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Contributed paper proposed for the 2009 IAMO Forum

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Transition from centrally planned economic systemto a market economy in CEECsthe agro-food supply and international agro-business marketing chains,

    Agro-food export variety growth: Empirical evidence from transition countries

    12ŠTEFAN BOJNEC and IMRE FERTŐ

    1 Professor and Associate Dean, University of Primorska, Faculty of Management, Cankarjeva 5, SI-6104 Koper p.p. 345, Slovenia, Phone: +386 5 610 20 33, Fax: +386 5 610 20 15, E-mail address: stefan.bojnec@fm-kp.si; stefan.bojnec@siol.net 2 Professor and Senior Research Adviser, Institute of Economics, Hungarian Academy of Sciences, Budaörsi u. 45, H-1112 Budapest, Hungary, Phone: +36 1 3092665, Fax: +36 1 3193136, E-mail address: ferto@econ.core.hu

Abstract

    This paper analyses determinants of agro-food export from transition countries to the European Union (EU). The baseline model explains agro-food export by its previous year, income in importing countries, real effective exchange rate, and measure of export product variety. The positive effect of the privatisation, transformation and restructuring process on agro-food export and its variety growth is confirmed, whereas price and trade liberalisations reduce agro-food export. The EU enlargement has induced agro-food export increases in homogeneous and referenced priced products, but less in differentiated products. The impact of increased agro-food product variety on agro-food export growth is positive.

    Keywords: export equation, agro-food, product differentiation, transition countries, European Union

1. Introduction

    Anderson (1992) argued at the early stage of transition from the central planning to a market economy that the transition Eastern European countries and the Soviet Republics might become major agricultural exporters. From this perspective Tangermann (1994) provides western looks to the East. They shed light on two important development and trade factors. First, the restructuring of the economy in the transition countries implies improving product quality by upgrading the production technologies. Second, production specialisation changes the quantity of exports in response to liberalisation. As trade barriers are removed, the composition of exports changes to reflect comparative advantages. Depending on the relative factor endowments, this leads to specialisation in certain industries. Even if a country specialises in low-skilled labour or resource-intensive industries, it could still experience restructuring. This can be done by gradually improving the production technology and thus the quality of the products in that industry. Now, almost two decades later the research question is what has really happened with agro-food export growth from transition countries to the European Union (EU-15) and what kind of factors have been shaping a potential agro-food export growth? Rozelle and Swinnen (2004) provide evidence for productivity improvement in agricultural sectors in a wide set of transition countries. However until now the potential sources of agro-food trade growth in transition countries are less documented. In general, an increase in trade could be a result of three factors: intensive margin where the same set of good is exported in larger volumes; extensive margin, where larger quantities of a larger set of goods are exported; and higher quality goods (Hummels and Klenow, 2002). Our special focus is on the role of export variety on agro-food export growth, which is in line with extensive margin factors and higher quality goods. During the last three decades following the pioneering Krugman’s (1979) work on potential gains from trade through the import of new varieties and the impact of increased variety on aggregate welfare, the importance of new trade theory for national welfare has been tested by several studies. Feenstra (1992), Klenow and Rodriguez-Clare (1997), Bils and Klenow (2001), and Yi (2003) made further contributions on the role of varieties and differentiated trade.

    This paper represents the first attempt to answer the question on the extent to which increase in traded varieties and a greater variety of agro-food exported products from the transition Central and Eastern European Countries (CEECs) have increased the demand for exports by the EU-15 countries. Transition from centrally planned economic system to a market economy in CEECs has likely affected the agro-food sector and rural areas in these countries. Our focus is on the analysis of agro-food exports of the CEECs to the EU-15 markets, and the lessons learnt in this process. We measure and analyze product variety for agro-food exports from the CEECs to the EU-15 markets and then use the agro-food export variety to model the determinants of agro-food exports for the CEECs to the EU-15 countries.

    The next Section 2 provides literature review. Section 3 describes the methodology and data used. Section 4 presents the empirical results to explain the agro-food export variety from the CEECs to the EU-15 markets. Final Section 5 concludes.

