Measuring the Impact of Distortions in Agricultural Trade in Partial and General Equilibrium

Contributor Notes

Author’s email address: Stokarick@imf.org

This paper provides quantitative estimates of the impact of removing agricultural support (both tariffs and subsidies) in partial- and general-equilibrium frameworks. The results show that agricultural support in industrial countries is highly distortionary and tariffs have a larger distortionary impact than subsidies. Removal of agricultural support would likely raise the international prices of food, resulting in an increase in the cost of food for many net-food- importing countries, although the increase is generally small. The results also show that most of the benefits from removing agricultural support accrue to the countries that liberalize.

Abstract

This paper provides quantitative estimates of the impact of removing agricultural support (both tariffs and subsidies) in partial- and general-equilibrium frameworks. The results show that agricultural support in industrial countries is highly distortionary and tariffs have a larger distortionary impact than subsidies. Removal of agricultural support would likely raise the international prices of food, resulting in an increase in the cost of food for many net-food- importing countries, although the increase is generally small. The results also show that most of the benefits from removing agricultural support accrue to the countries that liberalize.

I. Introduction

To say that markets for agricultural commodities are highly distorted would be an understatement. Indeed, many countries—mainly the orgnization for Economic Cooperation and Development (OECD) countries with their high per capita income—provide support to their agricultural producers through a complex array of policy measures, such as tariffs that discriminate against agricultural imports, subsidies that enourage greater production and exports, and input subsidies that effectively lower the cost of production. These support policies are often cited as important obstacles to more rapid development of low-income countries, as well as a major reason farmers remain mired in poverty in developing countries. Both the International Monetary Fund and the World Bank have called on OECD countries to eliminate the support they provide to their agricultural sectors in order to reduce poverty and spur economic development. At the World Summit on Sustainable Development conference in Johannesburg in 2002, world leaders also called for a reduction (and eventual removal) of agricultural support in rich countries, especially on products of export interest to developing countries. Indeed, a broad-based, international consensus has emerged that agricultural support policies in OECD countries are detrimental to the interests of developing countries.

There is no question that agricultural support in OECD countries harms developing countries and the world as a whole. Thus, removal of support in OECD countries would raise real income in the world and developing countries as a group. But the inflamed political rhetoric has led many observers to lose sight of two important aspects of the economic impact of removing agricultural support, especially on developing countries. First, nearly all empirical studies demonstrate that the bulk of the costs of agricultural support fall on the country that imposes such policies and not on other countries. In other words, agricultural support policies hurt OECD countries relatively more than they hurt developing countries. As is well known, the costs of distortions depend on the size of the distortion, the relevant elasticities, and the share of the affected commodity in GDP (share of imports in the case of a tariff).2

The second aspect is that subsidies provided by many OECD countries actually benefit some poor, developing countries. This occurs because industrial countries generally apply subsidies to commodities that they export, which tends to stimulate production and thereby depress the world prices of these products. As a consequence, developing countries that are net importers of these commodities actually benefit from subsidies applied by industrial countries because they can import these goods at a lower price. The subsidies have opposing effects on different groups within the developing country, as producers would be hurt and consumers would benefit. On balance, in net-importing countries, the gain to consumers would outweigh the loss to producers. The results of a number of empirical studies reveal that tariff barriers in OECD countries actually inflict more damage than subsidies on developing countries.

Agricultural subsidies in OECD countries do, however, hurt countries that are net exporters of subsidized products, as the subsidies reduce world prices and the export earnings of competing countries. Thus, the net impact of agricultural subsidies applied by OECD countries on developing countries depends on whether the country is a net importer or exporter of the product to which the subsidies apply. In the context of a multilateral initiative to remove agricultural support—as called for under the Doha Round of trade negotiations-recognition should be taken of the differential impact of liberalization across countries. This was done in the context of the Uruguay Round, but needs to be kept in mind in future trade rounds as well.

The impact of agricultural support in OECD countries depends largely on the structure of trade across countries, the types of support, and the commodities to which they apply. As shown below, agricultural subisidies in OECD countries apply mostly to commodities that they export—temperate zone products such as grains (wheat and corn)—tend to be net importers of these products. However, there are a few exceptions to this rule. Production of rice and cotton are subsidized in some OECD countries, and these products are important sources of export earnings for some poor countries. Products that constitute major sources of export earnings for developing countries, such as coffee, tea, and cocoa, are not subsidized in OECD countries largely because they are not produced there. As shown below, the major source of gains for developing countries would arise from removal of tariffs, rather than subsidies, in OECD countries. Therefore, to estimate the impact of agricultural support in OECD countries on developing countries, a detailed analysis, which takes into account the specific type of support and the net trade pattern by commodity and country, is required.

