The costs of agricultural support policies and protection are heavy. Liberalization can bring great rewards
In recent years the agricultural support policies of the industrial countries have come under increased scrutiny because of their rising costs, distortionary effects on prices and trade, misallocation of resources, and contribution to large global imbalances in agricultural production. Agricultural support policies have been discussed within the Organization for Economic Cooperation and Development (OECD) as an important area for structural reform, while the multilateral liberalization of agricultural trade is a key issue in the Uruguay Round of trade liberalization in the GAIT (see preceding article by Naheed Kirmani). This article reviews some of the agricultural support policies of the industrial countries and discusses the benefits of liberalization for these countries and for others.
Extensive agricultural support programs are a characteristic of most industrial countries. The OECD estimates that the direct cost to consumers and taxpayers of the support policies of the major agricultural producers was about $185 billion per year in 1984–86, equivalent to almost 40 percent of the value of producers’ income (see table). It has also identified the dairy sector as one that receives very high levels of support across almost all countries; recent increases in the value of support for rice and sugar in some countries have also been substantial. In 1984–86 such support accounted for more than half the value of production by dairy farmers in the countries surveyed (excluding New Zealand). Total support for the dairy industry in the United States during 1986 amounted to $1,400 per cow (average support per cow in the European Community was not far behind). There have been limited attempts to reform these policies. Moreover, the large stockpiles existing in the mid-1980s have been reduced as a result of both disposal at heavily subsidized prices and the recent drought in some major countries of the Northern Hemisphere. Fundamental production and trade distortions, however, remain in the agricultural sector.
The institutional features of support policies differ greatly across countries but their principles are similar. Most involve primarily domestic measures, but these are almost always supplemented by trade actions. For example, domestic producer prices are raised by restricting the supply entering the market through tariffs, import quotas, and variable import levies, as well as by domestic production controls (e.g., production quotas); the costs of these measures are primarily borne by consumers. To raise producer prices further, official agencies may make purchases to reduce the supplies entering the domestic market. The resulting official stocks and other domestic production may also be exported at a subsidized price, adding to the budgetary and consumer cost. Producer prices can also be raised without affecting consumer prices, by direct budgetary payments to farmers (generally termed deficiency payments).
See also the September 1986 issue of Finance & Development for a series of articles on trade in agriculture, mainly relating to developing countries, based on the World Development Report, 1986.
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In the EC, most food products are supported under the Common Agricultural Policy, in operation since the early 1960s. Its stated objectives are to raise productivity, ensure a fair standard of living for the agricultural community, stabilize markets, provide food security, and ensure reasonable prices for consumers. The main instruments are variable levies on agricultural imports that effectively exclude imports by raising their prices in the EC to above the Community’s heavily supported market price for the same commodities. Official purchases and export subsidies (“restitutions”) are also used to direct surplus production of major agricultural products from EC markets. In addition, sugar and dairy products are supported by domestic production quotas.
The case of subsidized grain markets
A review of recent developments in the trade and support policies for grains can best illustrate some of the problems associated with agricultural trade policies.
Grains are the main internationally traded food commodity, and the United States is the largest exporter. During the early 1980s, the US share of world wheat trade shrank considerably, from 47 percent in the crop year 1980/81 to 29 percent in 1985/86. Recent attempts to redress this situation contributed to agricultural trade frictions. To some extent the operation of US support policies contributed to the reduction of its own market share. Support prices for grains were set at high levels during the early 1980s and were not changed until 1985. As a result the government accumulated large stocks of grain that would otherwise have been exported. Together with the appreciation of the US dollar, this policy effectively supported the world price of grains at a higher level, giving other exporters, notably the European Community (EC), an opportunity to expand their subsidized exports of excess production.
The 1985 US Farm Bill aimed to change this situation and to regain the traditional US share in world markets by lowering domestic support prices and by using the surplus stocks and budgetary allocations to subsidize exports under the Export Enhancement Program. The EEP, originally designed to compete with the subsidies used by the EC, has since been broadened in scope to help increase the US market share generally. In 1987/88 the US share of world wheat exports returned to 41 percent.
