ICES Journal of Marine Science: Journal du Conseil Advance Access originally published online on March 19, 2007
ICES Journal of Marine Science: Journal du Conseil 2007 64(3):439-445; doi:10.1093/icesjms/fsm019
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Potential rent and overcapacity in the Swedish Baltic Sea trawl fishery for cod (Gadus morhua)
1 Department of Economics, Göteborg University, PO Box 640, SE 405 30, Göteborg, Sweden
2 University of Stavanger, N-4036 Stavanger, Norway
Correspondence to H. Eggert: tel: +46 31 7734175; fax: +46 31 7731326; e-mail: hakan.eggert{at}economics.gu.se
Eggert, H. and Tveterås, R. 2007. Potential rent and overcapacity in the Swedish Baltic Sea trawl fishery for cod (Gadus morhua). – ICES Journal of Marine Science, 64: 439–445.Many European Union (EU) fisheries have problems with depleted stocks and fleet overcapacity following the regulation of open-access regimes. Some EU countries have introduced individual vessel quotas (IVQs), which can stop "the race to catch" and provide fishers with incentives to minimize costs for a given catch. We model an IVQ fishery using a cost function approach and apply the methodology to the Swedish cod fishery in the Baltic Sea. Estimating a translog cost function for a data set of Swedish trawlers in 2001, we assess the potential gains from structural adjustment of the fleet. Results suggest a desired fleet reduction of 50–60% and a potential resource rent amounting to 25–30% of the landing value.
Keywords: cost function, efficiency gains, individual vessel quotas, Swedish fisheries
Received 21 August 2006; accepted 18 December 2006; advance access publication 19 March 2007.
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Introduction |
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 Top Introduction The Baltic Sea cod...MethodologyResultsDiscussion and conclusionsReferences |
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Global marine capture fishery production has been declining since 1988 as, excluding the Peruvian anchoveta and adjusting for Chinese misreporting (Watson and Pauly, 2001), several valued commercial stocks have become severely depleted. During the same period, technical improvements increased the fishing power of most vessels. This contributed to the overcapacity, which is still a major problem afflicting marine fisheries (Kirkley and Squires, 1999). The fundamental underlying reason for these problems is the lack of well-defined property rights for marine fisheries (Gordon, 1954; Ostrom, 1990), in which a sole owner, as depicted by Scott (1955), would allocate optimal levels of labour, vessels, and stock for production. Even in an ideal state, there may be overcapacity, for instance, through misperceptions on feedback (Moxnes, 1998), from a marine ecosystem perspective where the fish catch is only a part of the total value (Eggert, 1998; Berman and Sumaila, 2006) or if private discount rates deviate from social discount rates (Clark, 1973; Dasgupta and Heal, 1979).
Many EU fisheries have problems with fleet overcapacity (Pascoe et al., 2001) and depleted stocks following regulation of open access regimes. Homans and Wilen (1997) demonstrated that most of the world's important fisheries do not operate under pure open access, as depicted by Gordon (1954), and introduced the term regulated open access, which implies gear restrictions, area closures, and restrictions on season length. Among economists, individual transferable quotas (ITQs) are generally seen as likely the best approach to handle such problems (Wilen, 2000). However, ITQs have met with considerable resistance since their introduction in, for example, the USA and Iceland (Matthiasson, 1997; Matulich and Sever, 1999). Countries in the European Union (EU), other than the Netherlands, have been generally reluctant to introduce the concept of ITQs.
A compromise is, however, the use of non-transferable individual vessel quotas (IVQs), with which each fisher in a fishery has the right to catch a share of the total allowable catch (TAC), but cannot buy or sell these shares. IVQs in various forms are now used inter alia in Norway, Sweden, Denmark, and the UK for certain species. The design of IVQ systems may vary, but for empirical application, we use data from the Swedish Baltic Sea trawler fleet, to which the Swedish authority grants an annual catch quota of cod (Gadus morhua) to the vessel licence-holder (in almost all cases the skipper), which is pre-allocated as weekly quotas depending on vessel size. The main contribution of IVQs is that the traditional incentive "to race for catch" is altered and fishers instead focus on minimizing their costs for a given catch. An IVQ system does not imply capacity adjustment, which in the long term is necessary to handle the general problem of overcapacity. In a successful ITQ system, voluntary trade occurs as long as the valuation of the marginal quota differs between fishers. The long-term effect from such trade is that some fishers exit the fishery, leading to capacity reduction, whereas the remaining fishers buy catch quotas until they utilize their capacity optimally (see ch. 8 in Clark, 1990).
