the due diligence system in the eu’s timber regulation ... · reason, an eco-certificate is...
TRANSCRIPT
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The Due diligence system in the EU’s
Timber Regulation: non-tariff trade barrier
or leverage effect?
Jan Brusselaers1,2
Guido Van Huylenbroeck1
Jeroen Buysse1
1 Ghent University – Department of Agricultural Economics, Coupure Links 653, 9000 Gent, Belgium
² Corresponding author
2
Abstract
This paper presents a novel spatial equilibrium model to analyse the leverage impact of the EU’s Timber Regulation (EUTR) on sustainable timber production. The EUTR is part of FLEGT which aims to stimulate legal timber production and sustainable forest management at global level. This leverage effect is an argument in favour of FLEGT but it has never been investigated thoroughly, or simultaneously for demand and supply. The leverage effect is measured in terms of the market share of sustainable timber in the total timber consumption and production of a region. Our research finds that FLEGT does not provide an incentive for sustainable timber production and consumption at global level. FLEGT creates a non-tariff trade barrier at the conventional timber markets of important producing regions (Europe and North America). This protectionist situation favours conventional timber which decreases the importance of sustainable timber. In addition, the protectionist situation decreases global welfare.
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1. Introduction and literature review
Since 2013, the EU’s Timber Regulation (EUTR) obliges ‘traders who place timber products on the EU market for the first time to exercise due diligence’ (Commission, 2015). Setting up an operational Due Diligence System (DDR) must minimize the risk of placing illegally harvested timber at the EU’s market1. The EUTR is part of the “Forest Law Enforcement, Governance and Trade Programme” (FLEGT) which aims to stimulate ‘both legal timber production and good forest governance’ at global level, particularly in tropical countries (Wodschow et al., 2016). FLEGT fits in a wider approach to mitigate deforestation and climate change.
This paper investigates to what extent the EUTR provides a leverage for legal timber production and consumption at global level. Legal timber in this narrative implies environmental and social sustainability (Wiersum and Elands, 2013). The market share and produced quantity of legal timber serve as a proxy indicator of the leverage effect of the EUTR an FLEGT.
Setting up a DDS at company level comes with a costs. This costs can impede trade towards the EU. Two instruments mitigate the DDS cost however. Both instruments involve a type of certification. First of all, tropical countries can negotiate a Voluntary Partnership Agreement (VPA) with the EU. Each VPA requires the set-up of a functional legality assurance system. This assurance system allows the VPA-countries to award FLEGT licences to its timber producers, processors and traders. FLEGT licenced companies can export timber to the EU without exercising the due diligence check. Second, also (eco-) certificates like PEFC and FSC2 fully comply with the EUTR requirements (PEFC, 2016; Trishkin et al., 2015). For this reason, an eco-certificate is accepted as sufficient proof of legality within the EUTR (UNECE, 2015) and eco-certified timber can pass a ‘due diligence light’ which entails lower costs. This paper defines legal timber as either eco-certified or VPA-licenced timber. Hence, eco-certification and VPA-licences are assumed to be each other’s equivalent, entailing the same costs and benefits. Assuming equal costs and benefits for both types of certification is a mere simplification of reality, but expert consultation in the Southern hemisphere confirms that this is a legitimate assumption. If the costs are not equal, it is claimed that eco-certification entails lower costs than VPA-licencing. In the latter situation, this paper’s approach underestimates the impact of the EUTR and prevents hasty conclusions.
Albeit potentially interesting for producers exporting towards the EU, both instruments are not very present in the Southern hemisphere. In May 2015, 10.9% of the total global forest area was eco-certified. But the Northern hemisphere accounts for 89% of the globally certified area while the Southern hemisphere only accounts for 11% (UNECE, 2015). 1 The three key elements of the "due diligence system" are: 1) Information: The operator must have access to
information describing the timber and timber products, country of harvest, species, quantity, details of the
supplier and information on compliance with national legislation. 2) Risk assessment: The operator should
assess the risk of illegal timber in his supply chain, based on the information identified above and taking into
account criteria set out in the regulation. 3) Risk mitigation: When the assessment shows that there is a risk of
illegal timber in the supply chain that risk can be mitigated by requiring additional information and verification
from the supplier. 2 FSC and PEFC are the two main eco-certificates for the timber industry at global level.
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Simultaneously, only 6 countries signed and implemented a VPA3. This paper will provide part of the explanation of this observation.
This paper provides an essential contribution to literature for two reasons. First, most of the previous research on the EUTR focusses on the legality aspects and principles of the EUTR (e.g. Wiersum and Elands (2013) or Trishkin et al. (2015)). Albeit useful, this type of research does not assess the policy objective: provide a leverage for sustainable timber production and consumption. Second, previous research predominantly investigates the impact of the EUTR at country-level (e.g. Atyi et al. (2013) or Roe et al. (2014)). Stand-alone case studies are not appropriate to investigate the EUTR’s leverage effect since different regions’ timber markets are ‘increasingly linked through international trade and global environmental policies’ (Raunikar et al., 2010). Through these linkages, demand and supply shocks in one region can impact other regions’ timber markets. Accordingly, one region’s forest conservation policy can leads to deforestation in other regions (Gan and McCarl, 2007; Sedjo and Sohngen, 2013). This validates the assumption that the EUTR, as a policy initiated by the EU, can impact other regions’ timber markets. The assumption is further strengthened by the observation that the EU is responsible for 20 to 40 % of global purchases of timber products (depending on the type of timber products) (FAO, 2015).
This research makes use of a Spatial Equilibrium Model (SEM) because SEMs allow interaction between regional markets. The traditional SEM as developed by Takayama and Judge (1971) is modified according to Brusselaers et al. (2015). The modification is necessary to distinguish the certified (eco-certified and VPA-licenced) timber from the conventional timber. Conventional timber is possibly, but not necessarily, illegal timber. In any case, certified timber guarantees the ecological and social trustworthiness of the product. In practise, a region’s certified timber production is positively linked to the region’s certified forest area. Consequently, it is assumed that increases in certified timber production positively impact on forest conservation and sustainable forest management practices.
This paper compares two scenarios in order to assess the EUTR’s leverage for certified timber production and consumption at global level. In the baseline scenario, both certified and conventional timber can be imported in the EU. In the FLEGT scenario, only certified timber can enter the EU. The basic framework, methodology, and scenario details is described in the second part of this paper. The third part discusses the outcomes of the model, while the fourth part discusses and explains some particularities of the outcome. The final part of the paper provides a brief summary and conclusion.
