Trade liberalization and private authority : global and New Zealand dairy case studies

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Trade liberalization and private authority: Global and New Zealand dairy case studies Page 1 of 95

MASTER THESIS INTERNATIONAL RELATIONS 2016 UNIVERSITY OF AMSTERDAM

Trade liberalization and private authority: Global and New Zealand dairy case studies

June 24 2016

Supervisor: prof. dr. J.W.J. Harrod Second reader: dr. R.J. Pistorius

Research project: Global politics of investment and trade Academic discipline: International Relations, Political Science

Faculty: Social and Behavioral Sciences Student: Thijs Bolhuis

Student number: 10819622 Graduate School of Social Sciences

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Trade liberalization and private authority: Global and New Zealand dairy case studies

Abstract

The global dairy trade is expanding and the demand for food is expected to grow substantially in the near future. As a result of growing exports, the global dairy industry has increased significantly in size and scope, which has changed the power relations in the sector. This study consists of two case studies on the sectoral power relations. The first case study describes the power dynamics in the global sector. The second case study investigates the dairy sector in New Zealand more closely, in order to examine the extent to which changes in sectoral power relations may be attributed to trade liberalization. The extensive liberal trade reform program of 1984, including the removal of agricultural subsidies and the lowering of import barriers, seems to have changed sectoral power relations in New Zealand only to a limited extent. In addition, the increase in exports could be attributed to other conditions including a broad range of favorable trade conditions accompanied by a wave of mergers and acquisitions that enabled manufacturers to take advantage of economies of scale.

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Table of contents

List of figures...p.5 List of tables and tables...p.5 List of abbreviations...p.5 Acknowledgements...p.7

Chapter 1. Introduction

1.1 Introduction to the topic...p.8 1.2 Purpose of and motivation behind this research...p.9 1.3 Research question...p.10 1.4 Research method...p.11 1.5 Case selection...p.12 1.6 Definitions, data, operationalization and implications...p.13 1.7 Outline of the research...p.17

Chapter 2. Theoretical framework

2.1 Introduction...p.18 2.2 Old trade theories: inter-industry trade...p.18 2.3 New trade theory: intra-industry trade...p.21 2.4 Global realism: private authority and market rationality...p.24 2.5 Conclusion...p.26

Chapter 3. Case study 1: Power distributions in the global dairy sector

3.1 Introduction...p.28 3.2 Trade in dairy products on the inter-state level...p.28 3.3 Multilateral trade negotiations and regulatory reforms...p.34 3.4 Inter-industry trade or intra-industry trade?...p.39 3.5 Multinational corporations and global trade...p.42 3.6 Conclusion...p.46

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Chapter 4. Case study 2: Power distributions in New Zealand’s dairy sector

4.1 Introduction...p.48 4.2 Path dependency: the historical evens in the dairy sector...p.49

4.2.1 Britain as the main driver for economic growth...p.49 4.2.2 Economic reforms and diversification...p.53 4.2.3 The dairy industry and the evolution of the NZDB...p.56 4.2.4 The formation of Fonterra...p.62

4.3 Fonterra's global presence and sectoral power relations...p.65 4.4 Conclusion...p.69 Chapter 5. Conclusion...p.72 6. Bibliography 6.1 Primary sources...p.76 6.1.1 Interviews...p.76 6.1.2 Government documents...p.76 6.1.3 Other sources and statistics...p.77

6.2 Secondary sources...p.82

6.2.1 General...p.82 6.2.2 New Zealand...p.86

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List of figures

Figure 1: World dairy exports in quantity, between 1965 and 2010 Figure 2: Major dairy exporters and importers

Figure 3: Top 10 dairy exporting countries in 2010

Figure 4: Producer Support Estimate (PSE) percentage of gross farm receipts Figure 5: Composition of New Zealand’s export markets, between 1850 and 2000 Figure 6: The average factor productivity of farming, before and after the reforms Figure 7: New Zealand’s dairy industry structure, before and after 2001

List of tables

Table 1: Grubel-Lloyd index, applied to the top 10 dairy exporting countries 2010 Table 2: Top 20 multinational corporations in terms of revenue, 2002-2012

Table 3: Timeline of mergers, acquisitions and joint ventures of the four leading dairy corporations, between 2002-2012.

Table 4: Mergers in the New Zealand’s dairy sector, between 1996 and 2001 Table 5: The sectoral power relations in 2010-2011

Table 6: New Zealand’s national revenue and Fonterra’s revenue, 2010-2014

List of abbreviations B2B- Business-to-business

CAP- Common Agricultural Policy

DCANZ- Dairy Companies Association of New Zealand DDA- Doha Development Agenda

DEIP- Dairy Export Incentive Program DIRA- Dairy Industry Restructuring Act DPA- Dairy Partners America

DPPSP– Dairy Product Price Support Program EC- European Commission

EEC- European Economic Community EU- European Union

FAO- Food and Agriculture Organizations of the United Nations FMCG- Fast Moving Consumer Goods

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FTA- Free Trade Agreements

GATT- General Agreement on Tariffs and Trade GDP- Gross Domestic Product

OECD – The Organisation for Economic Co-Operation and Development IDF- International Dairy Federation

IUF- International Union of Food Workers IPE- International Political Economy IR- International Relations

MAF- Ministry of Agriculture & Forestry MILC- Milk Income Loss Contract MNCs- Multinational Corporations NDP- National Dairy Plan

NZBR- New Zealand Business Roundtable NZDB- New Zealand Dairy Board

NZD- New Zealand Dollar

NZMP- New Zealand Milk Products

NZO- Nederlandse Zuivel Organisatie, Dutch Dairy Industry Association PSE- Producer Support Estimate

ROW- Rest Of the World

SMP- Supplementary Minimum Price UK –United Kingdom

UNCTAD – United Nations Conference on Trade and Development URAA – Uruguay Round Agreement on Agriculture

US - United States of America USD- United States Dollar

USDA- United States Department of Agriculture WTO- World Trade Organization

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Acknowledgements

By submitting this master thesis, I hope to start a new phase in my life. Nevertheless, I really enjoyed my life as a student and I realized my privileged position as a student at the University of Amsterdam. During my study, various professors, lecturers, family, and friends supported me. Without their support I would never have been able to complete this study. Therefore, I want to thank some people in particular.

