Agriculture in the GATT

Agriculture in the GATT An assessment of the USA’s 1989 proposal

H. Guyomard and L.P. Mahi?

This article provides an assessment of the USA’s 1989 GATT proposal for farm policy reform. The implications of the orooosal for the EC and the USA are h&tigated through a simulation over a five-year period. The proposal required tariffication of all supports and the phasing out over five years of export subsidies and over 10 years of other measures (tariffs, deficiency payments). It would have hurt farm income and the trade balance considerably more in the EC than in the USA, but budget savings would have been larger in the EC. Overall the burden and the pace of adjustment resulting from this proposal would have weighed much more heavily on the EC than the USA. This analysis stresses the weakness of the EC’s position due to the excessive use of export subsidies in the conduct of the CAP. H. Guyomard is with the lnstitut National de la Recherche Agronomique, Station d’Economie et Socioloaie Rurales de Rennes, 65 rue de St-Brikc, 35042 Rennes Cedex. France. L.P. Mahe is with the Ecole Nationale Superieure Agronomique, Departement des Sciences Economiques et Sociales de Rennes, 65 rue de StBrieuc, 35042 Rennes Cedex, France.

330

The meeting in Brussels in December 1990 of trade ministers failed to conclude the Uruguay Round negotiations of the General Agreement on Tariffs and Trade (GATT) with an agreement, in spite of last-minute efforts to bridge the gap between the EC and US positions. Agriculture played an unprecedented role in the negotiations. In fact, at the final stage the USA took the firm position that any progress on other issues was contingent on an agreement on agricultural policy reform. This turned out to be impossible, and the agricultural conflict led to an extension of the round. Ever since the beginning of the Uruguay Round in Punta de1 Este in 1986, the debate has been dominated by the EC-US agricultural trade conflict. The USA has played the more active role, calling for full trade liberalization which it expected to open outlets for depressed US exports, mainly in grains and soybeans. The EC has always been more passive, reacting to the moves of other players rather than taking initiatives. But at the time of writing the Community has reached a point where the CAP has produced so many domestic and external distortions that it is caught under irresistible pressure from inside and outside, and a profound reorientation of the CAP is now inevitable. It is unclear, however, whether the track followed by the reform will be a retreat towards further insulation from world markets or a bolder opening towards world competition. Undoubtedly, along the way the negotiating positions have included a good deal of posturing but the gap between the EC and the USA has been so large that an agreement will be hard to reach. The first proposals tabled by the USA argued for the complete elimination of farm programmes in contracting parties by the year 2000: this was the ‘double zero’ option (so called because of the proposed elimination of both border measures and internal subsidies). The EC’s response to these proposals was a flat rejection of the call for elimination of farm subsidies. The EC suggested that national policies be maintained but that levels of support be gradually reduced. In its 1987 proposal the Community stood by the current basic structure of the Common Agricultural Policy (CAP) and called for general but non-binding policy reforms.

0306-9192/91/040330-12

@ 1991 Butterworth-Heinemann

Ltd

Agriculrure in the GATT

‘As noted by Hathaway, the agricultural negotiations have been a struggle between the proponents of reform, led by the USA and the Cairns Group (14 countries that are exporters of agricultural products: Argentina, Australia, Brazil, Canada, Chile, Colombia, Fiji, Hungary, Indonesia, Malaysia, New Zealand, the Philippines, Thailand and Uruguay), and the proponents of restraint, led by the European Community and followed by Japan, Switzerland, Austria and the ‘Nordic’ group (Sweden, Norway and Finland). See D.E. Hathaway, ‘Agriculture in completing the Round: a results-oriented Uruguay approach to the GATT trade negotiations’, in J.J. Schott, ed, Disharmonies in Agricultural Policy Measures, EC, Luxembourg, 1988. ‘Such an agreement was possible essentially because the USA adopted (temporarily) a less inflexible position by abandoning the idea of a complete elimination of export subsidies and by accepting a discussion on short-run measures without a precise accord on long-run objective: see ‘Marches: contexte international et negociations du GATT’, Perspectives Agricoles, No 141, November 1989. This agreement was also concluded as a result of great pressure from the secretariat and the chairman of the negotiating group: see E.P. Woltjer, working document on the GATT negotiations, European Parliament, Committee on Agriculture, Fisheries and Rural Development, 1990. 3Decoupling is a very general principle. A decoupled policy instrument may be defined as an instrument which allows national governments to continue support for farm income while reducing or eliminating international trade distortions: see DR. Harvey, ‘The GATT and agriculture: the Production Entitlement Guarantee (PEG) option’, paper presented at the symposium on ‘The world field crops economy - scope and limits of the liberalization of agricultural policies’, Paris, December 1990. %ubmission of the United States on Comprehensive Long-Term Agricultural Reform, GATT Secretariat, Agricultural Negotiating Group, 1989.

