Chapter

VI Agricultural Trade Policies: Recent Developments and Issues in Reform

Author(s):
International Monetary Fund
Published Date:
January 1992
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During the 1980s, awareness of the need for substantial reforms in agricultural support policies has increased. Such reforms are essential for an open multilateral trading system and for the integration of Eastern European and developing countries into that system. Reform would also ease budgetary pressures and price distortions in industrial countries and reduce trade frictions. Many countries, especially those undertaking major economic reforms, have a strong interest in ending the export of surplus production and in achieving greater market access for their products. Another prominent issue is the growing concern about the environmental damage caused by excessive incentives for intensive agricultural production; the perceived advantages of more ecologically sound land use, particularly in the densely populated industrial countries, are encouraging needed reforms. Despite these developments, the fundamental changes that would reduce support and make agriculture more market oriented have not generally been implemented. This trend is reflected in the total value of transfers from taxpayers and consumers to support agriculture in 1990, which rose significantly to $300 billion.

Relatively few major liberalizations in agricultural support policies have occurred since the start of the Uruguay Round in September 1986. Some changes introduced in the United States in the 1990 Farm Bill have made the operation of support policies for cereals less distorting, but expenditures, especially export subsidies, are likely to increase and import barriers to remain. The EC discussions are continuing on the reform of the CAP to reduce the need for import barriers and export subsidies, but negotiations are likely to be protracted. In Japan, despite liberalization of some products and reductions in the overall level of support in 1990, there is no discussion of a fundamental reform of its policies, although the possibility of a limited opening of the rice market has been raised. Canada has introduced changes to rationalize its support policies, but its support levels remain high. Australia, New Zealand, and Sweden have made reforms to their agricultural policies that entail reductions in support.

Eastern European and most developing countries could gain substantially from a worldwide reform of agricultural protection policies if they continue with the structural reforms they are implementing. Reduced export taxes, more appropriate exchange rates, reduced industrial protection, and other market-oriented reforms will make the exports of these countries more competitive. Improved market access and the elimination of export subsidies are important to sustain the economic reform in Eastern Europe and developing countries. Reforms in food-importing developing countries and the likely phasing of industrial country liberalization would reduce the amount of adjustment food importers would need to make.

Recent Policy Developments

General Setting

Despite the attention given to agriculture in the 1980s and in the Uruguay Round, support levels for agriculture remain high. Total transfers associated with support policies in OECD countries peaked at $300 billion in 1990 (Table A22). About 40 percent of such transfers came from government budgets; the remainder was paid by consumers through higher domestic prices resulting from trade barriers. These transfers from taxpayers and consumers were about 2 percent of GDP in 1990; in the Scandinavian countries, total transfers amounted to more than 4 percent of GDP, while in Japan and the EC they were slightly more than 2 percent of GDP (Table 15). This amount is substantial in comparison with the value added of agriculture, about 3 percent of GDP in OECD countries (Table A23). Support, measured by producer subsidy equivalents as a percentage of the value of production, increased sharply in the mid-1980s to an average level of 50 percent for OECD countries (Table 16).104 In 1988 and 1989, support declined mainly because of increases in world prices (in terms of U.S. dollars) owing to poor weather-affected harvests (Table A24). Lower prices associated with a return to normal crop seasons were the main source of increased producer subsidy equivalents in 1990.

Table 15.Total Transfers Associated with Agricultural Policies(In percent of GDP)
1979–811983–8519861987198819891990

Estimate
Average
Australia0.40.50.50.30.20.20.2
Austria1.72.62.83.22.72.22.4
Canada0.91.72.22.21.91.41.4
EC-1211.62.52.92.82.52.12.2
Finland6.84.94.84.34.3
Japan1.72.82.82.82.42.32.1
New Zealand0.82.03.80.30.50.30.2
Norway3.94.03.93.64.1
Sweden2.61.91.61.61.5
Switzerland3.23.23.12.92.8
United States0.81.92.11.81.41.41.3
Average OECD21.32.22.52.42.11.81.9
Sources: Organization for Economic Cooperation and Development (OECD), Agricultural Policies, Markets and Trade, Monitoring and Outlook (Paris), various issues; and International Monetary Fund, International Financial Statistics, various issues.
Table 16.Net Producer Subsidy Equivalents1

(In percent of total value of production)2

1979–811983–8519861987198819891990

Estimate
Average
Australia914161191011
Austria36374948473946
Canada24334949423741
EC-12337355049464148
Finland6872737072
Japan57657576747168
New Zealand182433147555
Norway7676767577
Sweden6057525259
Switzerland8080787378
United States16254241342930
Total29345150464144
Source: Organization for Economic Cooperation and Development, Agricultural Policies, Markets and Trade, Monitoring and Outlook (Paris), various issues.

