Lecture notes on Agricultural Policies, EEP 131

1. Lecture notes on Agricultural Policies, EEP 131 September 2007

2. Why is a section on Agriculture part of this course? • Agriculture is one of the main “sticking points” in the current WTO trade negotiations (the “Doha Round”), and it was important to the formation of the WTO. • Agriculture is an important component of NAFTA. • The environment provides “services” that are essential to agriculture, and agricultural practices impact the environment. • Policies, particularly those in developed countries, strongly influence agricultural sectors in those countries, and (via international markets) also influence agriculture in developing countries. • The US is currently debating a new Farm Bill that will determine US ag policy during the next six years.

3. Background of Uruguay Round Agriculture Agreement (URAA) • Uruguay Round Agreement on Agriculture sought to bring Ag into GATT. (Discuss history, ag exemption, give examples of accidental developments, e.g. Europeans had low import restrictions on soybeans when soybeans were not an important crop in the 60s and 70s. Imports increased drastically and Europe sought to impose restrictions, which were resisted by the US) • Remind students that trade restrictions cause welfare losses; countries gain by reducing their trade restrictions even if partners maintain their restrictions. Ag policies inflict costs on domestic economies and also on trade partners. • Explain that a given level of producer support is more costly to achieve with tariff than with producer subsidy. Mention production and consumption distortions. • Trade and domestic policies are linked; for example, maintaining a producer price higher than world price requires import barriers or export subsidies, or for govt to hold large stocks. (Mention history of EU's lakes and mountains.)

4. Background, continued • Trade restrictions may be a cheap way -- in terms of government revenue, not of social welfare -- to provide producer protection. (See next slide.) Reduction of trade restrictions increases the fiscal costs of protecting producers. Therefore, a reduction of trade restrictions may put downward pressure on domestic (non-trade) policies. • (Show that if an importing country imposes a production subsidy, without a trade restriction, the government has to either buy surplus or make “deficiency payments” – the subsidy.) • Payments under farm programs are capitalized into land value. This means that the farmer who is receiving current government payments may already have "paid" for them in paying a higher price for land.

5. Suppose that the world price is pw. Under free trade, country shown in this diagram is an importer. Government wants to support producers by increasing producer price to p* > pw. (i) Show that tariff and import quota (where quota licenses are auctioned) are “equivalent”. (ii) Show that under either policy, deadweight loss is b+d. (iii) Show that if govt switches from tariff to a producer subsidy, producer price remains at p* and consumer price falls to pw. Consumers gain a+b+c+d and taxpayers lose a+b+c. The net gain is d, the amount by which deadweight loss falls. Producer subsidy is more efficient than trade policy (tariff or quota) but producer subsidy requires higher govt expenditures P* a c b d pw

6. Information about URAA • Distinction between Coupled Vs Decoupled payments. Decoupled payments supposedly have minimal trade impact. • Green box, blue box and amber box policies. • Green box policies supposedly do not “distort” (i.e. Increase) production. Crop revenue and insurance program protects farmers against losses due to adverse weather and other non-market conditions. These programs are not commodity-specific. They are green box provided that they do not exceed 5% of the total value of production – otherwise amber box. • Blue box are exempt direct payments linked to supply controls (which supposedly offset distortionary effect of payment), e.g. a payment to idle land. • Amber box are market price support, other direct payments, e.g. output and input subsidies. • PSE (producer support estimate, formerly producer subsidy equivalent); AMS (aggregate measure of support). These are usually expressed as a percentage of farm revenue. • AMS is the support to producers associated with amber box policies, as a fraction of their revenue. PSE includes green box and blue box measures. • The “Peace clause” was an agreement not to use the WTO dispute process to oppose domestic ag policies, provided that these policies did not violate the URAA – in particular provided that support levels did not exceed agreed limits

7. Three main areas of reform under URAA • (i) Reduce trade barriers and make them more transparent via tarrification, TRQs (tariff rate quotas) URAA eliminated non-tariff barriers and "tarrified" them, but some countries put "water in the tariff". Average tariff cuts were to be 36% for DC's (minimum 15%); average 24% for developing countries (min 10%). Example of differing responsibilities for DC and LDC • (ii) reduce AMS 20% for developed countries, 13 % for developing countries. • (iii) reduce value of export subsidy by 36% for DC and 24% for LDC.