This paper has several objectives. First, the next section identifies the major factors that influence the size of the welfare impact of removing agricultural support in countries that liberalize, as well as those that do not. The third section provides a profile of the magnitude of agricultural support in OECD countries, the principal countries that intervene, and the commodities that are affected. The fourth section provides details on the partial-equilbrium model of trade used to quantify the effects of removing agricultural support, while the fifth section provides the welfare effects of liberalization in terms of the effects on consumers, producers, and the government. The section also identifies the extent to which some types of agricultural support are more distortionary than others. The calculated changes in world prices are then used to estimate the impact of removing agricultural support in OECD countries on net-food-importing developing countries. The sixth section of the paper assesses the impact of agricultural support in a the context of a global general equilibrium model—one that takes into account the complex linkages that exist across countries. The final sectiion concludes.

II. The Economics of Agricultural Support

This section lays out the main economic principles that are relevant for an evaluation of the welfare effects of removing agricultural support. The emphasis is on identifying the factors the influence the size of the changes in welfare on a country that undertakes liberalization, as well as on countries that are either competing importers or exporters and who may not liberalize.

For a net-importing country that consumes two goods—food (which is imported) and all other goods—the change in welfare is a price-weighted sum of the change in consumption of each good:

dy=dDo+pdDF(1)

where dy is the change in real income, dD0 is the change in consumption of goods other than food, p is the domestic relative price of food (good 0 is the numeraire), and dDF is the change in consumption of food. Using the budget constraint that expenditure equals income from production plus tariff revenue, the change in real income can be written as:

dy=Mdp*+(pp*)dM(2)

where M is the quantity of food imports, dM is the change in imports, and (p–p*) is the difference between the domestic relative price of food (p) and the world price (p*) as a result of a support measure, such as a tariff.

Equation (2) demonstrates that the change in welfare due to a tariff can be decomposed into two parts: a distortionary effect [(p–p*)dm] and a terms-of-trade effect[-M dp*]3. In the case of a “small” country—one that cannot affect international prices—a tariff would only have a distortionatry effect, asme dp*= 0. At an unchanged terms of trade, a tariff that reduces the quantity of imports dM<0 would lower real income. In this case, the degree of the welfare loss is directly related to the size of the tariff. In the case of a large country, the effects of a tariff are ambiguous: the tariff depresses the world price and confers a terms-of-trade gain (dp*<0), but it also introduces a distortionaty effect.4 For a net-importing country then, the net-welfare effect of a tariff depends on the size of the terms-of-trade gain, relative to the distortionary cost.

For net exporters, the change in real income can be expressed as:

dy=Edp*(PP*)dE(3)

which is analogous to equation (2) for importers, where E is the quantity of exports, dE is the change in exports, (p – p*) is the difference between the domestic relative price and the world price (p*) of the subsidized export as a result of an export subsidy, and dp* is the change in the world price. As in the case of a tariff, the welfare effect of an export subsidy consists of a distortionary effect [-(p-p*)dE] and a terms-of-trade effect.[E dp*] Holding the terms of trade constant, an export subsidy reduces real income: the subsidy expands the volume of exports and raises p above p. In the large-country case, an export subsidy would depress the world price (dp*< 0), which would also reduce welfare. Thus, in this case, the distortionary cost and the terms-of-trade effect reinforce each other, so welfare unambiguously declines.

Equations (2) and (3) are also useful in evaluating how liberalization by a group of countries (e.g. developed countries) affects countries that do not liberalize. In the first instance, the effects of removing agricultural support in one country on a competing exporter or importer come through changes in the terms of trade. Net-importing countries that do not have distortions in place would be hurt by an increase in the world price of the supported product, while competing exporters would benefit. These results follow simply from equations (2) and (3), assuming p = p*

