245 Smallholders 0.6865 3.0774 -1.0407 Sri Lanka 0.6368 4.2386 13.0913 Thailand 0.3952 3.9536 6.7137 Rest-of-the- 0.4142 4.4404 15.0592 World Notes: (1) Short-run elasticities refers to the supply responses in the current period. (2) Medium-run elasticities refer to the sum of supply responses in the current and first three lagged periods. (3) Long-run elasticites refer to the sum of supply responses in the current and all lagged periods. Page 88 For Brazil the short-run elasticity is negative in value and may be a reflection of the unsystematic nature of Brazilian natural rubber cultivation up to the mid-1970s. During the historical period natural rubber production in Brazil seemed to have behaved more in accord with a backward bending supply curve with increased production when price falls and decreased production when price rises. A possible explanation for the decline in long-run supply elasticities for African and Malaysian smallholder production may be the fall in average yield due to replanting that took place during the historical period. This is especially pertinent to the case of Malaysian smallholder production which will be discussed in detail later (in Section 8.7, Chapter Eight). Since the yield is embedded in the composite price coefficients, the price coefficients are affected differentially so that the relative size of the ( Ti ) coefficient values are similarly affected. In the next chapter, the supply response for Malaysian natural rubber producers will be re-estimated under world price net of export tax. It will be found that the smallholder supply response obtained in this chapter under world price, gross of export tax, will be vindicated after export tax have been deducted. 13 In 1973, the Federal Government of Brazil declared statutory measures to implement systematic cultivation of natural rubber; for details, see Ribeiro(1980). Page 89 3.7 Oligopoly, Vertical Integration and Synthetic Rubber Supply The conditions under which synthetic rubbers are produced contrast sharply with those for natural rubber. Unlike natural rubber, synthetic rubbers are produced under imperfect competition and a high degree of vertical integration; while natural rubber is openly traded on commodity markets and exchanges, no such trading is observed for synthetic rubbers. Synthetic rubbers are derived from petrochemical feedstocks so that the industry is dependent on the petrochemical industry for its raw material feedstocks. Since the processing of feedstocks into synthetic rubbers only entails marginal extensions of the machinery used in oil refining, the backward integration of synthetic rubber production with the petrochemical industry is thus not surprising. on the other hand, the bulk of synthetic rubbers are consumed by the tyre industry, thus galvanising the forward integration of the synthetic rubber industry with the tyre industry, and providing the synthetic rubber output with a captive market. Such vertical integration facilitates intra-firm transfers and protects the captive sales from market instabilities to some extent. Through this vertical integration the synthetic rubber market also acquires the oligopolistic structure characterising the oil and tyre industries. 15 For example, a study conducted in 1967 found that rubber fabricators in the US own about 44 percent of the synthetic rubber 15 production capacity. See Barlow(1970). The world oil and tyre industries are dominated by seven and nine transnational corporations respectively. Page 90 Apart from the capital-intensive feature of synthetic rubber production, its production is also characterised by economies of scale in capital and labour inputs but not in raw material inputs. Consequently production capacity and its rate of utilization are important to synthetic rubber price determination. With the introduction of new processing technologies in the mid-1950s for styrene-butadiene (such as cold-stream polymerisation and oil extension) and the introduction of the second-generation stereo-regular synthetic rubbers (polybutadiene and polyisoprene), new production Icapacities were constructed. Hence capacity underutilization was substantial up to the mid-1960s. To keep synthetic rubber prices relatively constant in comparison with natural rubber price and to induce further substitution by these rubbers, producers were believed to have adjusted their inventories and rates of capacity utilization and employed both price and non-price incentives. Thus Behrman argued that a "supply function clearly cannot be defined for such an industry." and until recentlyt studies on the rubber market have invariably treated the synthetic rubber sector exogenously.17 16 See Behrman (1971). Behrman therefore analysed synthetic rubber supply indirectly by concentrating on the technological progress aspect and explaining synthetic rubber price in terms of four technology indices computed for the major types of general-purpose rubbers produced. It should be pointed out that Behrman was dealing with the rubber market in the period up to 1965; that is, before the 17 era of rising oil price. For details see Behrman (1971:17-22). In a recent study by Man and Blandford (1980), the synthetic rubber sector has been partially endogenised through a price equation for styrene-butadiene. For details see footnote 11 in Chapter Five in this study. Page 91 While recognising the oligopolistic and vertically-integrated features leading to Behrman's caveat on modelling synthetic rubber supply, it was considered useful to specify such supply via the assumption of monopolistic supply and treating world synthetic rubber supply aggregatively. The reasons for doing so are manifold, most important of which is the impact of oil price. While the price of crude oil steadily declined in the 1950s and stabilised in the 1960s, the 1970s initiated the period of rising prices. However, the interest here in analysing the longer-run impact of oil price on synthetic rubbers and hence on natural rubber production and prices explains this attempt to endogenise the synthetic rubber sector. The interaction between natural and synthetic rubbers, which is integral to natural rubber price formation and will be discussed with reference to the post-oil crisis period in Chapter Six, can then be analysed from the two interrelated markets. Under the assumption of monopolistic supply, synthetic rubber supply (output) and price are joil.tly determined. Their specifications will therefore be presented simultaneously in Chapter Five where the natural and synthetic rubber price equations are specified. Page 92 APPENDIX 3..A ESTIMATES OF ACREAGE FUNCTIONS Table A3.l presents the estimates of the investment (acreage) equations for the four major rubber producing countries; for the static case fairly good fits were obtained except for the case of Indonesian estates. The Indonesian case may be explained by the political upheavals in Indonesia in the 1950s and 1960s during which discrimination against foreign-ownership as well as problems associated with the Indonesian foreign exchange rate all contributed towards the decline of the foreign-owned rubber estates. The price estimates in the remaining equations also highlighted a behavioural difference between land-abundant Indonesia and Thailand and less land-abundant Malaysia and Sri Lanka. Although the price estimates for Malaysia and Sri Lanka had the expected positive sign only that for the Malaysian estate equation was significant. It thus appears that price was a significant determinant of area expansion only in the highly-organised estate sector of Malaysia. For Indonesia and Thailand the price coefficients had incorrect negative signs; as for the Malaysian smallholder and Sri Lanka equations, the price estimates were insignificant. The general inference that can be drawn from these estimates is the distinct difference between smallholder attitudes towards rubber cultivation in the land-abundant vis-a-vis the less land-abundant situations. In the case of Indonesia and Thailand (where currently about 70 percent and 97 percent of the rubber are respectively produced by smallholders), the rubber For details on this issue see Teken (1971:27-29). Table A3-1: Estimates of Investment Functions for the Major Natural Rubber Producing Countries, 1956-1978 Constant A A -A PN R2 F DW (1) Indonesia (a) Estates A 87.9927 0.2619 0.5162 0.0096 0-4720 5.0665 2.2104 (0.9) (1.2) (2.4) (0.6) (a') Estates AA (b) Smallholders A 154.6163 0.9492 -0.0044 -0.0265 0.9667 164.7365 2.0864 (1.7) (4.0) (-0.02) (-1.3) (b') Smallholders AA (2) M4alaysia (d) Estates A 15.6287 0.9579 -0.0329 0.0115 0.9945 1022.5484 1.2371 (0.2) (11.5) (-0.4) (2.1) (a') Estates AA -21.5349 0.4807 0.0094 0.5688 11.8724 1.5937 (-3.1) (2.9) (2.6) (b) Smallholders A 69.1785 0.9537 -0.0233 0.0064 0.9892 517.0353 0.9971 (b') Smallholders MA -5.240 0.6604 0.0082 0.4943 8.7969 1.8885 (-0.4) (3.9) (1.0) (3) Sri Lanka A 26.3213 0.8803 -0.0230 0.0042 0.8195 25.7208 2.0563 (1.0) (3.6) (-0.1) (0.8) A (4) Thailand A 306.2197 0.8270 0.0671 -0.0965 0.9665 124.9532 2.0935 (2.0) (3.1) (0.3) (-1.5) AA 102.8092 -0.0416 -0.0286 0.0241 0.1731 1.9674 (1.3) (-0.2) (-0.6) NOTES: PN represents natural rubber price per tonne. A represents area under natural rubber AA represents the change in area under natural rubber between two consecutive years. Figures in parentheses denote the t.statistics of the corresponding estimates. Page 94 smallholders are in the main also cash and/or subsistence crop cultivators. Given the relatively low opportunity cost of land and also of labour (especially in the non-harvesting season for annual crops) in these regions during the historical period studied, rubber planting is a form of creating potential capital assets. In due course when rubber prices are remunerative, the potential of these capital assets could then be exploited (tapped) for additional cash 2 income.2 The situation may gradually be changing in the face of Government-supported rehabilitation and replanting programmes in these countries. The more systematic approach to rubber cultivation also provides employment for those landless rubber tappers who would previously be tapping on a wage or share-cropping basis. Page 95 CHAPTER FOUR MALAYSIAN NATURAL RUBBER EXPORT TAXATION 4.1 Introduction The estimates of natural rubber supply response presented in the preceding chapter were obtained by using the world price for natural rubber. In practice however, prices actually received by producers (that is, 'farmgatel prices) are lower than world prices because of the imposition of export taxes in most primary-producing countries and because of the deduction of marketing margins by the middlemen traders. The price differentials between world and 'farmgate' prices are known to vary across countries; for example, Malaysian smallholders on average are estimated to receive about 70 percent, while their Indonesian counterparts are known to receive only about 35 to 40 percent of f.o.b. price (World Bank, 1981:13). Clearly the use of world price leads to biased-estimation of supply response, and the relevant price to use is the lower 'farmgatel price. But to derive 'farmgate' price, data on export taxes as well as marketing margins (of which the latter in particular are not easily available) are required. This chapter attempts to examine the effect of natural rubber export taxation on natural rubber supply response, using Malaysia as an example. The choice is based on consideration that Malaysia is not Page 96 only the world's largest single rubber producing country but has also devoted concentrated efforts to upgrade its rubber industry. Since the Malaysian natural rubber export tax constitutes a major source of government tax revenue, averaging about 40 percent of total export duties during the period under study, the inclusion of export tax into the model will also permit analysis of rubber export tax revenue profiles under varicus scenarios. In the following sections, the natural rubber export tax in Malaysia is first reviewed. The question of e*port taxation leads to consideration of tax incidence and the extent to which such taxation impacts on supply response and producer returns. The estimates of the acreage and supply response equations using price net of export taxes are then presented. The main finding from these estimates is that export taxation affects estate and smallholder producers differentially. While taxation affected the supply response of both smallholder and estate producers, it is found to influence the decision to invest in natural rubber in the case of the estate sector only. Natural rubber export duty as a share of total export duties ranged from 81 percent in 1959 to only 21 percent in 1972 when prices fell. For details on the distribution of export duties in Peninsular Malaysia during 1947-1974, see Chan(1976:89). Page 97 4.2 Tenure of the 4-Component Export Tax For the 1956-1978 period the export tax, which is levied at the time of shipment, may be described as consisting of the following four components: (1) Schedule I Tax -- a price-based export duty; (2a) Schedule II Tax - a price-based anti-inflation tax (pre-1961); (2b) Surcharge -- a price-based anti-inflation tax (post-1970); (3) Schedule III Tax -- a volume-based research cess; (4) Schedule IV Tax -- a volume-based replanting cess. The Malaysian export tax on natural rubber is thus a complicated tax, the characteristics of the multiple-component export tax being (a) the use of both price and volume as tax bases and (b) the use of the government gazetted RSS1 price of natural rubber in calculating 2 The number 'four' is arbitrary, primarily dependinig on a person's attitude towards the Schedule II and Surcharge components. Pee and Arope treated these components individually, therefore stating there are "five types of taxes"; in contrast Lim called it a "three-part tax with surcharge as a levy ...". For details see Pee and Arope (1976:187) and Lim (1976a:6). In general the term "cess" refers to a form of tax which yields revenue that provides a source of "cess funds" from which activities associated with natural rubber investment, such as 4 replanting, can be financed on a grant basis. This tax structure has been described locally as being 'primitive'; see Anon.(1980b:15). Page 98 the price-based tax components. The gazetted price is a moving average of natural rubber prices in previous weeks, the use of which has implications for the export tax paid and will be discussed in detail subsequently in Section 4.3 below. Despite periodic modifications in tax compositions and/or tax rates, the basic structure of the natural rubber tax has remained unchanged over the last twenty years. The major modification concerns the merging of Schedule II with Schedule I in January 1961; subsequently a Surcharge component was introduced in February 1970. The tenure and details of the different rates applied to each of the four components are shown in Appendix 4.A Tables 4.A.1 to 4.A.3. As a result of the overlap in tax rate changes, the 1956-1978 period is treated as six subperiods delineated by the timing of the introduction, modification and/or cessation of the various tax components. The six subperiods are: 1956-1958, 1959-1960, 1961-1964, 1965-1966, 1967-1969 and 1970-1978. In the following each of the four tax components will be discussed so as to draw out the implications of the various tax bases and government gazetted price. Schedule I Tax This is the basic export duty component with the gazetted price of M$0.60 per pound RSS1-grade natural rubber serving as demarcation for the application of either a constant ad valorem tax or Hereafter Schedule I will be referred to as the export-duty component and the entire 4-component tax as the export tax. Page 99 a progressive tax for both estate and smallholder production. Since the quality of smallholder rubber production was largely of lower than RSS1-grade, the use of RSS1 price as the reference price meant that smallholder rubber was effectively being taxed at a higher rate than estate rubber. Details of the different tax rates used during 1956-1978 are presented in Appendix 4.A Tables 4.A.1. Schedule II Tax In comparison with the Schedule I basic export duty, Schedule II is the supplementary export duty levied only in times of high prices. Schedule II was first introduced in 1951 following the impact of the Korean War on rubber prices and was intended as a compulsory replanting cess. In June 1955 it was replaced by an anti-inflationary cess that was operative when price exceeded M$1.00 per pound. The tax per se was anti-inflationary because it lowered the domestic price received by the rubber growers; whether it was effectively anti-inflationary would depend however on how the tax revenue raised was used by the government. In January 1961 this Schedule II tax was merged with the Schedule I tax. The rates used during 1956-1961 are given in Appendix 4.A Table 4.A.2(a). Page 100 Surcharge Like the Schedule II tax, the Surcharge is a supplementary export duty which is levied during high price periods. It was introduced in February 1970 as an anti-inflationary cess to be imposed when price exceeded M$0.60 per pound; the rates used since 1970 are given in Appendix 4.A Table 4.A.2(b). Schedule III Cess Introduced in 1946 to finance publicity and research, this is a specific tax aimed at extracting part of present income to generate future gains. Using rubber export volume as a tax base, the cess is imposed at all price levels and has been subject to frequent changes in rates. The various rates used are given in Appendix 4.A Table 4.A.3. Schedule IV Cess This is a replanting cess introduced in May 1952 to induce faster replanting rates. Like Schedule III it is a specific tax using the export volume as the tax base. Of the various tax components, this is the only component where the fixed rate of M$0.045 per pound (when rubber price exceeded $0.60 per pound) was retained throughout the entire 1956-1978 period. 6 At present the funds collected under Schedule III are used by the Malaysian Rubber Research and Development Board for production, processing and policy research programmes. The revision of Schedule III rate actually occurred in May 1967. Because annual data is used in this study, the revision will be assumed to have occurred in January 1967. Since the change in tax rate was 0.125 cents per pound of natural rubber, the margin of error resulting from this approximation is negligible. Page 101 4.3 Implications of Price and Volume Based Taxes The price-based Schedules I and II and Surcharge components serve to extract part of the producer (treating planters, dealers and exporters aggregatively) gains from price increases due to outward shifts in the demand schedule. When demand is completely elastic, the tax burden falls entirely on the producers. Since smallholder rubber is traded through intermediary dealers and exporter-traders, it is likely that there is (relatively) more speculative trading with smallholder rubber than with estate rubber. The price-based tax components thus also impinge on the returns to private inventory policies for speculative purposes; given that estates hold stocks largely for supply management purposes, this efficacy in extracting gains is more significant for rubber from the smal]holder sector. The impact of the price-based taxes is best understood in conjunction with the meaning and role of the government gazetted price. The government gazetted price for natural rubber is published weekly. Before October 1977, this gazetted price was a two-week moving average of official prices quoted up to the orevious week; 7 from October 1977, it became a four-week moving average. These official prices are based on prices quoted daily on the Malaysian Rubber Exchange and The Rubber Association of Singapore. These prices are in turn based on prices reported to the Exchange and Association by traders operating in the two markets. The official prices may be regarded as an indicator of the market movement; while they need not See Economic Intelligence Unit (1978:88-89) and footnote 17 in this chapter. Page 102 be the actual price at which natural rubber is traded, they are used as the basis for trading. As in other commodity exchanges where paper trading takes place, there is scope for manoeuvering to place official prices at vantage levels. In the Malaysian case, aside from speculative activities, the rationale for such potential manoeuvering stems from (a) purchases of smallholder rubber being based on official prices and (b) wages in the rubber industry being based on gazetted prices (with bonus payments made in accordance with these gazetted prices). As the price-based tax components are based on gazetted prices, it follows that the export duty and surcharge fluctuate in accordance with the gazetted, and hence the official prices, albeit with a time lag. This known time lag is crucial in providing additional scope for speculation (other than those stemming from world market conditions) since dealers can sell "paper" rubber at prices that go towards forming the gazetted price and hold physical rubber. If higher prices should obtain at the time of shipment, then the value of the exported rubber would become greater because of the lower duty paid. This may be reinforced by the fact that export contracts generally have price clauses geared to shipment dates. Thus the price-based taxes also contain a tool for extracting gains from that speculative stockholding which is motivated by the role of gazetted price in the determination of export duty and surcharge. The differential impact of this on planters and traders is better understood in the context of tax incidence which will be discussed in detail later. For details of the wage structure in the rubber industry of Malaysia, see Pee and Arope (1976:141-152). Page 103 In contrast to the price-based Schedules I and II tax components, the Schedules III and IV components are based on export volumes aad hence are irrespective of price movements. By considering a situation of increased exports under constant prices, it can be seen that Schedules III and IV are aimed at extracting the gains from increased productivity due to the research output of organisations such as the Rubber Research Institute of Malaysia. Since these taxes are earmarked for research and replanting, the tax extractions may be said to be "returned" to the producers eventually, either indirectly via research findings or directly through the replanting refund covenant. But the size and asset differentials between smallholder and estate producers raise questions about the equity effects. In general Schedules III and IV benefit the larger,more than the smaller. estate and smallholder producers. As larger producers own more assets, they are generally able to use more of the services being provided by the Rubber Research Institute and related support organisations. The Schedule IV tax component per se (disregarding the scope within the marketing system for the backward shifting incidence of the export tax to be discussed below) also appears to discriminate For example, it is known that Goodyear's long-term contracts are based on prices during the month previous to the month of shipment; it is possible that such a price clause was aimed at counteracting such gains. The wide variation in the export duty collected weekly (due to the instability of RSS1-price) has also been observed to encourage smuggling of Malaysian rubber to Thailand and the periodic "rushing over" of rubber to Singapore to evade anticipated higher duties. The Malaysian Rubber Producers' Council recently raised the question of modifying the export tax base, arguing that the use of RSS1-price was unfair since it disregards the fact that physical trading generally involves lower-grade rubbers. Moreover, in periods of heavy speculative trading, the paper price of RSS1-grade rubber far exceeds the physical price; the export duty could thus be based on an unrealistic price highly divergent from the price actually received for the physical rubber traded. For details, see Anon.(1980b:2, 13). Page 104 against smallholder production during the period under study. This is because the Schedule IV tax is unconditionally refundable to estates on evidence of their production, and hence replanting (since the yield of natural rubber trees decline about twenty years after tapping). Although the smaller rubber holdings are generally not replanted, those that do replant do not receive the entire replanting cess for which they are eligible. Chan(1976) pointed out that not all smallholders who qualify for the subsidy receive the grant to replant the total acreage in their holdings. For example it was only since 1967, when Scheme 4 was introduced, that smallholdings of five or more acres were granted the subsidy equivalent of replanting one-third of their total area (Chan, 1976:165). In comparison with the replanting cess rebate situation for estate production, the Schedule IV tax component has therefore been considered by several writers to be, in effect, an additional tax on the smallholders. In order to put this complicated issue in perspective, it is necessary to indicate that while smallholder producers in general do not pay income taxes because of their low incomes, a person earning the equivalent of their rubber earnings would also be exempt from income taxation under the Malaysian tax regulations. The problem of smallholder tax burden is compounded by the fact that the export taxes on smallholder rubber are paid indirectly by the exporters. From the above discussion it is seen that the four-component export tax has differential impacts on estate and smallholder rubber. To assess the impact of export tax on natural rubber production supply (in contrast to export supply) response, it is necessary to consider See Edwards (1970:211-247) where he discusses why the tax burden is effectively higher on smallholders than on estate producers. Page 105 the question of tax incidence. The following discussion on tax incidence and marketing muargins draws on the studies by Chan (1976) and by Lim (1976). 4.4 Incidence of Erport Tax From the earlier discussion of the natural rubber export tax structure, it is 3een that this export tax is intended for the purposes of (a) acting as a counter-cyclical device to stabilise domestic incomes from rubber production during high price periods and (b) raising government revenue. The question of incidence of an export tax has two facets: (1) the incidence on the domestic producers/suppliers vis-a-vis the incidence on the foreign consumers and (2) the incidence on domestic exporters/dealers vis-a-vis the incidence on the natural rubber planters. These two facets of the natural rubber export tax incidence will now be discussed in the above order. Since the export tax is imposed by the Malaysian Government, the question raised is whether this incidence is shifted forwards to the foreign consumers. If the export tax is shifted forwards, the world price at which foreign consumers pay for their natural rubber is higher than would be the case in the absence of the export tax. The ability of Malaysian producers to shift this export tax forwards therefore depends on the elasticity of the world natural rubber demand and the bargaining strength of the Malaysian producers. As the Page 106 discussion on world natural rubber demand in Chapter Two showed, the determination of the inelastic natural rubber demand is complicated because of Ci) the existence of a synthetic substitute, (ii) the property of minimum input requirements in tyre production and (iii) the vertically-integrated feature of the rubber goods manufacturing industry. In contrast natural rubber is traded in an open, perfectly competitive market. Although a main producer of natural rubber, Malaysia nevertheless remains a price taker in the world market. Consequently the export tax paid by the exporter cannot be externally shifted forwards to the foreign consumers, and the tax burden is borne domestically (ignoring the benefits that may flow from government expenditures stemming from the tax revenue collected). That the export tax is paid by the rubber exporter and the tax burden borne within the rubber producing country -- through a decline in money income -- leads to the question of the export tax incidence on the rubber exporters/dealers vis-a-vis the rubber planters. This in turn hinges on the relative bargaining strengths of the various domestic parties. To determine whether the formal (who formally pays the tax) and the effective (who actually bears the tax burden) incidence coincide, it is necessary to briefly describe the marketing and export of natural rubber in Malaysia. Here again differences exist between the smallholder and estate rubber. In the marketing and export of smallholder rubber, three levels of trading occur before the rubber is exported. Functioning at the village level, '-he first-level dealer collects the rubber from the smallholder and sells to the second-level intermediate dealer at the Page 107 town level. The intermediate dealer then sells to the exporter. At 11 each level a marketing margin is built into the traded price. Since it is the exporter who is exposed to the world market and who must finally dispose of the rubber, the lower level trading prices are therefore functions of the price at which the exporter is prepared to buy. Chan's (1976) survey showed that although the exporter pays the export tax, the tax is fully deducted by the exporter from the f.o.b. world price which approximates the official price; the price offered is therefore the world price net of the export tax and the exporters' marketing (including profit) margin. At subsequent dealer levels, deductions of marketing margins are consistently made. By this process the export tax incidence is thus entirely shifted back to the smallholder producers. This backward shifting incidence of the export tax is enabled by (i) the nature of rubber production which does not permit shifting of res-irces in and out of natural rubber production easily and (ii) the lack of bargaining strength at the smallholder level. The downward rigidity of profit margins at the various dealer levels is a further manifestation of the two smallholder handicaps described above.13 Thus for smallholder rubber the formal and effective incidence of export tax do not coincide. While the formal incidence occurs at the exporter level, the effective incidence is on the smallholders themselves. Moreover, since any wages paid by the smallholders are positively related to the gazetted price of natural rubber rather than The marketing margin at each trading level encompasses the payments for the service of dealers in assembling, smoking, storing, transporting, grading, packing and insuring the rubber. The marketing margin therefore represents the costs incurred by the various levels of dealers in getting the natural rubber ready for export in the desired form at the required time and place plus returns earned by each for their services. Page 108 the actual price received by the smallholders, the smallholders' tax burden (in real terms) is therefore higher than the export tax incidence would suggest. For the estate sector, the incidence of export tax is related to the way in which estate rubber exports are marketed. For most estates the natural rubber produced is exported via three main channels: (i) by direct consignment to selling agents in the consuming countries; (ii) by selling to consumers' buying agents located in Asia and (iii) by selling to dealers and brokers operating in both Malaysia and the consuming countries. In contrast to the marketing of smallholder rubber, the marketing of estate rubber is therefore more direct in that fewer intermediaries are involved. Consequently, the total marketing margin that is deducted is also lower. 12 Until recently, smallholders had limited alternative employment opportunities; their general lack of transport facilities also meant total reliance on the first-level dealers to absorb their rubber for export. This constrains their bargaining strength. Chan's survey conducted during May 1973 and January 1974, found that during brief periods of falling prices, the smallholders do not seek alternative employment nor abandon their tapping tasks; instead they attempt to step up production so as to maintain their income. This seemingly "backward" supply may be interpreted as a response to "compensate" for the lack of bargaining strength. By the later 1970s this situation had changed considerably due to the rural-urban migration arising from the Malaysian government's emphasis on labour-intensive industrialisation programmes. By early 1980 the labour shortage faced by the plantation (including natural rubber) sector had become sufficiently severe to prompt a call for imported contracted labour from the surplus labour areas within ASEAN. For details of the recent labour scene in the Malaysian plantation industry, see Anon.(1980b:5-6) and Smith (1981a, 1981b). 13 Chan examined this by testing for asymmetry in the behaviour of marketing margins under fluctuating prices, and examining the correlation between the first level dealer price, that is, price offered to (received by) smallholders and the world price. For details of Chan's test, see Chan (1976:133-145). Page 109 For the larger estates, production and processing are fully integrated so that the processing services of an intermediate dealer are unnecessary. In addition some large estates either have links with, or are owned by, the consumers; thus some estate rubber may be shipped directly to consumers, thereby requiring lesser involvement of dealers/traders than in the case of smallholder rubber. The upshot of more direct trading is that (a) the marketing margin deducted from world price is smaller than that in the smallholder case and (b) the formal and effective export tax incidence may or may not coincide, depending on whether or not the estates export their output directly. When the estate rubber is exported through dealers/sellers, the export tax incidence is shifted backward to the producers as in the smallholder case. But there is a marked difference here in the attitude towards the treatment of export tax by the two types of producers. In general the smallholders are unfamiliar with the intricacies of the multiple-component tax and the compilation of the gazette price and export tax rates; the same cannot be said of the estate sector. Furthermore, while both the smallholders and estates may receive prices net of their respective marketing margins and export taxes, the estates are able to treat these tax payments as part of their production cost. Chan(1976:186) found that estates treated the export duty, surcharge and research cess as cost components and the recoverable replanting cess as a revenue item in their company tax statements. Thus although the export tax incidence is shifted back to the estates, there is scope for diluting its effects through the 14 Ma (1959) had found that for public companies in the rubber industry, export tax and cesses approximate 17 percent of the companies' estate production costs. This treatment of export taxes leads to a further divergence between estate and smallholder producer prices. Page 110 company tax returns. Hence the price received by the estates is some function of the world rubber price, the marketing margin of the dealers/exporters and the export taxes. The precise functional relationship depends to a large extent on the relationship between export tax and company tax; however, analysis of this issue is beyond the scope of the present study. The contrast between prices received by the smallholder and estate producers may be summarised as follows: (4.1) PN(S)= PN(W,S) - [X + S + R(C) + Rep(C) ] - MI(S) (4.2) PN(E)= PN(W,E) - [X + S + R(C)](1-t) - MM(E) where PN(S) is the price actually received by smallholders; PN(E) is the price actually received by estates; PN(W,S) is the world/Singapore price received for smallholder rubber (typically for RSS3- or lower grades); PN(W,E) is the world/Singapore price received for estate rubber (typically for RSS1- and RSS2-grades); X is the basic export duty; S is the supplementary export duty (Schedule II or Surcharge) whenever it applies; R(C) is the research cess; Rep(C) is the replanting cess; MM(S) is the marketing margins of the various level dealers/ exporters who handle smallholder rubber; MM(E) is the marketing margin of the dealers/exporters who handle estate rubber; t is the proportion of export taxes that can be effectively offset by treating the non-recoverable tax components as part of estate production costs in the estates' company tax statements. Page 11 In summary, it can be said that by virtue of the marketing and export tax systems, the onus of rubber price volatility lies relatively more on smallholder than on estate producers. However, because of data limitations, it is assumed in the following empirical analysis that export taxes for estate rubber are shifted backwards fully as in the case of smallholder rubber. 4.5 Empirical Ertimates of Malaysian Supply Response Under Export Taxation This section presents the supply response estimates of Malaysian natural rubber producers under export taxation. It is assumed that export taxes are fully shifted backwards for both estate and smallholder producers so that the price actually received by both types of producer is the world price less the non-recoverable export taxes paid. The basis for calculating the export taxes to be deducted are the tax schedules presented in Tables 1 to 3 oL Appendix 4A. During 1956-1978 the export taxes on smallholder rubber were uniformly based on the gazetted RSS1-price, despite the fact that smallholder production were generally of lower than RSS1-grade. The price net of export tax was obtained by deducting the RSS1-based four-component export tax from the f.o.b. Singapore price for RSS3-grade rubber; this price net of tax was then used in re-estimating the smallholder acreage and supply response equations. Page 112 The calculation of price net of export tax for the estate sector is similarly based on the f.o.b. Singapore price for RSS1-grade rubber. However, since estates can recover the replanting cess payments, only the three non-replanting (and hence non-recoverable) components, viz. basic export duty (Schedule I), supplementary export duty (Schedule II) or Surcharge and the research cess (Schedule III) were deducted from the f.o.b. price. It is seen from the above discussion that data non-availability has precluded any consideration of the marketing margins taken by the intermediary dealers. Consequently, the prices net of export taxes used in the estimations are not 'farmgate' prices (which should exclude the marketing margins). Tables 4.1 and 4.2 present the estimation results for supply and acreage respectively as fanctions of natural rubber price net of export tax (hereafter referred to simply as net price) for the smallholder and estate sectors. The estimates for the two sectors will be discussed separately, comparirng them in each case with their corresponding estimates when gross price (that is, world price which includes export tax) was used. 4.5.1. Impact of Export Tax on Smallholder Supply But Not Acreage For the smallholder sector, the estimates of supply response under net price revealed smallholder supply to be price responsive as was the case under gross price discussed in Chapter Three. When gross 15 Thus "t" in equation (4.2) is assumed to equal zero. Page 113 0 0 N O 9' o'9 - N 00 *O a a IN 'N a a a a ON N- N - ' a ON ONH -a - 00 ON 'N 'fi a- aVla . -- a.-a In ,4 ' } N a-I a. .a a tO OA A } O A Table 4.2: Malaysian Acreage Equations Under Export Taxation, 1956-1978. Explanatory Variable Constant X A A AA R2 F DW Dependent -1 -2 R1 Variable Smallholder Sector (1) A 43.0931 0.0073 1.4856 -0.5278 0.9933 837.4589 2.0605 (1.2) (0.6) (8.7) (-3.3) (F 3,17) (2) AA -16.0039 0.0190 0.6213 0.5336 10.2969 2.0401 (-1.0) (1.6) (3.8) (F 2,18 Estate Sector (3) A -5.4178 0.0129 1.5266 -0.5536 0.9967 1693.2528 1.7826 (-0.4) (2.8) (9.4) (-3.3) (F3,17 (4) AA -23.6624 0.0119 0.4796 0.5506 11.0247 1.4641 (-2.9) (2.4) (2.8) (F2,18 Notes: (1) X represents natural rubber price net of export tax (dollars per tonne). (2) A represents area under natural rubber (acres). AA -(A-A1) represents the change in planted area between any two consecutive years. CD H H Page 115 price was used the best fit had a shorter lag structure with price coefficients regaining positive values in the sixth lag (see Table 3.1 of Chapter Three). In contrast the lag structure under net price involved 14 periods with price coefficients regaining positive values in the tenth lag (see Table 4.1). If net price was deflated by the consumer price index, the estimation resulted in equally significant but higher-valued estimates. For the acreage equation, neither gross nor net price was a significant explanatory variable; instead the significant explanatory variables were the lagged acreage variables. The estimates of the supply equations substantiate the negative impact of export tax and multi-level dealer trading on smallholders' supply response. As the lagged gross price coefficients regained positive values after fewer lagged periods, it may be interpreted that smallholder producers would commence tapping sooner had they received the hiqher gross price for their output. The estimation results therefore indicate that reducing the marketing margins of dealers, such as by improving smallholders' access to transport facilities, and lowering the export tax burdens of smallholders, is & potential means of increasing their supply. This is substantiated by the estimated supply elasticities presented in Table 4.3, where for each of the short-, medium- and long-run supply elasticity is higher under gross price than under net price. However, this benefit of reduced taxation to smallholders should be weighed against the potential use of export tax as a supply management policy instrument for short-run price leverage in the international markets. This is particularly relevant to natural rubber not only because its demand is derived in nature, but also because of the competition from synthetic rubbers. In Table 4.3: Malaysian Supply Elasticities Under Gross and Net Prices, 1970-1978 Supply Estate Sector Smallholder Sector Elasticity Gross Price Net Price Gross Price Net Price . Short Run 0.3007 0.0302 0.6865 0.4873 (i=o) Medium Run 3.6422 3.3320 3.0774 2.3952 (i=0,l,.,4) Long Run 8.9245 8.5422 (-1.0407) (-0.5321) (i=0,l1.,l4) Notes: (1) Figures in parentheses denote values countrary to expectations. (2) * denote that if the insignificant current net price coefficient (of 0.0142) is disregarded, then the short run supply elasticity equals zero. P3 Lo~ H Page 117 examining the price \stabilisation issue, it would therefore be interesting to investigate the interaction between export tax variations and stabilisation activities. The insignificance of gross as well as net prices in explaining smallholder acreage may be a reflection of the land availability constraint on smallholder rubber cultivation. Furthermore, as employment in the manufacturing sector became increasingly available, new investment (planting) in natural rubber may have been dictated not by natural rubber price per se but by a comparison of the discounted return from natural rubber investment with that of wages paid by the manufacturing sector. 