RISK MANAGEMENT IN THE INTEGRATED NAFTA MARKET: LESSONS FROM THE CASE OF BSE

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RISK MANAGEMENT IN THE INTEGRATED NAFTA
MARKETLESSONS FROM THE CASE OF BSE

• Julie A. Caswell
• and
• David Sparling

NAAMIC - Cancun May 7, 2004
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Organization

• Integration of NAFTA beef industries
• BSE as a case study
• Impact of BSE on the NAFTA beef markets
• Integrated markets integrated regulations?
• Implications and challenges for policy

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NAFTA Beef Integration

• Prior to CUSTA and NAFTA tariffs inhibited
  extensive integration
• 1989 CUSTA removed Canada/US barriers
• 1994 NAFTA removed barriers to trade with
  Mexico
• Extensive integration at every level

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NAFTA Beef Cattle Trade Flows
United States
Canada
Mexico
0.59 M lbs. 0.68 M lbs
0.23 M lbs. 0.24 M lbs
0.74 M lbs. 1,091 M lbs
0.016 M lbs. 0.016 M lbs
Domestic Market
Domestic Market
Domestic Market
Processing
Processing
Processing
gt 700 lbs 439,016
1,259,536
Cow/Calf and Stocker
Feedlot
Feedlot
1,229,220 816,460
Stocker/ Backgrounder
Stocker/ Backgrounder
Legend Trade in Beef Trade in Cattle
lt 700 lbs 12,520 221,782
Cow/Calf
Cow/Calf
2003 values 2002 values
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Production Shift

• Source Canfax and Gracey 2002, The Cattle Cycle,
  p. 19.

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Relative Sizes of NAFTA Industries
2002 Beef Production, Consumption and Trade (in '000 Metric Tons) 2002 Beef Production, Consumption and Trade (in '000 Metric Tons) 2002 Beef Production, Consumption and Trade (in '000 Metric Tons) 2002 Beef Production, Consumption and Trade (in '000 Metric Tons) 2002 Beef Production, Consumption and Trade (in '000 Metric Tons) 2002 Beef Production, Consumption and Trade (in '000 Metric Tons) 2002 Beef Production, Consumption and Trade (in '000 Metric Tons) 2002 Beef Production, Consumption and Trade (in '000 Metric Tons)
Consumption Consumption Consumption Exports Imports Net trade as a of consumption Net trade as a of consumption
Canada 992 992 992 610 307 30.54 30.54
Mexico 2409 2409 2409 10 489 -19.88 -19.88
US 12738 12738 12738 1110 1460 -2.75 -2.75
2002 Cattle Production, Slaughter, and Trade (in '000 Animals) 2002 Cattle Production, Slaughter, and Trade (in '000 Animals) 2002 Cattle Production, Slaughter, and Trade (in '000 Animals) 2002 Cattle Production, Slaughter, and Trade (in '000 Animals) 2002 Cattle Production, Slaughter, and Trade (in '000 Animals) 2002 Cattle Production, Slaughter, and Trade (in '000 Animals) 2002 Cattle Production, Slaughter, and Trade (in '000 Animals) 2002 Cattle Production, Slaughter, and Trade (in '000 Animals)
Slaughter Beef Cattle Exports Beef Cattle Exports Beef Cattle Imports Net trade as a of slaughter
Canada Canada 3753 1690 1690 138 41.35 41.35
Mexico Mexico 8310 948 948 206 8.93 8.93
US US 36970 244 244 2505 -6.11 -6.11
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Percentage Flows-Beef Exports
10 of Canadian Exports
66 of U.S. Exports
2 of Mexican Exports
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Production and Markets are Integrated Are the
systems?
Level of Integration Nature Final
Market End Products Production Intermediate
products Control systems Information,
planning Policy Regulations, programs,
planning
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The Case of BSE?

• Bovine Spongiform Encephalopathy
• Disease of the central nervous system in cattle
• Origin uncertain but believed to be linked to
  ingesting feed containing rendered central
  nervous system material from contaminated animals
• Thought to be linked to CJD fatal in humans

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Why Study BSE?

• Beef industry is integrated at every level
• Integration interdependence
• Smooth operation of NAFTA industry depends on
  flow of cattle and beef
• Impact of a case of BSE is immediate and
  substantial
• Management of BSE is an interesting mix of
  science and politics

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Animal Health/Food Safety Events - Two Broad
Categories

• Private Events
• Risks and impacts limited to supply chains in
  which they occur
• E. coli, Salmonella
• Government response
• Censure fines, closures
• Additional monitoring
• Industry wide initiatives to reduce risk

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• Public Events
• Impacts reach outside supply chain
• Impact may be
• Regional Avian Influenza in British Columbia
• National BSE, Foot Mouth Disease
• Trade distorting
• Government Response
• Assessment of the impact and notification of
  trading partners and OIE
• New regulations
• Mitigation of impacts
• Industry survival and recovery strategies

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BSE and International Trade

• BSE protocols managed by the OIE
• Based on risk analysis - science based
• 5 levels of BSE risk status
• Guidance on import restrictions for cattle and
  beef for each risk status
• Country goal - BSE free status
• Importing countries response to BSE case in
  previously BSE free country, contrary to OIE
  guidance, is complete closure of borders for
  cattle and beef

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BSE Reported 1989-2004
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First NAFTA BSE Event

• May 20, 2003 Canada
• One animal found with BSE
• Animal had already been removed from the food
  system
• Trading partners notified
• All borders closed immediately for cattle and beef