In the first place, I would like to express my gratitude to prof. dr. Harrod for his unlimited patience, belief in me, and support. It was a great honor to have a professor from this stature as supervisor. I enjoyed his academic and professional working attitude with a sharp sense of humor.

Furthermore, I want to thank my interviewees for their time and the effort they made to introduce me to the dairy sector and to help me to gain a better understanding of the most significant developments in the sector on a global level. Therefore, I must thank Jan Maarten Vrij, Henk Mulder, Werner Buck, and Wim Kloosterboer, who shared their comprehensive knowledge and work expertise in the dairy sector with me.

Finally, I need to thank my parents, who always stayed positive, cheered me up, and believed in me. My two brothers encouraged me to study at the university and helped me to be ambitious. In addition, my thanks go to my closest friends, for all of the support they gave me, and the relaxed moments we shared on the weekends. I am so fortunate, grateful, and happy to have you all in my life.

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CHAPTER 1. INTRODUCTION 1.1 Introduction to the topic

Dairy is a voluminous and perishable commodity that contains calcium, fat, protein, and other nutrients. The components of raw milk are processed and used for the production of consumer products, such as butter, cheese, milk or skimmed milk powder, whey, and yogurt. For a long period of time, dairy farming was characterized as a small-scale family business. The milk price was most often volatile and, in order to curtail imbalances in local markets, farmers joined forces in co-operatives. By working together, farmers could exercise power collectively and obtain a stronger position in markets. The co-operatives evolved and grew in size. The possibilities of foreign trade, however, were limited due to political factors and extensive state regulation.

In the 21st century, considerable steps were taken in the worldwide reduction of tariffs, subsidies, and price support mechanisms in the agricultural sector. Although the food sector continues to be distorted by state intervention, the dairy industry is becoming increasingly oriented towards global markets. The demand for food has increased enormously, and it is expected that it will continue to rise in the near future. The steep rise in demand is a result of three irreversible globally occurring phenomena: a fast growing world population, urbanization, and increased levels of prosperity.

In order to understand global trade, the state is no longer sufficient as a primary unit of analysis. Multinational corporations (MNCs), which operate in various beyond-border markets, are taking advantage of trade opportunities and becoming significant powerful actors. Their enormous size and scope of operations is often justified with the argument of global market competition. However, in contrast to this prevailing conception, MNCs dominate certain sectors and operate within imperfect market structures.

In this regard, trade is not a neutral economic transaction but is deeply transforming the power dynamics between states and markets. However, the conception of market

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competition is widely dispersed and still prevalent in the economical, political, and societal realms. Therefore, it is of great importance to understand the dynamics of power and the socioeconomic implications in the context of the rising proportions of global trade.

1.2 Purpose of and motivation behind this research

The purpose of this master thesis is to explore the evolving relationship between states and markets in the dairy sector. This subject was chosen for three primary reasons.

Firstly, the production and distribution of food continue to be the topics of an embedded political discussion on multiple levels. On the multilateral level, states are negotiating the reduction of trade barriers for agricultural products. However, this process is hampered by the variety of interests among the negotiators. For most nation-states, the food sector is a substantial element in the economy and is needed for political stability in relation to national food security. Partly for these reasons, the agricultural sector is historically intertwined with rigorous state regulations and market interventions. On the non-state level, the leading food corporations have the aim of improving access to world markets, while non-profit organizations, such as Greenpeace, strive for sustainable dairy production in order to minimize greenhouse gases and reduce the pollution of soil and water.

Secondly, according to the estimates of the United Nations, the global demand for food will increase by 70% by 2050. By then, the world population will have grown to 9.1 billion people, which is 34% greater than today’s population (FAO, 2009:2). This trend is supplemented with increasing urbanization and higher levels of prosperity, which are both associated with higher levels of food consumption. However, increasing concerns about environmental issues are challenging the supply of food. If the animal density per surface area increases, one must deal with issues such as the pollution of soil and water, greenhouse gases, and animal welfare. As a result, dairy farmers are facing more extensive legislation on the leaching of fertilizers and minerals into streams and rivers, for example. The fundamental challenge for the dairy industry is to expand production within the limits of what the planet can handle and of what is socially accepted.

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Thirdly, MNCs are seizing trade opportunities and have become significant powerful actors on a global scale. The size and power of these actors continue to increase, but their socioeconomic impact is widely underestimated by academics. For example, the field of International Relations (IR), which seeks to understand the dynamics of power, focuses mainly on nation-states due to the historical prevalence of the realist tradition (Strange, 1996:4). Likewise, the study of international economics is not able to understand the power of private actors either. Economic calculations cannot solve power-related puzzles. For this reason, International Political Economy (IPE) combines both disciplines in order to understand the interaction between states and markets. Susan Strange (1988), who was one of the founders of contemporary IPE, was keen to emphasize the influential role of non-state actors. Nevertheless, the power dynamics of private actors continue to be underestimated. Yet, not only academic researchers have great difficulties in comprehending the power of non-state actors; newspapers and political debates also frequently discuss trade as a matter of the exchange of capital, goods, and services between states rather than markets, whereby the powerful role of private actors continues to be underexposed.

1.3 Research question

As noted in the previous paragraph, the purpose of this thesis is to explore and understand the evolving relationship between states and markets. In order to obtain a better understanding of this relationship, the following research question has been formulated: “To what extent does trade liberalization change sectoral power

relations?” Both “trade liberalization” and “sectoral power relations” are spacious

concepts and could be interpreted in multiple ways. Therefore, these concepts are defined and operationalized in section 1.6.

For the purpose of this research, this study focuses on the global dairy sector and the dairy sector in New Zealand; the motivation behind choosing this focus is presented in section 1.5. In order to understand case-specific events, it is useful to perceive the global context. To do this, the following two sub questions have been formulated: “Who are the principal actors in the global dairy sector?” and “How can the global

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power relations in New Zealand: “How can the sectoral power relations in New

Zealand’s dairy sector be defined?”

1.4 Research method

Given the fact that the relationship between states and markets varies over time and space and that the interaction can evolve in multiple ways, it is crucial to understand the specific context of trade. Therefore, this thesis used a qualitative case study method. The advantage of this method is that it is an in-depth analysis that provides comprehensive insights into one specific case. This thesis consists of two case studies, which will be elaborated in the following section.