In traditionally managed fisheries with regulated or unregulated open-access conditions, each fisher can select the size of his/her landings by increasing (decreasing) his/her input by, for instance, changing such vessel characteristics as engine power. In principle, the same applies for an efficiently functioning ITQ fishery, in which the only additional feature is that the fisher would have to buy (sell) ITQ shares. The important difference, though, is that in a traditionally managed fishery, a fisher disregards the social cost imposed on others when racing for the catch, whereas the same fisher is forced to take this cost into account, because each unit caught must have a quota with its corresponding opportunity cost. The modelling implication of open access and ITQ regimes is to use a profit function approach (Squires, 1987a, b) or a restricted profit function for input restrictions (Dupont, 1990, 1991). (For an overview of applications of dual theory in fisheries, see Jensen, 2002.) Selecting the output level is not an option for a fisher in an IVQ fishery, because his/her annual catch is a given and cannot be changed. If many fishers operate in such a fishery, a single fisher has no impact on the price paid and the revenues are, in principle, given exogenously. Fishers then focus on the cost in an IVQ regime and, given that they are profit maximizers, we would expect them to minimize costs. Hence, we assume that fishers can select input levels (endogenous variables such as labour and capital), but face up to given input prices and output levels (exogenous variables). The appropriate modelling approach for an IVQ fishery is then a cost function (Christensen and Greene, 1976; Bjørndal and Gordon, 2000; Asche et al., 2003).1
Here, we use a cost function approach to model the production technology of an IVQ-regulated fishery to study economies of scale, i.e. how average cost varies with output level, and the minimum average landing cost for vessels in such a fishery. If there are increasing economies of scale, then a given percentage increase in the scale of a vessel (i.e. input use) leads to a greater percentage increase in output, and consequently to a decline in average cost per unit of harvested fish. If one finds increasing economies of scale and that some vessels operate at a suboptimal scale compared with others that are scale-efficient, one can calculate the gains from replacing suboptimal vessels with scale-efficient vessels. We assess the potential gains if high-cost-of-landing vessels are replaced and all landings are carried out at the minimum average landing cost. We apply the methodology to the Swedish cod fishery in the Baltic Sea and estimate a translog cost function for a data set of Swedish trawlers operating in 2001. The resulting estimates are then used to determine economies of scale in that fishery.
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The Baltic Sea cod fishery |
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Biologists usually refer to two cod stocks in the Baltic Sea, one west and one east of Bornholm Island. During the highly productive years for cod, 1978–1986, the stock was completely dominated by the eastern stock. For simplicity, we refer to the two stocks as one throughout this paper. The exploitation of Baltic Sea cod led for many years to a high-yield fishery, and from 1980 to 1985, annual landings exceeded 300 000 t, then >10% of global landings of cod. Subsequently, very high levels of fishing mortality resulted in the stock declining drastically, and since 1997, landings have been <100 000 t (Figures 1 and 2).
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Today, the spawning-stock biomass (SSB) is judged to be less than safe biological limits, and a 4-month moratorium was imposed during 2003 in an attempt to recover the stock. According to the ICES Baltic Fisheries Assessment Working Group, however, the stock is currently at historically low levels and there is no indication of an increase in SSB. On the basis of estimates of SSB and fishing mortality, ICES classifies the stock as suffering reduced reproductive capacity, and currently being harvested unsustainably (ICES, 2006). The Baltic Sea fisheries were managed by the International Baltic Sea Fishery Commission (IBSFC) during the period 1973–2003. The IBSFC started to set TACs for the cod fishery in 1974, but owing to disagreement on jurisdiction of the Baltic Sea, no functioning TAC was applied during the period 1982–1988. Since 2004, the fishery has been in the domain of the EU.