2. Methodology
The reason to opt for a SEM to investigate the impact of the EUTR is twofold. First, the world’s different regional timber markets are strongly interlinked through trade. These linkages allow the dissemination of the EUTR’s impact across the world. A SEM can incorporate the interconnectivity between regional markets. Second, a SEM can distinguish a policy measure’s welfare impact on the demand side from the welfare impact on the supply
3 Cameroon, Central African Republic, Ghana, Indonesia, Liberia, Republic of the Congo.
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side of a market. Since it is the goal of FLEGT to increase both demand and production of certified timber it is essential to analyse both sides of the market simultaneously
More in particular, this paper modifies the traditional single-product SEM by Takayama and Judge (1971) according to Brusselaers et al. (2015). The 5 regions which are taken into account are: Europe (including Russia), Latin America, North America, Africa, Asia (including Oceania). The modification is necessary and an essential contribution to literature for two reasons.
First, the modified SEM can analyse markets which are characterised by the presence of certified next to conventional products. In the case of the timber market, certified timber is a credence good which is vertically differentiated by process attributes (Dulleck et al., 2011). The certificate demonstrates accordance to FLEGT’s legality principles. Nevertheless, certified and conventional timber are physically homogeneous and remain substitute goods. The specific price mechanism for certified timber prevents the use of the traditional multi-product SEMs for substitute goods however. At the timber market, the certified timber price (��,���� and ��,���� for demand and supply) consists of the conventional timber price (��,�� and
��,��) to which a price premium (��� ��,� and ��� ��,�) is added. Hence, the standard
assumption of a positive (negative) cross-price elasticity for demand (supply) for substitute goods does not hold (O'Sullivan et al., 2011; Takayama and Judge, 1970). Most research expresses the price premium for certified timber as a percentage increase of the conventional timber price (e.g. Cai and Aguilar (2013)). The modified SEM adheres this approach and applies the following price relations:
��,���� = ��,� ∗ (1 + ��� ��,�) ( 1 )
��,���� = ��,� ∗ (1 + ��� ��,�) ( 2 )
Hence, a price increase for conventional wood increases the certified wood price by the same percentage and both wood types remain equally expensive in relative terms. We refer to Brusselaers et al. (2015) for the technical details of the introduction of the price premium in the model as well as the specification of the regional demand and supply functions and the bilateral trade costs. The modified SEM still optimizes the global economic welfare. This optimization results in an optimal timber production and consumption (��,�∗ and ��,�∗ ) for each
region. The equilibrium quantities encompass both the production and consumption of certified and conventional timber. The standard demand and supply functions also determine the optimal prices for demand and supply (��,�∗ and ��,�∗ ). As described in (1) and (2), a price
premium needs to be added to these prices in order to find the prices for certified timber.
A second main contribution to literature relates to the endogenous distinction between certified and conventional timber in the modified SEM. Our model is not the first SEM which investigates the impact of the EUTR. Also Moiseyev et al. (2010) conducted a global assessment of the impact of VPAs by making use of a SEM. But Moiseyev et al. (2010) determine the share of legal (certified) timber in a region’s total timber consumption and
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production exogenously4. Instead, our paper presents a SEM which distinguishes the share of certified (legal) timber in a region’s total timber production and consumption endogenously. The share depends upon the price of conventional timber and the price premium. This approach is more appropriate to investigate the leverage effect of the EUTR for certified timber because it allows producers and consumers to switch from one timber type to another. Brusselaers et al. (2015) determine the share of certified timber in a region’s total timber production and consumption by introducing 2 new parameters in the model: the Willingness To Pay (WTP) and Willingness To Accept (WTA) per region. These parameters allow to determine the price premiums Pprem�,� and Pprem�,� endogenously (Equation 1 and
Equation 2). This is explained in the following parts of this section.
2.1. Willingness to pay
The WTP is a measure of the consumers’ marginal utility of the credence qualities of certified timber (Dulleck et al., 2011). Hence, certification is a market based instrument with voluntary price signals (Pirard, 2012). Notice that the WTP is not the result of a contingent valuation method which perfectly monetarises the environmental and societal gains. The WTP for certified wood differs regionally for many reasons5. This research links the WTP to income, as described by Greenstone and Jack (2015).
Brusselaers et al. (2015) assume a logistical distribution for the WTP because the function can be analytically intergrade. Hence, The WTP in each region i is symmetrically distributed around a known mean (�� !,�) following a logistic distribution with variance "#$� !,�# 3⁄ .
Each region i’s cumulative distribution function for certified timber consumption can be constructed out of the known logistic distribution:
'ℎ)� �,���� = 1 − ,,-�
.(/01234,5.678/,5) 978/,5: ( 3)
The cumulative distribution function determines the certified share of a region’s total timber production for each price premium level. It has a downward slope (Figure 1). This implies that a low price premium ��� �;< on top of the conventional equilibrium timber price ��,�∗
results in a high proportion of certified consumption ('ℎ)� �,����ℎ=) in the total equilibrium
timber consumption ��,�∗ . A high price premium ��� �>�?> results in a small share:
'ℎ)� �,����@AB in Figure 1. This reasoning is also justified by Fajgelbaum et al. (2011) who
4 Also the EU commissioned an official impact-monitoring. The ITTC became responsible for an independent
market monitoring project. The project keeps track of some global trends, and how the EU and wider
international markets for FLEGT licensed timber develop during the set-up of the VPAs. But the monitoring has
two main restrictions: 1) it does not provide insights into the dynamics which explain the monitored evolutions,
and 2) it does not take into account the situation in countries which did not negotiate a VPA. 5 E.g.: (1) the longer presence of certification in North America and Europe, (2) market failures including both
the classic market failures of public goods and externalities, and the market imperfections more common to
developed countries (missing land, capital, and labour markets), although missing credit markets lead to
revealed preference measures that reflect liquidity constraints, rather than WTP. Cai, Z., Aguilar, F.X., 2013.
Meta-analysis of consumer's willingness-to-pay premiums for certified wood products. Journal of Forest
Economics 19, 15-31. and Greenstone, M., Jack, B.K., 2015. Envirodevonomics: A research agenda for an
emerging field. Journal of Economic Literature 53, 5-42.
