Value-added Forestry

Timber and other forest land resources enter into value-added calculations at the point at which they are consumed (point of purchase) – either as an end product, or as an input to an intermediate process producing an end product in another sector. A resource may flow through a number of processes as an intermediate input before being purchased as an end product (or part of one). A tree, for instance, may initially be sold as a sawlog to a sawmill, then as sawnwood to a furniture manufacturer and then to consumers at the retail level. Mushrooms, game meat and fence posts, however, may be consumed by the same user by which they are acquired.

When a tree is converted into a log, it has value-added to it . Monies from the sale of the log are distributed to those ‘factors of production" contributing to its production. The value-added component of those payments consists only of:

labour’s wages

capital investors and suppliers interest payments

entrepreneurs profits ("normal profit" + unearned economic rents)

Payments for the purchase of raw materials or supplies, or principal payments, or depreciation are not included in value-added for the activity under consideration. The contribution of such items to value-added is calculated within other activities or sectors from which they are sold as end products.

Stumpage constitutes the economic rents earned by the state from the production of forest stands. It is a payment to the owners of the "forest capital" and, as such, is a legitimate contribution to value-added. Therefore, stumpage must be deducted from the logger’s own contribution to value-added to avoid double counting.

To calculate value-added for successive activities –from harvesting to subsequent downstream processing - similar deductions must be made. A sawmill consuming sawlogs can not be credited with the value-added of producing the log itself. As demonstrated, the logs’ value-added was already calculated at its point of purchase.

To calculate the total value-added derived from timber resources, the above approach is applied for each activity or product of which they are a part until their purchase by consumers as an end-product (or by an other sector as an intermediate product or input).

Value-added can be affected by any factor that impedes (directly or indirectly) maximising productivity or efficiency or the equitable distribution of economic rents. This introduces a potentially wide scope of issues to the ROL/FAO project’s optimisation goals. In respect of reorganising the structure and function of the state’s forestry authorities, priority areas directly subject to review include:

Resource valuation (appraisal methodology)

Resource information management systems

Inventory (sampling plots and strategies, field measurements, growth & yield modelling and research)

Silviculture (species selection, planting spacing, thinning)

Harvesting (rotation age, volume recovery, removal strategy)

Tenure (stumpage, allowable costs, profit margins, risk allowances)

Processing (unprocessed log exports, lumber recovery, residue markets, product and market development, capital efficiency )

Governance (laws, regulations, practices, procedures, enforcement, sanctions).

Each of the above can affect the quality of decisions made to optimise forest sector productivity and efficiency.

Less directly, any issue related to institutional structure, management, administration, budgeting, and legislation can weigh on aspects of the sector’s efficient operation and potential value-added.

It is one thing to fell a log, put it on a truck, deliver it to a port and sell it into export markets. It is quite another to take that same log and turn it into secondary and further processed products for sale in both domestic and export markets.

Latvia’s log exports in 1997 totalled 2,124 m³ and a further 1,240 m³ of fuelwood and chips. These volumes represent about 36% of the AAC for that year. The consequence of not further domestically processing some or all of such large volumes of roundwood may constitute a significant loss to Latvia – including foregone value-added.

Log exports do generate value-added – from all of the activities involved in producing a log of export quality and then handling and transport to the point of delivery. Thereafter, the foreign buyer continues the process of value-adding through its own processing and selling activities – all of which, of course, accrue to national accounts outside of Latvia.

It has been argued – popularly and theoretically – that log exports constitutes "exporting jobs, incomes and value-added". Foregone value-added losses are calculated as:

In cases where secondary processing facilities exist, it is not difficult to calculate this figure.

Latvia has limited efficient production capacity and questionable domestic demand. The potential volume recovery and grade quality of Latvia’s timber resources from domestic processing is yet to be fully established. Potential labour and capital productivity, end product standards and selling prices have a direct bearing upon VA calculations – and are all currently very difficult to ascertain for Latvia. In summation, it is far from a trivial exercise to estimate net foregone VA resulting from Latvian log exports.

Many factors determine whether further secondary or downstream manufacturing actually increases VA beyond levels realised through log exports. These include:

absolute volume of timber supply (too little volume may prohibit economies of scale at whatever level)

relative value of timber supply (e.g. pulp logs vs. peeler logs)

physical and economic accessibility of timber supply (absence of roads and other infrastructure and low volumes/hectare affects both)

type and cost of technology (determines utilisation and productivity rates, and cost/unit – all of which impact upon competitiveness and profitability)

end product type, quality, and selling prices (affect gross revenues and therefore the potential investment and recurrent costs that could be supported)

competitive and geographic proximity to markets (e.g. fortunately, Latvia is widely recognised as one of the key "gateways" – from west to east, and from east to west – within its geographic area).

