Vertical effective protection under mixed pricing: a study of the Canadian food industry

The intent of this study is to adjust the measure of effective protection across national industries by accounting for industry-specific pricing regimes and thereby more accurately estimate the direct and indirect resource allocation effects resulting from changes in tariffs and other protective instruments. The inquiry is cast in a partial equilibrium framework designed in part to evaluate and compare the measurement of effective protection as dependent upon the underlying pricing assumptions. Trade models traditionally model price formation with the Ricardian assumption that suppliers will price to the limit of the domestic price plus the tariff on their competing imports. Econometric evidence, however, suggests that prices in certain imperfectly competitive markets are more a mixed function of both the competing import price and the level of domestic costs in these industries. The empirical dimension of the study is an input-output construction that measures effective protection according to these two types of pricing assumptions, and examines the changes in protection that are implicit in the implementation of the 1988 Canada-U.S. Trade Agreement (CUSTA) and as it chiefly affects the Canadian food producing and processing sectors. The food processing sector is of particular interest because of the presence of various degrees of imperfectly competitive behaviour among these industries and because, in contrast to most other manufacturing activities, this sector is an important user of commodities that are quite heavily protected. The Canadian economy is aggregated here into one consisting of 31 industries that feature 29 of these as comprising the food industry. Allowing for mixed pricing suggests that the standard law-of-one-price assumption significantly overestimates effective protection in those processing and manufacturing sectors where imperfect competition is an important consideration. Not to account for mixed pricing in trade liberalization models may therefore seriously overestimate the calculation of gains to trade for these industries. The results also suggest that the CUSTA continues to protect primary agriculture while maintaining pressure on added value in the processing sector. Moving to free trade would likely result in some gains to the processing sector but value added in primary agriculture would be under pressure to contract by as much as 20 per cent over the whole sector.Land and Food Systems, Faculty ofGraduat