Agricultural Subsidies in Industrialised Countries

Table of contents

Acronyms and Abbreviations

List of Tables

List of Figures

1 Introduction

2 International Trade
2.1 Globalisation and Trade Liberalisation
2.2 The Role of the World Trade Organization

3 Development of International Agricultural Trade
3.1 Agricultural Protectionism in Developed Countries
3.2 Trade Liberalisation Efforts

4 Africa’s “White Gold” and the Cotton-4
4.1 Current Cotton Production and Trade
4.2 The Role of the Cotton-4

5 Problems Faced by African Cotton Farmers
5.1 Cotton Subsidies in the US and the EU
5.2 Implications on the Cotton-4
5.2.1 Economic Implications
5.2.2 Social Implications
5.3 WTO Agricultural Negotiations and their Outcomes

6 Conclusion

7 References

Acronyms and Abbreviations

C-4 Cotton-4

CAP Common Agricultural Policy

DDA Doha Development Agenda

DSB Dispute Settlement Body

DSM Dispute Settlement Mechanism

EU European Union

FCFA West African CFA Franc

FSRI Farm Security and Rural Investment

GATT General Agreement on Tariffs and Trade

GDP Gross Domestic Product

IMF International Monetary Fund

LDC Least-developed country

TRQ Tariff-rate quota

UN United Nations

URAA Uruguay Round Agreement on Agriculture

US United States

USA United States of America

USDA U.S. Department of Agriculture

WTO World Trade Organization

List of Tables

Table 1: The GATT Trade Rounds

Table 2: Total World Trade and Agricultural Trade, 1950 – 2002

Table 3: Market Access: URAA Commitments and Factors Limiting 12 their Effectiveness

Table 4: Domestic Support: URAA Commitments and Factors Limiting 13 their Effectiveness

Table 5: Export Support: URAA Commitments and Factors Limiting 14 their Effectiveness

Table 6: Top Five Cotton Producers in 1990/91, 2000/01 and 2015/16 15

Table 7: Top Five Cotton Exporters in 1990/91, 2000/01 and 2015/16 17

Table 8: Top Five Cotton Importers in 1990/91, 2000/01 and 2015/16 18

Table 9: Estimated Assistance Provided by Governments to the Cotton 20 Sector during the Seasons 2014/15 and 2015/16

Table 10: Overview of Cotton Exports in Selected Countries, 1990-2009

Table 11: Cotton Production and Exports from Selected Countries, 26 2000-2004

Table 12: Cotton Subsidies in Selected Countries, 2000-2004

Table 13: Literature Summary of Studies Indentifying the Effects of 30 Distorting Support Programmes on the World Price

Table 14: Losses in Export Value from US cotton subsidies, 1999-2002

Table 15: Effects of World Price Changes on Households in the Cotton-4

List of Figures

Figure 1: World Cotton Production between 1945 and 2015

Figure 2: World Cotton Production by WTO Country Classification, 2010-15

Figure 3: World Cotton Exports between 1945 and 2015

Figure 4: Cotton Prices According to the Cotlook A-Index, 2005-2014

Figure 5: Development of Cotton Subsidies and Cotton Prices from 1997/98 to 2015/16

Figure 6: Cotton Production in the Cotton-4 from 1980/81 to 2015/16

Figure 7: Cotton Exports as Share of a Country’s Total Merchandise Exports (2004-2007 average)

Figure 8: Effect of Worldwide Removal of Subsidies on Cotton Prices

Figure 9: Development of Subsidies in Selected Countries from 2000/01 to 2015/16

1 Introduction

Although the primary sector, which also includes agriculture, is rather small in most developed economies compared to the secondary and tertiary sector nowadays, agricultural trade has always played an important role in global trade. In fact, trading agricultural products is still a necessity for most countries due to various reasons such as environmental differences in climate or soil prohibiting the cultivation of certain plants in some regions. Countries further participate in agricultural trade to use comparative advantages which is the “ability of [exporting] countries to produce goods at lower costs than importing countries” (Leche, 2009, p.1).

Since World War II there has been a tremendous increase in international agriculture trade mainly due to the liberalisation of trade. Between 1980 and 2015, the trade in agricultural products more than quintupled and was worth $1568 billion in 2015 (World Trade Organization, 2017), accounting for around 10% of the world merchandise trade (World Trade Organization, 2016).

