EVENTS

Date:	Wednesday, June 9, 2004
Time:	10:00 AM -- 11:30 AM
Location:	Wohlstetter Conference Center, Twelfth Floor, AEI 1150 Seventeenth Street, N.W., Washington, D.C. 20036

June 2004

Agriculture and the Doha Round: The 2004 OECD Analysis of National Producer Support Policies

Reform of trade-distorting national agricultural support policies is the central challenge to a successful completion of the WTO Doha Round of trade negotiations. The Organization for Economic Cooperation and Development's annual survey and analysis of current national agricultural support policies is of central importance in assessing what is on the table in the negotiations, including the impact of new reform proposals from key players such as the United States and the European Union. At a June 9 AEI conference, a panel of trade and agricultural policy experts discussed this year's OECD report, agricultural policy reforms in the United States and European Union, and implications for the Doha Round and world trade.
 
Ken Ash
Organization for Economic Cooperation and Development

Over the last three years, the level of support across the OECD area has totaled about $238 billion USD per year. A decade and a half ago, support to producers as a percent of gross farm receipts approached 40 percent. In the period from 2001 to 2003, we see a lowering of the level of support and a decrease in the most production- and trade-distorting types of support, with more progress remaining to be made in terms of the variation across commodities. These are all important developments, but certainly there is a fair amount of unfinished business with respect to the farm policy reforms. The market outlook for agriculture over the next ten years is for some growth in global income and demand, but for very moderate price increases. We do expect increased trade, in particular between OECD and less developed countries. The increase in preference for more value-adding and more differentiated products is expected to continue. We also predict continued disparities between world and many domestic prices for quite a range of sensitive products, particularly dairy, rice, and sugar.

There have been two major policy developments over the past year: the first full year of implementation of the farm bill and the agreement on reform of the Common Agricultural Policy in the EU (which has not yet been implemented). Regarding the farm bill, the earlier ad hoc emergency payments that had been in place since 1998 were effectively institutionalized, thereby reducing risks for farmers and linking support more closely to production, which had the effect of isolating producers from market signals, particularly as prices began to decline. So what you saw after the farm bill passed was actually a reduction in the level of support.

The key accomplishment of the reforms under the Common Agricultural Policy (CAP) has been important progress towards disconnecting support from production decisions-known as decoupling--which allows producers in the European Union to see markets and respond to market signals more clearly. By using direct payments instead of the price system, governments can transfer income to producers more efficiently. There is a shift now away from the very blunt instrument of price supports and toward more targeted policies.

The composition of support across OECD countries is where we begin to make the link very clearly between domestic policies and trade policies. Market price support essentially represents our estimation of the gap between domestic prices that are maintained high by governments relative to world prices.  There is a very large reliance on this type of support in the EU; the United States uses this type of support less, though still at a significant level. The United States has a greater fondness than the EU for output and input payments, which are production-based, but not price-linked. In both cases, and across the OECD as a whole, almost two-thirds of support is directly linked to production.

The next type of support that is prevalent, more in the EU than in the United States, are payments based on area and animal numbers. Our analysis suggests that twenty-five cents on the dollar of price-based support finds its way into a farmer's pocket. A large part of the support is capitalized into asset values. Now to the extent, for example, that you own those assets at the time the policy is introduced, that is good news for you--there is a one-time wealth gain since your asset has appreciated in value. To the extent that you are a subsequent generation farmer and you have to acquire those assets--land or production quota--at the inflated capitalized value, then your production costs increase, which means your profits go down. The government does not intend such a perverse effect. To the extent that production incentives encourage farmers to produce, they may do so on otherwise marginal or more sensitive land, and this might have negative environmental effects.

The other point to consider is the trade-distorting nature of market price support. If a government wishes to maintain domestic prices above world prices, it does so by closing or otherwise impeding access to its borders. Over time, this will encourage people to produce more than they otherwise would. If domestic production exceeds domestic consumption, you have to do something with the product: either use export subsidies to get rid of it at relatively high prices, stockpile it, or introduce production quotas to constrain production. So there is a very clear link between price and production-linked support and the kind of trade policy instruments that cause conflict on international markets.