8. Limited achievements of URAA • URAA set “Bound rates”, the max permissible tariff rate. These remain much higher for ag than for manufacturing. Tariffs particularly high for certain products important to LDCs: staple food products, tobacco, beverages, fruit and veg, meat products, ground nuts. • Tariff "dispersion" (or "escalation") remains a problem. Higher tariffs associated with more highly processed products discourages development. Average tariff on processed product as a multiple of average tariff on unprocessed products: 2.75 (EU), 1.25 (US), 3 (Canada), 3.75 (Japan). (OXFAM pg 98)

9. Recent US Farm Bills • 1996 FB (“Freedom to Farm Act”) emphasized Production Flexibility Contracts. Under these, whole-farm payments were not linked to production of specific crops and therefore supposedly do not create inter-crop distortions. • Payments may lead to increased farm income and thereby increase ag investment; they also reduce exit from agriculture. • 2002 Farm Bill (“Farm Security and Investment Act”) re-introduced Direct Payments, replacing Production Flexibility Contracts. The direct payments are calculated on the basis of previous acreage, so the US claims that they do not distort production decisions. • However, the reference period used for calculating payments was recently changed from 1986-88 to 1998-2001. If farmers anticipate that there will be subsequent revisions, they have an incentive to change their acreage. In this case, the direct payment distorts production decisions. • In addition, direct payments are contingent on farmers using land for agricultural purposes, but do not allow farmers to use the land to cultivate fruits, vegetables and certain other crops. (Explain the point of this restriction: policymakers are concerned that producers will switch to these other crops, causing oversupply in those sectors.) It is disputed whether Direct payments are in the Green box or the Amber box.

10. 2007 Farm bill and Doha Round/WTO • Doha Round and US Farm bill both scheduled for completion in 2007. Doha Round “collapses”. Farm bill likely to reflect budget constraints and domestic politics rather than goals of international ag reform. Congressional leaders say they will not try to “anticipate” the results of a Doha deal on agriculture. House Agriculture Chair Colin Peterson, D-Minn.: “I want to write a Farm Bill that’s good for agriculture. If somebody wants to sue us [at the WTO], we’ve got a lot of lawyers in Washington.” • The U.S. has not reported and categorized its domestic support payments to the WTO since 2001—the year before the last Farm Bill was passed. This lack or reporting makes it difficult to know whether the Farm Bill is complying with WTO rules. • The U.S. has not complied with WTO dispute panel ruling on U.S. cotton subsidies. Brazil has requested a new WTO dispute panel to force the U.S. into full compliance

11. US Proposals • US 2005 proposal for ag reform was to re-categorize subsidy payments from Amber Box to Blue Box, leaving US total spending unchanged, but requiring other WTO members to cut their ag tariffs; also requested an extension of the Peace Clause, which would exempt Farm Bill subsidy programs from legal challenge at the WTO. • In 2006, the European Union and nine other WTO members asked for an economic simulation of the various agriculture proposals at the WTO. The simulation found that under the U.S. proposal, U.S. agriculture spending could legally increase.

12. Emerging biofuels market • Emerging biofuels market likely to make US ag less dependent on exports. For example, if only a quarter of the ethanol plants currently proposed in the Midwest do come on-line and if the corn needed to supply these plants and the plants currently under construction were to be diverted from exports, Midwest corn exports could be cut in half by 2008.

13. Subsidy levels: a cause or an effect of world price changes? • U.S. subsidies are associated with commodity dumping that depresses world prices. U.S. farm subsidies (using WTO classification) rose from $7 billion in 1995 to $23 billion in 2000 and have recently fallen. Fluctuations occur because (some) subsidies depend on the market price. Subsidy falls when market price rises (as has recently occurred for grains) • IATP claims that U.S. farm subsidies do not “dictate price fluctuations; rather, the market price dictates overall subsidy levels. And subsidies play only a marginal role in the cropping decisions of U.S. farmers.” This statement implicitly accepts that subsidies are “decoupled” from supply decisions. Use graph (next slide) to show that a policy that makes US supply less elastic causes fluctuation in demand (e.g. arising from biofuel demand) to increase variability of US exports, thus increasing fluctuations in world price • IATP continues: “…the significant increase in U.S. subsidies over the past ten years is tied almost directly to the removal of supply management tools in the 1996 Farm Bill, which required farmers to set aside a percentage of their acreage to qualify for government payments. Without those tools, U.S. farmers overproduced at such levels that the market price for most major crops dipped well below the cost of production.” (Hard to reconcile this statement with the claim that subsidies are “decoupled”.)