The intensive case study analysis allows for the exploration and understanding of complex issues or rare social phenomena. Furthermore, this method offers the opportunity to discover potential patterns or causal mechanisms that can subsequently be tested in a greater number of cases. In addition, this method examines social phenomena in their natural setting and, as a result, improves the ecological validity of this thesis (Gerring, 2007: 20).

This research used multiple sources of data and was confined to a literature review, expert interviews, and an analysis of descriptive statistics. In order to study and verify the collected data, this thesis used the triangulation method. This method entails using multiple sources of data, thereby strengthening the reliability of this research (Bryman, 2012: 392). The collection of data was sampled purposively with reference to the research questions and the aims of this thesis. The primary source of data in this thesis consists of an extensive literature review of various academic papers, governmental and non-governmental policy documents, and corporate reports. Most of the descriptive statistics have been derived from the database of the Food and Agriculture Organizations of the United Nations (FAO). These descriptive statistics are used to illustrate international trade flows in the sector. Nonetheless, these data are applied to the inter-state level and are therefore not able to capture the fundamental role of non-state actors in global trade. Corporate specific trade data are most often confidential and not publicly available. The interviews were semi-structured and respondents were selected on the basis of purposive sampling. The interview data represent views from either individual experts in the field or

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organizations in the Netherlands. The aim of these interviews was to explore and understand global developments in the sector. Hence, the experts who were consulted do not comprise a representative sample.

This research design, however, also entails significant caveats. Generalizability is limited because of the context sensitivity of the case study. In other words, the case is not necessarily representative of the entire population, which reduces the external validity of the study. Furthermore, the replicability of this research is limited because no standard procedures were followed for the gathering of data (ibid: 405).

1.5 Case selection

For the purpose of this research, two case studies were selected. First of all, in order to answer the research question to what extent trade liberalization changes sectoral power relations, the power dynamics in a given sector have to be analyzed. In this study, the global dairy sector was selected as a first case study. The primary reason for this is that, historically, the dairy sector was intertwined with rigorous state interventions. Most states worldwide intervened in the sector through the provision of import tariffs, export subsidies, and price support mechanisms. Since the multilateral Uruguay Round agreement in 1994, however, considerable steps have been taken in the reduction of state support in the dairy sector. Although the sector continues to be distorted by state intervention, there is generally more reliance of market price mechanisms and global trade.

In addition, this case study was also selected because the trade in dairy products is expanding and the demand is expected to increase due to a growing world population, rising levels of worldwide prosperity, and urbanization. MNCs take advantage of the trade opportunities that these developments offer. Their size and scope of operations is increasing and as a result, these MNCs are becoming significant and powerful actors.

Furthermore, in order to examine the extent to which changes in sectoral power relations may be attributed to trade liberalization, a particular case of trade liberalization has to be analyzed. In this study, the dairy sector in New Zealand was

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selected as a second case study. This case represents a small component in the broader understanding of the relationship between states and markets in the agricultural sector. The selected case was a deviant case and was chosen for three primary reasons.

Firstly, with reference to the research questions, New Zealand adopted liberal agricultural principles in the mid-80s of the last century; at that time, this was an uncommon phenomenon. New Zealand reformed its agriculture with strong reliance on market price mechanisms, and substantially reduced the pre-existing trade barriers. Even though these reforms were unilateral, New Zealand had been advocating for strong reductions in international trade barriers on the multilateral level as well. Secondly, contrary to other major dairy producing countries, this sector in New Zealand has become fundamentally outward-oriented, typified with a high proportion of dairy exports and low quantities of imports. Although the size of the national economy is relatively small, it has become one of the leading dairy exporting countries in the world. The dairy production in New Zealand represents a modest 2% of global production, but roughly 95% of the domestic production is exported. This is in sharp contrast with other states, where the production is mostly confined to domestic consumption (Le Heron et al., 2010).

Finally, the dairy sector has become the most important sector for New Zealand’s national economy. The export of the dairy sector represents approximately 29% of the total national exports (DCANZ, 2016). Fonterra Co-operative Group (hereafter: Fonterra) is the largest corporation in New Zealand’s dairy industry and is therefore an influential actor in politics and society.

1.6 Definitions, data, operationalization, and implications

The fast growing levels of global trade have frequently been associated with trade liberalization and further integration in the world market. The former concept is widely dispersed in the public and academic spheres, and therefore needs to be defined.

Trade liberalization is often broadly defined, for example as “any act that would make the trade regime more neutral” (Papageorgiou, Michaely & Choksi, 1991:13). However, according to Greenway (1993), more neutrality could be

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achieved by a reduction of import barriers and export subsidies. In the economic studies of Bhagwati (1978) and Krueger (1978), trade liberalization refers to national economies becoming “outward-oriented” with more reliance on market price mechanisms. This does not imply zero tariffs or full reliance on price mechanisms, but rather a process of reducing market distortions and becoming gradually more open to world markets (Edwards, 1993).

For social scientists, however, trade liberalization is a complex phenomenon, because markets can be distorted in multiple ways, including tariff- and non-tariff barriers. Restrictions on trade, especially non-tariffs, consist of complicated constructions. This impedes measurement, because it is difficult to observe the extent to which the liberalization has taken place (Dean, Dasai & Riedel, 1994). As a result, the relationship between trade liberalization and private authority is empirically difficult to demonstrate. For this reason, the used definition in this thesis is limited to a few basic conceptions. In order to do this, it is important to understand that trade liberalization in relation to agriculture is commonly discussed in terms of reductions in import tariffs, domestic price support, and export subsidies (e.g. FAO, 2001; OECD, 2004; WTO, 1996).

In this context, the Krueger and Bhagwati perspective seems to be a useful starting point for analysis. Therefore, I define trade liberalization as,

“outward-oriented policy reforms with reliance on market price mechanisms, including lowering of import tariffs, reduction of export subsidies and the curtailment of producers’ support systems”. Hence, the reductions in tariffs, subsidies, and price

supports are the most significant indicators to demonstrate trade liberalization in the agricultural sector. The observable trade regulatory reforms essentially take place at the state, regional, or multilateral level. Trade liberalization can take form in unilateral reforms, or in bilateral or multilateral treaties. In this thesis, anecdotal evidence and literature are used to demonstrate liberal-oriented reforms.