4.5.2 Impact of Export Tax on Estate Supply and Acreage The estimates for the estate supply and acreage equation under price net of export tax contrasts markedly with those for the smallholder sector. For the estate acreage (which proxies investment) equation, both net price and lagged acreage variables proved to be significant explanatory variables. But the use of net price in the supply response estimation failed to give satisfactory estimates. Despite estimation attempts with alternative lag lengths for net price and polynomials of different orders for the Almon scheme, no estimated equation with significant F-value was obtained under net prices; this was the case for the corresponding equation using gross price. In Page 118 using the supply equation estimates to calculate supply elasticities, it is found that as for the smallholder sector, supply elasticities are lower under net price than under gross price. 4.6 Generalised Export Tax Functions In order to simulate the model of the rubber market with Malaysian supply equations estimated from prices net of export taxes, it is necessary to endogenise the different export taxes imposed on estate and smallholder rubber exports respectively. This is so that for each type (estate or smallholder) of rubber supply, the price net of export tax can be obtained by deducting the relevant export tax from the f.o.b. Singapore prices generated as solution values by the model. Since the Malaysian export tax consist of four components, a simple way of representing the export tax is to specify generalised export tax functions for the estate and smallholder sectors severally. Each generalised export tax function will then be used for calculating the ad valorem equivalent tax rate that corresponds to each solution value of the f.o.b. Singapore price generated by the model. In view of the fact that export tax rates were revised in 1980, two sets of generalised export tax functions are therefore required: one for the historical period 1956-1978 and one for the forecast period 1980-1995. The first set of export tax functions (one each for the estate and smallholder sectors) will be used in validating the model for the Page 119 historical period while the second set will apply when the model is used to simulate alternative scenarios for 1980-1995. 4.6.1 Generalised Export Tax Functions, 1956-1978 The simplest generalisation of the export tax function is to obtain ad valorem equivalent tax rates for the various price ranges. Figures 4.1 and 4.2 give scatter diagrams of the export tax rates against unit price for smcllholder and estate rubber exports respectively during 1956-1978. From the scatter diagrams, the tax rates can be restated in terms of ad valorem equivalent tax rates expressed as a function of the world natural rubber price. The tax rates for smallholder rubber exports are then endogenised through the smallholder export tax function (t ) which is generalised as follows: (4.3) tS 0.0600 if PN<$1400.00 0.1240 + 0.1530 (PN-1400/1000) if PN>$1400.00 where PN is the f.o.b. Singapore RSS3-price. Similarly, the ad valorem equivalent tax rates for the estate sector can be generalised as: Ad Valorem Equivalent Tax Rate (t) 0.26 0.24 0.22 -t = 0.1240+0.1530(PN-1400/1000) if PN >$1400 0.20 - 0.18 - 0.16 I 0.14 - 0.12 -- = 0.1240 0.10 0.08- 0.06 S t 0.06 if PN < $1400 0.04 °'Natural Rubber 800 1000 1200 1400 1600 1800 2000 2200 2400 2600 2800 Price (S$/Tonne) I-u Figure 4.1: Generalised Export Tax Function for Smallholders, 1956-1978. D 0 Ad Valorem Equivalent Tax Rate (t) 0.25 0.20 / E = 1400 t = 0.06+0.2000(PN-1400/1000) I /if PN > $1400 0.15 0.10 0= .06 0.05 E t =0.06 if PN $1400 0 L a I a I ' - I ' I ' ' Natural Rubber 800 1000 1200 1400 1600 1800 2000 2200 2400 2600 Price (S$/Tonne) LQ (D Figure_4.2: Generalised Export Tax Functions for Estates, 1956-1978. Page 122 (4.4) tE 0.0600 if PN<$X..400 0.0600 + 0.2000(PN-1400/1000) if PN>$1400 4.6.2. Generalised Export Tax Functions for 1980-1995 Before specifying the export tax functions for obtaining natural rubber price net of export tax in the forecast period 1980-1995, the changes in export taxation during 1978-1980 will first be discussed. In the two years following the sample terminal year (1978) the export tax structure has been revised twice: (a) in November 1979 and (b) in December 1980. The revision in November 1979 involved the introduction of new formulae for calculating the export duty payable, and raising the minimum taxable price to over $0.60 per pound (or $1.33 per kilogram). No export duty was collected for natural rubber exports at prices below $0.60 per pound. The revision in December 1980 (which might have been prompted by the earlier comment of the Malaysian Rubber Producers' Council referred to in footnote 9 above) is significant in that export duties Page 123 for RSS1-grade and lower grades natural rubber are now differentiated. Consequently different minimuim price levels and different export duty schedules apply to the different natural rubber grades. For RSS1-grade rubber, the minimum price for export duty imposition is M$1430.00 per tonne; for RSS2- and lower-grade rubbers, the minimum price for export duty imposition is M$1540.00 per tonne. Table 4.4 gives the export duty schedules for the two groups of rubber exports. The export tax functions applicable for the post-1980 period can be calculated from Table 4.4; Figures 4.3 and 4.4 are graphical presentations of the export tax functions; ad valorem equivalent export tax functions for the smallholder and estate sectors respectively are derived in accordance with Table 4.4. 17 The 4 percent ad valorem export duty when price was below $0.60 per pound was deleted in the October 1977 tax revision. Other changes in this revision involved (a) new formulae for calculating the Schedule I export duty, (b) the incorporation of the Surcharge component into Schedule I accompanied by a 30 percent tax concession for the producers in Sabah and Sarawak since they were previously exempted from the Surcharge payments and (c) the change of the gazetted price basis from a two-week to a four-week moving average of prices in the period immediately preceding the gazette price announcement. This revision has been examined in detail by Lim and Tay(1977) who concluded that: (1) the downward revision of export duty in October 1977 was of small magnitude and the benefits of the lower duty were not expected to flow on to the smallholder producers; (2) the adoption of a four-week moving average for the gazetted price only reduced the weekly fluctuations of the gazetted price marginally; thus considerable scope remained for export tax exploitation by the producers and traders. Since the October 1977 downward revision of export duty was small in magnitude, it was assumed here that no revision took place. The tax schedule prior to October 1977 was applied to 1978 prices in the estimation of the supply response equations for 1956-1978. For 18 details of this study, see Lim and Tay (1977). For smallholder rubber, total export tax payments include the export duty, Schedule III research cess and Schedule IV replanting cess; for estate rubber the total export tax payments include only the export duty and research cess payments since the replanting cess payments were refundable. Page 124 Table 4.4: Export Duty Structure Announced in December 1980 Price Price Range Ad Valorem Export Duty (%) (M$/tonne) (M$/tonne) RSS1 Grade Other Grades $ 1430.00 0.00 - 1430.00 0.00 0.00 + 110.00 1431.00 - 1540.00 20.00 0.00 + 110.00 1541.00 - 1650.00 25.00 20.00 + 110.00 1651.00 - 1760.00 30.00 25.00 + 110.00 1761.00 - 1870.00 35.00 30.00 + 110.00 1871.00 - 1980.00 40.00 35.00 + 110.00 1981.00 - 2090.00 45.00 40.00 + 110.00 2091.00 - 2200.00 50.00 45.00 P - 2091.00 50.00 + Balance ?- 2201.00 50.00 Source: Malaysian Government Gazette P.U. (A) 356, 12 December 1980: 2043-2044; Ad Valorem Equivalent 0.32i Tax Rate (t) 0.30 0.28 a=2800 0.26 I / t = 0.23+0.0750(PN-2800/1000) 0.24 if PN > $2800 40.23 0.22 0.20 0.18 s 0.16 t 0.08 + 0.1170(PN-1540/1000) if $ 1540 < PN 4 $2800 0.14 0.12 a = 1540 0.10 0.08 * ) -- = 0.08 0.06 tS =0.08 if PN $1540 0.04 0.02 0 Natural Rubber 1400 1600 1800 2000 2200 2400 2600 2800 3000 3200 3400 Price (S$/Tonne) Figure 4.3: Generalised Export Tax Function for Smallholders, 1980-1995. Q Ad Valorem Equivalent Tax Rate (t) a=3000 0.28 0.26 , E - t = 0.23+0.0770(PN-3000/1000) 0.24 - if PN > $3000 = 0.23 0.22 - 0.20 0.18 * 0.16 0.14 - /t = 0.0280 + 0.1430 (PN-1540/1000) 0.12/ if $1540 < PN 4 $3000 0.10 0.08 0.06a 15 0.04X ~ ~$ =0.0280 o.02. E t= (22.05/PN) PN £ $1540 0 ' a -*Natural Rubber Price (S$/Tonne) P 1400 1600 1800 2000 2200 2400 2600 2800 3000 3200 3400 3600 Figure 4.4: Generalised Export Tax Function for Estates, 1980-1995. Page 127 Based on Figure 4.3 the generalised export tax function for the smallholder sector is: (4.5) t = 0.08 if PN<$1540 = 0.08 + 0.1170(PN-1540/1000) if $1540$2800 From Figure 4.4 the ad valorem equivalent tax rates for estate rubber can be generalised as: (4.6) t = (22.05/PN) PN<$1540 = 0.0280 + 0.1430(PN-1540/1000) if $1540$3000 Page 128 APPENDIX 4.A SCHEDULES OF NATURAL RUBBER EXPORT TAX IN MALAYSIA, 1956 - 1978 In the schedules given in the following Tables, the price (PN) refers to the government gazetted price. All prices, taxes and cesses are quoted in Malaysian cents per pound natural rubber exported. Tables 4.A.1: Schedule I Export Duty June 1955 to December 1960 Export Duty =0.04(PN) if PN> 60 =0.18625(PN)-8.775 if 60< PN< 80 =0.3125(PN)-18.875 if 80< PN< 100 =0.25(PN-100/10) +0.75(PN-100/10)+0.125 if PN > 100 Page 129 January 1961 to December 1979 Export Duty =0.04(PN) if PN >60 =0.18625(PN)-8.775 if 60 100 Table 4.A.2(b): Surcharge (Anti-inflation Cess) February 1970 to April 1974 Surcharge = 0.0 if PN > 60 = 0.125 if 60.000< PN< 60.125 = (PN-60.125) if 60.250< PN< 60.750 = (PN-60.250) if 60.875< PN< 61.250 = (PN-60.375) if 61.625< PN< 62.125 Page 130 = (PN-60.500) if 62.250< PN< 62.375 = 2.0 if PN> 62.375 From April 1974 Surcharge =0.000 if PN> 60.000 =0.125 if 60.000< PN< 60.250 =0.250 if 60.250< PN< 60.375 =0.375 if 60.375< PN< 60.500 =0.500 if 60.500< PN< 60.625 =0.625 if 60.625< PN < 60.875 =0.750 if 60.875< PN< 61.000 =0.875 if 61.000< PN< 61.125 =1.000 if 61.125< PN < 61.250 =1 . 125 if 61.250< PN< 61.375 =1.250 if 61.375 130.00 Table 4.A.3: Schedule III Tax (Research Cess) Tenure Cess March 1953 - December 1958 0.500 January 1959 - December 1964 0.750 January 1965 - May 1967 0.875 June 1967 onwards 1.000 Page 132 CHAPTER FIVE BEHAVIOUR OF RUBBER STOCKS AND PRICES 5.1 Introduction In this chapter the modelling of the stocks and price behaviour of the natural and synthetic rubbers will be discussed and the estimates for the corresponding equations presented. Again the different levels of disaggregation adopted for the two types of rubber are dictated by data availability and the lengthier discussion of the stocks and price behaviour of natural rubber will be presented first. The emphasis is on the different scope and motivation for natural rubber stockholding by the various parties concerned. 5.2 Ownership versus Location of Natural Rubber Stocks In dealing with natural rubber stocks it is necessary to consider the roles played by ownership and location of these stocks in the rubber price formation process. The disaggregated treatment of natural rubber stocks is facilitated by stocks data that are differentiated by their location. Data on natural rubber stocks therefore pertain to stocks located Page 133 (a) in the producing regions (about 30 percent during the historical period); (b) in the consuming regions (about 46 percent during the historical period); (c) at sea as "stocks afloat" (about 24 percent during the historical period). Regrettably these stock data are of lesser analytical value than their disaggregation suggests because the organisation of the natural rubber market is such that stock ownership, a more relevant criterion, cannot be identified with the location criterion. As indicated before, while natural rubber production is concentrated in Southeast Asia, its consumption is concentrated in the Western industrial countries and Japan. Had these location-based stocks data distinguished and reflected mutually-exclusive ownership of stocks, an analysis of the role of separate producer- and consumer-owned stocks in the determination of natural rubber price could have been attempted. It would also have been pertinent to the stabilisation issue to examine the Nurkse hypothesis that the onus of stockholding is forced onto the primary-producing countries during periods of slump (Nurkse, 1958:252). However this is not the case. Instead the variously located stocks are owned severally by producers, rubber dealers/traders, consumers and agents as their interlocking ownerships reveal: Page 134 Stock Location Stock Ownership (1) Producing Regions Producers, Dealers/Agents, Consu3mers (2) Stocks Afloat Agents, Consumers (3) Consuming Regions Agents, Consumers From the above locational distribution of stockholdings and other evidence (Economic Intelligence Unit, 1978:80-90), it can be inferred that the bulk of the world's natural rubber stocks -- which average three months' world natural rubber consumption -- are in the hands of consumers and the trading agents. As indicated below, the activities and services provided by these natural rubber trading agents are integral to the natural rubber price formation process. A review of the reasons for maintaining stocks in different locations by theiL various owners is therefore pertinent to the specification of stockholdings according to their location. The following review serves to elaborate on the existing theory of storage developed by Working and others by highlighting those aspects of natural rubber stockholding that are important to the question of competition between natural and synthetic rubbers. Page 135 Producer-Owvned Stocks Since the bulk of natural rubber trading is on the basis of long-term contracts (generally of twelve to eighteen months), stockholding by rubber producers is motivated primarily by the need to meet the shipment requirements scheduled by these contracts. Such stockholding, motivated by supply management, may be referred to as stockholding for precautionary reasons. Although some producer stocks which are not for sale on long-term contracts are held for speculative purposes, this is understood to be minimal largely because smallholder producers in general lack both the financial and physical facilities required of speculative activities. While estate producers may hold stocks for speculative activities, this would be represented partially by the activities of their agents. In Malaysia for example, such activities are related to the specification of the export tax with respect to the government export tax as discussed in Chapter Four. Furthermore, where estates are owned by foreign rubber companies which are integrated with the tyre manufacturing industry, stockholdings are for ensuring smooth supply of raw rubber to their parent companies.1 For example 80 percent of natural rubber imports into USA were found by Helleiner (1979) to stem from related parties. Page 136 Agent-Owned Stocks Agents serve producers and consumers as intermediaries. However, the role of trading agents in the natural rubber trade is complicated by the fact that they also act for producers and consumers (jointly in some cases), thus providing producer-agent and consumer-agent links. Consequently, stockholdings by agents are variously located in the producing and consuming areas and afloat (on board ships en route to the consuming regions). In general, stocks are held by agents in the producing areas to fulfil the shipment schedules of long-term contracts to which they are committed. Some stocks are kept afloat to minimise storage costs through savings on warehousing costs. Stocks afloat that are uncontracted are generally sold by the time these stocks arrive at destination. The remaining agent-owned stocks are located in the consuming areas. As representatives of and intermediaries between producers and consumers, the agents are likely to be best informed on the market situation. Given their wider access to market information and financial (banking) facilities, agents would naturally be more actively involved in speculative and hedging activities than would producers. In addition, fluctuations in exchange rates extend the scope for speculative and hedging activities from rubber shipments to exchange rate futures. Given the delivery lags caused by the geographical distance between the producing and consuming regions, the influence of speculation and hedging by agents on natural rubber spot price formation per se, in London becomes critically dependent on the Page 137 distribution and timing of their stocks afloat. This is facilitated by the producer-agent links and the several terminal markets in Europe. For example, any natural rubber shipment can be packed in small lots, say of ten tonnes each, and shipped under separate bills of lading and destined for any European port. These small tonnages of natural rubber will then be unloaded at the European port closest to where the agent is able to find a buyer offering the best price. Such trading behaviour has implications for natural rubber price formation as discussed below in the section on consumer-owned stocks. Consumer-Owned Stocks In analysing the demand for natural rubber, it was emphasised that the competition between natural and synthetic rubbers is dominated by their competitive usage in the transport sector; to reiterate, this competition is restricted to the input range beyond the minimum requirement of eithier input. Since the approximate minimum requirement of natural rubber in each period is known to consumers, long-term contracts for monthly deliveries of at least this minimum requirement should, ceteris paribus, ensure regular and smooth supplies of the necessary natural rubber input in rubber manufacturing. Two other factors reinforce the raison dletre for such long-term trading arrangements. The first factor is climatic-cum-seasonal. In the industrial countries (mainly located in the northern hemisphere 2 See footnote 4 of Chapter Two on the role of natural rubber buyers in the rubber manufacturing industry. Page 138 temperate zone) natural rubber consumption also exhibits a marked seasonal pattern with consumption being lowest typically during the third quarter. When natural rubber is stored in colder climates it tends to harden, thus incurring higher processing costs when eventually used. Under such well-established seasonality in consumption it is therefore cheaper to have some portion of consumer requirements held as stocks in the producing regions, either directly or indirectly (through the scheduled long-term contracts). In either case, savings would be made on warehousing costs that would otherwise have been incurred at the consuming locales. The other factor favouring the long-term contractual trading arrangement is the ready availability of synthetic rubbers and their associated discount trading. These factors, together with the proximity of several European and Japanese natural rubber markets to the rubber consumers, are manifested in the observed speculative activities of the rubber consumers who have the choice of making up any balance input requirements by buying either natural rubber (on the spot market in London or that stock currently afloat and due to arrive soon) or synthetic rubbers. Given that synthetic rubber is traded under varying discounts proportional to (a) the volumes of synthetic rubber traded, (b) the tightness of the natural rubber and synthetic rubber feedstocks markets and (c) the seller-client relationship, consumers utilise both rubber (natural and synthetic) markets to their advantage. This trading acumen is warranted by the vertical integration within the synthetic rubber industry against a highly competitive international market for natural rubber and rubber For details of the varied roles of the rubber exchanges located across the world, see Ng and Sekhar(1977). Page 139 products. Since synthetic rubbers and synthetic textiles and fibres are based on the same petrochemical feedstocks, this scope for shifting feedstock resources between the two industries provides an additional instrument for the vertically-integrated rubber fabricating industry to exploit the natural rubber market. Consumer-owned stocks of natural rubber thus play a critical role in enabling consumers to operate on those features of input-substitution and market organisation that are peculiar to the rubber industry and market respectively. In discussing the motivations for the variously owned and located stockholding, the precautionary versus the speculative and hedging activities have been differentiated to highlight the location factor. Built onto these basic reasons for stockholding are the use of stockholdings (via their shipment schedules) for exchange rates speculation and hedging, and for fiscal purposes. Thus fluctuations in stockholding (via the flow of natural rubber stocks from producing to consuming regions) reflect natural rubber trading that results from The analysis of inter-reactions between the natural rubber, cotton, synthetic rubber and synthetic textiles industries should provide an interesting study which, to the best of this writer's knowledge, has not been undertaken to date. However, some evidence of the impact on cotton and natural rubber pricing from their synthetic counterparts are tangentially provided by the trend estimates obtained by Hwa(1979) in his analysis of prices for six commodities: cotton, rubber, copper, cocoa, coffee and sugar. Hwa incorporated a trend term to proxy increasingly efficient inventory control methods (during the period 1962-1975 for cotton and 1955-1975 for rubber). Of the six commodity prices, the trend estimates had conspicuously higher negative values for cotton and rubber. In private communication with Hwa on the alternative interpretation of these trend estimates, Hwa agreed that the trend estimates could "partially reflect the strong competition stemming from the synthetic substitutes of these two commodities". Thus his re-estimates for the period up to 1972 only (to exclude the high oil price era), for testing the stability of the price equation estimates, could also be interpreted as reflecting asymmetrical responses of synthetic rubbers and synthetic textiles to the energy crisis of 1973-1974. Page 140 perceived natural rubber consumption requirements and financial market trends. An in-depth study of these interactions is beyond the scope of this study. Yet this pattern of location and ownership of stocks suggests that the primary force determining the London natural rubber spot price emanates from stocks held in the consuming regions. 5.3 Stocks Location and Spot Price Formation In the discussion of the dispersion of ownership and location of natural rubber stocks it was reasoned that it is the stocks held in the consuming regions that is central to the London spot price formation for the commodity. This is not to deny that stockholdings in the producing regions may influence price formation. However, because natural rubber is a primary commodity with a derived demand concentrated in the industrial countries, it is posited that the spot pricing process is dominated by stocks held in the consuming regions. The size of these stockholdings (nearly half of total stockholdings) and the operation of the spot market by consumers reinforce this argument. Thus it is the London spot price that exerts ultimate influence over natural rubber price formation in the producing areas in each period. On an annual basis it is therefore the London spot price that calls the tune. The role of location can be incorporated by juxtaposing the location factor with the supply management (precautionary) and speculative motives for stockholding,thus reducing stockholdings to Page 141 two distinct groups: those held within the consuming regions versus those held outside the consuming r-gions. The hypothesis regarding the role of location can be tested by treating stocks in the producing regions and afloat jointly; in this way, the several ownerships of stocks can also be accounted for, albeit implicitly. Fortuitously, the approach overcomes the problem associated with the quality of stocks data. This is particularly relevant to the belated realignment in 1973 of 1961 and 1962 stocks data in the Bulletin by the IRSG so as to provide more realistic estimates of stockholdings. The stocks in the consuming regions will therefore be treated singly. The specification of the stocks function for stocks held in the producing regions and afloat will now be discussed. Two hypotheses were tested for these stockholdings. The first hypothesis gives equal weight to the precautionary, speculative and hedging motives for stockholding, while the second hypothesis concentrates on the precautionary motive and emphasises the location factor. As the first hypothesis was not vindicated empirically, it will be discussed only briefly. Support for this hypothesis may be gleaned from Kanbur and Morris (1975) whose spectral analysis of monthly rubber prices led them to assert that the London market price fluctuations seem to be systematically in advance of those fluctuations observed in the Kuala Lumpur/Singapore markets. They consider this to be consistent with a market dominated by supply inelasticity and with London being closer, and therefore more immediately responsive to demand changes. However, Kanbur and Morris do not take into consideration the presence of synthetic rubbers and their impact on natural rubber trading and price behaviour; such consideration adds further substantiation to their observation. For a general discussion of price formation in primary commodity trading, see Kaldor(1976). Page 142 In the first hypothesis, the precautionary motive for stockholding gives the producer- , agent- and consumer-owned stocks as functions of rubber production and consumption. Under the speculative and hedging motives, the desired stocks are functions of price expectations. Using a partial stock adjustment process to obtain actual stockholding from the desired stock level, and extrapolative expectations to translate expected price into observed spot price, the stockholding in the producing regions(SNP) and afloat(SNA) can then be specified as some function of natural rubber consumption(CN), production(QN), current spot price(PN ) and the lagged values of stockholdings and prices. That is: 6 I am grateful to Dr. P.J. Watson of the IRSG for bringing this realignment to my attention upon my query of the sharp increase in stockholdings between 1961 and 1962. The realignment in early 1973 of stockholdings was striking in its concentration on stocks in the consuming regions. As a proportion of natural rubber consumption, these consuming regions' stockholdings increased from about 10 percent in 1961 to 22 percent in 1962. Although the IRSG d.½es not elaborate on the cause of this data realignment, one reason may have been. the releases of stockpiled natural rubber by various governrments. In the post-Korean War period, the releases of natural rubber from the various government (notably Australia, Britain, Italy and United States) stockpiles began in 1960 with a release of 16,000 tonnes. This was followed by releases of 30,000 and 67,000 tonnes in 1961 and 1962 respectively. Subsequent huge releases were in 1965 and 1966 of 122,000 and 157,000 ta'nnes respectively. The releases in the early 1960s were prompted by the natural rubber demand in the postwar reconstruction period while those in the mid-1960s were probably due to the escalation of the Vietnam War. In both periods, the increasing availability of improved synthetic rubber must have minimised the urgency of national stockpiling or natural rubber for strategic reasons. The stockpiles held by the Australian, British, and Italian governments were completely disposed of by 1971. According to the Bulletin of December 1980, the US-governmnent natural rubber stockpile then amounted to 122,000 tonnes. Page 143 The estimated (SNP+SNA) equation under this hypothesis is: (5.la) (SNP+SNA) = 163.2141 + 0.1642QN - 0.0562CN (1.8) (0.8) (-0.2) + 0.4208(SNP+SNA) - 0.2589(PN ) (1.5) -1(0.9) - 0.0357(PN ) + 00256(PN.0 (-0.1) (0.1) R =0.7991; F 9.2785; DW = 1.9235; 6,14 The second hypothesis takes into account the fact that price fluctuations within the year are smoothed out in the annual data. Consequently, the focus is on the precautionary motive and the location factor will be highlighted. From the discussion of stocks by ownership, it is seen that the variously-owned stocks in producing regions are mainly held for supply management consideration. Bearing in mind the long-term contracts of a year or more, the stockholding by producers or their agents will be a function of production. For the consumers and their agents, such stockholdings are a function of consumption. The total stock in producing regions is then some function of rubber production and consumption; that is: (5.2) SNP = f2 (QN, CN) Stocks held afloat (SNA) however, are motivated primarily by considerations of meeting consumption needs at minimal costs. Thus such stockholdings will be some function of consumption; that is Page 144 (5.3) SNA = f3 (CN) Then the total stocks held in the producing regions and afloat (SNP+SNA) is given by (5.4) (SNP+SNA) = f2 (QN, CN) + f3 (CN) = f 4(QN, CN) On an annual basis, the change in ownership of stocks in producing regions and afloat from producers and agents to the consumers can be implicitly analysed if we specify the stock function above in terms of rates of change. If the increase in consumption during the year is greater than the increase in production during the same period, then stocks held in producing regions and afloat should, ceteris paribus, decline as more stocks would have been transferred to the consuming regions. In discrete terms, the equation can be written as (5.5) (SNP+SNA) = ' A (CN/QN) + 2 (SNP+SNA) with 1 < 0 when A(CN/QN) > 0 and 32 % 1.0 Page 145 Table 5.1 presents the estimates for equation (5.5) from which support for the hypothesis that the effect of stocks on spot price formation depends on their location may be inferred. The estimated value of S2 is 0.8130 which is close to its expected unitary value. Thus stocks located away from consuming regions appear to fulfill the transactions (of producers) and precautionary (of consumers) needs more than influencing spot price formation. There now remains to discuss the stocks in the consuming regions. In contrast to the stocks referred to above, these stocks influence price determination through their location and proximity to major consumers. Given the poor quality of stocks data (especially for stocks in the consuming regions), it was considered expedient to treat price formation directly. Consequently, stocks in the consuming regions are treated as a residual via the balance identity used to close the natural rubber submodel. 5.4 Spot Price Determination Under Stock Disequilibrium Two hypotheses were tested for spot price formation. These hypotheses concern the demand for stocks and are based on the ideas of equilibrium/disequilibrium demand for stocks. Since the hypothesis concerning price determination under stock equilibrium was not substantiated empirically, this approach will only be briefly outlined here. Under this hypothesis the location factor is subordinate to the globally dispersed but closely related and Table 5.1: Natural Rubber Stocks and Spot Price Equations Exnlanatory 2 Variables Constant CN QN SNC (SNP+SNA) A(SNP+SNA) A(CN/QN) (SN/CN) A\SNG (PN'/WPI)I DV(1) DV(2) DV(3) R F DW Dependent\ Variables (SNP+SNA) 93.8514 0.8749 -728.9927 0.8435 45.8213 2.0570 (1.5) (9.4) (-2.7) (F2,17) (PN5/WPI) 5.8449 -15.9685 -0.0022 0.3340 1.2696 0.8211 -0.4866 0.7673 7.1430 2.4692 (3.6) (-3.3) (-0.6) (1.7) (1.6) (1.4) (-0.6) (F 6,13) SNC -0.4814 0.5822 0.5725 -0.2456 -0.2885 0.9637 66.3335 3.0414 (-1.8) (2.7) (2.1) (-1.1) (-0.R) (F4,10) Notes: (1) (PNs/WPI) denotes the London RSS1 spot price deflated by the UK Wholesale Price Index for manufactured goods. (2) The sample period used in estimating the equation for stocks in consuming regions is 1963-1977. The reason for using 1963 as the initial year is so as to avoid the quantum jump given to stocks in the consuming regions as a result of the stocks data realignment undertaken by the IRSG in 1973. The sample period for the other two equations in Table 5.1 is 1958-1977. (3) DV(1), DV(2) and DV(3) are the three dummy variables mentioned in the text. 5 Page 147 interacting natural rubber markets. The London spot price then results from equilibrium in the various demands for stocks. Under stock equilibrium, the estimated demand for the various consuming regions' stocks would equal their supply which is given by the balance identity. The spot price equation under stock equilibrium is obtained by substituting the total demand for stocks into the balance identity and selecting the spot price as dependent variable. Since the demand for stocks in producing regions and afloat as a function of spot price was also not substantiated empirically, the impact of location (due to the time required to transfer stocks elsewhere to the consuming regions), cannot be ruled out. This leads to the alternative hypothesis of price determination under stock The spot price function so obtained is given by PN = f5{CN, CN 1, QN, SNC SNC2, ASNG, A(CN/QN)} and the OLS estimation gives S PN = 4.1765 - 0.0074(CN) + 0.0019(CN ) + 0.0077(QN) (3.0) (-1.6) (1.0) (1.9) - 0.0053(SNC ) - 0.0051(SNC_) - 0.0022ASNG (-2.4) (-2.1) (-0.6) + 4.6728 . A(CN/QN) (0.6) 2 R =0.8028; f 7.5595; DW = 1.5343; 7,13 Page 148 disequilibrium. The hypothesis of price determination under disequilibrium in the demand for stocks hinges on the features of organisation and trade of the rubber market and industry and what they facilitate. The existence of several rubber exchanges in the consuming regions and the proximity of the synthetic rubber suppliers to consumers (all the major rubber consuming countries produce synthetic rubbers) allow any natural rubber requirement not covered by the long-term contracts to be made up from either natural rubber stocks already held in the consuming regions or by synthetic rubbers. Which of the two categories of rubbers is finally selected to fill the demand shortfall thus depends on their current relative prices; this is substantiated empirically in the estimated demand equations. The long-term trading arrangement for natural rubber and the activities of the various natural rubber exchanges is therefore reinforcing in that each facilitates the activities of the other. This argument is similar to that of Adams (1958) who attributed price instability to changes in stockholdings in consuming regions, and argued that stockholding patterns of the consuming countries are related to whether these countries are trading centres for natural rubber as well, since stockholdings partially reflects fluctuations in trade. Hence price fluctuations are due to such stocks being too heavy (thus depressing prices) or below normal (thus causing a bullish impetus to the market). However Adams was writing in 1958 when the phenomenal growth of the synthetic industry was just beginning and when private stockholdings in consuming regions was a lower share of total stocks than was subsequently observed for the 1960s and 1970s because the national stockpiles precipitated by the Korean War had not then been released. Adams therefore argued that the smaller share of stocks held in consuming countries was a reason for price fluctuations because "unexpected increases in demand or decreases in the supply of (natural) rubber are more likely to cause a scramble for near-by (natural) rubber and in consequence exaggerate price movements, than would be the case if larger stocks were available to 'cushion' the effect." The observed higher share of stocks in consuming regions from the mid-1960s is partly a reflection of the higher levels of natural rubber consumption. Page 149 Following the approach of Hwa (1979), the function for determining spot price under stock disequilibrium will now be derived. Basically the observed spot price in the terminal market results from partial adjustment of the spot price towards that price level which would yield stock equilibrium. Let * SNC be the desired (equilibrium) demand for consumer stocks of natural rubber; SNC be the actual demand for consumers' stocks stocks of natural rubber; CN be the total natural rubber consumption; S PN be the London spot price and PN be the expected London spot price in the next period. Under the precautionary motive for consumers' stockholding of natural rubber, consumers' desired demand for stocks will be some function of their total consumption. Hence * (5.6) SNC f (CN) 6 -G + a1(CN) (ct > 0) Under the speculative and hedging motives, demand for consumer stocks is determined by the difference between the expected and the current spot prices. Hence Page 150 *S* S (5.7) SNC = f (PN - PN ) 7 a2 (PNS* -PNs) (O2 > ) The total desired demand for stocks is then given by *S* S (5.8) SNC = f (CN) + f (PN - PN ) 6 7 =c0 + a(CN) + a(PN - PN) 0 1 2 On the other hand the supply of consumer stocks, given by the balance identity, is (5-9) SNC = SNC-1 + STP-1 + SNA1 + QN-CN - SNP - SNA + ASNG where ASNG refers to net releases from the various government stockpiles of natural rubber. * If the desired demand SNC is satisfied, then there is an equilibrium spot price PN such that (5.10) SNC = SNC -S S Equating (5.8) and (5.9) and setting PN = PN gives (5.11) PN = a 0 + a (CN) - SNC} + PN* 2N o 0 1 Page 151 -_S However, the equilibrium spot price PN is not attained in each period because the desired demand SNC cannot be attained. * Since SNC 4 SNC, therefore (5.12) SNC - SNC = c0 + aL(CN) + a2(PN - PNS SNC * Substituting PN from (5.11) in (5.12) gives * S (5.13) SNC - SNC = a (PN PN ) 2 Alternatively, -S s 1 * (5.14) PN PN (SNC SNC) a2 That is, the deviation of the observed spot price PN from the -S equilibrium spot price PN is proportional to the deviation of the observed consumer stockholdings (SNC) from their desired level * (SNC ). The adjustment of spot price and. consumer stockholdings are inter-reacting. Assuming a partial adjustment process for the spot price to its equilibrium level yields S S -S S - (5.15) PN -PN =p(PN - PN 1) giving -S S 15 5 (5.16) PN PN = (1 - l)(PNS -PN S t t -i Substituting (5.16) into (5.15) leads to Page 152 (5.17) PNS - PNS = [ *SNC- SNC] Substituting SNC in (5.17) gives (5.18) PN PN1 ( ){ac+c (CN)+O2 (PN -PN)-SNC} PN = k + k (CN) + k2(PN )- k (SNC) 0 1 2 3 + k (PN 1 4 -1 where k0 °p/ 2 1 1 2 2 p k3 = /a2 and k = (1-p) Using the extrapolative model to translate the expected spot price PN into observable variable(s) gives: 3* 5 S. S (5.19) PN = PN1 + Y(PN1 - PN2) 0 < y < Substituting into the spot price equation above gives: S S (5.20) PN = k + k (CN) + (k2 + k2y + k4) PN1 0 1 2 ) k kY(PN)- k (SNC) 2 2 3 Page 153 Hence the spot price is determined by the levels of natural rubber consumption and stockholdings in the consuming regions and spot price in prevtious periods. Some further modifications are needed. To obtain the real price of natural rubber the London spot price was deflated by the UK Wholesale Price Index (WPI ) for all commodities. With releases from government stockpiles of natural rubber occurring throughout 1959-1977, a variable for the net change (measured by the releases) in the government stockpiles was incorporated to reflect their dampening effects on the price level. To account for the episodic increases in spot price due to extraneous factors, three dummy variables were used: DV(1) for 1969 to proxy the racial riots in Malaysia during May of that year, DV(2) for the first oil crisis of 1973/1974 and DV(3) for the 1975 recession and the peak of the Malaysian "Crash Programme" activities (for details, see Appendix 6.A). The modified equation is: (5.21) (PN2/WPI UK) = f{CN, SNC, ASNG, (PN s/WPI UK (PN /WPIK)2 DV(l), DV(2), DV(3)} In equation (5.21) spot price is expected to be an increasing function of natural rubber consumption and the one-period lagged spot price and a decreasing function of stocks in consuming regions, the stockpile releases and the two-period lagged spot price. Estimation of (5.21) Page 154 yields the following results: S UK (PN /WPS ) = 4.3275 + 0.0007(CN) - 0.0056(SNC) - 0.0007(ASNG) (1.0) (0.5) (-1.9) (-0.1) + 0.3346(PN s/WPI ) - 0.0411(PN s/WPIUK -l -2 (1.4) (-0.1) + 1.1627 . DV(1) + 1.0974 . DV(2) - 0.3114.DV(3) (1.2) (1.4) (-0.3) 2 R = 0.7630; F = 4.4257; DW = 2.3340; 8,11 Although the estimates for lagged pr ice and stocks were not highly significant, they have the expected signs. However the estimate for natural rubber consumption was negligible and insignificant. These estimates led to a reconsideration of the natural/synthetic rubber nexus and the influence of their substitutability on natural rubber spot price formation. In the absence of synthetic rubbers, the impact of increased natural rubber consumption on spot price should be positive. However, the presence of synthetic rubbers appears to dilute the positive impact which unanticipated increases in rubber consumption would otherwise have had on the spot price formation through the advantages obtainable from consuming more synthetic rubbers. In other words, the observed spot price is the resultant effect of the level of stockholdings and the trading activities of consumers in both the natural and synthetic rubber markets. In the historical period when Page 155 continuous expansion of synthetic rubber production under decreasing costs took place, the formation of spot price became dominated by the level of natural rubber stockholdings in the consuming regions and additional natural rubber (vis-a-vis synthetic rubber) was consumed only when warranted by relative prices. To account for that part of increased stockholdings required by higher consumption (that is, the precautionary requirements), stockholdings was deflated by consumption, giving (5.22) (PNS/WPI ) = fg (SNC/CN) ASNG, (PN S/WPI UK) 9-1 S~ UK (PN /WPI )U DV(1), DV(2), DV(3)} The estimation results of (5.22) are presented in Table 5.1; the equation with one price lag was selected since estimation with two price lags gave poorer (less significant) estimates. Equation (5.22) will be used for model validation and simulation purposes. Although the estimate for DV(3) was insignificant, it was retained for aiding the simulation of the sharp decline in natural rubber price in 1975. 10 As mentioned before, the natural rubber stocks in the consuming regions was then used as a balance identity (see equation 5.10). Owing to the large measurement errors in the stocks data, an estimated The alternative of using a moving average price over three or more periods was not adopted because price expectations based on such 10 long price lags are considered unlikely. It should be mentioned that the volatility of natural rubber price is also exacerbated by the erratic natural rubber purchasing programmes of the centrally-planned economies. However since price behaviour in this study is not examined from the angle of rubber trade, this issue cannot be analysed directly. Page 156 equation was used to proxy the balance identity for closing the natural rubber submodel. Table 5.1 also presents the estimates for this balance equation. 