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demonstrated that higher incomes lead to larger fractions of consumers buying high-quality goods.
Brusselaers et al. (2015) determine the regional parameters �� !,� and $� !,� out of the
global meta-analysis on consumers’ WTP for certified timber by Cai and Aguilar (2013) by making use of the logistic regression model by Jacobsen and Hanley (2009). Basically, the WTP is positively correlated with a region’s GDP per capita. Hence, wealthier regions have a higher �� !,� and likely purchase more certified timber. Appendix A presents the regional parameter values. The WTP as determined by Brusselaers et al. (2015) is based upon research on eco-certification. No research on the WTP for FLEGT-licencing exists. This papers considers eco-certification and FLEGT-licencing as similar instruments however. As a consequence, it is assumed that the WTP for eco-certification is equal to the WTP for FLEGT-licencing. This assumption is justified by the observation that the FLEGT-licence goes beyond the legality issues related to trade. Also environmental and societal issues of the local communities are taken into account by the FLEGT-licence (European Commission, 2016). Hence, the FLEGT-licence and the eco-certificate are very alike. We acknowledge one limitation of this approach: the FLEGT-licence is not physically visible, while the eco-certificates are.
Figure 1: Cumulative distribution function of certified timber in total demand and supply for a region i. NOTE.-The low and high price premium are determined arbitrarily.
2.2. Willingness to accept
Van Deusen et al. (2010) described how environmental and societal-friendly production practises restrict forest management options and increase production costs. Consequently, eco-certification and FLEGT-licencing comes with a costs. Following the assumption of competitive behaviour, producers will only obtain a certificate if the additional costs are
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compensated by a price premium ��� ��,�. The WTA is a measure of the requested price
premium at the supply side of the market. In accordance with the WTP, this paper assumes that the WTA eco-certification is equal to the WTA FLEGT-licencing.
According to expert knowledge, the high set-up cost of a FLEGT-licencing system prevents the actual issuing of FLEGT-licences. This strengthens our believe that the FLEGT-costs is higher than the cost of eco-certification. By assuming equal costs (and WTA) for both certification types, we could underestimate the costs of the FLEGT-licence. The interpretation of the results must take this limitation into account. The assumption of equal costs originates from our observation that both certification types comply to the EUTR’s legality criteria. Nevertheless, this approach at present also provides the best proxy for the additional production costs related to FLEGT certification since no accurate data on these costs exists. In addition, considering both types of certification simultaneously is necessary to conduct a global impact assessment of the DDS at the supply side of the market. The VPAs are specifically targeted at timber producing countries in the Southern hemisphere. Hence, also including the possibility of eco-certification is necessary to offer countries without a VPA (e.g. in the Northern hemisphere) the possibility to demonstrate the legality of their timber exports.
The mean WTA differs regionally due to regional differences in the indirect and direct costs related to certification. The indirect costs stem from the changes to the management practices to meet certification standards (Bass, 2001). The magnitude of the indirect cost is inversely related to the quality of the current management practices. Regions with good (legal) standards for forest management face low indirect costs. The direct costs are the costs of the certification process. The direct costs are not dependent on the size of a forest/company (Ebeling and Yasué, 2009). Consequently, the costs are relatively low for large-scale producers and relatively high for small-scale producers (Gullison, 2003). Because large-scale producers and operators tend to be located in the Northern hemisphere, the average certification cost in this hemisphere also tends to be lower.
Brusselaers et al. (2015) determined the parameters (mean and variance) of the logistic distribution of the WTA for each region (Appendix B). In accordance with the WTP approach, a cumulative distribution function of certified production is constructed out of a region i’s logistically distributed WTA (equation 4). This allows the SEM to endogenously determine the certified share of a region’s production for each price premium:
'ℎ)� �,���� = ,,-�
.(/0123C,5.678D,5) 978D,5: ( 4 )
Figure 1 visualises the relation between the price premium and the certified share of a region’s timber production.
2.3. Objective function
Respecting the standard approach, this paper’s SEM maximizes the sum of all regions’ quasi-welfare under the assumption of transport costs. A region’s quasi-welfare encompasses the consumer and producer surplus. Both surpluses are calculated by integrating respectively the
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demand and supply function over the equilibrium quantity (Takayama and Judge, 1971). This maximisation of the global welfare is retained in the modified SEM’s objective function. The demand and supply functions as used by Brusselaers et al. (2015) are presented in Appendix C. Note that the demand and supply function do not distinguish between certified and conventional timber. Hence both certified and conventional timber are responsible for this regional quasi-welfare. The supply and demand function endogenously determine the response of the demanded and supplied quantities to price changes. The baseline values for the demanded and supplied quantities are calibrated by making use of real-time data. The baseline production, and consequently the production potential of each region is quite distinct. At present, Europe, North America, and Asia are producing the most timber (respectively 29.66%, 29.46%, and 25.89% of the world’s production). Latin America and Africa produce less timber (12.57% and 2.42% of global production, respectively). The consumption pattern is comparable. Europe, North America, and Asia account for most of the global timber consumption (respectively 30.97%, 27.98%, and 26.30%). Latin America and Africa account for smaller shares of the global timber consumption (respectively 12.72% and 2.03%).
The modified SEM adds an additional welfare element to the traditional SEMs objective function. Figure 1 demonstrates how a low price premium ��� �;< on the demand side of region i’s market encourages a high percentage of the consumers ('ℎ)� �,����ℎ=) to acquire
certified wood. Most of these certified timber consumers are willing to pay an even higher price premium however. The difference between the equilibrium price premium ��� �;< and a consumer’s individual WTP represents the additional consumer surplus related to the introduction of certification and the price premium. The integral of the cumulative logistic distribution function (equation 3) over the right hand side of the equilibrium price premium adds all individual consumer surpluses. A maximum price premium of 100% is assumed:
E'���� = F 'ℎ)� �,����G��� ��,�,H − F 'ℎ)� �,����G��� ��,�!I��J4,5H ( 5 )
On the supply side of the market, the introduction of the price premium creates additional value for producers. An equilibrium price premium equal to ��� �>�?> convinces a high proportion of a region i’s producers ('ℎ)� �,����ℎ=) to produce certified wood (Figure 1).