The cod fishery has been subject to various measures and, in the early 1990s, when SSB was first estimated to be below safe biological limits (Bpa), i.e. 240 000 t, a temporary moratorium was imposed. The Swedish cod fishery in the Baltic Sea is carried out with fixed gear, mainly gillnets, and with mobile gear, mostly trawls. Landings with fixed gears amount to roughly 70% of the total Swedish catch, and the other 30% is caught with mobile gear. In 1995, a regulation was introduced for the Swedish cod fishery in the Baltic Sea, which resembles an IVQ system. Each vessel is granted a weekly quantity of cod related to its size and capacity. This system has been in place ever since, but the authorities have both increased and reduced the original weekly catch quotas during the period 1995–2003. These weekly quotas for Swedish vessels during 2001 allowed catches of 6.4 t for vessels <9 m long, 9.6 t for vessels >9 m but <21 grt, 12.8 t for vessels in the range 21–40 grt, and rising gradually for vessel size classes up to 161 grt. Vessels >161 grt were allowed to catch a maximum of 32.0 t of gutted cod.
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Methodology |
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Modelling the structure of production in an IVQ fishery
Neoclassical production theory in economics offers a useful approach to studying production and cost relationships. A fundamental result is that, given certain regularity conditions, such as continuity, concavity, finiteness, etc., the specification of a production function implies a particular cost function, and vice versa (Diewert, 1971). Hence, an empirical study of production can use either a production function or a cost function, and the choice between the two should be made on statistical empirical grounds. If output is endogenous, a production function is preferred, whereas a cost function is more attractive when the level of output is exogenous (Christensen and Greene, 1976; Jensen, 2002).
We assume that firms are profit maximizers and, for an open-access fishery, we can model the relationship between production and cost with a profit function 
(p, w) = Max{py – wx}, where the firms are assumed to be price-takers in input and output markets. The firm will then simultaneously determine its demand for inputs, x, and its supply of outputs, y, based on perceived input and output prices denoted by w and p, respectively. The same modelling approach would apply to an ITQ fishery, with the quota as an additional input and its rental price as the input price. However, an IVQ fishery implies that each firm operates under an output regulation, so that an individual firm lacks influence on both output price and quantity. Instead, a profit-maximizing firm will minimize the cost function C(w, y) = Min{wx; y}. Such firms will base their input demand, x, on the input prices, w, for the given output level, y. Hence, a profit-maximizing fisher will try to combine the inputs (labour, capital and fuel) in a manner that allows them to land their given amount of fish at a minimum cost. (Here, fuel also includes other consumable supplies such as ice.)
Our objective is to estimate the minimum of this cost function, and we have selected the translog cost function, which places no a priori restriction on substitution possibilities among inputs and allows scale economies to vary with the level of output. In our case, the translog is specified as follows:
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i and ij the coefficients to be estimated, and u a random error assumed to be normally distributed. By differentiating Equation (1) with respect to the input prices, and using Shephard's lemma, the set of cost-minimizing factor cost shares can be derived, given by
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From the cost function can be derived the returns to scale, which are defined as 
y = 1/(
ln C/ln y). The conditional own price elasticity of demand for input i is defined as i = (ii + Si2 – Si)/Si (Binswanger, 1974). The marginal cost function of the translog model is
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Data and variable construction
The Swedish National Board of Fisheries collected the data used in this study. The logbook database identifies vessel, including vessel characteristics, fishing effort, gear type, and landing date on a per trip basis. Economic data come from a sample of vessels' tax reports for the year 2001, which include gross revenues, expenditure data on fuel, maintenance, insurance, labour costs, crew size, ice, and product fees. The merged data set from these two data sets provides information on annual fishing effort, gross revenues, and total costs. As we use aggregate observations for a single year, we assume that all fishers face the same situation in terms of stock abundance, i.e. the state of the cod stock in 2001. The total sample of observations was 37 vessels, but because some necessary information was missing, the final analysis was carried out on 30 observations of Swedish trawlers catching cod in the Baltic Sea2. The 30 observations and the original 37 are almost identical in means, and null hypotheses of equality could not be rejected for relevant variables such as capital, crew, revenues, and costs at the 5% level of significance. The descriptive statistics for the sample vessels are listed in Table 1.