FOOD POLICY August 1991

The EC-US confrontation’ led to the failure of the mid-term review meeting in December 1988 in Montreal. Nevertheless, the April 1989 session was concluded by an agreement2 to the effect that, before the end of 1990, the contracting parties would agree upon a programme of long-run reform of agricultural policies and set a time schedule for its implementation. Proposals aimed at achieving these objectives were due before December 1989. In October 1989 the US delegation issued its revised proposal for long-run reform which dealt with four topics: market access, export competition, domestic support programmes and sanitary-phytosanitary regulations. Broadly speaking, the proposals argued for four principles which were already included in previous declarations: tariffication, decoupling,” an export subsidy ban, and reinforcement of rules and disciplines. With regard to the transition period, a general time horizon of 10 years was suggested for most policies except for export-promoting subsidies which were to be eliminated within five years. In this article we provide a quantitative assessment of the impact of the USA’s October 1989 proposal on the agricultural sectors of the EC and the USA and on world market prices. As the eventual impact after 10 years was to be complete trade liberalization, a five-year projection will reveal both the relative magnitude and the pace of adjustment that would have been imposed on US and EC farm policies as a result of a full implementation of the US proposal. The scenario is fairly complex since all policies are affected, but in differential ways. The economic and political rationale lying behind the results will be elucidated and set within the perspective of EC and US interactions. Finally, the US 1989 proposal is assessed against the historical record of EC-US trade conflict over the CAP. The US position, although dressed in the clothes of policy instrumentation and general principles of policy reform rather than formulated as the usual critique of EC protectionism in agriculture, amounts in reality to a demand to do away with the principles of the traditional CAP as they relate to the trade policy counterpart of domestic support. Although the US position as restated in October 1990 is less drastic and calls only for a 90% reduction over 10 years in export subsidies and a 75% reduction over 10 years in total agricultural supports, the results of the present simulation exercise still highlight EC-US interactions and help us to understand why the EC sees the US positions in the GAIT negotiations as unrealistic and unacceptable because of their much larger impact on the EC farm sector than on the USA.

The US proposal of October 1989 The novelty of the USA’s 1989 proposal4 lay not in the repeated call it made for ‘a long-run global reform of agriculture’ but in the specific treatment of various policy measures that it advocated. Policy instruments were divided into four categories: (i) import access, (ii) export competition, (iii) domestic support, and (iv) sanitary and phytosanitary regulations. The proposal required reforms in all four areas, which were to be considered as an ‘integral part of a global reform rather than as distinct proposals’. In the introductory section of the text tabled in the GATT, the USA first emphasized the cost of current farm policies to the budget, to consumers and to the environment, and their distorting effects on trade.

331

Agriculture in the GATT

It proposed that ‘traditional forms of support which are directly tied to levels of production and prices should be progressively eliminated over a period of 10 years’. Non-tariff barriers on imports would have been converted into border tariffs (the so-called tariffication) and, together with pre-existing tariffs, were to be progressively reduced over a IO-year period. Export subsidies would be progressively eliminated over five years. Export restrictions were to be eliminated. As regards sanitary and phytosanitary regulations, disciplines were proposed which would establish new notification, consultation and conflict solution procedures. The last-mentioned non-tariff barriers are difficult to assess and will be left aside in the present quantitative exercise, which deals only with the first three types of policy measures. Import access The proposal stipulated that tariffs, including those resulting from converting non-tariff barriers into tariffs, would be limited to the levels prevailing on 1 January 1991, then phased out over a IO-year transition period ‘down to final rates to be negotiated’. ‘Final rates would be zero or small.’ It is worth noting that when it came to specific items the proposal left room for negotiation. While it was stated in the introduction that all policy measures tied to prices and production should be eliminated over 10 years, the USA seemed willing to accept some non-zero moderate support through import tariffs, although such support would clearly not be decoupled from production and trade. Similarly, safeguard mechanisms were envisaged to prevent overlarge increases in imports from one year to the next. During the transition period tariff quotas would be used to deal with non-tariff barriers, but eventually the import regime would only be based on bound tariffs. Import quotas at agreed tariffs would replace existing barriers and quantities admitted would be progressively increased, while a tariff based on the gap between domestic and border prices would apply to imports over and above quotas. Export competition The manipulation of export competition through subsidies was treated more severely, and a period of five years was proposed for the progressive elimination of export subsidies. A long list of measures to be eliminated was provided which included export subsidies as defined by Article XVI of the GATT treaty. Food aid would not be included in the ban, but new rules to monitor food aid would be necessary to ensure it did not distort normal commercial sales. Export embargoes and taxes, particularly those aimed at providing cheaper raw materials to processing industries, would have been prohibited. Article XI (2a) would be withdrawn so that export embargoes would not be allowed at all. Domestic support The policy measures which contribute to domestic into three categories according to their distorting volumes and therefore on trade. 0