However, most of these certified wood producers are also willing to provide certified wood at a lower price premium. The additional producer surplus is quantified by integrating the cumulative logistic distribution function of the certified share of wood production (equation 6) over the left hand side of the equilibrium price premium.
�'���� = F 'ℎ)� �,����!I��JC,5H G'ℎ)� �,���� ( 6 )
Both the additional consumer and producer surplus (respectively equation 5 and 6) are multiplied with the regional equilibrium conventional timber price (respectively ��,�∗ and ��,�∗ )
and the regional equilibrium timber quantity (respectively ��,�∗ and ��,�∗ ). This multiplication is
added to the traditional SEM’s objective function in order to construct the modified SEM’s objective function (Appendix C). The traditional SEM’s price condition for trade and the trade balances remain valid in the modified SEM.
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The traditional SEM’s trade balances remain valid in the modified SEM. First, region i only exports timber to region j if region j’s demand price compensates region i’s supply price and the bilateral transport costs KE�,L. For certified timber, this price condition also takes the price
premium in both regions into account. The trade balance stipulates that a region cannot export more timber of a specific type (certified or conventional) than it produces. Simultaneously, a region cannot import more timber of a specific type than it consumes (Appendix C).
The modified SEM simultaneously solves each region’s equilibria under the assumption of bilateral trade costs (Appendix C). Hence, the transport costs separate, but not isolate different regions’ markets. The transport costs are retrieved out of Buongiorno and Shushuai (2014) according to Brusselaers et al. (2015). The outcome of the modifications is an equilibrium state for the market which is no longer two-dimensional (price and quantity). Instead, the equilibrium consists of four dimensions: price, quantity, price premium, and certified share of a region’s total consumption/production. This finally allows to determine each region’s and the global quasi-welfare.
2.4. MODELLED SHOCK
This paper compares two scenarios in order to assess the impact of FLEGT: the baseline scenario and the FLEGT scenario. FLEGT does not exists in the baseline scenario. Consequently, both conventional and certified timber can be imported in the EU. Importing timber does not entail any additional costs, besides the standard transport costs. The FLEGT scenario assumes the perfect implementation of FLEGT. This implies that timber importers must provide a sufficient prove of legality by setting up a DDS or by importing certified timber. Out of expert knowledge we conclude that the costs of setting up a DDS at individual level surpass the costs of a certificate. For this reason, this paper assumes that only certified timber is imported in the EU. This implies that the non-negativity constraint for the transported conventional timber quantity towards the Europe (K�L,MN� ) must be further
tightened. This variable is set at zero for each region, except the EU:
∀P ≠ RS:K�L,MN� = 0 ( 7 )
The European timber production is supposed to meet the EU’s legality standards. Therefore, no certificate is explicitly required for European timber destined for the domestic market.
The non-negative price premium for certified timber implies that the trade restriction (Equation 7) might create a non-tariff trade barrier for timber. But the outcome of the policy is not straightforward. At the one hand, FLEGT might stimulate certification outside the EU. At the other hand, this policy strengthens the competitive position of the EU’s conventional timber producers. They do not face competition by other regions’ conventional timber producers in the FLEGT scenario.
3. Results
The section first investigates whether FLEGT achieves its main objective: stimulating certified timber production. The certified timber production is analysed at both global and regional level. Subsequently, also the impact on certified consumption at regional and global
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level is described. Finally, this section discusses the impact of FLEGT on each regions’ welfare.
I. Certified production
Table 1 presents the production, supply price, and supply price premiums per region and at global level for both the baseline and FLEGT scenario. In the baseline scenario, Europe and North America are the most important certified timber producers. Respectively 46.53% and 84.84% of their timber production is certified. The certified share in the three remaining regions’ production is below 5%. Together, Africa, Latin America, and Asia only account for 3.05% of the global certified timber production.
At global level, the production of certified wood decreased by 26.69% due to FLEGT. But the regional impact of FLEGT on the certified production is ambiguous. On the one hand, FLEGT increases the certified timber production in the Southern Hemisphere. Africa, Latin America, and Asia increase their certified timber production by 18.16%, 18.16%, and 17.64% respectively. Together, these 3 regions account for 5.17% of the global certified timber production in the FLEGT scenario. The share and volume of certified timber production in the Southern hemisphere remains small however.
On the other hand, the certified timber production decreases in Northern America (-41.70%) and Europe (- 0.83%). In Europe, FLEGT prevents the import of conventional timber. Hence FLEGT relieves the European conventional timber producers from non-European competitive pressure. This enables the conventional European producers to exercise some monopolistic power and increase prices by 1.05% (Table 1). Consequently, conventional timber production becomes more attractive and part of the previously certified producers switch to conventional production. The decreased interest for certified timber at the supply side off the market decreases the European price premium by 1.32%.
The certified production in North America decreases by 41.70%. This apparent decrease is explained by the evolution of the certified timber price (+0.17%) in relation to the conventional timber price (-5.49%). These simultaneous evolutions push producers towards conventional instead of certified timber. The evolution of the timber prices in North America is strongly related to the evolution of prices in Europe. This follows from the observation that Europe is the most important competitor of North America in terms of produced volume. For conventional timber, the price increase in Europe allows the North American producers to increase their price without losing consumers to European producers. For certified timber, the decrease of the European price premium has the opposite effect. If North American producers want to remain competitive they have to decrease their price premium as well. They succeed in doing so since in the FLEGT scenario, no certified timber is imported in North America. The European producers are not able to penetrate the North America certified market.
Two elements deserve some additional attention. First, the North American price premium in the baseline scenario (36.27%) by far surpassed the European price premium (27.83%). The converging trend in price premiums between Europe and North America decreases the North American premium relatively more (to 27.46% and 28.57% respectively). This explains the sharp decrease of certified production in North America. Second, Only the North American
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and European producers can adhere the strategy of decreasing the price premium in order to remain competitive. This follows the observation that those two regions are the most efficient certified wood producers. The less efficient producers in Africa, Latin America, and Asia face higher certification costs. This translates into a high WTA, and a high requested price premium. Hence, a decreasing price premium first drives the most vulnerable producers out of the market.
II. Certified consumption
The global consumption of certified timber decreases by 26.69% because it needs to remain in balance with the global certified timber production. Table 2 presents the SEM’s solution for each demand-related variable for both scenarios.