Some major shifts in the pattern of agricultural trade occurred in the 1980s. The United States is the largest agricultural exporter; the value of its exports declined for much of the 1980s but rose sharply in 1988 (Table A25). The EC is the second largest exporter, and the largest agricultural importer. It was the largest net importer of agricultural products in 1980, but the size of its net imports has declined steadily. Japan became the largest net importer by 1983 and has experienced strong growth in agricultural imports since 1987.

Cereals are the main food commodity traded internationally; the largest exporters are the industrial countries; the largest importers are developing countries (Tables A26 and A27). The United States, the largest exporter, lost some market share in the mid-1980s but has subsequently regained most of it. The share of the EC in world cereal exports has continually expanded and the market shares of Australia and Argentina have declined since 1987. The volume of Japanese cereal imports has grown slightly since the late 1970s, but EC cereal import volumes have fallen dramatically. Cereal imports of North Africa have stabilized at around the levels of the mid-1980s, but those of sub-Saharan Africa have declined sharply.

United States

The system of agricultural support in the United States is very complex; some basic features are outlined in Table A28. The operation of these policies has generally remained the same since 1985, although in 1990 limited progress toward an increased market orientation for export crops was made.105 While it was expected that the changes to farm policies would reduce agricultural spending, lower world prices have increased budgetary costs (Table A29).

Support for cereals, the main export crop of the United States, is now mainly based on income support through the system of deficiency payments. The major change introduced in the 1985 Farm Bill was the substantial reduction in support prices (loan rates) for cereals while farmers’ incomes were sheltered by target prices, on which deficiency payments are based and which were only reduced slightly (Table A30). In the 1990 Farm Bill, target prices were kept at their 1990 level. This system of deficiency payments entails high levels of budgetary expenditures when world prices are low, as in 1985/86–1986/87 and probably in 1990/91 (Table A31). Expenditures are partly limited by the operation of the set-aside, which reduces the acreage on which deficiency payments are based and restrains production to prevent further declines in world market prices.

The 1990 Farm Bill only addressed a limited range of distortions created by the support system for cereals. First, because payments are related to farm size there is an incentive to expand the size of the farm, often using new land that is only marginally productive and environmentally fragile. Second, deficiency payments are based on participation in a program crop and producing another crop reduces the entitlement to such payments. The 1990 Farm Bill partly addressed these problems by tightening some environmental provisions and by introducing some options to increase planting flexibility. Nevertheless, deficiency payments continue to contribute to increased production by supporting production at levels of average costs that are above world prices.

The export subsidies under the Export Enhancement Program (EEP), mainly on cereals, were continued in the 1990 Farm Bill. The limit on EEP spending was replaced by a minimum funding requirement of $500 million annually. It is expected that $900 million and $1,200 million will be spent in the 1991 and 1992 fiscal years, respectively; the latter is above the high levels of the mid-1980s when export competition drove grain prices to very low levels (Table A31). Thus, while the EC budget is put under stress, unsubsidized exporters bear the brunt of the adjustment to low world prices as shown in Table A26. Recently, U.S. wheat has been exported to Brazil with EEP bonuses, under protest from Argentina and Uruguay. Australia has also protested strongly at the use of the EEP in markets where it has been traditionally strong, for example, in the Middle East and China.

Restrictions on imports competing with domestic agricultural production remain tight (Table A32). In 1990, a GATT panel found that quotas imposed on raw sugar under a headnote to the U.S. Tariff Schedule were not consistent with the GATT. To bring them into compliance with the GATT, the quotas were converted to tariff quotas with a prohibitive tariff for imports in excess of the quotas. The quota on peanuts, one of the products protected by quotas under the 1955 waiver from the GATT, restricts imports to very low levels. Domestic supply problems resulted in a decision to increase the quota in 1991, but a very short time frame for bringing in imports resulted in a low level of actual imports. Imports of dairy products also remain restricted, and reductions in the support price for milk from its 1990 level were ruled out until 1995. The continued tendency for excess supply has resulted in renewed Commodity Credit Corporation (CCC) accumulation of dairy stocks.

The 1990 Farm Bill included a “GATT trigger” under which, if there is no agreement in the Uruguay Round by mid-1992, export competition from the United States will be intensified. The measures provide for increased funding of the EEP by $1 billion, marketing loan programs for wheat and feedgrains (which effectively are also export subsidies) (see Table A28), and a waiver of the set-asides. These measures, if implemented, would both push down world prices significantly and greatly increase budgetary costs.

A recent study by the U.S. Department of Agriculture (USDA) suggests that relatively little would have to be modified in the 1990 Farm Bill if the proposals made by the United States in October 1990 in the Uruguay Round group on agriculture were accepted.106 Increases in world prices for grains would be expected to reduce support levels sufficiently to enable the commitment on internal supports and export subsidies to be met. There would have to be some reduction in support prices for dairy products and sugar, which could reduce incomes of those producers by up to 10 percent. With the anticipated world price increases, the income of the U.S. farm sector could rise by $1–2 billion in 1996.