support were divided effects on production

Policies which have a significant impact on trade were to be progressively eliminated over the IO-year transition period. The list included administered prices, production and input subsidies

FOOD POLICY August 1991

Agriculture in the GATT

0

0

‘which are not granted on an equal basis’ (ie which are coupled with production levels). Policies providing subsidies to inputs or to investments on an equal basis, and those which have not led to excessive use and are less distorting, were to be reduced and controlled. Policies not tied to production volumes would still be allowed. Conservation and environment policies, research, extension and education programmes, bona fide domestic food aid and resource retirement programmes were included in this category.

These three categories of policy measures correspond very closely to the distinction made in the summer of 1990 by the President of the Negotiating Group on Agriculture in the so-called ‘De Zeeuw paper’, which also stipulated differential schedules of change over time for ‘red light’, ‘yellow light’ and ‘green light’ policies. The US proposal drew a clear distinction between the treatment of export restitutions on the one hand and import access restrictions and production-tied domestic subsidies on the other. It left unclear, however, how a number of policy measures should be treated. The present quantification exercise dealt only with measures directly affecting production, consumption and use, together with supply management policies. Although deficiency payments as such were not oddly enough - explicitly mentioned in the proposal, they belong to this category even if, combined with set-aside as in the USA, their effect may be lessened. As a consequence, deficiency payments were eliminated over a IO-year period. Processing subsidies for oilcakes and feed proteins in the EC were treated in the same way. In the proposal there was also room for interpretation of coresponsibility levies and domestic human consumption programmes. For the sake of simplicity, it will be assumed that all these taxes and subsidies tied to production and consumption would be eliminated. Supply management policies, and more especially production quotas - not mentioned as such in the US proposal - were assumed to be acceptable and were included in the exercise.

Simulation over five years Policy instruments and phase-out regimes Two regimes 0 0

of transition

towards

free trade

were implemented:

A five-year regime, where support is cut at the rate of 20% per year of the initial level, was applied to export refunds. A lo-year regime, where support measures are phased out at the rate of 10% per year of the initial ad-valorem tariff equivalent, was applied to import tariffs and to domestic production subsidies.

According to the principle of tariffication, administered prices through variable refunds or deficiency payments were no longer to be pegged in the simulation, but they were tied to world prices by the remaining tariff equivalent in each particular year. Domestic prices will therefore depend on developments in world prices occurring over the period as a result of both exogenous factors and policy changes. The pace of adjustment of support in the EC and the USA clearly depends on the initial trade position and on the type of instruments used. Thus the EC initiates the five-year regime for most commodities

FOOD POLICY August

1991

333

Agriculture

in the GATT Table 1. Agricultural abbreviations.

outputs

and inputs

aWheat and coarse grains. “Except for olive oil (included in the rest of agriculture). ‘Citrus pulp, millings and other vegetable byproducts. “Olive oil, vegetables, fruits, wine, sheep and goat meat. This residual group allows the model to cover the whole of the farm sector.

in the model,

and corresponding

Inputs

outputs Grains? Vegetable proteins Vegetable oilb Corn gluten feed Maniac Other grain substitutesC Beef meat Pigmeat and poultry Milk Sugar Rest of agricultured

covered

WW (VPP)

(OIL) (CGF) (MAN) lOGSI (BEEj (P&P) (MfK) (SUG) (PO4

Grain9 Vegetable proteins Co& gluten feed Maniac Other grain substitutesC Milk

(GPA) (VPP) (CGF) (MAN (OGS) (MIK) ~

Other feed ingredients Fertilizers Other intermediate consumption Capital services

(OTF) (FEP) (OIC) (CAP)