Despite this trend and many rounds of international negotiations like the Uruguay Round, the agricultural sector is still largely protected through government interventions including tariffs, quotas and subsidies resulting in market distortions (Leche, 2009). Cotton has been at the centre of many of those negotiations due to its important role for the global textile industry. It is also an export product that many developing and least-developed countries economically depend on, especially in Africa, while its production is highly subsidised in many developed countries such as the United States of America. The probably most prominent cotton dispute started in 2003 when “four African cotton producers (Benin, Burkina Faso, Chad and Mali, the so-called [Cotton-4 or] C-4) argued that cotton subsidies caused world cotton prices to decline and reduced their export revenues” (Baffes, 2011, p.1535) and brought the case to the World Trade Organization (WTO).

The aim of this term paper is to examine the magnitude of cotton subsidies in developed countries and their impact on developing and least-developed countries as well as to inquire the effectiveness of the WTO in promoting free trade among its member states, especially with regards to the cotton sector. The WTO does currently not have a specific definition or certain criteria that classify a country as ‘developed’ or ‘developing’; WTO members rather decide it for themselves. This classification can, however, be challenged by other members. Concerning a definition for least-developed countries (LDCs), the WTO employs the classification of the United Nations (UN). According to the UN, LDCs are countries that “are deemed highly disadvantaged in their development process, for structural, historical and also geographical reasons” (UNCTAD, 2017). There are currently 48 countries classified as an LDC, 36 of which are WTO members.

Due to the scale of the paper, only subsidies in the USA and the European Union and their economic and social consequences for the Cotton-4 will be considered. To achieve this objective, this paper will firstly identify some of the underlying theoretical concepts. The development of agricultural trade and the reasons for protectionist measures in developed countries will be identified after looking at the trade liberalisation efforts made since World War II and the role of the WTO. In the following, this paper will analyse the current cotton market and the significance of cotton exports for the Cotton-4 states and their economies. The next section will then focus on the cotton subsidies in the US and the EU and explain the economic and social impacts of these protectionist measures on the Cotton-4. This will be followed by an analysis of the ongoing negotiations regarding the reduction of cotton subsidies at the World Trade Organization and their outcomes. The last chapter will present the conclusion as well as an outlook.

2 International Trade

Trading goods has always played an important economic role and many countries were able to advance their economies by lowering their trade barriers. Trade barriers are government measures to protect a country’s domestic industries and can be divided into tariffs and non-tariff barriers. A tariff is “a tax levied on imported goods, usually with the intention of raising the price of imports and thereby discouraging their purchase” (Griffiths and Wall, 2008, p.593). Tariffs can either be set as a fixed amount per unit (lump sum) or ad valorem, as a percentage based on the product’s value.

The two main types of non-tariff barriers are quotas, which are pre-set quantitative limits on the import of a certain good within a specific time period, and subsidies, which are payments or assistance “to domestic producers so as to improve their competitiveness in both the home and world markets” (Griffiths and Wall, 2008, p.594). In addition, non-tariff barriers can also be labour standards, technological and environmental standards, administrative barriers as well as boycotts (Griffiths and Wall, 2008; Reddy, 2011).

2.1 Globalisation and Trade Liberalisation

By participating in trading, countries cannot only use their resources more efficiently but also increase their productivity – “that is, the efficiency with which global resources are used to produce economic goods” (Obstfeld, 2016, p.12). The reason for this effect was already explained by David Ricardo’s theory on the comparative advantage in 1817 which was later supported by empirical research. Beyond that, trade can further decrease a country’s poverty, transfer technology from more advanced to less technologically developed countries and raise the overall product quality (Leche, 2009; Obstfeld, 2016).

Prior to the First World War, trade relations were characterised by a diverse network of bilateral trade agreements with relatively low barriers that allowed the international trade to flourish (Irwin, 1995). With the beginning of the war, however, this network collapsed as “countries imposed higher tariffs, import quotas, licensing requirements, and foreign-exchange controls” (Irwin, 1995, p.323). This situation prevailed in the years following the war as this interwar period lacked any “institutional mechanism to facilitate the reduction of the extensive trade barriers” (Irwin, 1995, p.323).