5.5 Primary-Terminal Markets Interaction and Price Linkage Besides the natural rubber exchange in London, other rubber exchanges are to be found in the primary markets of Kuala Lumpur and Singapore and in the terminal markets of Hamburg, New York, Tokyo and Kobe. Because of the longitudinal and consequent time differentials between these centres, the activities of these markets are continuously linked in that the daily closing of the primary markets coincides with the daily opening of the terminal markets (excluding Tokyo and Kobe which ar' relatively unimportant to the rubber markets beyond Japan). Thus prices in these different markets are interrelated. Since it is the cei .f./f.o.b. prices quoted in the London, New York and Singapore markets that are used in estimating the supply and consumption equations for the various countries, equations to explain these other prices are required. These price linkage eauations are estirmiated by simple regressions, after converting the London spot price into -the same currency as the local prices to be explained. Coulsequently there are six price linkage equations in the natural rubber submodeL; these are presented in Table 5.2. To cater for the average natural rubber prices which were used in some instances, Table 5.2: Natural Rubber Price Linkage Equations Explanatory riables s 1,UK 1,NY l,Sing 2 Constant PN PN PN PN R F DW Dependent Variables (1) PN ' -8.8825 0.9838 0.9637 371.5403 2.2456 (-0.6) (19.3) 3 UK (2) PN3' 8.0995 0.9488 0.9903 1433.2024 1.3860 (1.2) (37.9) (3) PNl1Sing 109.6575 0.8372 0.8608 86.5816 2.2393 (0.7) (9.3) (4) PN3,Sing -39.9678 0.9878 0.9831 811.9535 2.2250 (-0.7) (28.5) (5) PN ' 54.1210 0.9369 0.9217 164.8808 2.4684 (1.1) (12.8) (6) PN 3' 12.7488 0.9511 0.9960 5235.2000 1.3999 (1.4) (72.4) VOTEY:: (1) Figures in parentheses denote t-values of the corresponding regression coefficients. (2) PN denotes the London spot price. (3) PN ' and PN ' are the c.i.f. prices in London for RSS1- and RSS3-grade natural rubber respectively. (4) ON 'Sg and PN 'Sg are the f.o.b. prices in Singapore for RSS1- and RSS3-grade natural rubber respectively. 1,NY 3,NY (D (5) PN and PN are the c.i.f. prices in New York for RSS1- and RSS3-grade natural rubber. respectively. - Ul -a Page 158 identities for generating these average price variables are also included. 5.6 Synthetic Rubber Supply and Price Determination In Chapter Three (section 3.7) the salient features of synthetic rubber supply and pricing were discussed. To recapitulate, the industry is dependent on the oil industry for its raw material inputs and on the tyre industry for the bulk of its demand. The upshot of these interrelations is tne observed vertically-integrated oligopolistic structure of the industry which facilitates intra-firm pricing and price discounting. Such closed trading also harbours the synthetic rubber industry to some extent from general market instabilities. In his study of the rnbber market up to the mid-1960s, Behrman's (1971) explanation of the declining synthetic rubber price was in terms of the four technical change indices mentioned in Chapter Two. In modelling the synthetic rubber market in this study, the focus is shifted away from the technical change issue for two reasons. Firstly, technical change in synthetic rubber production in the more recent period has been more significant for the specialty than for the general-purpose synthetic rubbers. Furthermore the future impact of technological progress and economies of scale in production are expected to be far less significant than have been in the past two decades (Grilli et al., 1978). Given the reaction of synthetic rubber Page 159 production and price to the oil crises since late 1973, and given the prospects of continually rising oil price, it was elected to focus on the impact of oil price and production capacity on synthetic rubber supply and price. This is pertinent because the future interaction between natural and synthetic rubbers now becomes hinged, to a large extent, to scenarios concerning oil pricing. In attempting to quantify this impact, albeit crudely, the estimation of synthetic rubber supply and price was based on the assumption of monopolistic behaviour for the total world synthetic rubber supply. Under this assumption, synthetic rubber supply and price are thus jointly determined. Assuming cost-plus pricing for synthetic rubber, the average price of synthetic rubbers (PS) is given by (5.23) PS = AC + m(PN) where AC is the average cost of synthetic rubbers production and m is the lvel of mark-up per unit synthetic rubbers sold. As the general-purpose synthetic rubbers compete with natural rubber, the mark-up is hypothesised as being determined by the level of natural rubber price (PN) so that m is some function of PN. Since average cost consists of average fixed cost (which in an industry with scale economies is determined by the production capacity) and average variable cost (which is dependent on the price of raw material inputs, chiefly oil), average synthetic rubber price is then given by: (5.24) PS = f10(CQSR, P , PN) where CQSR is the total world synthetic rubber production capacity/ Page 160 and p oil is the price of oil. Similarly synthetic rubber production (supply) is some form of (5.25) QSR = f11 ( CQSR, Po , PN) where QSR is total world synthetic rubber production. To reflect the interaction between economies of scale and prices the log-linear form was adopted in estimating the supply and price equations. In estimating these two equations, the average list prices for styrene-butadiene (grades 1500 and 1712) and polybutadiene quoted in France, Italy and UK were used after converting to US dollars. For oil the f.o.b. price of light crude oil, (ex-Saudi Arabian port of Ras Tanura), was used while the c.i.f. London RSS1-price was chosen as the natural rubber price. To obtain the real price of synthetic rubbers, the average list price was deflated by the US Wholesale Price Index (WPI ) for manufactured goods. There is an argument for using unit export/import values (typically for US exports/UK imports respectively) instead of their list prices. This is that synthetic rubbers are traded under unpublicised variable discounts. Since consumers do not pay list In the study by Man and Blandford (1980) the synthetic rubber sector was partially endogenised through a price equation for styrene-butadeine: SBR oilSB P = a0 + cX1 (P ) 2 S*P where PSBR is the wholesale price of styrene-butadiene(SBR) quoted in the New York market and P is the posted f.o.b. price of Saudi Arabian light crude oil. However no mention is made of the grades of SBR for which the price refers. Man and Blandford do not concern themselves with the synthetic rubber sector since they are only concerned with the supply and demand of natural rubber. Page 161 prices, list prices are not representative of the actual cost of synthetic rubber consumption. However the relative superiority of using unit export/import values becomes less clear wqhen it is remembered that not only are synthetic rubbers largely produced in the major tyre-producing countries but their production capacities are also largely owned by the vertically-integrated transnational tyre-producing corporations. The domestic production of synthetic rubbers implies that major tyre manufacturers consume synthetic rubbers that are mainly domestically produced. On the basis of list price quotations in France, Italy and UK it would appear that cross-country differences in production costs exist. On the other hand the transnational characteristic of the synthetic rubber industry provides scope for intra-firm transactions so that the unit export/import values need not reflect market-determined values either. Furthermore, the occasional "dumping" of synthetic rubbers in the international market would also affect unit export/import values. It is therefore argued that for the purpose of stabilising the natural rubber market, an understanding of list price formation is relatively more useful since such prices, which are published in advance, are held constant over a given period of time after they have been announced. Based on the average European list price quotations, the estimates for the synthetic rubber supply and price equations for inclusion in the model are given in Table 5.3; the natural rubber price variable is omitted since its inclusion does not contribute significantly to the explanation of synthetic rubber production and Table 5.3: Synthetic Rubber Production and Price Equations Constant ln CQRS ln(p /WPI ) R2 F DW ln QRS 1.4172 1.1142 -0.0712 0.9831 378.4948 2.4742 (3.9) (18.8) (-2.2) (F 2,13) In (PSR/WPI ) 5.0869 -0.6104 0.2768 0.8532 37.7877 1.8838 (11.8) (-8.7) (7.2) (F 2,13 CD HQ N) Page 163 price formation. 12 The supply equation shows, as expected,that the observed synthetic rubber output is positively related to production capacity and negatively related to oil price, the net effect being dominated by the level of production capacity. In contrast the level of synthetic rubber price is a negative function of production capacity and a positive function of oil price. However, despite the fact that feedstocks and energy inputs constitute about 70 percent of synthetic rubber production costs (Grilli et al., 1978), the elasticity of 12 The synthetic rubber production and price equations when natural rubber price is included are: (a) ln QSR = 0.4559 + 1.2217 ln CQSR - 0.1185 ln (P /WPI ) (1.2) (23.1) (-4.4) + 0.1935 ln (PN /WPI ) (3.5) 2 R = 0.9917; F = 477.7798; DW = 2.7450 3,12 (b) ln (PS/WPI ) - 5.8474 - 0.6954 ln CQSR + 0.3143 ln (P /WPI ) (10.3) (-8.8) (7.8) - 0.1531 ln (PN S/WPIUK) ( -1 .9 ) 2 R = 0.8861; F = 31.1257; DW = 1.4633; 3,12 The estimates show that the explanatory contribution of the natural rubber price variable is marginal, while the Durbin-Watson statistic is worsened. Furthermore the natural rubber price estimate has the wrong the sign; a priori, increases in natural rubber price in (b) should provide scope for increasing synthetic rubber price. It is plausible that this relationship is not established empirically because it is the price discounts given to consumers,rather than the known list prices that are affected by the behaviour of natural rubber price. Page 1.64 synthetic rubber price with respect to oil price approximates only 0.2768 in the historical period. The influence of capacity effect is reflected by the elasticity of -0.6104 of synthetic rubber price with respect to production capacity. Thus synthetic rubber supply and price are significantly dependent on the creation of new production capacities and the behaviour of oil price. To close the synthetic rubber submodel a synthetic rubber stocks(SSR) balance identity was used; that is: (5.26) SSR = SSR 1 + QSR - CSR where QSR is the total world synthetic rubber supply and CSR is the total world synthetic rubber consumption. In view of the minor discrepancy in the synthetic rubber stocks data, the balance equation (5.26) with unitary coefficients was adopted in the model. As for the natural rubber sector, price linkage equations are also required for the synthetic rubber sector. This is because the various European list prices were used individually and in various combinations in the demand equations. Thus while the average synthetic rubber list price is explained by a price equation, the individual list prices will be explained separately. This is done by simple regression of the individual prices on the world average price, thereby linking the individual prices to the world price which is determined by total production capacity and oil Price. Table 5.4 gives the simple correlation coefficients for the nine price linkage equations for styrene-butadiene (grades 1712 and 1500) and Page 165 Table 5.4: Synthetic Rubber Price Linkage Equations Constant PSR R2 DW France PSBR1712 -47.5182 0.9218 0.9807 456.7479 1.4011 (-1.9) (21.4) PSBR1500 -20.7280 1.0646 0.9789 416.9732 1.6603 (-0.7) (20.4) PBR 43.5738 0.9583 0.9740 336.9862 1.8924 (1.4) (18.4) Italy PSBR1712 -47.1914 0.9321 0.9707 298.5333 2.5318 (-1.5) (17.3) PSBR1500 8.1344 1.0098 0.9454 155.9352 1.1087 (0.2) (12.5) PBR 227.8280 0.7119 0.8367 46.1234 1.2985 (3.7) (6.8) UK PSBR1712 -116.3742 1.1389 0.9897 865.9875 1.2879 (-5.1) (29.4) PSBR1500 -82.0917 1.2366 0.9835 535.8682 1.2895 (2.6) (23.1) PBR 34.3674 1.0279 0.9428 148.2463 0.9523 (0.7) (12.2) Page 166 polybutadiene prices in France, Italy and UK. In general the regressions gave good fits but with severe serial correlation in most cases. Page 167 CHAPTER SIX MODEL STRUCTURE AND VJALIDATION 6.1 Introduction In this chapter the various components of the model developed in Chapters Two to Five are synthesised for empirical validation of the model for the historical period. Time paths of some key variables to demonstrate the ex post performance of the model will be presented after a discussion of (1) the data and econometric methods used in model estimation and (2) the causal structure of the model. In view of the oil crises which substantially affected rubber demand behaviour during the latter one-third of the sample period (the 1970s), the penultimate section of this chapter examines the overall impact of the oil crises on the rubber market. This, together with the discussion on the overview of instability in the natural rubber market during the historical period, sets the stage for the subsequent chapter on evaluating crude oil availability, the prospect of its substitution by synthetic crude oil and the likely time paths of oil price so as to identify those factors relevant to the question of longer term stabilisation of the natural rubber market. Page 168 6.2 Data and Econometric Methods Used in Mlodel Estimation This sections discusses the data and econometric methods used in estimating the model. Most of the time-series data used were extracted from the Rubber Statistical Bulletin published by the IRSG. In addition, national statistical publications were referred to for data on industrial activity indices, wholesale price indices and the production of rubber goods. For synthetic rubber prices, the annual data on list prices were based on monthly list prices quoted in the European Chemical News. Of the data series used, those on natural rubber stocks and synthetic rubber price were most unsatisfactory. The problems with these two data series will now be discussed. The problem of obtaining reliable data on stockholdings is well-known. For natural rubber stockholdings, the problem is compounded by the fact that stocks are distinguished by location. Thus separate series on stocks in producing countries, in consuming countries and afloat are available. A consequence of this differentiation by location is that the margins of error are widened. These errors lead to cumulative errors which can be severe as illustrated by the 1973 revision of stock data mentioned in Chapter Five. It will be recalled that the extensive data revision in 1973 pertained to stockholdings in 1961 and 1962, and was for the purpose of providing a more realistic estimate of the world stocks. Although this revision was made after deliberations by the Committee of Experts on Rubber Statistics of the IRSG, no reason was given for confining the revision only to data on stockholdings in the consuming countries. Page 169 Since stocks in consuming regions play a critical role in the natural rubber spot price formation equation, the errors in the stock data therefore affects the regression estimates. This is because estimation with data having measurement errors will result in bias and inconsistent estimates. The other data problem concerns that of synthetic rubber list prices. As explained in Chapter Two, synthetic rubbers are traded under price discounts. In estimating the demand equations, the relative price variables should ideally be formed from the traded prices of natural rubber and synthetic rubbers. However, as traded prices for synthetic rubbers are not available, their corresponding list prices had to be used. This data inaccuracy introduces another source of bias in the regression estimates. It is known that the use of ordinary least squares regression in estimating equations with lagged endogenous variables results in consistent but biased estimates. However, in view of the data deficiencies discussed above, it was considered that the use of two-stage least squares regression would yield only marginal returns over that from ordinary least squares regression. Two other reasons reinforce the choice of using ordinary least squares. First, since the time-series data is for the 1956-1978 period only, the sample size is small. If the property of consistency in the estimates is to be t-,Aded off for variance reductions, then ordinary least squares has the advantage. Second, since the model consists of 87 equations, it may be considered as a large model. In general, ordinary least squares and two-stage leaLA'- squares are known to give similar results Page 170 when the model is large, since the use of two-stage least squares requires a large number of instrumental variables. In such a situation, the values of the endogenous variables from the first-stage estimation will be very similar to the observed values. A characteristic of the estiipations is the use of Almon's lag scheme to represent the lagged price effects in the natural rubber supply equations and the natural and synthetic rubbers demand equations. The rationale for the presence of these lagged price effects have been discussed in Chapters Two and Three. The number of lagged periods used initially in estimating the equations of the model were based on a priori considerations. In estimating the natural rubber supply equation, the number of lags used initially was based on the fact that the yield of rubber trees levels off about ten years after the first tapping. Since tapping of rubber trees may begin in their fourth or fifth year, the yield of the trees would level off in about its fourteenth or fifteenth year. This feature is reflected in the supply response equation (3.22) which was obtained by first-differencing equation (3.21) in Chapter Three, whereupon the number of price lags is reduced to the number of years before the tree yield levels off. Thus 14 lags were first applied to the Almon scheme in the estimation of all supply equations. If the R2 and the minimum standard-error statistics were unsatisfactory, then the equations were re-estimated with shorter lags. Throughout the estimations, no end-point constraint was used for the Almon scheme. Page 171 On the demand side, it is known that because of "habit persistence", the effects of relative price changes could be lagged up to four years. Thus lags up to four periods were first tried in the application of the Almon scheme to demand equations. Similarly, if R and the minimum standard-error statistics were unsatisfactory, then the number of lags was progressively reduced until more acceptable test statistics were obtained. As for the estimation of the supply equations, no end-point constraint was used for the Almon scheme. 6.3 Causal Structure of the Model The estimated model consists of an 87-equation system having 42 exogenous variables. It consists of various production and consunption blocks. The 87-equation model can also be viewed as consisting of two submodels, one for each group of rubber and interacting tlhrough their relative price effects on consumption. An overview of the model is provided by Figure 6.1 which summarises the various rubber production and consumption blocks in the model and their interaction. The 87 endogenous variables are listed below. Figure 6.1: Flowchart of the Interacting Flows in the Estimated Model Natural Rubber Production Synthetic Rubber Production Malaysia Indonesia Thailand Sri India Africa Brazil Rest-of- World Synthetic Lanka Ida A ic Brzl the-WorldRubrOtt . . I .Rubber Output p 3pNSng T Y World Natur .Synthetic Rubber Consumption Rubber Outpu France T NT West Germany T NT Italy T NT Stocks in Produc- Synthetic- ing Countries PN Rubber Japan T NT United Kingdom T NT United States T NT Australia Brazil Canada | Gvrnmen t N a t u Rubber Stocks| - Stockpile C uming Regions COMECON India World Natural Rubber World Synthetic Rubber Netherlands Consumption e Consumption Rest-of-the -World f |France |Gr |Italy |Japan U K U SA a|I I | 13|Rest- 1 T 1NT |T |NT |T |N |TN T T|T NT T|T |NT | J 9 -a | i 0 | O 4 |g| World Natural Rubber Consumption hj KEY: (D T: Transport Sector - NT: Non-Transport Sector |Explanatory| -i; |endet Variable > IVariable j Page 173 Endogenous Variables in the Model Y(1) -- Estate Natural Rubber Production, Malaysia Y(2) -- Smallholder Natural Rubber Production, Malaysia Y(3) -- Estate Natural Rubber Production, Indonesia Y(4) -- Smallholder Natural Rubbber Production, Indonesia Y(5) -- Natural Rubber Production, Thailand Y(6) -- Natural Rubber Production, Sri Lanka Y(7) -- Natural Rubber Production, India Y(8) -- Natural Rubber Production, Africa Y(9) -- Natural Rubber Production, Brazil Y(10) -- Natural Rubber Production, Rest-of-the-World 10 Y(11) -- Natural Rubber Production, World Total [Y(11) = Z Y(i)] Y(12) -- Natural Rubber Consumption, Australia Y(13) -- Natural Rubber Consumption, Brazil Y(14) -- Natural Rubber Consumption, Canada Y(15) -- Natural Rubber Consumption, China Y(16) -- Natural Ruabber Consumption, COMECON Y(17) -- Natural Rubber Consumption, India Y(18Y -- Natural Rubber Consumption, The Netherlands Y(19) -- Natural Rubber in Transport Sector, France. Y(20) -- Natural Rubber Consumption in Non-Transport Sector, France Y(21) - Natural Rubber Consumption in Transport Sector, West Germany Y(22) -- Natural Rubber Consumption in Non-transport Sector, West Germany Y(23) -- Natural Rubber Consumption in Transport Sector, Italy Y(24) -- Natural Rubber Consumption in Non-Transport Sector, Italy Y(25) -- Natural Rubber Consumption in Transport Sector, Japan Page 174 Y(26) -- Natural Rubber Consumption in Non-Transport Sector, Japan Y(27) -- Natural Rubber Consumption in Transport Sector, UK Y(28) -- Natural Rubber Consumption in Non-Transport Sector, UK Y(29) -- Natural Rubber Consumption in Transport Sector, USA Y(30) -- Natural Rubber Consumption in Non-Transport Sector, USA Y(31) -- Natural Rubber Consumption, Rest-of-the-World 31 Y(32) -- Natural Rubber Consumption, World Total [Y(32) = Z Y(i)] i=12 Y(33) -- Natural Rubber Stocks in Producing Regions and Afloat Y(34) -- Natural Rubber Stocks in Consuming Regions Y(35) -- Synthetic Rubber Consumption, Australia Y(36) -- Synthetic Rubber Consumption, Brazil Y(37) -- Synthetic Rubber Consumption, Canada Y(38) - Synthetic Rubber Consumption, COMECON Y(39) -- Synthetic Rubber Consumption, India Y(40) -- Synthetic Rubber Consumption, The Netherlands Y(41) -- Synthetic Rubber Consumption in Transport Sector, France Y(42) -- Synthetic Rubber Consumption in Non-Transport Sector, France Y(43) -- Synthetic Rubber Consumption in Transport S\ tor, West Germany Y(44) -- Synthetic Rubber Consumption in Non-Transport Sector, West Germany Y(45) -- Synthetic Rubber Consumption in Transport Sector, Italy Y(46) -- Synthetic Rubber Consumption in Non-Transport Sector, Italy Y(47) -- Synthetic Rubber Consumption in Transport Sector, Japan Y(48) -- Synthetic Rubber Consumption in Non-Transport Sector, Japan Y(49) -- Synthetic Rubber Consumption in Transport Sector, UK Y(50) -- Synthetic Rubber Consumption in Non-Transport Sector, UK Y(51) -- Synrthetic Rubber Consumption in Transport Sector, USA Y(52) -- Synthetic Rubber Consumption in Non-Transport Sector, USA Page 175 Y(53) -- Synthetic Rubber Consumption, Rest-of-the-World 53 Y(54) -- Synthetic Rubber Consumption, World Total [Y(54)= E Y(i)] i=35 Y(55) - Synthetic Rubber Production, World Total Y(56) -- Average Real Price of Synthetic Rubbers [Y(78)/WPI 3 Y(57) -- Price of Styrene-Butadiene 1712, France Y(58) -- Price of Styrene-Butadiene 1500, France Y(59) -- Price of Polybutadiene, France Y(60) -- Price of Styrene-Butadiene 1712, (SBR1712), Italy Y(61) -- Price of Styrene-Butadiene 1500, (SBR1500), Italy Y(62) -- Price of Polybutadiene, (BR), Italy Y(63) -- Price of Styrene-Butadiene 1712, UK Y(64) -- Price of Styrene-Butadiene 1500, UK Y(65) -- Price of Polybutadiene, UK Y(66) -- Price of RSS1-grade Natural Rubber, c.i.f. London Y(67) -- Price of RSS3-grade Natural Rubber, c.i.f. *Iondon Y(68) -- Price of RSSI-grad.e Natural Rubber, c.i.f. New York Y(69) -- Price of RSS3-grade Natural Rubber, c.i.f. New York Y(70) - Price of RSS1-grade Natural Rubber, f.o.b. Singapore i(71) -- Price of RSS3-grade Natural Rubber, f.o.b. Singapore Y(72) -- Spot Price of RSS1-grade Naturel Rubber, London Y(73) -- Average Price of RSS1- and R.SS3-grade Natural Rubber, c.i.f. London Y(74) -- Average Price of RSS1- and RSS3-grade Natural Rubber, f.o.b. Singapore Y(75) -- Average Price of SBR1712 in France, Italy and UK Y(76) -- Average Price of SBR1500 in France, Italy and UK Y(77) -- Average Price of BR in France, Italy and UK Y(78) -- Average Price of SBR1712, SBR1500 and BR in France, Italy and UK Page 176 Y(79) -- Average Price of SBR1712 and SBR1500 in France, Italy and UK Y(80) -- Average Price of SBR1712 and BR in France Y(81) -- Average Price of SBR1712 and BR in UK Y(82) -- Average Price of SBR1712 and BR in France, Italy and UK Y(83) -- Synthetic Rubber Stocks, World Total Y(84) -- Export Tax Rate for Malaysian Smallholder Natural Rubber Y(85) -- Export Tax Rate for Malaysian Estate Natural Rubber Y(86) -- F.o.b. Singapore Price of RSS1-grade Natural Rubber less Export Tax Y(87) -- F.o.b. Singapore Price of RSS3-grade Natural Rubber less Export Tax The system of 87 equations can be divided into two distinct blocks of equations. Block I contains 15 equations explaining the endogenous variables Y(15), Y(16), Y(20), Y(24), Y(30), Y(31), Y(37), Y(38), Y(42), Y(46), Y(48), Y(52), Y(53), Y(55) and Y(56). These equations are dynamically non-integrated so that the relationship is one way with no feedback effects. Block II contains the remaining 72 equations (16 of which are identities) for the balance endogenous variables; these equations are dynamically integrated in that each contains two or more endogenous variables. Thus the two blocks of equations form a block-recursive system with the simultaneous determination of the endogenous variables in Block II being dependent on all the structural equations of Block I. To analyse the causal structure of the system, the causal ordering procedure of McElroy (1978) was adopted. The method consists of examining the relationship between variables in each equation and Page 177 tracing their causality by means of a flow-chart. Tracing the causal ordering of the system provides a schematic view of the causal structure of complete subsets of co-determined (directly by being in the same class or indirectly by transitivity through a chain relationship) variables. Table 6.1 presents the causal structure of the 6 complete subsets of 87 variables; the ordering of subsets denotes causality, the higher-order subsets being "causally-dependent" on those of lower order. For an idea of the causal structure of the model the causality between natural rubber price and synthetic rubber price as revealed by the causal ordering will now be discussed. In the zero-order subset it will be noted that synthetic rubbers production Y(55) and its real price Y(56) are co-determined; the monetary price of synthetic rubbers is then determined in the first-order subset. Natural rubber price Y(72) and production Y(11) (both in class [a]) and consumption Y(32) (in class [b]) as well as some consumption of synthetic rubbers are determined in the second-order subset and hc-nce are causally-dependent on synthetic rubber production and price. The balance synthetic rubber consumption are then determined in the third-order subset which then determines total synthetic rubber consumption. Synthetic rubber stocks are subsequently determined (as a residual) in the fifth-order subset. Thus the determination of natural rubber price in the historical period has been causally-dependent on the average price of synthetic rubbers and co-determined with natural rubber production and natural and synthetic rubber consumption. Page 178 Table 6.1: Causal Structure of the 87-Equation Model (Column Headings Indicate the Order of Complete Subsets) Zero First Second Third Fourth Fifth Order Order Order Order Order Order Y(15) Y(78) [a], [b], [c], Y(35), Y(54) Y(83) Y(16) Y(2), Y(3), Y(4), Y(36), Y(20) Y(5), Y(6), Y(7), Y(39), Y(24) Y(8), Y(9), y(19), Y(40), Y(30) Y(22), Y(23), Y(25), Y(41), Y(31) Y(26), Y(27), Y(28), Y(43), Y(37) Y(33), Y(57), Y 58), Y(44), Y(38) Y(59), Y(60), Y(61), Y(45), Y(42) Y(62), Y(63), Y(64), Y(47), Y(46) Y(65), Y(76), Y(77), Y(49), Y(48) Y(73), Y(75), Y(79), Y(50), Y(52) Y(80), Y(81), Y(82), Y(51), Y(53) Y(84), Y(85), Y(87), Y(55) Y(56) Notes: (1) [a], [b] and [c] are variable classes wherein each Variable appear in the same equation as one or more of the other variables in the same class. Variables in the same class are therefore directly co-determined. (2) Class [a] contains Y(l), Y(ll)', Y(34), Y(70), Y(72) and Y(86.); Class [b] contains Y(10), Y(ll), Y(12), Y(17), Y(32), Y(34), Y(70), Y(71), Y(72), and Y(74); Class [c] contains Y(13), Y(14), Y(18), Y(21), Y(29), Y(32), Y(66), Y(67), Y(68), Y(69), and Y(72). Page 179 6.4 Empirical Validation of the Model The model was validated by one-period and dynamic (multi-period) ex post simulations of the sample period 1970-1977 using a simulation programme written by Carland (1977), and using the Gauss-Seidel method for solving the simultaneous equation system. The time paths generated by one-period and dynamic simulations for any variable can then be compared with the observed time paths to see how well the simulated values track the observed time paths. Figures 6.2(i)-(viii) presents actual and simulated time paths for world natural rubber production and consumption, world synthetic rubber production and consumption, natural rubber stocks in consuming regions, world synthetic rubber stocks, natural rubber spot price in London and the average European price for the general-purpose synthetic rubbers. Based on the behaviour of the simulated time paths, the model may be considered as tracking the market behaviour during 1970-1977 quite well. Overall, the model is seen to perform well, given that the dynamic test is very demanding for large-scale models such as the one presented here. The model was validated for 1970-1977 only because several equations in the model were estimated from times series data ending in 1977. 2 The simulation programme was originally written as part of his doctoral research. Modifications made to the programme were for purpose of handling the larger number of equations and the tax functions discussed in Chapter Four above. Production (Th. Tonnes) 3800 Page 180 3700 1 3600 . 3500 7 e \ 3400 ~ 3300 3200 3100 Actual -~ - -One-Period Simulation 3000 . Dynamic Simulation 0 tYear 1970 1972 1974 1976 1978 1990 Figure 6.2(i): Time Paths of World Natural Rubber Supply, 1970-1978. Consumption 3900 (Th. Tonnes) - -) 3800- 3700 3600 / 3500 .1 3400. 3300 / 3200 3100 1' 3000 o .raYear 1970 1972 1.974 1976 1978 1980 Figure 6.2(ii): Time Paths of World Natural Rubber Consumption, 1970-1978. Page18 Natural Rubber Spot Price (Sterling Pounds per tonne) 600 400 200 * - Actual One-Period Simulation 0 1970.Dynamic Simulation 0 -- - , - -fYear 1970 1972 1974 1976 1978 1980 Figure 6.2(iii): Time Paths of London Spot Price for RSSl-grade Natural Rubber, 1970-1978. Synthetic Rubber Price (US$/Tonne) 1.000 800 600 400 - Actual One-Period 200 s- y Simulations Dynamic o G ,-Year 1970 1972 1974 1976 1978 1980 Figure 6.2(iv): Time Paths of Average European Synthetic Rubber Price, 1970-1978. Synthetic Rubbeae L Production Page 182 9000' (Th. Tonnes) 8000 / 7000' 6000 Actual {rOne-Period 5000 Dynamic Simulations 0 Year 1970 1972 1974 1976 1978 1980 Figure 6.2&(v): Time Paths of World Synthetic Rubber Supply, 1970-1978. Synthetic Rubber Consumption (Th. Tonnes) 9000 8000" /i 7000 6000 / -Actual 5000 One-Period Simulation O Dynamic Simulation . Year 1970 1972 1974 1976 1978 1980 Figure 6.2(vi): Time Paths of World Synthetic Rubber Consumption, 1970-1978. ,Page 183 Natural Rubber Stocks (Th. Tonnres) 900 . " . 800 . 700, 600 500 - Actual - - - One-Period Simulation 400- .-Dynamic Simulation o.rl. > . fi1 Year 1970 1972 1974 1976 1978 1980 Figure 6.2(vii): Time Paths of Natural Rubber Stocks in Consuming Regions, 1970-1978. Synthetic Rubber Stocks (Th. Tonnes) 2400 2200 2000 . . pa. 1800 1600 V 1400 ,XYear 1970 1972 1974 1976 1978 1980 Figure 6.2(viii): Time Paths of Synthetic Rubber Stocks, 1970-1978. Paqe 184 3 The root mean square percentage error (RMISPE) for real natural rubber price were 11.5 percent and 14.5 percent in the one-period and dynamic simulations respectively. As seen from the time paths of natural rubber price in Figue 6.2(ii), the simulated value for natural rubber price in 1975 was poor despite the use of a dummy variable for that year. For real synthetic rubber price, the corresponding percentage errors were 6.8 percent for both types of simulation (the time paths and hence RMSPE are identical in both one-period and dynamic simulations because the average synthetic rubber price equations does not involve any lagged variables. However, the performance for the simulated time paths for natural rubber stocks in the consuming regions and for synthetic rubber stocks were less satisfactory. For natural rubber stocks in consuming regions, the PISPE for one-period and dynamic simulations were 8.7 percent and 11.9 percent respectively. For synthetic rubber stocks, the corresponding RMSPE were 14.8 percent and 23.5 percent respectively. The interaction between tvariables is seen from the simulated time paths shown in Figure 6.2. Since the interaction between natural rubber stocks in consuming regions and natural rubber price formation The root mean square percentage error (RMSPE) of any variable Y, defined as: RMSPE = I [ t )L x 100.0 where Yt is the actual value of the dependent variable, Yt is the forecast value of the dependent variable in period t and n is the number of period for wlhich forecasts are made, is a summary statistic indicating the model's overall performance. Page 185 is illustrated through their time paths, these two variables will be discussed. Figure 6.2(vii) shows that stocks are over-estimated in 1975 and under-estimated in 1976. From the natural rubber spot price equation, it is known that spot price is positively related to the level of stocks in the consuming regions. This over- and under-estimation of stocks in 1975 and 1976 respectively partially explains the over- and under-estimation of spot price in 1975 and 1976 respectively. Prior to using the validated model in forecasting exercises, it is necessary also to validate the model for the interim period 1978-1980, a period for which data became available only after the data collection for this study had been undertaken. Having extended the time series data to 1980, the model was re-validated for 1970-1980, using both one-period and dynamic simulations; these simulations for the 1978-1980 period are called ex post forecasting and provides another test of the model. The root mean square percentage errors for natural rubber price now range from 11.6 percent to 13.2 percent in the one-period and dynamic simulations respectively. An examination of the simulation results show the residuals to be bigger in the 1978-1980 period. This may be due to a change in price relationship during the late 1970s from that used in the model. This change in price relationship will be discussed in detail in the next section. For synthetic rubber price, the root mean square is now increased to 11.0 percent. Page 186 6.5 Aftermath of the 1973 Oil Crisis Before discussing the question of natural rubber market instability during 1956 to 1978, the aftermath of the 1973 oil crisis as observed in both the natural and synthetic rubber markets will first be reviewed. The period following the oil crisis provides an excellent illustration of the means by which the synthetic rubber industry reacts to random shocks, and the impact of these reactions on the natural rubber market. The review will therefore place in perspective the trend reversal of natural rubber price since 1973 from the declining trend observed since the mid-1950s; it will also highlight the importance of assumptions concerning the synthetic rubber industry in the subsequent evaluation of the future of natural rubber. The effects of the oil crisis from late 1973 and the world recession in 1975 can best be discussed in the context of the trends in natural and synthetic rubber consumption shares during 1956 to 1980 -- a period which, from a historical perspective, has been labelled the "petrochemical era" by Allen (1979). Table 6.2 shows that between 1956 and 1973, the consumption share of natural rubber fell from 62.3 percent to 31.0 percent while that for synthetic rubbers rose from 37.7 percent to 69.0 percent. Upon By this stage the loss in the natural rubber market share had provoked questioning by natural rubber producers of the natural rubber market share they may expect to have were natural rubber supply to grow at a higher rate than in the historical period and if the disadvantages faced by natural rubber, such as natural rubber price instability and captive market of synthetic rubbers can be removed. The study by Allen et al. (1974) to answer this question concluded that on techno-economic grounds, natural rubber's potential share can range between 40 to 50 percent. Page 187 Table 6.2: Natural Rubber and Synthetic Rubbers Consumption Shares, 1956-1980 (%) Year Natural Rubber Synthetic Rubbers Total Rubbers 1956 62.32 37.68 100.00 (3060,7) 1957 60.13 39.86 100.00 (3210.6) 1958 61.57 38.43 100.00 (3321.2) 1959 57.23 42.77 100.00 (3759.2) 1960 53.11 46.89 100.00 (3945.0) 1961 52.21 47.79 100.00 (4132.5) 1962 50.14 49.86 100.00 (4487.5) 1963 42.90 57.10 100.00 (5297.5) 1964 40.86 59.14 100.00 (5825.0) 1965 39.56 60.44 100.00 (6187.5) 1966 38.08 61.92 100.00 (6677.5) 1967 37.25 62.75 100.00 (6805.0) 1968 36.33 63.67 100.00 (7652.5) 1969 35.21 64.79 100.00 (8280.0) 1970 34.67 65.33 100.00 (8625.0) 1971 33.33 66.67 100.00 (9277.5) 1972 32.43 67.57 100.00 (9960.0) 1973 31.00 69.00 100.00 (10977.5) 1974 32.07 67.93 100.00 (10967.5) 1975 32.40 67.60 100.00 (10395.0) 1976 30.69 69.31 100.00 (11420.0) 1977 30.61 69.39 100.00 (12135.0) 1978 29.85 70.15 100.00 (12480.0) 1979 29.90 70.10 100.00 (12910.0) 1980 30.76 69.24 100.00 (12450.0) Notes: Figures within parentheses are the total volumes of natural and synthetic rubbers consumed (in thousand tonne units). Page 188 the rise in oil and feedstock prices in 1973 these trends were reversed in 1974, the reversal being reinforced by the subsequent recession in 1975. However by 1976 the historical trend of declining share for natural rubber was reinstated, persisting through to 1980 when the second oil crisis of 1979 precipitated another trend reversal. As these trend reversals can be identified with each major increase in oil price and its impact on synthetic rubber production, the behaviour of rubber consumption and prices during 1973-1980 will be used to trace the influence of the organisation of synthetic rubber production on natural rubber consumption; thb focus will be on the short-lived increase in the share of natural rubber consumption in 1974 and 1975. Table 6.3 shows that after the oil price increase in late 1973, the average synthetic rubber price promptly increased by some 60 percent in 1974. In contrast natural rubber spot price remained relatively unaffected even though oil price affects natural rubber 5 production costs indirectly. The subsequent slowdown in economic activity is reflected by the fall in both natural and synthetic rubbers production in 1974, albeit marginally. However, the differential effects of ma-rket organisation in the two markets is made conspicuous by the 1975 world recession. The flexibility of synthetic rubber production meant that stocks depletion could be accompanied by The case for natural rubber is also interesting in that the price increase observed for several primary commodities in 1972, the start of the 1972-1975 commodity boom, was not observed for natural rubber. With reference to Houthakker's (1976) hypothesis that the episodic coimmodity price rises in 1972/73 was a manifestation of inflationary pressures that had built up from the sixties and culminated in 1972, it would seem that the hypothesis does not apply to natural rubber -- possibly because of the competition posed by the lower-priced synthetic rubbers. Page 189 Table 6.3: Rubber Prices, Production and Stocks During 1973-1980 vear Price (US$/Tonnes) Production ('000 Tonnes) Stocks ('000 Tonnes) NR SRs NR SRs NR SRs 1973 779.00 413,70 3505.0 7757.0 L58.