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Impact Live Cattle Imports to U.S. from Canada
and Mexico, 2003
250,000
200,000
150,000
Mexico
Head
Canada
100,000
50,000
-
Dec-02
Jan-03
Feb-03
Mar-03
Apr-03
May-
Jun-03
Jul-03
Aug-03
Sep-03
Oct-03
Nov-03
Dec-03
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Price Impacts

• Canadian market oversupplied
• Farm gate prices plummeted 50
• Imports dropped 50
• Already tight U.S. market undersupplied
• Prices began to increase
• By fall the Mexican market became tight and
  prices began to rise

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Partial Reopening of the U.S. and Mexican Borders

• September 2003
• U.S. reviewed Canadian response to BSE event and
  risk of importing BSE from Canada
• Gave Canada a special low risk status
• Imports of de-boned beef from cattle under 30
  months allowed
• Mexico took similar action

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Canadian Beef Exports, 2002-2003
240
200
160
120
80
40
0
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Second NAFTA BSE Event

• Dec. 23, 2003
• BSE found in U.S. dairy cow
• Traced back to Canadian herd
• Possibility that it was fed ruminant protein
  prior to total feed ban
• Traceback could only locate half of animals which
  may have received the same feed

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Impact

• All exports halted
• Redirected to already tight U.S. market
• Prices eased back from record highs
• Mexican market now short and prices increased by
  as much as 15 in early 2004

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Prices for U.S. Cattle and Beef
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Partial Border Reopening

• In March-April 2004, Mexico and Canada reopened
  border to U.S. boneless beef cuts from animals
  under 30 months
• No reopening yet for live animals

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BSE in NAFTA

• Dramatic example
• Market integration exacerbating trade disruptions
  when problems occur
• Importance of risk management systems
• Drawbacks of market integration without
  regulatory integration

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Managing Regulatory Integration

• Country
• Risk analysis
• Choosing appropriate level of protection
• Designing the regulatory program
• Country to Country
• Policy coordination
• Equivalence agreements
• Harmonization

• Internationally
• SPS Agreement of WTO
• Disputes
• International Standards Bodies
• World Organization for Animal Health (OIE)

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Origins of the BSE Trade Crisis

• Inadequate risk management at country level
• Inadequate regulatory integration within NAFTA
• Breakdown of international discipline on import
  restrictions

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International OIE Standards for BSE Risk
Management

• Criteria for determining BSE status
• 5 status levels
• BSE free
• BSE provisionally free
• Minimal BSE risk
• Moderate BSE risk
• High BSE risk

• OIE does not evaluate countries and assign them
  to a status
• Importing countries judge the status of
  exporting countries

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Imports Recommendations v. Reality

• OIE recommends
• Import restrictions that are appropriate for each
  risk status
• KEY POINT in no case recommends complete
  prohibition of imports when BSE free status is
  lost

• What countries do
• Immediately close borders to imports from country
  with BSE case(s)
• RESULT huge trade impacts

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Impact of BSE on NAFTA Countries

• Set up by failure of international discipline on
  BSE management
• NAFTA countries were full partners
• Aided by lack of regulatory integration within
  NAFTA to control internal impacts
• Further abetted by inadequate risk management at
  the country level

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Living with BSE Positive Status

• Putting new regulations in place
• Reopening borders
• Encourage all to follow OIE standards, prove
  minimal BSE risk
• Negotiate ad hoc border openings (perhaps based
  on OIE standards)
• Accomplished within NAFTA for many beef products
  from younger animals
• Not accomplished yet for live animals
• Little progress with other trading partners
• Being prepared for more cases

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Lessons from BSE (1)

• NAFTA is pursuing high level of market
  integration
• E.g., with elimination of tariffs
• But has a relatively low level of coordination in
  regard to nontariff barriers, such as regulations
• Economic integration has outrun regulatory
  integration, leaving industries more vulnerable
  to disruption

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Why Cant We Agree?

• Same or very similar
• Scientific assessment of risk
• Choice of appropriate level of protection for
  human health
• Different benefit-cost calculus due to
• Uncertainties
• Costs and acceptable level of costs
• Market risks of problems (e.g., first or
  subsequent BSE cases)
• Regulatory culture

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Lessons from BSE (2)

• There are legitimate reasons why countries are
  reluctant to harmonize regulatory policy
• And market integration within NAFTA poses
  problems for exports to non-NAFTA countries

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Rebuilding the NAFTA Market

• Through ad hoc negotiation of border openings
• Go further?
• Integrated Risk Management System

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What Would Needto be Harmonized?
Feed regulations
Production, shipping, slaughter standards
Testing regimes
Tracking regimes
Response to case(s)
Monitoring enforcement
Subsidies for investment, market relief
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Lessons from BSE (3)

• NAFTA currently has no mechanism to move toward
  regulatory integration except on a very ad hoc
  basis
• Serviceable mechanisms exist for closer
  coordination of regulatory policy but they are
  limited
• NAFTA countries will have to decide to what
  extent to take the next step toward policy
  harmonization

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NAFTA Has Suffered from Poor Harmonization

• Partly due to international breakdown in regard
  to BSE but
• KEY POINT Bulk of trade impact was within NAFTA
  and could have been avoided through concerted
  effort before the fact (before BSE cases)

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Lessons from BSE (4)

• Harmonization itself depends on further
  development of risk management capabilities in
  each country
• Failure to address regulatory integration will
  be
• A continuing drag on market integration
• Leave markets vulnerable to recurring disruptions

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The Science and Politics of Managing BSE Risk

• Integrated markets put a premium on good risk
  management
• Integrated markets put a premium on integrated
  risk management
• NAFTA trade disruptions as a result of BSE were
  unnecessarily large due to shortcomings in both
  these areas