14. US target price of p* makes US supply inelastic at prices below p*. US target price policy makes US excess supply less elastic. Therefore, the target price policy causes fluctuations in US demand (left panel) to increase fluctuations in world price (right panel). P* High demand Low demand US supply and demand US “excess supply” and world demand

15. Fallout from 1996 Farm Bill and biofuel surge • 1996 Farm Bill was written to comply with WTO rules. It required most farm subsidies to be phased out by 2001 – payments were to be decoupled. Farmers were allowed to produce as much as they wanted (“Freedom to Farm” act), prices collapsed and the subsidies were restored in the form of “emergency payments.” In 2002, Congress transformed those “emergency” payments into a permanent part of the Farm Bill, calling them “countercyclical payments.” • 2006, the growth of the ethanol market sent corn prices higher than they had been in a decade and has led to price increases for other crops, particularly other animal-feed crops like wheat and soybeans. Ethanol’s growth and rising prices had an immediate impact on farm subsidies, which went down from $24.3 billion 2005 to an estimated $16.5 billion in 2006. The U.S. Department of Agriculture projects prices to continue to rise in 2007 and subsidies to again decline. Will the price increases be sustained? There was also a price increase in 1995, when the 1996 Farm Bill was written.

16. Dumping in ag trade • Dumping means exporting at a price less than average cost. The dumping margin is the difference between export price and production costs. Dumping is illegal except for agriculture. US policy allows the use of anti-dumping penalties, known as countervailing duties. • OXfam calculates export prices as % of production costs (percent dumping margins): US and EU account for approx half of wheat exports. In these countries, export prices are 46% (US) and 34% (EU) below production costs. US accounts for 50% of world maize exports; export prices are 20% below production costs. • Prices received by (Organization of Economic Cooperation and Development) OECD* farmers were about 31% above world prices, compared to 57% higher than world prices in mid 1980s. (Farm prices higher than world prices by 0% in Australia and New Zealand, 10% higher in US, 35% higher in EU and 100% higher in Iceland, Japan, Korea, Norway and Switzerland. (*OECD consists primarily of wealthy countries and some middle-income countries such as Mexico.) • High variation in PSE across countries and commodities: average PSE is 18% in US and 36% in EU. PSE is 48% for sugar and milk and 80% for rice. • Amber box support is 76% of total producer support, down from 90% in late 80s. Gross farm receipts in 2002 46% higher than they would have been absent government support, compared to 61% in mid 80s Consumer subsidy equivalent (CSE) 24% compared to 33% n mid 80’s.

17. Recent farm bills and ag dumping The last two U.S. Farm Bills encouraged over-production and low priced commodity crops, leading to increased ag dumping. Compare dumping levels 1990-1996 to the 1997-2003: Wheat dumping levels increased from an average of 27 percent per year pre-1996 Farm Bill to 37 percent per year post-1996 Farm Bill. Soybean dumping levels increased from an average of 2 percent to 11.8 percent. Maize dumping levels increased from an average of 6.8 percent to 19.2 percent. Cotton dumping levels increased from an average of 29.4 percent to an average of 48.4 percent. Rice dumping levels increased from an average of 13.5 percent to an average of 19.2 percent.

18. Food aid • (Simulation results) Global reform leads to a slight overall decline in food aid (because of decreased supply in aid-giving countries, presumably), although the decline is significant in some areas (9% decline in Southern Africa). • Higher food prices increase need for food aid, but increased export earnings decrease the need. • In addition, reduction in domestic tariffs in developing countries is more than offset by increase in world price, leading to an increase in domestic price and a positive supply response.

19. US policies and food aid • U.S. programs are controversial; almost all the aid is in the form of food produced, bagged, fortified and shipped in the U.S. by U.S.-based firms. • The alternative (followed by most donors other than US and Canada) provides cash to buy food as close to the final destination as practical, in order to support long-term agricultural capacity in the area suffering food shortages, and to inject cash into local economies. (Mention A. Sen’s research) • Consequence is U.S. food aid is slower to arrive and as much as twice as expensive as prevailing commercial prices. Local purchases ought to be the first recourse for food aid to minimize the risk for future dependency and to provide an injection of cash into the local economy. • In 2005 Bush proposed – and Congress rejected – adding $300 million for food aid purchased from local or regional sources. Opposition to the proposal came from U.S. shipping firms, U.S. agribusinesses that provide the food; and U.S. NGOs; the latter deliver food aid (project aid for development purposes and humanitarian aid in emergencies). They sell some of this food in recipient countries to generate funds for their development work (“monetization”). “Monetization” is inefficient but NGOs believe that U.S. government would be unlikely to provide offsetting cash for development.