Since the end of World War II many steps and measures have been undertaken in order to liberalise the world trade. The term trade liberalisation refers to “the removal of trade barriers (both tariff and non-tariff barriers) to promote free trade” (Reddy, 2011, p.8688). Besides founding several international institutions including the International Monetary Fund (IMF) and the International Trade Organization, the international community mainly pursued this effort by establishing a multilateral trade agreement, namely the General Agreement on Tariffs and Trade (GATT) (Leche, 2009).

In October 1947, during the first round of multilateral trade negotiations in Geneva, the GATT was formed and came into effect at the beginning of 1948 in 23 countries that accounted for more than two thirds of the world trade (Irwin, 1995). Seven further negotiation rounds followed thereafter and in 1994 the number of countries that had signed the agreement amounted to 123 (see Table 1). The GATT’s main purpose was to accelerate the reduction of trade barriers and end any discriminatory trade policies in international trade to “contribute to rising standards of living and full employment” (Irwin, 1995, p.325). The agreement should also provide “codes of conducts for international commerce and a framework for periodic negotiations” (Ferris, 1992, p.1). In short, the international community wanted to avoid repeating the interwar experience.

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Table 1: The GATT Trade Rounds World Trade Organization, 2015b, p.16

Douglas A. Irwin (1995), who examined the achievements and effectiveness of the GATT, came to the conclusion that the initial objective of the agreement was achieved. Between 1948 and 1995, tariffs imposed by industrialised countries fell from more than 40% to about 5%. The GATT had a long-lasting impact on the world economy bearing in mind that the agreement had no autonomous power and only existed due to the commitment of its members. Nonetheless, Irwin (1995) also concluded that the GATT had many shortcomings. For once, the GATT did not regulate some areas of trade such as agriculture or textiles. In addition, antidumping measures and voluntary restraint agreements arose in some states to counterbalance the reduced tariffs.

The trade liberalisation promoted by the GATT and several international institutions led to an enormous increase in international trade. The world merchandise trade grew by around 313% from $59 billion in 1948 to $18,494 billion in 2014 (World Trade Organization, 2015a). Due to policies such as the GATT framework and the technological advances during the last two decades, the world economy also became increasingly integrated, in other words globalised. The International Monetary Fund (1997, p.45) defines globalisation as “the growing economic interdependence of countries worldwide through the increasing volume and variety of cross-border transactions in goods and services and of international capital flows, and also through the more rapid and widespread diffusion of technology”. International trade and globalisation are key elements of today’s economic growth and progress that can benefit especially developing countries. Globalisation is also associated with “with the efforts to bring all countries within the economic framework of the WTO” (Reddy, 2011, p.8688).

2.2 The Role of the World Trade Organization

The eighth and final round of GATT negotiations started in September 1986 in Punte del Este, Uruguay, and is thus also referred to as the Uruguay Round. Besides covering tariff negotiations, the round also focused on intellectual property rights, trade in services as well as aspects of agriculture (see Table 1). The Uruguay Round ended in April 1994 in Marrakesh, Morocco, with two major achievements: the Uruguay Round Agreement on Agriculture (URAA) and the creation of the World Trade Organization (Leche, 2009). This section of the paper will mainly concentrate on the establishment of the WTO; whereas the URAA will be further examined later on (see section 3.2).

The WTO replaced the GATT as the international organisation to promote liberal international trade to the benefit of all but the GATT “still exists as the WTO’s umbrella treaty for trade in goods, updated as a result of the Uruguay Round negotiations” (World Trade Organization, 2015b, p.19). The WTO can be described as rules-based; a system based on agreements that were negotiated during the Uruguay Round. As of today, the WTO has 164 member states.

In addition to providing its member states with a framework to negotiate multilateral trade agreements, the WTO also sets rules to promote free trade and provides ways and procedures to settle trade disputes (Dakouré, 2013). Regardless of the different aspects of trade that the WTO agreements deal with, there is a set of underlying principles that build the foundation of the trading system (World Trade Organization, 2015b). The multilateral trading system should be:

- non-discriminatory – a country should treat all its trading partners equally (most-favoured nation) as well as their products, services and nationals (national treatment);
- more open (freer) – lowering trade barriers such as tariffs, quotas and import bans to encourage free trade;
- predictable and transparent – tariffs and non-tariff barriers need to be stable and predictable to encourage investment; consequently, WTO members are bound to their tariff rates and market-opening commitments;
- more competitive – encourage fair trade practices by disapproving of unfair practices such as export subsidies to gain market share;
- more beneficial for less developed countries – grant those countries more time to adjust, special privileges and greater flexibility as over 75% of the WTO members are developing and transitioning countries (World Trade Organization, 2015b).