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Total costs are divided into three components: capital costs, fuel and other operating costs, and labour costs. The price of capital (w1) is defined as the capital cost divided by total capital, where total capital is measured by the insurance value. Capital cost is defined as the sum of depreciation costs and opportunity cost. Several vessels in the sample are old, and there is a tendency among fishers to invest surpluses from successful years in equipment, e.g. reducing mortgages on the vessel. The result is that the depreciation and interest costs reported to the tax authorities are small. Hence, the average fisher in our sample may perceive capital costs as very small because of low mortgage loans and depreciation, but from a social perspective, the use of these values would lead to downward-biased estimates of the capital cost. We therefore add a social user cost of capital, changing the average price of capital to 15% of the total capital, which corresponds to an interest rate 2% more than the inter-bank market rate, and a depreciation of 8%, in line with other studies such as those of Asche et al. (2003) and Squires (1987a). In the analysis, we also carry out sensitivity analysis for lower capital costs. The composite price of fuel and other inputs (w2) is calculated using monthly prices of fuel derived from the International Energy Agency for 2001 and monthly prices on materials and services from Statistics Sweden. We calculate the average annual fuel price for each vessel as a Divisia index, using the number of trips per month as weighting for the monthly prices of fuel, material, and services. The price of labour (w3) is defined as recorded labour costs divided by crew size. Output (y) is measured by harvest in kilogrammes.
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Results |
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In Table 2, we report the descriptive statistics for the sample variables used in the estimation, and the estimated parameters are given in Table 3. The r2 statistic for the cost function was 0.989, and for the two share equations, capital and fuel costs were 0.843 and 0.968, respectively, indicating good fit to the data. The desired flexibility of a translog function leads to individual parameters that are difficult to interpret, so instead we focus on the elasticities derived from the parameters, which provide a more meaningful economic interpretation of the results.
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The own price elasticities, which are significant at the 1% level, are listed in Table 4. All elasticities have the expected negative sign and we see, for instance, that
capital = –0.67. All else being equal, this indicates that a 1% increase in capital costs will lead to a capital reduction of 0.67%. Returns to scale are derived at the mean prices and output level and are 1.43. This indicates that the average vessel operates at a downward-sloping average cost curve, i.e. an increase of total output by 1.43% would raise the total cost by just 1%. Hence, if these vessels were not restricted by quota, we would expect them to increase their output, but in the current situation, there are substantial economies of scale.
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Figure 3 shows the estimated marginal and average cost curves. The cost-effective catch, given the prevailing regulation, was 660 t during 2001. We note the large reductions in unit costs for annual landings up to around 400 t, whereas landings above that value do not enjoy scale economies to any great extent and, as noted above, there are scale diseconomies for landings >66 t.
The optimal annual catch of 660 t is based on a capital cost, which on average corresponds to a real inter-bank market rate of 5% and a depreciation value of 8%. If we assume that the social cost of capital is lower than this and use values corresponding to depreciation of current vessel value over 30 y and a real inter-bank market rate at 2.7%, economies of scale are fully exploited at an annual catch of 1700 t. Such an annual catch is far above the best catch recorded that year. This situation is likely a reflection of the regulated open-access regime (Homans and Wilen, 1997) of all Swedish fisheries before 1995. All vessels in the sample were built before 1992, with the single exception of a medium-sized vessel built in 1999. The overall picture is that the industry has the commonly seen L-shaped average cost curve (Robidoux and Lester, 1992) with large returns to scale in the lower interval and then a flat average cost curve, another reason for the sensitivity of the level of optimal catch.
