The dairy industry has traditionally been one of the more highly protected of Australia's agricultural industries, operating under a complex regime of market intervention - see, for example, Parish (1962), Parish and Kerdpibule (1968), Lewis (1972), I.A.C.

(1975, 1976), Barrett (1981), Albon (1976). While significant exports of dairy products have occurred over recent decades - see B.A.E. (1980) - there is some suggestion that, stripped of the various forms of intervention in the market, the dairy industry could be an import competing industry - see Parish (1962).

For our purposes, there are several important features of these dairy marketing arrangements. Firstly, the price of fluid milk sold in the main metropolitan markets has traditionally been administratively determined, and set at a level substantially in excess of the price paid for milk used for manufacturing purposes. To limit the supply of fluid milk forthcoming at these administered prices, supplies have typically been drawn from only a limited number of dairy farms, under a quota arrangement.

Milk used for manufacturing purposes has attracted a

substantially lower price than that for fluid milk. Nevertheless, the manufacturing milk price has traditionally been supported by a high level of protection from imported dairy products. For a time, a measure of protection was also provided against a major dairy substitute, margarine. In addition, substantial direct subsidies to dairy farmers have been paid over lengthy periods.

While the marketing and institutional arrangements in the

dairy industry have been very complex at a microeconomic level, the broader macroeconomic implications are, fortunately, reasonably clear:

(i) as was the case in the simple model in Section II, there has been at least some scope for exogenous changes in the volume of milk production to be absorbed in changes in the volume of exports of dairy products, with little pressure on the value and volume of local sales of dairy products;

(ii) to the extent that the export market for Australian dairy products is imperfect, there may also be some buffering role played by stocks of manufactured dairy products in the short run;

(iii) to the extent that administered prices of fluid milk are based, in part, on the assessed cost of milk production in quota areas, then sharp changes in seasonal

conditions may have some influence on the fluid milk price;

(iv) the value and volume of dairy production, the value and volume of dairy exports, and real farm incomes would be affected, to some extent, by exogenous changes in the overseas prices of dairy products, and probably in the conventional direction implied by the simple model in Section II. The relative magnitudes of such effects, of course, would be substantially distorted compared to the very straight forward linkages implied by the simple model. As was also the case for wheat and sugar, the local prices paid by domestic consumers for either fluid milk, or for manufactured dairy products, would be

Section VIII The Five Paradigms

It is clear that, from a microeconomic viewpoint, few, if any, of Australia’s major agricultural industries operate under a regime of marketing and institutional arrangements which closely resemble

the simple, hypothetical market structure set out in Section II.

However, from our macroeconomic viewpoint, there are several broad implications of the simple model which are shared, at least to some degree, by the actual workings of the market structure in a number of Australia's rural industries:

(i) in the simple model, exogenous changes to the volume of production are largely absorbed by an appropriate change in the volume of exports, with no significant pressure on prices, and hence with no significant change in the volume and value of sales on the domestic market. The value of production, the value of exports and real farm incomes move in the same direction as the change in the volume of production. Such a scenario would seem to be a reasonable description of the actual workings of the wheat, sugar, beef, mutton and lamb, dairy and some horticultural industries, at least in some periods. In addition, while an exogenous change in the volume of wool production would, ceteris paribus, impose

significant pressure on wool prices, it is not

inconceivable that the more general conclusion - that the value of production and exports, and real farm incomes, would move in the same direction as the volume of production - would remain valid. It would seem useful, therefore, to consider the macroeconomic

implications of a paradigm where an exogenous shock to the volume of farm production occurs and is absorbed entirely by exports at unchanged prices. This will be referred to as the ’first paradigm', and will be

considered in detail in Chapter III;

(ii) in the simple model, an exogenous change in the local equivalent of the overseas price of farm commodities would cause the value and volume of production, the value and volume of exports, and real farm incomes, to move in the same direction as the change in price. The volume of local sales would move in the opposite

direction to the change in price, and the change, if any, in the value of local sales would be ambiguous. Such a scenario is a reasonable description of the outcome in the beef, mutton and lamb industries in some periods. Further, if a broader definition of exogenous overseas developments was adopted, which included

changes in some arguments in overseas demand functions for Australian farm produce, or changes in the volume of imports allowed in under quota, such a scenario would become even more relevant for the beef, mutton and lamb industries, as well as becoming relevant for the wool industry. In several other industries, such as wheat, sugar and dairying, such overseas developments can

influence the volume and value of production, the volume and value of exports, and real farm income, in the

conventional direction but have little, if any, bearing on the volume and value of local sales. Despite this

latter qualification, it would seem useful to consider a paradigm where an exogenous change occurs in the local equivalent of the overseas price of farm commodities, and which flows through into the value of production and exports, the value and volume of local sales, and real farm incomes. This will be referred to as the 'fourth paradigm' and will be taken up in Chapter VI.