European Community

The need to reform the CAP has been a recurrent issue for many years. High levels of support for agriculture in the EC, which had a producer subsidy equivalent ratio of 48 percent in 1990, have significantly reduced the EC’s net food imports since the 1970s, and substantially increased self-sufficiency ratios (Table A33). The CAP has been under great pressure to reduce the drain on the EC budget, to recognize the export interests of other countries, especially those undergoing economic reforms, and to unlock the Uruguay Round.

In Kelly and others (1988), it was noted that the range of measures agreed to in February 1988, while a first step at reform, focused mainly on reducing the budgetary cost of the CAP but did not increase market access for imports or reduce directly the extent of subsidized exports. The February 1988 measures completed the system of “stabilizers” for each of the main products and set an overall limit on the increase in EC spending on agriculture to not more than 74 percent of the rate of increase in the GNP of the EC.

Although EC agricultural spending was limited by higher world prices for food products in 1988–89, subsequent world price declines, a large accumulation of beef stocks, and the additional cost of support in eastern Germany placed pressure on spending in 1991. Estimates in early 1991 indicated that CAP spending would increase in 1991 by a record 32 percent, to ECU 36.6 billion, or about ECU 1.1 billion over the budget guideline (Table A34), although ECU 1.5 billion was attributed to the cost of German unification.107 The 1991 price package agreed on at the end of May 1991 held spending close to the budgetary guideline although it did not address the major reform issues. The price package included a slight reduction in the support price of cereals (Table A35) with an increase in the co-responsibility levy to 5 percent, but producers who set aside 15 percent of their acreage would receive an exemption from that levy, a 2 percent reduction in the quotas for milk, and a slight reduction in the intervention price for beef.

Pressure for the reform of the CAP has been mounting in Europe. There remains the continuing disparity of price supports benefitting the more affluent farmers in northern countries more than the smaller and poorer farmers in the southern countries. Also, there is a growing awareness of the environmental consequences of the intensive agriculture encouraged by high price supports. In addition, an expansion of the EC to include some EFTA countries108 would magnify current problems under an unreformed CAP. The reforming Eastern European countries need a destination for their exports. The EC is an attractive market for farm products from Eastern Europe but these are limited by restrictions; the export of beef to the EC has been blocked by EC activation of its quotas to avoid further growth in stockpiles.

The proposals of the EC Commission for the reform of the CAP issued in mid-June 1991 called for substantial reductions in support prices with offsetting direct income support. The main reforms proposed were for cereals where support prices would be reduced by about 35 percent to ECU 100 a ton over three years. Under a scheme similar to the U.S. system of deficiency payments for cereals, compensatory payments would be made to compensate for the reduction in support price. Comparable arrangements would be introduced for oilseeds and protein crops (which are alternate crops for cereal farmers). The compensatory payments would be based on a regional yield and a farm area adjusted for the proposed set-aside, initially set at 15 percent for the combined area of cereals, oilseeds, and protein crops. Farms of 20 hectares or less would be exempt from the set-aside; compensation for the set-aside would be subject to a ceiling of 7.5 hectares so that farms of over 50 hectares would not receive an additional payment on the set-aside. Once EC market prices are aligned with world prices, export refunds would no longer be required. Beef support prices would be reduced by 15 percent because of lower feed costs. Milk quotas would be cut by 4 percent. An early retirement scheme would be introduced for farmers aged 55–65 (about half the EC farmers), and there would be increased incentives for using farmland for forestry. Budgetary spending would initially rise as the costs now borne by consumers would be transferred to the budget. However, the Commission estimates that if the plan becomes operational by 1993, by 1997 the cost of the reformed system would be below the cost of the current policies extrapolated to that date.

Initial reactions by EC member agriculture ministers were mixed. Ministers from the northern countries criticized the proposals; the French, German, and U.K. ministers would prefer direct controls on supply, which have a lower budgetary cost. The U.K. minister also criticized the reduced payments to larger farms on the grounds that such payments would encourage inefficient small farms. Ministers from the southern countries broadly supported the plan with its full compensation to small farmers. While the Commission’s proposal was not entirely acceptable to all EC members, it could provide a basis for completing negotiations on the reform of the CAP. For a discussion of some of the issues related to agricultural reform see the section below titled “Approaches to the Reform of Support Policies.”