Although the Krueger and Bhagwati-based definition represents an economic perspective on trade liberalization, this thesis does not accept the implicit assumption that nation-states act rationally and are the primary actors that set and shape regulations and the conditions of the market. From a political economy point of view, the formation of state regulation is influenced by either endogenous or exogenous

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power structures (Strange, 1994: 212).

Another important concept is “power”, and in particular “corporate power”. For the IR discipline, the conceptualization of power is one of the most controversial but central problems in political science (Gilpin, 1981:13). Despite ambiguity among IR scholars, there is consensus among political scientists regarding the need to investigate the sources and dynamics of power (Baldwin, 2012).

The conventional IR realist would describe power as “the power of A to get B to do something they otherwise would not do” (e.g. Dahl, 1957:202-203). This definition corresponds to Strange’s notion of “relational power” (1988). According to Strange, however, power is not only the ability to shape the specific actions of one specific actor, but also the capacity to shape the overarching framework wherein states and non-state actors relate to each other.

The power to shape this framework is “structural power” and is defined as,

“the power to shape and determine the structures of the global political economy within which other states, their political institutions, their economic enterprises and (not least) their scientists and other professional people have to operate” (ibid: 25).

Strange denotes four principal domains that could be overshadowed: the ability to control security; the ability to control the means of production; the command of the supply of credit; and the shaping of knowledge, principal beliefs, and ideas (ibid: 27). It is beyond the scope of this thesis to discuss these four domains in further detail. What is important to understand, however, is that power is broader than the ability to determine one specific political outcome.

As mentioned before, this thesis focuses on the power of non-state actors; therefore, it is relevant to define the term “corporate power”, which is used as equivalent for the term “private authority”. One of the first scholars who wrote about this subject was John Kenneth Galbraith. According to Galbraith (1983), corporations are planners that exert power to downplay competitive market forces. In his view, technology is one of the driving forces of capitalism. The investment in technology implies risks, since new innovations can be easily replaced by other new innovations.

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Furthermore, the investment in technology is in essence capital-intensive and as a result requires long-term commitment. Investment equals risks and, in order to minimize uncertainties, large corporations need systematic planning instead of the uncertainty that results from subordination to competitive market forces. Market competition is typically focused on the short term and is consequently an unstable structure for long-term investment in technology and innovation (ibid.).

If the insights of Galbraith and Strange are merged together, and the focus is placed on the relationship between states and markets in the context of trade liberalization, it is useful to define corporate power as, “the power wielded by

corporations within a broader framework of society including their political lobbying power and consequently influence over the governmental policy-making progress”

(Moore, 2013:18).

Similarly to the difficulties of the conceptualization of trade liberalization, corporate power is empirically difficult for political scientists to comprehend. This is mainly for two reasons. Firstly, the understanding of corporation operations is complicated by the fact that MNCs operate across borders in multiple markets. Secondly, out of strategic considerations, most corporate data are concealed, which means that in-depth corporate information is held privately and is not publicly available.

To address these empirical problems, this thesis focuses on “sectoral power relations”. In general, the top 10 largest corporations within a certain sector are the main actors in the sector. The main actors interact with international governmental organizations, states, state institutions, sector organizations, and other stakeholders. The size of these actors can be illustrated with industry concentration ratios, employment rates, revenue or assets, and market share. These features can in turn be used as indicators of corporate power (Roach, 2007:6-7).

For the purpose of the discussion in this thesis, the indicators are limited to revenue data and industry concentration rates. The revenue is an indicator of power and illustrates the total sum of spendable money for resources in order to create a surplus. In order words, this is the corporate budget to spend on goods and services, including: marketing, consultants, research and development, labor and political lobby (Harrod,

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2005:207). To put this data in perspective, a comparison is made with the revenue of other large corporations in the sector and additionally, with total budget of the New Zealand government. It is important to note that the national budget is a different indicator than the gross domestic product (GDP). The GDP is the amount of added value by production and therefore not comparable with corporate revenues (Grauwe & Camerman, 2002:313).

1.7 Outline of the research

The following chapter, chapter 2, presents the theoretical framework of this thesis. In this study, this framework forms the fundamental basis for analyzing and understanding the empirical phenomenon of global trade. In order to conduct any case study on one country, the power dynamics of the sector have to be researched. For this reason, chapter 3 examines the sectoral power relations on the global level. Building upon this analysis, chapter 4 examines specific developments in the dairy sector in New Zealand. Finally, chapter 5 summarizes the most important findings of this study, and discusses what these findings mean as well as the limitations of this study.

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CHAPTER 2. THEORETICAL FRAMEWORK 2.1 Introduction

Social science, and more specifically political science, is derived from certain world perspectives. Most of the influential theories in international politics, international economics, and political economy reflect a specific social and intellectual context, which is bound to a particular time and space (Cox, 1986). The initial purpose of trade theory, for example, was to explain inter-state trade relations during the epoch of pax-Britannica. However, to obtain a better understanding of trade flows in the 21st century, this thesis combines “new trade theory” with “global realism” as a theoretical framework. This framework is introduced with the conventional views on trade illustrated with the “old theory”. Although the trade theories altogether provide a better understanding of trade, both are essentially economic theories with the practical aim of solving specific empirical puzzles in a fixed social context. Consequently, these economic theories do not comprehend the nature and dynamics of power. In order to do so, this framework is supplemented with the critical approach called global realism.

2.2 Old trade theories: inter-industry trade

“It is quite important to the happiness of mankind that our enjoyment should be increased by the better distribution of labour, by each country producing those commodities for which, by its situation, its climate and its other natural or artificial advantages, it is adapted, and by thus exchanging them for the commodities of other countries, as that they should be augmented by a rise in the rate of profits” David Ricardo (1951 [1821]: 132).

The academic work of David Ricardo (1773-1823) represented a cornerstone of economic trade theory from the early 19th century until the 1970s. The conventional view on trade takes the principle of comparative advantage as its foundation. States will export those goods that can be produced for relatively lower costs compared to other countries. From this perspective, trade is always beneficial since it makes it

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possible to take advantage of country-specific dissimilarities in terms of technology or factor endowments.