2. Literature review

    The importance of international trade in differentiated products has been highlighted by the theory and evidence on intra-industry trade (IIT), which explains occurrence of trade within the same industry. Gains from IIT reflect economies of scale with lower costs and wider consumer choices. The product differentiation is likely to lead to the monopolistic competition in producing the differentiated good that is exported in a greater extent than imported, and demands by consumers for variety, where international trade increases welfare by increasing consumers' utility. The benchmark model for product variety was developed by Krugman (1979, 1980, 1981), who modelled countries as producing an endogenous number of varieties. With fixed output costs of producing each variety, the number of varieties produced in a country is proportional to the size of the economy. In this simplest Krugman world, all countries export the same quantity per variety and export at the same unit prices. Neither unit prices nor quantity per variety vary with gross domestic product (GDP) per worker or the number of workers. The Krugman model has the property that, conditional on producing a variety, a country exports this variety to all other markets. In the model there are two channels for the gains from trade arising from variety growth. The first is

    through reductions in trade costs. If trade costs fall, countries will gain through the import of new varieties. The second is through the growth of the foreign country. As the size of foreign country increases it will produce more varieties, and this will be a source of gain for the home countries. The product variety has also important policy implication. Romer (1994) demonstrates in a simple calibration that trade liberalization increases the number of traded varieties as a source of welfare gains.

    There are several studies that investigate the role of product variety in exports. Funke and Ruhwedel (2001) investigate empirically whether increasing export variety has contributed to the export growth of 10 East Asian countries. Their econometric results suggest that producing highly differentiated export goods gives a competitive advantage which allows selling more products. In a companion paper, Funke and Ruhwedel (2002) investigate the link between export growth and export variety for 15 OECD countries. They have empirically ascertained the hypothesis that improvements in the variety of exports are an explanation of OECD trade flows. More recently, Hummels and Klenow (2005) decompose the growth of world trade into the two parts belonging to the extensive margin and the intensive margin. They find that extensive margin accounts for two-third of the greater exports of larger economies, and one-third of their imports. In another application, Broda and Weinstein (2006) measure the impact on welfare for the importer. For the United States (US), they find that the upward bias in the conventional import price index (due to ignoring product variety) is approximately 1.2 per cent per year, implying that the welfare gains from cumulative variety growth in imports are 2.6 per cent of GDP in 2001. Feenstra and Kee (2007) study the effects of US tariff reductions on export variety in trade with China and Mexico. Their empirical results indicate that tariff liberalisation is important in expanding export variety. Kandogan (2006a, 2006b) investigates the role of product differentiation to explain the export growth of transition countries. He finds that opening up to new trade partners, at first, increases the number of sectors in which trade occurs. However, only those in certain industries succeeded, which led to specialization in certain product categories. The results also reveal an increase in the variety of product categories in which the transition countries have specialized. In sum, empirical studies confirm the importance of product variety in export growth. The existing research also highlights that while the static gains from trade have been widely studied and documented to be relatively small, the

    dynamic gains due to the expansion of export variety may well be more important (Feeenstra and Kee, 2004, 2007).

3. Data and methodology

    A number of measures of product variety from the literature are available and discussed. These range from simple ones such as the number of product categories exported to more sophisticate ones (Feenstra, 1994; Funke and Ruhwedel, 2001; Hummels and Klenow, 2005). For our purpose we employ ΔPV index, which is the measure of si

    product variety proposed by Funke and Ruhwedel (2001), which is defined as:

    (pxfififFipxfififFlnPV;, (1) sipxfsfsfFspxfsfsfF

    where we have two groups of countries with different set of products F={1..... N} and ss

    F={1..... N} with N>N. In this case, the common set of products is F=F and the iiisis

    denominator is 1. The negative values for the product variety index indicate lower product variety in CEEC i compared to the EU country s. In our case f denotes agro-food products.

    We start with our baseline export equation, which includes traditional explanatory variables on a scale variable representing foreign demand and a price competitiveness indicator measured by effect of real effective exchange rate appreciation or depreciation on one hand, and export variety variable as the additional non-price export supply-side effects on the other (Funke and Ruhwedel 2002). We specify the baseline export equation as:

    EUX = f (X, REER, GDP, ΔPV), (2) itit-1it-1tit

    where X represents the agro-food exports of CEEC i in period t to the EU-15 countries it

    as export destinations.

Among the baseline explanatory variables X represents the agro-food exports of it-1

    CEEC i in the previous period t-1 to the EU-15 countries as export destinations. The source of agro-food trade data is the Eurostat Comext trade dataset. The agro-food products are defined by the EU-Commission (1997).

    REER represents the real effective exchange rate index of CEEC i in period t-1. The it-1

    REER defined as the nominal effective exchange rate index adjusted for relative movements in national price or cost indicators of the home CEEC country and selected countries. The weights are derived from trade in manufactured goods. An increase in the index reflects an appreciation. The real effective exchange rate indices (1995 = 100) were taken from the Bank of International Settlements database.

    EUGDP represents the GDP volume of the EU-15 countries in period t. The source of t

    data is the Eurostat database.

    The ΔPV index is calculated using highly disaggregated trade data at the five-digit it

    Standard International Trade Classification (SITC) level consisting of 557 items for 12 CEEC transition economies (see further section 4.1) for the years 1995 to 2007, i.e., after the transformational recession.