In addition, there are several important scenarios which we have seen to be relevant to at least some farm industries, but which were not explicitly identified in the context of the simple model:

(iii) an exogenous change in the volume of farm production may need to be absorbed entirely on the domestic market, requiring an appropriate change in the domestic price of farm commodities - in other words, there is no change in the volume of exports, and no buffer stockholding. The value of production, the value of local sales and real farm incomes may move in the same, or in the opposite, direction to the change in the volume of production. Such a paradigm is relevant for non-traded agricultural commodities - for example, a wide range of horticultural commodities, and several intensive livestock

industries. It is also likely to be relevant for the beef, mutton and lamb industries in some periods - for example, when constraints on the volume of exports to the main overseas markets are effective. This will be referred to as the 'second paradigm', and is taken up in Chapter IV;

(iv) in a number of farm industries, short term changes in the volume of production are, in some periods, likely to be at least partly absorbed in buffer stocks. The value of production and real farm incomes would move in the same direction as the volume of production, while the value and volume of exports and non-inventory sales on the domestic market would be largely unchanged. This paradigm, which will be referred to as the 'third paradigm', and which is taken up in Chapter V, is relevant to the wheat and wool industries in some periods and, perhaps to a lesser extent, the sugar and dairying industries;

(v) there has been, until recently, a direct linkage between changes in the value and volume of wheat production and changes in the domestic credit component of the high powered money stock. As we shall see in Chapter VII, this issue has been the subject of some debate in policy circles, and a significant change in the policy stance adopted by the monetary authorities has occurred in recent years. In view of this, it would seem useful to examine a paradigm - the 'fifth paradigm' - in which an advance payment scheme for a farm commodity is

explicitly introduced, and the macroeconomic implications of the various alternative means of financing that advance payment are considered. The

'fifth paradigm' is taken up in Chapter VII.

It is clear, of course, that these five paradigms do not exhaust the range of potentially interesting and important issues identified in the review of the marketing and institutional

arrangements in the various rural industries, undertaken in the present chapter. For example, amongst the issues which have been noted but which will not be developed further are:

(1) the possibility that an exogenous change in the volume of wool production could, in some periods, result in a more than proportionate change in the wool price, so

that the value of production and exports, and real farm incomes, would move in the opposite direction to the change in the volume of wool production and the volume of wool exports;

(2) the possibility that the value of farm exports may change, with no impact on the volume and value of

production or domestic sales, or the level of real farm income. Such an outcome could be of relevance to the wool industry in some periods - for example, if an exogenous change in overseas demand for wool was met entirely out of A.W.C. stocks. It could also be

relevant for the beef, mutton and lamb industries - for example, if a change in the local equivalent of the overseas prices of those commodities was to occur in the presence of an effective constraint on the volume of exports and if export quotas were held by local residents.

The decision not to expand further upon such cases is not to deny their potential importance. Rather, it is a reflection of

time and space limitations within the context of the thesis, and the judgement that the five paradigms actually taken up may be of relatively more importance. Of course, these remaining issues could be readily examined within the model framework developed in the thesis, as part of a future research project.

CHAPTER III

MODEL I: PHILOSOPHY, STRUCTURE AND SOME ANALYSIS OF THE FIRST PARADIGM Introduction

In Chapter II, in the light of a review of the marketing and institutional arrangements which have operated in Australia’s major farm industries, five paradigms, relating to shocks originating in the farm sector, were identified and put forward for further analysis. These paradigms differed in either the nature of the shock in the farm sector, or in the broad features of the marketing and institu­ tional arrangements in the relevant farm industries. In the

present chapter, we will focus on the first, and perhaps the most simple, of these paradigms. In particular, we will consider the case of an exogenous shock to the volume of farm production in the presence of a perfect residual export market.

The shock in the farm sector could be conceptualised as any influence which results in a sharp, and relatively short term, change in the farm production function - for example, a drought, a recovery from an existing drought, or perhaps the advent of above average seasonal conditions. The assumption of a perfect residual export market means that any part of the change in the volume of farm

production which is not absorbed voluntarily on the domestic market, at given prices, would be absorbed on the export market at given prices. In Chapter II, it was argued that such a paradigm is likely to be of some relevance for the wheat, sugar, beef, mutton and lamb, dairy and some of the horticultural industries, at least in some periods.

