Medium-Term Scenarios for the Finnish Pulp and Paper Industries

This report analyzes the competitiveness of the pulp and paper industry in Finland as well as potential future changes in its structure in response to changes in factors affecting the business environment. Examples of such factors include development of market demand, availability of raw materials, and production capacity growth in competing countries. Feasibility of alternative capacity projects is studied using a spatial partial equilibrium model that accommodates firm level and regional details of the Finnish forest sector. Alternative competition hypotheses, perfect competition and Cournot oligopoly, are applied to assess the sensitivity of the results to the choice of market hypothesis. Also, a set of hypothetical mergers is explored as potential future developments. The model structure, the data used, and the results of the alternative scenarios are reported. In addition to the scenario outcomes, we derive the following results that we consider useful in future research. First, our results suggest that, with the current structure of the European paper industry, it is relatively safe to adhere to the perfect competition hypothesis when modeling the use of existing capacity. To model capacity expansion, further empirical work elucidating an accurate behavioral form is required, because the competition pattern significantly contributes to the investment behavior of the leading firms and hence to overall developments in the industry. Second, an interesting finding was that when firms realize the price effect of their output but do not consider their influence on their rivals' behavior the industry that is initially composed of several heterogeneous firms converges toward a more homogenous size distribution when the same technology is available to all the firms in the market. This is explained by the fact that if the industry lacks the ability to coordinate investments, the large firms have less incentive to expand their capacity, because the potential decrease in product prices hurts them more than it would hurt a small firm with little initial capacity. Mergers are a safe way for large firms to expand or maintain significant market share without harming market prices. However, our result repeats earlier presented conclusions: in homogenous product markets, mergers do not necessarily provide the merged firms private gain other than the potential savings in fixed cost. Instead, an exogenous change in industrial structure can cause losses for the merged firms if they try to dominate the industry in order to restrict output. However, mergers increase concentration, which facilitates coordinating investments. This provides public good to the entire industry