$.0 1707.5 (-1.7%) (-2.4%) 1974 775.40 674.00 3445.0 7575.0 1590.0 1832.5 (-3.8%) (-9.5",) 1975 671.30 769.20 3315.0 6855.0 1550.0 1660.0 (+8.2%) (+17.1%) 1976 875.80 703.40 3585.0 8030.0 1635.0 1775.0 (+1.1%) (+5.4%) 1977 904.95 787.10 3625.0 8465.0 1545.0 1820.0 (+3.6%) (+4.6%) 1978 1043.36 932.80 3755.0 8850.0 1575.0 1915.0 (+2.8%) (+5.0%) 1979 1288.05 1188.00 3860.0 9290.0 1565.0 2155.0 (-1.6%) (-7.1%) 1980 1487.94 1389.20 3800.0 8625.0 1495.0 2204.0 Sources: Rubber Statistical Bulletin, various issues; European Chemical News, various issues. Notes: (1) NR denotes Natural Rubber; SRs denotes Synthetic Rubbers. (2) Natural rubber price is the London spot price for RSS1 rubber. (3) Synthetic Rubber Price is the average of list prices quoted for styrene-butadiene (grades 1712 and 1500) and polybutadiene in France, Italy and UK. (4) Figures in parentheses are rates of change between consecutive years. Page 190 prompt curtailment of production to a level compatible with demand. Since natural rubber production is relatively inelastic in the short-run the rate of fall in natural rubber production was less than 6 half that for synthetic rubbers. Thus while synthetic rubber production was reduced by 720,000 tonnes in 1975, the corresponding reduction of natural rubber production was only 130,000 tonnes. This was accompanied by depletion of synthetic rubber stocks of some 170,000 tonnes whereas the run-down of natural rubber stocks was only about 40,000 tonnes, (bearing in mind the Malaysian government stockpile of 22,000 tonnes), thus substantiating Behrman's observation that synthetic rubber producers are known to adjust capacity utilization and inventories in accordance with market conditions. By 1975, natural rubber, which had always been more expensive than synthetic rubbers, became almost US$100.00 cheaper per tonne. This is at variance with the historical pattern (during the cheap oil era) where, despite continued domination of rubber consumption by synthetic rubbers during recessionary periods and which depressed natural rubber price further, synthetic rubbers remained cheaper than natural rubber For the first time (1975) the situation reversed, and natural rubber spot price became lower than synthetic rubbers. In the event the increase in natural rubber's share of consumption in 1974 and 1975 6 Had the Malaysian government not implemented its own national stockpiling and production control "Crash Programme" in mid-1974, the decline would probably be less. For details of the said "Crash 7 Programme" see Appendix 6.A. It should be emphasised that the price paid for the bulk of natural rubber consumed are the contract f.o.b. or c.i.f. prices which, on average, differ from spot price. Thus although spot price was higher than synthetic rubbe; prices before 1975, it was known for example, in the period just before 1970, that styrene-butadiene price per pound was about three to four cents higher than prices paid for comparable grades of natural rubber (Barlow, 1970). Page 191 resulted from the compound effects of the rise in oil and hence synthetic rubber prices, the accompanying fall in synthetic rubber production and the world recession. By 1976 as the oil crisis shock became accommodated and the world economy picked up, synthetic rubber production was promptly increased by 17.1 percent; in contrast, the constraint imposed by potential output in the case of natural rubber facilitated an increase in natural rubber production of 8.2 percent only. The increased demand for rubbers in 1976 and the supply inelasticity of natural rubber resulted in an increase of natural rubber price of about 30 percent in 1976, thus making natural rubber price higher than synthetic rubber price once again. This led to a fall in natural rubber consumption share to lower than even before the first oil crisis, thus suggesting that there are also secular factors at work. In addition, consumers may be discouraged from favouring more natural rubber consumption because of the emerging labour shortage in the Malaysian plantation sector as well as the competition between natural rubber and other plantation crops. The change in trading habits in the late 1970s which is discussed below is partly the manifestation of these considerations. This decline in share continued until 1980 when the second oil crisis of 1979 and the attendant world economic slump apparently precipitated another advantageous shift for natural rubber.8 8 The trend reversal observed in 1980 should not be considered to be definitive of a new trend direction since it reflects behaviour of only one year. Page 192 Another interesting feature during the post-1973 period is the variance in the London spot and c.i.f. London price (which is used typically in longer-term contracts) relationship. Barring 1957 (the year after the Suez crisis), the London spot price has historically always been higher than the c.i.f. price. However for 1974 (beginning of the high oil price era) and from 1978 to early 1981 (the period of ex post simulation) a reversal was observed whereby the London spot price became lower than the c.i.f. London price. A plausible explanation for this revolves around a gradual structural change in natural rubber trading habits. This change may be viewed as beginn,ing from the first oil crisis of late 1973 and accelerating after the second oil crisis by which time it was accepted that the era of cheap oil and synthetic rubber feedstocks was over, at least until the late 1980s. The question of adequate natural rubber supply therefore took on a new urgency. To understand the change in natural rubber trading habits, recall that prior to the oil crisis consumers had been able to use the ready availability of synthetic rubbers and their known and stable administered prices to trade in the spot market for their balance natural rubber requirements. Following the oil crisis and resulting uncertainty concerning synthetic rubber supply, consumers now ensured supply of their natural rubber requirements by greater use of long-term contracts. This shift and the less stable synthetic rubber prices thus resulted in reduced interest in the spot market. Two Another reason given by London traders is the decline in warehousing facilities in the London docks. This is a moot point since the warehouses may have been allowed to deteriorate because of the falling demand for their services (Allen, 1981). Page 193 extraneous factors caused the shift to become marked in the late 1970s. Firstly, the second oil crisis exacerbated consumers' concern with the longer-term implications of palm oil and cocoa as increasingly attractive plantation crop alternatives to natural rubber, especially in Malaysia. Since at that time the world economy was expected to pick up in the ensuing years (that is end 1970s/early 1980s), the general expectation was that there would be a natural rubber shortage by the early 1980s. This reinforced the shift to greater reliance on long-term contracts for natural rubber supplies. Secondly, the declining interest in spot trading in the late 1970s was reinforced by the transfer of speculative and hedging activities from the natural rubber market to the precious metals markets which were especially buoyant then. Consequently, throughout 1978 to the beginning of 1981, the spot price remained lower than the c.i.f. price. This discussion of the relationship between the London spot and c.i.f. prices provides another reminder of the importance of the level of economic activity and oil price to future developments in the natural rubber market. It also shows that the two types of speculative buying distinguished by Krause (1976), and the recommended use of buffer stock operations to reduce speculative buying when such buying stems from fear of supply availability, should be considered carefully in the case of commodities with close substitutes.11 10 Price data for July 1981 shows that the earlier relationship of spot price being higher than c.i.f price has been reinstated by July 1981. This may be due to the excess purchasing of natural rubber by long-term contracts in the preceding years as well as to the levelling off of oil price in the first half of 1981. In addition, speculative interest in the natural rubber market might have been restored in view of the less buoyant bullion markets. Page 194 6.6 Overview of Natural Rubber Market Instability, 1956-1978 The discussion of the rubber market in the aftermath of the oil crisis has highlighted the flexibility(inflexibility) of the synthetic(natural) rubber industries in the face of rapidly changing conditions. In this section the question of natural rubber instability with respect to price, export volume and value over the entire sample period will be surveyed. The contrasting impacts of the synthetic rubber industry on the natural rubber market under "normal" vis-a-vis "abnormal" conditions that emerge is useful in providing a basis for evaluating the prospects for natural rubber under differing degrees of uncertainties regarding the oil, and hence synthetic rubber, industries. Figure 6.3 presents three time paths of f.o.b. Singapore price for RSS1-grade natural rubber in the historical period. While the annual average price show the trend, the highest and lowest monthly prices within each year provides an indication of the amplitude of natural rubber price fluctuations. Using the criterion of amplitude 'The two types of speculative buying distinguished by Krause (1976) are: (i) speculative buying for fear of unavailability; (ii) speculative buying in anticipation of price rises. Krause asserts that types (i) and (ii) speculative buying can be modified by buffer stock operations and intervention in the futures markets respectively. An implicit assumption in the recommendation of buffer stock operations for type (i) buying seems to be that such buying will be accompanied by a boom in industrial production as was the case in the early 1950s. If the assumption does not hold, that is, if industrial production was to stagnate as in the recent commodity boom, then the adverse effect will be higher capital costs for operating the buffer stocks. While consumers may now not force prices up through their speculative buying, the buffer stock management may, in the case of an industrial boom not eventuating, require larger capital resources than otherwise to prevent prices from falling below the floor prices. RSS1-Price f.o.b. Singapore (S$/Tonne) 5000 4000 Phase I Phase II Phase III ,Monthly(High) Annual 3000 Monthly(Low) O l , // . aI .L * : * * i 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 Year Figure 6,3: Time Paths of Average Mon, ly and Annual Natural Rubber Prices in Singapore, 1953-1980. - Q 1 Ch Page 196 of price fluctuations, three phases of price behaviour may be distinguished: (i) phase I in the pre-1960 period; (ii) phase II covering the 1960-1972 period; (iii) phase III in the post-1972 period. The pre-1960 period after the Korean War boom covers the period when the synthetic rubber industry in the USA became commercialised (through the government sale of its synthetic rubber capacities to the private sector in 1956); at the same time, new processing techniques were developed for styrene-butadiene production and in the production of the second-generation stereo-regular synthetic rubbers. In this period of consolidation, the ultimate impact of the synthetic rubbers was not discernible. In phase II the impact of the growth of the synthetic rubber industry is seen from both the price trend and the amplitude of price fluctuations. While expansion of the synthetic rubber industry led to lower production costs and hence lower prices, the lowering of minimum natural rubber input requirements (per type of tyre) widened the scope for substitution, and hence competition, between natural and synthetic rubbers. Consequently the falling trend in natural rubber price reflects the trend in synthetic rubber prices while the narrowing amplitude in price fluctuations reflects the competition from synthetic rubbers whose growing role was facilitated by its short lead times in production. Page 197 Phase III illustrates natural rubber price behaviour when the relative stability in the synthetic rubber industry was disturbed by the oil crises. Apart from the price trend reversal -- largely explained by the rise in synthetic rubber prices -- the amplitude of price fluctuations also widened. As the discussion of the market in the aftermath of the oil crisis revealed, much of the market instability was shifted onto the natural rubber market because of the ability of the synthetic rubber industry to adjust its production and inventory programmes accordingly. The three phases show that so long as the oil industry remained relatively stable, the synthetic rubber industry was a stabilising factor for the natural rubber market. However, when instability was introduced to the oil industry, the flexibility of the synthetic rubber industry was used to protect the industry from market instability. By shifting the onus of instability, this flexibility therefore worked to the disadvantage of the natural rubber market. Figure 1.2 in Chapter One had shown the time paths of natural rubber export earnings for Indonesia, Malaysia, Sri Lanka and Thailand during the historical period. It can be seen now that three phases corresponding to those for natural rubber price could also be delineated. As the behaviour of global export volumes and values for natural rubber during 1950-1976 has been succinctly summarised by a set of indicators calculated by Blandford (1979), his results will be presented here. Page 198 Blandford examined the annual growth rates and degree of instability of the global export volume and value for 1950-1976 and for the three subperiods 1950-1959, 1960-1969 and 1970-1976, which correspond closely to the three phases discussed above. Before presenting his estimated annual rates of growth and degree of instability, the data and methodology used will first be discussed. The gross export volume data refers to figures published by FAO; these figures include rubber re-exports, and no correction was made to the data for the possible bias it might have contained. The nominal value of these rubber exports was then calculated as the product of export volume and export price, where price refers to the New York c.i.f. price for RSS1-grade natural rubber. Since the New York price served only as an "indicative" price, the export values obtained should also be viewed as "indicative" in the same sense. (These export values are over-estimates since not all rubber exported is of RSS1-grade.) To obtain "real" value of rubber exports, the nominal value of exports was then deflated by the index of prices of manufactured goods exported by the developed countries. The export volume and "real" value figures were first converted to indices (using 1970=100) before use. The annual growth rates for export volume and value are obtained from exponential trend lines that are fitted to the indices, and the standardised coefficient of variation was used to measure the degree of instability. 12 Table 6.4 presents the annual growth rates and degree of instability of natural rubber export volume and value obtained by Blandford. From Table 6.4 it can be seen that although 1960-1969 was a phase of relative stability of export value, the period also Page 199 Table 6.4: Growth and Instability of Natural Rubber Export Volume and Value. Export Volume Export Value Time Period Rate of Degree of Rate of Degree of Growth Instability Growth Instability 1950-1959 1.0 3.2 -3.8 12.7 1960-1969 0.0 3.5 -6.0 4.8 1970-1976 2.0 2.3 2.7 11.2 * * 1950-1976 1.4 3.0 -2.8 10.4 Source: Blandford (1979 : 59) Notes: (1) Export Volume and Export Value converted to Volume and Value indices using 1970=100. (2) Rate of growth measured in percentage change per annum. (3) Degree of Instability measured by standardised coefficient of variation. (4) * indicates statistical significance at 10 percent confidence level. Page 200 witnessed the most dramatic decline in natural rubber export earnings. Over the period 1950-1976, export value experienced a negative rate of growth of 2.8 percent annually while the annual rate of instability amounted to 10.4 percent. Figures 6.4 and 6.5 are scatter diagrams based on the analysis given in Table 6.4. Fiuure 6.4 presents a scatter diagram of the rates of growth of export value against export volume; while export volume growth rate was positive throughout 1950-1976, the export value growth rate only became positive in 1970-1976. Figure 6.5 gives a scatter diagram of export value growth against its degree of instability. When taken together, these two figures highlight the impact of oil price on natural rubber export and hence value. In contrast to the 1950-1969 period when an increase in export volume was accompanied by a decrease in export value, the first half of the seventies saw an increase in export volume now accompanied by a correspondingly greater increase in export value. 12 The standardised coefficient of variation V(S) is defined as 2 V(S) = V ID) t { x max [ 2(l - 1/n) where u is the deviation from the exponential trend; n in the number of time periods; x is the arithmetic mean; V(D) is the coefficient of variation and V (D) is 2(1-1/n). max 45v line Rate of Growth A of Export Value (% per annum) 3 -1970-1976 2 1/ I, Rate of Growth O 2 3 4 of Export Volume -1 (% per annum) -2 -3 1950-1976 -4 .1950-1959 -5. -6 1960-1969 PD Figure 6.4: Natural Rubber Export Value Growth Rate against Export Volume Growth Rate, 1950-1976. H Rate of Growth of Export Value 450 line (% per annum) /1970-1976 2- .._ . Degree of Export 0 2 4 6 8 10 12 14 16 Value Instability -2 e 1950-1976 4 .1950-1959 -6 ,1960-1969 -6- tD Figure 6.5: Natural Rubber Export Value Growth Rate against 0 Export Value Instability, 1950-1976. Page 203 The influence of economic activity on rubber demand and of synthetic rubber supply flexibility on prices,and their interaction with supply inelastic natural rubber is clearly illustrated by the developments during 1973-1980. Given that rubber demand is dictated by business cycles} it can be argued that a possible means of counteracting the business cycle-induced instability is some buffer stock scheme. However the problems of successful market stabilisation via such stock arrangements is complicated by the need to anticipate, not only busines cycles,but developments in oil pricing and synthetic rubber investment and production as well. The next chapter therefore examines the question of oil price and the prospects for continued expansion in synthetic rubber production. The question of stabilisation is then examined in the subsequent chapters. Page 204 APPENDIX 6.A THE MALAYSIAN NATIONAL "CRASH PROGRAMME" OF 1974-1976 6A.1 Introduction The so-called Malaysian national "Crash Programme" (hereafter referred to as the Programme) for natural rubber was introduced in November 1974. In order to view the Programme in perspective, it is necessary to refer to the behaviour of natural rubber prices in the period immediately preceding the Programme. The reference to natural rubber price during 1972-1974 will also highlight the vagaries of the natural rubber industry. The socio-political repercussions of falling natural rubber prices, particularly against rising price levels resulting from rising oil price, provides an added dimension to the need for government intervention; this dimension is seen by some to have been instrumental in the implementation of the Programme. For details of the manifestations of social unrest in Malaysia during this period and its political overtones, see Meyanathan (1980:151-152). Page 205 6A.2 Events Precipitating the Programme Table 6A.1 gives the RSS1-grade natural rubber price during September 1972 to October 1974. The UK list price for styrene-butadiene grade 1712, the major synthetic rubber competitor (used mainly in tyre treads) to natural rubber, is also provided for the purpose of comparing price behaviour during the critical period of structural change in the oil industry. The volatility of natural rubber price is vividly illustrated by the prices for September 1972 and September 1973 given in Table 6A.1; following the quadrupling of oil price in October 1973, the rubber price also increased in the ensuing months, reaching a peak in January 1974. Thereafter prices began to dip; although oil prices remained high, the price of natural rubber had, by July 1974 fallen to less than the pre-oil crisis price of September 1973. In an effort to arrest the price decline observed up to that time (but anticipated to be transient), the Malaysian government announced a plan on 18 July 1974 to reduce the country's natural rubber supply to the world market by .10 percent through an upward adjustment in commercial stockholdings. This was originally intended to last only a month. However, despite increasing synthetic rubber prices, natural rubber price continued to decline; thus between January and November 1974, while synthetic rubber prices rose by about 64 percent, natural rubber price had instead declined by about 58 percent. This continuous price descent precipitated the government-supported Programme on 28 November 2 Such short-term palliative measures had been used by the Malaysian government previously (viz. September 1967, March 1968 and March 1971). As Lim (1976b) pointed out, in this as in earlier instances, the price response was immediate but transient since they were due to the dominant speculative activities. See Lim (1976b). See also Economic Intelligence Unit (1974). Page 206 Table 6A.l: Natural and Synthetic Rubber Prices, 1972-1974 Natural Rubber Price Synthetic Rubber Price Date (Malaysian Dollars (Sterling Pounds per Tonne) per Tonne) September 1972 868.00 142.50 September 1973 1731.00 153.00 November 1973 1898.00 168.50 December 1973 2432.00 January 1974 2691.00 198.50 May 1974 2027.00 290.60 July 1974 1623.00 -58% 308.00 +64% October 1974 1422.00 325.00 November 1974 1134.00 Sources: Rubber Statistical Bulletin; European Chemical News. Notes: (1) * denotes the month before the occurrence of the oil crisis in 1973; (2) The price for synthetic rubber (styrene-butadience 1712) quoted for each month is actually the price for the corresponding quarter. Thus price for the months of November and December 1973 is actually the overall price for the fourth quarter of 1973. Since the figures in this Table are presented for purpose of comparing the trend underlying the two price series, this approximation is not critical to the broad pattern emerging. Page 207 1974. The decision to undertake the Programme was prompted by consideration of the rubber market outlook in the face of two discouraging phenomena: (i) Despite the marked increase in oil prices in late 1973 (which in turn affected synthetic rubber production costs) and thereafter, the natural rubber price fell continuously throughout the first ten months (and longer as events were later to prove) of 1974; (ii) The fall in natural rubber prices throughout 1974 was such that for the first time in nearly two decades (a period corresponding to the dramatic growth in the synthetic rubber and transport industries), natural rubber prices had fallen below that for synthetic rubber. The observed phenomena thus emphasised the dependence to date of the natural rubber industry on the business activity of the industrialised countries for its survival, and the influence of economic activity on natural rubber price formation. The Programme was therefore an attempt at supply management to counter the worldwide recession anticipated for 1975. Page 208 3 6A.3 A Six-Point Programme The twin objectives of the Programme were: (1) to reduce supply from the world market during periods of falling demand; (2) to raise productivity in the long-run by taking advantage of recessionary periods (and its concomitant demand shortfall) to accelerate replanting. Under the Programme a financial outlay of three hundred million Malaysian dollars was made by the Malaysian government to implement a six-point package of instruments. For the first objective of reducing natural rubber from the world market, the four instruments were: (1) the banning of the use of chemical stimulants, especially ethrel; this would lower productivity and therefore help to reduce overall supply; (2) the reduction of tapping frequencies by the estate sector via the implementation of a new Wage Agreement which provided workers with weekly rest days and a 14-day paid holiday annually wghich would reduce output in the short-run; (3) the packer-remiller-exporter levels were given supply quotas; supply to the market was thus reduced and the traders forced to hold Based on reporting in Natural Rubber News, (1975:2-4) Rubber Market Review (1975:8). Page 209 higher stocks during this period; (4) the direct buying of smallholder rubber by the government who would then stock the rubber, since smallholder tapping frequencies cannot be controlled; For the second objective of accelerated replanting to raise future productivity, the two instruments were: (1) the compulsory repplanting within two years by all estates of all their acreages having yields below 800 kilograms per hectare (or 712 pounds per acre); (2) the encouragement of further smallholder replanting (including those smallholdings under five acres) through the assistance of the Rubber Industry Smallholder Development Authority(RISDA). The organisations that were simultaneously established to implement the Programme were: (1) a government Committee on Rubber to monitor the Programme; (2) a Special Unit to supervise the direct government purchasing of smallholder rubber; (3) an Operations Centre to administer the daily buying operations of smallholder rubber; (4) an Estate Sector Unit to supervise the acceleration of estate replanting and to ensure that the ban on ethrel usage and reduced tapping frequencies were being observed; (5) a Packer-Remiller-Exporter-Dealer Unit to check that their supply quotas were heing observed. Page 210 6A.4 One-and-a-Half Years of the Programme In implementing the Programme the Malaysian government was fully aware of its efficacy as a short-term measure only. Consequently a proposal for an international Buffer Stock Scheme among producing nations and those consuming countries wishing associate membership4 was presented by Malaysia in January 1975 to the Association of Natural Rubber Producing Countries (ANRPC). While negotiations at ANRPC continued, the Malaysian government meanwhile passed a Natural Rubber Price Stabilisation Bill at the end of 1975 (a year after the introduction of the Programme). The Bill enabled the establishment of a national advisory council to supervise the government's natural rubber stockpile activities. Throughout 1975 the 'Kuala Lumpur (and world) price of natural rubber remained fairly stable in the range of M$1,200 - M$1,400 per tonne. By virtue of the six-point Programme natural rubber stocks in Malaysia (averaging 230,000 tonnes) were simultaneously being monitored. However natural rubber price began rising again from M$1614 in December 1975 to $2101 in May 1976. Malaysian stocks for the corresponding months fell from about 231,000 tonnes to 180,500 tonnes (which was lower than the monthly stock level during the 1963 4 The proposal was therefore not an attempt at cartelisation. For further details on the difficulties of reaching as consensus, even among ANRPC members only, on a buffer stock scheme, see various issues of the Economic Intelligence Unit's quarterly review for the economies of Malaysia, Singapore and Brunei during 1976 and 1977. While timing made this proposal a de jure forerunner of the Buffer Stock Scheme under the UNCTAD International Natural Rubber Agreement (INRA), this proposal served as a contingency scheme that would have been implemented had the INRA negotiations failed. The idea of a buffer stock operation amongst producing countries was first proposed by Indonesia soon after the establishment of the ANRPC in 1970. Page 211 commodities boom period). The Malaysian authorities then felt that the bans on chemical stimulants usage and Sunday tappings could be 7 lifted, thus bringing the one-and-a-half years' Programme to a close. 6A.5 Gains Bestowed by the Programme The effects of the Programme have been quantified by Lim (1976b) soon after the Programme terminated. Cost-benefit estimations by Lim to evaluate the efficacy of the Programme to stall falling prices between mid-1974 to early 1976 indicate gains received by the various national rubber sectors. For an idea of the magnitudes involved, the major findings in Lim (1976b) will be summarised. Lim estimated the gains to the government, smallholder, estate and trade sectors by assuming that the gross difference between prices obtained with and without the Programme amounted to about 15-20 Malaysian cents per kilogram. During the Programme, the Malaysian government acquired 22,000 tonnes of smallholder output, of which 4,000 tonnes was subsequently lost in a fire outbreak. The remaining 18,000 tonnes natural rubber A misreporting by the Economic Intelligence Unit that the stock level in early 1976 was about 10 percent of the stock level in 1975 should be mentioned. See Economic Intelligence Unit (1976, no. 2:5). It is relevant to note that as prices declined in 1974 and stabilised in 1975, world total natural rubber production fell and was lower than consumption by an average of about 60,000 tonnes annually in both years. Obviously consumers were running down stocks because of the uncertain economic outlook, thus partially explaining the ilncreased share of natural rubber consumption in 1975. 7 See Economic Intelligence Unit (1976). Page 212 stock was entirely disposed of in February 1976 at a net (of salaries, staff allowances, warehousing, insurance and transportation expenses incurred by the stocks) profit of M$1.4 million. This was comparable to a 6 percent return had the capital been invested commercially. For the smallholder sector, Lim distinguished the direct and indirect effects of the Programme. The direct effect referred to the smallholders' increased rubber earnings due to the implementation of the Programme; according to Lim's estimations, the smallholders were found to receive increased earnings of about M$110-$159 million. The indirect effect referred to the non-quantifiable spillover effect of higher prices on marginal producers. Since prices for lower rubber grades are related to the RSS1-price, the higher RSS1-price would induce marginal producers to enter production.8 For the estate sector Lim estimated that to maintain the price level an additional 26,000 tonnes of rubber stocks had to be retained by this sector. The net profit from the sale of this stock in early 1976 approximated M$1.8 million, an amount comparable to an 8 percent net return on commercial investments. On the above evidence it may be concluded that the three-pronged Programme of government stockpiling, enforced private stockholding and production control succeeded in stabilising both price and earnings (by avoiding loss in earnings had the pricte fall been permitted to occur). However stabilisation at the floor level per se is 8 While Lim does not qualify this positive indirect (spillover) effect, it is necessary to point out that the effect is positive only in so far as the impact of the behaviour of marginal producers on price is defirnitely negligible. If marginal producers form a significant production force, then their increased production may well become a counteracting element to the Programme's effort to uphold the price level. Page 213 insufficient evidence that comprehensive stabilisation will be equally beneficial. Any international price stabilisation agreed to by producers as well as consumers necessarily encompasses ceiling price levels. Thus gains from floor price stabilisation should be weighed against earnings foregone/lost through ceiling price stabilisation. Overall gains/losses must further be discounted to reflect maintenance and operational costs of the national stockpile even when prices are within the agreed price bands. Page 214 CHAPTER SEVEN EXOGENOUS VARIABLES PROJECTIONS: 1980-1995 7.1 On Projecting Oil Price In the historical period under sturay, the synthetic rubber industry stemmed largely from the dynamic oil and petrochemical industry upon which it is dependent for its energy and raw material inputs (feedstocks). Owing to its critical dependence on oil for energy and feedstocks, the price of synthetic rubbers is thus highly correlated with oil price as the estimated equation for synthetic rubber price confirmed. In this chapter the interest in oil pricing is restricted to its direct impact on synthetic rubber production cost and therefore on synthetic rubber price. To examine the future role of synthetic rubbers in *the world rubber market during 1980-1995, expectations about synthetic rubber price behaviour are required. Hence the need to explore the possibilities on the energy front and translate them into oil price projections. The synthetic rubber industry currently depends on the oil industry for about 85 percent of its feedstocks and this situation is expected to persist through to the end of this century (Norton, 1981). However, in view of the extensive intersectoral linkages (within an economy) botween the petrochemical industry and other industries and the long lead-times associated with energy development projects, it is not unrealistic that in its current concerted efforts at developing alternative energy resources, the energy industry should Page 215 also be searching simultaneously for alternative sources of feedstocks supply for the longer-term future. Thus in projecting oil price it would be desirable to have assumptions about alternative energy resources and their potentials in competition with oil, both as sources of energy as well as of industrial raw material inputs. Given the growth rate of the world economy, the demand for the various types of energy will primarily be determined by their relative availability and supply. The supply of oil and non-oil energy is therefore the cornerstone for projecting the price of oil for 1980-1995. The non-oil energy resources are coal, natural gas, hydro-energy, alcohol fuel, nuclear energy, solar energy, primary motive powers and others. Before presenting the method used in projecting the price of oil, the question of oil and non-oil energy supply in the next 15 years will first be discussed. Through the discussion the constraints in the demand choice for alternative energy resources will be defined. Against alternative assumptions regarding the various supply and demand growth rates, the price of oil can then be projected. In the following some background information on various types of energy resources will first be presented. The constraints likely to influence supply of each during the next 15 years will then serve as criteria for dividing the 15 years into subperiods. For each subperiod, the likely supply situation will be discussed. Synthetic rubbers only constitute about 10-15 percent of all petrochemical products end uses. Given that the polymer industry at present provides materials that is the equivalent of agricultural production from 3 million square miles of land, it is not unrealistic to expect that efforts to sustain the past gowth of this industry will be continued. For details on the role of petrochemical feedstocks in synthetic rubber production vis-a-vis other synthetic materials production, see Horton (1979). Page 216 7.1.1 Supply of Oil In evaluating the future supply of oil, it is helpful to distinguish oil reserves from oil resources. Oil reserves, also known as proven reserves, refer to those oil deposits that have been well investigated and worked and are therefore well-known. Oil resources refer to those oil deposits that are less well investigated and to those which eventually would be found in new regions with oil potential. The distinction between reserves and resources is important in considering the future leverage of the.Middle-Eastern oil producers on oil pricing since a primary reason for the Arab-instigated oil crises since late 1973 is that although their share of the world's reserves is substantial, their share of the world's resources is insignificant. While they can chiefly count on their remaining proven reserves, their share of current world oil production has been proportionately higher than their share of the world's total oil resources. Since oil is a depletable resource, the determinants of oil supply hinge to a large extent on the feasibility of employing the earnings from oil production to generate future income. The determinants of oil supply are therefore: (1) the producing countries' absorptive capacity of investment (from oil revenues) without causing social disruption (a major consideration especially in the Arab oil-exporting nations); 2 The quantity of oil found or expected to be found in a given region can be expressed either as recoverable amount or as amount in place, the former being the product of amount in place and the recovery factor. Since it is impossible to recover all the oil contained in an underground formation, the recovery factor is less than 1.0 in value. Page 217 (2) the current price of oil versus the expected price of oil; (3) the current yield versus the expected yield of foreign assets and investments that can respectively be bought and made with the oil revenues. The question of absorptive capacity of investment is less constraining elsewhere than in the Middle-East where the political factor adds another dimension to the already complicated issue of oil price formation. The question of present oil price versus the expected price of oil is related to questions of alternative new (viz. hydrogen, nuclear, atomic and solar) and renewed (viz. coal and oil shale) energy resources, of primary motive (wind and tidal) power and of reversal in oil refining objectives (from refining crude oil chiefly for fuel as at present to refining crude oil chiefly for feedstocks). Up the late 1960s, the political situation within the Middle-East oil producing countries was relatively stable and was an unimpo.tant factor for oil pricing. By the 1970s, the situation had changed because of the various perceptions of oil as a political instrument by the "monarchic bloc" countries (of Saudi Arabia, Kuwait, United Arab Emirates and Qatar) and the "socialist bloc" countries (of Algeria, Libya and Iraq). The relative political stability within the Middle-East oil producing countries was thus affected. Consequently oil pricing in the 1970s had also to contend with the conflicting interests and relative strengths of the two blocs of countries within the Organisation of the Arab Petroleum Countires (OAPEC). For a formal study of influence based on the coalition of states within OPEC, see Doran(1979). Doran's study concluded that for most of 1969-1978, Saudi Arabia seemed to have shaped the cartel policy through a dominant and primarily stable coalition of states that included Iran. With the change of regime in Iran and the changed nature of this coalition, Saudi Arabia is expected to become the focal point of two sets of pressures: (1) pressures involving price escalation or price stability and (2) pressure involving the security of the Saudi Monarchy and that of political unity within Arab and Muslim circles. Page 218 The question of existing versus expected yield in foreign assets bought and investments made with the oil revenues is related to the problems of balance of payments, resource transfers and the recycling of surplus oil funds. 7.1.2 Supply of Coal Of the primary energy resources, coal is predominant. Table 7.1 illustrates the share of main primary energy resources in China, USSR and the USA. The importance of coal resource is two-fold: as a source of energy per se and as a raw material in synthetic crude oil (hereafter syncrude) production. In comparison with other non-oil energy resources, coal is not only cheap and abundant but also enjoys existing supply (transport) infrastructure. Thus increased production and international trade in coal are expected in future.4 The process of coal liquefaction for obtaining syncrude from coal has been known since the 1930s. So long as oil remained cheap and readily available, coal liquefaction was no,t economically viable. For details, see Shell Briefing Service (1979). In the light of the available coal resources and the accompanying transport infrastructure, it is unclear as to why the World Bank (1980b:16) should only credit coal with a projected steady 30-32 percent share in world energy supply throughout the 1970-2020 period. It can only be surmised that bulkiness, the non-aesthetic features of coal and pollution considerations were implicitly used to discount the rate of development of coal resources. Perhaps natural gas possess less of a pollution problem and does not produce as much waste material as coal (the waste material from natural gas is about 1 percent carbon black). However, if pollution was the dominant factor influencing the World Bank projections, then it should be emphasised that the waste disposal problem associated with coal consumption is much less harmful than that deriving from nuclear energy consumption. Page 219 Table 7.1: Share of Primary Energy Resources in ChinaJ USSR and USA (percentages) Type of China USSR USA Primary Energy Oil 7.48 4.68 5.88 Coal 90.42 92.76 64.89 Natural Gas 0.40 1.42 2.73 Oil Shale 1.70 1.13 26.50 -3T-L 100.00 100.00 100.00 Source: Ikonnikov (1982) Page 220 With the quadrupling of oil prices, coal liquefaction has reappeared and (although still an expensive process) is expected to be of increasing importance generally as weLl as to the synthetic ribber industry for both its fuel and feedstock potentials. 7.1.3 Supply of Natural Gas Like coal, natural gas also is a source of energy per se and a raw material for the petrochemical industry. Hence natural gas is also potentially important to the energy sector in general and synthetic rubber industry in particular for both its fvLel and feedstock supply capabilities. Natural gas resources are known to be widely spread and many countries are known to have significant production prospects. The natural gas supply constraint is that its production and transport infrastructure is, relatively speaking, not as well-developed as in the coal industry. Furthermore, in many cases, transportation of natural gas would also entail investment in facilities for liquefying the gas. Ironically the reappearance has exacerbated oil price increases in recent years, possibly because the Middle-East oil producers now see the remaining period during which they can exercise their price leverage as being curtailed. Page 221 7.1.4 Supply of Hydro and Nuclear Energy Both hydropower and nuclear power are important for electricity generation. The production of hydroelectricity is expected to be encouraged and expanded without hindrance but will have little impact on the total energy supply because of its minute share of total energy resources. The potential of nuclear power is very much larger but the basic issue here concerns the pollution (waste disposal) problem; thus development of nuclear energy relies on the reconciliation/solution of the environment problem. 7.1.5 Supply of Alcohol Fuel Alcohol can be derived from biomass, from cultivated food materials (viz. cereals, sugar crops and root crops) and natural biomaterials (viz. dried leaves, twigs, weeds, woodchips, et cetera.). The technology for producing alcohol is well-established, with its production for fuel becoming increasingly viable as oil price increases. However, because of its agro-base the long-run economic viability of alcohol fuel production rests on the availability of land and the impact of alcohol fuel production on food prices. The importance of alcohol fuel lies in its potential as (a) a source of transport fuel and (b) a source of feedstocks for the synthetic rubber industry. In the transport industry, a mixture of gasoline and alcohol (where a minimum of 80 percent of the former and a maximum of 20 percent of the latter is reported to be the limits Page 222 suitable for existing car engines) is used in Brazil which is presently a leader in world production of alcohol fuels for the transport industry. Thus the potential *exists for reducing the transport industry's dependence on oil for its fuel. Alcohols such as ethanol and methanol can also be used to obtain ethylene and butadiene (which are key inputs in the production of general-purpose synthetic rubbers). Alcohols therefore provide the synthetic rubber industry with another source of feedstocks inputs. 7.1.6 Supply of Other Energy Resources The remaining sburces of energy supply are those based on solar energy, hydrogen, primary motive powers and others. Although these energy resources are important to the question of oil pricing, they do not directly impact on the transport and rubber industries. This is because to date they are not viewed as potential supply sources for transport fuel nor for synthetic feedstock raw material inputs. Against the prospect of continued escalation of oil prices for a period of time and the problem of environmental protection, primary motive (wind and tidal) power concepts have become increasingly attractive. Some of these concepts, though still relatively new, are on the horizon and are expected to be viable by the next decade. 