Consumers have some degrees of freedom to optimize their quasi-welfare. First, they can switch between conventional and certified timber if one timber type becomes relatively cheaper than the other. Second, consumers can switch between domestically produced timber and imported timber. The transport costs impede the switch from domestic to foreign timber however. The transport costs create an additional margin between a region’s domestic demand price, and other regions’ supply prices. This margin separates, but not isolates, the different regions’ market. Due to the margin, domestic producers can increase their price without immediately losing consumers to foreign producers. Consequently, high transport costs make consumers more dependent on choices of domestic producers.
This phenomenon is also observed in Europe and North America. The previous part provided an explanation of the growing interest in conventional production in both regions. The North American and European consumers are obliged to follow this trend and consume more domestically produced conventional timber. The protectionist nature of FLEGT prevents of switch towards foreign conventional timber. The transport costs impede the consumers of substituting the previously domestically produced certified timber by certified timber produced abroad. Hence, the home effect of the monopolistic situation outweighs the potential benefits of certified timber imports into Europe. This results in a 4.24% decrease of certified consumption in Europe, despite the relative high European WTP for certified timber.
Also the North American consumers are obliged to follow the decisions of the North American producers. This implies a 41.7% decrease of the certified timber consumption. In the baseline scenario, certified timber consumption was the standard in North America. Even to that extent that no price premium was required at the demand side of the market. The lost volume of certified timber consumption in North America surpasses the global loss of certified timber consumption.
The certified timber consumption decreases in Africa and Asia. In those regions, the consumers did not follow the decisions of their domestic timber producers (i.e. produce more certified timber). This follows the observation that most certified timber in those regions is destined for the foreign market. The African and Asian WTP for certified timber is, due to their lower income per capita, not sufficiently high to compensate the increasing price premium in the export markets.
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The explanation for the increase of certified timber consumption in Latin America is twofold. First, the Latin American consumers follow the decision of its domestic producers to produce more certified timber. This trend is initiated by the import conditions set by FLEGT. Second, a decreased price premium for consumption is observed in Latin America. This is an indirect result of the disappearance of African and Asian export of conventional timber towards Europe. Those two regions had a comparative advantage in conventional timber production. In contrast, Latin America had a comparative advantage in certified timber, and its producers could set an advantageous price premium. Due to FLEGT, production decisions do not consider the comparative advantage anymore. Instead all regions focus more on certified timber production. For this reason, Latin America faces higher competition from African and Asian certified timber producers. Consequently, the price premium for the consumption of certified timber decreases in Latin America. This raises more interest for certified timber consumption in Latin America and explains the certified timber import by Latin America out of Africa and Asia.
III. Welfare implication
FLEGT has the same effect as a protectionist non-tariff trade barrier. Restrictive policies do not maximise welfare at global level: the global welfare decreased by 0.26% due to FLEGT. The welfare effect is further analysed at regional level. Table 3 displays the percentage change of each region’s total, consumer, and producer welfare.
Some trends in Table 3 are apparent. At first, the consumer welfare decreases in each region. This is a result of the monopolistic situation at the European conventional timber market. This increases the European conventional timber prices. The importance of the European timber market at global level entails a conventional price increase in all other regions as well. Higher prices decrease the consumed quantities and decrease consumer welfare. The conventional timber price only decreased in North America. But in the baseline scenario, certified timber consumption was the standard in North America and the conventional price equalled the certified price. FLEGT initiated a drop of certified timber production, and the reappearance of the price premium. The increased certified timber price damages the North American consumer welfare.
A second trend concerns the increased producer welfare in all regions, except North America. The protectionist measures drive up prices, which encourages production. This leads to an increased producer welfare. Only North American producers experience a welfare loss. The explanation for this phenomenon is twofold. First, the North American producers produce less certified timber. As a consequence, they miss out a considerable amount of price premium. This drop is less considerable in, for example, Europe. Second, FLEGT exempts the North American conventional timber producers from Europe’s timber market. In the baseline scenario, North America exported conventional timber towards Europe. The disappearance of the important European export market negatively impacts the North American producer welfare.
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Table 1: Production of timber, production of certified timber, supply prices, and supply price premiums (baseline scenario and FLEGT scenario)
Africa Latin America Asia Europe North America World
Baseline FLEGT Baseline FLEGT Baseline FLEGT Baseline FLEGT Baseline FLEGT Baseline FLEGT
Quantities:
Q�,� .38 .38 1.95 1.96 3.34 3.35 4.61 4.65 4.58 4.59 14.87 14.92
Q�,�change (%) +.14 +.14 +.14 +.83 +.14 +.35
Q�,�WXY .01 .01 .04 .05 .15 .18 2.15 2.07 3.89 2.27 6.23 4.57
Q�,�WXY change (%) +18.16 +18.16 +17.64 -3.65 -41.70 -26.69
Share�,�WXY (%) 2.12 2.51 2.12 2.51 4.52 5.31 46.53 44.46 84.84 49.39 41.93631 30.63391
Share�,�WXY change (%) +18.00 +18.00 +17.48 -4.45 -41.78 -26.95
Prices:
P�,� 1.05 1.06 1.05 1.06 1.05 1.06 1.05 1.06 1.05 1.06 1.05 1.06
P�,� change (%) +.17 +.17 +.17 +1.05 +.17 +.45
Pprem�,� (%) 27.83 28.57 27.83 28.57 27.83 28.57 27.83 27.46 36.27 28.57 33.10 28.07
Pprem�,� change (%) +2.69 +2.69 +2.69 -1.32 -21.23 -37.83
P�,�WXY 1.35 1.36 1.35 1.36 1.35 1.36 1.35 1.36 1.44 1.36 1.40 1.36
P�,�WXY change (%) +.76 +.76 +.76 +.76 -5.49 -3.23
NOTE.-Prices are in 100 USD per m³. Quantities are standardised. Asia encompasses Oceania and Europe encompasses Russia. The world prices are calculated as the volume weighted average of each region’s prices. The percentage changes represent the change of the variable’s value in the FLEGT scenario compared to the baseline scenario. The displayed price premiums are the percentage increase on top of the conventional timber price.