When competing importers and exporters themselves have distortions in place (and pp) the welfare effects of liberalization become more complicated, as noted by Anderson (1998) and Anderson and Tyers (1993). For example, in the case of net-importing countries, it is possible that an increase in world prices following liberalization could actually improve welfare, if these net-importing countries already have distortions in place. If imports are subsidized (perhaps to make them more affordable to the low-income segment of the population), then the quantity of imports consumed exceeds the optimum. An increase in the international price would therefore reduce imports and move consumption back toward the optimal amount. As shown in figure 1, the net welfare effect of an increase in the world price, in the presence of an import subsidy, depends on how subsidy expenditure changes (and a decline in the volume of imports). If subsidy expenditure declines sufficiently, an increase in the world price could generate a net welfare gain. In figure 1, the initial world price is PW/ and the domestic price is PD1, reflecting the fact that an import subsidy reduces the domestic price below the international price. For a given import subsidy, an increase in the international price to PW2 would raise the domestic price to PD2 and reduce the quantity of imports, because domestic production increases fromX; to X2 and domestic consumption declines from Di to D2. The change in producer surplus is the sum of areas A+B, the change in consumer surplus is the areas –(A+B+C+D+E), and the change in net government revenue is(H+O+I+P+J+B+C+D+E+F) less(L+M+N+O+P) Thus, the net welfare change is (H+J+B+F-M-N), the sign of which is ambiguous. If a net-importing country has a tariff in place instead, an increase in the world price would lower welfare, because the price increase would exacerbate the effect of a tariff.

Figure 1.
Figure 1.

Welfare Effects of an Increase in the World Price in the Presence of an Import Subsidy

Citation: IMF Working Papers 2003, 110; 10.5089/9781451853360.001.A001

The net welfare effect equals the areas H+J+B+F-L-M-N.

III. Agricultural Support: Who Does What to Whom?

Industrial countries use a complex array of policies to support their agricultural sectors. An important part of the support takes place through the market—that is, policies that create a wedge between the price received by an agricultural producer or the price paid by a consumer and the world price. This paper considers four types of agricultural support: import tariffs, export subsidies, production subsidies, and input subsidies. Following the OECD (2002), import tariffs and export subsidies are referred to as “market price support,”

as they affect both the price paid by consumers and the price received by producers for the supported commodity. The effects of this type of agricultural support are well known, but it is worthwhile to describe them briefly:

  • Import tariffs raise the price paid by consumers and the price received by the producer above the world price. For countries that are “large” in world markets, a tariff will depress the international price. Empirical work by Cernat et al. (2002) and the International Monetary Fund (2002) suggest that tariffs have larger effects on welfare than other types of support, namely export and production subisides.

  • For net exporters, export subsidies raise both consumer and producer prices in the exporting country above the world price. Export subsidies are used by only a few countries; the largest user is the European Union (EU). Total expenditure on export refunds by the EU amounted to EURS3.4 billion in 2001, down from EURS5.6 billion in 2000.

  • Production subsidies raise the price received by the producer of the supported commodity above the world price, but allows the consumer to face the world price. Production subsidies are applied to commodities that are both exported or imported across OECD countries. To maintain a price to producers that is above the world price, the government pays producers the difference between the world price and a support price.

  • Input subsidies effectively lower the cost of producing a given level of output by lowering the price paid by agricultural producers for inputs. Their effects are similar to those of production subsidies.

Governments in OECD countries also provide support to agricultural producers through direct income payments that are not tied to prices or output. These payments are designed to supplement the income of agricultural producers and require government expenditure. It is difficult to assess, however, how this type of support affects markets, as it may not alter marginal production decisions. However, research suggests (OECD, 2001) that agricultural support policies that are directed toward supporting the income of farmers through transfers, rather than by altering prices, have a smaller distortionary impact in terms of their effects on trade and welfare.

According to the OECD (2002), there have been some important changes in the profile of agricultural support since the mid-1980s:

  • Total agricultural support provided by OECD countries amounted to US$331 billion in 2001, equal to 1.3 percent of GDP. Despite this high level, support to producers has been on a downward trend since 1986-88. Across OECD countries, the aggregate producer support estimate (PSE) declined from 38 percent of farm receipts in 1986-88 to 33 percent in 1999-2001.5

  • The major portion of the agricultural support still comes from measures that affect market prices—tariffs and export subsidies—but this component has declined over time as well. Approximately 82 percent of support to agricultural producers was due to maket price support in 1986-88, and this proportion declined to 70 percent in 1999-2001. There has been a shift away from “market price support” toward payments that are not directly linked to production.

  • In 2001, support to agricultural producers, as measured by the PSE, was highest in Switzerland (69 percent), followed by Norway, Iceland, Japan and Korea. Support was lowest in New Zealand (1 percent). The commodities that receive the highest amounts of support include rice, sugar, and dairy products, especially milk.

  • The overall level of agricultural support has declined only slightly in the EU in recent years, but there has been a significant decline in market price support. A growing portion of the support is now provided through direct income payments to farmers. On average in 2001, prices received by agricultural producers were 33 percent above world prices, which is also above the OECD average of 31 percent.