20. WTO negotiations and Farm Bill on Food aid • Doha negotiations involved U.S. food aid under heading of export competition. US uses export credits to sell program food aid, pricing competing exporters out of the market. • The U.S. has resisted reforms on food aid, particularly on monetization. Recipient countries have supported US position to avoid risk of reducing total food aid • Role of food aid in current Farm bill uncertain. Bush’s proposal included more money for the purchase of food aid by recipient countries. Some but not all U.S. NGOs reducing their support for monetization.

21. History of environment in Farm Bills • First US ag conservation initiative:Soil Conservation Act of 1935, created with strong public support because of the disastrous affect the Dust Bowl on agriculture. In constant dollars, nearly twice as much funding was available for conservation programs in 1937 as in 1999. • The Agricultural Act of 1956 initiated the Soil Bank, taking 29 million acres out of production. Objective was to institute conservation practices on “soil bank acres” and also to decrease surpluses. First goal successful, second was not. Farmers put least productive acres in the soil bank, so effect on production is modest. The Soil Bank was an expensive supply management tool. It illustrated the importance of limiting retirement on a per-county basis to avoid devastating local economies and also the importance of a bid system rather than fixed payments. • Farm productivity (output/acre) increased by 50 % between 1950 and 1970, largely through the adoption of hybrid corn, improved plant breeding, increased acres of row crops, and improved management, including fertilizers, pesticides and favorable weather. • The Emergency Feed Grain Act of 1961 began a trend that paid farmers to replace production acres with conservation acres. In 1965, the Act was amended to provide for five- to ten-year contracts for farmers to take corn and grain sorghum out of production and use the land for conservation purposes. Again, farmers removed the least productive land from production and used the income for more inputs, thus commodity supplies continued to increase.

22. Farm Bills in the 60s and 70s • The Emergency Feed Grain Act of 1961 paid farmers to replace production acres with conservation acres. In 1965, the Act was amended to provide for five- to ten-year contracts for farmers to take corn and grain sorghum out of production and use the land for conservation purposes. Farmers removed the least productive land from production and used the income for more inputs, thus commodity supplies continued to increase. • In 1970s world grain prices increased due to Soviet shortages. US policy encouraged planting “fence row to fence row” policy was established by the U.S. Secretary of Agriculture, Earl Butz. Land that the government had spent millions helping to establish in conservation uses went under the plow as soon as the conservation contracts expired. Row crop production expanded at the expense of pasturelands and woodlands, land prices increased. Increased production led to lower farm prices and the ag crisis of the late 70s and 80s • Farm policy in the 1980s included broader environmental concerns, including soil quality, water quality, air quality, biodiversity and wildlife. The environmental lobby became active in farm policy, recognizing that it was easier to achieve environmental goals using agricultural rather than environmental legislation. The 1985 Farm Bill contained the Sodbuster, Swampbuster, Conservation Compliance, and the Conservation Reserve Program (CRP).

23. Farm bills in the 80s • By 1985 the environmental effects of “fence row to fence row” philosophy were apparent. Commodity policies contradicted the goals of conservation programs. The 1985 Farm Bill initiated conservation compliance requirements, requiring farmers to meet a minimum standard of environmental protection on environmentally sensitive land (primarily highly eroded land or wetlands) as a condition of eligibility for federal farm program payments. It was difficult to establish the level of acceptable soil loss. • A more flexible approach required owners of highly erodible lands to develop and implement a farm conservation plan by 1995, or face significant financial penalties. Between 1992 and 1997, conservation compliance, and the adoption of other conservation measures (e.g. no-till and conservation tillage) helped to reduce soil erosion by up to 295 million tons per year • Enforcement of conservation compliance provisions lead to political disputes. USDA employees were called “soil cops,” and enforcement was spotty and varied significantly between counties. That lesson cast a cloud on the conservation compliance provisions, and although the legislation still exists, it is rarely enforced