It is obvious that an enormous amount of data would ordinarily be required to accurately, or even roughly, calculate the magnitude and distribution of a given sector’s economic contributions. Statistical data processing, documentation and distribution in Latvia is well advance. However, data collection problems persist and the completeness and representativeness of statistics in many areas is acknowledged to reflect this. This has hampered the project’s ability to provide an accurate "snapshot" of the sector. In that respect, the project has made considerable use of professional judgement and local experience available to it.

The figures and discussions below are based partly upon a model developed for this purpose by the project. However, they are based mostly on a reconciliation of customs volume and sales data, LSFS timber flow estimates, published prices and Latvijas Statistics data. The analysis aims to provide estimates of Latvia’s forest sector contributions to value-added and government tax revenues. It is simplistic in its design and relies heavily upon coarse estimates of a number of parameters and the relationships between them. This approach does, however, permit analysis and estimates, which would otherwise have remained unexplored.

Timber flow estimates within the forest sector for 1997 (from forest stand to final domestic or export sales) provide the point of commencement of the processes modelled. These were produced by forest service statistics personnel and reflect the best professional judgement and local experience in Latvia that could have been applied to this task. The analysis can be further calibrated to incorporate greater detail and provide greater precision as data sources improve.

To facilitate comparisons, value-added and taxation estimates are presented on an LVL/m³ basis. An annual harvest rate of 10,000,000 m³/annum is used for this purpose.

The project team made vigorous attempts to minimise or avoid unrealistic estimates. However, the analyses’ representativeness is qualified by very limited accurate production cost data – which therefore necessitated using estimates. Another sever restriction relates to the productivity and conversion or recovery rates of specific industry processes.

Value-added estimates

This project has used an income approach to calculating value-added, as opposed to the output or the expenditure methodologies – though all three are meant to provide the same measure.

An initial estimate of the forest sector’s wage bill can be estimated by applying an annual average income for sector workers to the total number of workers in the sector. The averages used here are LVL 1200/annum (cf. Table 4.1.1) for incomes and 50,000 (cf. Table 4.3.1) for number of employees. This provides an estimate of LVL 60,000,000 for annual wage incomes. This translates into LVL 6/m³.

The capital structure of the forest sector is poorly recorded in any statistics and difficult to estimate. Estimates for the interest payments component of VA were taken as a percentage of all non-income costs.

The analysis provides an estimate of LVL 9,580,000 as the total interest payments for the sector. This represents LVL .96/m^3.

For the current state of the fixed capital in the sector, the above estimate may be realistic. If this is the case, however, the estimate does indicate a very low level of capitalisation. Predictably, as the sector develops, the contribution to VA from interest payments will very significantly increase.

Current markets are not the strongest that Latvia has experienced in recent months. However, recent, published prices for higher grade sawlogs range from LVL 60/m³ to LVL 105/m³. Domestic selling prices usually exceed LVL 20/m³ for the lowest grade logs. Listed selling prices for pulpwood range between LVL 17/m³ and LVL 24/m³. Credible (if not actually low) estimates for average selling prices range between LVL 32/m³ to LVL 35/m³.

It should be kept in mind that these profit levels are derived totally from an estimation procedure that may not be substantiated by empirical data. However, they are not unrealistic for Latvia’s current circumstances and may in fact actually understate profit levels of certain operations. Further estimates for VA presented below use a 17% profit level based entirely on anecdotal observations made during the project.

Profits are not themselves a measure of value-added – though in some circumstances they afford a good indication of its order of magnitude. This is especially the case where entrepreneurs face low labour and capital input costs – and profits accrue principally to the entrepreneurs account. This is assumed to be the case for many of Latvia’s producers. This analysis continues with a treatment of the questions of value-added levels by frequent reference to profit levels.

Customs statistics for total volumes and total values for 1997 for log exports of roundwood and fuelwood can be used to calculate average selling prices of LVL 32.74/m³ and LVL 34.20/m³, respectively. The volume figure for these exports in 1997 was almost 3 million metres cubed. Because of the credibility of customs export statistics, at least for these figures the average selling prices are not in dispute.