Our estimates of potential rent and overcapacity are based on the assumption that high-cost vessels are replaced by cost-effective larger vessels, today landing 300–400 t, and that those are given IVQs of 660 t. Hence, we compare the actual cost of the 30 vessels in the sample with the costs of the cost-effective vessels predicted by the estimated translog cost function. This would lead to a cost reduction of >30%, from the sample average cost per kilogramme >(SEK) 18 (Swedish kronor) (given by the average cost of 2 560 452 SEK divided by an average catch of 141 157 kg; Table 2) to <SEK 13 (given by the estimated minimum average cost shown in Figure 3), and that seven large vessels instead of the 30 sample vessels could have harvested the same quantity of fish, which corresponds to a reduction in gross registered tonnage of about 
50–60%. Owing to a lack of data, we do not evaluate the fixed gear fishery, but catches are taken in the same area so landings by fixed gear potentially can be replaced by trawlers (B. Sjöstrand, Marine Institute, Sweden, pers. comm.). Fixed gear may be preferred because, for instance, the exploitation pattern may differ, and our aim is merely to obtain a value of the potential rent for the fishery based on our results. Hence, if cost-effective vessels could have replaced fixed gear vessels and landed the total Swedish take of cod, which in 2001 was almost 18 000 t, the gains from landing at a unit cost <SEK 13 instead of slightly >SEK 18 would lead to a total profit of about SEK 70–90 million, 25–30% of the total landing value in 2001, namely SEK 300 million.
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Discussion and conclusions |
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TopIntroductionThe Baltic Sea cod...MethodologyResultsDiscussion and conclusionsReferences |
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Here, we modelled an IVQ fishery by assuming that fishers wished to minimize costs and applied the model to the Swedish cod fishery in the Baltic Sea. The results indicate an L-shaped average cost curve with considerable economies of scale at low levels of output but diminished economies of scale at output levels of the larger vessels. There were substantial gains to be made from adjusting the fleet to enjoy economies of scale. Of note is that larger vessels are, on average, more profitable despite the prevailing regulation in which the weekly allocation system is designed in favour of smaller vessels. The estimated optimal landing level is sensitive to the selected additional user cost of capital, but the initial cost reductions achieved by increasing landings from lower levels are robust. However, the additional user cost is not perceived by individual fishers, and our estimates confirm how regulated open access leads to overcapacity, a parameter that still awaits reduction in the Swedish fishery. Our study indicates potential cost savings of SEK 70–90 million, 25–30% of the current value of landings, and desirable capacity reductions of 50–60% for the current state of the stock. Additional gains are also possible. First, the Swedish system uses weekly quotas, which means that fishers cannot allocate their trips optimally in terms of stock availability but are forced to make at least one trip per week to utilize their quota. This is a drawback of the system. A potential benefit, although not explored here, is better compliance. Monitoring and enforcement activities in the current system lead to a greater risk of detection of those who try to exceed their allocation, compared with the same activities in an annual IVQ system. Second, if future fishing mortality for Baltic cod is reduced drastically, the current poor state of the Baltic Sea cod stock may be recovered. Recovery to the natural scientific recommendation, i.e. 240 000 t, implies an increase to roughly three times the 2001 level. Doubling the stock size for a uniformly distributed species such as cod implies a doubling of landings for the same amount of effort (Hannesson, 1993). Hence, optimal utilization of a substantially recovered stock would imply both increased landings and more fleet reductions, i.e. further increases in rent and further fleet reductions in the fishery, than that shown by our results.