15
Table 2: Consumption of timber, consumption of certified timber, demand prices, and demand price premiums (baseline scenario and FLEGT scenario)
Africa Latin America Asia Europe North America World
Baseline FLEGT Baseline FLEGT Baseline FLEGT Baseline FLEGT Baseline FLEGT Baseline FLEGT
Quantities:
Q�,� .28 .28 1.81 1.81 4.00 4.00 4.64 4.64 4.13 4.19 14.87 14.92
Q�,� change (%) -.07 -.06 -.03 -.01 +1.34 +0.35
Q�,�WXY .00 .00 .06 .19 .14 .05 2.15 2.05 3.89 2.27 6.23 4.57
Q�,�WXY change (%) -18.54 +215.14 -59.99 -4.24 -41.70 -26.69
Share�,�WXY (%) .80 .65 3.36 10.58 3.43 1.37 46.26 44.30 94.09 54.13 41.94 30.63
Share�,�WXY change (%) -18.48 +215.34 -59.98 -4.24 -42.47 -26.95
Prices:
P�,� 1.33 1.33 1.27 1.27 1.26 1.26 1.26 1.26 1.55 1.26 1.34 1.26
P�,� change (%) +.15 +.14 +.14 +.14 -18.81 -5.94
Pprem�,� (%) 23.60 24.24 30.50 24.40 20.81 24.00 23.35 23.98 0.00 23.98 8.80 24.00
Pprem�,� change (%) +2.71 -20.02 +15.35 +2.71 +∞ +172.76
P�,�WXY 1.65 1.66 1.66 1.58 1.52 1.57 1.55 1.56 1.55 1.56 1.55 1.56
P�,�WXY change (%) +.66 -4.54 +2.79 +.66 +.66 +.70
NOTE.-Prices are in 100 USD per m³. Quantities are standardised. Asia encompasses Oceania and Europe encompasses Russia. The world prices are calculated as the volume weighted average of each region’s prices. The percentage changes represent the change of the variable’s value in the FLEGT scenario compared to the baseline scenario. The displayed price premiums are the percentage increase on top of the conventional timber price.
Table 3: Percentage change of the total, consumer, and producer welfare per region Regional Welfare Producer welfare Consumer welfare
Africa 0.0062 0.3052 -0.1902
Latin America -0.4228 0.3040 -0.7896
Asia -0.1717 0.3305 -0.2604
Europe 0.0331 1.4171 -0.0531
North America -0.5979 -7.2989 -0.1091
World -0.2601 -1.8366 -0.1161 NOTE.- Asia encompasses Oceania and Europe encompasses Russia. The percentage changes represent the change of the variable’s value in the FLEGT scenario compared to the baseline scenario and are displayed in 100%.
16
In General, a region’s welfare decreases if the decrease of the consumer welfare outweighs the increase of the producer welfare. This is the case in all regions, except Europe and Africa. The increase of the African producer surplus is mainly explained by the certified timber exports (also towards Latin America). The considerable welfare increase of the European producers (+1.42%) is a direct consequence of the protectionist situation created by FLEGT. The monopolistic power at the domestic European conventional timber market allows them to benefit from monopolistic rents.
4. Discussion
I. Trade barrier
FLEGT creates a trade barrier for conventional timber to Europe. North and Latin America are directly impacted by this ban. Latin America managed to redirect its flow of conventional timber from Europe to Asia. In fact, Latin America is exporting more conventional timber in the FLEGT scenario. Since the Latin American conventional timber producers receive a slightly higher price, this positively impacts their situation and welfare. All other regions’ conventional international timber export collapsed. As a result, also the international trade of conventional timber decreased by 1.21%.
FLEGT does not stimulate trade of certified timber towards Europe. The transport costs, ad valorem tariff , and price premium complicate certified timber trade towards Europe. In addition, Europe is an efficient producer of certified timber itself. Europe can fulfil the remaining demand for certified timber itself. This finding is in line with the home-effect by Fajgelbaum et al. (2011) who explain why richer countries specialise in high-quality goods. Nevertheless, the global trade of certified timber increased by 636.28% however. This is due to increased exports of certified timber from Africa and Asia towards Latin America. The volumes of produced and traded certified timber in these regions remain small however.
The outcomes of this paper’s SEM describe how the tropical regions cannot compete with certified timber production in the Northern hemisphere. This is also observed in reality. The International Tropical Timber Council describes the dangers for the future of certification: if ‘producers are forced to drop out from traditional markets, as has already happened in some cases, product prices are driven down’. In some regions, this can lead to a reduction in the value of the resource, encouraging its conversion into other uses (ITTC, 2004).
II. Price premium as incentive for certification
This paper adheres a strictly economic approach towards certification, based upon the assumption of perfect competition. The SEM only allows producers to switch to certified production if the certification costs are compensated by the price premium. Experts of the ITTC (2004) confirm this economic approach: without ‘tangible benefits deriving from certification in terms of profitability or competitiveness, enterprises will have little incentive to improve forest management with higher costs’. This problem is found particularly serious in the case of tropical timber producing countries (Simula et al., 2004). Nevertheless, recent literature draws attention to less tangible benefits for eco-certified timber producers (e.g. community empowerment) (Carlson and Palmer, 2016).
17
III. Leverage effect
Consumption and production of certified timber decreased at global level. Hence, in this setting, FLEGT does not provide a leverage for certified and legal timber production or consumption. Only the regions in the Southern hemisphere managed to expand their certified area. But nevertheless, the certified share in those regions’ production remains equal to or below 10%. The positive relationship between the WTP, the GDP, and the certified share in a region’s consumption indicates that ‘Willingness to Pay’ is probably the wrong choice of words. It rather reflects the ‘Capacity to Pay’ for certified products.
The SEM’s outcomes (Table B1) are also observed in reality. This suggests that the cost of certification is higher than the price premium received by the producers in the Southern hemisphere. Government policies could aim to reduce the costs of certification to make certification more inclusive at global level. Potential points of attention are: the legislative framework in support of certification (Putz et al., 2000), the distance and convenience of timber transport (Gullison, 2003), and the available financial means (ITTC, 2004). Other government policies could focus on group dynamics and cooperative initiatives in the forest industry. A higher level of vertical integration along the production chain, for example, reduces certification costs (Atyi and Simula, 2002).