Given the prevailing operating cost structure for Latvia it is credible that profit levels – to the point of sale of logs alone – of at least LVL 8/m³ to LVL 15/m³ are achievable from log extraction and sales – and should be almost routine for forest owners. Applying the above rationale to at least the 3,000,000 m³ of roundwood sold into export markets – and for which the data is known to be credible – yields contributions of from LVL 24,000,000 to LVL 45,000,000 for 1997.

A similar examination for the sawmilling sector gives equally interesting results.

Customs statistics for sales volumes and prices for 1997 for sawnwood provide an actual average selling price of LVL 129.89/m³. Sales for 1997 reached about 2.7 million cubic metres.

Again, given the cost structure of operating in Latvia, it is likely that for the sawnwood volumes – almost 4/5^ths of which is sold into export markets at the average prices presented above – actual profits per cubic metre of output material input is much higher. However, applying a 17% profit level to export sawnwood yields an LVL 22.08/m³ profit for producers.

Applied to the exported volumes only, the total contribution to domestic value-added from sawmilling profits then reaches LVL 59,619,510. The project derived a sawnwood recovery factor of .47 for the sawmilling sector as a whole. Applying this gives a profit of LVL 10.38/m³ per cubic metre of input raw material.

Customs statistics for other products, representing a relatively small part of total sale volumes, nevertheless, demonstrate significantly higher unit (/m³) selling prices. This is true for "deeper" manufactured products such as particleboard, chipboard, fibreboard, and plywood and veneer. The combined export sales of the above reached LVL 76,767,000 in 1997.

Again using a 17% figure, the profit for these activities becomes LVL 13,050,390 for 1997. This study estimates that, on a weighted output basis (by product by selling price) profit levels of LVL 61.94/m³ per cubic metre of sold product may have been realised for 1997.

Estimates for the forest sector as a whole are relatively less sensitive to these last estimates because of the small part these activities play there. Their total volume reached only 226,700 m³ in 1997. It is very problematic to calculate specific raw material recovery rates for the number of "engineered" wood products included in these last calculations – especially in circumstances of evolving technology, prices, etc. However, a rough estimate of profit per cubic metre of input raw material would be LVL 20.44.

Total profits to the sector, base upon estimates for 1997, can then be summarises as follows:

In summary, value-added contributions for the Latvian forest sector for 1997 are estimated as:

wages to labour LVL  60,000,000 or LVL 6.00/m³

interest payments LVL   9,580,000 or LVL .96/m³

entrepreneurs return LVL 160,386,570 or LVL160.39/m³

for a total of LVL 229,966,570.

In inefficient markets, economic rents that otherwise accrue to the owners of forest resources are often "captured" by others. Owners with less perfect market information experience lower selling prices – including the possibility of foregone stumpage in the case of public forests. Intermediaries, sometimes providing the full range of development activities to the point of product deliveries, may actually be the dominant players in a sector – as well realising rent capture.

In transitional countries such as Latvia, where economic or political risk may be higher than in more mature markets, profits are also justifiably higher. Where this persists during the evolution to more stable political-economic systems, rent capture results in above "normal" profits.

One quick way for assessing the scope for rent capture is to calculate the difference between existing profit levels and normal profit levels. Though that figure need not necessarily totally represent economic rent, it does serve as a proxy or yardstick as to where its order of magnitude may lie. For example if, in fact, Latvia’s circumstances dictate a normal profit level of 17% (as used in examples above) and profits of 25% are actually being realised, then entrepreneurs may be able to capture a large part of the LVL 75,476,030 difference, ( LVL 235,862,600 – LVL 160,386,570) as economic rents.

Taxation estimates

The estimates presented below are based upon employment income (income taxes, and social security taxes) and corporate income (corporate taxes) and on estimates of non-sector production costs (value-added taxes) used during modelling procedures.

Applying a rate of 25%, to the total incomes presented in section 5.4.1.1 above, annual state revenues from forest sector personal income taxes would be LVL 15,000,000.

Based upon estimates for 1997, state revenues from forest sector corporate income taxes would range upwards from LVL 57,491,650 if they were, in fact, collected.

Estimating value-added taxes is the least precise of the estimates that could be generated by this study. No estimates will be provided until industry participants through this study make production processes and cost data available.

The estimate for these taxes is derived from applying the appropriate tax rate (37%) to the estimates of the industry wage costs. This produces a figure, for total social-security tax payments, of LVL 22,200,000 for 1997.