There are alternatives. The first step involves disconnecting support from production decisions. Decoupling policies do not require border protection or export subsidies. Once you have undone the negative effects by decoupling, identify the specific goals and intended beneficiaries of your support policies and target your actual support instrument to them. This is much less costly, much more efficient, and does not cause the kind of spillovers we see today. The aim of agricultural policy is not in dispute, but rather the choice of instrument that is used to achieve it.

Tassos Haniotis
Deputy Head of the Cabinet of the EU Commissioner for Agriculture

Is CAP reform worth the effort, and why does it matter for the Doha Round? The cost of the CAP can be seen in two ways: The first is in absolute terms--approximately 50 billion Euros. Reference solely to this figure misses many points, however, such as the EU budget, through which very few public expenditures go; issues of policy competence--education, health, defense--decided by member states; and the changes to the CAP structure and the impact of various successions. Last month we increased the number of farmers by 50 percent and increased our agricultural budget only 15 percent. Agricultural spending declined as a percentage of GDP, as a percentage of public expenditure, and as a percentage of the EU budget.

How much you spend on agriculture is a domestic issue for every country to decide; the real question is what do you do with the money. Previous reforms of the CAP have focused on the issue of more efficiency, mainly by changing policy instruments to shift support from products to producers. The more recent reforms have moved even further by decoupling the most significant elements of support; by making producers responsible for complying with environmental, food quality, and animal welfare standards; and by shifting funds within an existing budget to finance both market reforms and rural development measures. With a fixed budget (as is the case with the EU), you cannot afford to do anything but focus on the efficiency of your policy instruments, because you do not have the luxury of increasing the budget.

In every single one of the three pillars of the WTO in agriculture--market access, export subsidies, and domestic support--we have moved into reducing the most trade-distorting policies. But does CAP reform matter on world markets? In most sectors, the CAP has a minimal impact on world price; we are mainly price-takers, even for products of interest to developing countries. Sugar and cotton are both products that have often been criticized for creating major distortions with respect to the policies of the developed countries. However, when Brazilian sugar exports go up, the world market price goes down. When the net cotton imports of China move up and down, the world price fluctuates as well. We have to focus concretely on the fundamental factors that control the evolution of these prices to draw definitive policy conclusions.

Most of the priorities in the OECD policy recommendations are already in the new CAP, but will they show? Of course the overall level of support did not change, but the composition of the support did. I think people should feel free to say that it does not matter, and that at the end of the day it is all equally trade distorting.

There are some basic features of the CAP that are important, such as the historical versus alternative approaches to decoupling. It is self-evident that most of the support would go to large farms, because they are linked to quantity. But it is also true that the largest farms have the capacity to produce more. We had the very long debate during the CAP reform process over whether to decouple based on the historical level of support, or on the original level where everybody receives the same level of support. Only one country will apply the second model. It is nice to say that everybody gets treated the same, but we want to make farmers more market-oriented. Land prices are affected by two things that are controlled within the policy debate: the evolution of commodity prices and the level of government subsidies. Land values going up and down because of commodity prices is a market-oriented development we want farmers to be aware of. But it becomes problematic if land values go up or down because we change the distribution of support through reforms. The reason is redistribution, which we tried to solve through modulation or cutting support from the largest producers and shifting them into rural development.

So we wanted to be neutral in decoupling, with respect to the redistribution impacts. There is also the impact of what the reform does to export subsidies and domestic support. We have more margin, and whether there is an agreement or not, everybody sees that there is less distortion. We need full parallelism in disciplines when we talk about all forms of support to exports, and we have offered to eliminate export subsidies completely.

Then there is the issue of market access.  We need significant market access improvement, but market access can only be a multilateral issue resolved through negotiations.