Ricardo (1951 [1821]:136-149) illustrates this rationale in a two-country model. For example, Portugal is a more efficient producer in the production of wine and clothes than Britain is. Nevertheless, although Portugal is more efficient in terms of labor costs per unit, it would be beneficial for both states to trade. If Portugal compares the domestic production costs, it must draw the conclusion that the production of wine is relatively more efficient than the production of textiles, while for Britain the reverse is true. Based on the logic of comparative advantage, it would be beneficial for Portugal to produce exclusively wine, and likewise for Britain to produce only clothes. This principle makes trade beneficial if both states specialize in the production of what can be produced relatively more efficiently. This is contrary to the logic of absolute advantage, in which Portugal would export both commodities.

The Heckscher-Ohlin model builds further on this principle and underscores the variation in factor endowments between countries. The exchange of goods and services is determined by factors of production or, in other words, the endowment of land, labor, and capital. States tend to export those goods that utilize abundant factors of production, and import those goods that use the country’s scarce factors. From this point of view, Britain would be characterized as an exporter of capital-intensive goods and an importer of labor-intensive goods (Ohlin, 1933).

The Nobel Prize winner Paul A. Samuelson (1973:647) illustrates the rationale of comparative advantage with a more frank and simplified example. For example, if a well-educated lawyer is also a proficient typist, this person masters both professions, and is even more efficient than the employed secretary staff. Does it then make sense for the lawyer to do secretarial work at the same time? Based on comparative advantage, it would be more efficient to do one single job. It is beneficial to specialize in the occupation that can be done relatively more efficiently. Likewise, states take advantages of specific endowments and specializations.

Even though this example is convenient and may be pervasive, it is important to note that the principle of comparative advantage does have important caveats. This model

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is built on at least three controversial assumptions. The first is the assumption of constant returns in production, which implies that increasing input equals the same proportion of output. This means that when a state or industry increases production, no scale effects occur (Helpman & Krugman, 1985: 31).

Secondly, the assumption of perfect market competition entails that a state or industry cannot individually set the price, but that instead markets determine the price. This means implicitly that producers will deliver the best possible product for the best possible price. This assumption is problematic since it does not sufficiently account for large-scale production and power distributions among producers (Robinson, 1934: 104).

Thirdly, the principle of comparative advantage presumes a fixed social and political context, and therefore does not address the wider socioeconomic context and the geo-political situation. For example, the illustrated wine-garments trade pattern disregards the Menhuen Treaty between England and Portugal. This treaty was signed during the Spanish Succession War in 1703. This agreement meant that Portugal would not charge Britain for the imports of English textiles, and England would subsequently import Portuguese wine for a lower tariff than France would offer. Hence, the wine-garments trade pattern between Britain and Portugal is not merely derived from economic comparative logic, but is deeply embedded in politics as well (Anderson, 2012:2).

Despite these criticisms, the underlying notion of dissimilar trade between dissimilar nations, in other words the inter-industry trade, continues to prevail in the economic discipline. According to economists, until the Second World War trade flows were well understood in terms of inter-industry trade. Baldwin and Martin’s (1999) study demonstrates, for instance, that in the early 20th century, Britain was a significant exporter of capital-intensive goods and a major importer of land- and labor-intensive goods. Likewise, China’s expanding exports are perceived to be a result of the abundance of labor combined with strong industrial capabilities (Krugman, 2008).

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2.3 New trade theory: intra-industry trade

Contrarily to the conventional perspective of inter-industry trade, how could it be that there is substantial two-way exchange in similar goods between states with similar technological features or factor endowments? Why would Germany export Mercedes cars to Sweden and at the same time import Volvo cars? This empirical puzzle became the foundation for new trade theory (Neary, 2009: 241).

In the mid-20th century, the exchange of similar goods and services between advanced economies increased as a consequence of trade liberalization. This trend, also known as intra-industry trade, was observed and discussed by Balassa (1967), Kravis (1971), and Grubel and Lloyd (1975). These authors explained trade as a result of economies of scale and increasing returns. Yet, these empirical observations did not fit in the conventional economic market structure models, and they were therefore were not sufficiently modeled (Krugman, 1979).

New trade theory explores intra-industry trade on the foundation of an imperfect market structure model. Trade is a matter of increasing returns rather than comparative advantage. Although this notion was not a fundamental new insight, the understanding that imperfect markets imply industrial organization was in fact a “Kuhnian” paradigm shift for international economics. Firms were previously excluded in economic models because in traditional models “industries” represented a single homogeneous group of products, such as wine or garments. In new trade theory, however, an industry consists of various specialized firms supplying differentiated products (Krugman, 1981; 1987).

The rationale behind new trade theory is simple. Increasing returns incentivize firms to exploit scale economies because higher proportions of production entail relatively lower production costs per unit. The given variety in consumer demands allows firms to specialize and differentiate their products. Firms tend to differentiate goods from imperfect substitutes and subsequently take advantage of a certain degree of monopoly power (Helpman & Krugman, 1985).

Hence, economies of scale imply imperfect competitive markets. Whereas in the comparative model states specialize in certain industries, with increasing returns firms specialize exclusively in a subset of products because specialization allows for large-scale production. There is trade between countries with similar factor

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endowments because it allows their firms to take advantage of greater economies of scale (Krugman, 1981; 2008).

The following example will help to make these assumptions more concrete. In contrast with Samuelson’s previous example, if two persons are equally capable of working as doctor and accountant, it will once again make sense that both persons will specialize, because doing both jobs will be not efficient. One person will choose to become a doctor, and the other person an accountant. The doctor will help the accountant in case of emergency, and the accountant will help the doctor with bookkeeping (Neary, 2009). In this situation, the gains from trade are not per se derived from the difference in factor endowments. Both individuals are equally suitable for both jobs, but trade gains occur from highly specific specializations. Likewise, states with comparable endowments specialize in the production of differentiated products and eventually take advantage of economies of scale (ibid.).