6 The Brazilian production of gasohol has striven to maximise the use of alcohol as the alcohol shares of the mixture testify: in 1977 the share was a mere 4.3 percent but by 1979 it had risen to 19.0 percent which is very close to the maximum feasible share. Brazil is also producing modified car engines operational on pure alcohol; for further details, see World Bank (1980b:chapter 3). Page 223 7.2 Three Subperiods of Energy Supply From the above brief survey of the various known energy resources and the problems concerning the potential substitution of non-oil for oil energy, the 1980-1995 period can be treated as three distinct subperiods. The survey of the various energy resources has indicated that the course of oil/non-oil energy substitution is dictated (a) by investment outlays on known technologies in the shorter-term and (b) by technological developments over the longer-term. These criteria provide a natural subdivision of the 15-year period into the three subperiods 1980-1985, 1985-1990 and 1990-1995. In 1980-1985, oil is expected to retain its dominant role and there remains potential scope for price leverage by the Middle-Eastern producers. Oil price may therefore continue to escalate at a rate above inflation, especially if the Middle-Eastern producers perceive this period as their final opportunity to maximise earnings from their balance oil reserves. While oil is expected to remain prominent amongst energy resources during the 1985-1990 subperiod, the leverage of Middle-Eastern producers in oil-pricing policies will be diluted by the expected increased oil production from regions outside the Middle-East. Increased oil production is expected from China, Egypt, Indonesia and Mexico -- countries which are not only rich in oil and other natural resources but also capable of absorbing their oil revenues for development ends. This is expected to be complemented by increased production and liquefaction (conversion) of oil shale, coal and natural gas, with shifts to their further consumption expected to be accompanied by increased efficiency and conservation. Furthermore Page 224 the trend set by Brazil in using alcohol fuel may become widespread so that the demand for natural oil by the transport industry may relax to some extent. Hence the pressure on natural oil demand may ease off slightly and the rate of oil price increases may be expected to be slower than during 1980-1985. By the 1990-1995 subperiod, it is envisaged that a new "equilibrium" position will emerge for oil. The key determinant of that is the expected investment during the mid-1980s in the production of coal, oil shale and natural gas and in their conversion to liquid fuels. Given the lead-times for these undertakings, such fuel production is not expected until the early 1990s. The feasibility of non-oil energy resources to relax the demand pressure on natural oil also raises the possibility of a reversal in oil refining priorities -- oil may then be refined chiefly for its petrochemical feedstocks. Such a reversal provides scope for mitigating the scenario of limited alcohol fuel production due to the constraint of land for food production. With the widening spectrum of technologies available for the remaining energy sources viz. hydrogen, nuclear and motive powers, the role of oil to the modern industrial economy is not likely to resume its critical position as in the 1970s. Thus given the lead-times for the energy industry, the key feature in price projections for the 1980-1995 period is that three distinct subperiods emerge. The supply leverage of the Middle-East dominated oil industry is expected to remain severe in 1980-1985; during 1985-1990 expansion of the traditional non-oil energy sectors, viz. coal, natural gas and hydroelectricity and the supply of oil from new regions (mainly outside the Middle-East) should relax the oil Page 225 supply constraint. During 1990-1995 the uncertainties thrown up by the 1973-1974 oil crisis are expected to recede as new technologies for utilising non-oil energy resources are finalised and brought on-stream. Based on these expectations, the outlook for further expansion of the synthetic rubber industry appears promising. This argument probably underlies the pervasive attitude within the synthetic rubber industry of viewing natural rubber as a 1trapidly changing and worthy competitor" (Ruebensaal71979) to synthetic rubbers rather than vice-versa. The three subperiods emerging from the above discussion are delineated by supply considerations. From Table 7.2, which presents the world energy supply composition in 1956-1974, it can be seen that only the share of coal declined during the period. This is in contradistinction to coal being the most abundant energy resource. 7.3 Demand for Energy Since energy demand is derived from demand for heating and transport fuels, total energy demand with respect to economic activity is fairly inelastic. Over the longer-run the demand mix of different energy resources will be influenced by their relative supply potentials. In conjunction with the three subperiods delineated by the supply factors for 1980-1995, two types of energy demand can be distinguished: Page 226 Table 7.2: Composition of World Energy Supply, 1956-1974 (percentages) Crude Natural Natural Coal Hydro & Total Year Petroleum Gas Gas Nuclear Liquids Electricity Supply 1956 33.8 1.3 11.4 51.8 1.7 100.0 (3,649.0) 1960 33.9 1.3 13.4 48.9 1.9 100.0 (4,478.0) 1965 39.7 1.5 16.1 40.6 2.1 100.0 (5,588.0) 1970 45.0 1.7 18.7 32.6 2.1 100.0 (7,420.0) 1974 47.5 1.7 19.4 29.1 2.4 100.0 (8,641.0) Source: United Nations, World Energy Supplies, Series J. No,e: Figure in parentheses denote energy consumption measured in million tonnes of coal equivalents. Page 227 (1) energy demand which is not oil-specific and for which alternative energy sources are substitutable with relative ease. Such demand stem from the heavy industries and heat and electricity generation plants. For these demands coal, oil shale, natural gas and nuclear power are expected to assume increasing importance. This market for non oil-specific energy resources may be called the "heat market",7 (2) energy demand which is oil-specific and for which significant substitutes by non-oil energy is not envisaged in the medium-term (say to 1995). This refers to demand for liquid fuels and feedstock raw materials by the transport and synthetic manufacturing industries and may be called the "premium market". Table 7.3 presents the composition of world energy consumption in 1956-1974 from which movement of shares are seen to correspond to the situation on the supply side. The declining share of coal consumption over the two decades is to be emphasised. Table 7.4 compares the price of the different energy resources during 1965-1978. 7.4 Time Paths for Oil Price:1980-1995 In projecting oil prices for 1E80-199L., the approach adopted here is based on several assumptions derived from the salient features of energy supply and demand. The assumptions are: This terminology is adopted from Cornia and Mayorga-Alba (1980). Page 228 Table 7.3: Composition of World Energy Consumption, 1956-1974 (Percentages) Crude Natural Natural Coal Hydro & Total Year Petroleum Gas Gas Nuclear Consump- Liquids Electricity tion 1956 30.2 1.1 12.0 54.9 1.8 100.0 (3,431.0) 1960 30.9 1.2 14.0 52.1 2.0 100.0 (4,243.0) 1965 36.2 1.3 17.0 43.3 2.2 10'0.0 (5,212.0) 1970 41.2 1.6 20.0 35.2 2.2 100.0 (6,877.0) 1974 43.1 1.6 21.0 31.8 2.6 100.0 (7,971.0) Source: United Nations, World Energy Supplies, Series J. Note: Figures in parentheses denote energy consumption measured in million toilnes coal equivalents. Page 229 Table 7.4: Price of Various Energy Resources (US Dollars per Tonne Coal Equivalent) Year Oil Coal Natural Gas 1965 8.46 14.30 1966 8.46 14.15 1967 8.46 14.20 1968 8.46 15.23 1969 8.46 15.65 28.41(a) 1970 8.46 18.26 1971 10.31 19.48 1972 11.58 20.10 1973 15.48 22.10 68.50 (a) 1974 54.45 33.80 74.69 (b) 1975 50.39 49.45 69.39 (b) 1976 54.11 51.20 1977 58.29 50.85 92.31 (b) 1978 59.70 49.28 Sources: IMF International Financial Statistics; OECD Foreign Trade Statistics, Series C. Notes: (a) Unit price of USA exports (b) Unit price of USA imports Page 230 (1) that positive efforts will be made to develop alternative energy resources in the coming decade; (2) that positive efforts will be made to develop synithetic fuel production. However, because of the lead-times and present high production costs (relative to current oil price), commercial synthetic fuel production is not expected to begin until the 1980s; (3) in view of the knoTwn abundant coal resources and its price competitiveness (as seen from Table 7.4 which gives a comparison of prices of the different energy resources), the rate of coal production will be increased. The counter-balancing force to price leverage of oil producers will therefore be provided by coal; (4) there will be increased oil production from regions outside the Middle-East, primarily from China, Egypt, Indonesia and Mexico. For an indication of their relative supply shares, see Table 7.5. Since oil is a depletable resource, these new major oil producers are expected to follow the pricing policy of OPEC so as to maximise their earnings from oil production; (5) Middle-East oil production will continue at its present rate; (6) the fall in oil consumption in the industrialised countries due to the gradual substitution of oil by non-oil energy in the "heat market" and increased conservation and efficiency in use will be offset by the increased oil consumption (especially in the "premium market" transport industry) in the developing and newly-industrialised and industrialising countries. Page 231 Table 7.5: Share of Crude Oil Supply in Developing Countries, 1956-1974 (Million Tonnes) Year Middle Mexico Indonesia Egypt Total East 1956 170 13 13 2 353 (48.2) (3.7) (3.7) (0.6) (100.0) 1960 261 14 20 3 495 (52.7) (2.8) (4.0) (0.6) (100.0) 1965 416 17 24 6 794 (52.4) (2.2) (3.0) (0.8) (100.0) 1970 695 22 42 16 1,309 (53.1) (1.7) (3.2) (1.2) (100.0) 1974 1,087 30 68 8 1,687 (64.4) (1.8) (4.0) (0.5) (100.0) Source: United Nations World Energy Supplies, Series J. Note: Figures within parentheses are percentages of the corresponding totals. Page 232 Overall the above assumptions imply that during 1980-1995 oil supply will not be a constraint. The issue is therefore not of oil availability but of the price at which this oil will be made available. Consequently the relevant issue for this study are the floor and ceiling levels within which oil price may be expected to settle. For the floor price of oil during 1980-1995, the assumption used is that pricing policy within OPEC will be dominated by the moderate "monarchic bloc" countries; these countries will aim at maintaining the real price of oil, so that the rate of increase in oil price will equal or exceed the world rate of inflation. Consequently the floor price of oil during 1980-1995 will be set by the 1980 price under an assumed world rate of inflation of 10 percent per annum. The ceiling price of oil over the long-term is assumer. !.o be given by the cost of producing synthetic fuels. This is in fact one of the pricing approaches considered by OPEC for correcting the supply/demand imbalances, despite their recognition of the fact that the "physical limitations and technological problems resulting from the process of substitution are still to be tested." (Al-Chalabi, 1980:127-128). Table 7.6 presents the estimated costs of synthetic fuels from different primary energy resources from which coal is seen to be the most competitive mode of liquid oil production to date. Assuming liquid oil production from coal comes on-stream in 1995, the estimated 1979 per barrel production cost of $28.00 for coal-based liquid oil will act as a ceiling price for oil in 1995. To obtain a plausible range for the price of oil, the 1995 price will be calculated from assumed rates of inflation during 1980-1995 of 12 Page 233 Table 7.6: Estimated Cost of Synthetic Fuels (1979 US Dollars) Source of US Dollars per Barrel Liquid Oil of oil equivalent Coal 20.00 - 28.00 Oil Shale 32.00 - 68.00 Alcohol Fuel 36.00 - 65.40 Source: World Bank (1980a). Page 234 percent and 14 percent for middle and ceiling price levels respectively. Given the floor, medium and ceiling oil price levels, their time paths during 1980-1995 will then be in accordance with the positions outlined for the three subperiods. The time paths presented in Figure 7.1 are derived from the floor, middle and ceiling prices presented in Table 7.7. For the ceiling price case, two alternative time paths are presented. Time path (a) is obtained from the calculated values in Table 7.7 while time path (b) is a modification of time path (a) under the additional assumption that the Middl-Eastern producers will exercise their supply leverage during 1980-1990 which they perceive to be their final opportunity of maximising earnings from their balance oil reserves. The above oil price projections stemmed primarily from the focus on future synthetic rubber feedstocks supply. The discussion on oil and non-oil energy supply and substitutability in the coming decades has revealed that liquid oil, and hence oil products, can be manufactured from several sources. Consequently the search for non-oil energy is likely to solve the question of energy and feedstock raw material inputs supply simultaneously, thus widening the spectrum of raw material availability for all synthetic materials, viz. fertilisers, fibres and rubber. The tendency is reinforced by the vertical integration of the petrochemical feedstocks and synthetic goods industries. For the purpose of this study the implication is that the oil supply constraint on the transport and synthetic rubber industries is expected to diminish over the longer-term. For the natural rubber industry the implication therefore is that the Page 235 Price of Oil (US$/Barrel) 260 240 --Ceiling 220 Price (b) / P 200 (a) 180 / / / / Mid-Level / / /Price 160 / / / / / / -/ // / 140 / / / 120 / / /Floor 100 r / / // / Price 80 / /7 / /7/ 7/ 60 - 404 40 / 20 0 - I a I , . l , * i , al I , , .,I I I . 1 il 1975 1980 1985 1990 1995 Year Figure 7.1: Time Paths of Oil Price Under Alternative Scenarios, 1980-1995. Page 236 Table 7.7: Alternative Price Level for Oil, 1980-1995 (current US Dollars per Barrel) Year Floor Price Mid-level Price Ceiling Price 1980 28.25 31.36 31.92 1981 31.08 35.12 36.39 1982 34.18 39.34 41.48 1983 37.60 44.06 47.29 1984 41.36 49.35 53.91 1985 45.50 55.27 61.46 1986 50.05 61.90 70.06 1987 55.05 69.33 79.87 1988 60.50 77.65 91.05 1989 66.60 86.96 103.80 1990 73.30 97.40 118.33 1991 80.60 109.09 134.90 1992 88.70 122.18 153.79 1993 97.50 136.84 175.32 1994 107.28 153.26 199.86 1995 118.00 171.65 227.84 Page 237 competition from the synthetic rubbers sector is likely to persist energetically in the foreseeable future. 7.5 Projecting Remaining Exogenous Variables The remaining exogenous variables that require projecting for purpose of simulating the estimated model are the industrial production indices of the individual countries and/or their production of tyres and tubes. The three assumptions used for simplifying the projection procedures are: (1) that the growth of industrial production will proceed at the same rate as gross domestic and/or national product; (2) the production of tyres is correlated with, and thus derivable from, the projected industrial production indices; (3) the production of tubes is correlated with the production of tyres. Consequently the projections of exogenous variables depend on the projected growth rates of gross domestic and/or national product. As such growth rates have been projected by various organisations, the published figures were referred to. The choice of growth rates used in this study followed from an evaluative review of projections by the World Bank (1980a, 1980b). Page 238 7.5.1 Economic Growth Rates and Price Indices As the level of oil price is seen to remain an influential determinant of economic growth rates attainable in the coming decade, the projected growth rates should be consistent with the projected price of oil. In evaluating growth rate projections for their consistency, it is therefore helpful if the oil price projections (on which they are based) be known. The advantage of using the World Bank projections is that the projected growth rates and oil prices for 1980-1995 are available simultaneously. A comparison of the oil price projections in Figure 7.1 with those by the Bank thus provides a link (between the price projections and the Bank's growth projections) which lends perspective from which to project alternative growth rates. Since the Bank's published growth rates refer to the high growth case, alternative medium and low growth rates were projected to correspond to the situations when medium and floor levels of oil price will obtain respectively. In projecting the wholesale price indices (WPI) it was assumed that the behaviour of prices during 1980-1995 will, to a large extent, be influericed by the behaviour of oil price. Using oil price as the explanatory variable, the projected low/medium/high wholesale price indices for UK and USA were estimated from simple regressions of the relevant price index on the price of oil. Page 239 7.5.2 Activity Indices and Rubber Manufacturing Industrial activity, measured by either the index of industrial production or of rubber goods production, is an exogenous variable for the input demand equations. In projecting this and other activity-related exogenous variables, the industrial production growth rates were assumed to be identical with those for GDP. Thus for each country the projected GNP growth rates were assumed as the rate of industrial production. The growth rates for USSR were assumed to be representative of the growth rates within COME&ON and therefore used as rates for that bloc of countries. To project the output of tyres, it was assumed that the rate of tyre production is associated with the rate of industrial activity.8 Since tubes are jointly used with tyres, their production depends on the level of tyre production. Except for Italy, the parameters used for projecting output of tyres and tubes were obtained by simple linear regressions. For Italy, despite the use of log-linear regression, the coefficient of determination remained low. The estimates used in projecting tyre and tube output are given in Table 7.8. Since industrial production indices compiled on a calendar year basis for Australia are unavailable, the GNP growth rates were assumed to be the growth rates of tyre production. Finally it is necessary to project the world synthetic rubber production capacity. 0 The rapid expansion of the synthetic rubber production capacity in the historical period arose from the 8 This is vindicated by Smit's projections of world rubber demand under alternative scenarios, where rubber demand was found to be highly sensitive to levels of economic growth but insensitive to different saturation levels. For further details of Smit's approach, see Smit (1981). Table 7.8: Projected Low(L), Medium(M), and High(H) Rates of Growth of Industr`ial Production, 1980-1995. (Percentages) 1980 1981 1982 1983 - 1985 1985 - 1990 1990 - 1995 Country L M H L M H L M r H L M H L M H L M H Austr-lia 2.8 3.0 3.5 2.5 3.0 3.5 3.0 4.0 4.5 3.5 4.5 5.5 3.5 5.0 6.0 3.5 5.0 6.0 Brazil 5.0 5.0 5.5 4.5 5.0 5.5 4.5 5.5 6.0 5.0 6.0 7.0 5.5 7.0 8.0 5.5 7.0 8.0 Canada 1.5 2.0 2.5 1.5 2.0 2.5 1.5 2.5 3.0 2.0 3.0 4.0 2.5 4.0 5.0 2.5 4.0 5.0 China 5.5 5.5 6.0 5.0 5.5 6.0 5.0 6.0 6.5 5.5 6.5 7.5 6.0 7.5 8.5 6.0 7.5 8.5 COMECON 3.0 3.0 3.5 2.5 3.0 3.5 2.5 3.5 4.0 3.0 4.0 5.0 3.0 5.0 6.0 3.0 5.0 6.0 France 2.0 2.0 2.5 2.0 2.0 2.5 2.0 3.0 3.5 2.5 3.5 4.5 3.0 4.5 5.5 3.0 4.5 5.5 West Germany 2.3 2.5 3.0 2.0 2.5 3.0 2.5 3.5 4.0 3.0 .0 5.0 3.5 5.0 6.0 3.5 5.0 6.0 India 5.0 5.0 5.5 4.5 5.0 5.5 4.5 5.5 6.0 5.0 6.0 7.0 5.5 7.0 8.0 5.0 7.0 8.0 Italy 2.0 2.0 2.5 1.5 2.0 2.5 2.0 3.0 3.5 2.5 3.5 4.5 3.0 4.5 5.5 3.0 4.5 5.5 Japan 4.8 4.5 5.0 4.0 4.5 5.0 4,0 5.0 5.5 4.0 5.0 6.0 4.5 6.0 7.0 4.5 6.0 7.0 Netherlands 1.8 2.0 2.5 1.5 2.0 2.5 1.5 2.5 3.0 2.0 3.0 4.0 2.5 4.0 5.0 2.5 4.0 5.0 UK -2.0 1.0 1.5 -1.0 1.0 1.5 0.0 1.0 1.5 0.5 1.5 2.5 1.5 3.0 4.0 1.5 3.0 4.0 USA -1.3 0.5 1.0 -1.0 0.5 1.0 0.0 1.5 2.0 0.5 1.5 2.5 1.5 3.0 4.0 1.5 3.0 4.0 ;Q Page 241 availability of low-priced oil and feedstocks and technological progress in producing synthetic rubbers not only more economically but with improved physical properties. These factors were reinforced by the economies of scale in synthetic rubber production, all of which enhanced the world expansion of synthetic rubber production capacity. Since the price of oil is an important determinant of synthetic rubber production cost, the future growth of the industry will depend partly on further technological progress to offset this source of increased production cost. The synthetic rubber industry is expected to step up research and development on two complementary fronts: the short-to medium-term search for new and/or improved rubbers to further compete with natural rubber both qualitatively and quantitatively is expected to be complemented by the longer term search for alternative sources of feedstocks. Thus the production capacity is some function of the price of oil and technological progress (proxied by a trend variable). The estimates obtained from log-linear regression of the historical data and presented in Table 7.9 are used in projecting the synthetic rubber production capacity for 1980-1995. The low/middle/high levels of production capacity are generaterd from the ceiling/middle/floor levels of oil price respectively. For technological progress it is simply assumed that the historical rate of development to persist. These projected production capacities were then revised in the light of lower observed values for 1980. The observed difference between these values as a percentage of the observed 1980 value were then used to scale down the low/middle/high levels of production capacities accordingly. The scaling factors were 7.5 percent, 13.8 percent and 15.0 percent for the low, middle and high levels respectively. Page 242 Table 7.9: Estimates Used in Projecting Values of Exogenous Variables. Dependent Oil oil 2 Variable Constant IPI QTY p 1in p Trend R F DW France QTYC -12074.4351 451.8766 0.9444 288.7231 0.5100 (-4.8) (17.0) QTYV 288.8001 40.8964 0.9291 222.6200 1.0575 (1.1) (14.9) West Germany GPIC 19.1382 0.7654 0.8697 140.1315 0.5883 (3.4) (11.8) GPIV -13.6284 1.0812 0.8951 179.1941 1.0910 (-2.0) (13.4) Italy QTY 3.4i21 0.4321 0.3871 7.5604 1.0768 (4.7) (2.8) QTU -5.0656 0.1322 0.7378 33.7579 1.9519 (-0.9) j5.8) Japan QTY -6.3450 0.3364 0.9870 1590.4401 1.8220 (-4.0) (39.9) QTU 14.9853 0.4165 0.8267 76.3379 0.4488 (4.8) (8.7) UK QTYC -19512.3717 431.9557 0.9253 259.9225 0.8964 (-8.0) (16.1) QTYV 420.4762 33.1630 0.7423 G0.4790 0.731G (1.1) (7.8) USA QTYC 24.0354 1.2668 0.8368 107.6919 0.8623 (2.0) (10.4) QTYV -6.440 0.3140 0.9446 358.1726 1.3352 (-3.9) (18.9) QTYT 2.1009 0.0246 0.4528 17.3781 1.0407 (3.6) (4.2) WPI UK 33.3040 0.0737 0.8675 117.8705 1.0806 (8.0) (10.9) (F1 18) WPIUSA 85.9227 0.0829 0.9285 233.9126 1.3056 (25.7) (15.3) ( 1, 18) ln CQSR 5.6923 -0.0561 0.0768 0.9917 771.9240 0.9287 (79.1) (-2.9) (21.6) (F2,13) Page 243 CHAPTER EIGHT STABILISING THE NATURAL RUBBER MARKET 8.1 Introduction This chapter examines the issue of stabilising the natural rubber market. In contrast to some recent wider-ranging empirical studies on commodity market stabilisation, the present study is limited in that the natural rubber market is considered in isolation. This is so as to focus on natural rubber stabilisation from the longer-term perspective of 15 years during which two trends are anticipated: (1) increasing natural rubber supply availability as a resuilt of increased and more productive investment in natural rubber production in Southeast Asia and also in Latin America, such as Brazil and Mexico, and (2) the widening range of synthetic rubber feedstocks supply snurces as synthetic crude oil production technologies improve. With the enforcement of the International Natural Rubber Agreement (INRA) under the Integrated Programme for Commodities, the stabilisation targets of the INRA provides the terms of reference for this analysis of stabilising the natural rubber market by buffer stock operations. The aim of this chapter is to evaluate price stabilisation in a longer-term setting which considers the outlook and prospects for natural rubber. In this context, the starting point is the scenario assumed for oil price. The analysis of medium-term price stabilisation under the low oil price scenario will be presented in Page 244 this chapter. In the next chapter longer-term price stabilisation will be analysed. In the following discussion the possible benefits of price stabilisation will first be surveyed. Then the theoretical underpinnings of price stabilisation, namely the positive and normative aspects, will be discussed. In discussing the positive aspects of price stabilisation, the array of trade-offs that are critical in evaluating any stabilisation programme will be highlighted. Then stabilisation targets and operational rules specified by the INRA for both zhe short-term (daily and monthly) and longer-term (one-and-a-half to five years) operation of a buffer stock will be presented. In order to use the annual model presented in Chapter Six to evaluate the INRA, it is necessary to focus on the operational rules specified for the longer-term. This is because these operational rules amount to constraints which provide guidelines for formulating a viable buffer stock policy to achieve the broad stabilisation targets of the INRA. As the study is concerned with the longer-term, and as the INRA is proposed for a 5-year period only, stabilisation over a 10-year period will be analysed in the next chapter on the basis of a hypothetical extension of the INRA for a further 5-year term. Page 245 8.2 Alleged Benefits from Price Stabilisation Although this exercise concerns the analysis of the positive aspects of price stabilisation, a brief discussion of the alleged benefits from price stabilisaton will be presented first. This is useful in placing the subsequent stabilisation results against the background of conflicting attitudes towards price stabilisation. Arguments for price stabilisation may be divided into (a) those from the standpoint of producer-countries, an aspect of which is the UNCTAD Common Fund position and (b) those from the standpoint of the consumer-countries. From the standpoint of the producing countries, it is sometimes alleged that the primary benefit of stabilisation lies in providing producing countries with bargaining strength to counter that of the consuming countries (Avramovic, 1978). This argument implicitly relies on the distinction between pure price stabilisation and stabilisation which also changes average price. The bargaining strength of producing countries is enhanced only wqhen stabilisation results in a higher average price than that without market intervention. Moreover, whether the greater bargaining strength actually conveys gains to producers requires further analysis. In contrast, pure price stabilisation allegedly benefits producers in two ways. First it is frequently assumed that risk-averse producers benefit from the resulting reduction in price variations. Second, although price stabilisation may be a short- to medium-term solution, the period of stabilisation would provide producing countries with time to evaluate their medium- to long-term resource allocation problem and to implement the necessary structural adjustment policies. The greater economic benefits of stabilisation is therefore viewed as Page 246 stemming from the dynamic effects associated with increased investment through more successful implementation of development plans enabled by more stable export earnings (Avramovic, 1978; Cline, 1979). Because of the interdependence between the primary producing and industrialised countries, price stabilisation also yield secondary effects beneficial to industrial countries. Such benefits are seen to stem from the levelling out of business cycle effects and may also impact on inventory policies in the industrialised countries (Harrod, 1958). Cline (1979:17) has argued that the largest economic benefits from commodity stabilisation would be the gains to industrialised countries through the reduced inflationary pressures (as a result of dampening price rises) in these countries. Such gains accrue because if price flu.tuations cause importing countries to implement macroeconomic policies aimed at reducing inflation caused by higher input prices, then the resultant effect may be lower levels of economic activity and employment and reduced real output. Over the longer-run, price stabilisation would probably also yield further macroeconomic gains for the industrial countries through minimisation of the "ratchet effect" of price increases of industrial raw materials. Price stabilisation would also lead to improvements in the overall world economy because more stable export earnings would improve the debt servicing of the developing countries and thus contribute to the international credit system. Other proponents of market intervention argue on the basis of the imperfection in commodity markets: in general, free trade need not be optimal because the assumptions of the free trade model are not satisfied in reality (Baldwin and Kay, 1975; Law, 1975; Rangaranjan, 1978). This last argument is of relevance to the natural rubber market because of the Page 247 contrasting industrial organisation of the synthetic rubber industry. There are counter arguments to these supposed benefits of price stabilisation. The argument for increasing producers' bargaining strength can be counteracted for two reasons. Firstly, where there is an existing, readily available substitute, as is the case with natural rubber, price leverage depends not only on overall supply and demand forces, but also on the "degree of essentiality" for the commodity (Stern and Tims, 1975). This "essentiality" condition is reflected in the minimum requirements for natural rubber in tyre production. Secondly, the price band that emerges in a stabilisation agreement is the outcome of bargaining between the participants; the agreed price band therefore reflects the resolution of price and political (due to the strategic nature of the commodity) leverage of the producers and consumers at the outset. Since stabilisation agreements typically provide clauses for re-negotiation of the stabilisation price bands (to avoid exhaustion of financial resources), the price leverage attained through the agreement can be negated if the price bands are subsequently revised downwards. On the wider issue of dynamic macroeconomic effects from commodity market stabilisation, there is also a spectrum of views. Cline, who argues for stabilisation, also admits that "Unfortunately, the state of the art does not provide any basis for estimating these (dynamic) effects, but they are probably much larger than the "static" benefits from stabilisation.' (Cline, 1979:17). However, Adams (1979) asserts that the empirical findings from his work COMLINK (linking commmodity models to the LINK system) suggest that the behaviour of conmodity markets do affect commodity prices, trade unit values, Page 248 domestic prices and real economic activity. This still leaves open the question of whether price stabilisation is necessarily the best policy to adopt. The argument against price stabilisation stem from similar c.onsiderations of commodity market features and economic interdependence between countries to those considered above. Opponents of price stabilisation agree in general that commodity markets do not operate under conditions of perfect competition, but tend to emphasise the complexities of market instability. Bauer and Myint (1976) for example, argue against price stabilisation because of the hidden costs involved and because controlled markets are considered to be so full of complexities that they will be difficult to beat. Moreover, they argue that there is inherent stability in commodity markets and that producers are not always poor. The latter point warrants careful consideration in a situation such as that for natural rubber where production is largely in the hands of smallholders. Opponents of price stabilisation also question the efficiency of price stabilisation by emphasising the essential divergence between producer and consumer interests. These writers then argue that the problem of price and export instability may be better approached by considering other instruments, such as commercial policies, domestic macroeconomic stabilisation, compensatory financing, exchange rate adjustments, etc. It suffices to indicate here that each of these instruments raises an attendant host of possible outcomes and qualifications. For example, in the use of compensatory financing, the question raised is whether to consider such financing with respect to the total export earnings or to export earnings on a commodity-to-commodity basis, since these have Page 249 differential implications for different primary producing countries (Morrison and Perez, 1976). Another position taken against price stablisation is that it is arguable whether export instabilty leads to negative effects, such as reduced development finance and hence reduced investment (Knudsen and Parnes, 1975). Thus MacBean (1966), for example, queries whether export instability is really a bad thing or whether its negative impact has been exaggerated. In this vein Ariff (1972) for example, argues that the long-term effects of export instability for Peninsular Malaysia has been neutralised by means of the built-in stabilisers in that country's fiscal policy. 8.3 Some Results of Theoretical Models In considering the theoretical results, it is pertinent to distinguish the normative from the positive results. The normative issue concerns the indirect welfare effects while the positive issue has concentrated on the direct price and income effects of stabilisation. The ultimate aim is to identify the gainers and losers from price stabilisation. Since the early studies concentrated on the welfare effects of stabilisation, these will be briefly discussed first. Most theoretical analyses of stabilisation assume complete price stabilisation, while in practice attempts at stabilisation have been of the partial type aimed at defending a price band rather than a Page 250 price level. The analytical results discussed here will first relate to complete price stabilisation. In theoretical studies prices are normally assumed to be serially uncorrelated so that there is no time cycle for price behaviour. As will be mentioned later, natural rubber prices have been observed to follow cyclical patterns. Early studies on price stabilisation generally assumed linear supply and demand functions with additive disturbances. Waugh (1944) focussed on the effects of price stabilisation on consumers only, and oi (1961) concentrated on the effects on producers only. Massell (1969) considered the effects of price stabilisation for producers and consumers simultaneously. Using linear functions and additive stochastic disturbances, Massell showed that while price stabilisation will unambiguously lead to a net welfare gain, the distribution of this welfare gain was not unambiguous; this was because the welfare gains/losses of the producers and consumers severally depends critically on the source of instability causing the price fluctuations. The level and distribution of the net welfare gain between producers and consumers also depends on the demand and supply elasticities. But as Porter (1969) indicated, it is not easy to assess accurately the 'blame' for the price fluctuations from observed market behaviour. Such assessments require a very specific set of (explicit and implicit) assumptions regarding the trend around which the fluctuations are to be measured and about the short-run price elasticities. Moreover, over a broad spectrum of commodities, the basic cause of price fluctuations is the interdependence of supply and demand fluctuations. For a recent study on the optimality of price-band stabilisation by buffer funds, see Quiggin and Anderson (1981). Page 251 More recently, work by Turnovsky (1978) and Just et al. (1978) with nonlinear functions have questioned the relative importance of the source of instability for determining the distribution of the welfare gain from price stabilisation. In their mo.els, stochastic disturbance terms are multiplicative and the supply and demand functions are nonlinear. Using nonlinear or linear functions poses an initial problem in terms of the price about which to stabilise, if the buffer stock is to be self-liquidating at the stabilised price. Under linearity, the stabilisation price for a self-liquidating buffer stock would be the arithmetic average of all observed prices; in contrast, self-liquidating stabilisation with nonlinear functions need not be about the expected price (Turnovsky, 1978). Assuming the stable price is chosen so as to be self-liquidating, the desirability of price stabilisation for either producers or consumers depends "only upon the shapes of the deterministic portions of the supply and demand curves. If one group benefits from having price stabilised, it will do so whether the random price arises from stochastic disturbances in demand or in supply." (Turnovsky, 1978:127). In other words, the effects of stabilisation depends on the interaction between the supply and demand elasticities and the random disturbances. In these circumstances, Just et al. (1978) have shown that opposite results to those found by Massell (1969) may obtain; for example, if the stochastic disturbance terms of the supply function is multiplicative, then consumers may still benefit from price stabilisation, despite the fact that the instability lies with supply. (Massell had earlier shown that if the source otA Page 252 inscability is on the supply side, then consumers would lose from price stabilisation.) Broadly speaking however, price stabilisation under nonlinear supply and demand functions with multiplicative stochastic disturbances tends to lead to an overall welfare gain which generally favours consumers. All of this means that the normative results of stabilisation depend crucially on the specifications of the model in question. Because the functions and disturbances may differ among individual producing and consuming countries, these results also imply that the extent of gains/losses may differ among producing or consuming nations. Another difficulty with empirical evaluation of the welfare effects of price stabilisation lies in the choice of the welfare criterion (criteria) for measuring the stabilisation benefits. In the main the concepts of consumers' surplus and producers' surplus have been used; for example, Turnovsky (1978) derived the change in producers' welfare (surplus) in terms of the change in producers' abnormal profits. The choice of the profits criterion raises the further question of the method by which producers' price expectations are formed, as the following discussion will show. Using linear supply and demand functions, and additive stochastic disturbances, Turnovsky (1978) shows that the change in profits depends on the slopes of the supply and demand functions as well as on the disturbance terms. The change in consumers' welfare as measured by consumers' surplus is shown to be determined by the same terms. Turnovsky then introduced price expectations into producers' behaviour. If expected prices are based Page 253 on adaptive expectations, then the producers' gains from price stabilisation is found to be determined by the difference between the expected and market prices. The importance of introducing price expectations is the introduction of lagged prices and hence autocorrelation in the disturbance terms into the system. However, under adaptive expectations, producers could still benefit from price stabilisation under demand shifts provided the fluctuations in demand are not excessively autocorrelated. But if producers' price expectations are formed along the lines of Muthian rational expectations, where expectations are made conditional on all the information available at the time of price forecasting, then producers will not benefit from price stabilisation for demand fluctuations. The problem of using expected consumers' surplus as a measure of welfare change from stabilisation under conditions of price uncertainty has also been examined recently by Turnovsky, Shalit and Schmitz (1980). By using the consumer's indirect utility function in order to derive demand functions, it is shown that assumptions about risk attitudes are implied by the expected value of consumers' surplus as the measure. This implies the restrictive assumption that the "income elasticities of those goods subject to price variation all egual the coefficient of relative risk aversion." (Turnovsky et al., 1980:141). Alternatively, if welfare change is measured by the more general expected utility criterion, then consumers' gains from price stabilisation is shown to be determined by (1) own price elasticity for the good under stabilisation, (2) coefficient of relative risk aversion, (3) the share of the consum6r's budget allocated to the good under stabilisation and (4) income elasticity of demand for the good under stabilisation. Page 254 These examples illustrate the difficulty of measuring the welfare effects since the price expectations hypothesis together with the choice of welfare criterion lead to further consideration of the assumptions made in the formulation of the objective function to be used. On this question, Labys (1980) has succinctly summarised all the issues that warrant simultaneous consideration for effectively determining whether producers or consumers gain or lose from stabilisation; these are: (1) the source of the price instability; (2) the nature of the stochastic disturbances (additive or multiplicative) and the autoregressive properties; (3) the nature of producer response and their formation of prħce expectations and attitudes towards risk; (4) the defini-tion of the surplus used; (5) the choice of partial as compared to complete price stabilisation and (e) the identification of importing or exporting nations as distinct from consumers and producers. Various writers have not only pointed to the drawbacks in the use of consi.mers' and producers' surpluses as conventionally defined, but have also proposed that the welfare criteria be extended to include the incorporation of the difference between consumer and producer prices, the recognition of final produict prices iio the c'.sumers' surplus and the consideration of input prices in the producers' surplus (Labys, 1980). Page 255 The discussion will now turn to the positive issues of the direct price and income effects of stabilisation. In considering market stabilisation, it is essential to distinguish two types of effects: (1) the effect of stabilising a variable x on the change in the average level of the variable itself and (2) the effect of stabilising a variable x on the stability and the average level of variable y as a result of interaction between x and y. Two variables other than price are commonly considered, namely producer incomes and export receipts. The difference between producer incomes and export receipts is dependent on (a) whether the commodity exported is also consumed domestically, (b) whether the export price differs from the domestic price for the commodity in question and (c) the use of imported inputs. It is therefore necessary to be clear about the following separate effects of price stabilisation and their interaction; namely, (a) the resultant change in average price; (b) income stabilisation/destabilisation and the resultant change in average income; (c) export stabilisation/destabilisation and the resultant change in export earnings. Price stabilisation is distinct from income stabilisation, although it is commonly assumed that price stabilisation must lead to stabilisation of producers' incomes. Indeed the two objectives may Page 256 not be compatible. Hence even if average price can be maintained by a self-liquidating buffer stock scheme, income stability may still be negatively affected. Radetzki (1970) has shown that whether price and income stabilisation are compatible would depend on the demand and supply elasticities as well as on the relative sizes of demand and supply fluctuations. Even if price and income stabilisation can be simultaneously attained, there is a question of whether average income (and export earnings) will be aff.tcted negatively. This is because many primary commodities face derived demands which are determined by business cycles. The argument that demand for these commodities tend to be highly inelastic during the upswing then facilitates the optimistic result that price and export instability provides opportunities for maximising export and foreign exchange earnings; in other words, price stabilisation may lead to a loss in export earnings during the boom period (Grubel, 1964) and to lower total export earnings over the entire period. The relevance of this for natural rubber lies in the minimum (essential) rubber requirements in tyre production. If producers' revenues are correlated with export revenue, then total producers' revenue over the stabilisation period may similarly be negatively affected. The co-financing of stabilisation schemes by the producing and consuming countries participating in the schemes also raises the question of the stability of incomes shares; price stabilisation may benefit producers differentially so that their gains from stabilisation need not correspond to their production, and hence financial contribution, shares. If buffer stocks are used to Page 257 stabilise price, then the trade-off between stabilisation gains and the capital and operational costs of the buffer stock programme have also to be taken into consideration. Consequently, evaluation of stabilisation schemes involves examining the effects of price stabilisation on incomes, export earnings and welfare of each country. Given all these difficulties, an alternative to estimating the distribution of welfare gains and losses is to analyse the positive aspect of price stabilisation on the distribution of prices, producer incomes and total sales. This approach is also more tractable and is adopted here. 8.4 The International Natural Rubber Aqreement (INRA) Natural rubber is one of the ten key primary commodities included for price stab_lisation under the pronosed UNCTAD Integrated Programme for Commodities. The first United Nations Conference on Natural Rubber was held in 1978 and the INRA subsequently drafted and in principle agreed upon in October 1979. The INRA was to come into provisional force on 1 October 1980 provided that it was ratified by countries representing 65 percent of ;'rorld producers and 65 percent of world consumers. Failing this, the INRA "will enter into force definitively on 1 October 1980 or any other date thereafter when countries/governments accounting for 80 oercent of net exporters and 80 percent of net importers have ratified the agreement". (Natural Rubber News, 1980:4) It is only when the INRA enters into force definitively and when the participatinq members have made the Page 258 necessary contributions that the proposed Buffer Stock can commence operations. Once enforced, the INRA would remain in force for five years unless otherwise extended or curtailed. The INRA was made operational at the first meeting of the International Natural Rubber Council (INRC) in Geneva in January 1981. At this meeting, Kuala Lumpur was chosen as the headquarters of the INRC and the principal officers of the INRC were named. By November 1981, the buffer stock manager had begun buying on the Malaysian and Singapore markets when natural rubber prices had fallen below the S$2100 floor price. The declared aims of the INRA are (a) to stabilise natural rubber price and (b) to obtain steady growth in the natural rubber export revenues of the producer-countries. In this Agreement a natural rubber buffer stock is the sole instrument for market interventions to attain the primary objective of price stabilisation. The total buffer stock capacity of 550,000 tonnes is to be divided between normal and contingency buffer stocks of 400,000 and 150,000 tonnes respectively. To implement a buffer stock scheme it is necessary to specify the terms of reference for its operations, these terms referring to price range and time horizon. For a given time period (assuming that the reference price is realistically and correctly set), the price range defendable is inversely related to the buffer stocks capacity; that is, the narrower the range within which price is to be stabilised, the larger the buffer stock required. Since the buffer stock is set, a priori, by the INRA, the time horizon is crucial in determining the Page 259 price range which the buffer stock is expected to, and can, adequately defend. The determination of this price range hinges on the choice of a reference price about which price fluctuations are expected to occur; thus the reference price links the buffer stocks and commodity market since the buffer stock operation rules are specified in relation to the reference price. If price stabilisation about the free market (that is, free in the sense of no intervention by stabilisation schemes) price is the primary purpose for operating a self-liquidating buffer stock, then the reference price may be approximated by the free market trend price. 