The Effects of a Large BSE Outbreak in a Specific Factors Model of the US Economy

1
The Effects of a Large BSE Outbreak in a Specific
Factors Model of the US Economy

• Osei-Agyeman Yeboah1,
• Henry Thompson2,
• Victor Ofori-Boadu1
• Albert Allen3

1 North Carolina AT State University 2 Auburn
University 3 Mississippi State University
2
Introduction

• For nearly two decades, Bovine Spongiform
  Encephalopathy (BSE) has been an issue for the US
  beef industry after its possible link to cases of
  Human Creutzfeldt-Jakob disease was developed.
• The BSE outbreak in the UK during the mid 1990s
  led various agencies of the US government to
  implement control measures.
• The spread of BSE to Japan and Canada in 2003 led
  to increased USDA surveillance and research.
• Regulatory efforts were further increased when
  the case of BSE was reported in the state of
  Washington in 2003.

3
Introduction

• Cattle prices fell by 16 and cattle futures
  price by 20 during the week of the reported
  Washington case.
• Though prices rose back the next quarter, studies
  show that consumers would change their habits
  given a major BSE outbreak.
• Within days of the Washington BSE incidence, 53
  countries including major importers such as
  Japan, Mexico, South Korea and Canada placed a
  ban on US beef imports.

4
Objective of the Study

• This study gauges the effects of a BSE outbreak
  on the US in a specific factors model of
  production with a focus on beef, poultry, and
  pork industries.
• Outputs and factor prices adjust to the falling
  price of beef in the model. The general
  equilibrium model provides a perspective based on
  the entire economy.

5
Specific Factors Model of Production

• The specific factors general equilibrium model
  assumes the following-
• constant returns to scale
• full employment
• competitive pricing
• cost minimization
• sector specific capital inputs
• mobility of shared inputs
• Competitive pricing of output and full employment
  of labor, energy, and industrial capital are the
  underlying behavioral assumptions.

6
Specific Factors Model of Production

• The comparative static model solves for
  adjustments in factor prices and outputs to
  exogenous price changes.
• Total factor supplies are fixed and capital
  remains industry specific, while labor and energy
  move freely between industries.
• Substitution elasticities ? summarize how cost
  minimizing industry alters inputs with changing
  factor prices. Industry shares ? are the share of
  each input in each industry, and factor shares ?
  the portion of industry revenue paid to each
  factor. The comparative static model is stated
  as-
• (1)
• The variables are written in vectors where w
  represents endogenous factor prices, x endogenous
  outputs, p exogenous output prices, and
  percentage changes

7
Source of Data

• Value added and the labor bills in meat and
  poultry processing, other manufacturing, and
  services from the 2002 Economic Census.
• Energy spending for manufacturing and services is
  from US Department of Energy (2001).
• Total receipts, labor inputs, and energy data for
  beef, poultry, pork, and other agriculture are
  from the 2002 Census of Agriculture Summary by
  North American Industry Classification System
  (NAICS).
• Capital inputs are residuals of value added after
  labor and energy bills.

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Specific Factors Model of Production

• Factor shares ? are the portions each factor
  receives from revenue, and industry shares ? are
  portions of factors employed by industry.
• Table 1 shows factor payments matrix used to
  derive factor shares and industry shares.
• The industries are
• Meat Processing
• Poultry Processing
• Other Manufacturing
• Service
• Beef Production
• Poultry Production
• Pork Production
• Other Agriculture

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Table 1. Factor Payment Matrix (Billion)
10
Factors Shares

• Table 2 presents the factor shares matrix ?, the
  share of each factor is the ratio of payments for
  the factor and the total sector revenue.
• Summing down a column in Table 1 gives total
  sector revenue. For instance, the total revenue
  of beef industry 27.1billion and the capital
  share is 22.3/27.1 82.
• Capital implicitly includes land and has the
  largest factor share in each industry.
• The service sector has the largest labor share of
  33.9 followed by the other manufacturing and
  poultry processing with labor shares of 14.5 and
  13.6 respectively.
• The labor share in beef production is 7.2 and in
  meat processing is 8.8.

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Table 2. Factor Shares, ?ij
12
Industry Shares

• Industry shares are reported in Table 3.
• Summing across rows in Table 1 gives total factor
  incomes. Assuming perfect labor mobility, the
  wage is the same across sectors leading to the
  share of each factor in each sector.
• For instance, total labor income in beef
  production is 1.9 billion, thus implying
  employment of 1.9/3,164 0.06.
• Results show that beef production uses twice as
  much labor (0.06) as that of poultry and pork,
  0.03 respectively, and the three accounts for
  68 of all agricultural labor.

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Table 3. Industry Shares, ?ij
14
Constant Elasticity of Substitution (CES)

• Substitution elasticities summarize the cost
  minimizing adjustments in inputs when factor
  prices change as developed by Jones (1965) and
  Takayama (1982).
• The cross price elasticity between the input of
  factor i and the payment to factor k in sector j
  is
• Eijk aij?/wk? ?kjSijk (2)
• where aij is the cost minimizing input and Sijk
  is the Allen partial elasticity of substitution.
  
• Cobb-Douglas production implies Sijk 1 and with
  constant elasticity of substitution (CES)
  production Sijk gt 0.
• Linear homogeneity implies ?kEijk 0 and own
  price elasticities Eiji is the negative of the
  sum of cross price elasticities.