Although new trade theory is modestly characterized as a complementary explanation to the existing inter-industry rationale, the underlying assumptions have profound implications for the conventional trade paradigm. Whereas the concept of comparative advantage is in essence unlimitedly supportive of free trade, new trade theory is more skeptical. With the awareness of imperfect markets, it could be beneficial for states to intervene in the domestic market with, for example, import quotas or export subsidies. In this way, governmental policies may support industries in establishing large-scale production. Clearly, the argument against free markets is not new. The prominent study by Brander and Spencer (1985) illustrates that in imperfect markets, under the right circumstances, governmental support fosters national firms to compete against foreign competitors.

Given the fact that advanced economies prevail in international markets, settled economies of scale, and seized first mover advantages, it may serve less-advanced states to support or protect infant industries. It is of crucial importance to understand, however, that this implicit credence to strategic trade policy is also problematic. Governments do not operate with perfect market information, and may withal not act in favor of national interest, since interest groups could shape trade policy interventions (Krugman, 1987:139).

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In some cases, under the right circumstances, intervention could stimulate the evolution of economies of scale. Nevertheless, it would be wrong to argue that new trade theory is in principle against free trade. In general, trade liberalization is perceived as beneficial for states, because open markets could disrupt distortions of a closed economy. Free trade and thus combined markets incentivize specialization, and firms inherently benefit from greater economies of scale. This motivation differs substantially from the comparative advantage argument that rests on the assumption of efficient markets (Krugman, 1979:478).

New trade theory helped to solve the intra-industry trade paradox, and the inherent theoretical findings will remain relevant since increasing returns and imperfect markets continue to be primary features of trade. Nevertheless, this theory does have some important shortcomings.

In the first place, similarly to the old trade theory, new trade theory is essentially a “problem-solving theory” with the aim of explaining current (universal) phenomena on the basis of a fixed social and political context. This means that trade theory is bound to an ahistorical worldview. The inherent implication is that it does not draw the wider socioeconomic context. The theory is rooted in economic assumptions and rests upon mathematical models that are not able to examine the power dynamics of private actors. Although new trade theory emphasizes the existence of imperfect markets, it does not denote the existence of monopolistic or oligopolistic structures, or the implicit power of corporations to shape and transform states and markets.

Secondly, most of the theories in the economic discipline are grounded in theoretical assumptions that do not fit the present status of the world economy (Strange, 1988:12). These assumptions view firms as being concentrated in one single location and located near the largest market, with the aim of maximizing the increasing returns and simultaneously minimizing transport costs (Krugman, 1980:955). However, the modern corporations operate substantially differently. Most sectors are dominated by MNCs with multiple production facilities in various states. The location of these facilities is not exclusively determined on the basis of economically efficient factors. MNCs have the ability to place facilities in locations

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with strategic and favorable conditions, for instance, with relaxed tax, labor, or environmental regulations (Markusen & Venables, 1998).

2.4 Global realism: private authority and market rationality

Although new trade theory is useful in order to explain the existence of imperfect market structures, it is not sufficient to investigate power relations within a particular sector. To address the previously noted shortcoming of new trade theory, the theoretical framework is supplemented with a critical approach called “global realism”. In this approach, power needs to be examined in a critical manner because those who are in power have the capability to construct rationalities. These rationalities are socially constructed worldviews and the key components for problem-solving theories. Critical theory subsequently deconstructs these rationalities. Hence, global realism is believed to be an appropriate framework for power analysis because it deals with multiple power sources and challenges prevailing rationalities (Harrod, 2001).

However, it is important to note that global realism differs from IR realism (hereafter: realism). Realism was originally a tradition with a historical mode of thought (Carr, 2001 [1939]). Yet, in the post-World War II era, the prominent scholars Hans Morgenthau and Kenneth Waltz converted realism into a problem-solving theory (Cox, 1986:211). Particularly Waltz’s third image perspective (or neo-realism) is illustrative of this statement. Neo-realism is built on the foundation that states are unitary actors that act rationally in order to obtain security and survival. The interests of nation-states are exogenously formed within an anarchical world structure. The neo-realism world perspective is problematic because it focuses on states as primary actors and does not envisage endogenous power structures such as corporate power.

In contrast with post-war realism, global realism is a critical theory. The purpose is to analyze sources and mechanisms of power rather than to create scientific laws that aim to predict specific social outcomes. Critical theory is sufficiently aware of multiple perspectives, and challenges these perspectives with a deliberate and historical mode of thought (ibid.). As already noted in the introduction, unraveling the nature and dynamics of power is one of the most controversial and central aspects in

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political science. In order to do this, the following question can be asked: qui bono? Or in other words, who gains? (Strange, 1998:6). To answer this question, it is not sufficient to limit the scope to nation-states; but non-state actors must be investigated as well. If the “who benefits question” is applied to the rising level of global trade, and if it is assumed that trade is incentivized by economies of scale that eventually result in imperfect markets, then it is important to investigate sectoral power structures.

In 2009, approximately 82,000 MNCs were operating worldwide, and this had more than doubled since 1992 (UNCTAD, 2009: xxi). Moreover, not only did the quantity increase, but the size and power also expanded significantly during the preceding decades (Roach, 2007). A popular illustration for this statement is that the world’s 100 largest “economies” altogether consist of 51 corporations and 49 nation-states. However, this statement is misleading because, as mentioned in the introduction, corporate revenue cannot be compared to GDP (Grauwe & Camerman, 2002). If the 100 largest “economies” are considered in terms of value added, which is a more suitable, the top 100 consist of 29 corporations and 71 countries (Roach, 2007:5). When consulting corporate revenue statistics, however, it is undeniable that the size and scope of these MNCs is increasing (Fortune 500, 2016). The enormous size of these non-state actors is often justified with the conception of global market competition. This idea suggests that MNCs aspire to maximize profits in global competitive markets. In other words, corporations are entirely subordinate to market forces that determine corporate decisions. In this regard, corporations do not wield power to transform the pre-existing features of states and markets. However, the fundamental problem with this is that it is deeply rooted in economic assumptions, and therefore does not consider the dynamics of power.

As noted by new trade theory, corporations operate in imperfect market structures. Yet, MNCs have the power to create, promote, and keep the market rationality in existence. In order to deconstruct this conception, a distinction must be made between profits and rents. The former concept is a surplus that is directly derived from production, while a rent is a surplus derived from factors other than production (Conybeare, 1982:25).