8.4.1 INRA Buffer Stock Price Bands To guide the buffer stock management on the timing of intervention, four sets of alternative price levels and ranges relating to optional/compulsory INRA interventions have been specified. These are: (a) Reference Price This is the level about which price is expected to fluctuate; for the initial term, the reference price is set at the nominal price of M$2100 per tonne for one-and-a-half years. 2 Hereafter all prices with regard to INRA specifications refer to the price per tonne of natural ruabber in Malaysian Ringgits(Dollars). Page 260 (b) Intervention Prices The intervention prices which define the no intervention price band are plus or minus 15 percent of the reference price (that is, $1790 and $2420). Within the no intervention price band the only operations required are those for stock rotation. Cc) Trigger Prices These are plus or minus 20 percent of the reference price (that is, $1680 and $2520) and draw the line between optional versus compulsory buffer stock operations. (d) Indicative Prices These are the reference price plus or minus $600 (that is, about 30 percent of S$2100) and contain the price band delineating the permissible price fluctuations. In contrast to the time horizon for the reference price, the indicative prices of $1500 and $2700 are to be valid for two-and-a-half years. The relation of the various price levels to.the Reference Price and their significance for buffer stock operations are summarised in Figure 8.1. The daily buffer stock operations will be based on the daily market indicator (different from indicative) price. The daily market indicator price is to be a composite weighted average of daily official curreiit-month prices on the Kuala Lumpur, Singapore, London Upper Indicative Price (2; Years Horizon) $ 2700 Price for bringing in Contin encyBuffer Stocks $ 2610 BuffrŽr Stocks --_Zeny --Sales Compulsory Upper Trigger Price $ 2420 Buffer Stocks * Upper Intervention Price Sa.le.s..Opton........................................... S O al No Buffer Stocks Reference Price (1 Year Horizon) $ 2100 Operation except Stock Rotation Lower IntPerveintionPrce Buffer Stocks Lower Trigger Price $ 1680 Purchases Optional Price for bring in Contingency Buffer Stocks $ 1590 Buffer Stocks ----.---------- -- - Purchases Compulsory Lower Indħcative Price (2½ Years Horizon) $ 1500 Figure 8.1: Price Ranges Specified for BufferStocks Operations Under the International I Natural Rubber Agreement q (D Page 262 and New York markets. Initially the daily market indicator price will be an equally-weighted average of the prices for RSS1, RSS3 and TSR20 grades of natural rubber quoted in Malaysian or Singapore currencies. To monitor price behaviour, the average market price for a minimum of five consecutive days will be used as a yardstick for evaluating the market indicator price in relation to the INRA-specified price levels. Thus if the market indicator price remains higher than the reference price for five or more consecutive days, then the market indicator price shall be deemed to exceed the stipulated reference price. In the use of the two-part buffer stock, the 400,000 tonnes normal buffer stock is expected to be adequate for defending the indicative price limits under normal circumstances. Should normal circumstances not obtain (that is, when buffer stock sales/purchases level reaches 400,000 tonnes before the upper/lower trigger price level is reached), the 150,000 tonnes contingency buffer stock is to be mobilised when either (i) the market indicator price reaches the trigger level or (ii) the market indicator price lies in the range when buffer stock operations are stipulated to be compulsory. Under the INRA, alternative (i) is to be applied when the market indicator price reaches the mean of the trigger and indicative prices unless the IRC votes to the contrary. Thus the total buffer stock will be used to ensure the maintenance of the indicative price band. Page 263 8.4.2 Price Band and Time Horizon Since the choice of the reference price level is influenced by the time horizon used, clauses providing for reference price revisions and the monitoring of buffer stock movements must be specified in relation to time. The time horizons for the INRA are: (a) a five-year term once the INRA in enforced; (b) one-and-a-half years for the reference price during which time it is to remain at $2100; (c) two-and-a-half years for the indicative price during which time the indicative price band ($1500, $2700) is to remain unchanged; (d) one-and-a-half years for buffer stock variations during which time the net change should not exceed 100,000 tonnes; that is, at any point in time, say at month t, the buffer stocks (BS) movement must satisfy (BSt - BS i) < 100,000 tonnes for i = 1, 2 ......... 18 months; (e) constraints to clause (d) are that net total BS sales/purchases should not exceed 300,0000 tonnes since Ci) the enforcement of the INRA, (ii) the last revision of the Reference Price, or (iii) the last revision of BS net sales/purchases of (d), whichever is the most recent. When any of the constraints become binding, then the Reference Price Page 264 is to be lowered/raised by 3 percent of current level unless the IRC decides differently. These constraints therefore provide for changes in the Reference Price. In the event of failure by the buffer stock operations to satisfy the time horizon constraints, the corresponding resolutions provided for each of constraints (b) to (e) above are: (b') if the six-month average daily indicator price prior to the review date exceed the intervention price limits, then the reference price should be revised upwards or downwards by 5 percent as the situation demands; (c') the indicative price band is to be reviewed when either (i) within two-and-a-half-years, the reference price has been revised upwards(downwards) by more than 3 percent subsequent to a previous indicative price revision and in the 60 ensuing days the market indicator price continues to be above(below) the upper(lower) intervention price, or (ii) within one-and-a-half years the reference price has been revised upwards(downwards) by more than 5 percent subsequent to the previous indicative price revisions, and in the 60 ensuing days the market indicator price continues to be above(below) the upper(lower) intervention price. (The same implication as in footnote 3 applies here.) The implication here being that the buffer stock capabilities is exhausted iand its effectiveness will be reinstated only if the indicative price band is revised. Page 265 (d') If the net change in buffer stocks exceeds 100,000 tonnes within one-and-a-half years, then the situation will be assessed and if necessary, one of the followina measures will be adopted: (i) suspend the buffer stock operations; (ii) change the rate of buffer stock operations (that is, by realigning the intervention and trigger price level for buffer stocks sales/purchases); (iii) revise the reference price without modifying the indicative price band. (e') Should net buffer stock sales/purchases exceed 300,000 tonnes (1) after the enforcement of the INRA or (2) after a revision of the reference price or (3) after the revision of the buffer stock net sales/purchases volumes permitted, whichever alternative is the most recent, then the reference price level shall be deemed inappropriate again and should be revised by plus or minus 3 percent of the existing level unless the IRC decides otherwise. 8.5 Towards a Viable Stabilisation Policy under the INRA The first aspect of INRA to be considered is the question of feasibility. In using the econometric model presented in Chapter Six to simulate buffer stock operations for purpose of identifying a viable price stabilisation policy for the natural rubber market in the medium- to longer-term, the desirability of price stabilisation will be maintained. The simulation exercises attempt to "tell, if Page 266 possible, what degree of stability can be realistically attained." (Klein, 1978:116) under a given forecast scenario, bearing in mind that the determination of the stabilisation price band depends critically on the capital resources available to the IRC as well as the conditions and constraints specified by the INRA for the buffer stock operations. The INRA is intended for a 5-year term; however, the INRA price bands are specified for the shorter period of one-and-a-half years after which they are subject to review and revision. The problem here is that frequent price band revisions -- suggestive of a myopic approach -- not only involve time-consuming negotiations but more importantly, could mean the loss of longer-term price stabilisation. Consequently, successful longer-term stabilisation that avoids frequent renegotiations should be based on price bands relevant to longer-term market behaviour. Thus the key features of the INRA outlined in section 8.3 will here be used only as a guide to the choice of simulation exercises. The basic capital resources available are represented by the proposed 400,000 to 550,000 tonnes of natural rubber stocks. The relation between this capital and time are provided by the above clauses (a) to (e) which specify the operational conditions and constraints for longer-term buffer stocks stabilisation. It is through these clauses that the price band becomes integrated with the time horizon envisaged for the programme. It will be recalled that the demand for natural rubber is derived in nature, and closely associated with business fluctuations of the industrialised countries. UNCTAD estimates show that during 1960-1974, natural rubber prices displayed complete cycles having a Page 267 maximum length of 42 months (peak-to-peak) with downswings extending at most to 27 months from peak to trough (UNCTAD, 1975:11). With reference to the lengths of these historical cycles, the operation of a buffer stock programme on the basis of a possible five-year downswing (which is the interpretation adopted here of the UNCTAD clauses) would constitute a cautious stabilisation policy that allows considerable flexibility at the margin. This will be elaborated in the following discussion. To illustrate how the buffer stocks will be initiated and operated on an annual basis, suppose that price forecasts for 1980 to 1990 lie within the price band delimited by the indicative f.o.b. Singapore prices $1500 and $2700. If the forecast price per tonne never falls below the nominal price of $2100, then no buffer stock simulations will be required. However, if the forecast price falls below $2100 in any year t, then the INRA will be implemented via commencement of buffer stock operations. Support buying of natural rubber for buffer stocks will begin (with a one-year lag) in period (t+1); such buying is known as prospective buying since, strictly speaking, no buffer stocks operation is required until the trigger prices are reached. However, because of the dynamics (lagged effects) in the system, such prospective buying may be more efficient in stalling price falls instead of allowing the downward pressure on price to gather momentum. Although the total buffer stocks cannot exceed the sum of (normal and contingency) buffer stocks of 550,000 tonnes, the stringent condition of not exceeding the "normal" stock of Since nominal prices are not necessarily the prices at which natural rubber are actually traded, the precise calculation of gains and losses requires knowledge of price actually paid for natural rubber deliveries. Since such detailed information are difficult to obtain, the simulation results based on nominal prices must be considered only as an indication of magnitudes. Page 268 400,000 tonnes will be assumed. To satisfy clause (d) of net buffer stock variations not exceeeding 100,000 tonnes within any eighteen months, an acceptable strategy of gradual buffer stock build-up would be to buy not more than 80,000 tonnes in any year. This means that even should support buying be required throughout the five-year duration of the INRA, the buffer stocks accumulated at the end of the fifth year will not exceed 400,000 tonnes. By not utilising the 550,000 stocks fully, a financial margin is provided for operational and administrative costs that will be required for implementing the scheme, thus conveying a degree of flexibility for the scheme. After the first buffer stock buying of 80,000 tonnes, the support (intervention) price P will be generated by the model. Similarly pt+1 the price Pt+2 in the following year (t+2) will also be generated by the model. If Pt+2 falls below $2100 again, then another 80,000 tonnes will be bought in period (t+2), the second year of the support buying. The support price Pt+2 and projected price pt+3 will again be determined from the model. Support buying at 80,000 tonnes annually will continue as described so long as the projected price in the next period remains below $2100. After four years of buffer stock buying, the stock will stand at 320,000 tonnes. If by this time the projected price for the following period is still below $2100 per tonne, then the reference price could, according to clause (e'), be revised by minus 3 percent unless the INRC decides otherwise. If the INRC decides not to alter the reference price level, the support price in the next period will then be determined by the reduced support buying of only 50,000 tonnes. This is because the buffer stock operations are expected to caution Page 269 and slow down as the buffer stock level tends towards its specified maximum. By now the buffer stocks will amount to 370,000 tonnes. Further support buying in future periods will be in smaller volumes, and it is expected that at this juncture the INRC will have to consider whether (a) to revise the stabilisation price band and/or increase capital outlay or (b) cease support buying when the buffer stock reaches 500,000 tonnes (or 550,000 tonnes, depending on financial constraints at that time) and thus allow market price to fall freely. The suitability/viability of the ceiling price level depends on the speed of oscillations in the model. However, if the model oscillates at high speed (so that breaking the $2700 ceiling may be due to the support buying in previous periods), then buffer stock sales at $2700 may be premature and could set off anc,ther round of price declines. Depending on the model's behaviour, a revision of the upper indicative price may also be required; that is, the floor and ceiling prices need not be equidistant from the reference price. 8.6 Some Aspects of the INRA Stabilisation Scheme lWhich Need to be Considered This section will discuss some of the aspects of INRA which need to be examined, assuming it is a feasible stabilisation scheme, in the context of its aspirations to stabilise price and increase export earnings simultaneously. Basically, the INRA can be viewed as a partial stabilisation/adjustment policy since it aims at reducing, Page 270 rather than eliminating altogether, natural rubber price variability by a price band policyf For a given buffer stock size, the success of partial stabilisation then depends on (a) the choice of the reference price level as well as (b) the effective interaction between buffer stocks and market price. Althougl: partial stabilisation entails knowledge of the long-run equilibrium price about which prices are to be stabilised, this price need not be knowm to the degree of precision required for successful complete stabilisation. In this respect partial stabilisation is easier to operate than complete stabilisation since a higher margin of error is tolerable for the reference price chosen to proxy the equilibrium price. But with one caveat: the larger the error, the larger the buffer stocks required and the more one-sided the interventions will be. This leads to the question of whether the price bands employed have to be equidistant from the reference price. While INRA specifies equidistant price bands about the $2100 reference price, no explanation is given for the choice of price level nor the economic rationale for the equidistant principle. Equidistant bands for a self-liquidating price are valid however, only wqhen either (1) prices are symmetrically distributed about a stationary trend or (2) prices are distributed about a non-stationary trend and skewed to the left(right) in the lower(upper) price range. If these stringent conditions concerning price trends and distributions are not met, then a self-liquidating buffer stock might not lead to equidistant price bands. Hence the choice of equidistant/non-equidistant price bands cannot be determined independently of the expected trend behaviour of prices. In analysing natural rubber price patterns, Allen (1969) Page 271 concluded that the behaviour of monthly prices during 1958-1969 approximated a normal distribution. However, it should be remembered that the 1958-1469 period coincides with the period of constant and low oil prices and continued steady growth of the synthetic rubber industry from 1956. As Figure 6.3 in Chapter Six of this study showed, the period used by Allen (1969) in his analysis is part of phase II. The normal distribution obtained by Allen may be explained by the gradual falling price trend and narrowing price fluctuations. From the behaviour of natural rubber prices during 1972-1980 (phase III in Figure 6.3), it is clear that uncertainties about rising oil and hence synthetic rubber prices lead to a sharp rising trend and wider fluctuations for natural rubber prices. Under such conditions, use of equidistant price bands would presuppose that the prices are distributed with certain skewness. Similarly, whether equidistant price bands are appropriate for the future period when prices are likely to behave in a similar way to those in 1972-1980 depends on the expected trend and distribution of prices. Regrettably, no explanation is given by INRA on how the reference price and equidistant price bands are determined. Effective interaction between buffer stocks and market price involves, in addition, assumptions about how private stockholdings will behave in the presence of a buffer stock, an issue that is receiving due attention. In a recent paper, Sianwalla (1981) has shown that private stockholdings are not neutral to public storage programmes, viz. a buffer stock scheme. In general, the effect of public storage supply on private stockholdings depends on (1) the existing levels of public and private stockholdings, (2) the level of financial resources for the supply of public storage and (3) the size Page 272 of (1) and (2) relcative to the market fluctuations arising fror random disturbances. Consequently, the supply of storage may shift between the two sources, with the scope for public displacement of private storage being proportional generally to the financial resources available for public storage. In the simulation exercises conducted in this study, it will be assumed that private stockholdings will nevertheless persist. These considerations of long-run equilibrium price and private stockholdings highlight the reliance of the management of buffer stock operations on the judgement of the buffer stocks manager. This leads to the problems of the dynamics inherent in the system, the ability of the manager to distinguish reliable from false price signals, and discretionary use of prospective buffer stock operations, problems which will be discussed again in the next section. The problems associated with the feasibility of operating and managing a buffer stock to attain these ends therefore cannot be overemphasised. As mentioned, the INRA is aimed not only at price stabilisation but also at the steady growth of export incomes of the producing countries. Two ways by which steady growth of export incomes may be attained are (1) through obtaining a higher average price under stabilisation and (2) increased consumption (via input substitution) and production of natural rubber due to reduced fluctuations and uncertainty about price. In the first case, the qrowth in export incomes can be viewed as a transfer of incomes from consuming to producing countries. This raises the question of consumers' agreement to and participation in such price stabilisation, bearing in mind the availability of synthetic rubbers. In the second case, even with Page 273 consumers' participation, the question is whether the two objectives of price stabilisation and income growth are compatible. Several questions concerning the stabilisation scheme need to be considered. On the indirect effects of stTbilisation, a difficulty is in deriving a measure for evaluating the welfare effects of stabilisation on the participating countries. 8.7 Price Stabilisation Under Low Oil Price Scenario, 1982-1986: Preliminary Comments Figures 8.2(a)-(c) present forecast time paths of natural rubber prices in the various primary and terminal markets under the low oil price scenario for 1980-1995 and without intervention a la INRA. A comparison of forecast New York prices with the World Bank forecast (using assumptions for the synthetic rubber sector which approximate those under the low oil price scenario) in Figure 8.2(b) shows the Bank's forecast to be the more optimistic. The corresponding time paths of world production and consumption of rubbers are presented in Figure 8.2(d). The forecasts give production of natural rubber in 1985, 1990 and 1995 to be 4.5, 5.6 and 6.9 million tonnes respectively, with the corresponding natural rubber consumption of 4.4, 5.3 and 6.6 million tonnes. For synthetic rubbers, the production volumes are 10.2, 12.3 and 18.1 million tonnes while consumption is expected to be 9.9, 13.0 and 17.2 million tonnes. Thus an excess demand for synthetic rubber will occur in 1990; this is due to the fact that while the business cycle begins an upswing in the Sterling Pounds 1600 per Tonne ,-......Spot-price RSS1-price 140 . , ~RSS3-price 1200 // 800 l ,,. 1' -- 1000 0oL 1980 1982 1984 1986 1988 1990 1992 1994 1996 Year LQ Figure 8.2(b): Forecasts of Average Synthetic Rubber Price and Natural Rubber Prices CD in New York, 1981-1995 (Low Oil Price Scenario) } Singapore Dollars per Tonne 550 5001 450c4 RSSl-price 450"',RSS3-price 4004t e 350 / 3000 N 7 2500 2000 1500 1000 500- 0 , Year 1980 1982 1984 1986 1988 1990 1992 1994 1996 Figure 8.2(c); Forecasts of Natural Rubber Prices in Singapore, 1981-1995 d (Low Oil Price Scenario) D ND Page 277 Production Consumption (thousand tonnes) Consumption - Production 26,000 24,000 , All Rubbers 22,000 / 20,000 18,000 / I Synthetic Rubbers /,' 16,000 - 14,000 - 12,000 1 10,000 - 8,000 0 ^Natural Rubber 6,000- 4,000 1980 1984 1998 1992 1996 Year Figure 8.2(d): Forecast Time Paths of Rubber Production and Consumption, 1981-1995 Page 278 second half of the eighties, expansion in synthetic rubber capacity is expected to remain restrained until 1990 when alternative energy, and hence feedstock supply, becomes available. The higher price of synthetic rubbers relative to that for natural rubber from about 1989 then favours a shift towards natural rubber consumption so that a higher natural rubber consumption share of 38 percent is observed by 1995. Two qualifications apply to the forecasts presented in Figures 8.2(a)-(d). First, Malaysian smallholder natural rubber production had to be treated exogenously in order to obtain the forecasts. This is because endogenous treatment of this smallholder production (using the estimated supply response estimates) leads to unrealistic projections of smallholder output in that the projections give exceptionally high output levels in the first few years of the forecast period followed by very rapid decline in production for most of the remaining forecast period. The reason for this behaviour lies in the pattern of supply response estimates for the historical period. it will be recalled that from the mid-1950s to the first oil crisis in late 1973, natural rubber price followed a falling trend. However, in the saine period, smallholder production was increasing. The reason for this rising production in the face of falling prices can be traced to the government programmes for rural development and natural rubber new planting and replanting since the mid-1950s (Barlow, 1978:76-89). The supply response estimates are therefore derived from supply response that was significantly influenced by the government-funded programmes to rejuvenate the natural rubber industry in the postwar period, rather than solely by natural rubber prices. However, by the 1970s, the behaviour of natural rubber price was markedly different Page 279 from that in the 1960s. The unrealistic projections for smallholder supply therefore arise from the application of historical supply response estimates to a period of very different behaviour in natural rubber price. This is reinforced by the long price lags used in the supply response equations, so that prices from 1967 are used in projecting supply from 1980 onwards. Second, because of the oil crisis and ensuing uncertainty about the price of feedstocks, expansion in new synthetic rubber production capacities is expected to be restrained until after 1990. If oil price should stabilise in the 1980s, and/or alternative sources of feedstock supply becomes available sooner, then more rapid investment in new synthetic rubber production capacities may be expected. Several assumptions are involved in using the model to simulate buffer stock operations for price stabilisation. The key assumption is that the existing market structure (as represented by the model) will remain valid. In particular it is assumed that behaviour of private stockholdings of natural and synthetic rubbers will be unaffected by buffer stock operations. This assumption is favourable to the buffer stock operations since as already mentioned, private stockholdings will not be neutral in general to the implementation of public stockholding schemes. Another assumption concerns the natural rubber price formation process. During the historical period, the London spot market was found to play an important role; on this basis the equation for natural rubber price determination in the model refers to the London spot price formation. This situation may change in future sirce as Chapter Six showed, the rise in oil and hence synthetic rubber prices, has led to greater reliance on natural rubber supply through longer-term contracts. The potential shift of focus to Page 280 other markets is also suggested by the fact that Singapore, an active centre for natural rubber trading, is not party to the INRA. Consequently, the reactions and speculative activities of Singapore traders to buffer stock operations remain to be seen. Finally, it is assumed that the buffer stock manager operates with sufficient financial reserves. Throughout the following, all simulations for the future period are non-stochastic in nature. Although stochastic simulations are preferable for realism, such simulations entail more time resources because of the larger number of experiments involved. Another reason for the use of non-stochastic simulations is the annual nature of the model used here. Since an annual model is essentially a long-term model, it is considered more useful to employ non-stochastic simulations and concentrate on the dynamic effects (of market intervention) arising from the long lagged structure of the model. However, the INRA intervention is based on daily market prices and all the constraint clauses are tied to these prices. Since these daily price variations are assumed away in non-stochastic simulations, it is obvious that the problems of price stabilisation are understated. In this sense the non-stochastic approach may be seen to provide a most favourable test of the INRA proposals. On the basis of the forecast time paths of prices, stabilisation of price within the price range specified by the INRA is not operative. This is because the f.o.b. Singanore price for RSS1-grade natural rubber for the 1981-1985 period is forecast to range from $2810 to $4100 per toiine. (Singapore dollar prices are used here for ease of comparison with the price ranges used by the INRA.) Thus in Page 281 the following simulations of buffer stock operations, the stabilising price band will be determined from the forecast prices for 1981-1985. Instead of the INRA-specified reference price of $2100, the reference price will be $3455 (the average of the difference between the highest and lowest forecast prices) and the floor (upper indicative) and ceiling (lower indicative) prices will be $2930 and $3973 respectively. The trigger prices will then be set at plus and minus 10 percent of the reference price; that is, $3109 and $3800 per tonne. In order to understand the dynamics of the model, the simulated time paths of RSS1-grade natural rubber price under two types of buffer stock operations will be compared. In the first simulation, the INRA rules for buffer stock operations with respect to price levels for optional/compulsory intervention will be stringently applied. This means that prospective buying/selling are prohibited so that buffer stocks are strictly operational only after prices have fallen outside the $3109-$3800 trigger price band. In the second simulation prospective buying/selling will be allowed in order to determine the sequence of buffer stock operations necessary for price stabilisation. Technically, the buffer stock operations are implemented by introducing a variable ABS for net change in buffer stocks into the balance equation for the natural rubber submodel. Thus equation (5.10) in Chapter Five for natural rubber stocks in consuming regions This price band is plus and minus 15 percent (or plus and minus $510) of the reference price. With respect to the INRA-specified $600 difference between floor/ceiling and reference prices detailed in 8.2.1 above, this price band is therefore slightly narrower. Page 282 (SNC) now becomes: (8.1) SNC = SNC - A(SNP+SNA) - ASNG + QN - CN - ABS where all variables are as previously defined. In simulating the model with equation (8.1), a coefficient of 1.0 will be used for the ABS-variable; coefficients for all other variables will be as reported in Table 5.1 of Chapter Five. The constraint of net change in buffer stocks not exceeding 80,000 tonnes annually will be observed throughout. 8.8 Price Stabilisation Under Low Oil Price Scenario, 1982-1986: Results Figure 8.3 presents the price forecasts under buffer stocks intervention without prospective buying/selling. Thus the first buffer stock purchase (positive net change) of 80,000 tonnes will occur in 1982 after the free market price ($2810) in 1981 had fallen below $2930.00, the lower indicative price. This buffer stock purchase raises the 1982 price from below to above the reference price. Since prices in 1982 and 1983 lie within the trigger price band, no intervention is permitted in these years. In 1984 the free market price exceeds the upper trigger price of $3930 thus necessitating buffer stock sales (negative net change) in 1985. Despite the disposal of all 80,000 tonnes stocks accumulated previously, the impact of this buffer stock is marginal with price in RSSl-price f.o.b. Singapore (S$/Tonne) 5500 5000 4500 - 4---pr+15% = $ 3973 4000-----------------------------------------------r ............. .........../ ---., , .p +10% = $ 3800 3500 80.0 -80.0 r = $ 3455 Z - r ' p -10% = $ 3100 3000. ............................ r - -_- ---p-15% = $ 2930 2500 2000 1500 1000 No Stabilisation 500 - - - With Stabilisation 1980 1982 1984 1986 1988 1990 1992 1994 1996 Year Figure 8.3: Time Paths of Natural Rubber Price in Singapore With and Without Market Intervention (No Prospective Buffer Stock Operations Allowed). Page 284 1985 and 1986 remaining outside the stabilisation price range. The behaviour of price under market intervention revealed by this simulation emphasises the need to consider prospective buffer stock buying/selling. The lagged effects of price on supply and demand can be seen from the behaviour of price during 1982-1984. Recall that supply response is affected by current and past prices up to 14-year lags, with price coefficients varying from positive values in the first 2-3 lags to negative values in the next 7 lags to positive values in the last 4 lags. A price rise in 1982 therefore causes an increase in supply in the ensuing 2 years before the negative effects set in. On the demand side, relative price effects extend to 4-year lags so that a relative price increase in 1982 could have a negative impact on demand up to 1986. This expected increase in supply and fall in demand explain the fall in price in 1984 and 1985 from their free market (free market here means market without stabilisation) levels. However, because of the derived demand nature for natural rubber, the dominant underlying force is the level of industrial activity in the consuming countries. Consequently price behaviour under market intervention is the net result of interaction between the exogenously-determined level of industrial activity and the endogenously-determined natural rubber supply and demand. As industrial activity picks up in 1983, it provides the underlying upward pressure on prices from 1983 onwards. In contrast to Figure 8.3, Figure 8.4 presents the simulated time path for price under buffer stock operations that include prospective trading. Again buffer stock purchases of 80,000 tonnes will commence in 1982 in response to the low price in 1981. Although the 1983 price RSS1-price f.o.b. Singapore (S$/Tonne) 5500 - 5000 4500 - 4000i ---- - ---------------- r+5% = $ 3973 80,0 -050 3500 80. - -.0 pr = $ 345 3000 -_- --------------------------r-15% = $ 2930 2500 L 2000 - 1500L 1000- No Stabilisation - - - With Stabilisation 500 - 0 p 1 1- 1980 1982 1984 1986 1988 1990 1992 1994 1996 Year Figure 8.4: Time Paths of Natural Rubber Price in Singapore With and Without D Market Intervention (Prospective Buffer Stock Operations Allowed). N) Ln Page 286 is at a level where no intervention is required by the INRA, prospective buying will nevertheless be made in anticipation of the subsequent increased industrial activity and hence demand. Thus another 80,000 tonnes will be bought by the buffer stock authority, causing the 1983 price to rise from about $3500 to $3600. Because of the lagged price effects on supply and demand, the price in 1984 will now be lower than in the free market case. But given the upswing in the business cycle, prospective sales will be made to dampen the upward pressure on price due to increased demand. Figure 8.4 shows that prospective sales of 80,000 tonnes annually in 1984 and 1985 are required to bring prices down to within the stabilisation price band. Thus to stabilise price, buffer stock operations through 1982-1985 are required, indicating that the model does not oscillate at high speed. By maintaining buffer stock sales in 1984 and 1985, the buffer stock authority would also have disposed of all stocks by 1986, the terminal year of the INRA. The lagged effects of lower prices on supply and demand lead to the price in 1986 becoming higher than under free market conditions, thus invoking the issue of the stabilisation agreement duration and the desired level of terminal stocks. if the constraint of net change in buffer stocks not exceeding 80,000 tonnes is binding, the end result of buffer stock operations (Figure 8.4) for price stabilisation during 1982-1986 will be a higher-than-free-market price in 1986. The impact of prospective buffer stock operations as shown by comparison of Figures 8.3 and 8.4 highlights the importance of such operations, and hence the reliance on the judgement of the buffer stock manager. This judgement is critical for the price system could give "false signals" (Lerdau, 1959) as would have been the case in Page 287 1974-1976 (see Chapter Six, section 6.5) had a stabilisation programme been implemented then. Because of the close interaction between the natural and synthetic rubber markets, reliable judgement would entail tracking the production and stockholding behaviour in the synthetic rubber industry.6 Given the structure of the model used here, it should be indicated that an implicit assumption in the buffer stock operations is that stock adjustment occurs only in the consuming regions; this is because the buffer stock variable is introduced via the equation for stocks in consuming regions. Since it is stocks in consuming regions that enter the price formation equation, price stabilisation implies shifting some of the stock adjustment to the producing countries; this is verified by the 10 percent increase in stocks held in the producing regions and afloat under the stabilisation case. ThiG qualification is important to the above findings since as discussed in Chapter Six, the increase in oil price has led to greater dependence on long-term contracts, thus reducing the role of the London spot market. It is possible that the role of the London spot market may be reduced further when buffer stock operations are introduced, in which case the price formation aspect of the present model will need modification. 