Japan

Although there has been liberalization in some agricultural products and progressive declines in the producer subsidy equivalency ratios, basic food commodities remain highly protected in Japan.109 Japan is the largest net importer of food and its overall self-sufficiency ratios remain very low, at about 30 percent for all grains but 100 percent for rice (Table A36). Support prices have been reduced progressively for almost all products since 1985 (Table A37) but for rice the support price is still about six times the world price. While budgetary spending on agriculture has fallen since 1980 (Table A38), most support is paid by consumers as a result of substantial import barriers (Table A22); the level of Japanese support, as measured by the producer subsidy equivalency ratio of 68 percent in 1990, is the highest of all the OECD countries, except some of the EFTA countries. Unlike the other major trading countries, there is no discussion of fundamental reforms for the major commodities (e.g., rice) through explicit steps to make the Japanese agricultural sector more responsive to world market prices. Some suggestions have been made to provide import access to a relatively small share of the domestic rice market. In the Uruguay Round, Japan has stressed the need to eliminate export subsidies as well as the need for provisions to ensure food security in basic foodstuffs.

Liberalization has occurred in a number of food items over the past few years. In line with agreements with the United States, Australia, and New Zealand, as of April 1991, the quotas on beef were eliminated and replaced with tariffs that will be progressively reduced.110 Imports of apple juice, oranges, and processed dairy products have been liberalized and nontariff barriers on imports of other minor products have been eased.

The main food products, especially rice, remain highly protected. The producer price of rice was reduced from ¥311 in 1986 to ¥275 per kilogram. This, together with increases in the world price for rice, has reduced the ratio of the support price of rice to world prices from about nine times in 1986, to six times in 1990 (Table A39).111 The current very high support prices tend to generate excess production, even with the current cost structure of farms, but relatively tight supply control systems are used to prevent the emergence of excess supply. Some limited steps have to be taken to improve the market orientation of rice production by excluding less efficient growers from the formula used to set support prices and to partly liberalize distribution of rice.

Although food security through self-sufficiency is an important goal of Japan’s rice policy, current policies do not achieve this objective efficiently. Food security requires efficient or potentially efficient production, but support policies and other regulations have resulted in highly inefficient rice farms. In 1985, the average size of rice farms was about 0.6 hectares, about 29 percent of farmers were over 65 years old, and only 20 percent of farm households were considered to have farming as their primary means of support.112

EFTA Countries

The EFTA countries have high levels of protection for their agriculture. In 1990, Norway, Finland, and Switzerland had producer subsidy equivalency ratios of more than 70 percent, although Austria and Sweden had lower levels of 46 percent and 59 percent, respectively (Table 16). In Finland and Norway, producer prices generally increased in 1990, and in Finland an additional flat subsidy was introduced to avoid an increase in cereal prices. The high producer prices in all EFTA countries are maintained mainly by import restrictions and deficiency payments related to production. Export subsidies are also used to dispose of excess production. In Finland, there are some additional income supports that are modulated in terms of farm size or region and are not linked to production.

Support for agriculture in Sweden is now in the process of being reduced. In the period up to 1986, support levels increased significantly, but as this did not provide reasonable food costs and an efficient use of resources, a program of reform was initiated in July 1990. The first round related to the deregulation of the domestic distribution arrangements. The second round—the phasing out over a three-year period of administered prices and export subsidies—started in July 1991. Supplementary income supports will be given to grain producers during the transitional period only. The government has undertaken to reduce border protection in the context of an agreement in the Uruguay Round.

Canada, Australia, and New Zealand

Canada, Australia, and New Zealand are all export-oriented agricultural producers with a strong interest in reform, as reflected by their membership in the Cairns Group.113 Despite this interest, Canada had a producer subsidy equivalency ratio of 41 percent in 1990 with an extensive income support system and a heavily protected, domestically oriented agricultural sector. Australia and New Zealand, after their reforms, have the lowest levels of agricultural support of the OECD countries.

Canada has introduced a major change to a substantial part of the country’s support programs by rationalizing them under a standard framework. This has been done by the introduction of the Gross Revenue Insurance Plan (GRIP) and the Net Income Stabilization Account (NISA), which for 1991/92 have been implemented for grains and oilseeds. The two programs are designed to replace the temporary measures provided in the recent past. The new schemes shelter the income of Canadian producers from variations in yields and price fluctuations. The protection for Canada’s import-competing products remains high. In 1990, a GATT panel found that Canada’s import restrictions for ice cream and yogurt were inconsistent with GATT Article XI.2(c). Canada has undertaken to bring these restrictions into conformity with GATT in light of an agreement in the Uruguay Round.

Australia has liberalized most of its agricultural sector. Controls on wheat marketing and sugar imports have been lifted. Under the Australia-New Zealand Closer Economic Relations Trade Agreement (ANZCERTA), free trade was established on goods with New Zealand in July 1990, including dairy products, thus subjecting Australian processed dairy products to world prices. The operation of the wool reserve price system of the Australian Wool Corporation (AWC) created severe problems for this sector by supporting a wool price in 1990 that was no longer viable. In February 1991, the Government suspended the wool reserve price system by which time the AWC had accumulated stocks equivalent to about one year’s supply and a government guaranteed debt of $2.4 billion. During this time other wool-growing countries benefitted from the high prices, although it is now expected that prices will remain relatively depressed until the surplus stocks are eliminated.