I

except oilseeds and grain substitutes, as it is a net exporter in most commodities and uses the variable-refund system. The USA mainly follows the lO-year regime because it presently uses deficiency payments for grains, and because the sugar and beef import quotas treated as tariff equivalent are to be phased out over 10 years. There is one exception in the US case, namely the Export Enhancement Program (EEP) for grains, which is treated under the five-year regime. In the case of the EC, where export subsidies play a major role, the rate of support over the transition period clearly depends on developments in the trade position. As support is reduced, net exports decline, potentially reduce to zero (self-sufficiency) or even switch to a net import position. Thus the time profile of the maximum level of support is endogenous and cannot be specified a priori. Moreover, when several policy instruments coexist (eg production quota and export subsidy), the margin of interpretation of the proposal becomes larger. In the case where the exporter country remains an exporter during the transition period, all support is eliminated after five years. Presumably if the country keeps exporting after this elimination, exports will start rising again between years 5 and 10, when domestic prices decrease less or increase after free trade is achieved. When an exporter country returns to self-sufficiency before the end of the five-year period, it is no longer compelled to stay on the five-year schedule of support elimination. Although export subsidies have been eliminated according to the five-year schedule, import barriers are only to be removed according to the IO-year timescale. Thus, once exports have been eliminated, the country is likely to remain at self-sufficiency for some years until the lo-year removal of import barriers makes importation feasible. ‘Used

in the CEC study, Disharmonies

in

EC and US Aqricultural Policies, report to the Commis&n of the European’ Communities bv EC/US Studv Grout. Brussels, 1988. . ‘The complete system of supply and derived demand is derived from a sectorrestricted profit function which satisfies the theoretical properties of symmetry, linear homogeneity and convexity with respect to prices. Further details on the magnitude of price elasticities can be found in L.P. Mahe and C. Tavera, ‘Bilateral harmonization of EC and US agricultural policies’, EuroDean Reviewof A&x/tura/ konomics, Vol 15, 1989, pp 327-348; and H. Guyomard, L.P. Mahe, C. Tavera and T. Trochet, ‘Technical change and EC-US agricultural trade liberalization’, Journal of Agricultural Economics, May 1991.

Model used The model used is an updated and extended version of the MISS mode1.s MISS is a simplified world trade model which allows the simulation of the consequences of agricultural policy changes from a base situation. The world is divided into four zones: EC, USA, Centrally Planned Economies and Rest of the World. The agricultural sector is disaggregated into 11 outputs and 10 inputs (six inputs of agricultural origin for animal feed and four inputs not produced by the farm sector; see Table 1). The behaviour of the model is driven by matrices of direct and cross-price elasticities’ of output supply and derived demand of the agricultural sector and of demand for other uses. Domestic prices can be either exogenously fixed or linked to world prices by protection rates as in the case of fixed ad-valorem tariffs, subsidies and taxes. Shifts of supply and demand, due to technical FOOD POLICY August 1991

Agriculture

change and income and import quotas.

growth,

can be implemented,

in the GATT

as well as production

Base year

‘The

EAGGF has two sections: the Section, which finances the common organization of agricultural markets, and the Guidance Section, which covers Community expenditure on agricultural structures..The Guarantee Section finances the expenditure incurred under the EC market organizations: refunds on exports to non-member countries and the cost of intervention to stabilize the agricultural markets. Guarantee expenditure is now covered by monthly advance payments made by the Commission to the member states against the booking of payments effected previously by the national paying agencies handling the beneficiaries’ files (The Agricultural Situation in fhe Community, 7989 Report, CEC, Brussels, 1990). 8Tab/eau bes ESP et ESC: 1979-7988, OECD, Paris, 1989. She price cut has an effect on delivered quantities if and only if the market price

Guarantee

decrease is greater thanthe higher level of quasi-rent (for more details see Guyomard d&;p

cit. Ref 6).