As a rules-based institution, the WTO agreements are not static but can be renegotiated and new agreements can be added (World Trade Organization, 2015b). In November 2001, a new round of negotiations was agreed upon by the WTO members at a conference in Doha, Qatar. This so called Doha Round is still ongoing, although the original deadline was 1 January 2005. A list of 21 subjects, the Doha Development Agenda (DDA), was agreed upon and includes issues such as agriculture, intellectual property rights, anti-dumping and subsidies as well as environmental issues (World Trade Organization, 2015b). The Doha Round, its effectiveness and outcomes will be analysed in more depth later on (see section 5.3). In addition to the fact that the WTO agreements can be renegotiated, member states can also use the WTO’s Dispute Settlement Mechanism (DSM) when they fear that a rule is not being followed (Dakouré, 2013).

3 Development of International Agricultural Trade

Compared to other sectors, the trade in agricultural goods did not progress as rapidly since World War II. When comparing the average growth rates of the total international trade with the rates of agricultural trade (Paiva, 2008), this becomes evident (see Table 2). On average, the total trade grew by 6.3% annually between 1950 and 2002, compared to an annual average growth of only 3.6% in agricultural trade during the same period (Paiva, 2008). As a result, the share of agriculture in total trade dropped from 38.4% in the early 1950s to 7.9% in 2000-2002. This also reflects the decreasing importance of agriculture as a driver of the global economy.

Table 2: Total World Trade and Agricultural Trade, 1950 – 2002 Paiva, 2008, p.629

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In 2015, the trade in agricultural products accounted for $1568 billion (World Trade Organization, 2017), which is around 10% of the world merchandise trade (World Trade Organization, 2016).

3.1 Agricultural Protectionism in Developed Countries

Until the Uruguay Round Agreement on Agriculture (URAA), agriculture had been granted certain immunity from liberalisation efforts and remained highly protected. Although the average global trade tariffs fell from about 40% to around 5% between 1948 and 1995 thanks to the efforts of the GATT, agricultural tariffs still averaged 62% in 1998 (Beierle, 2002). The reasons for wanting to protect the agricultural sector right after World War II seem obvious but the pressure to protect the domestic production persisted long beyond that due to strong agricultural lobbies in developed countries. This development has been especially harmful for the economies of developing and least-developed countries that still rely heavily on agriculture and agricultural trade to reduce poverty. On average, agriculture still provides a living for more than half of the population in developing countries, compared to only about 9% in developed countries (Beierle, 2002).

“Agriculture is historically considered special for economic, social, political and strategic reasons” (Hitiris, 2002, p.155). Accordingly, most industrialised and even some developing countries intervene in this sector to regulate and modify its trade and production (Hitiris, 2002).

Interventions in the agricultural sector are mostly justified by the belief that the free market cannot move the sector in preferred directions. In doing so, governments mainly pursue four objectives:

1. maintaining a “certain degree of self-sufficiency in agricultural products” to avoid the risk of foreign supplies;
2. providing domestic products for domestic consumption rather than importing products to save foreign exchange;
3. “stabilizing prices at reasonable levels for consumers and products” to ensure growth in the agricultural sector;
4. raising the growth rate of agricultural incomes by improving the productivity and efficiency of this sector (Hitiris, 2002, pp.155-156).

In addition, governments argue that agricultural interventions are necessary to ensure the distribution of national income towards the agricultural sector because agricultural incomes are usually relatively low and often fluctuate heavily (Hitiris, 2002). This is frequently a liable argument although only a very small percentage of the total population is still engaged in the agricultural industry in developed countries.

Agricultural policies in developed countries highly distort international trade because they directly affect global prices for agricultural products and consequently hurt the economies of developing countries. In 2001, a report issued by the U.S. Department of Agriculture (USDA) identified the costs of agricultural policy distortions. The USDA came to the conclusion that distorting policies “leave world agricultural prices about 12 percent below levels otherwise expected” (U.S. Department of Agriculture, 2001, p.5). Another finding of the USDA (2001) was that developed countries are accountable for about 80% of the agricultural market distortions, with the EU accounting for 38% and 16% attributable to the US.