New Zealand is the industrial country that has most completely liberalized its agriculture, but the full gains from the liberalization have not yet emerged. The reforms in New Zealand since 1984 were part of a general liberalization of all sectors of the economy. It was expected that the liberalization program would benefit the farm sector as resources shifted there on the basis of comparative advantage. However, while some important adjustments have taken place in the farm sector, including the diversification into a range of horticultural products and nontraditional livestock, it has remained weak. Macroeconomic developments, including an appreciation of the real exchange rate and high real interest rates; the much slower liberalization of the manufacturing sector, resulting in negative effective rates of assistance to the agricultural sector; and continued low world prices of farm products partly caused by policies of other industrial countries, have worked against the agricultural sector in New Zealand.114

Eastern Europe

Since the early 1970s, Eastern Europe and the former U.S.S.R. had been a major source of increased demand for agricultural products, mainly cereals, but the reforms in these countries are likely to change this situation dramatically. Despite having more arable land per person than Western Europe, Eastern Europe and the former U.S.S.R. as a group had become major net importers of agricultural products because of both lower productivity and much higher losses in the food distribution system.

As reforms in Eastern European economies take hold, agricultural exports are likely to increase. The initial exportable surplus has come from reduced demand as food subsidies have been cut back, but after a short lag, there should also be a significant supply response.115 While initial conditions vary across countries, the experience of China and Viet Nam suggests the agricultural sector can have a strong and relatively quick supply response to market-based reforms. Hungary, for example, which has been a grain exporter to other Eastern bloc countries in the recent past and to much of Europe in the prewar period, could again return to world markets. The implications of this for world markets depends on the responses of other countries; if barriers to agricultural products remain, increased exports from Eastern European countries will place further downward pressure on world prices for food products, thereby weakening the reform efforts of a broad range of countries. Mounting surpluses in Czechoslovakia have resulted in a plan to subsidize farm exports. The move toward trade in convertible currencies between the former members of the CMEA has also reduced regional exports as the United States and EC are able to offer the Commonwealth of Independent States generous credit terms for their agricultural exports.

Developing Countries

As with the industrial countries, the trade and trade-related aspects of the agricultural policies of the developing countries are complex. In general, however, the policies of many developing countries have resulted in a net bias against agriculture, although this has been reduced in the context of recent structural adjustment programs. Continued progress in this direction is necessary to enable developing countries to take advantage of market opportunities. Developing country exporters would gain from the liberalization of agricultural trade by industrial countries, mainly from the liberalization of temperate products but also from liberalization in tropical products. Reductions in direct and indirect export subsidies by industrial countries and domestic reforms in developing countries would enable food importers to improve their self-sufficiency in food. The liberalization of developing countries’ direct support for agriculture should be coordinated with the rest of their structural adjustment programs to avoid increasing the negative effective rates of protection on agriculture.

The biases against agriculture resulting from exchange rate and industrial protection policies in developing countries up to the mid-1980s have been significant. In a recent study, Krueger, Schiff, and Valdés (1988) examined the net effects of direct and indirect policy interventions on export crops and food crops. In the case of export crops, the net effect of policies was highly negative at minus 40 percent. For food products, the positive direct support did not offset the negative indirect effects of other policies; the net effect was minus 6 percent. However, upper-income developing countries, especially Malaysia and Korea, have tended to give their import-competing agricultural sectors more positive support. If these countries are excluded, the average net impact of policies on food crops in the remaining countries was strongly negative, minus 22 percent.

The net effect of policies was derived from direct and indirect support. Direct support was taken as the difference between domestic producer prices, net of explicit taxes, and world prices at the official exchange rate; in 1980–84 for export crops and food crops this averaged minus 11 percent and plus 21 percent, respectively (Table A40). For export crops, the negative support was due to export taxes and excessive margins retained by state trading entities; for food crops, high domestic producer prices and input subsidies for materials and credit contributed to the positive support. Indirect support was calculated as the divergence between the official exchange rate and the exchange rate that would have prevailed under well-functioning markets with free trade, plus the effects of protection for the industrial sector, and was estimated to average minus 29 percent in 1980–84.

Since the mid-1980s, most developing countries have undertaken important structural adjustment programs that have addressed many of these problems. There have been significant reductions in the taxation of exports, and steps have been taken to correct misaligned exchange rates, and to improve the targeting of food subsidies. Progress has also been made, although of a more limited character, in reducing the protection for the manufacturing sector in many of the low-income developing countries.116 A reduction in the biases against agriculture is important to enable developing countries to take advantage of liberalization by industrial countries, as domestic economic problems have at times constrained the supply response by developing countries. For example, Brazil, a large sugar producer, has recently had to import sugar and has been unable to meet its quota allocations for sugar exports to the United States. In this connection, however, the reduction of the direct support for the agricultural sector should be coordinated with the reform of industrial policy. As shown in the case of New Zealand, welfare gains are likely to be reduced if agriculture is liberalized ahead of a more highly protected industrial sector.