FOOD POLICY August 1991

The base period is 1988 for budget data, protection estimates and animal products. It is 1987/88 for crop quantities. Animal feed use is represented by its ingredients and the oil included in supply corresponds to the oil content of oilseeds which are domestically produced. The data were calibrated so as to approximate budget, income and trade as well as possible. In the EC, budget expenditures are smaller than total EAGGF (European Agricultural Guidance and Guarantee Fund) outlays (Guarantee Section) for various reasons.’ First, as imports and exports are presumed to be perfect substitutes only net trade is represented. Thus tariffs or levy proceeds are deducted from gross export subsidies, meaning that estimates of budget expenditures are net. Second, only policies significantly affecting trade are included. The nominal protection estimates are therefore lower than the OECD Producer Subsidy Equivalents (PSE)s as the latter include various items such as government subsidies to research or regional aids which could be maintained according to the US 1989 proposal. Intervention outlays on storage are not included since they may be considered to be the result of an inefficient means of delaying exports. However, increases in stocks are included in exports, so that the associated refund cost is included in the budget. Net exports therefore correspond to exportable surplus rather than to actual exports. The situation of quota-ridden products in the base year is important since the level of the quasi-rent determines the price cut necessary to trigger a downward supply response. This was not a problem in the present case since, due to quota reductions and other policy changes, the required producer price cut was lower than the decrease in the dairy and sugar shadow prices, as a result of the effect of technical change and of the cuts in various price supports on competing outputs or on inputs. In other words, the price cut for milk implied by an application of the US 1989 proposal is not effective in further reducing milk supply,’ given that the EC reduces the production quota level by 14%. A five-vear i 1uroiection J It’has already been mentioned that the time dimension is crucial in the present context since the pace of price support reduction depends on policy instruments. But the time dimension is also important because technical change keeps enhancing production, outpacing growth in the demand for farm products in industrial countries. The pattern of evolution of the trade position is therefore a function of both technical change and price support cuts and this pattern determines whether a given commodity programme is eligible for the five-year or the lo-year phasing-out schedule. Technical progress is also important in the presence of supply management policies. Technical change shifts the bpportunity cost down for dairy and sugar in the EC and supplies of other products should be affected accordingly as resources can move from one subsector to another. Another aspect of the time dimension is that some trade-offs between policy targets are modified when technical growth is reflected in income change is allowed for. ‘(I Productivity growth and the trade-off between farm income loss and budget savings

335

Agriculture in the GATT

will be less severe when policy changes are spread over time. A pure comparative-static approach therefore overestimates the burden of adjustment of the farm sector due to partial liberalization. For these reasons a five-year projection was performed where both policy changes and general economic trends were taken into account. Technical change parameters were calibrated on the basis of the 1979-89 period. Actual trends of production and disappearance volumes were corrected for price changes in order to get an estimate of pure technical change effects. Demand trends were also corrected for price effects. ” Simulation results do not show the isolated impact of the US 1989 proposal as compared to an alternative no-policy-change scenario, but they show the magnitude of changes in economic indicators after five years, as a result of both economic trends and policy changes in the EC and the USA. Finally, it should be noted that the results discussed below assume that other countries maintain their current policies.

Results Because of tariffication, policy instruments are now ad-valorem protection rates or equivalent-import quotas or production quotas. Domestic price changes come as a result of both world price and nominal protection changes. Income and budget implications of the US proposal result from both domestic and world price changes. Level

“For more details, see H. Guyomard, L.P. Mahb and C. Tavbra, Agriculture in the GATT: A Quantitative Assessment of the US 7989 Proposal, Working Paper 90-02, INRA-ESR, Rennes, France, 1990.

of support

As the EC is a net exporter of most commodities and uses export subsidies, the ad-valorem equivalent tariff falls by more than half for several products. This is the case for grains, where it has to decrease by two-thirds from 105% to 29% in order to bring the EC back to self-sufficiency. Pigmeat and poultry follow the same pattern, and price support is nearly eliminated (the nominal rate of protection [NRP] falls from 28% to 5%). The EC would therefore most likely become a permanent exporter of pork and poultry under free trade if grains and feeds were further liberalized. For beef, the situation is somewhat different and - on the basis of the year 1988 - a 50% cut of the NRP is more than what is required for the EC to cease being a permanent exporter. At domestic prices higher than world prices by about 40%) the EC would after five years import more than the amount required by the special beef import quotas granted by the EC to selected exporters, so that the EC can go onto the IO-year schedule. This is also the case for dairy products, due to a companion policy change: a reduction in the production quota making the EC just self-sufficient. The NRP falls only to 47% for dairy under the condition that quota rights are reduced by 14%. Without making use of the quota instrument, the EC would remain an exporter and dairy prices would be cut even further, according to the five-year schedule. With these policy changes and technical progress, the shadow price of milk would fall by a further 33% and come close to the world market price. This implies that after five years a significant amount of rent would still be associated with the quota and that the producer price cut implemented would not affect milk supply. A similar analysis applies to sugar, but reducing the NRP by half is enough to bring the EC back to self-sufficiency. Other commodities are eligible for the lo-year schedule since the EC

FOOD POLICY August 1991

Agriculture

in the GATT

Table 2. Actual policy changes in the EC and USA over five years: nominal rate of protection (in % of border price).

