Is exchange rate pass-through in pork meat export prices constrained by the supply of live hogs?

Before investigating the economic implications of the statistical model, it is important to test cointegration and homogeneity restrictions in the system. The Phillips-Ouliaris [Z.sub.[tau]], and [Z.sub.[alpha]] residual-based tests reject the null hypothesis of no cointegration for each equation and thus the dependent and independent variables are considered cointegrated. (7) Homogeneity restrictions are particularly important from an efficiency perspective because a homogenous system implies that the three equations in (14) could be pooled to proceed with the panel DOLS estimator of Mark and Sul (2003). The MDE has the advantage of being asymptotically normally distributed and linear restrictions can be tested using a Wald test. The homogeneity restriction for the ERPT coefficients of the U.S. system ([[beta].sup.QC,US] = [[beta].sup.MB, US] = [[beta].sup.ON, US]) in table 1 is strongly rejected as the joint restrictions [[beta].sup.QC,JP] = [[beta].sup.MB,JP] = [[beta].sup.ON,JP]). The two other homogeneity restrictions also yield p-values lower than 0.01. Hence, it is not surprising that the Wald test for the joint restrictions of homogenous coefficients throughout the system yields a very low p-value. Similarly, the exchange rate coefficients seem to be different across provinces for the Japan export price equations. The only homogeneity restriction that is not rejected by the data is the joint restrictions that the coefficients of the hog price are all equal (p-value of 0.421). The joint restrictions leading to pooling the three export price equations is strongly rejected for Japan.

Table 2 presents the estimation results for the ERPT equations in the U.S. market. The coefficients of the lead and lagged first differences are not reported out of concern for space. The adjusted coefficient of determination ([R.sup.2]) of each equation is large, suggesting that the model explains well the variability in the export price. The Jarque-Bera (JB) statistic (Greene 2003) indicates that the null hypothesis of normally distributed residuals cannot be rejected for the Quebec and Manitoba export price equations at conventional levels of significance. (8) The large value of the JB statistic of the Manitoba equation is due to excess kurtosis in the distribution of the residuals. (9)

The ERPT coefficients in table 2 for each of the three provinces have the expected sign and are statistically different than zero at the 5% significance level in all three provinces. The coefficient of the hog price is positive and significant (p-value less than 0.01) as well. The coefficient for hog slaughters is statistically significant in Quebec and Ontario and has the expected sign. However, the p-value of the null hypothesis [[beta].sup.MB,US] = 0 is larger than 0.10; thus suggesting that output in Manitoba does not impact the export price. The coefficient of the yen exchange rate is statistically significant in Quebec and Ontario ERPT cointegrating equations. The yen exchange rate has a positive coefficient in the Manitoba equation but is not statistically significant.

Based on the theoretical framework, when (predetermined) hog supplies have no impact on pricing, the export price in a given market is independent of the exchange rate in the other destination. Hence, testing the nonsignificance of hog production on pork meat pricing decisions in province ] is a test of the null hypothesis: [[beta].sup.j,JP] = [[lambda].sup.j] = 0. When the joint null hypothesis of zero coefficients on the yen exchange rate and the capacity variable is tested, the p-value is 0.308 for Manitoba but less than 0.01 in Quebec and Ontario. The latter results provide additional evidence that the supply of live hogs impacts Quebec and Ontario pork export prices in the United States.

The results in table 2 are consistent with anecdotal evidence in the Canadian hog/pork industry. Quebec packers historically processed all hogs that were marketed by Quebec hog producers while Manitoba has been known to produce and export large volumes of live hogs. While exports of live hogs from Ontario were also significant from time to time over the sample period, Ontario has run a positive inter-provincial trade balance for live hogs with other Canadian provinces (AAFC 2006) suggesting that there is stronger competition for the local supply of live hogs in Ontario than in Manitoba, which has had a negative inter-provincial trade balance. Hog marketing arrangements in Ontario and Manitoba rely heavily on private contracts between producers and packers while it is mandatory for Quebec hog marketings to go through the producers' marketing board. These differences in marketing institutions combined with different domestic competitive forces in the market for live hogs can explain the different results with respect to the effect of hog supplies on pork meat export prices.