6 Although this requirement of monitoring the development in the synthetic rubber industry is not explicitly stated in the INRA, it may be interpreted as being implicit in Article 38 of the draft INRA which mentions the need for "reliable data on production, consumption, stocks, trade and prices of natural rubber and other factors that influence demand and supply of natural rubber." (UNCTAD, 1979:44). Page 288 8.9 Distribution of Gains from Price Stabilisation Assuming that the 5-year INRA is implemented from 1982 (subsequent to the low price in 1981) and terminated in 1986, the effects of INRA-price stabilisation on producers and consumers can now be discussed. Figures 8.5(a) and (b) present time paths of world natural rubber output and consumption volumes and their corresponding values (in current US dollars) under a free market and under market intervention. The global effects of price stabilisation during 1982-1986 are summarised in Table 8.1. A comparison of world supply and demand under the free market and under price stabilisation shows the main effect of stabilisation to be a fall in the levels of supply and demand; however, Table 8.1 shows the impact of price stabilisation on average supply and demand volumes during 1982-1986 to be small. Average production during the period falls by a marginal 0.42 percent while average consumption falls by an even smaller value of 0.22 percent. The variations in supply and demand as measured by their coefficients of variation are found to be unaffected. However, the stabilising effects become significant when the dollar values of natural rubber production and consumption are considered. For nataral rubber export earnings, the trade-off for reduced fluctuations (from a coefficient of variation of 0.16 to 0.10) is a fall in average earnings of US$105 million. Price stabilisation therefore benefit consumers since a negligible (0.22 percent) reduction in consumption volume will bring about an average savings in consumption expenditure of US$81.0 million. In this discussion of stabilisation effects, the US dollar will be used as the unit of measurement. Page 289 Production Export Earnings (Th. Tonnes) (US$m) 4800 4600/ 10,00c- // 4400 / 9000 / 4200 / % 8000 4/ 7000 / 4000 60X 3800 _ No stabilisation - - With Stabilisation O ' l -,xear 0 L ! . tYear 1982 1984 1986 1982 1984 1986 Figure 8.5(a): Time Paths of World Nat-ural Rubber Supply Consumption Consumption (Th. Tonnes) Expenditure (US$m) 4800 4600 10,000 4200 .00 9000 4400 e X - 08000 4200 / 4000 - - 700 6000 1 Year Year 1982 1984 1986 1982 1984 1986 Figure 8.5(b): Time Paths of World Natural Rubber Demand. Page 290 Table 8.1: Summary of Price Stabilisation Effects, 1982 - 1986 V Average Value Average Value Change due to Variable Under Free Under Market Market Market Intervention Intervention World Natural Rubber 4331.0 4313.0 -18.0 Production (0.06) (0.05) (Thousand Tonnes) World Natural Rubber 4270.0 4260.0 -10.0 Consumption (0.05) (0.05) (Thousand Tonnes) Natural Rubber Stocks 749.4 824.7 +75.3 in Producing Regions (0.02) (0.19) and Afloat (Thousand Tonnes) Natural Rubber Stocks 1047.5 1046.0 -1.5 in Consuming Regions (0.07) (0.07) (Thousand Tonnes) World Natural Rubber 8134.2 8028.6 -105.6 Export Earnings (0.16) (0.12) (Million US Dollars) World Natural Rubber 8354.3 8273.3 -81.0 Consumption Expenditures (0.15) (0.12) (Million US Dollars) World Natural Rubber Real 6536.9 6477.9 -59.0 Export Earnings (0.07) (0.02) (Million 1981 US Dollars) World Natural Rubber Real 6839.1 6671.8 -167.3 Consumption Expenditures (0.07) (0.02) (Million 1981 US Dollars) Note : (1) Figures in parentheses denotes coefficients of variation of the distribution of values from which the corresponding averages are derived. (2) Export earnings do not equal consumption expenditures because the values presented here are estimates based on actual production and consumption volumes (not equal) and the relevant market (fob/cif) prices. Page 291 The effects of price stabilisation on individual countries will now be discussed, beginning with those on producing countries. Table 8.2 summarises the effects of price stabilisation on the major natural rubber producing count ies of Africa, Brazil, Indonesia, Malaysia, Sri Lanka and Thailand. The analysis concentrates on total production and export earnings (in current and constant dollars) effects; the corresponding coefficients of variation for the distribution of production and export earnings are also presented. Time paths of production and export earnings in markets with and without intervention are given in Figures A8.1-A8.6 in Appendix BA. The effects of stabilisation on production volumes in the main producing countries are small, both in output level and degree of instability. More importantly, Table 8.2 shows that stabilisation does not affect the producing countries systematically; for example, the average Indonesian output falls by 11,000 tonnes while the fall in average output for Sri Lanka is less than 1000 tonnes. Of the smaller producers, the output of Africa is shown to fall while that for Brazil rises. The effects of stabilisation on export earnings are more significant, with reduced export instability being accompanied by reduced average export earnings which can amount to 5 percent as in the case of Africa. The uneven effects of stabilisation also apply to average export earnings; for example, the average export earnings for Malaysian estates falls by US$6.82 million while that for Indonesia falls by S$42.06 million. Of the countries examined, only Brazil will benefit from price stabilisation in terms of an increase in output and average export earnings. But this increase in earnings is accompanied Page 292 Table 8.2: Summary of Price Stabilisation Effects on Major Producers, 1982 - 1986 Average Natural Rubber Output Average Natural Rubber Export Earnings (Thousand Tonnes) (US $ million) Country (a) (b) Change due to (a) (b) Change due to Intervention Intervention Africa 74.14 71.07 -3.07 139.43 132.28 -7.15 (0.29) (0.25) (0.33) (0.27) Brazil 35.73 36.52 +0.79 66.81 68.06 +1.25 (0.05) (0.06) (0.12) (0.13) Indonesia 1108.78 1049.66 -11.12 2084.50 2042.44 -42.06 (0.07) (0.05) (0.17) (0.12) Mlalaysia 649.50 649.26 -0.24 1248.44 1241.62 -6.82 Estates (0.10) (0.07) (0.16) !0.14) Smallholders 897.20 897.20 0.00 1718.92 1666.46 -52.46 (0.01) (0.01) (0.14) (0.08) Sri lanka 172.16 171.28 -0.88 325.84 320.12 -5.72 (0.15) (0.12) (0.36) (0.18) Thailand 435.00 431.02 -3.98 808.92 790.96 -18.06 (0.00) (0.09) (0.08) (0.03) Notes: (1) The constancy in Malaysian smallholder production is due to treating this variable exogenously. (2) Figures in parentheses denote coefficients of variation of the distributions of the values from which the corresponding averages are derived. (3) Case (a) refers to results under the free market. Case (b) refers to results under market intervention. Page 293 by increased instability. In summary, the effects of price stabilisation differ among producing countries, both in extent and direction. The effects of price stabilisation on export earnings, volumes and instability tends to be offsetting, so that whether the overall effect of stabilisation is a gain or loss is a moot point. Moreover, the change in instability and total (and hence average) earnings move in different directions for different countries and have important implications for members of the INRA. Table 8.3 summarises the effects of price stabilisation on total natural rubber consumption volumes and expenditures of the major consuming countries of France, West Germany, Italy, Japan, UK and USA. As for production, the analysis concentrates on comparing total consumption volumes and values in markets with and without intervention and their differing degrees of instability. The distribution of consumption volumes and values over time under the different market situations are presented in Figures A8.7 - A8.12. For the main consuming countries, gains from price stabilisation in terms of lower natural rubber expenditures are partially due to slight reductions in their levels of consumption. Except for Japan, the levels of savings are correlated with the volume of consumption; thus bigger savings are achieved by the major consuming countries of Italy, West Germany and USA. As for producing countries, whether the overall effect of stabilisation on consumers is a gain or loss is again a moot point. Page 294 Table 8.2. Summary of Price Stabilisation Effects on Major Consumers, 1982-1986 Average Natural Rubber Consumption Volume Average Natural Rubber Consumption Expenditure (Thousand Tonnes) (US $million) Country (a) (b) Changes due to (a) (b) Changes due to Intervention Intervention France 192.42 3.92.24 -0.18 375.74 372.74 -3.00 (0.03) (0.03) (0.13) (0.10) West Germany 228.14 225.44 -2.70 445.88 437.12 -8.76 (0.05) (0.04) (0.14) (0.10) Italy 166.00 165.66 -0.34 325.08 321.84 -3.24 (0.05) (0.06) (0.15) (0.13) Japan 469.74 468.48 -1.26 875.60 870.60 -5.00 (0.02) (0.02) (0.13) (0.09) United Kingdom 126.82 126.76 -0.06 246.60 245.08 -1.52 (0.02) (0.01) (0.09) (0.06) United States 836.04 835.04 -1.00 1622.80 1600.36 -22.40 (0.02) (0.02) (0.12) (0.08) Notes: (1) Figures in parentheses denote coefficients of variation of the distributions of values from which the corresponding averages are derived. (2) Case (a) refers to results under the free market. Case (b) refers to results under market intervention. Page 295 Finally operation of a buffer stock scheme also incurs operational (carrying and rotation) and administrative costs. These costs must be considered in an overall evaluation of the net result of buffer stock price stabilisation. Based on UNCTAD estimates of handling and storage costs of natural rubber (Reynolds, 1978:81) and more recent (1981) estimates obtained from traders in the Singapore market, the estimates of operational costs relevant to the 1982-1986 period are presented in Table 8.4. Assuming that the buffer stock will consist of equal shares of RSS1- and RSS3-grades natural rubber bought on the primary markets on the basis of f.o.b. Singapore prices, the value of the buffer stock purchases and sales in each period can be calculated from the support (intervention) prices determined by the model. Since according to traders in Malaysia, it is viable to keep stocks in the primary markets for periods up to a year without rotation (Brown, 1974: footnote 11), it will be assumed that stocks are rotated annually. The total net buffer stock outlay in each period is then the sum of the value of the buffer stocks and the operational costs. The total buffer stock outlay required in each period is presented in the first column of Table 8.5; assuming an interest rate of 10 percent per annum for financing this outlay, the total buffer stock debt up to each current period is given by Table 8.5; thus the total debt incurred by operating a buffer stock over the 1982-1986 period is US$152.1 million (current dollars). In constant 1981 US dollars, this is equivalent to US$181 million. Table 8.4: Estimates of Buffer Stock Operational Costs by Item, 1981-1986 Carrying Costs Rotation Costs Administrative and Overhead Year (US$/tonne) (US$/tonne) Costs (US$ million/year) 1981 228.60 7.14 0.5714 1982 252.90 7.90 0.6341 1983 280.00 8.80 0.7000 1984 310.00 9.70 0.7692 1985 344.00 10.70 0.8421 1986 377.00 11.80 0.9625 Notes: (1) Carrying Costs consist of warehousing and insurance costs of storing the buffer stocks in licensed warehouses. (2) Rotation Costs consist of brokerage, transportation, handling and internal haulage costs. (3) Administrative and Overhead Costs consist of salaries of personnel serving the Buffer.stock. organisation, home leave provisions, insurance, auditor's remuneration, expenses of International Rubber Council, recruitment expenses, rental, utilities, fixtures and fittings, postage and telecommunications, etc. fD N, Table 8.5: Buffer Stock Outlay and Cumulative Buffer Stock Debt in each period, 1982-1986 Buffer Stock outlay Cumulative Buffer Stock Debt Year Current Constant Current Constant US$m US$m US$m US$m 1982 155.1666 146.9380 155.1656 146.9380 1983 188.2572 165.4281 358.9404 315.4133 1984 -126.5230 -102.7806 268.3102 217.9611 1935 -157.7747 -118.6275 137.3665 103.2830 1986 0.9625 0.6702 152.0656 105.8952 Notes: (1) Buffer Stock Outlay refers to the sum of bufferstock purchases/sales and the operational and administrative costs of bufferstock operations in each period. Positive(negative) values denote expenditure(revenue) due to net change in buffer stock volumes. (2) Cumulative Buffer StockDebt in each period is the sum of debt and 10 percent interest costs incurred by the buffer stocks authority up to that period. Page 298 8.10 Conclusion The results of price stabilisation for 1982-1986 may now be summarised. A comparison of the supply and demand coefficients of variation for the main producing and consuming countries show that instability is higher for natural rubber supply than for demand, despite the fact that natural rubber is a perennial crop. Thus buffer stock operations to stabilise price are essentially focussed on smoothing out the cycles in rubber demand and fluctuations in supply. However, as the s1tabilisation results indicate, other effects of pure price stabilisation have to be considered. This chapter has shown that a number of problems exist with the INRA price stabilisation scheme, in particular those of feasibility and management. As the analysis of stabilisation effects have shoTwn, the two aims of the INRA of price stabilisation with steady growth of export earnings need not be compatible. The results of simulating buffer stock stabilisation for 1982-1986 about equidistant price bands indicate a fall in export earnings both at the world and individual country levels. In particular, the changes in totals and instability of a variable for a country are offsetting, while changes in totals and instability vary in sign and magnitude among variables. These offsetting effects therefore makes it difficult to assess the benefits of stabilisation. Furthermore, for a given variable, the effects vary across countries. Both these aspects show that stabilisation has complex effects which are very different from the naive view that price stabilisation solves the problem of instability due to demand and supply shifts. Page 299 APPENDIX 8.A GRAPHIC PRESENTATION OF PRICE STABILISATION EFFECTS, 1982-1986 The appendix presents Figures A8.1 - A8.12 giving time paths of production, export earnings, consumption volumes and values for individual countries in markets with and without intervention during the period 1982-1986. Page 300 J'Production &Export Earnings (Th. Tonnes) 240 (US$m) 110 220 100 / 200 90 180 80 ; 160 70 ,/ 140 60 / 120 50 v,100 ~ No'Stabilisation With Stabilisation 80 t..--Year O0 i - Year 1982 1984 1986 1982 1984 1986 Figure A8.1: Time Paths of Natural Rubber Supply and Export Earnings, Africa. / Production I Export Earnings (Th. Tonnes) / (US$m) 40 . / 90 39 / // 38 -80 37-- 36 ,/70 - 35 34 /60/ 33 / 32 50 o--..Year 0. . Year 1982 1984 1986 1982 1984 1986 Figure A8.2: Time Paths of Natural Rubber Supply and Export Earnings, Brazil. Page 301 Production JExport Earnings (Th. Tonnes) (US$m) 1300 2800 2600 1200 / 2400 / 2200 1100 / 2000 / .0/ 1800 / 1000 1600 - No Stal-;-,K'Iation 1400 -- W;ii Stabilisation 900 1200 0 ,Year 0 .Year 1982 1984 1986 1982 1984 1986 Figure A8.3: Time Paths of Natural Rubber Supply and Export Earnings, Indonesia. Production t Export Earnings (Th. Tonnes) 3400 (US$m) 1700 3200 / 3000' 1600 /20 // 2600 . - 1500 2400 2200 1400 2000, 1800 0LI £ .- Year 0 Year 1982 1984 1986 1982 1984 1986 Figure A8.4: Time Paths of Natural Rubber Supply and Export Page 302 Production Export Earnings (Th. Tonnes) (US$m) 200 190 / 500 180 1" / 450 170 '~/400 160 350 150 I 300 / 140 / 250 / 130 / No St&.tilisation 200 - - With Stabilisation 120 r oL a ** Year 0 y Year 1982 1984 1986 1982 1984 1986 Figure A8.5: Time Paths of Natural Rubber Supply and Export Earnings, Sri Lanka. Production Export Earnings (Th. Tonnes) (US$m) 900 500. 800 X NI 400 -- 700 - 300, 600 o0Cy A I - ,* lYear 0 L- , I - -Year 1982 1984 1986 1982 1984 1986 Figure A8.6: Time Paths of Natural Rubber Supply and Export Earnings, Thailand. Page 303 Consumption Consumption (Th. Tonnes) Expenditure 440 (US$m) 210 420 400 / , 200 X 380 / ~360/ 190 340 / 320 - 180 300 - No Stabilisation - - With Stabilisation 280 oLI J Year ° Year 1982 1984 1986 1982 1984 1986 Figure A8.7: Time Paths of Natural Rubber Consumption, France. i Consumption Consumption (Th. Tonnes) Expenditure (US$m) 250 540 240 500 230 4 460 / 220 - 420 / 210 - 380 / 200 340 190 ,300 O LI Year O- - 3Year 1982 1984 1986 1982 1984 1986 Figure A8.8: Time Paths of Natural Rubber Consumption, West Germany. Page 304 Consumption Consumption (Th. Tonnes) Expenditure (US$m) 500 190 450 180 400 170 350 - 160 7/ 300 150 250 140 No Stasilisation 200 - - With Stabilisation - -Year C-~ 0xear 1982 1984 1986 1982 1984 1986 Figure A8.9: Time Paths of Natural Rubber Consumption, Italy. Consumption A'Consumption (Th. Tonnes) 00 Expenditure s1000 (US$m) 480- / ~900 A /U 4 t*° / / 470/'-% / ~800 / 460. / // 700 450 600 o t Year oL0 'Year 1982 1984 1986 1982 1984 1986 Figure A8.10: Time Paths of Natural Rubber Consumption, Japan. Page 305 j Consumption J Consumption (Th. Tonnes) Expenditure 140 (US$m) 300 135 250 130 200 125 150 No Stabilisation With Stabilisation 120 - 0 X -Year 0 ..... -yhear 1982 1984 1986 1982 1984 1986 Figure A8.11: Time Paths of Natural Rubber Consumption, UK. Consumption (Th. Tonnes) Consumption Expenditure (US$m) 900 1800 850 1600 / 8 1400 800/ 1200 lI sYear 0 L/ 4 - Year 1982 1984 1986 1982 1984 1986 Figure A8.12: Time Paths of Natural Rubber Consumption, USA. Page 306 , Production Prodtcers' (Th. Tonnes) Revenue (US$m) 1200 2800 1100 X -~~ 1000/ 2600 9 - 900 / / 800" / 2400 700 600 No Stabilisation - - With StabiliSat4on 0 Year 0 0-xear 1982 1984 1986 1982 1984 1986 Figure A8.13: Time Paths of Natural Rubber Supply and Producers' Revenue, Malaysian Estates. Production (Th. Tonnes) Producers' Revenue (US$m) 2800, 2700 1400 2600 -- 2500p 1200p 2400 - , 2300 1000 2200 0 -11 -ear OL X Year 1982 1984 1986 1982 1984 1986 Figure A8.14: Time Paths of Natural Rubber Supply and Producers' Revenue, Malaysian Smallholders. Page 307 CHAPTER NINE PRICE STABILISATION FOR 1982 - 1991 9.1 Introduction This chapter extends the analysis of Chapter Eight in three respects. First, a common reason given by rubber consumers for their preference for synthetic rubbers over natural rubber is the relative price stability of the former. However, results in Chapter Eight show that with a 5-year stabilisation programme, the increase in world consumption of natural rubber was 0.22 percent only. Given the lagged price effects on consumption, it may be that longer-term stabilisation is necessary to establish any significant shift towards natural rubber consumption. The first part of this chapter therefore focus on longer-term stabilisation by assuming that the 5-year INRA wqill be extended for a second term from 1986 so that the stabilisation period now extends from 1982 to 1991. Second, this chapter also considers the effect of introducing non-equidistant price bands. Third, it will be recalled from Chapter Seven that political uncertainties in the Middle-Eastern oil producing region provides a basis for a high oil price scenario. Hence it is useful also to forecast natural rubber prices under the high oil price scenario since the forecast time paths of nattural rubber price under the low and high oil price scenarios will delineate the price range within which the Page 308 natural rubber price is likely to fall. This focus on delineating the probable forecast price range under alternative scenarios reinforces the basis for using non-stochastic instead of stochastic simulations in this study. The final section presents forecast time paths of natural rubber price under a high oil price scenario during 1980-1995. 9.2 Stabilisation for 10 Years About Equidistant Price Bands As in Chapter Eight, the simulation results of buffer stock operations with and without prospective buying/selling will be presented to highlight the importance of prospective buffer stock operations. If price is to be stabilised at the average of the price range observed for 1982-1991, then the reference price is $3650. The trigger price bands, given by plus and minus 15 percent of the reference price, are delineated by $3102 and $4197. The indicative price bands which are plus and minus 20 percent of the reference price are then given by $2920 and $4380 respectively. In line with the INRA stipulations, it will be assumed that buffer stock operations are compulsory only when price falls outside the trigger price bands. Thus without prospective buying/selling, the buffer stock will be operated on (other than stock rotation) only when price lies outside the trigger price bands. From Figure 9.1 it can be seen that without prospective buying/selling, buffer stock operations are required only in 1982 (when 80,000 tonnes will be bought) and 1989 (when 80,000 tonnes will be sold). During 1983-1988 no market intervention is required. RSSJ-Price f.o.b. Singapore (S$/Tonne) 5500 5000 4500 r p +15% = $4197 4000 r 350p =$3650 8 r_-15% $3102 3000 r 2% $22 2500 ___ No Stabilisation 2000- - With Stabilisation 0 pYa 1980 1982 1984 1986 1988 1990 1992 1994 1996 Ya Figure 9.1: Price Stabilisation Without Prospective Buffer Stocks Purchases/Sales., Pi 1982-1991. L 0 Page 310 However, as the time path of price under such buffer stock operations shows, the degree of price stabilisation is minimal. Figure 9.2 presents buffer stock operations with prospective buffer stock buying (net change in buffer stocks is positive) and selling (net change in buffer stocks is negative) volumes as indicated along the stabilised price path. It will be noted that the constraint of net change in buffer stock not exceeding 80,000 tonnes in each period is satisfied. The effects of price stabilisation according to Figure 9.2 are summarised in Table 9.1. Two main features emerge. Firstly, price stabilisation according to INRA specifications does not significantly affect overall supply and demand, both in terms of volume and current dollar value. Secondly, the coefficients of variation show that longer-term price stabilisation with equidistant price bands has negligible effect on the instability of total world production, consumption and export earnings. The time paths of world supply and consumption with and without price stabilisation are presented in Figures 9.3(a) and (b). The stabilisation effects on the major producing and consuming countries are presented in Tables 9.2 and 9.3 respectively. These tables show that stabilisation about an unchanged reference price throughout the 10-year period have minimal effect on the degree of instability in production and consumption in the individual countries both in terms of volume and value. RSSl-Price f.o.b. Singapore 5500 (S$/Tonne) 5000 4500 $ 4380 400 0 ; 0 / 70 -40.0 4000 $ 3650 80.0/-t -50. 3500 80.0 r 5 3000 $ 292 / 2500. 2000 1500 No Stabilisation 1000 - With Stabilisation 500 1980 1982 1984 1986 1988 1990 1992 1994 1996 Year (D Figure 9.2: Price Stabilisation With Prospective Buffer Stocks Purchases/Sales, 1982-1991(Equidistant Price Bands). Page 312 Table 9.1: Summary of Effects of Price Stabilisation with Equidistant Price Bands, 1982-1991 Variable Average Value Under Average Value Under Change Due to Free Market Market Intervention Market Intervention World Natural Rubber 4789.34 4781.84 -7.50 Production (0.12) (0.11) (Thousand Tonnes) World Natural Rubber 4684.56 4683.19 -3.37 Consumption (0.10) (0.11) (Thousand Tonnes) Natural Rubber Stocks 828.85 840.33 +11.48 in Producing Regions (0.03) (0.02) and Afloat (Thousand Tonnes) Natural Rubber Stocks 1183.00 1179.56 -3.44 in Consuming Regions (0.14) (0.14) (Thousand Tonnes) World Natural Rubber 10408.80 10376.71 -32.09 Export Earnings (0.26) (0.25) (Million US Dollars) World Natural Rubber 10595.15 10600.34 +5.19 Consumption Expenditures (0.25) (0.25) (Million US Dollars) World Natural Rubber Real 6746.80 6737.62 -10.18 Export Earnings (0.07) (0.04) (Million 1981 US Dollars) World Natural Rubber Real 6943.47 6890.55 -52.92 Consumption Expenditures (0.06) (0.03) (Million 1981 US Dollars) Note: Figures in parentheses denote coefficients of variation of the distributions of values from which the corresponding averages are derived. Page 313 AProduction 4Export Earnings (Th. Tonnes) (US$m) 6000 No Stabilisation 16,000 - - With Stabilisation , ,,1- 14,000. 5000 <1' 12,000 / II' SS10,000 - 4000 8000 -' 6000 0 Yea ___ _ 0 ,_,_Year 1982 1986 1990 1982 1986 1990 Figure 9.3(a): Time Paths of World Natural Rubber Supply. (Equidistant Price Bands) Consumption ,Consumption (Th. Tonnes) Expenditure 6000 16,000 (US$m) 5500 14,000. 5000 12,000 ./ 4500 10,000 . 4000 8000 . 3500 6000 . 0 Year 1r Year 1982 1986 1990 1982 1986 1990 Figure 9.3(b): Time Paths of World Natural Rubber Demand. (Equidistant Price Bands) Table 9.2: Summary of Price Stabilisation Effects on Major Producers, 1982-1991 (With Equidistant Price Bands) Average Natural Rubber Output Average Natural Rubber Export Earnings (Thousand Tonnes) (US $million) Changes Due to Changes Due to Country (a) (b) Intervention (a) (b) Intervention Africa 152.31 150.73 -1.58 351.49 352.66 +1.17 (0.59) (0.60) (0.70) (0.70) Brazil 41.57 41.49 -0.08 90.61 90.56 -0.05 (0.15) (0.14) (0.29) (0.2O8) Indonesia 1270.04 1275.80 +5.76 2776.79 2779.24 +2.45 (0.16) (0.15) (0.30) (0.29) Malaysia 675.46 674.09 -1.37 1488.23 1581.67 +93.44 Estates (0.10) (0.09) (0.20) (0.27) Smallholders 926.70 926.70 0.00 2012.58 1984.87 -27.71 (0.04) (0.04) (0.18) (0.18) Sri Lanka 206.42 206.42 +0.04 454.82 453.08 -1.74 (0.21) (0.20) (0.35) (0.34) Thailand 430.23 426.14 -4.09 918.35 907.57 -10.78 (0.07) (0.09) (0.17) (0.16) Notes: (1) Figures in parentheses denote coefficients of variation of the distributions of values from which the corresponding averages are derived. (2) Case (a) refers to results under the free market. Case (b) refers to results under market intervention. Page 315 Table 9.3: Summary of Price Stabilisation Effects on Major Consumers, 1982-1991 (Case of Equidistant Price Bands) Average Natural Rubber Consumption Volume Average Natural Rubber Consumption Expenditure! (Thousand Tonnes) (US $million) Country (a) (b) Changes Due to (a) ( Changes Due to Intervention Intervention France 203.75 203.86 +0.11 458.08 457.88 -0.80 (0.07) (0.07) (0.21) (0.21) West Germany 238.63 237.64 -0.99 536.44 538.67 +2.23 (0.07) (6.08) (0.22) (0.21) Italy 181.71 181.56 -0.15 410.79 410.84 +0.05 (0.10) (0.10) (0.25) (0.21) Japan 492.46 492.13 -0.33 1059.74 1061.56 +1.82 (0.06) (0.06) (0.21) (0.21) United Kingdom 128.57 128.50 -0.07 286.82 287.15 +0.33 (0.02) (0.02) (0.17) (0.16) United States 867.83 867.55 -0.32 1927.29 1893.01 -34.28 (0.04) (0.05) (0.19) (0.22) Notes: (1) Fiqures in parentheses denote coefficients of variation of the distributions of values from which the corresponding averages are derived. (2) Case (a) refers to results under the free iiiarket. Case (b) refers to results under market intervention. Page 316 The shares of export earnings of the main producers tend to correspond to their production shares. Except for Malaysian estate production, the gains/losses of producing countries because of price stabilisation are small in magnitude. However, longer-term price stabilisation benefits Malaysian estates significantly, as verified by the 6.3 percent increase in their export earnings. From Table 9.3 it can be seen that longer-term price stabilisation affects individual consuming countries unevenly. While consumption in France increases (although only by 0.05 percent), the remaining main consuming countries are shown to reduce their natural rubber consumption. The effects of price stabilisation in terms of consumption expenditures also vary between countries. Except for France and USA, all other countries are shown to expend more on their reduced consumption. Significantly, the USA -- which is the largest single consumer -- is seen to save nearly 2 percent in consumption expenditure from a reduction in consumption of 0.03 percent. Time paths for natural rubber production and consumption of individual countries under markets with and without stabilisation are presented in Appendix 9.A. The effects of stabilisation on Malaysian producers' revenues are presented in Table 9.4 while the time paths of Malaysian estate and smallholder production and producers' revenues are presented in Figures A9.13 and A9.14 respectively in Appendix 9.A. The constancy in average production of the smallholder sector is due to the exogenous treatment of this variable in the ex ante simulations. Table 9.4: Effects of Stabilisation With Equidistant Price Bands on Malaysian Average Producers' Revenues, 1982-1991 (Million US Dollars) Free Market Gains/Loss Due to Producer Market Intervention Intervention (%) Estates 1019.60 1014.33 -0.52 (0.17) (0.16) Smallholders 1353.83 1355.11 +0.10 (0.15) (0.10) hd Pi Page 318 Table 9.5 gives the estimates of buffer stock operational costs by item while Table 9.6 presents the net buffer stock outlay and cumulative buffer stock debt in each period. In constant 1981 US dollars, the total debt incurred by the buffer stock authority in 1991 after a 10-year stabilisation programme is US$243 million. Table 9.7 presents the natural rubber shares with and without price stabilisationr. Under the given technology, it is seen that extending the stabilisation period to 10 years will have no positive effect on natural rubber consumption shares. 9.3 Stabilisation for 10 Years About Non-Equidistant Price Bands A problem with stabilising price for 10 years from 1982 to 1991 about the single reference price $3650 is that prices in 8 out of 10 years lie above this reference price. The interaction between the strong upward price trend in the latter half of the 1980s and the lagged price effects of stabilisation in the early period causes the 1991 price to exceed the ceiling price. This reiterates the question raised in Chapter Eight about the relationship between the reference price, self-liquidating buffer stocks and the associated problein of equidistant/non-equidistant price bands. What the longer-term stabilisation has highlighted is the need to take into account the influence of lagged price effects on the price formation in subsequent periods, and hence on the overall distribution of prices. Table 9.5: Estimates of Buffer Stocks Operational Costs by Item, 1981-1991 Carrying Costs Rotation Costs Administrative & Overhead Year (US$/tonne) (US$/tonne) Costs (US $million/year) 1981 228.60 7.14 0.5714 1982 252.90 7.90 0.6341 1983 280.00 8.80 0.7000 1984 310.00 9.70 0.7692 1985 344.00 10.70 0.8421 1986 377.00 11.80 0.9625 1987 411.70 12.85 1.0291 1988 457.00 14.30 1.1423 1989 505.40 15.90 1.2689 1990 557.80 17.44 1.3943 1991 616.80 19.30 1.5416 Note: Components of the various cost items are as for Table 8.2 in Chapter Eight. 1D (-J Table 9.6: Buffer Stocks Outlay and Cumulative Buffer Stocks Debt in each period, 1982-1991 (Stabilisation with Equidistant Price Bands) Buffer Stocks Outlay Cumulative Buffer Stocks Debt Year Current Constant Current Constant US$m US$m US$m US$m 1982 156.1666 146.4380 156.1666 146.4380 1983 188.2572 165.4281 358.9404 315.4133 1984 -61.0674 -49.6079 333.7670 271.1348 1985 -78.4570 -58.9902 288.6867 217.0576 1986 148.5445 79.4355 466.0998 324.5820 1987 47.7345 25.8024 560.4442 361.3437 1988 -144.5359 -86.2386 471.9527 281.5946 1989 -98.0189 -54.2139 421.1290 232.9253 1990 1.3943 0.7135 464.6362 237.7872 1991 1.5416 0.7299 512.6414 242.7279 Note: Definitions of Buffer Stocks Outlay and Debt as in Chapter 8, Table 8.3. 0 Table 9.7: Natural Rubber Consumption Shares With and Without Price Stabilisation with Equidistant Price Bands, 1982-1991 (Percentages) Year Case A Case B Case C 1982 32.3 (12242.4) 32.2 (12251.1) 32.2 (12251.1) 1983 32.2 (12942.3) 31.9 (12955.8) 31.9 (12955.8) 1984 31.7 (13593.9) 31.5 (13592.9) 31.4 (13595.4) 1985 30.8 (14311.8) 30.9 (14303.2) 30.8 (14307.6) 1986 30.0 (15014.3) 30.3 (15005.0) 30.1 (15016.5) 1987 29.8 (15820.0) 30.0 (15811.7) 29.8 (15819.9) 1988 29.5 (16596.8) 29.5 (16588.7) 1989 29.3 (17419.0) 29.3 (17415.3) 1990 28.9 (18305.7) 29.0 (18303.8) 1991 28.6 (19309.8) 28.7 (19304.7) Notes: (1) Case A refers to market without stabilisation Cases B and C refer to market with stabilisation and for the periods 1982-1986 and 1982-1991 respectively. (2) Figures within parentheses denote total volume of rubber (natural and synthetic) consumption in thousand tonnes. fD Page 322 Supposing the buffer stock authority gives due consideration to the role of lagged price effects in price formation and knows, a priori, how the distribution of prices will be affected after the buffer stock operations have begun. Then the determination/choice of reference price may be made in one of the following ways: (1) on the basis of moving averages, viz. 3-year moving average; (2) on the basis of 5-year intervals so that the reference price is adjusted after 5 years; (3) on the basis of the arithmetic mean of forecast prices for the full 10-year period. Each of the above methods of selecting the reference price raises problems of feasibility and management for the buffer stock scheme. The problems associated with methods (1) and (2) stem from the increased frequency in negotiating new reference prices, a procedure which is time-consuming in general. Furthermore, frequent revisions of reference price could negate the pure price stabilisation objective. Method (3) raises different problems and warrants a separate discussion. If the lagged price effects subsequient to buffer stock operations in the initial years of a 10-year stabilisation programme are recognised, then the buffer stock authority may choose to incorporate the lagged effects by lifting the ceiling price. The extent of increase for the ceiling price may be so as to retain the INRA principle of equidistant price bands. However, this would widen the stabilisation price band. Moreover, the feasibility of lifting the ceiling price is contingent upon the agreement of the consumer Page 323 countries. If the willingness of the consumer countries to participate in INRA stems mainly from their interest in securing a known ceiling price for their future natural rubber consumption, then their approval for lifting the ceiling price may not be obtained easily. Alternatively, a higher reference price may be chosen on the basis of the expected distribution of prices and the dynamic lagged price effects. Using the original floor and ceiling prices, this means that stabilisation will now be about non-equidistant price bands. For the period 1982-1991, a reason for the use of non-equidistant price bands is the sharply rising price trend and the skewed distribution of the forecast prices towards the ceiling level. This upward pressure on price is due primarily to increased demand during the upswing in business cycles. Figure 9.4 presents time paths of natural rubber price under the non-stabilised market and under buffer stock stabilisation about the higher reference price of $3900, but retaining the original floor and ceiling prices. This means that price stabilisation is now about non-equidistant price bands. The effects of stabi7Lisation with prospective buffer stock operations on world production and consumption are summarised in Table 9.8, and their time paths given in Figures 9.5(a) and (b). A comparison of Table 9.8 with Table 9.1 shows stabilisation gains/losses to be the same qualitatively, but differing in magnitude. In terms of volume, stabilisation about different reference prices do not lead to marked difference in global production and consumption. However, because of the higher reference price and non-equidistant price bands, producers gain since they now receive the same export earnings for less output. In contrast, consumers lose because they now consume less at approximately the same RSS1-Price 480 f.o.b. Singapore 4800 (S$/Tonne) 4600 4400 $4380 4200 f// 4000 $3900 - 3800 3600 3400 / 3200 3000 / $292N, l 2800 - No Stabilisation 2600 - - - With Stabilisation -- Year t*'. - - - 1980 1982 1984 1986 1988 1990 1992 1994 1996 Year Figure 9.4: Price Stabilisation with Prospective Buffer Stocks Purchases/Sales, Q 1982-1991 (Non-Equidistant Price Bands). @ w Page 325 Table 9.8: Summary of Effects of Price Stabilisation with Non-Equidistant Price Bands, 1982-1991 Average Average Valuc Under Change Due to Market Variable Value Under Market Intervention Intervention Free Market World Natural Rubber 4798.34 4775.04 -23.30 Production (0.12) (0.11) (Thousand Tonnes) World Natural Rubber 4686.54 4678.89 -7.65 Consumption (0.10) (0.11) (Thousand Tonnes) Natural Rubber Stocks 828.85 844.44 +15.59 in Producing Regions (0.03) (0.15) and Afloat (Thousand Tonnes) Natural Rubber Stocks 1183.00 1178.89 -4.12 in Consuming Regions (0.14) (0.14) (Thousand Tonnes) World Natural Rubber 10408.80 10377.76 -31.04 Export Earnings (0.26) (0.24) (Million US Dollars) World Natural Rubber 10595.15 10596.18 +1.33 Consumption Expenditures (0.25) (0.24) (Million US Dollars) World Natural Rubber Real 6746.80 6751.87 +5.07 Export Earnings (0.07) (0.03) (Million 1981 US Dollars) World Natural Rubber Real 6943.47 6892.18 -51.29 Consumption Expenditures (0.06) (0.03) (Million 1981 US Dollars) Note: (1) Figutes in parentheses denotes coefficients of variation of the distgibutions of the values from which the corresponding averages are derived. (2) Case (a) refers to results under the free market. Case (b) refers to results under market intervention. Page 326 Production Export Earnings (Thousand Tonnes) (US$million) - No Stabilisation - - - With Stabilisation 16,000 6000 14,000 - 12,000 5000 > / 10,000 8000 4000. 6000 0L, Year 0L -Year 1982 1986 1990 1982 1986 1990 Figure 9.5(a): Time Paths of World Natural Rubber Supply, (Non-Equidistant Price Bands). Consumption .Consumption (Thousand Tonnes) Expenditure (US$million) 16,000 6000 14,000. X 12,000- 5000 10,000 - 8000. 4000 - /6000 0 AYea 0 C_ , Year 1982 1986 1990 1982 1%; 1990 Figure 9.5(b): Time Paths of World Natural Rubber Demand (Non-Equidistant Price Bands). Page 327 cost. Measuring the monetary gains and losses in constant (1981) US dollars, it is found that stabilisation with non-equidistant price bands reduces the loss in export earnings by about half, but does not affect consumders' expenditures significantly. The overall gain is therefore higher. However, as Table 9.9 shows, this is offset by a higher buffer stock debt of $365 million at the end of the period. The effects of stabilisation about non-equidistant price bands on the main producing and consuming countries are summarised in Tables 9.10 and 9.11 respectively. Time paths of production and consumption of the main countries under the free market and market with non-equidistant price bands stabilisation as well as for Malaysian producers' revenues are given in Figures A9.15 - A9.28 in Appendix 9A. A comparison of the Tables 9.10 and 9.11 shows that the effects of stabilisation a7oout non-equidistant price bands are more marked for producing countries. Most significantly, the gains made by Malaysian estate producers from stabilisation about equidistant price bands is now lost; instead Indonesian producers are the main gainers from non-equidistant price band stabilisation, albeit with greater instability. The response of Indonesian producers suggest that improvement of infrastructure so that producers may receive a higher share of the world price is likely to increase Indonesian production significantly. In terms of producers' revenues, the Malaysian case again reiterates the uneven effects of stabilisation. From Table 9.12 it can be seen that the effect of non-equidistant price band stabilisation brings about an increase of 0.23 percent in smallholders Table 9.9: Buffer Stock Outlay and Cumulative Buffer Stock Debt in Each Period, 1982-1991 (Stabilisation with Non-Equidistant Price Bands) Buffer Stock Outlay Cumulative Buffer Stock Debt Year Current Constant Current Constant US$m US$m US$m US$m 1982 155.1666 146.4380 155.1666 146.4380 1983 188.2572 165.4281 358.9404 315.4133 1984 -16.7726 -13.6251 378.0618 307.1176 1985 -24.4458 -18.3803 391.4221 294.3023 1986 214.1135 149.1041 644.6778 448.9399 1987 151.9016 97.9378 861.0471 555.1560 1988 -129.6010 -77.3275 817.5508 487.7988 1989 -172.3512 -95.3269 726.9546 402.0766 1990 -98.9891 -50.6597 700.6609 358.5777 1991 1.5416 0.7299 772.2685 365.6574 Note: Definitions of Buffer Stock Outlay and Debt as in Chapter 8, Table 8.3. (D w co Page 329 Table 9.10: Summary of Price Stabilisation Effects on Major Producers, 1982-1991 (With Non-Equidistant Price Bands) Average Natural Rubber Output Average Natural Rubber Export Earnings (Thousand Tonnes) (US $million) Changes due to Changes due to Country (a) (b) Intervention (a) (b) Intervention Africa 152.31 148.69 -3.62 351.49 342.36 -9.13 (0.59) (0.58) (0.70) (0.69) Brazil 41.57 42,92 +0.35 90.61 91.15 +0.54 (0.15) (0.15) (0.29) (0.30) Indonesia 1270.04 1286.83 +16.79 2776.79 2819.97 +43.18 (0.16) (0.18) (0.30) (0.32) Malaysia 675.46 673.98 -1.48 1488.23 1488.88 +0.65 Estates (0.10) (0.09) (0.20) (0.19) Smallholders 926.70 926.70 0.00 2012.58 1995.27 -17.31 (0.04) (0.04) (0.18). (0.18) Sri Lanka 206.42 206.13 -1.77 454.82 453.38 -1.44 (0.21) (0.20) (0.35) (0.33) Thailand 430.23 424.73 -5.50 918.35 905.01 -13.34 (0.07) (0.09) (0.17) (0.14) Notes: (1) Figures in parentheses denote coefficients of variation of the distributions of values which the corresponding averages are derived. (2) Case (a) refers to results under the free market. Case (b) refers to results under market intervention. Page 330 Table 9.11: Summary of Price Stabilisation Effects on Major Consumers, 1982-1991 (With Non-Equidistant Price Bands) Average Natural Rubber Consumption Volume Average Natural Rubber Consumption Expenditures (Thousand Tonnes) (US $million) Country (a) (b) Changes due to (a) (b) Changes due to Intervention Intervention France 203.75 203.56 -0.19 458.08 458.47 +0.39 (0.07) (0.07) (0.21) (0.20) West Germany 238.63 236.52 -2.11 536.44 531.36 -5.08 (0.07) (0.08) (0.22) (0.22) Italy 181.71 181.42 -0.29 410.79 410.71 -0.08 (0.10) (0.10) (0.25) (0.24) Japan 492.46 491.64 -0.82 1059.74 1061.59 +1.85 (0.06) (0.06) (0.21) (0.20) United Kingdom 128.57 128.43 -0.14 286.82 287.43 +0.41 (0.02) (0.17) (0.16) United States 867.83 867.09 -0.74 1927.29 1929.27 -0.02 (0.04) (0.05) (0.19) (0.18) Notes: (1) Figures in parentheses denote coefficients of variation of the distributiorsof values from which the corresponding averages are derived. (2) Case (a) refers to results under the free market. Case (b) refers to results under market intervention, Table 9.12: Effects of Stabilisation with Non-Equidistant Price Bands on Average Malaysian Producers' Revenues, 1982-1991 (Million US Dollars) Free Market Gains/Loss Due to Producer Market Intervention Intervention (%) Estates 1019.60 1020.03 +0.04 (0.17) (0.16) Smallholders 1353.83 1357.04 +0.24 (0.15) (0.14) I- F'd Page 332 producers' revenue, but only 0.04 percent for estate producers' revenues. It should be pointed out that this result is biased against the smallholders because their production was held constant as a result of exogeneity. In conclusion, the results reiterate the uneven effects of price stabilisation on individual countries. Furthermore, whether equidistant or non-equidistant price bands are used also lead to different results. These findings raise in particular the question of distributing the financial burden between producing and consuming countries in their joint funding and operations of a buffer stocks scheme. 9.4 Ex Post Stabilisation for 1970-1980 The stabilisation results presented thus far are derived from non-stochastic simulations with exogenous treatment of the Malaysian smallholder supply. In order to check for the possibility that the qualitative stabilisation outcomes discussed so far are due to the non-stochastic and exogenous features mentioned above, ex post stabilisation for 1970-1980 was simulated. Figure 9.6 presents the actual and stabilised price paths for 1970-1980 while the stabilisation effects on world production and consumption are summarised in Table 9.13. From Table 9.13 it is found that the qualitative effects of stabilisation during 1970-1980 are similar to those under non-stochastic simulation of price stabilisation for 1982-1991. As before, price stabilisation leads to RSSl-Price iPrice with f.o.b. Singapore Stabilisation (S$ per tonne) 3200 l 3 000 I 2800 1 I 2600 2 400 $2340 / 2 200 / 2 000 1 800 10 1 600 1 400 $-f 260 - 1 200 -- 000 .