A strong domestic food industry has often been recommended as an important element for diversifying the productive structure of developing countries, but it is important that this be achieved efficiently. The volatile nature of earnings from their export crops results in problems for developing countries with the management of their economies and foreign exchange flows. Since export price stabilization schemes have not generally proved successful, an alternative is a more diversified agricultural sector.117 The programs supported by the Fund and the World Bank have sought to aid the agricultural sector by reducing the biases against it, both direct and indirect, while Bank projects have contributed to improved infrastructure and information services. Some reports on this problem have stressed the importance of fostering increased domestic food production capacity with the aim of self-sufficiency.118 While direct positive support through import restrictions on agricultural products may produce a quick supply response in the protected products, the efficiency of such production is often low. Also, strong net positive support for import-competing agriculture, in the presence of net support for industry, is likely to increase the bias against export-oriented agriculture.

The Reform of Agriculture

Rationale for Agricultural Support

The rationale for agricultural support is made along three main lines: (1) agriculture provides some important externalities or noneconomic benefits that need to be supported; (2) support can influence other countries’ policies directly or can be a bargaining chip in trade negotiations; and (3) as discussed immediately above, mainly in the case of developing countries, direct support is needed to preserve the sector that is adversely affected by indirect biases against it from industrial and exchange rate policies.

Noneconomic justifications for agricultural support are based on the view that free markets would not achieve some goals that are considered to be socially desirable. These goals include food security, the preservation of small family farms, a certain type of landscape, and a certain regional pattern of development—especially to avoid the centralization of populations.

The need for food security in the basic crops has been strongly argued by Japan, Korea, Switzerland, and the Nordic countries. While it is clear that food is a necessity, it is important to distinguish between food security and self-sufficiency. Food security could be achieved through stockpiles and diversified supply contracts with other countries rather than by self-sufficiency. Japan, for example, is highly dependent on many imported commodities in addition to food, such as energy and inputs for agriculture, and has secured relatively stable sources of supply for these commodities. Compared with other essential commodities, the sources of food exports are very diverse so that alternative supplies are generally available in case of an embargo. Hostilities need to reach the stage of a blockade before there may be an appreciable effect.119 Also, the best strategy for self-sufficiency during an embargo may not be self-sufficiency during normal times since intensive farming can degrade the quality of farmland.120

Other noneconomic reasons, such as support of the family farm, regional development, and the natural environment and traditional landscapes, should also be scrutinized to find the most efficient means of achieving these goals.121 The experience of the EC and the United States has shown that market price supports mainly benefit large farmers and those in the highly productive regions. To the extent that farm size and regional goals are strongly desired, carefully targeted income supports not related to production, but directly to the goal, should be used. Indeed, the preference for small farms may reflect the more fundamental desire of retaining a certain population pattern in some regions. Regional objectives may be better supported by providing infrastructure and leaving the market to decide whether agriculture, industry, or services should develop in that region. Intensive farming resulting from high support prices has a very damaging effect on the natural environment owing to high levels of pesticide and fertilizer use.122 Payments for farming, including those decoupled from production levels, create an incentive for farming compared with alternative land uses, including grazing, forestry, and recreational uses. Many of the marginal farmlands in remote areas are ill-suited to farming, which has degraded the quality of the land. Direct incentives for conservation uses as in the United States and the proposed reforms of the CAP are second-best policies; a reduction in direct incentives for farming would be more efficient.

The tactical rationale for support is relevant for both large and small countries. A large country may choose to intensify its subsidies to influence the offending policies of another country; for example, the United States has attempted to direct the EEP against the EC’s export subsidies. While this strategy may have increased the market share of the United States and increased the pressure for the reform of the CAP, the effects on smaller third countries need to be considered. Evidence suggests the increase in the market share of the United States has been at the expense of smaller nonsubsidizing exporters (Table A26). Some smaller countries have high levels of support, despite an internationally competitive agricultural sector, for example, Canada. In some of these cases, support has been justified as a “defensive” strategy against price swings amplified by protection and export subsidies in other countries.

Studies of the Gains from Liberalization

Liberalization in Industrial Countries

Recent estimates in studies confirm that the economic costs of agricultural support policies are high. Aside from the actual value of the transfers, the burden to taxpayers and consumers of support policies is reflected both in terms of static welfare losses, measured by partial equilibrium (or single sector) models, and the loss of competitiveness of the more efficient sectors from the support of the less efficient sectors and the resultant higher real wages (in terms of world prices), as analyzed by general equilibrium models. In all these models the costs of agricultural support policies are generally measured by complete liberalization; this is distinct from the impact of a possible Uruguay Round agreement that may involve only a partial liberalization.