In the European Community, the escalation in costly subsidies has prompted some reform measures in the EC but no fundamental changes have occurred. Sheltered by the Common Agricultural Policy, the production of grains, particularly wheat, grew rapidly and by the late 1970s it had started to exceed consumption. During the 1980s, the EC needed to export its subsidized grains to avoid the accumulation of excess stocks. Fortunately for the EC, this coincided with the reduction in US exports, mentioned above. The changes in US policy since 1985 including the competitive subsidization of exports, the fall in world grain prices until 1987, and the depreciation of the US dollar, all have dramatically increased the budgetary cost of the EC’s grain subsidy policies. The package of reform measures for the CAP, adopted in February 1988, was primarily aimed at limiting the increase of the budgetary cost of the CAP and easing trade tensions by restraining the growth of exportable surpluses. The measures on grains were among the most important ones in the package and included steps to increase producer levies and reduce intervention prices if a certain level of production was exceeded. However, the agreed level was still well above that of domestic consumption.
Reduced market access and the competitive subsidization of exports have adversely affected traditional exporting countries. Canada, for example, has provided its grain producers additional subsidies to offset the effect of US and EC subsidies. On the other hand, in recent years New Zealand and, to a lesser extent, Australia have reduced their agricultural support policies as part of a package of economy-wide liberalization measures and to reduce their fiscal imbalances. Food exporting developing countries, unable to match the subsidies of the major trading countries, have also suffered from low world prices and restricted market access. The formation of the Cairns Group in 1986, to represent the position of these food-exporting countries in the Uruguay Round, reflects the widespread nature of the problems created by the agricultural support policies of the major industrial countries. The Group comprises Argentina, Australia, Brazil, Canada, Chile, Colombia, Fiji, Hungary, Indonesia, Malaysia, New Zealand, the Philippines, Thailand, and Uruguay.
The mechanisms for agricultural support in the United States are more diverse and the reasons for it are varied. Grains and oilseeds are supported by operations of the Commodity Credit Corporation (CCC), which provides concessional credit and sets the support price to farmers at which it will acquire these crops. The 1985 Farm Bill introduced the Export Enhancement Program (EEP) to provide export subsidies, mainly for grains and oilseeds. It also substantially increased the deficiency payments for grains. Import quotas are used to support dairy products, sugar, and beef, although they are rarely imposed on beef imports, since these are often limited by voluntary export restraint agreements.
Food security in basic farm products is a fundamental goal of Japanese agricultural policy and this is achieved mainly through the control of imports by state trading enterprises. There are virtually no rice imports; domestically produced rice is sold at about nine times the world price, despite recent reductions in support prices. Japan’s imports of feed grains, which enter duty free and without restrictions to support its highly protected livestock industry, have been rapidly increasing. The beef industry is heavily supported by a tariff and quotas; in 1988 a plan was adopted to liberalize the system over a period of five years, partly in response to concerns of Japan’s trading partners about access to the Japanese market.
Limited reforms have been attempted in each of these country groups but the extent of these measures has been heavily constrained by political factors. The original version of the 1985 Farm Bill in the United States envisaged a substantial reduction in assistance but political pressure, rationalized by the continuation of extensive protection in other countries, resulted in the inclusion of measures that ultimately increased the extent of support. Measures adopted by the EC, culminating in the February 1988 package, were primarily aimed at reducing the budgetary cost and surplus production rather than opening up European markets. Reductions in support prices in Japan have been very modest. (See box on grain markets for an example of recent developments.)
Rationale for support
Support for agricultural production and export subsidies has been justified for a variety of reasons, including food security, food aid, a mechanism for redistributing income toward farmers (particularly small-scale ones), and to stabilize food prices. Food security is an important issue for many countries, particularly for an island economy such as Japan. However, it is not clear how domestic production serves this purpose since the intensive farming required by such a policy often relies on imported feed grains and other inputs (e.g., fertilizers or their constituent raw materials). While imported inputs could be stockpiled, it is often more efficient to use long-term supply contracts and stockpiles of the imported final products.
Other countries have justified their large stockpiles of surplus agricultural production on the basis that this policy permits more food aid. However, the long-term benefits of food aid to recipient countries are not clear. Emergency food aid forms only a small part of total food aid, while some types of aid, in fact, reduce the incentives for local production in the importing country.
Some argue that support programs help preserve the agrarian environment; the reality may be different. More intensive agriculture may create problems as a result of excessive fertilizer and pesticide use to boost production. In addition, these policies often encourage the cultivation of marginal and often environmentally fragile land, thus reducing the supply available for more “natural” and environmentally sound uses.
While support policies represent a transfer of income from consumers and taxpayers to farmers, this is a very inefficient means of achieving such distributional goals and is also regressive. The transfer from the former groups (about $185 billion per year for the countries in the table) is generally much more than the net gain to farmers because of the losses inherent in the distortion of consumption patterns and less efficient production. Support programs based on higher consumer prices also place a disproportionate burden on the poor in these countries. The main beneficiaries of the transfers are usually intended to be family farms; but in practice, especially in the United States and the EC, they tend to be the larger farms that do not need such support.