    The association between the X and the X is expected to be positive. According to itit-1

    economic theory and the previous studies (Funke and Ruhwedel, 2002), increased

    EUGDP volume encourages foreign demand and therefore is expected to have a positive effect on a CEEC's agro-food exports. The association between the X and the REER is it

    expected to be a negative as the CEEC currency appreciation with the increase in the REER in the previous year is expected to reduce the demand for the CEEC's agro-food exports. Consistently with the previous theoretical explanations, we expect a positive associations between the increases in agro-food products exported varieties and the increase in agro-food exports. Therefore, the increase in product variety is expected to increase agro-food exports and hence the regression coefficient for ΔPV is expected to it

    be a positive.

    In addition to the baseline model specification, we extend the model specification to include the variables that are related to the CEEC transition process and the CEEC adjustment and entry to the EU. We specify this with the group of reform and infrastructure variables from the EBRD (2008) transition indicators:

    EUX = f (X, REER, GDP, ΔPV, reform) (3). itit-1it-1tit

    We expect that the greatest is the progress of the reform and the most is the developed infrastructure the greatest is the export variety and agro-food export growth. To capture the features of transition with liberalisation, privatisation and restructuring, we include two groups of additional explanatory variables. First, among the drivers and their impacts on agro-food export growth we include reform and infrastructure variables that are related to privatisation, transformation and restructuring, and second, we include variables for price and trade liberalisations that are related to the transition process and adjustment to the EU membership. The transition process to market economies with liberalisation, institutional and policy reforms, privatisation and restructuring in the CEEC economies have likely affected the agro-food sector technological and product restructuring and quality improvements within the agro-food supply and international agro-business marketing chains, which are likely to positively affect the CEECs agro-food export performances on the EU-15 markets. The transition process by the CEECs might differ also by the CEECs due to the country-specific successes or failures in transition process, institutional and policy changes, adjustments and the entry of CEECs into the World Trade Organization and the EU. Due to these specific conditions in the agro-food sector with expected the increasing vertical integration of food chains over time we also experiment with country and dummy variables to capture cross-country differences and possible changes and shifts over the analyzed period.

4. Empirical results

    4.1. Importance of export variety

    Following Broda and Weinstein (2006) we define a good to be a five-digit category and a variety is defined as the import of a particular good to the EU-15 from a particular CEEC. We use the data set for 12 CEECs. They are the eight new EU member states from the CEEC that entered into the EU in 2004 (Estonia, Hungary, the Czech Republic, Latvia, Lithuania, Poland, Slovakia, and Slovenia) and the two new EU member states from the CEEC that entered into the EU in 2007 (Bulgaria and Romania). In addition to these ten new EU member states from the CEEC, we also include Russia, which in addition to the Baltic States (Estonia, Latvia, and Lithuania) is from the Former Soviet

    Union territory, and Croatia, which in addition to Slovenia is from the former Yugoslavian territory. Therefore, Russia and Croatia are taken as proxies for performance of other states from their territories that are still outside the EU membership. In addition, we use Rauch's (1999, 2001) commodity classification to get more insights for agro-food trade flows. He classifies trade into three commodity groups: homogeneous products that are traded on organized exchanges, reference priced products not sold on exchanges but whose benchmark price exists, and differentiated products for all other products.

    Figure 1 shows the agro-food exports of the CEEC-12 to the EU-15 in real 1995 Euro prices by Rauch's (1999) product groups. Between 1995 and 2007, the CEEC-12 agro-food exports to the EU-15 markets increased from 5.8 billion Euros to more than 18.7 billion Euros in current prices or deflated in 1995 Euro prices, from 5.8 billion Euros to 14.9 billion Euros. At the 1995 Euro prices and during the same analyzed period, the CEEC-12 differentiated products exports increased from 1.3 billion Euros to more than 2.5 billion Euros or by 95.7% between the first and the last analyzed years. The CEEC-12 reference priced products exports increased from 3.2 billion Euros to 8.3 billion Euros or by 163.7%. The most rapid was the CEEC homogeneous products exports from 1.4 billion Euros to 4.0 billion Euros or by 194.1%. Particularly rapid CEEC-12 agro-food exports to the EU-15 markets have been since the EU enlargement in 2004, the results, which is consistent with Bojnec and Fertő (2008b). However, our empirical

    results do not confirm that the CEEC-12 exported agro-food products have become more differentiated in varieties (Figure 1).

    Now we turn to the importance of growth of varieties. Table 1 shows the increase in total number of varieties in the EU-15 agro-food imports from the CEEC-12 particularly for all goods in the years 2000-2007, when the share of total EU-15 agro-food imports from the CEEC-12 either remains at a similar level or has declined.