  • Agricultural support in the United States, as measured by the PSE, declined in 1999-2001, compared to the period 1986-88. The overall level of support provided in the United States is lower than in the EU. On average in 2001, prices received by agricultural producers were 15 percent above world prices.

Agricultural support policies that fit into one of four categories (tariffs, export subsidies, production subsidies, and input subsidies) are considered in this paper. Table 1 lists the degree of support, measured by comparing domestic and international prices for the commodities contained in the PSE database (OECD, 2002). Also, Table 1 lists the ad-valorem production subsidy rates, as well as a measure of input subsidies (per unit of output).

Table 1.

Agriculture Support Measures For 2000 Used in the Partial-Equilibrium Model

(Ad valorem rates, unless otherwise specified)

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Source: Organization For Economic Cooperation and Development (2001); and author’s calculations.

The price gaps for some commodities are extremely high, especially for milk, largely a result of stringent barriers to imports. Reflecting the high degree of market orientation (and hence the absence of border measures) in Australia and New Zealand, the prices paid by consumers in these countries are very close to world prices. Of the remaing countries, the price gap are lowest for the United States and highest for Japan and Korea, with significant price gaps for Switzerland and Norway.

Direct export promotion—through export subsidies—are used by only a few countries, notably the EU, and this type of support is more limited in terms of its coverage across commodities, compared to other support policies. Support to agricultural producers through production subsidies is more prevalent in the United States, especially as applied to grains, than in the EU. Producer support through input subsidies is common across all countries and commodities, but substantially smaller in magnitude than production subsidies and market-price support.

IV. Partial-Equilibrium Methodology For Assessing the Impact of Agricultural Support in Industrial Countries

This section presents the structure of a partial-equilibrium model of trade that is used to quantify the welfare effects of agricultural support policies noted above. The structure of the model is similar to other partial-equilibrium models used to assess the impact of agricultural support, such as the one used by the OECD (2001), Hoekman, Ng, and Olarreaga 2002), and Vanzetti and Graham (2002). The model used by the OECD (2001) includes factor markets explicity, and thus, is able to assess the effects of input subsidies, while the models of Hoekman et al. and Vanzetti and Graham do not consider the impact of input subsidies. The model used in this paper evaluates the economic impact of input subsidies without modeling factor markets explicitly. For a given commodity, the model consists of supply and demand relationships in each country that applies some form of agricultural support. In addition, behavior in the rest of the world is captured through the specification of import demand and export supply functions. The market for each commodity must clear; therefore the world price adjusts to ensure this condition is satisfied. Commodities are treated as homogenous; therefore the law of one price is assumed to hold across countries. Since market clearing is imposed, the model could be interpreted as a framework that isolates the factors that influence adjustment in commodity markets in the long run, after agricultural support is fully eliminated.

A. Model Structure

This section presents a partial-equilibrium model that takes into account the main channels through which agricultural support affects welfare. For a given commodity that is subject to some form of agricultural support, domestic demand in country k is a function of a demand price, PDk (which includes the support measures):

Dk=D0k(PDk)ηk(4)

where D0 is a constant and n is the price elasticity of demand. Similarly, supply in country k is a function of the supply price, PSk:

Xk=X0k(PSk)εk(5)

where X0 is a constant and e is the price elasticity of supply. Of course, both demand and supply depend on factors other than prices, e.g. income, but these are assumed to remain constant. Net exports of the supported product from country k are simply the difference between production and domestic consumption:

Ek=XkDk(6)

Net exports from countries in the rest of the world are modelled as a upward sloping function of the world price:

EX=Ex0(PW)γ(7)

where EX are net exports from the rest of the world, EXO is a constant, PW is the world price of the supported commodity, and y is the export supply elasticity. Similarly, demand for the supported product in the rest of the world (import demand by third countries) is a downward sloping function of the world price, PW:

MD=MD0(PW)δ(8)

where MD is import demand in the rest of the world, MD0 is a constant, and S is the elasticity of demand for imports. The world price is determined where total imports (MD) equal exports from the country applying the support (E) plus exports from other countries (EX):

E+EX(PW)=MD(PW)(9)

It remains to specify how agricultural support measures are treated in the model. In the case of a net exporting country applying support, the demand price in country k would be the same as the world price, unless the country in question applies an export subsidy.6 In this case:

PDk=PW(1+e)(10a)

where e is the ad-valorem export subsidy rate. If support in country k takes the form of a production subsidy, an input subsidy, or both, then the demand price would equal the world price:

PDk+PW(10b)

The supply price facing the producer in country k (PSk) depends on the precise type of agricultural support measure in place. For countries that apply an export subsidy only, the supply price is:

PSk=PW(1+e)(11a)

If support takes the form of a production subsidy, then the supply price is:

PSk=PW(1+s)(11b)

where s is the ad-valorem rate of production subsidy. In this case, the demand price would be determined by equation (7b).