24. Conservation reserve program (CRP) • CRP was established in the 1985 Farm Bill and reauthorized in the 1990, 1996 and 2002 Farm Bills. Purpose of the program is to convert highly erodible cropland or other environmentally sensitive acreage to resource-conserving vegetative cover; also intended to reduce crop production. It provides annual rental payments for 10 to 15 years to landowners through the Commodity Credit Corporation (CCC) based on the agriculture rental value of the land (as determined through competitive bids). It also provides up to 50 percent cost share for approved conservation practices. • 36 million acres currently in the conservation reserve. It helps to conserve soil and protect wildlife, and is supported by farmers and wildlife groups. It is associated with a 25 percent reduction in soil erosion. • It is important in protecting the water quality of the Upper Mississippi River Basin and the Gulf of Mexico. The five Mississippi River basin states (Illinois, Iowa, Minnesota, Missouri and Wisconsin) currently have a total CRP enrollment of 7 million acres, or approximately 19 percent of the national CRP acreage. Many acres will expire in 2007

25. CRP, continued • CRP has generated approx $500 million per year in conservation enhancements (freshwater recreation and wildlife hunting and viewing). Enrollment of 36 million acres has reduced soil erosion by more than 44 million tons per year, protected and improved soil quality and productivity, produced benefits to wildlife – also reduced surplus commodities • The 2002 Farm Bill increased the CRP enrollment cap from 36.4 million acres to 39.2 million acres; some contracts could be extended up to 15 years. • CRP contracts on over 28 million acres expire between 2007 and 2010. Concern that increased grain prices could cause many acres to be returned to production. As of March 2007, 4.6 million of the 27.8 million eligible acres will be reenrolled, and in the Corn Belt states, 1.4 million of the eligible acres will exit the program. • Greater environmental benefits can be achieved with the same amount of money the program is targeted to specific outcomes; e.g., targeting toward increasing the amount of carbon in soil could improve wildlife habitat and water quality. Targeting CRP on erosion gives almost a three-fold reduction in soil loss and double the nitrate runoff reduction (important for dealing with problem of hypoxia in Gulf.

26. Conservation Security Program (CSP). • CSP introduced in 2002 Farm Bill, rewards farmers for voluntary conservation practices on their working lands, combining production of economic products and environmental benefits: surface water quality, groundwater protection, air quality, fish and wildlife habitat, energy conservation, soil quality, biodiversity and genetic preservation. • Farmers receive annual payments as they provide public benefits to the nation’s natural resources and environment. Any farmer who incorporates conservation practices can participate. Other conservation programs are ignore farmers who are already practicing good stewardship. All regions of the country and all types of agriculture can participate in CSP. Payments per farm are also capped at a modest amount annually so that large farms will not benefit disproportionately, but support continues life of the individual five- to ten-year conservation plan and contract.

27. (New sub-topic) Estimated effects of ag liberalization (ca. 2003) • Give a sketch of how economists estimate the effects of policy reform. • Developed countries account for 80% of distortions, (EU 38%, US 16%, Japan and Korea 12%, Canada 2%). Elimination of polices would increase price of ag products by 12%. • USDA/ERS estimated world benefit of removing all ag policies is $56 billion per year. (This includes static welfare gains and the dynamic gains -- 45% -- caused by higher investment due to increased income. • Food importing countries may have static welfare losses but dynamic gains. Claims that poorer countries enjoy the greatest dynamic gains) • $35 billion accrues to developed countries ($11 B to EU and 13 B to US). $21 B to developing countries ( $2 B to China, $6 B to Latin America, $1.6 B to Mexico, $5 B to other Asia, $0.8 B to South African Countries.

28. Estimated effects, cont. • Greatest gains to poor countries comes about due to their removal of their own trade policies. • Claims that most of the gains to US come from reduction in partners' trade policies. Full reform would increase US exports by 19% per year. • Compare these estimates to OXfam's: Full liberalization by industrialized countries generates gains of $3 billion each for India, China, Brazil, more than $14 billion for Latin America, $2 billion for sub-Saharan Africa. These estimates exclude dynamic effects.

29. Features of ag protection • High tariffs in developed countries tend to be associated with more highly processed commodities (“tariff dispersion” discussed above). • Decreasing these tariffs promotes growth of ag processing sectors in developing countries. Developing countries who have “preferential trade agreements” will lose from trade reform, e.g. countries in Caribbean Basin Initiative, which import to US at preferential rates, or Lome Convention countries that import to EU. • However, even these countries might benefit from removal of distortions if it encourages diversification.