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An imperfect market structure suggests that corporate decisions are not completely determined by market forces. This provides corporations with leeway to seek non-productive related surpluses or rents. Instead of deriving surpluses from production, MNCs have the capacity to create surpluses in the political arena. MNCs benefit from dissimilarities in state regulations, or can, for instance, enforce preferential tax benefits or relaxed environment policies (Harrod, 2005).

Of course, corporations are bound to state regulation and do not have the power to promptly alter these regulations. However, corporations could implicitly reshape policies by lobbying or bargaining with political elites. The corporate investment in these practices is essentially rent-seeking behavior. In this way, corporations do not merely act as economic actors, but are significant political and societal actors as well. This notion has profound implications for the nexus between states and markets (ibid.).

2.5 Conclusion

For a long period of time, the principle of comparative advantage was the cornerstone for international trade theory. This principle means that international trade entails inter-industry trade, as a consequence of dissimilarities between nation-states in terms of technological features or factor endowments. From this perspective, it is beneficial to specialize and exchange. States can take advantage of factor dissimilarities and are inherently supportive of free trade.

Nevertheless, the logic of comparative advantage is highly disputable for several reasons. The assumptions of perfect market competition and constant returns are evidently wrong. Furthermore, the principle presumes a fixed social and political context, and consequently does not address the wider socioeconomic context and the geo-political situation. Finally, the comparative logic cannot explain the exchange of similar goods between states with comparable factor endowments.

New trade theory solves this paradox and demonstrates that trade is driven by increasing returns and economies of scale. Increasing returns incentivize firms to produce on a large-scale basis, because a higher level of production results in relatively lower production costs per unit. The primary reason for intra-industry trade is that firms have greater access to markets and can take advantage of economies of

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scale. However, the economy of scale production and increasing returns imply the existence of imperfect market structures.

With the awareness of imperfect markets, it could be beneficial for states to intervene in the domestic market, and is thus not simply in full support of trade liberalization. However, trade liberalization can break up market distortions and a combined market incentivizes specialization, and allows the seizing of opportunities of large-scale production. Therefore, according to new trade theory, it is in most cases beneficial for states to open up markets. This argument in favor of free trade is more nuanced and differs from the comparative logic motivation.

Nevertheless, new trade theory does have some important drawbacks as well. Similarly to the logic of comparative advantage, it is rooted in economic theory, and the mathematical formulations cannot comprehend the dynamics of power. Most of the assumptions in economic theories do not fit in the present status of the world economy. New trade theory excludes MNCs in the analysis and withal does not sufficiently denote the socioeconomic implications derived from imperfect market structures.

Contrarily to these economic trade theories, global realism is a historical approach with the ability to analyze multiple sources of power and challenge the prevailing rationalities. If the “who benefits question” is applied to the increased levels of global trade, then it is not sufficient to confine the analysis to nation-states and inter-industry trade. In the 21st century, MNCs are taking advantage of global trade opportunities and are becoming significant powerful actors. The immense size of these non-state actors is predominantly justified with the market-based rationality.

This rationality suggests that corporations are entirely subordinate to competitive market forces and do not have the power to shape states and markets. However, corporations operate within imperfect markets and wield the power to create, promote, and keep the market rationality in existence. The imperfect market structure provides leeway for corporations to seek rents in the political realm instead of seeking profits in competitive markets. In this way, corporations do not merely act as economic actors, but are significant political and societal actors too. This notion has profound implications for the nexus between states and markets.

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CHAPTER 3. CASE STUDY 1: POWER DISTRIBUTIONS IN THE GLOBAL DAIRY SECTOR

3.1 Introduction

In order to conduct any case study on one country, the power dynamics of the sector have to be researched. Therefore, the aim of this chapter is to examine the sectoral power relations on the global level. However, before doing this, it is necessary to obtain a more comprehensive understanding of dairy trade in a global context. In this regard, two sub questions are investigated in this chapter. The first question is the following: "Who are the principle actors in the dairy sector?" For the purpose of this thesis, the answer focuses on the principle actors in terms of exports. Furthermore, with reference to the trade theories, this chapter aims to answer the following question: "How can global dairy trade be understood?"

3.2 Trade in dairy products on the inter-state level

In 2009, the total amount of produced dairy in the world was 696.55 million tonnes of milk equivalent. That year, the most significant states in terms of production were India, the United States (US), China, Pakistan, and Russia. These top five accounted for more than 43% of the total world production altogether. Furthermore, the European Union (EU) member states produced more than 153.00 million tonnes of milk equivalent, which is more than 21% of the world’s total. Within the EU, Germany, France, the United Kingdom (UK), Poland, and the Netherlands are prominent dairy producing countries, representing 13% of the world’s production altogether. Overall, these numbers indicate that dairy farming takes place in both developed and developing countries. Although a temperate climate zone is generally perceived to be more appropriate for production, dairy farming is a relatively geographically dispersed phenomenon (FAO, 2010).

India and the US were the leading dairy producing states in 2009. However, most of the production and distribution of dairy was historically confined to local markets. States predominantly acted to protect the local food supply, including the dairy sector, and hence discouraged inter-state trade through the provision of extensive regulations. In this regard, India is a notable example. The Indian population is growing enormously and, therefore, so is the demand for food.

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However, the Indian government introduced the “National Dairy Plan” (NDP) in order to help local farmers to increase production, and it eventually proved to be successful. The policy has the purpose of stimulating local supply, and is relatively little focused on global trade. With the NDP, India has managed to increase its production and to feed its own population (IUF, 2011).

Figure 1: World dairy exports in quantity, between 1965 and 2010

The trade statistics in Figure 1 demonstrate that approximately 30 million tonnes of milk equivalent were exported in 2009. This means that around 96% of world production is consumed in domestic markets, a finding that corresponds to earlier studies (Pritchard, 2001; OECD, 2004). Altogether these statistics confirm the statement that dairy production is mainly purposed for domestic consumption. This can be explained by two leading factors.

* Export quantity in million tonnes of milk equivalent

Note: trade figures refer to milk equivalent in trade in the following products: butter, casein, cheese, cream, ghee, milk, whey, and yoghurt related products (see appendix 7.1)

Source: FAO crops and livestock products statistics 2013a, constructed by the author.