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Constant Elasticity of Substitution (CES)

• Aggregate substitution elasticities are the
  weighted average of cross price elasticities for
  each industry,
• ?ik ? ?j?ijEijk ?j?ij?kjSijk. (3)
• Cobb-Douglas substitution elasticities are
  presented in Table 4.

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Results

• Factor shares and industry shares are used to
  derive the Cobb-Douglas substitution elasticities
  in Table 4.
• The largest own substitution occurs for energy
  and the smallest is for capital in the poultry
  industry.
• Every 1 increase in energy prices causes 0.61
  decline in energy use.
• Every 1 increase in the return to poultry
  capital lowers capital input by 0.069.
• Own labor substitution elasticities are larger
  than own capital elasticities.
• Capital is more of a substitute for labor than
  energy, and energy is more of a substitute for
  labor than vice versa

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Table 4. Cobb-Douglas Substitution Elasticities,
?ik
18
Results

• Table 5 presents elasticities of factor prices
  with respect to prices of goods in the general
  equilibrium comparative statics.
• Every 1 decrease in the price of beef would
  lower the return to capital in the beef industry
  by 1.22.
• The returns to all other industry capitals rise
  slightly with labor and energy released from beef
  production.
• Larger industries have larger price effects.
  Every 1 increase in the price of other
  agricultural products raises that return to
  capital by 1.34 and the price of energy by 0.04
  with very small losses spread across labor and
  other capital returns.

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Table 5. Elasticities of Factor Prices with
Respect to Output Prices
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Results

• Table 6 reports the price elasticities of outputs
  along the production frontier.
• A higher price in each sector raises output in
  the sector and thus draw labor and energy away
  from other sectors.
• The largest own output effect occurs in other
  agriculture where every 1 price increase raises
  output by 0.34.
• Every 1 price increase in beef raises output by
  0.22 with trivial decreases across other
  industries and sectors.
• The smallest own effect occurs in services.

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Table 6. Elasticities of Output with Respect to
Output Prices
22
Results

• Simulated Adjustments to Price Changes
• If the price of beef falls, demand for poultry
  and pork would increase thus those prices would
  rise.
• In this study it is assumed that, these price
  changes for poultry and pork are 10
  respectively. The price of meat processing is
  assumed to fall 5 with increased pork processing
  partly offsetting the lost beef processing. The
  price of poultry processing is assumed to rise
  10.
• Other agriculture might enjoy increased demand to
  offset the lost beef consumption. There might be
  small negative spillover effects on demand for
  manufacturing and services. To capture these
  adjustments, assume price changes of 1 for other
  agriculture, -1 for other manufacturing, and -1
  for the service sector.
• The output effects in Table 7 are derived by
  multiplying the output elasticities in Table 6 by
  the projected vector of price changes

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Table 7. The Projected Impact of BSE on the
Major Sectors of the Economy
24
Results

• Capital returns in beef production and meat
  processing fell by 12.0 and 5.57, larger than
  the underlying price changes due to the
  magnification effect of Jones (1965).
• The return to capital in other agriculture
  increases 1.69. The capital returns in the
  poultry and pork industries rise about 11.
  Wages and energy prices each fell about 1.
• Outputs increase about 2 in poultry processing
  and pork production, and about half that much in
  poultry production. Other manufacturing output
  falls slightly, and output in other agriculture
  rises by 0.69. Beef production falls -1.97 and
  beef revenue about 12, the sum of the price and
  output declines.
• Regarding sensitivity to substitution, factor
  price adjustments are identical for any degree of
  CES production while outputs effects are scaled.
  If CES ½ the output adjustments are half as
  large, beef output falling 1 and beef revenue
  6. Estimates of substitution in the applied
  production literature are typically between ½ and
  1.

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Results

• In the long run the lower capital returns will
  diminish investment and the stock of productive
  capital, leading to larger output adjustments.
• Suppose capital inputs ultimately change in
  proportion to their returns with every 1 change
  in return leading to a 1 adjustment in that
  capital stock.
• The subsequent output changes closely mirror
  adjustments in industrial capital stocks given
  constant returns to scale. The approximate long
  run output changes are then equal to the vector
  of capital return changes, much larger than the
  short run adjustments.
• Revenue changes would be the sum of these output
  changes and the underlying price change. Beef
  revenue would fall 22 in the long run.

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Conclusion

• The present model provides some perspective on
  the potential of lower beef prices to affect the
  US economy. Substantial industrial and local
  effects would closely mirror any permanently
  lower price of beef but the rest of the economy
  would not be much affected.
• Falling outputs and capital returns in the beef
  industry would be offset somewhat by benefits for
  the pork and poultry industries.
• Output adjustments are smaller than price changes
  while effects on industry capital returns are
  magnified. Short run output adjustments would be
  negligible beyond the industries directly
  involved.

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Conclusion

• Decreased capital returns would lower industrial
  investment leading to larger long run output
  adjustments, the decline in beef production
  ultimately mirroring the lower price.
• The model predicts a 12 reduction in beef
  revenue, amounting to 1.5 billion for 2003,
  providing a gauge of the benefits of increased
  BSE surveillance.
• Though there is little if any potential health
  danger of a BSE outbreak to humans, the potential
  impact on the beef industry is sizeable.