OECD countries typically support their agricultural sectors through multiple measures (e.g. such as production and input subsidies), rather than just one. In the case where a country applies both production and input subsidies, the price facing the producer would equal the world price multiplied by the ad-valorem production subsidy rate, s, plus a measure of the subsidy applied to inputs, β. To introduce input subsidies, define β as total expenditure on input subsidies divided by the quantity of output, X.

β=bPIX=bPiai(12)

where ai is the amount of input i used in the production of the final output, b is the subsidy rate on inputs, and I is the quantity of the intermediate input used in the production of X. Thus, the price to producers, inclusive of both the production and input subsidy is:

PSk=PW(1+s)+β(13)

The equations of the model are only slightly modified for the case where countries providing agricultural support are net importers instead of exporters. When net importers apply support through a tariff, the demand price PD, will differ from the world price, PW by the relevant tariff rate t:

PDk=PW(1+t)(14)

and the supply price, PSk is given by:

PSk=PW(1+t)(15)

Also, the demand for imports in country k, MDk, would be determined by the excess of domestic demand over domestic production:

MDk=DkXk(16)

Thus, for the case of net importers, equations (3), (7a), and (10) are replaced by equations (11), (12), (13). The equations specified above characterizes a simultaneous system that determine all of the endogenous variables, PD, PS, PW, D, X, E, EX, and MD.

B. Welfare Analysis

This section examines the welfare effects of removing two common types of agricultural support in the context of two cases. In the first, the welfare effects of removing both a production and an input subsidy are examined for the case of a net-exporting country. The second case details the welfare effects of removing an import tariff and an input subsidy for a net-importing country. Other combinations of support measures are possible, but these are perhaps the most common cases. In analyzing the effects of any change in trade policy, the net change in welfare is comprised of a change in producer surplus, consumer surplus, and net government revenue, as shown in Corden (1957). These principles are applied to an analysis of the net welfare effects of removing agricultural support.

Case of a Production Subsidy and Input Subsidy Applied to an Exportable Commodity

Figure 2 depicts the effects of agricultural support applied through both a production and an input subsidy. The example assumes that the producer receiving the support is a net exporter. As shown, support reduces welfare in the affected market because it distorts producer behavior and requires budgetary expenditure, which must be financed either from borrowing or taxation, which are generally distortionary. It is assumed that lump-sum taxation is not available.

Figure 2.
Figure 2.

Welfare Effects of Removing Produccion and Input Subsidies

Citation: IMF Working Papers 2003, 110; 10.5089/9781451853360.001.A001

The net welfare gain from removing both types of subsidies is the sum of areas B+E+F+I+J+K+L, where (B+E+F) represents the gain in production efficiency and (I+J+K+L) represents the terms-of-trade improvement.

Initially, the world price is PWi, which is determined by the intersection of world demand and supply. As both the production and input subsidy do not create a wedge between the world price and the price paid by consumers, PD1 = PW1. The price facing producers, PSi, (equal to PW1(l+s) + β) differs from the world price as a consequence of the production subsidy, s, and the input subsidy β. At price PS2, output is X1. So at intital prices, the difference between production and consumption (X1 - D1) equals the quantity of exports (figure 2).

Removal of both the output and input subsidy would shift the supply curve from S1 to S2. The lower level of output would raise the world price to PW2, if the country in question is large enough in world markets to affect international prices. Once all distortions are eliminated, the new producer price, PS2 must equal the consumer price PD2 and both of these prices must equal the new world price PW2. At these new prices, the quantity consumed declines to D2 and production falls to X2.

Removal of both types of agricultural support reduces consumer surplus by the sum of areas G and H (–(G+H)), as consumers pay a higher price. Producer surplus declines by the sum of areas A, C, and D (–(A+C+D): the change in producer surplus associated with the undistorted supply curve (S2) between the orginal supply price PS1 and the new equilibrium price, PS2 (figure 1). The change in the government budget is (A+B+C+D+E+F+G+H+I+J+K+L) (figure 1), which is positive, as expenditure is reduced. Therefore, the net welfare gain from liberalization is (B+E+F+I+J+K+L). The area (B+E+F) measures the efficiency gain on the supply side, while (I+J+K+L) is the terms-of-trade gain, measured relative to the initial quantity of exports.