The models that focus on the response of the agricultural sectors across countries to liberalization are useful in analyzing the effects of support policies on prices for agricultural products and trade flows. Table A41 shows the latest estimates of the price effects from various models. Overall there would be a significant rise in the world prices of most agricultural products, especially those that now have high rates of domestic support, such as dairy products, sugar, and meats. The results are less clear-cut for cereals. One group of models (the Tyers and Anderson (1) and the Krissoff, Sullivan, and Wainio (USDA) models) shows that there would also be a significant increase in the price of cereals, while another group (the Moreddu and Huff (OECD-MTM), Tyers and Anderson (2), and Zeitz and Valdés models) suggests that there would be price falls.123 In general, the studies have also assumed that policies of Eastern Europe and the former U.S.S.R. will remain unchanged from the base period, that is, this group will remain a net importer. Policy reforms by these countries, as noted above, should eventually reduce their net import demands, with the effect of reducing prices compared with those prevailing in the 1980s.

These models of agricultural markets show substantial gains to consumers and taxpayers, as a result of liberalization, that are significantly greater than the costs to producers. One study shows, based on support levels in 1986/87, that complete liberalization would result in a net welfare increase of $35 billion (Table A42).124 Producers would lose $66 billion but consumers and taxpayers would gain $104 billion from complete liberalization. Since an agreement in the Uruguay Round would not rule out nondistorting supports, some of the producer losses could be offset by transfers that would leave the net benefits roughly unchanged.

The impact of agricultural liberalization is also important for the rest of the economy. One model, the OECD’s WALRAS model, estimates that OECD income could rise by about 1 percent, $72 billion in 1988 prices and exchange rates, which is significant in comparison to agriculture’s 3 percent share of GDP. It suggests that agricultural output would decline by about 14 percent for the OECD and by 19 percent and 24 percent for the EC and Japan, respectively. Output in the nonagricultural manufacturing sectors would increase, especially in the EC and Japan, with increases of 2–4 percent. In terms of cost per job “saved” in agriculture the WALRAS model suggests that this would vary from about $13,000 in Japan, to $20,000 in the EC and the United States, and $100,000 in Canada.125

Liberalization in Developing Countries

The effect of liberalization on agriculture in developing countries depends greatly on their individual economic policies. Many agricultural exporters would gain substantially, with the amount increasing with the degree of structural reform in their economies. Food-importing developing countries would roughly break even in terms of their agricultural trade balance if they passed through the full value of the price increases. Further liberalization of developing countries’ agricultural and industrial policies would produce very significant gains.

The importance of a reduction in support levels in industrial countries for most developing countries is highlighted by the results of some multi-country models (Table A41). Their baseline scenarios show that the agricultural trade balance of all developing countries combined would increase substantially.126 Latin America and Asia, where there are major food exporters, gain very substantially. The results are less clear for North Africa and the Middle East where the gains are smaller but are only negative in one of the four studies presented. The loss in sub-Saharan Africa comes from the model using a 1981–83 base period. Models using more recent base periods show this region gaining.

Two models designed to analyze the effects of industrial and developing country liberalization are Tyers and Anderson (1992) and Krissoff, Sullivan, and Wainio (1990).127 Their alternative scenarios assume developing countries liberalize their own economies by completely removing distortions affecting their agricultural and industrial sectors and realign their exchange rates to market clearing levels. These assumptions result in an improvement in the agricultural trade balance for all developing countries of about twice that in the baseline scenarios and is positive for all regional groups. The sustained implementation of structural adjustment programs that have been undertaken by most developing countries is likely to mean that the impact of industrial country liberalization is closer to that shown in the alternative scenarios.

These results underscore the importance of industrial country liberalization for supporting the reform efforts of developing and Eastern European countries. The liberalization of the agricultural policies of the industrial countries, especially improved market access, is important to current and potential food exporters, to enable them to support their liberalization programs and to restore their growth on an efficient and sustainable basis. Major increases in net supply from Eastern European countries and the Commonwealth of Independent States, without improved market access in industrial countries for all countries, will only add to the intense trade conflicts in this sector. Liberalization should not only be in the temperate food products but also in tropical products and should seek to reduce the escalation of tariffs and nontariff barriers on such products. Such products are important for a broad range of developing countries, including those that import significant amounts of food.

Approaches to the Reform of Support Policies

Three broad approaches to the reform of agricultural policies are widely discussed. The first is based on nonmarket intervention to restrict domestic supply while retaining import restrictions to maintain high support prices. The second would allow production to be sold at roughly world market prices, thus obviating the need for import restrictions and export subsidies, but provide general direct income support to compensate farmers for lower prices. The third alternative is similar to the second but income support would be targeted to achieve specific objectives after it has been determined that the optimal method to attain the non-economic goals is indeed a subsidy.