30. Effect of reform on developing countries (ca. 2003) • In around half of developing countries, ag exports account for more than a third of export earnings. Ag trade is important to these countries. • (World Bank report quoted by OXFAM says that elimination of OECD ag distortions would benefit developing countries by $20 billion per year, almost the same as USDA report.) • Elimination of developed country distortionary ag policies increases developing countries’ value of exports by 24% and cause the value of their imports to fall by 3% (due to higher world prices). (A decrease in value of imports following an increase in price implies that developing country demand for ag imports is elastic.) • Elimination of developing country distortionary ag policies (mostly trade restrictions) cause value of their imports to increase by 20% and value to increase by 8%. • Elimination of developing country distortions causes the value of their exports to increase by 5.5% (volume to increase by 4%). This increase is partly due to demand effect (to the extent that developing countries export to other developing countries) and partly due to supply effect (to the extent that developing countries implicitly or explicitly tax their exports, e.g. via state traders.)

31. Other estimates of the effect of farm policies • Oxfam (ca 2003) provides other reports of the welfare costs of current policies. It claims that EU CAP depresses terms of trade for Argentina and Uruguay 7-8% and costs Argentina $2 billion per year. • US corn farmers receive $20,000 govt support per year (not clear how this is measured), while Filipino farmers earn $365 per year. • Oxfam claims that Filipino liberalization of (trade) corn market caused US import prices in Philippines to fall by 30% in one year. (Not clear what the market effect of this was, since we aren't told size of imports.) • Poor farmers obtain a large fraction of their income from corn sales, so any decrease in price harms them a lot. Remember that although importers have a net gain from a reduction in import price, competing producers in import countries lose. An example: EU milk subsidies that increase EU exports to Jamaica displace Jamaican milk.

32. Another version of corn in Philippines • Another paper (by Cristina David) disputes Oxfam's claims re corn in Philippines. Her data shows that nominal protection rates increased from 25% in late 1970's to 90% by late 90s. This tariff is an implicit tax on hog production, a commodity for which the Philippines is thought to have a comparative advantage. Overvalued exchange rate also is implicit tax on exports. Claims that "dirty tariffication" limited the impact of URAA. • (Interesting monopoly power story: She also mentions the Philippines attempt to behave as monopolist vis a vis Japan in bananas. Existing banana growers were allowed to limit the area planted to bananas, for export. The banana cartel limited productivity growth, and Philippines share of banana market declined.)

33. Policy status in OECD countries (based on OECD 2003 pub: Ag Policies, Monitoring and Evaluation) • What has actually happened to levels of ag support since URAA? • OECD is Organization Economic Cooperation and Development. Mostly “rich” countries, but includes some middle income countries, e.g. Mexico. • Support levels unchanged in recent years but down over long term. • Circa 2003 average OECD PSE was about 31%, down from 38% in 1986-88. (In contrast, the absolute as opposed to the percentage level of support has increased, according to Oxfam.)

34. Levels of support • Support to OECD farmers in 2000-02 was $235 billion per year. (Total support to ag was $318 B -- 75% went to producers and 15% to general services, such as research, education, inspection and control). • Compare to per capita income of low-middle countries ($2,000) and low income ($410). • Total support for OECD ag = 1.2% of GDP, down from 2.3% in mid 80's. US farmers receive an average of $21,000 in subsidies ($16,000 for EU farmers). • These average figures are misleading, because the distribution is extremely skewed. There are legal limits on the amount of subsidies that a farmer can receive, but these limits appear to be easy to avoid, by having many family members own portions of the corporate farm. • Rich country support goes disproportionately to rich farmers. In EU, 17% of farmers receive 50% of support; in US, top 20% of farms receive 84% of support (OXfam pg 114) Across all crops, richest 10% of farmers receive two thirds of total govt payments to agriculture. For cotton, richest 10% receive 73% of total payments

35. Other kinds of impediments to ag trade (apart from explicit trade restrictions and producer support) • Non-tariff barriers; sanitary and phytosanitary restrictions. • Consumer boycotts. PETA boycott of Indian leather reduces Indian shoe exports. • EU standards to protect consumers from aflatoxin reduces African exports by $670 million per year, with negligible (?) health benefits. • EU blocks Indian bed linen. • U.S. catfish producers persuade Congress to redefine "catfish" excluding Vietnamese species. • Requirement of “dolphin safe” labeling for US market.