Case of a Import Tariff and Input Subsidy Applied by a Net Importer

Figure 3 demonstrates the effects of removing a tariff on imports and an input subsidy for the case where the country is a net importer. Initially, the price facing producers is PS i, which differs from the world price PW1 as a consequence of both the tariff and the input subsidy. The price facing consumers, PD1, differs from the world price by the tariff. At these initial prices, production is at Xi and consumption is at Di, so the quantity of imports equals (D1 – X1).

Figure 3.
Figure 3.

Welfare Effects of Removing an Import Tariff and an Input Subsidy

Citation: IMF Working Papers 2003, 110; 10.5089/9781451853360.001.A001

The net welfare effect is the sum of the areas B+E+G-H, where (B+E) is the gain in production efficiency, G is the gain in consumption efficiency and H is the terms-of-trade loss.

Removal of both the import tariff and the input subsidy will result in a smaller quantity of output (a decline from X1 to X2), as the price facing the producer declines to PS2. Also, tariff removal results in a lower price paid by consumers, PO2 and a corresponding increase in consumption to D2. If the country in question is large in world markets, the world price would rise to PW2. After removal of all support, both the producer and consumer prices fall, and they equal the world price, as there are no distortions in place. Following liberalization, the quantity of imports rises from (Di – Xi) to (D2 – X2).

Overall, the net welfare effect of liberalization is ambiguous. The loss in producer surplus is equal to the sum of areas (A+D), while the gain in consumer surplus equals the sume of areas D+E+F+G. The effect on net government revenue is ambiguous, because both tariff revenue and subsidy expenditure decline. The government gains net revenue, equal to areas (A+B) (the decline in subsidy expenditure), but loses tariff revenue, equal to areas (F+H). Therefore, as shown in Figure 2, the net welfare gain from liberalization is the sum of areas B, E, and G less area H. The areas (B+E) measures the increase in efficiency on the supply side and area G is the increase in consumer efficiency. These gains are balanced against the terms-of-trade loss, (area H), so the net welfare effect of liberalization is ambiguous. If there is a net welfare gain, it would likely be larger than the gain from just removing the tariff, because the input subsidy intensifies the tariff distortion. With a tariff only in place, area E would measure the efficiency gain on the supply size, which is obviously smaller than (B+E).

C. Data and Elasticities

Agricultural support is represented by four types of measures in the model: tariffs, export subisidies, production subsidies, and input subsidies. Data on agricultural support for all commodities, except cotton, were taken from the producer/consumer support estimate (PSE/CSE) database maintained by the OECD (2001). Support measures for cotton were constructed from budget data maintained by the U.S. Department of Agriculture. The gaps between consumer and world prices in the PSE/CSE database are used to represent market-price support—tariffs and export subsidies. For the net-importing countries, the percentage price gaps are used to represent tariffs (t), while for net-exporting countries, the price gaps are used to represent export subsidies (e). The production subsidy rates, (s), are obtained by taking dividing “payments based on output” as reported in the PSE/CSE database by the value of output.

The data used in this paper for production subsidies differ from the one used by Hoekman et al. (2002), who used the information on aggregate measures of support (AMS) from country notifications to the World Trade Organization (WTO). The AMS data have a number of limitations, perhaps most importantly, the fact that they use a fixed base period—1986 to 1988—to measure price support. As is well known, the welfare costs of agricultural support depend on the size of the “wedge” between current domestic and world prices, not the size of the wedge compared to the base period 1986-88. Therefore, AMS data are not used in this paper. Finally, values for β, the parameter that represents input subsidies, is obtained by dividing “payments based on input usage” in the PSE/CSE database, by the quantity of output. Data on production are are also taken from the PSE/CSE database. Data on trade flows, (exports and imports) on a country basis, are taken from the Food and Agricultural Organization (FAO). The benchmark year for all data is 2000.

The partial-equilibrium model requires four elasticity parameters for each commodity: the own-price elasticity of demand, the own-price elasticity of supply, the import demand elasticity in the rest of the world, and the export supply elasticity in the rest of the world. Values for both the domestic demand and supply elasticities by commodity and country were taken from Gardiner et al. (1989). Values for these elasticities were also crosschecked with those contained in OECD (2001) to insure broad consistency. Best-guess estimates were used for both the import demand and export supply elasticities. In most cases, the value used for the import demand elasticity was -0.75, and the values used for the export supply elasticity ranged from 1.5 to 10, depending on the product, so that the behavior of the rest of the world would correspond roughly to a “small” country in theory.

The model is used to perform four simulations: removal of market-price support, removal of production subsidies, removal of input subsidies, and removal of all forms of support. Each of these four simulations are performed on a multilateral basis, that is, all countries are assumed to liberalize at the same time.