Nonmarket Intervention

Proponents of this approach to reform note the problem of excess supply in agricultural markets and advocate overcoming it by restricting supply by means of direct controls. In conjunction with import restrictions this approach can maintain a high domestic support price, which is effectively paid for by consumers rather than by the budget; this enables farmers to claim that they are earning their living from the market rather than from “government handouts.” The volume of subsidized exports would be determined by the severity of the supply controls. Proponents point to GATT Article XI:2(c), which permits the use of import restrictions to enable the operation to supply controls on a like product. Recent GATT panel reports have restricted the applicability of this provision, but many countries want the applicability of Article XI:2(c) to be broadened.128 Market access would be negotiated and set in terms of quotas at levels that could be above the current ones. Proponents of specific provisions for food security also advocate some modification to the GATT to permit import restrictions for this purpose.

The main problem with this approach is that it maintains current inefficiencies and thus can inhibit further reform.129 The high support prices under this approach are paid by consumers, while large producers are able to obtain most of the benefits from this system. In addition, the high marginal return on production induces excessively intensive production that results in high levels of pesticide and fertilizer use that has damaging environmental consequences. While quotas could be set at levels that are attractive to some exporters, especially because these may also benefit from the rents, they do not fully address the rights of all potential exporters, especially those currently reforming their economies and that have yet to realize their full supply potential.

Generalized Income Supports

Generalized income supports also create market distortions, although they are less severe than those created by market price supports. In the above survey of recent developments in support systems, it was observed that some form of direct income support had been adopted by countries seeking to improve the efficiency of their agriculture while maintaining the income levels of farmers. This includes the United States, Canada, Sweden, and the EC Commission’s proposal for the reform of the cereal sector of the CAP. In all of the above cases, except Sweden, the income supports are generalized; typically, the subsidy is calculated per unit as the difference between a “target price” and the market price. Thus, they may be considered production or farming subsidies as they are either related to past, present, or future production or a factor of production (often land) and require the recipient to be engaged in the production of crops or a particular crop.130

Since this form of support does not require border protection, the cost to consumers is eliminated and the support is funded entirely from the budget. Budgetary spending will increase substantially, as was the case in the United States and is expected in the proposed reform of the CAP. This increase can be limited by land set-asides and from second-round increases in world prices as export subsidies and production are reduced. Explicit export subsidies would not be required, but income supports under the current schemes would be paid on exported production.131 However, as noted in the case of the United States, generalized income supports can have a significant production-enhancing effect compared with no supports, because they enable farmers to operate at higher levels of average costs, are based on farm area, and are linked to the production of specific crops.

Targeted and “Pure” Income Supports

The problems of the production-enhancing effect and high budgetary cost of generalized income support should be addressed efficiently through better targeting of the support to desirable noneconomic factors rather than the use of supply controls. Compared with market price supports, income supports can be targeted to achieve certain objectives and to foster desirable noneconomic benefits. Reducing the relationship of these supports to production, factors of production, and farming activities, as well as the duration of the supports mitigates the impact on production. One role of income supports is to compensate farmers for their loss of the distorting market price supports, but there is no reason to do this in perpetuity. The cost and the production-distorting effect could be reduced if payments are made only to current farmers on the basis of current farm size and possibly only for a transitional period; Sweden has adopted this form. Attractive early retirement schemes are also useful in restructuring farms that would not be viable at world prices when a large proportion of the farm population is close to retirement age, as in the cases of Japan and the EC. While targeted income supports may not be the most efficient means, they can also be used to promote regional development.

Concluding Comments

A decision on the reform of the CAP has acquired a highly visible position, and it is important that such a decision reflect the role of the EC in the international trading system. Initial reactions by some EC agriculture ministers have focused on the high budgetary costs and the inefficiencies that may result from higher support levels per unit of output directed to small farms. Solutions to reduce budgetary costs proposed by some EC members entail continued market price supports bolstered by supply restrictions. These would, however, give rise to the problems noted above. Lower rates of support for large farms through the operation of the set-aside scheme that reduce the budgetary cost have been criticized as promoting inefficient production methods. However, it is unlikely that the roughly 15 percent margin in unit levels of support for small farmers will create an incentive for inefficient farms, as the cost advantages of large farms typically exceed this margin. Further improvements in the targeting of income supports or reduced unit levels of support are the most efficient ways of reducing the budgetary costs.

The proposed system of generalized income supports for growers of cereals and oilseeds, while an improvement on the current CAP, would have production distortions comparable to support systems in the United States and Canada. As noted earlier, all these direct income support systems entail significant production distortions. Thus, it is essential that support levels are reduced substantially and market orientation in agriculture is increased in all industrial countries.

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