36. Agriculture and environment in OECD countries • Ag accounts for 40% of land use and 45% of water use. • Most policies have promoted intensification of agriculture, exacerbating environmental problems. • Some improvement since early 90s, lowering demand for chemical and mechanical inputs and grazing for livestock. • Soil erosion and water pollution remain major problems, costs many billions per year. • Since mid 80's, environmentally-related payments to farmers have increased from 1% to 3% of total OECD support to producers. (EU expenditures on ag-environmental payments -- excluding member state contributions -- comprise 5% of CAP budget; 8% of US ag budget.

37. Ag and environment, continued • Support to producers increasingly tied to environmental cross compliance. Types of programs: payments to adopt and support low-intensity farming, including organic; land retirement; payments to farmers to meet transitional costs of complying with new env regulations; promoting the planting of "shelterbelts" for sequestration of greenhouse gasses and production of bioenergy. • Payments made to farmers on basis of farmland covered, not environmental results; objective is to cover farmers' costs of complying with programs. • Programs not well targeted, leading to mixed results. (In US, since 1990, enrollment in Conservation Reserve Programme (CRP) have been targeted using Environmental Benefits Index, which related environmental benefits to costs.) • Some times the programs are undercut by other programs that worsen environmental problems. Some programs subsidize "basic environmental maintenance" activities, contrary to “Polluter Pays Principle”.

38. Ag and environment, continued • Environmental charges and taxes rarely used, because most ag pollution is non-point. (Explain distinction between point and non-point source pollution.) • Taxes on inputs, e.g. pesticides, used in Belgium and Scandinavian countries. These may not be efficient, unless there is a direct relation between input and environmental problem. (Explain “Principle of Targeting”). • Examples of other market measures: Netherlands has a system of tradable permits for manure produced by farms. Wetland mitigation banks; tradable water rights in US.

39. Types of environmentally-related regulations: • Regulations on use of pesticides, regulation of farm practices such as spreading manure, stocking rates, construction of livestock facilities. • How important are these costs to location decisions? OECD study of pig sector concludes that difference in compliance costs associated with the use of manure has small effect on international competitiveness of pig farms, relative to traditional factor such as producer support, wages, land rents and capital costs. • Receipt of support in some cases requires certain type of environmentally friendly behavior. In US, 44 million hectares of highly erodable cropland and 31 million hectares of wetlands are subject to cross-compliance restrictions. • The effectiveness of these programs may be undermined when they coexist with production-linked support that cause the environmental problems.

40. Case study, Mexican corn • Corn and Mexico is an interesting case study because US ag policies and NAFTA combine to affect corn production, producer welfare, and biodiversity in Mexico. • Mexican corn has tremendous genetic diversity. 60% of Mexican farmers use locally adapted varieties; these cover 80% of area under cultivation. • When NAFTA was introduced, corn accounted for 60% of Mexican land under cultivation, made up 2/3 the value of Mexican ag output. Horticulture accounted for less than 6% of value. • Ag accounted for 7% of Mexican GDP in 1998 (down from 15% in 1960), employed 22% of labor force. This difference indicates lack of productivity in sector. • Mexican govt wanted to use NAFTA to encourage reallocation of labor out of ag, and within ag to more productive crops (sugarcane, coffee, horticulture), and also relieve fiscal pressure by decreasing need to subsidize food and ag inputs. • Mexico thought that NAFTA would also relieve pressure to farm marginal land, improving environment. There are typically costs of adjustment. The plan was to offer adjustment assistance.

41. Current situation • Corn in Mexico accounts for 60% of cultivated land, employs 3 million farmers (8% of Mexico’s population and 40% of people working in agriculture) and is the country’s main staple food crop. • There are a total of 18 million people dependent on corn production, including farmers and their families. • Seventy-two percent of national corn-producing units are organized into ejidos— mostly small-scale holdings that account for 62% of corn production. Corn production accounts for more than two thirds of the gross value of Mexico’s agricultural production,while horticultural crops account for only 6%.

42. Land supply in Mexico • Mexico’s climate ranges from desert wasteland conditions in the North to tropical conditions in the Southeast, so has possibility of diversified production. • Mostly mountainous and much of it is arid; only 11.8% of land area is arable. • The scarcity of high-quality land creates disputes. The issue of land and land rights important for understanding Mexican history and still generates conflicts today. • 6.6 million ag workers in Mexico do not own land.