V. Impact of Removing Agricultural Support on OECD Countries: Partial Equilibrium

A. Multilateral Liberalization

This section presents the results from using the partial-equilibrium model described in section three to estimate the welfare effects of multilateral agricultural trade liberalization in OECD countries. The results are presented for ten commodities: wheat, maize, rice, milk, cotton, sheepmeat, soybeans, refined sugar, wool, and beef and veal. The welfare effects of eliminating agricultural support are broken down into three parts: the change in producer surplus, change in consumer surplus, and change in government net revenue. As shown previously, terms-of-trade effects are part of the change in net government revenue.

In general, all of the liberalization scenarios performed result in an increase in the international price of the supported commodity (Table 2). This occurs because removing agricultural support in net-exporting countries reduces output and exports of the supported commodity. Net-exporting countries that liberalize gain from removing agricultural support for two reasons: a terms-of-trade improvement and efficiency gains from better resource allocation. Net-importing countries that liberalize suffer a terms-of-trade loss, but enjoy and efficiency gain. In nearly all cases, the efficiency gains exceed the terms-of-trade losses. Tables 3 through 12 present the welfare effects on the countries that remove their agricultural support to the ten commodities mentioned above. As shown, when all countries remove all forms of support, that is, if all price gaps and subsidies were to be eliminated simulataneously, all countries tend to gain, with a few exceptions. In the case of maize, when all countries remove support simulataneously, Canada suffers a small welfare loss (US$4.6 million). This occurs because Canada is a net importer of maize, and the terms-of-trade loss outweighs the efficiency gains from removing its own support. Two points should be made about this result. First, Canada would gain (about US$1 million) if it were to remove its support on maize while all other countries maintained their support. Second, even though Canada would suffer a welfare loss if all countries liberalize, it would lose even more if it did not liberalize with the rest of the world. This is because if it did not liberalize, it would only suffer a terms-of-trade loss (US$51/2 million), which would be greater than the loss it would incur from liberalizing (US$4.6 million). By liberalizing, it reaps effciency gains, as it would suffer a terms-of-trade loss in either case. Thus, it pays Canada to join with other countries in removing its support on maize.

Table 2.

Effects on World Prices of Multilateral Agricultural Trade Liberalization

(Percentage changes)

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Source: Author’s calculations.
Table 3.

Welfare Effects of Multilateral Agricultural Trade Liberalization: Partial Equilibrium (Commodity: Beef)

(In millions of 2000 U.S Dollars, unless otherwise specified)

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Source: Author’s calculations.
Table 4.

Welfare Effects of Multilateral Agricultural Trade Liberalization: Partial Equilibrium (Commodity: Wheat)

(In millions of 2000 U.S Dollars, unless otherwise specified)

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Source: Author’s calculations.
Table 5.

Welfare Effects of Multilateral Agricultural Trade Liberalization: Partial Equilibrium (Commodity: Milk)

(In millions of 2000 U.S Dollars, unless otherwise specified)

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Source: Author’s calculations.
Table 6.

Welfare Effects of Multilateral Agricultural Trade Liberalization: Partial Equilibrium (Commodity: Rice)

(In millions of 2000 U.S Dollars, unless otherwise specified)

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Source: Author’s calculations.
Table 7.

Welfare Effects of Multilateral Agricultural Trade Liberalization: Partial Equilibrium (Commodity: Maize)

(In millions of 2000 U.S Dollars, unless otherwise specified)

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Source: Author’s calculations.
Table 8.

Welfare Effects of Multilateral Agricultural Trade Liberalization: Partial Equilibrium (Commodity: Cotton)

(In millions of 2000 U.S Dollars, unless otherwise specified)

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Source: Author’s calculations.
Table 9.

Welfare Effects of Multilateral Agricultural Trade Liberalization: Partial Equilibrium (Commodity: Sheepmeat)

(In millions of 2000 U.S Dollars, unless otherwise specified)

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Source: Author’s calculations.
Table 10.

Welfare Effects of Multilateral Agricultural Trade Liberalization: Partial Equilibrium (Commodity: Wool)

(In millions of 2000 U.S Dollars, unless otherwise specified)

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Source: Author’s calculations.
Table 11.

Welfare Effects of Multilateral Agricultural Trade Liberalization: Partial Equilibrium (Commodity: Soybeans)

(In millions of 2000 U.S Dollars, unless otherwise specified)

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Source: Author’s calculations.
Table 12.