Cooperative initiatives among producers can also decrease the direct certification costs since the direct costs are not dependent on the size of a forest/company (Ebeling and Yasué, 2009). Consequently, the costs are relatively low for large-scale producers and relatively high for small-scale producers (Gullison, 2003). Moreover, large-scale timber producers are also favoured over small-scale timber producers by the buyers of certified timber. Demand for certified timber is mainly driven by retail, which demands large volumes, consistent quality, and low prices. Large-scale timber producers are better able to meet these requirements (Klooster, 2005; Molnar and Trends, 2003; Rametsteiner and Simula, 2003; Taylor, 2005). But large-scale producers and operators tend to be located in the Northern hemisphere. Cooperative initiatives in the Southern hemisphere can tackle the issue of scale. But a phased approach is needed for this kind of policy (Simula et al., 2004). In a more comprehensive strategy, certification can play a complementary role in sustainable forest management.
5. Conclusion
At global level, FLEGT does not stimulate the consumption and production of certified timber. However, a leverage effect is observed in the production in the Southern hemisphere. The market shares of certified timber in these regions remain small however. These findings are in line with what is currently observed in reality, suggesting that more attention must be devoted to the costs of certification. The leverage effect is not realised in Europe and North America (the main producers of timber). In Europe, FLEGT allows producers to switch to conventional production and exploit a monopoly rents in this market segment.
At the demand side of the market, this models’ dynamics explain how, due to the transport costs, consumers are obliged to follow the production decisions of their domestic producers in
18
favour of certified or conventional timber to some extent. The transport costs in this logic further separate the regional timber markets. Certified timber consumption decreased in all regions except Latin America. This is explained by the increased production of certified timber in Latin America and the increased availability of imported certified timber in this region. This certified timber is imported from Asia and Africa, who cannot focus on the production of conventional timber anymore, due to the implementation of FLEGT. The comparative advantages which are supposed to determine production decisions and trade flows are ruled out due to the policy.
The innovative features added to traditional Spatial Equilibrium Modelling also allow us to analyse the impact of the policy for each regions’ quasi-welfare. At global level, the quasi-welfare decreased because FLEGT creates a protectionist situation in Europe. Protectionism by default lead to non-optimal welfare outcomes. The considerable weight of the consumer welfare in the quasi-welfare of Latin America, Asia, and North America decreases their regional quasi-welfare. These decreases occur at the expense of a welfare increase in Europe (the initiator of FLEGT) and Africa. For both continents, the welfare increase is due to an improved producers surplus. Also the European and African consumers are worse off.
This model is a simplified representation of reality. Therefore it cannot be used for exact forecasting of the leverage effect of FLEGT on each region’s certified share of timber consumption and production. The usefulness of the model lies in the revealing of mechanisms which impact a country with a country profile comparable to one of the 5 regions’ profiles.
19
Appendix A: Determination of mean regional WTP and scale factor
Cai and Aguilar (2013) conducted a meta-analysis of the regional WTP assessments to gain a global picture of WTP. They conclude that the global mean WTP for certified timber products is 12.2 % and has a standard deviation of 8 %.
Each region’s WTP distribution is determined by linking the WTP to the regional GDP per capita. Linking the WTP to GDP occurs via the double logistic regression model developed by Jacobsen and Hanley (2009). They found a coefficient of 0.38 for the GDP per capita. This coefficient describes the percentage change in the WTP following a one percentage change in the GDP per capita. Details of the calculation can be found in Brusselaers et al. (2015).
Table A1: Calculation of the regional WTP and scale parameter estimates based on the regional GDP per capita.
Region Annual GDP per capita
(1000 USD)
Percentage deviation to global
GDP per capita
WTP estimate (%)
Scale parameter (%)
Africa 1.56 -77.44 8.61 3.11 Latin America 9.25 33.85 13.77 4.98 Asia 2.78 -59.78 9.43 3.41 Europe 21.75 214.54 22.15 8.01 North America 26.76 287.07 25.51 9.22 World 6.91 - 12.20 -
SOURCE.-Cai and Aguilar (2013): Meta-analysis of consumer's willingness-to-pay premiums for certified timber products, & Brusselaers et al. (2015): Green public procurement of certified wood: impact on international trade and global welfare. NOTE.-Asia encompasses Oceania and Europe encompasses Russia. If the percentage deviation to global GDP per capita is named u, the WTP estimate per region is found by 0.122*(1+0.38*u). If the percentage deviation to
lobal GDP per capita is named μWTP�, the scale parameter is found by 0.08/0.122*μWTP*√3/π.
Appendix B: Determination of regional mean WTA and standard
deviation
Producers of certified timber receive a price premium. This premium varies depending on the type of forest product and country of production. Previous research estimates price premiums ranging from 1 % to 30 % on top of the conventional timber price (Yamamoto et al., 2014). FSC (2012) reported price premiums ranging between 15 and 25 %. This research, at the first stage, assumes that certified producers around the world receive a price premium of 25 %.
The data by UNECE/FAO (2014) demonstrates that the leverage effect for certification of the 25 % price premium is not consistent across the 5 regions analysed (Table ). Only a marginal fraction of the forest in the Southern hemisphere is certified. In contrast, certification is much more present in the Northern hemisphere. The regional differences are explained by the regional differences in WTA. The WTA expresses the price premiums producers require in order to produce certified timber. The higher the costs associated with certification, the higher the WTA.
It is assumed that for each region, the WTA is symmetrically distributed around an unknown mean. With a known ��� ��,� of 25 %, and known share of certified forests 'ℎ)� �,� it is
then possible to determine the mean WTA per region (�bKc�,�):
20
'ℎ)� �,� ∗ $bKc�,� + 0.25 = �bKc�,� The standard deviation from the demand side of the market is also applied to the supply side of the market. However, the WTA distribution is transformed into a logistic distribution by
computing new scale variables. This is again done by multiplying with √3 "⁄ and simultaneously safeguarding the proportion 8% 12.2%⁄ .
Table B1: Calculation of the regional WTA and scale parameter estimates based upon the certified forest area
Africa Latin America
Asia Europe North America
World
Certified forest area (%) 1.0 1.8 2.2 65.2 35.4 10.9 WTA estimate (%) 44.64 41.80 41.08 21.88 27.96 25.0 Scale variable 9.86 9.44 9.28 4.94 6.32 8.00
SOURCE.-UNECE/FAO (2015): Forest Products Annual Market Review 2014 – 2015, and own calculation NOTE.-Asia encompasses Oceania and Europe encompasses Russia. If the regional WTA estimate is named
�bKc�, the scale variable is found by (0.08/0.122)*�bKc�*√3/".