USA

EC

Initial (year 1)

Final

initial

Final

(year5)

(year1)

(year5)

105 75 75 0 100 25 75 28 94 210 25

29 37.5 37.5 0 50a 12.5 37.5 5 47b 105 12.5

70 0 0 0 0 0 2 0 85 156 29

35 0 0 0 0 0 1 0 42.5 78C 14.5

Supply side

?mport quota increased from 7.0 to 8.4 million tn”s ._.._. bProduction quota decreased by 14%. ‘Import quota increased from 0.97 to 1.89 million tons.

GRA VPR OIL CGF MAN OGS BEE P&P MIK SUG ROA Average

66.3

28.1

36.0

18.4

is a net importer in these cases. NRPs are therefore cut by 50% for oilseeds, protein crops, maniac, other grain substitutes, and the rest of agriculture. The first group of commodities clearly bears the main burden of adjustment, although the use of production quotas gives the EC a sizeable margin for manoeuvre. The weighted average NRP in the EC falls from 66.3% to 28.1% after five years (see Table 2). The required changes in US protection rates follow the lo-year pattern as the USA is either an importer (animal products,‘* sugar, rest of agriculture) or an exporter without significant export subsidies (soybeans, corn gluten feed, other grain substitutes). There is one exception - grains - with a significant EEP programme which is to be eliminated after five years. But even in that case some farmers, namely beef and pork and poultry producers, would benefit rather than lose from the resulting fall in user prices. All other nominal protection rates are reduced to half their value in the base year. This is obtained through an increase in quotas for sugar and dairy products, while the USA is likely to become an exporter of beef due to a world price rise.‘” Overall, the US rate of adjustment can be closer to the 50% reduction schedule due to the policy instruments it currently uses and its trade position (see Table 2). World price changes

“For dairy products there is again room for interpretation as we use milk equivalent and as the sign of the US balance seems to depend on whether it is expressed on the basis of the fat or the protein content of milk. j3The result is consistent with the estimate of the tariff equivalent to the beef import quota made by the USDA (A.J. Webb, M. Looez and R. Penn. Esfimates of Producer anb Consumer Subsidy Equivalents, Statistical Bulletin No 803, USDA, ERS, Washington, DC, 1990). It would be different if the higher OECD estimate of the US beef PSE were used.

FOOD

POLICY

August

1991

The world price for cereals increases by 10% as a result of the elimination of EC exports, following the reduction of support which cuts production (by 6.5%) and stimulates feed demand (by 5%), although beef and dairy production levels are reduced. The pigmeat and poultry sector in the EC expands by 12% in spite of a nearly complete elimination of support, because the cost of concentrated feed in the EC falls markedly (from 14% for feed proteins to 31% for other grain substitutes, cereals falling by 30%) (see Table 3). World prices of protein feed and various grain substitues fall, except for maniac. The price of maniac increases for two reasons: first, the EC imports more maniac by relaxing the Voluntary Export Restraint Agreement; second, maniac is an important food item in various parts of the world and human demand increases as cereal m-ices rise. corn gluten feed and other grain substitute prices fall due td a contraction of the beef and dairy sectors in the EC and to substitution by grains in animal feed.

337

Agriculture in the GATT Table 3. Changes in world and domestic market prices at the end of five years (in %).

Agricultural products GRA VPR OIL CGF MAN OGS BEE P&P MIK SUG ROA

World

EC

USA

+io.a

~30.6 ~32.0 -23.1

-11.9 -14.0 -2.5 -22.2

-31.3 ~18.5 -19.2 -11.1 (-33.0)a -29.3 (-28.4)a p9.0b

-23.3 +2.1 -1.1 -9.8 -25.5 -10.9

-14.1 -2.8 -22.2 +7.1 -42.5 +3.2 Pi.1 +17.4 f7.4 +o.o

-15.0

Average Agricultural GRA VPR CGF MAN OGS OTF

inputs

OIC aShadow price changes in parantheses. bPrice index based on 1988 ROA aggregate in the EC.