Table 3 presents the estimation results for the Japanese market. (10) The adjusted coefficients of determination in the regressions are all lower than in the U.S. case. Once again, it is highly unlikely that the empirical distribution of the residuals in the Manitoba equation is normal. (11) The ERPT coefficient in the Japanese market is negative and statistically significant for the Quebec and Manitoba provinces, but it is positive (and significant) in the Ontario export price equation. The latter finding is puzzling because a depreciation of the Canadian dollar with respect to the Japanese yen is expected to increase the export price in Canadian dollars, albeit in a smaller proportion. A positive ERPT coefficient is usually termed perverse pass-through (Bowen, Hollander, and Viaene 1998) and similar results have been reported in the literature (e.g., Webber 1999). (12)

The price of live hogs is insignificant in Quebec and Manitoba. As in the U.S. case, the coefficients of the number of hogs slaughtered within the province are strongly significant in Quebec and Ontario (and have the correct sign), but the number of hogs slaughtered in Manitoba is not significant at the 99% confidence level and has the wrong sign under the assumption of constant returns to scale in processing. The Wald test of the joint null hypothesis [[beta].sup.j, US] = [[lambda].sup.j] = 0 is strongly significant (p-value less than 0.001) for Ontario and Quebec, which indicates hog supplies have an important impact on the export price response. It is also significant (13) for Manitoba despite the large standard error associated with the coefficient on hogs slaughtered because the coefficient for the exchange rate in the U.S. market is strongly significant (t-statistic is--13.96).

The Manitoba result for the Japan system is not a rejection of the hypothesis that production lags have an impact on export pricing decisions. The number of hogs slaughtered could capture some factor other than the existence of lags in production and marketing. For example, a positive (or even a small negative) coefficient could indicate that there exist decreasing returns to scale in pork meat processing. In that case, the output coefficient could capture two opposing effects: production lags and increasing marginal cost. While a negative coefficient provides evidence that marketing lags and hog production impact pork meat export pricing decisions, the converse is not true; a positive or insignificant coefficient could still be consistent with significant marketing lags if there exist decreasing returns to scale.

It is useful at this point to investigate pass-through coefficients using standard empirical techniques that do not account for lags between hog production and marketing decisions. The existence of lags can introduce some significant bias in ERPT coefficients if output and other currency exchange rates are omitted from the ERPT equations. The framework of Knetter (1989, 1993) is used to investigate potential misspecification problems associated with "traditional" ERPT equations. It is adapted to account for unit roots and cointegration, and uses a somewhat different specification to proxy firms' costs. Knetter's ERPT equation assumes that marginal cost is exclusively a function of time while processors' marginal costs in the current model are proxied by hog prices. Moreover, his analyses usually employ the first difference of the variables to address nonstationarity in the data.

Table 4 reports the ERPT coefficients as well as the constant and marginal cost coefficients for export prices in one province to each market, as well as the t-statistic of the null hypothesis that the coefficient is not statistically different than zero. The only ERPT coefficient in the U.S. system substantially different from the estimates in table 2 is for the Ontario equation. However, the ERPT coefficients in the Japanese market reported in table 4 are strikingly different than the coefficients in table 3. When potential marketing lags are not considered, the empirical framework finds little evidence of significant exchange rate pass-through in the export price in Japan. The coefficients for Ontario and Manitoba are definitely not significant while the magnitude (in absolute value) of the ERPT coefficients for Quebec has decreased compared to the results in table 3. Hence, the failure to account for lags in production and marketing activities in agri-food supply chains can create substantial biases in the estimation of ERPT effects. In the current application, the standard Knetter ERPT equation underestimates the ability of Ontario firms to exercise some market power in the U.S. market.

Concluding Remarks