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Firstly, political factors and the inherent protection of domestic agriculture partially explain the relatively low proportion of exports. It was not only dairy farmers who sought stability by joining co-operatives; political representatives also wanted to provide a reasonable income for those farmers. The rationale was that stabilizing the agricultural market would strengthen national food security, which in preceding periods of war was an important concern. In addition, agriculture was a substantial component of the domestic economy for most nation-states, and the farmers altogether represented a vast potential for political support. As a result of these political factors, since at least the 50s of the last century, the dairy sector is predominantly driven by policy rather than market forces. Most states worldwide substantially intervene in agricultural markets through the provision of export subsidies, price support systems, import tariffs, or other forms of quotas (Mulder, 2016).

A second crucial factor to explain the low proportion of exports is that dairy is a perishable commodity. Therefore, the boundaries for trade are limited. In general, fresh dairy products such as milk and yogurt are consumed in a local or regional context. In the EU, for example, trade within the internal market is mainly the exchange of fresh products, whereas trade outside of the EU includes products that can be stored longer, such as butter, cheese, condensed milk, casein, and skimmed milk powder. These latter products are more appropriate for exports, and as a result can be purchased all over the world. Particularly skimmed milk powders can be stored easily, which makes this product highly suitable to sell on global markets (Buck & Kloosterboer, 2016).

The export in dairy products rose significantly in the preceding decades. As can be seen in Figure 1, the total amount of exports was 3.29 million tonnes of milk equivalent in 1965, and this rose to 29.20 million tonnes of milk equivalent in 2010. Within a period of 45 years, the total amount of exports increased almost ninefold. This trend is rooted in a process of changing features of supply and demand, and is driven by multiple factors, including changing agricultural practices and higher yields per cow, more liberalized trading conditions, corporate consolidations, and increasing global demand. For instance, there has been a fundamental change in dairy

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farming. These changing agricultural practices have typically resulted in larger herd sizes per farm and higher yields per cow. Whereas dairy farming was traditionally a small-scale family business, it evolved into more large-scale and technologically based farming. The average herd size of dairy farmers has increased substantially, and higher yields per cow are associated with improved animal nutrition, technological innovations in farming and processing, and improved farm management (Dobson et al. 2007).

Using the US as an example, and comparing the statistics between 1970 and 2006, it can be observed that the total amount of cows in the US fell from 12 million to 9.1 million during this period. Nevertheless, the average herd size increased from 19 cows to 120 cows and the yield per cow in pounds per year rose from 9,751 to 19,951. As a result, the average production increased twelvefold per farm (USDA, 2007).

Furthermore, there has also been a significant change in demand. The demand for dairy has increased due to the previously mentioned globally occurring phenomena: a growing world population, urbanization, and growing prosperity. Urbanization is often associated with higher levels of consumption of dairy products. This is probably due to the fact that people in urban areas do not have to rely on dairy supply in rural communities. Instead people in urban areas buy dairy products in stores and have a refrigerator where they can store milk for a longer period of time. This is supplemented with growing prosperity. When people have higher levels of income, they typically consume more animal products (Vrij, 2016).

These trends are mainly observed in developing countries. In the 21st century, Asia, and in particular China, is experiencing a tremendous growth in population, and hence in the demand for dairy. This growth is not only occurring in Asia; Africa is also gradually beginning a growth spurt, and it is expected that within 10 years it will represent a major demanding market for dairy products as well. Hence, the growth prospect for the dairy industry is mainly in Asia, North Africa, and South America (ibid.).

As illustrated in Figure 2, the most significant importing countries in the Asian market are China, Indonesia, Russia, and Saudi Arabia. In the North African market,

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Algeria and Egypt are major importers, and in North America Mexico is the biggest importer of dairy products. The major exporting states are Argentina, Australia, the EU member states, New Zealand, and the US.

Figure 2: Major dairy exporters and importers

Source: (FAO, 2013b:56).

The detailed trade matrix of the FAO (2013a) indicates that most of the significant exporters are EU member states. The top three exporting countries are Germany, France, and the Netherlands. For these exporting states, most of the production and distribution occurs in local and regional markets. For the Netherlands, for example, 35% of the dairy production is consumed in the domestic market, 45% is traded within the EU, and 20% is exported outside of the EU. Most Dutch dairy exports go to other giant producing states: Germany, Belgium, and France (NZO, 2016).

This suggests that there is intra-industry trade, and the interregional trade in the European internal market explains the dominant position of the European member states in Figure 3. Furthermore, the dietary habits and relatively high levels of income could also partially explain this trend. Most European inhabitants consume cheese, milk, or yogurt on a daily basis. In comparison, in Japan, a country with similar levels of income, less consumption is observed because of differences in dietary preferences (Pritchard, 2001).

However, although the European market is an important market in terms of production, consumption, and trade, the prospects of growth are diminishing due to

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demographical factors. The European population is aging, and younger people typically consume more dairy products than older people do. Moreover, the population growth is stagnating, and consequently so too is the demand for dairy products (Vrij, 2016).

Figure 3: Top 10 dairy exporting countries in 2010

New Zealand is the fourth greatest exporter. If the interregional trade in Europe is excluded, then New Zealand even becomes the largest exporter of dairy products in the world. In terms of production, however, New Zealand is a relatively small player and accounts for a mere 2% of worldwide production (FAO, 2010). Yet, unlike the other significant producing states, roughly 95% of its production was purposed for export. Thus, whereas most states tend to be inward-oriented, it is evident that New Zealand is outward-oriented (IUF, 2011).

The US is the sixth largest exporting state, and its production represents more than 10% of the world’s total. Similarly to Europe, the consumption per capita is

0.76 0.81 0.88 1.14 1.25 1.85 2.25 2.27 3.01 5.49 0 1 2 3 4 5 6 Denmark Poland The United Kingdom Austria The United States Belgium New Zealand The Netherlands France Germany Export quantity*

* Export quantity in million tonnes of milk equivalent

Note: trade figures refer to milk equivalent in trade in the following products: butter, casein, cheese, cream, ghee, milk, whey, and yoghurt related products (see appendix 7.1)