-8.5

FER CAP

+10.8 f14.7 -22.2 t7.1 -42.5 -1.8 -0.2 -0.1 to.2

-30 6 -14.0 -22.2 -19.2 -31 3 ~1 8 -13 -1.9 +1.4

t2.7 -14.0 -222 _ ~23.3 ~1.8 -0.1 -0 1 -0.2

World dairy product and sugar prices increase notably (by 17% and 7% respectively) because EC and US policy changes are somewhat similar and reinforce each other. The large cut in the EC milk quota is the main reason for world price increases. For sugar, the rise is more limited as EC supply does not react to the price cuts because of a large initial quasi-rent that is perpetuatedI by the package of policy changes. Beef, pigmeat and poultry prices do not change markedly because the USA tends to dampen the effects of the EC’s liberalization. US production of pigmeat and poultry increases as a result of higher world prices and of technical change since the US protection for these products is zero or close to zero in the base year. Domestic

price changes

Nominal rates of protection in the EC are cut by 50% or more, but the actual fall in domestic prices is dampened for many products because world prices rise. This is the case for grains, maniac, dairy produce and sugar. Although the NRP is reduced by two-thirds for grains and only one-half for oilseeds, producer prices of these commodities fall in nearly the same proportion because the price ratio between feed proteins and grains deteriorates sharply on world markets. In the USA producer prices fall relatively less than in the EC because of the smaller decrease in nominal protection. Due to the tariffication of price support, EC and US domestic prices are now directly affected by world price changes induced by each other’s liberalization. All feed input prices fall in both the EC and the USA, except for grains in the USA where they increase by 2.7% because of EEP abolition. These cheaper feed prices are the consequence of the lower protection granted to feed products and to the animal sector. They reduce the negative effect of liberalization on farm incomes. Economies “?Sugar

quotas

1988 levels.

are

maintained

at their

from banning

export subsidies

Large budget savings occur in both the EC and the USA (see Table 4). Moreover, they have a similar magnitude although their economic

FOOD POLICY August

1991

Agriculture in the GATT Table 4. Budget expenditures (million ECU/yr) and changes in the agricultural (net exports, billion ECU) at the end of five years. EC Budget expenditures Initial Final (year 1) (year 5)

aNegative figures are the consequence of tariff revenues on net imports. Qestitutions (including ACP re-exports) net of sugar levy. 7he reported figure IS gross export in this case.

GRA VPR OIL CGF MAN OGS BEE P&P MIK SUG ROA

2 690 2 276 1 186 0 -30” -15@ 1 050 201 4018 727b 4 127

0 1113 666 0 -9a -5oa -556a 0 0 221b 2 572

Total

16 087

3 957

Trade balance change -2.6 + 1.4 -0.2 -0.0 -0.1 +0.2 -2.8 -0.7 -2.3 -0.4c -5.5 -13.0

trade balance

USA Budget expenditures Final Initial (year 1) (year 5)

Trade balance change

12 175 0 0 0 0 0 0 0 1 345 0 2 504

7 895 0 0 0 0 0 0 0 -260a 0 1 239

+0.5 -0.6 -0.1 0.0 0.0 0.0 +2.0 +1.5 -0.4 -0.2 -2.4

16 024

8 874

+0.3

rationale and the affected commodities differ substantially. The main reduction in budget costs in the USA concerns deficiency payments in the grain sector. Other substantial savings are made in consumption subsidies in the dairy sector and in various subsidization programmes benefiting the aggregate ‘rest of agriculture’. The EC budget savings are spread over most commodities: 2.7 billion ECU for grains, 1.7 for oilseeds, 1.6 for beef, 4.0 for dairy. The main source of savings in the EC comes from the elimination of export refunds in grains, dairy produce and beef as a result of the return to self-sufficiency (grains, dairy, pork and poultry) or even to a net importing position (beef) The trade balance in agricultural products evolves quite differently in the EC and in the USA. The negative EC balance deteriorates sharply (by about 13 billion ECU) while the US balance improves by 0.3 billion. In the EC it is clearly the reduction in price incentives and in protection which brings the EC to self-sufficiency or to an importing position in temperate-zone products. In the USA the conjunction of lower domestic prices and sharp increases in grain prices on world markets improves the trade position by 0.5 billion ECU in grains. This is nearly offset, however, by the loss in soybean and soybean product exports as the EC’s imports decrease and as world prices fall. The US 1989 trade also improves in the animal sector, particularly in beef, taking advantage of the rise in the world prices. The net effect of EC liberalization on US trade in crops is more or less neutral as the EC support reductions in grains and the animal sector tend to offset each other from the US point of view. Altogether the US proposal appears to be quite favourable to the US trade balance and to force the EC to leave the world market as a significant exporter. Differential impact on global indicators Table 5 shows the evidence of the differential impact of the US proposal on major global policy indicators. Total savings in budget expenditures are far apart (12.2 billion ECU in the EC, 7.1 in the USA) and other indicators exhibit even larger differences between the two countries. Net farm incomes in the EC fall dramatically over the five-year period (21.7 billion ECU or about one-fourth), whereas they are reduced by only 7.0% in the USA. In the EC the fall in income does not seem bearable over five years without some compensation which would use up all the budget savings and more. The USA seems to be in a position

FOOD POLICY August

1991

Agriculture in the GATT Table 5. Changes in major policy targets at the end of five years (billion ECUlyr).