Although the support policies currently in use achieve more stable domestic food prices, these prices are typically at a much higher level than world prices. The more basic sources of risk to farmers are income instability and uncertainty; in industrial countries, market-based options, such as savings, futures contracts, and crop insurance, exist to overcome these concerns. Australia and Canada also have government-sponsored income stabilization schemes for wheat growers that guarantee them a large percentage of their average incomes for the previous years, at much lower cost than price support schemes. Price support schemes also distort and destabilize world prices because they insulate the domestic market from the effects of the forces of demand and supply. For example, a shortfall in world output will have a larger effect on the world price if some areas are insulated from the effect of the price increase and hence do not reduce the quantity they demand.
Benefits of reform
The liberalization of the agricultural support policies of the industrial countries could play an important role in their own programs for structural reform and fiscal adjustment. It would also improve market conditions for other exporters, many of which are highly indebted developing countries. A variety of studies have shown that a liberalization of support policies in industrial countries would increase world prices of agricultural products and reduce world price instability. While the situation of food-importing developing countries, especially in Africa, would worsen without any changes in their own policies, the higher costs of food imports may spur them to overcome problems in their agricultural sectors. Such structural reforms could offset much of the potential loss from higher import bills, and make them less dependent on food aid in the long term.
The economic advantages to the liberalizing country accrue with both multilateral and unilateral liberalization. Liberalization, in addition to removing some of the direct costs noted earlier, also has important macroeconomic benefits for the whole economy. By the same token, support for one sector (agriculture), and its insulation from adjustment, places a greater burden on other, less supported, sectors.
One of the major fallacies used to justify support policies is that export subsidies can be used to improve the current account balance by promoting exports. In reality, when such subsidies are financed by increasing budget deficits, the reverse may be true; for example, under floating exchange rates and a non-accommodating monetary policy which are characteristic of the situation for the United States, the current account actually worsens. This is because, for the economy as a whole, net capital inflows increase in order to finance the budget deficit. This causes the exchange rate to appreciate and, despite some increase in agricultural exports, the overall current account balance worsens. A significant reduction in the current account deficit of the United States, for example, will require some reduction in the budget deficit; and a reduction of the roughly $21 billion spent on agricultural support could make an important contribution toward that end.
Agricultural support policies financed by consumers (through higher food prices) and indirect taxes, as in the Common Agricultural Policy (CAP) of the European Community, have also an adverse impact on macroeconomic performance. Studies suggest that the abolition of the CAP would significantly increase employment, output, and manufactured exports. Liberalization would result in lower food prices and value-added tax rates, and (assuming rigid real wages) nominal wages would fall or increase less rapidly than with the CAP. This would improve the competitiveness of the less protected industrial and service sectors and increase total output. Because other sectors in Europe use labor more intensively than agriculture, total employment would also increase.
While agricultural support policies can promote farm employment, such gains are more than offset by losses in other sectors in Europe. This contributes to the chronically high unemployment. A more general lesson is that support for agriculture has been at the expense of nonagricultural industries and services, including “high-tech” industries. In industrial countries, these nonagricultural activities have a higher value added and greater long-term growth prospects. The heavy support for agriculture has contributed to the difficulties with imported products experienced by key non-agricultural sectors in Europe, leading those sectors also to demand protection from foreign competition.
Liberalization may have an adverse effect on the agricultural sector but adjustment policies can be designed to ameliorate some of this. Multilateral liberalization, by correcting supply and demand imbalances, will tend to raise and stabilize world prices, and thus ease the transition to freer trade. Studies suggest that the main way in which farmers would lose from liberalization would be through a one-time fall in the values of their land and production quotas. Greater efficiency could be achieved with specific policies to address the problem of property values, while the need for adequate and stable farm incomes for certain groups could be met with support payments unrelated to production levels, and improved access to market-based stabilization facilities.
The Uruguay Round provides a unique opportunity for progress in the multilateral liberalization of agriculture. While such an opportunity should be fully used, it is important to realize that even unilateral liberalization carries substantial benefits for the liberalizing country in terms of increasing its own welfare, easing macroeconomic imbalances, and improving the competitiveness of non-agricultural sectors. There is no doubt that farm lobbies have a strong voice in many legislatures and are resisting meaningful agricultural reform. Heightened awareness of the widespread benefits of reform, to non-agricultural industries, as well as to consumers, is vital to develop the domestic political consensus which will be necessary for such a major policy change.