Mary Bohman
U.S. Department of Agriculture

In 1981 U.S. farm policy increased the gap between market prices and supported prices, so we had high farm program cost, increasingly large stocks, and the need for supply control. The United States had to rely on all three methods to control all the surpluses from high prices. In 1985, the United States started to move towards more market orientation, but it did not go far enough. Costs were still quite high, and a budget deficit grew, so there was significant pressure in the 1990 Farm Act to further break this link between policies and markets. Also in 1990 breakages occurred between supply controls and market prices, allowing more flexibility in producers' decisions. In 1996 Farm Bill there was still an intellectual climate to further break links between markets and agricultural support, and in that year the United States first introduced policies that broke links between prices and payment. There are some good principles of politics designed behind many of these changes. People were trying to do the right thing, but reform was incomplete and the process was too political.

Going back to 1986, new types of payments were introduced based more on historical entitlements. So at that time we had more policies--not less--but we also had real changes in planting restrictions. There was no longer an annual set-aside, and farmers were no longer tied to base acreage or limits on production per crop. In 2002, there was a controversy over countercyclical payments based on historical acreage because payments were linked to market prices. As market prices have been relatively high, farmer support under this new type of payment has gone down. So PSE tracks somewhat both the level of support and market conditions.

We have an increasingly complex world of agricultural policy. Before the Uruguay round, the PSE did not exist. There was no consistent way to look across a country's policies, so this is a strong accomplishment. Thanks to the work of OECD and the recent work on multi-functionality and payment efficiency, we now have general agreement that targeted policies are more effective. We have less global consensus on whether the increasingly complex area of payments to farmers do or do not destroy the markets. Let me present some data to illustrate these points: First, U.S. farms who sell more than $250,000 are run by about 8 percent of the U.S. farmers and receive on average around 47 percent of the payments. Then there is another large group of farms with sales of less than $250 000, run by full-time farmers who receive around 40 percent of the payments. Seventy percent of all U.S. farmers say that farming is not their principle occupation, but they receive only 13 percent of the payments. So for the United States, the OECD pattern of payments does go to the largest farms. Farmers are also increasingly integrated in the overall economy, and they have similar income as non-agricultural households.
 
I think that the U.S. transition is incomplete; we still have market price support, but policies are becoming increasingly market-oriented over time. We have payments that now are linked to historical production. Our research is showing that this kind of payment is less distracting and more targeted. 
      
Jason Hafemeister
Office of the United States Trade Representative

There is broad consensus among economists about the distortion we see in agriculture, and these conclusions have been incorporated into the WTO structure. In the WTO we talk a lot about export subsidies, export competition measures, and all these measures that have been mentioned today have also been taken in to account. Export subsidies are generally viewed as the most distorting, so we see the most ambitious proposals for reform there. The Europeans have come with conditional offers for getting rid of export subsidies--something that we call hyper-parallelism--and it reflects the consensus here. These export subsidies are distracting measures that need to be dropped.

Similarly on the domestic support in the WTO we have distinguished across different kinds of payments: Totally decoupled payments now affect production incentive. We also have some payments that are only partially decoupled, and they have to be reformed. And finally we have the input output payments that are related to the level of production and are the most distracting, so this is where the most of the focus of WTO is right now.

Our big challenge is to work out our differences within the pillars¾the export competition and the parallelism is a very good example of that. What we are trying to do as a first step in WTO negotiation is to set up a framework with formulas without numbers; and what we can do after this framework is established is to work out with different countries on how we balance the cuts.

Kevin Hassett
AEI

I think people have moved to lump-sum subsidies that have stopped the real problems. So if we just go out and see the farmers in the Midwest that get subsidies, they no longer have to make cuts or grow soybeans to get the money; they can do whatever they want, what the market tells them to grow that year. So we might end up with too much of one thing or another in one year.

So why is there still movement towards lump sum subsidies? I think there is still a strong movement of cultural heritage, but there has been recognition that previous agricultural policies were causing really bad price distortions and were especially harmful for developing countries. Subsidies based on historical subsidies are promising, which is good from the point of view of developing countries.

There are no questions that all these agricultural subsidies have produced more farmers. If we look at the places with a lot of subsidies we can say that those are the places that have the most problems. There is no economic development and huge migration. I think that there a lot of ways that we can think how subsidies are disturbing the market, but we have to think the most about the damage we are doing at home to the regions that receive this subsidies.
       
AEI interns Miso Nikolov and Andy Mack prepared this summary.