    Poland has the greatest number of agro-food products that are exported to the EU-15 markets (Table 2). Hungary and the Czech Republic have changed the positions on the second and third places by the number of agro-food products that are exported to the EU-15 markets. The deterioration in the ranking by the number of exported agro-food products to the EU-15 markets is seen for Russia, Croatia, and to a lesser extent for

    Slovenia after the EU 2004 enlargement, whereas improvements are seen for Bulgaria, Lithuania, and to a lesser extent for Romania. The least diversified agro-food export structures to the EU-15 markets are found for Latvia.

    The CEEC-12 distribution by the contribution to the agro-food export variety growth to the EU-15 markets during the second half of the 1990s is rather bi-polar, and more similar during the first years of the 2000s (Table 3). During the first analyzed sub-period 1995-2000, the major contributors to agro-food export variety growth from the CEEC-12 to the EU-15 markets were Lithuania, Poland, the Czech Republic, and Latvia. On the other hand, the negative contribution to agro-food export variety growth is seen particularly for Croatia, but also for Bulgaria, Russia, Slovakia, Slovenia, and Estonia. During the second analyzed sub-period 2001-2007 the each of the CEEC-12 has had the positive contribution to agro-food export variety growth to the EU-15 markets, but with the greater contribution to agro-food export variety growth by Lithuania, Bulgaria, Slovenia, and Estonia. This implies catching up of these initially less advanced agro-food exported CEEC contributing to greater similarities between the CEEC-12 in agro-food export variety to the EU-15 markets.

    Among the CEEC-12, the greatest agro-food exporters to the EU-15 markets are Poland with increasing export shares, Russia, and Hungary with declining export shares, and the Czech Republic with a similar export shares between the both analyzed sub-periods. The individual CEEC-12 export shares in the total CEEC-12 agro-food exports to the EU-15 markets implies the country’s size of agro-food sector and its export abilities on

    the EU-15 markets.

    4.2. Baseline dynamic panel model

    When we log-linearize (2) we get the following dynamic panel data model to be estimated:

    EUlnX = β + βX + βREER + βGDP, βΔPV + ε, (4) it01it-12it-13t4itit

    where i = 1.....12 refers to the number of CEECs, t = 1,..., 13 refers to the number of years in the time period 1995-2007. Equation (4) is the basic specification of our empirical estimates. To estimate (4), we use the system Generalized Method of Moments (GMM) estimator recently suggested by Blundell and Bond (1998). This is an efficient extension of the Arellano and Bond (1991) first-difference GMM estimator,

    which can be subject to a large downward bias and very low precision as a result of weak instruments in situations, where the series are highly persistent and/or the relative variance of the fixed effects increases even for large i when t is small. The system GMM estimator combines the first-difference and the level specification to deal with the problem of weak instruments highlighted in recent empirical work (Roodman, 2006). Blundell and Bond (1998) show that in autoregressive distributed-lag models, first differences of the series can be uncorrelated with the firm-specific effects provided that the series have stationary means. Thus, we experimented with lagged differences of the variables as instruments for the level equation. As linear GMM estimators, the Arellano-Bond and Blundell-Bond estimators have one- and two-step variants. But though two-step is asymptotically more efficient, the reported two-step standard errors tend to be severely downward biased (Arellano and Bond, 1991; Blundell and Bond, 1998). To compensate, we employ a finite-sample correction to the two-step covariance matrix derived by Windmeijer (2005).

    The agro-food export growth is classified as total agro-food export growth and separately for three groups of products using Rauch’s (1999) product classification.

    Table 4 presents the results of dynamic panel estimations by using for one period lagged variable for agro-food export growth by the CEEC-12 to the EU-15 markets. The Hansen test with the reported other diagnostic tests below the estimates does not reject the joint test of model and instrument validity. The regression results confirm theoretical expectations. The lagged agro-food export variable is statistically significant in the three cases for baseline models, implying that the CEEC-12 agro-food exported product in the previous period does matter for the agro-food export growth to the EU-15 markets. This is also in a line with empirical findings by Funke and Ruhwedel (2002) for merchandise trade in OECD countries. As expected, the association pertained to this variable is positive and significant. The coefficient of elasticity is the lowest in the case for the reference priced products, and higher in the case for differentiated products and homogeneous products. The highest coefficient of elasticity is found for total agro-food export growth in the previous period than by the Rauch’s product groups.

    The coefficient of elasticity pertained to the real effective exchange rate index (REER) for one period lagged variable has a negative sign and is statistically significant only in the case of homogeneous products. In this single case, the negative association is

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