One can broadly differentiate three categories of agricultural protection policies: market access, export support and domestic support (Beierle, 2002; Green, 2000; Leche, 2009). These are the most common protection measures and they were also at the centre of the URAA reforms (see section 3.2). Market access policies concern tariffs and non-tariff barriers. Tariffs are considered to be very trade-distorting, especially when implemented by large developed countries, due to their negative indirect effect on world prices. As a side effect tariffs raise government revenues, making them very appealing, also to developing countries. According to the study by the U.S. Department of Agriculture (2001), tariffs account for more than half of the agricultural price distortions.

Export supports are very trade-distorting policies that countries use to increase their international market share by selling their excess supplies below the global market price (Leche, 2009). Besides export credits and food aid, the most common form of export supports are export subsidies which are direct payments that compensate producers for selling their products at below-market rates. They encourage an overproduction which depresses world prices while keeping domestic prices high (Beierle, 2002). Export subsidies account for 13% of international price distortions (U.S. Department of Agriculture, 2001) and are mainly used by developed countries because they are very expensive.

Domestic support policies are subsidies which can be described as direct payments to agricultural producers regardless if their products are consumed domestically or exported. There are various forms of domestic support policies and some are more trade-distorting than others. The U.S. Department of Agriculture (2001) estimates that domestic subsidies account for 31% of the global price distortions. The report also compared the different types of policies by country and found that the EU and the US make more use of domestic support and export subsidy policies than other countries.

3.2 Trade Liberalisation Efforts

The first multilateral effort to liberalise the agricultural sector was made with the establishment of the URAA in 1994. The agreed upon reforms focused on the three main categories already mentioned earlier: market access, domestic support and export support (Beierle, 2002; Green, 2000; Leche, 2009). The reform commitments made under the URAA concerning these three categories as well as the factors that limited their effectiveness can be seen in Tables 3, 4 and 5 respectively. The following paragraphs will only highlight the main achievements of implementing the URAA and the status of the post-Uruguay Round protectionism.

The main achievement concerning the URAA market access policy reforms (see Table 3) was a process also known as ‘tariffication’. In the URAA, the signing countries agreed to a conversion of all non-tariff barriers into tariffs, binding maximum rates and reduction targets. Tariff-rate quotas (TRQs) that “established fixed quantities (quotas) of imports to be charged lower tariff rates” (Beierle, 2002, p.18) were also implemented.

As part of the URAA, domestic subsidies were classified into three categories according to their degree of distortion:

- Amber box: very trade-distorting policies that directly influence prices or quantities and hence encourage overproduction (e.g. market price supports, direct per-unit payments);
- Green box: non- or minimally trade-distorting policies that are publically funded and not directly linked to the production (e.g. payments for environmental protection or research);
- Blue box: amber box policies that are offset by policies that limit production (Beierle, 2002; Leche, 2009).

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Table 3: Market Access: URAA Commitments and Factors Limiting their Effectiveness Adapted from Beierle, 2002, p.23

Only subsidies that fell into the amber box were relevant under the URAA and were subject to reduction commitments which led many experts to question the effectiveness of the domestic support reforms (see Table 4). Moreover, the blue box was only created for the USA and the EU to allow them to “continue offering deficiency payments and compensatory payments to their farmers” (Leche, 2009, p.31).

As part of the URAA reforms, member states further agreed to a reduction in export subsidy expenditures and volumes, and members were not allowed to implement any new export support programmes (see Table 5). Many experts consider the exclusion of food aid and export credits from the agreement one of the shortcomings concerning the export support reforms.

Table 4: Domestic Support: URAA Commitments and Factors Limiting their Effectiveness Adapted from Beierle, 2002, p.37

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As the first multilateral effort to liberalise agricultural trade the URAA is very important because it paved the way for any further rounds of negotiation at the WTO. Most countries met their commitments concerning the reduction of specific policies in the given timeframe. Nonetheless, the overall “levels of protection, as a percentage of agricultural output, have remained relatively constant” (Beierle, 2002, p.17) and hence, the URAA was not able to substantially liberalise agricultural trade.

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