- Year 1970 1972 1974 1976 1978 1980 Figure 9.6: Time Paths of Natural Rubber Price With and Without Buffer Stocks Stabilisation, 1970-1980. Page 334 Table 9.13: Summary of Ex Post Price Stabilisation Effects, 1971-1980 Variable Average Value Average Value Change due to Under Free Under Market Market Market Intervention Intervention World Natural Rubber 3509.50 3418.30 -91.20 Production (0.07) (0.06) (Thousand Tonnes) World Natural Rubber 3423.10 3422.20 -0.90 Consumption (0.08) (0.08) (Thousand Tonnes) Natural Rubber Stocks 761.30 746.50 -14.80 In Producing Regions (0.05) (0.08) and Afloat (Thousand Tonnes) Natural Rubber Stocks 776.50 765.77 -10.73 in Consuming Regions (0.05) (0.09) (Thousand Tonnes) World Natural Rubber 2772.70 2817.50 +44.80 Export Earnings (0.50) (0.46) (Mi.llion US Dollars) World Natural Rubber 3045.40 3058.00 +12.60 Consumption Expenditures (0.50) (0.50) (Million US Dollars) World Natural Rubber Real 1630.60 1668.30 +37.70 Export Earnings (0.28) (0.19) (Million 1981 US Dollars) World Natural Rubber Real 1788.20 1797.20 +9.00 Consumption Expenditures (0.22) (0.22) (Million 1981 US Dollars) Note: (1) Figures in parentheses denotes coefficients of variation of the distributions of values from which the corresponding averages are derived. (2) Export earnings do not equal consumption expenditures because the valuespresented here are estimates based on actual production and consumption volumes (not equal) and the relevant market (fob/cif) prices. Page 335 a fall in world production and consumption in volume terms. However, when production and consumption are measured in monetary terms, stabilisation leads to an increase in export earnings and a marginal increase in consumption expenditures. A 10-year stabilisation programme will benefit producing countries by increasing their natural rubber export earnings by S$44.8 million (US$37.7 million in constant 1970 dollars). The effects of price stabilisation (for the historical period 1971-1980) on the main producing countries are presented in Table 9.14; comparing Table 9.14 with Table 9.2 it can be seen that qualitatively, the stabilisation effects are neutral to stochastic or non-stochastic simulations. But the stochastic simulation for the historical period leads to more marked quantitative effects, thus suggesting that the gains to producing countries indicated by the non-stochastic simulations earlier tends to be under-estimated. This vindicates the argument in Chapter Eight that non-stochastic simulation provides a most favourable test of the INRA scheme. Table 9.14 also provides an evaluation of the impact of price stabilisation on Malaysian smallholder production. For the historical period, it is seen that price stabilisation would have led to a slight reduction in Malaysian smallholder production but an increase in export earnings. Table 9.14 also shows that stabilisation in the presence of random disturbances leads to more significant gains for Indonesian producers. For 1971-1980, price stabilisation would have benefitted Indonesian producers by an increase in export earnings of US$115.6 million. Page 336 Table 9.14: Summary of Ex Post Price StabilisatbnEffects on Major Producers, 1971-1980 Average Natural Rubber Output Average Natural Rubber Export Earnings (Thousand Tonnes) (US $ million) Country (a) (b) Change due to (a) (b) Change due to Intervention Intervention Africa 207.33 205.47 -1.86 155.44 162.15 +6.71 (0.07) (0.08) (0.38) (0.35) Brazil 23.08 21.33 -1.75 18.05 17.21 -0.84 (0.12) (0.09) (0.54) (0,44) Indonesia 857.41 920.55 +63.14 673.88 789.49 +115.61 (0.05) (0.09) (0.49) (0.55) Malaysia 637.93 643.09 +5.16 505.04 535.58 +30.54 Estates (0.64) (0.08) (0.42) (0.37) Smallholders 814.13 808.74 -5.39 600.78 675.70 +74.92 (0.14) (0.07) (0.54) (0.46) Sri Lanka 145.71 156.75 +11.04 111.86 133.53 +21,67 (0.06) (0.10) (0.44) (0.54) Thailand 413.61 422.79 +9.18 399.92 365.84 -34.08 (0.17) (0.12) (0.60) (0.56) Notes: (1) Figures in parentheses denote coefficients of variation of the distributions of values from which the corresponding average are derived. (2) Case (a) refers to results under the free market. Case (b) refers to results under market intervention. Page 337 The effects of stabilisation on Malaysian producers' revenues are given in Table 9.15; as before, stabilisation will result not only in higher export earnings but also higher producers' revenues. The effects of price stabilisation during 1971-1980 on the main consuming countries will now be discussed. Table 9.16 presents the effects of stabilisation on consumption volumes and expenditures. Comparing Table 9.16 with Table 9.3, it can be seen that the qualitative effects of stabilisation are also neutral to stochastic or non-stochastic simulations. Most importantly, the results in Table 9.16 substantiate the earlier finding that price stabilisation affects the consuming countries unevenly. 9.5 Forecasts for Rubber Market under High Oil Price Scenario Figures 9.7(a) and 9.7(b) present the forecasts of natural rubber prices in Singapore and New York under alternative oil price scenarios. In order to reflect supply response due to higher natural rubber prices, the Malaysian smallholder supply is assumed to grow at 2 percent per annum from the 1981 production level. The price forecasts show that natural rubber prices are expected to be $4151, $4750 and $5500 by 1985, 1990 and 1995 respectively. Natural rubber production is forecast to reach 4680, 5870 and 7700 thousand tonnes respectively for the three benchmark years while consumption is forecast to reach 4500, 5600 and 7300 thousand tonnes respectively. 2 The 2 percent annual rate of growth is based on the rate of new planting observed in the 1970s. Table 9.15: Effects of Ex Post Price Stabilisation on Malaysian Average Producers' Revenues, 1971-1980 (Million US dollars) Free Market Gains Due to Producer Market Intervention Intervention (%) Estates 398.40 436.93 +9.67 (0.30) (0.29) Sma2lholders 481.60 523.82 +8.77 (0.42) (0.35) Lo Page 339 Table 9.16: Summary of Ex Post Price Stabilisation Effects on Major Consumers, 1971-1980 Average Natural Rubber Consumption Volume Average Natural Rubber Consumption Expenditures (Thousand Tonnes) (US $ million) (a) (b) Change due to (a) (b) Change due to Intervention Intervention France 164.98 164.50 -0.48 137.76 144.40 -6.64 (0.04) (0.04) (0.46) (0.46) West Germany 191.62 156.00 -35.62 184.20 134.60 -49.60 (0.04) (0.07) (0.39) (0.41) Italy 124.50 127.70 +3.20 103.52 113.90 +10.38 (0.06) (0.07) (0.44) (0.50) Japan 331.32 290.30 -41.02 265.96 241.70 -24.26 (0.13) (0.04) (0.58) (0.46) United Kingdom 162.23 156.05 -5.18 127.68 130.30 +2.62 (0.12) (0.11) (0.31) (0.31) United States 717.57 706.10 -11.47 644.94 650.40 +5.46 (0.10) (0.10) (0.49) (0.48) Notes: (1) Figures in parentheses denote coefficients of variation of the distributions of values from which the corresponding averages are derived. (2) Case (a) refers to results under the free market. Case (b) refers to results under market intervention. Singapore Dollars 'per Tonne 6000 High Oil Price Scenario 5000 / *-.- ,Low Oil Price / Scenario 4000 / // 3000 2000 1980 1984 1988 1992 1996 Year Figure 9.7(a): Forecasts of RSSl-grade Natural Rubber Prices in Singapore Under Different Oil Price Scenarios, 1981-1995. (D 0 US Dollars per Tonne 5000 4000 RSSl-Grade Natural Rubber Price, c.i.f. New York // Average Synthetic 3000 r0 , ,Ya 0 _ _ _ _ _0 _,Year i982 1986 1990 1982 1986 1990 Figure A9.18: Time Paths of Natural Rubber Supply and Export Earnings, Malaysia. (Non-Equidistant Price Bands) Page 353 Production Export Earnings (Th. Tonnes) (US$m) 700 - No Stabilisation / - - With Stabilisation 300 GOO ,/ ~// 250- 500 200G 400 / 150' 300 / 100 200 o Year o Year 1982 1986 1990 1982 1986 1990 Fig4-re A9-;19: Time Paths of Natural Rubber Supply and Export Earnings, Sri Lanka. (Non-Equidistant Price Band) Production Export Earnings (Th. Tonnes) ,(US$m) 600 1200 550 1100 1000 500- 400 /800 350 700 Or L ,Yea; OL ---,Year 1982 1986 1990 1982 1986 1990 Figure A9.20: Time Paths of Natural Rubber Supply and Export Earnings, Thailand (Non-Equidistant Price Band) Page 354 Consumption Consumption / (Th. Tonnes) Expenditure (US$m) - No Stabiliaation 250 - With Stabilisation 500- 200 - 400. 150 300 oL Year L Year 1982 1986 1990 1982 1986 1990 Figure A9.21: Time Paths of Natural Rubber Consumption, France. (Non-Equidistant Price Bands;) Consumption Consumption (Th. Tonnes) Expenditure (US$m) 800 / @/ 250 700, 600. 200 500 . X 400 / 150 300 0 Year Y_____ear, 1982 1986 1990 1982 1986 1990 Figure A9.22: Time Paths of Natural Rubber Consumption, West Germany. (Non-Equidistant Price Bands) Page 355 Consumption Consumption (Th. Tonnes) Expenditure (US$m) 240 - No Stabilisation - -With Stabilisation 600 220 200. ' 6 p400 180 160 200 0 Year 0 Year 1982 1986 1990 1982 1986 1990 Figure A9.23: Time Paths of Natural Rubber Consumption, Italy. (Non-Equidistant Price Bands) Consumption Consumption (Th. Tonnes) Expenditure 550 / (US$m) / 1400. 500 1t 1200p '- 1000 . -, // 450 800. 600. 400 oc.Year *Year. 0 _ or0L 1982 1986 1990 1982 1986 1990 Figure A9.24: Time Paths of Natural Rubber Consumption, Japan. (Non-Equidistant Price Bands) Page 356 Consumption Consumption (Th. Tonnes) ' Expenditure (US$m) No Stabilisation 140 - - With Stabilisation 400 350 130 7 300, 120 200- 0 Year 0 L Year 1982 1986 1990 1982 1986 1990 Figure A9.25: Time Paths of Natural Rubber Consumption, UK. (Non-Equidistant Price Bands) Consumption Consumption 950 (Th. Tonnes) 2500 Expenditure / (US$m) 900s 2000 850. 1500 / 800 Year 1000 Year 0 o r- I l 1982 1986 1990 1982 1986 1990 Figure A9.26: Time Paths of Natural Rubber Consumption, USA. (Non-Equidistant Price Bands) Page 357 Production tProducers' (Th.Tonnes) Revenue 3000 - No Stabilisation 1300 (US$m) / \ 2900 Stabilisation 1200, X J- 2800 X 1100 / 2700 /// 1000 / 2600 / 900 / \ 2500 800 o Year O,Year 1982 1986 1990 1982 1986 1990 Figure A9.27: Time Paths of Natural Rubber Supply and Producers' Revenue, Malaysian Estates. (Non-Equidistant Price Bands) Production Producers' (Th. Tonnes) Revenue (US$m) 3000 1700 ~// 2900 - - 1600 28001 1500 A 2700 1400 , ,1 / 2600 // 1300 / 2500 1200 0 !Yeax 0 o ,Year.- 1982 1986 1990 1982 1986 1990 Figure A9.28: Time Paths of Natural Rubber Supply and Producers' Revenue, Malaysian Smallholders. (Non-Equidistant Price Bands) Page 358 CHAPTER TEN IMPACT OF MALAYSIAN EXPORT TAXATION 10.1 Introduction Since Malaysia is the single most important natural rubber producing country, a change in Malaysian natural rubber production would, ceteris paribus, affect total world production, and hence world price. This penultimate chapter examines the role of Malaysian natural rubber export tax in the world rubber market, by varying the level of export taxes and examining the consequences of such tax variations on Malaysia and the rest-of-the-world. These tax variations will reveal the incidence of the tax and its effects on producers and consumers in Malaysia and in the rest of the world. It will also highlight the interaction between export tax and natural rubber price formation and the underlying interdependence between natural rubbe:r producing countries through the effect of natural rubber price on their supply response. This case study of the effects of Malaysian export tax variations on the rest-of-the-world also provides an example of the impacts of national government market interventions on world commodity markets. Page 359 10.2 Effects of Lower Malaysian Export Taxes The Malaysian export tax rates will be varied in order to evaluate the sensitivity of natural rubber price formation to the levels of this tax. The effects of lower export tax rates will be examined within the context of the world rubber market under low oil price scenario. In doing this, the forecast values of prices, production and consumption under alternative tax rates will be compared with the forecast values in the free market (without stabilisation) presented in Chapter Eight. In varying the export tax rates, it was found that the world rubber market under a low oil price scenario was insensitive to a 15 percent reduction in the existing rate. But the market was found to be sensitive if the export taxes were reduced by 30 percent. The effects of a 30 percent reduction in Malaysian export taxes on world production and consumption will now be discussed. Under a 30 percent reduction, the generalised export tax functions now become: S t =0.08 if PN< $1540 =0.08+0.0642(PN-1540/1000) if $1540 < PN <$2800 =0.1610+0.0525(PN-2800/1000) if PN >$2800 Page 360 and E t =(22.0500/PN) if PN <$1540 =0.0280+0.0914(PN-1540/1000) if $1540 < PN< $3000 =0.1600+0.0555(PN-3000/1000) if PN> $3000 The lowering of export taxes by 30 percent means that producers will receive a higher share of world prices. Malaysian producers will respond to these higher 'farmgate' prices by increasing production, thereby raising world natural rubber output. Although natural rubber price is determirned by the demand for stocks in the consuming regions, it is also ne;jatively related to the volume of world natural rubber output. The higher Malaysian output, and hence higher world output will lead to a fall in world price unless this higher output is matched by a corresponding rise in demand for stockholdings in the consuming regions. The interest here is to see whether in the final outcome the tax falls mainly on the suppliers or on the buyers. This question of tax incidence is complicated in a dynamic model because of the lagged effects of any tax change "shockc" to the world market. Table 10.1 presents the various natural rubber prices under the existing tax rates and those lowered by 30 percent. The various price series shown in Table 10.1 are as expected: price net of export tax received by Malaysian producers are higher when the export tax rates are reduced. But the 30 percent reduction in Malaysian export taxes results in a maximum fall in world prices of 2 percent only over the whole period. These results substantiate the argument that despite Page 361 Table 10.1: Comparison of Price Forecasts Under Alternative Export Tax Rates, 1981-1995 Existing Tax Rates Reduced Tax Rates Year Spot pNSing Sing Spot PSing Sing-5 PN PN PN-_Tax PN PNg PN _a 1981 657.78 2810.00 2221.00 656.90 2807.20 2403.45 1982 802.23 3324.80 2476.90 794.70 3276.40 2701.90 1983 855.76 3457.40 2540.40 844.20 3415.60 2790.30 1984 1031.87 4045.20 2789.20 1019.00 3977.40 3125.30 1985 1062.63 4063.50 2796.10 1053.30 4013.10 3145.40 1986 998.00 3811.60 2696.70 987.70 3737.50 2986.50 1987 1048.55 3923.60 2742.10 1042.00 3928.70 3097.60 1988 1218.10 4476.60 2938.00 1203.70 4429.40 3369.30 1989 1278.40 4547.70 2959.80 1266.00 4496.80 3403.70 1990 1233.78 4395.00 2912.00 1221.50 4325.30 3315.10 1991 1258.40 4363.70 2901.80 1261.40 4345.80 3325.88 1992 1345.57 4477.40 2938.30 1342.20 4470.80 3390.50 1993 1434.72 4586.00 2971.20 1420.70 4531.70 3421.40 1994 1499.40 4657.60 2991.90 1480.80 4607.35 3459.20 1995 1491.48 4454.30 2931.00 1465.00 4382.40 3345.00 Notes: (1) PNSPOt refers to the London Spot price for RSS1-grade natural rubber, in Sterling Pounds per tonne. (2) PNSing refers to the f.o.b. Singapore price for RSS1-grade natural rubber, in Singapore Dollars per tonne. (3) PNSingTax refers to the f.o.b. Singapore net of export tax for RSSl-grade natural rubber, in Singapore Dollars per tonne. Page 362 being a major producer, Malaysia nevertheless remains basically a price taker in the world rubber market. Hence the tax falls chiefly on the Malaysian suppliers and there is negligible terms of trade effect. As world price remains relatively unaffected by a reduction in Malaysian export taxes, the overall effects of price stabilisation by buffer stock operations are similar to those reported earlier and will not be repeated here. The focus here will therefore be on comparing the effects of stabilised prices on Malaysian production, producers' revenue and export tax revenues under the two different tax regimes. Since Malaysian smallholder production was treated exogenously, the comparison of export tax effects concern Malaysian estate production only. Table 10.2 compares the behaviour of Malaysian estate production under the two different export tax regimes and equidistant price band stabilisation about the price of S$3650. From Table 10.2 it can be seen that a downward adjustment of export tax results in an all-round gain to estates as one would expect. Increased output leads to higher export earnings. However, the biggest gain due to reduced export taxes accrue to producers' revenue which rises by 23 percent. Thus it can be inferred that, in the absence substantial terms of trade effects, the burden of export taxation falls almost entirely on producers. For the Malaysian government, lower export taxes will mean a fall in natural rubber export tax revenue, but this is more than offset by the tax revenue from a higher volume of exports; the net effect of lowering export taxes by 30 percent is an increase in export revenue by almost 5 percent. Table 10.2: Effects of Alternative Export Tax Rates and Price Stabilisation on Malaysian Estate Production, Export Earnings, Producers' Revenue and Export Tax Revenue, 1982-1991. Variable Higher Export Lower Export Increase (%) Tax Rates Tax Rates Output 6740.9 7223.8 7.2 Export Earnings 24347.4 28955.8 18.9 Producer's Revenue 18680.3 23017.9 23.2 Export Tax Revenue 5667.1 5937.9 4.8 Notes: (1) Outout refers to estate natural rubber production in thousand tonnes. (2) Export Earnings, Producer's Revenues and Export Tax Revenues are in Million Singapore Dollars. Page 364 10.3 Effects of Zero Malaysian Export Taxation This section examines the role of Malaysian natural rubber export tax in the world rubber market by examining the interaction between this tax and other key variables when tax is reduced to zero. In doing so, the pattern of interaction between variables in the model will also be highlighted. In section 10.2 above, it was found that a 30 percent reduction in export tax lowers world price by 2 percent at most. Hence the effect of this partial tax reduction on other variables is marginal. To illustrate the interaction between export tax and other variables more clearly, a 100 percent tax reduction will now be applied so that Malaysian producers will receive the full world price. The effect of this higher 'farmgate' price on producers in other countries and on consumers, other things remaining constant, will now be discussed. The forecast prices of natural rubber with and without Malaysian natural rubber export tax are compared in Table 10.3. As before, the reduced tax will mean higher prices for producers who will respond by increasing output. This will lead to higher world production and hence lower world prices. However, Malaysian producers now receive the world price in full. As seen from Table 10.3, the price rise for Malaysian producers due to zero export taxes range from 25.4 to 49.7 percent. In contrast, the fall in world prices range from 0.9 to 5.3 percent only. Table 10.4 shows the effects on Malaysian estate production when export tax is reduced to zero. While such tax reduction will cause estate production to rise by 23.5 percent, the increase in producers' Page 365 Table 10.3: Forecasts of Natural Rubber Prices With and Without Export Tax in Malaysia, 1981-1995 With Export Tax Without Export Tax Year Spot pNSing ing pNSPot pNSing PNSing-Tax (1) (2) (3) (4) (5) (6) 1981 657.78 2810.00 2221.00 653.05 2785.60 (-0.9%) (+25.4) 1982 802.23 3324.80 2476.90 782.31 3237.50 (-2.6%) (+30.7) 1983 855.76 3457.40 2540.40 816.70 3280.70 (-5.1%) (+29.1) 1984 1031.87 4045.20 2789.20 993.89 3875.00 (-4.2%) (+38.9) 1985 1062.63 4063.50 2796.10 1021.42 3917.10 (-3.6%) (+40.1) 1986 998.00 3811.60 2696.70 953.07 3608.70 (-5.3%) (+33.8) 1987 1048.55 3923.60 2742.10 1021.73 3822.10 (-2.6%) (+39.4) 1988 1218.10 4476.60 2938.00 1192.91 4387.50 (-2.0%) (+49.3) 1989 1278.40 4547.70 2959X80 1244.88 4422.90 (-2.7%) (+49.3) 1990 1233.78 4395.00 2912.00 1195.10 4231.70 (-3.7%) (+45.3) 1991 1258.40 4363.70 2901.80 1232.97 4278.90 (-1.9%) (+47.5) 1992 1345.57 4477.40 2938.30 1318.32 4355.80 (-2.7%) (+48.2) 1993 1434.72 4586.00 2971.20 1392.17 4472.70 (-2.5%) (+50.5) 1994 1499.40 4657.60 2991.90 1437.36 4477.50 (-3.9%) (+49.7) 1995 1491.48 4454.30 2931.00 1405.08 4238.10 (-4.9%) (+44.6) Notes: (1) PNSpot refers to the London Spot price for RSSl-grade natural rubber, in Sterling Pounds per tonne. (2) PN Sing refers to the f.o.b. Singapore price for RSS1-grade natural rubber, in Singapore Dollars per tonne. (3) PNSingTax refers to the f.o.b. Singapore price net of Export Tax for RSSl-grade natural rubber, in Singapore Dollars per tonne. (4) Figures within parentheses are percentage changes between Corresponding prices With and Without export tax. Table 10.4: Effects of Export Tax on Malaysian Estate, Production, Export Earnings, Producers' Revenue and Export Tax Revenue, 1982-1991. Varal With Export Without Export Difference(%) Variable Tax Tax Output 6740.9 8326.1 +23.5 Export Earnings 24347,4 32465.9 +33.3 Producers' Revenue 18680.3 32465.9 +73.8 Export Tax Revenue 5667.1 0.0 -100.0 Notes: (1) Output refers to estate natural,rubber production in thousand tonnes. (2) Export Earnings, Producers' Revenue and Export Tax Revenue are in Million Singapore Dollars. . t pd Page 367 revenue amounts to nearly 74 percent. At the national level, export earnings from estate production will rise by 33.3 percent but the tax revenue from this source of exports is now reduced by the full 100 percent. The effects of reduced export taxes on Malaysian smallholder producers are not presented here because of the exogenous treatment of smallholder production so that smallholder supply is assumed to be unaffected by export tax variations. An implication of this is that the export tax discriminates in favour of smallholders' share of Malaysian production. However, it may be surmised that the qualitative effects of reduced export taxation on smallholders will be similar to those for estate production. Table 10.5 compares natural rubber production in the main producing countries for 1982-1991 with and without Malaysian export taxes on natural rubber. For Malaysia, reducing export taxes completely is seen to induce a 9.8 percant increase in production over a 10-year period. However, such export tax reduction impacts on the remaining producing countries negatively. With the exception of Africa, all other producing countries/regions show reduced output by about 2 percent. Consequently, the net result is an increase in world output of less than 2 percent over the entire period. The effect of zero export taxation in Malaysia on world rubber consumption and natural rubber consumption share will now be discussed. Since reduced export taxes mean lower world prices for natural rubber, a resultant increase in natural rubber consumption is to be expected due to the lower relative price of natural to synthetic rubbers. This substitution of natural for synthetic rubbers is borne out by Table 10.6. However the degree of substitution is marginal, Table 10.5: Effects of Malaysian Export Tax on Natural Rubber Supply in Main Producing Countries, 1982-1991 (Thousand Tonnes) Country With Export Without Export Difference Tax Tax (%) Africa 1523.1 1555.5 +2.1 Brazil 415.7 406.3 -2.3 Indonesia 12,700.4 12456.3 -1.9 Malaysia 16,021.6 17593.1 +9.8 Sir Lanka 2064.2 2029.3 -1.7 Thailand 4302.3 4181.9 -2.8 Rest-of-the-world 10865.8 10603.5 -2.4 World 47893.1 48825.9 +1.9 Pi cD oo. Table 10.6: Effects of Malaysian Export Tax on World Natural and Synthetic Rubbers Consumption, 1982-1991 Variable With Export Without Export Difference Tax Tax (%) Natural Rubber Consumption 46,865.6 (30.1) 47,602.5 (30.6) +1.6 Synthetr Conumptio Synthetic Rubber 108,690.4 (69.9) 107,713.5 (69.4) -0.9 Consumption Total Rubbtnr 155,556.0(100.0) 155,316.0(100.0) -0.2 Consumption LQ (D w Page 370 since the natural rubber consumption share increases by 0.5 percentage point only over the entire 10-year period. Table 10.6 also shows an overall fall in rubber consumption of 0.2 percent, which averages to a fall of only 2000 tonnes total rubber consumption annually. Thus a maximum fall in world natural rubber price of 5 percent will induce an increase in natural rubber production of 1.6 percent over the same period, indicating the low price elasticity of substitution between natural and synthetic rubbers under the present industrial organisation. Table 10.7 compares natural rubber consumption in the main consuming countries in situations with and without export tax in Malaysia during 1982-1991. The biggest increase in natural rubber consumption of 13 percent was in France while the USA -- the largest consumer -- was seen to increase natural rubber consumption by less than 1 percent. The value of the findings presented in Table 10.7 lies in the insight they provide on the distribution of the increased natural rubber consumption between countries. A study of the numbers in Table 10.7 shows that no generalisation of "he distributional effects is possible. Whereas higher increases and hence greater substitution are observed for the medium-sized consuming countries of France and West Germany, the increases are found to be marginal for the smaller-sized consuming countries of Italy and UK as well as the bigger consuming countries of Japan and USA. Table 10.7: Effects of Malaysian Export Tax on Natural Rubber Consumption in Main Consuming countries, 1982-1991 With Export Without Export Difference Country Tax Tax (%) France 2037.5 2303.2 +13.0 West Germany 2386.3 2532.8 + 6.1 Italy 1817.1 1836.5 + 1.1 Japan 4924.6 5004.8 + 1.6 United Kingdom 1285.7 1298.7 + 1.0 USA 8678.3 8758.8 + 0.9 Page 372 10.4 Indirect Effects of Export Tax Variations on Market Instability So far the discussion has centered on the direct consequences of variations in Malaysian export taxes on Malaysian production, production of the other producing countries and on world rubber consumption. The discussion has shown that the direct effects of varying export taxes in one country on the rest of the rubber market is minimal. The discussion will now turn to the question of the indirect effects, since the exogenous variations in export tax rates of a major producer are a source of randomness and instability in the world market. The implications of the above findings for price stabilisation in general will then be considered. Chapters Eight and Nine have shown that successful price stabilisation by buffer stock operations depends on a variety of factors, chief of which are the correct identification of the long-run equilibrium price and appropriate prospective buffer stock operations. The simulation results have also shown that the goal of price stabilisation need not be compatible with that of achieving steady growth of export earnings. Furthermore, the uneven distribution of stabilisation gains raises the problem of fund contributions to the buffer stock. The problems of buffer stock price stabilisation become more complicated once the possibility of changes in the export taxation of producing countries in the interim is taken into consideration. This chapter has shown that a change in the export taxation of one country affects world price and hence production of the remaining countries as well as world rubber consumption. Given that most natural rubber producing countries impose export taxes on their rubber exports, Page 373 successful operations of a buffer stock scheme would entail that the judgement of the buffer stock manager encompass, among other things, the potential effects of prospective changes in export tax structures of the producing countries. Page 374 CHAPTER ELEVEN SUMMARY AND CONCLUSION 11.1 Introduction This chapter summarises the key results of Chapters Two to Ten, focussing on the world rubber market structure and problems associated with effective price stabilisation. 11.2 Empirical Findings For 1956-1978 The estimated annual model of the world rubber market consists of two supply-demand type submodels, and abstracts from speculative and hedging activities. These submodels differ (a) in their level of disaggregation and (b) in their representation of market structure. The disaggregated natural rubber submodel consists of separate natural rubber supply and demand equations for the major producing and consuming countries respectively. Perfect competition in the natural rubber market is reflected in the price formation equation which is based on disequilibrium demand for natural rubber stocks in the consuming regions. The synthetic rubber submodel consists of disaggregated consumption equations corresponding to those for natural rubber, but presents world synthetic rubber supply in aggregate. To proxy the imperfect competition within the synthetic rubber industry, Page 375 the assumption of monopolistic synthetic rubber supply was used; thus synthetic rubber supply and price in each period are jointly determined within this submodel with synthetic rubber stocks as a residual. The nexus between the two subm:)dels is provided by the relative price variables in the demand equations. The dominant features of the estimated model are (a) the lag structures in the natural rubber supply equations as well as the natural rubber and synthetic rubbers consumption equations, and (b) the residual nature of synthetic rubber stocks. The significance of these features lie in their implications for buffer stock operations for natural rubber price stabilisation. For the historical period, natural rubber supply was found to be influenced by prices up to 14-year lags. Demand for both types of rubber were also found to depend on lagged prices, albeit up to four years only. Consequently, successful price stabilisation requires the stabilisation authority to anticipate business cycles (because of the derived demand for rubbers) and understand the differential lagged price effects on production and consumption that would arise from any market intervention. The residual nature of synthetic rubber stocks is related to the organisation of the synthetic rubber industry and its ability to adjust production and inventories according to market conditions. This is vividly illustrated in the post-1973 period when synthetic rubber production was curtailed upon the quadrupling of oil price. This led to a temporary trend reversal in consumption shares favouring natural rubber for the first time since the "take-off" of the world synthetic rubber industry in 1956. The flexibility of the synthetic Page 376 rubber industry in adjusting production and inventories, the proximity of the industry to consumers and the trading of synthetic rubbers under unpublicised price discc-unting provides the raison d'etre for explaining natural rubber spot price formation in terms of demand for natural rubber stocks in consuming regions. This is because rubber goods manufacturers generally cover their minimum natural rubber requirements by long-term contracts and use the terminal spot markets to obtain additional requirements. As general-purpose synthetic rubbers and natural rubber are substitutable in the range beyond the minimum requirements, the choice between the two types of rubber beyond their minimum requi ements is explained by their relative prices. Empirical validation of the model by ex post one-period and dynamic simulations of the 1970-1978 period generated time paths which tracked the market reasonably well. The causal structure of this 87-equation model by causal ordering of the equations substantiate the fact that the determination of natural rubber price has been causally-dependent on the price of synthetic rubbers and co-determined with natural rubber production and total consumption of all rubbers. As indicated in Chapter One, a sound analysis of the postwar natural rubber market entails understanding the interrelations between natural rubber and the synthetic rubbers in consumption. This turns on an understanding of the dependence of the synthetic rubber industry on the oil and petrochemical industries. Thus the natural rubber market cannot be understood in isolation. This study reported the estimation and validation of an econometric model representing the world natural and synthetic rubbers market with price of oil Page 377 incorporated explicitly. The findings provide the basis for using the model (a) to forecast natural rubber price under the assumption of an unchanged market structure, (b) to simulate alternative buffer stock schemes for the purpose of stabilising natural rubber price and increasing producers' incomes and (c) to examine the effects of changes in Malaysian natural rubber export taxation to illustrate the impacts of national government interventions on world commodity markets. 11.3 Implications of Price Stabilisation, 1981-1991 The model was first used to forecast the time paths of natural rubber prices in the primary and terminal markets under a low oil price scenario for 1980-1995. On the basis of these forecast prices, buffer stock operations were then simulated in accordance with the rules of the International Natural Rubber Agreement (INRA). In view of the long price lags in the estimated model, medium- (5 years) and long-term (10 years) stabilisation were simulated to ascertain the effect of the choice of time horizon on the attainment of the INRA goals of stabilising price and inducing steady growth of natural rubber export revenues of the producer-countries. As the model is based on annual data, the relevant INRA rule for buffer stock operations is that the net change in the buffer stock between any two points in time not exceeding 18 months should not be more than 100,000 tonnes. In this study, the INRA rule is translated approximately into the condition that net change in buffer stock does Page 378 not exceed 80,000 tonnes between any two consecutive years. The simulated buffer stock operations were made to satisfy this constraint. Under the low oil price scenario, the natural rubber prices forecast by the model-with no intervention were found to lie outside the stabilisation price bands specified by the INRA. Thus in the buffer stock simulations, the stabilisation price bands were determined from the relevant forecast price ranges. In all the stabilisation results reported below, the constraint of net change in buffer stocks not exceeding 80,000 tonnes annually was binding. The results of medium- to long-term price stabilisation for the future period on the basis of non-stochastic simulations may be summarised as follows. First, the simulations show prospective buffer stock operations to be an essential part of successful partial price stabilisation. This arises from the need to consider the lagged effects in a dynamic system. The stabilisation results discussed below therefore pertain to stabilisation with prospective buffer stocks operations. Second, the simulations show that the stabilisation results are critically dependent on the choice of reference price and the use of equidistant or non-equidistant price bands. Partial price stabilisation about equidistant price bands for a 5-year period results is a loss in producers' incomes. But if stabilisation is conducted about non-equidistant price bands, then the loss in producers' export earnings is found to be lower than in the equidistant case, the lower export earnings stemming from lower Page 379 natural rubber production. This comparison highlights the importance of the choice of reference price and equidistant/non-equidistant price bands about which to stabilise. This is because the lower loss in export earnings in the case of non-equidistant price band stabilisation can be s_eei as a shift of income to producing countries. The results of stabilisation with equidistant and non-equidistant price bands also reiterate the relative inelasticity of natural rubber demand vis-a-vis that of natural rubber supply; for both types of price stabilisation, the change in world natural rubber consumption over the stabilisation is seen to be negligible. Third, the simulations show that price stabilisation causes differential effects across countries. Among producing countries, price stabilisation benefits Africa, Brazil, Indonesia and Malaysia by raising their average export earnings. However, stabilisation resulted in lower average export earnings for Sri Lanka and Thailand. Similarly, the effects of stabilisation on consuming countries are uneveny furthermore, the outcomes for individual consuming countries were sensitive to the use of equidistant or non-equidistant price bands stabilisation. In order to ascertain the persistence of these qualitative effects of stabilisation in the presence of random disturbances, ex post stabilisation with equidistant price bands was simulated for 1971-1980. The simulation results reiterated the qualitative effects of stabilisation on production and consumption volumes presented above. At the global level, price stabilisation has negligible effect on the world natural rubber consumption volume because of the inelastic demand for natural rubber. As a result of this inelastic Page 380 demand and the price rise for natural rubber in the 1970s, expenditure on natural rubber consumption increased. As for non-stochastic simulation, price stabilisation for 1971-1980 will lead to lower natural rubber production. However, due to the stabilisation of the marked fall in natural rubber price during 1974-1976, higher export earnings are obtained for the lower volume of output. This increased export earnings stem from a greater number of countries experiencing higher export earnings under the stochastic than under non-stochastic simulation. Over the 1971-1980 period, price stabilisation would have led to higher export earnings for the majority of the main producing countries, viz. Africa, Indonesia, Malaysia and Sri Lanka. Although the export earnings for Brazil is lowered by stabilisation, this decrease is negligible. The uneven effects of stabilisation on consuming countries are repeated, with France, West Germany and Japan expending less on natural rubber consumption due to their higher long-run elasticities of natural rubber demand. In contrast, Italy, UK and USA would have higher natural rubber consumption expenditures under stabilisation. Thus it can now be stated that the operations of INRA will shift revenue from consumers to producers. This study has shown how this shift will affect the most important countries. Page 381 11.4 Caveats for Successful INRA Operations The results of ex post stochastic simulation of price stabilisation during 1971-1980 and the non-stochastic simulation for 1982-1991 have indicated that producers benefit from price stabilisation. However, three caveats for the successful operation of INRA to stabilise price and increase export earnings are in order. First, the need for prospective buffer stock purchases/sales is contingent on foresight about the behaviour of business cycles and natural rubber price in future periods. The importance of foresight for successful stabilisation highlights the critical reliance on the judgement, and ability to act appropriately, of the buffer stock manager -- the decision-maker in the timing of the buffer stock operations. As Nurkse (1958) and Benoit (1958) have indicated, buffer stock operations could result in investing excessive arbitrary authority on the buffer stock manager. Second, the simulations have shown that given the INRA resources and the constraint on annual net change in buffer stock, the buffer stock operations are more useful in modifying price over a two to three year period than in affecting price significantly in any one period. This limited impact is due to the lagged price structures in the system. The need to consider wide price fluctuations due to random disturbances in any year is prompted by the historical sensitivity of natural rubber price to political developments in consequence of it being an industrial and strategic raw material. For the future period, it is necessary to add the oil price uncertainty to the political dimension so that price fluctuations wider than those forecast may be envisaged. These considerations add to the Page 382 difficulties associated with the determination of the reference price and price bands about which to stabilise. Third, the uneven effects of stabilisation raise the question of distribution of financial responsibility among countries participating in INRA and hence the problems of feasibility and management of the buffer stock operations. In reality, the gains to producing countries from price stabilisation by buffer stock schemes will be weighed against the contributions which these countries have to make towards the cost of operating the buffer stock. 11.5 A Final Perspective The buffer stock simulations presented in Chapters Eight and Nine were conducted with no regard for the private sector storage responses that may be induced by the buffer stock operations. This is unrealistic. Furthermore, it is pragmatic to consider the reaction of speculative and hedging ativities to the implementation of buffer stock operations. This factor is reinforced by the non-participation of Singapore (a major natural rubber primary market with active speculative and hedging trading) in the INRA. Although buffer stock operations constitute direct intervention, and have immediate effects in principle, the simulation results have shown that the effects are limited by the resources at the disposal of the INRA. Consequently, a scenario of destabilising speculation in response to buffer stock operations cannot be precluded. In view of the difficulties associated with buffer stock operations discussed above, it is Page 383 pertinent to consider other alternatives to buffer stock operations. Given the long gestation in natural rubber production, its long productive lifespan and its essentiality to the modern economy, a more efficient way to ensure adequate world natural rubber supply as well as minimise long-run uncertainties may be via price support schemes. The advantage of a price support scheme is that it would ensure producers' returns and provide guidelines for resource allocation. The significance of the latter point lies in the land and labour inputs required for natural rubber production. To ensure that consumers will not be faced with unforseen shortages, an optimal stockpiling policy could then be identified and incorporated. However, the uncertainties for the rubber market, such as those raised by oil price and the business cycle behaviour, lead to the question of a stockpiling policy that is also aimed at managing short-run surpluis/shortages due to these uncertainties. Gardner (1978) for example, has emphasised the sub-optimality of price band stabilisation because of the absence of an overall objective function. As seen from the stabilisation results presented in the preceding chapters, the range of feasible outcomes are dictated by oil price, industrial activity and interest rates. In this context, Gardner therefore asserts that the use of an analytical framework such as that developed by Massell does not permit formulation of a stockpiling policy because the implications of optimal stockholding for price behaviour and optimal price stabilisation are not sufficiently recognised. Since a stockpiling policy is in essence a market price policy, Gardner therefore argues for an optimal stockpiling (price) policy which meets the requirements of all possible scenarios. The Page 384 optimal stockpiling policy involves an optimisation problem, the solution of which would define a set of optimal storage rules over an infinite time horizon and for all feasible levels of supply. The optimal level of stocks for every scenario will therefore be derived from the optimal storage rules. This study has developed a model of the world rubber market with explicit treatment of the synthetic rubber industry and oil price, the latter being a key variable about which there is great uncertainty. In this study the model was first validated and then used to evaluate the effects of natural rubber price stabilisation under a low oil price scenario and according to the INRA stockpiling constraints. However, in the absence of an objective function, the optimality of the stockpiling programmes from buffer stock simulations cannot be assessed. It is proposed that the model presented here be considered as a basis for further work on the world rubber market, along lines similar to that of Gardner (1978). Once the objective function is defined, the model could be used to search for the optimal choice of instruments and targets for all possible scenarios. Page 385 BIBLIOGRAPHY Books and Articles Adams, F.Gerard (1979) "Integrating Commodity Models into LINK", in J.A. Sawyer (ed.), Modelling the International Transmission Mechanism, North-Holland Publishing Company. Adams, F.Gerard and Sonia A. Klein (eds.) (1978) Stabilising World Commodity Markets, Lexington Books, D.C. Heath and Company, Massachussetts. Adams, P.F. (1958) Memorandum on the Fluctuations in the Price of Natural Rubber, Federation of Malaya Government Press, Kuala Lumpur. 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