Welfare Effects of Multilateral Agricultural Trade Liberalization: Partial Equilibrium (Commodity: Refined Sugar)

(In millions of 2000 U.S. Dollars, unless otherwise specified)

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Source: Author’s calculations.

In the case of sheepmeat, when all countries liberalize, two countries—the United States and the European Union—lose. The European Union loses because the terms-of-trade losses far outweigh the efficiency gains. The European Union has market power in sheepmeat: it is the largest producer and imports half of total world trade. The United States would suffer a welfare loss because the terms-of-trade deterioration outweighs the efficiency gains from removing its relatively low level of support. In soybeans, the European Union loses when all countries liberalize: the terms-of-trade deterioration exceed the efficiency gains. Like the case of maize, it would be in the interest of the European Union to liberalize, as it would suffer a terms-of-trade loss if it did nothing.

The welfare gains are largest when support on milk and milk products is eliminated, reflecting the large price gaps that exist across countries. Simultaneous removal of all support on milk would raise welfare in the United States by over US$3 billion, and by over US$7 billion in the EU. As shown, consumers bear large costs of supporting the milk sector. The net-exporters with a comparative advantage in milk products—Australia and New Zealand—also gain because of the substantial terms-of-trade improvement. In beef and veal, where there is also significant support in place, the welfare gains exceed US$6 billion for the United States, US$0.8 billion for Switzerland (.34 percent of GDP), and US$0.7 billion of Korea (. 16 percent of GDP). As with milk, consumers would reap large gains from liberalization, while producers would lose. In these simulations, removal of all support on beef and veal causes Canada to switch from a net-exporter to a net-importer, and exports from the EU fall by more than half.

As shown, the welfare results of liberalization depends importantly on the type of agricultural support measure that is eliminated. For example, the simulations support the conclusion that production subsidies are harmful because they distort trade and lower world prices. However, some countries may lose as a result of just removing production subsidies, rather than all forms of support. In the case of wheat, simultaneous removal of all production subsidies, while keeping all other forms of support in place, would reduce welfare in the EU by about US$39 million. This is because the principal distortion that the EU has in place on wheat is export subsidies. When all countries remove their production subsidies, the world price rises. With export subsidies in place, the increase in the world price leads to an expansion in output of a subsidized product in the EU, which worsens welfare; the increase in the world price exacerbates the existing distortion (export subsidy). This result, which follows from equation (3), makes the point that the form of agricultural support matters. Liberalization should be undertaken as a complete package—removal of all forms of support—rather than a piecmeal approach that includes only certain types of support.

Not surprisingly, the simulations confirm that “market-price” support, i.e. tariffs and export subsidies, have the largest distortionary impact of the four types of support considered. This result is similar to the findings of Hoekman et al. (2002), who conclude that tariff removal produces larger welfare gains than subsidy removal. Although nearly all countries apply input subsidies, these have relatively small effects on welfare and world prices, compared to the other types of support. There are some exceptions to this general result and they occur mainly in the case of the United States, which relies more heavily on production and input subsidies. For example, in the case of rice and maize, the United States gains substantially more from removal of production subsidies, compared to the gains from removing market price support.

In general, the magnitude of the increases in world prices is largest when market-price support is removed, although there are some exceptions to this (Table 2), depending on the product and the degree of support. For five of the ten commodities, the increase in the world price is largest when market-price support is removed. For three commodities (rice, cotton, and soybeans), the world price increases the most as a result of removing production subsidies, reflecting the relatively high levels of domestic support applied to these commodities in the United States. The largest increase in the world price from liberalization occurs in milk and milk products, given the very high degree of support in place across countries.

B. Impact of Multilateral Liberalization on Net-Food-Importing Countries

A major concern expressed by a number of developing countries in the Uruguay Round was the potential negative impact agricultural liberalization might have on net-food-importing countries (NFICs). Removal of agricultural support would likely raise the international prices of food, leading to higher import costs for countries that rely on imported food. In response to this concern, the Uruguay Round Agreement on Agriculture included the Marrakesh Decision7. Using the estimated changes in the world prices presented above, this section presents estimates of the increases in import costs resulting from the world price increases. The change in import costs by country is calculated by applying the change in the world price that results from liberalization and an import demand elasticity (mentioned in Section IV) to the quantity of net imports of each commodity in 2000.

Table 13 presents the effects on import bills for the 79 countries designated as net-food importing by the WTO, broken down by commodity. Several results emerge. First, and most striking, import costs do not increase for all countries. While nearly all countries in table 13 are net importers of grains (wheat and maize), a number of countries are exporters of other supported products, such as cotton, refined sugar, and rice. For a number of countr