In Section II, the broad philosophy and structure of the macro­

economic model to be used in the analysis, Model I, is presented and discussed. Most of this discussion, of course, is also relevant for the other versions of the model - Models II, III, IV and V - which

are used in subsequent chapters to analyse the four remaining paradigms. It is also largely relevant for the theoretical simulation variants of Model I and Model II, which are developed in Chapter X and O'Mara et al (1985) respectively and which, amongst other things, allow a more rigorous and complete analysis of the first and second paradigms.

As a point of departure, and for reasons of clarity and ease of exposition, the analysis presented in Section III abstracts from explicit balance of payments considerations and from movements in wages and non-farm prices. In Section IV, the analysis is extended by incorporating explicit balance of payments considerations. Then,

in Section V, the analysis is further extended by endogenising nominal wages and non-traded goods prices.

Ir. each of these three sections, III to V , a similar modus operandi is adopted. Firstly, the structure of the relevant variant of Model I is set out algebraically. In each case, the model proves

to be too large and complex to manipulate using strictly formal algebraic techniques. Therefore, a geometric characterisation of each variant of the model is presented which, while being less rigorous than an algebraic approach, is conducive of some useful and enlightening analysis. The implications of the first paradigm are then analysed within these geometric frameworks.

Section II_____ Philosophy and Structure of the Model

It is assumed that the farm sector of the model can be

characterised as the aggregate of a group of price taking producers operating in the presence of a perfect residual export market for farm output. This, of course, is the specification dictated by the first paradigm.

There are two main complications built into this largely classical structure. Firstly, it is assumed that the volume of gross fixed capital formation in the farm sector is influenced, in the short run, by the level of farm internal liquidity or 'residual funds1. As we shall see in Chapter VIII5 there is an extensive

theoretical and empirical literature, both in Australia and overseas, supporting the significance of such a relationship. Secondly, a separate consumption function is specified for the farm sector in order to reflect the finding in the literature, again as reviewed in Chapter VIII, that the short run response of farm households to a change in measured income may differ to that of non-farm households.

In the non-farm sector of the model, a distinction is drawn between the non-farm traded goods sector, and the non-traded goods sector. The former could be conceptualised as the aggregate of non­ farm exporting industries and import competing industries. It is assumed that, like the farm sector, the non-farm traded goods sector operates along neo-classical lines. In particular, producers take as given the local equivalent of the prices ruling on overseas markets, and set their output and employment so as to maximise profits, given their capital stock, the state of technology and the real wage. This implies, of course, that production of non-farm traded goods is

independent of the level of demand for non-farm traded goods in the domestic economy, other factors unchanged.

A sharp distinction exists between the philosophy underlying the farm and non-farm traded goods sectors on the one hand, and the non-traded goods sector on the other. Using the classification suggested by Corden (1978), the philosophy underlying the non-traded goods sector could be described as ’Popular Keynesian', rather than

'General Theory Keynesian’ or 'Classical'. It is assumed that, in general, the non-traded sector of the economy is dominated by firms possessing at least some price searching capability, and that there are some (unspecified) rigidities in price movements in response to a change in demand for non-traded goods in the short run. This implies that the level of output and employment in the non-traded goods sector is not necessarily consistent with simple, classical optimising behaviour at all points in time. Within this general framework, it could be assumed that non-traded goods prices are either completely unresponsive to demand changes, or are only

partially responsive. In much of the analysis undertaken in Chapters III to VII the former assumption is adopted for simplicity. The main exception is the analyses undertaken in Section V of the present chapter. Of course, when we move on to consider the theoretical

simulation variant of Model I, in Chapter X, we will be able to assess a variety of assumptions as to the degree of responsiveness of non-traded goods prices.

There now exists a wide body of literature on rationed equilibrium theory, which has largely succeeded in placing this

'Popular Keynesian' approach on a firm theoretical base. Some of the important contributions to this literature include Clower (1965) , Barro and Grossman (1971, 1976), Malinvaud (1977), Muellbauer and Portes (1978) and more recently, Backhouse (1980) and Roberts (1982). Useful reviews of the literature in this area have been provided by Drazen (1980) and Gordon (1981). Much of this work has taken as

given the existence of price rigidities. However, there has also emerged a significant literature attempting to provide a theoretical rationale for such price rigidities - see for example, Gordon (1981) and Blinder (1982).

Most of the early rationed equilibrium literature focussed on closed economy models. However, in two important papers, Dixit

(1978) and Neary (1980) extended the approach to models of an open economy. They emphasised that the distinction between traded and non-traded goods is likely to be particularly important in rationed equilibrium theory. More specifically, the theory is likely to be more relevant to the non-traded goods sector of an open economy, where producers are likely to have some price searching ability,

than for the traded goods sector where prices are strongly influenced

In document Linkages from the farm sector to the Australian macroeconomy : towards a theoretical and empirical analysis (Page 64-81)