An additional feature of a regulated open-access system, which applies to most Swedish fisheries, is the general uncertainty associated with seasonal closure. Most Swedish fishers tend to be risk averse (Eggert and Tveterås, 2004), and the more risk averse they are, the more they support the introduction of IVQs (Eggert and Martinsson, 2004). Swedish taxation is asymmetric in the sense that profits are taxed, whereas investments are deductible. The outcome of this condition is that the stochastic nature of fisheries, with some very profitable years, leads to fishers rein-vesting heavily, which often means reducing mortgages and updating equipment. The latter implies increased fishing power, and the former implies lower private capital costs. An article entitled "Med havet som arbetsplats" ("The sea as a working place") in a daily Swedish newspaper reports the situation for two Swedish fishers in this respect:
The two brothers bought the vessel in 1997 and paid half of the total SEK 14 million cash. They got an interest free loan of 3 million from the EU, which is depreciated by 10% annually, and the remaining 4 million from the bank are completely repaid today. The Sorensson brothers do not have any interest to worry about (Göteborgs Posten, 7 February 2004).Such fishers clearly experience zero capital expenditure, so overcapacity can persist despite poor profitability.
Our results that indicate a desirable fleet reduction of 50–60% and a potential rent from such reduction of 25–30% of the total value of landings in 2001 may seem high. However, they are actually low and in line with a few similar studies of this area. Dupont (1990, 1991) estimated the potential rent for the British Columbia salmon fishery to be 42% and held that the fleet should be reduced by 50%. A more recent study by Dupont (2000) estimated the potential rent to be 33% for the same fishery. Weninger (1998) estimated optimal fleet reduction of 80% for the Mid-Atlantic surf clam and ocean quahog fisheries, but did not provide a measure of potential rent. Asche et al. (2003) estimated the potential rent in Norwegian fisheries to be 60–70% of the value of landings, given that the fleet has been reduced by 70%. Weninger and Waters (2003) studied the economics of the reef fishery of the northern Gulf of Mexico and suggested that optimal fleet reduction should exceed 80%.
The EU has aimed at structural adjustment for >20 y through multi-annual guidance programmes, but overcapacity is still a major problem for European fisheries (Lindebo, 2005). According to recent estimates, overcapacity in the total EU fleet still exceeds 40% (DG Fish, 2000). At the same time, structural adjustment programmes have at best mitigated overcapacity problems, but have served mainly as a means of income transfer to the vessel owners who remain in the fishery (Weninger and McConnell, 2000). Additionally, repeated offers of scrap premiums may encourage investment in new vessels and actually reinforce the problem of overcapacity (Clark et al., 2005). The Swedish IVQ programme for Baltic cod during the period 1995–2001 has not solved the problem of overcapacity. This study has shown that fleet reduction has to be substantially greater than has been achieved within structural adjustment programmes. How decommissioning of redundant vessels should be carried out is beyond the scope of this study, but according to Dupont (2000), the most compelling argument in favour of individually transferable vessel quotas is their ability to ensure an orderly exit from the fishing industry. Overall, our assessment is that the Swedish IVQ fishery with weekly assignment of quotas has at best mitigated the depletion of the Baltic cod stock but has not been successful in generating rent. A first step towards that target would be to allocate annual IVQs in all Swedish fisheries and to allow fishers to decide themselves when to catch. The greatest merit of the prevailing regulation is probably that it paves the way for necessary changes to Swedish fishery regulation. These changes include a more complete use of IVQs and the introduction of ITQs for some segments of the fishery, to facilitate some of the badly needed capacity reduction.
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Acknowledgements |
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The work was sponsored by the EU project "Modelling fishermen's behaviour under new regulatory regimes" (QOL–2000) and by the Swedish Board of Fisheries. Financial support from the Swedish International Development Agency to the Environmental Economics Unit at Göteborg University is acknowledged. Comments from two anonymous referees, the editor, Frank Asche, Sean Pascoe, Bengt Sjöstrand, and Mats Ulmestrand are gratefully acknowledged. However, the views expressed in this article are those of the authors alone and do not necessarily reflect official EU policy.
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Footnotes |
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1 It is possible that introduction of an IVQ regulation in some fisheries would induce fishers to focus both on revenue increase and lowering costs, e.g. by exercising market power and catching and landing at specific points in time. In the Swedish cod fishery in the Baltic, quotas are allocated to fishers weekly, and Swedish landings are themselves only a small portion of the total cod landings in a well-integrated market, reducing the likelihood of such behaviour.
2 All costs, output, and revenue data are confidential at the level of the individual firm.
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