Regulatory Approval Decisions in the Presence of Market Externalities: The Case of Genetically Modified Wheat

By Furtan, W. H.; Gray, R. S. et al. | Journal of Agricultural and Resource Economics, April 2005 | Go to article overview

Regulatory Approval Decisions in the Presence of Market Externalities: The Case of Genetically Modified Wheat


Furtan, W. H., Gray, R. S., Holzman, J. J., Journal of Agricultural and Resource Economics


This study examines the optimal approval strategy for genetically modified (GM) wheat varieties in Canada and the United States. Without an affordable segregation system, the introduction of GM wheat will create a market for "lemons" that will result in the loss of important export markets. Using a differentiated product trade model for spring wheat, with endogenous technology pricing, a payoff matrix is generated for the possible approval outcomes. Results show that the existence of the market externality removes the first-mover advantage for wheat producers from the approval of the new GM wheat variety. There are large distributional effects; wheat producers lose economic surplus, while consumers and the biotech company gain economic surplus. With a larger domestic market, the United States is more likely to experience net gain in economic surplus from the introduction of GM wheat.

Key words: biotechnology, market externalities, non-cooperative games, strategic approval decisions, trade

Introduction

Important strategic relationships exist between research and development (R&D) expenditures, new product approval decisions, and the gains from international trade. Edwards and Freebairn (1984) demonstrate a positive relationship between the development of cost-reducing technologies and the welfare of domestic firms that compete in the international market. Furthermore, Spencer and Brander (1983) show domestic firms achieve a first-mover advantage from the approval of a cost-reducing technology. In this paper, we extend the strategic framework to a social welfare analysis, which includes consumers, domestic firms, and the profits of the innovators. Using the case of genetically modified (GM) wheat, this analysis shows that negative asymmetric information externalities can eliminate the first-mover advantage for domestic firms (i.e., farmers).

The case of GM wheat has relevance to policy makers. As of March 2004, both the U.S. and Canadian governments have been faced with the decision of whether to approve a GM spring wheat variety which is tolerant to the low-cost herbicide Roundup®.1 According to the Canadian Wheat Board (CWB), GM wheat is viewed as an inferior product by many wheat-importing countries. Moreover, it is difficult and costly to segregate GM wheat from non-GM wheat because they are not visually distinguishable from each other. Due to this lack of ability to segregate the two types of wheat, the market place is unable to distinguish adopters of GM technology from non-adopters. Given these conditions, the introduction of GM wheat will result in "a market for lemons," as described by Akerlof (1970), where all wheat exports from the GM adopting country are assumed to be inferior in countries where GM wheat is viewed as inferior to other bread wheat varieties.2 This information externality will change trade flows, price levels, and the welfare impacts of innovation.

The welfare impacts of the introduction of GM wheat are estimated using a partial equilibrium trade model with a vertical structure where the technology provider uses its monopoly to maximize profits, and the wheat producers are assumed to be competitive with a differential willingness to pay for the technology. The Canadian and U.S. governments are assumed to act strategically to maximize domestic welfare. We calculate the optimal approval decisions for GM wheat in the United States and Canada using a non-cooperative game.

There are two important empirical results reported in this paper. First, without an affordable segregation system, the findings reveal there is no first-mover advantage for wheat producers in either country from the approval of a GM variety because of the "lemons" problem and the loss of export markets. Second, the optimal approval strategy for a new crop, and the outcome for the bilateral game, are dependent on the welfare function of the government regulators. The results show that wheat producers in both countries are made worse off, while the biotech firm and consumers are made better off from the approval of GM wheat. …

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