Appendix C: Main equations of the modified SEM
The demand and supply function are retrieved from Brusselaers et al. (2015). The demand function calculates the equilibrium consumption ��,�∗ and equilibrium conventional timber
price ��,�∗ from the baseline demand quantity ��,�H and the baseline demand price ��,�H as a
function of the response to a price change (△ ��,� = ��,�∗ −��,�H ). The extent to which the
demand quantity responds to price changes is determined by each region’s price elasticity for demand �,�:
��,�∗ = ��,�H j1 + �,� △ ��,���,�H k
Simultaneously, the supply function is constructed:
��,�∗ = ��,�H l1 + �,� △!C,5!C,5m n
The baseline value of each region’s �,�, �,�, ��,�H , ��,�H , ��,�H , and ��,�H is based on Buongiorno
and Shushuai (2014)6.
6 Buongiorno et al. (2014) developed the Global Forests Product Model (GFPM) . This is a dynamic economic
model which determines production, consumption, trade, and prices for the most important forest products in
world markets. This paper only considers industrial roundwood and will abstract the necessary data for this
wood product. This still allows the analysis of GPP, since Input-Output parameters in the GFPM ensure that an
increased share of certified end products requires an increasing share of certified raw material (e.g. industrial
roundwood). In reality, the certifications’ Chain of Custody policies also stipulate that certified material must
be tracked throughout the entire value chain.
The data by Buongiorno et al. (2014) provides information at country level. This paper calculates regional
weighted means (based on volume) out of their data. This is necessary, since country level information does
not exist for all other parameters (e.g. the WTP and WTA).
The GFPM cannot be used to analyse our research question, because it does not differentiate between certified
and conventional wood. Nor has it ever been developed to distinguish public from private procurement.
21
Integration of both the demand and supply function over the equilibrium quantities leads to the consumer surplus E'� and producer surplus �'�related to a region’s total timber production and consumption (no distinction between certified and conventional timber is made):
E'� = F (o4,5∗ ∗pq,rmsq,rm ∗Xq,r −
pq,rmXq,r
o4,5∗H + P�,�H − P�,�∗ )d��,�∗ = Q�,�∗ (P�,�H l1 − ,Xq,rn − P�,�∗ ) + o4,5∗ u∗pq,rm
#∗Xq,r∗sq,rm
�'� = F (oC,5∗ ∗pC,rmsC,rm ∗XC,r −pC,rmXC,r
oC,5∗H + P�,�H − P�,�∗ )d��,�∗ = Q�,�∗ (P�,�H l1 − ,Xv,rn − P�,�∗ ) + oC,5∗ u∗pC,rm
#∗XC,r∗sv,rm
Equation 5 and Equation 6 describe how additional consumer surplus E'���� and producer surplus �'���� is calculated due to the introduction of the price premium. Calculating these integrals results in:
E'���� = w 'ℎ)� �,����G��� ��,�,H
−w 'ℎ)� �,����G��� ��,�!I��J4,5
H
= 1 − $� !,� ∗ lnz {78/,5 |78/,5⁄ + , |78/,5⁄ } − ��� ��,� + $� !,�∗ lnz {78/,5 |78/,5⁄ + !I��J4,5 |78/,5⁄ }
And:
�'���� = w 'ℎ)� �,����G��� ��,�!I��J4,5
H
= $� ~,� ∗ lnz {78D,5 |78D,5⁄ + !I��JC,5 |78D,5⁄ } − �� ~,�
Both the E'���� and �'���� still need to be multiplied by the equilibrium price and quantity in
order to quantify these surpluses at the same scale as the E'� and �'�. The modified SEM’s objective function also takes the transport costs for each bilateral trade
flow between the regions into account. Bilateral transport costs are the per unit transport costs
between the two regions (KE�,L) multiplied with the traded quantities of certified and
conventional timber (respectively K��,L��� and K��,L�):
��(K��,L���L�
+ K��,L�) ∗ KE�,L
6 This finding is in line with the standard theory that price elasticity is positively related to the importance of a
product in the overall consumer budget (Gordon, B.R., Goldfarb, A., Li, Y., 2013. Does price elasticity vary with
economic growth? A cross-category analysis. Journal of Marketing Research 50, 4-23.).
22
The combination of the standard SEM’s objective function and the additional elements added
due to the modifications then results in the following objective function which maximizes the
global quasi-welfare �b:
�)��b = ∑ E'�� + ∑ (��,�∗ ∗ ��,�∗ ∗ E'����)� + ∑ �'�� + ∑ (��,�∗ ∗ ��,�∗ ∗ �'����)� −∑ ∑ ((K��,L���L� + K��,L�) ∗ KE�,L)
Whether a region i transports timber towards region j depends upon the trade balances. These trade balances stipulate that trade can only occur if the importing region’s demand price at least compensates the exporting region’s supply price and the bilateral trade costs. For conventional timber this results in the following trade balance:
��,�∗ + KE�,L ≤ ��,L∗ → K��,L� > 0
No trade occurs (K��,L� = 0) in the alternative scenario. The trade balance for certified wood
takes the price premium into account:
��,�∗ + ��� ��,� + KE�,L ≤ ��,L∗ + ��� ��,L → K��,L� > 0
The unit costs of shipping timber between two regions comprise two parts. This data is retrieved out of Buongiorno and Shushuai (2014) according to Brusselaers et al. (2015). The first component is a fixed cost of shipping one unit from one region to another (USD 20.2). The second component is a region-dependent ad valorem percentage. This ad valorem percentage varies from 7.197% for Africa to 0% for Europe and North America.
A region cannot export more than it produces. This leads to the following constraints on the export of respectively conventional and certified timber:
(1 − 'ℎ)� �,����) ∗ ��,�∗ ≤�K��,L�L
'ℎ)� �,���� ∗ ��,�∗ ≤�K��,L���L
These equations also include the production for the domestic market (K��,�). Simultaneously,
a region cannot import more than it consumes:
'ℎ)� �,���� ∗ ��,�∗ ≤�K��,L���L
'ℎ)� �,���� ∗ ��,�∗ ≤�K��,L���L
Finally, a non-negativity constraint is set for the following variables: ��,�∗ ��,�∗ , ��,�∗ , ��,�∗ , and
K��,L∗ . The SEM also assumes that the price premiums ��� ��,� and ��� ��,� are non-
23
negative. This implies that the price of conventional timber is below or equal to the certified timber price.
24
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