43. Mexico’s decision to not use the adjustment period • NAFTA allowed Mexico a 15 year adjustment period on corn trade, giving its farmers more time to adjust. During the first year of NAFTA, Mexico’s tariff-free import quota was set at 2.5 million metric tons of corn. This quota was to expand 3% a year , reaching a tariff-free import quota of 3.6 million metric tons of corn. • Since beginning of NAFTA, annual corn imports into Mexico have exceeded the allotted tariff-free quota. Mexico did not collect revenues from these above-quota imports. Instead of phasing out corn tariffs in 15 years as planned, the tariffs were phased out in 30 months, during which time corn prices fell 48%. (Imports of US corn rose by a factor of 15.) Mexico essentially removed trade restrictions, eliminating tariff revenues. This loss, together with more restrained fiscal policy, reduced govt's ability to support ag sector, leading to lack of adjustment assistance. • This accelerated process took place along with decreases in government support for farmers, further compounding the adverse effects on corn farmers. The decision to truncate the adjustment period benefited large companies importing corn as animal feed.

44. Mexico’s rapid adjustment • Lost revenue from Mexico’s decision not to implement the “tariff rate quotas” (TRQ) for corn exceeded $2 billion. Reasons for the decision to speed adjustment include disorganized control mechanisms at the border and perceived need to lower prices and reduce inflationary pressures. Government wanted to obtain cheap corn for processors (illustrating balance of power between corn processors and producers). Until recently, producers were not even represented on the committee to set import quantity. • Mexican corn production remained at high levels, area of corn cultivation expanded, so productivity fell; expansion on to marginal land increased environmental damage. (Increased fruit and horticulture production has not absorbed amount of land or labor that govt anticipated -- more efficient use of inputs have led to productivity increases, lowering amount of labor per unit of output.) • Figure next page shows that had adjustment been gradual, and tariff revenues used to compensate Mexican corn farmers, the effect of NAFTA on the farmers would have been minimal. (But part of the point of NAFTA was to induce the corn sector to shrink.)

45. Effect on producers of reducing domestic price from a to pw, rather than from a to b, as permitted by NAFTA a b Additional lost producer surplus Lost tariff revenue pw

46. Consumers were expected to gain from cheaper corn • Tortilla price did not fall because at end of 1998 Mexico ended price controls on tortilla and stopped subsidizing tortilla mills. • Tortilla producers (maybe) are local monopolists in Mexico, and they did not pass on cost reductions -- lower corn prices-- to consumers – see next slide. • Price controls can increase economic efficiency if good is provided by a monopoly.

47. Competitive firms and monopolist respond differently to fall in costs • Graph in next slide shows linear demand and constant costs, which fall from c to c – 1. With competitive firms, price falls from c to c-1, i.e. all of the fall in price is passed on to consumers. • With monopoly, price is set where marginal revenue (MR) = marginal costs (constant in this example). • In this example, demand slope = a, so MR slope = 2a. Using formula “slope = rise/run”, show that price falls by ½. The monopoly passes on only half of the fall in costs. • The same qualitative result holds under increasing marginal costs and “most” demand functions (linearity is not needed).

48. price 1/2 1/2a Costs = c New costs = c -1 1/2a Inverse demand (slope = “a”) Marginal Revenue (Slope = 2a) quantity

49. Rural poverty in Mexico • As of 2001, 81.5% of people in rural areas were living in poverty. For the economically active population in agriculture the incidence of poverty increased from 54% in 1989 to 64% in 1998.6 • Since 1992, the proportion of workers employed in agriculture has shrunk by 10%; rural wages are 30% lower than other sectors of the economy, such as construction. • Rural population obtains 44% of household income from non-farm wages; 80% of families living in rural areas have at least one family member living outside of the community. (Are these figures an indication of vulnerability or of farmers’ successful “diversification” strategies?) • Slight increase in the average per capita GDP during NAFTA period, together with increase in rural poverty in Mexico. Average annual growth rates in the agricultural sector averaged 1.7% in the 1990s, 0.6% in 2000 and 1.9 % in 2001. • Ag becoming less important in national economy: down 4% points since 1980, currently 4.4% of the GDP.

50. Inequality in Mexico