(year I)

EC Final (year 5)

82.5 16.1 _

60.8 3.9 _

Initial

Net farm income Budget costs Consumer surplus Trade balance

-18.9

-31.9

Change ~21.7 -12.2 +20.9 -13.0

Initial (year f )

USA Final (year 5)

67.0 16.0 _

62.3 8.9 _

+8.5

t8.8

Change ~4.6 -7.1 f1.6 to.3

to compensate producer losses by using the taxpayer’s money saved.” This is not the case in the EC because a significant amount of the existing transfer to producers comes from consumers, who would gain 20.9 billion ECU from the EC’s partial liberalization. So if the EC had to compensate producers, most consumer gains would have to be recaptured by fiscal means. Another conspicuous differential impact is on trade. Under the simulation the USA manages to improve its position by benefiting from world price rises and because of limited production cuts (the trade balance improves by + 0.3 billion ECU), while the EC agricultural trade position deteriorates sharply (-13.0 billion ECU).

Concluding comments

‘% the USA the fall in income is politically within reach, given the rate of outmigration of labour.

340

The quantitative assessment of the USA’s 1989 proposal reported here shows distinctively different impacts on the EC and the USA. The adjustment burden that would be put on the EC is considerably larger than that on the USA, particularly in terms of farm income and trade, while budget savings would be similar. The USA’s 1989 proposal amounts to a differential treatment of the EC and the USA, due to their sharply different initial positions and to the types of policy instruments implemented. As the EC relies on export refunds and on high user prices to support farm incomes, the budget saving versus farm income trade-off is more severe in the EC than in the USA. By ruling out export refunds after five years the US proposal would eliminate the EC from the world export market. The best the EC could do would be to return to self-sufficiency in most highly protected commodities which are now in excess supply. The size of the EC agricultural sector is considerably reduced under the scenario. The USA should also realize, however, that a smaller animal sector in the EC means a smaller outlet for feed items and lower world prices for soybeans. The USA’s 19X9 proposal, although formulated in terms of general rules of policy reform, would have put specific pressure on the CAP. It is at bottom nothing short of a demand to dismantle the CAP’s principles in the current context of a bolstered position for the EC based on refunds. This assessment confirms that the mounting surpluses and their budget implications have increased the pressure for reform of the CAP, hence the recent implementation of budget stabilizers and supply control policies. The USA’s 1989 proposal is now out of date, but its simulated implications reveal the economic fundamentals of farm policy reforms in the EC and in the USA, and therefore shed light on the logic of the changing negotiating positions of both countries. The more severe trade-off between farm income losses and budget savings has trapped the EC in a situation where full compensation of

FOOD POLICY August

1991

Agriculture in the GATT

income losses by decoupled payments is not feasible with available budget savings, hence the limited magnitude and the slow pace of adjustment that EC farm ministers have been able to agree upon. The same rationale also explains the strong temptation to resort to supply management policies to reduce the spillover of the CAP on foreign competitors and on budget costs, while escaping from the conflict between farm income and budget savings. In the foregoing analysis, production quotas were used by the EC to retreat to self-sufficiency so as to limit producer losses and to switch from the five-year regime to the less demanding lo-year schedule. This illustrates the risk that a discriminatory treatment of support measures against export subsidies could push the EC towards generalized production quotas, thus ending up in a CAP even more isolated from the world market. The design of the US 1989 proposal is also consistent with the benefit expected by the USA from a CAP reform focusing on grain support cuts, but its unacceptability to the EC - and also to many US domestic players - led the USA to soften its negotiating position in October 1990. The EC position hastily agreed the following month calls for a 30% reduction of support from 1986 to 1996 and is still a long way from the US stand. The limited policy changes envisaged by the EC are due to the severe conflicts between domestic goals it faces. Any avenue towards an acceptable compromise between the EC and the USA will require either a slower pace of adjustment that the one demanded in the US proposals or a substantial amount of compensation with ceilings on payments to limit budget outlays, or a combination of both. In any case, although domestic forces are the main driving force for reform, external pressure is likely to contribute to a revision of the open-ended export subsidy system in the EC, as it has already helped the Commission to obtain a partial tariffication of variable levies.

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341