Farm Programs and the Economics of LDC Cotton

1. Farm Programs and the Economics of LDC Cotton Presented at the “International Conference on Cotton: The Next Steps for Africa” Woodrow Wilson Center, Washington DC October 26, 2006 Daniel A. Sumner* *University of California Agricultural Issues Center and Department of Agricultural and Resource Economics, U.C. Davis

2. Focus • U.S. cotton subsidies depress world prices and thereby hurt some very poor exporters of cotton • It is important to understand why and how much • What is happening to reduce or eliminate these adverse effects • What more can be done

3. Three Cotton Subsidy Proceedings Converge • Brazil won its WTO cotton dispute on US cotton subsidies, but the US is resisting implementation • (This may not be in the overall interest of the US, but not a surprise) • The African cotton initiative of the Doha Development Agenda negotiations depends in part on the fait of the DDA • But it can keep the pressure on the US and compensation does not depend on the DDA • The next US farm bill may make major subsidy changes and can be a vehicle for additional cotton subsidy reductions, after the WTO dispute implementation

4. Why Cotton? • It is natural that cotton has been highlighted in both a Doha Initiative and WTO litigation as well and US domestic pressure for reform • Cotton has very high subsidies in the United States, even relative to other subsidized crops • United States has a big market share and a major influence on world markets • LDC farmers are significant exporters of cotton and have suffered from price suppression caused by subsidies

5. Cotton Clarifications • Subsidies is not all there is in the cotton market. The weather and other factors affect year to year fluctuations and some trends. • But, underlying all this, the subsidies keep US production high and prices lower than the would be, especially in years when low prices are already expected. • Every study finds that cotton subsidies drive down world prices. Some studies find very, very high effects of subsidies. Others find implausibly low subsidy impacts by only looking at a subset of subsidies or by looking at years when high prices are already expected, or by assuming almost all the adjustments happen in quantities and not price. • The bottom line, most plausible (and modal) estimates are for substantial subsidy effects on world price.

6. US Farm Subsidies: Costly and Complex • US subsidies comprised an array of programs • Total value of subsidy varies inversely with price … For cotton often roughly equal to the market value of the crop $2 to $4 billion mostly tax financed. • Marketing loan… payments on all production • Direct payments… on historical (updated) base with some planting restrictions • Counter-cyclical payments…tied to price and paid on historical (updated base) with restrictions • Crop insurance subsidies • Export credit guarantees for buyers of US cotton • Focus here on the first three “farm bill” subsidies

7. Government Cotton Payments under the 2002 Farm Bill Government cotton payments average about half of total revenue for cotton farms Target Price – $0.724 } CCP Do not have to currently produce cotton to get these payments Loan Rate – $0.52 } Fixed payment – $0.0667 } MLG/LDP Market Price Paid per unit of production of cotton (Based on a figure from Joe Outlaw Texas A&M) Market Receipts

8. Budget for Commodity Subsidies

9. Determinants of Policy Effects on World Price • Cotton programs provide substantial revenue that is linked to production incentives. • Subsidy share of revenue (about 50% for cotton in many years) • Degree of subsidy linkage (see subsequent slide, high for cotton, but less for some subsidy types than others • Supply response in US to fall in expected per acre revenue, large because removing subsidy would remove 35% to 40% of effective revenue (drive revenue below variable costs) • The Cotton Council is right, many US cotton growers need these subsidies to stay in the cotton business!

10. Determinants of Policy Effects on World Price • US share in world markets (40% of exports and 20% of world production) • Supply response and price transmission into other countries (Likely to be small among major producers, but not everywhere) • The bigger the supply response the more production growth in other countries and smaller overall price jump 5. Demand response to price (Limited…cotton is a unique input for many uses

11. Effects of Complex Subsidies: expectations, insurance and “decoupling” • Impacts of price contingent cotton subsidies depend on expected price • Expected marketing loan benefits are directly tied to production and offset low prices. They naturally boost production • Some payments are not tied directly to current production but are not divorced from production incentives. They are not fully “decoupled”: • Bankers more willing to finance the crop, if grower has guaranteed cash flow • Growers are restricted on what they can plant • Updating…expectation that future subsidy is tied to current production • Counter-cyclical payments…a price hedge

13. Share of total subsidy from each program, 2005(LDP, and CCP have largest production incentives)

14. World Market Shares, 2005

15. Effect of Removing Cotton Subsidy • If we put these factors into a simulation model to see the magnitudes we find large US and world market impacts of removing US cotton subsidies • Effects would vary by year, but US production would be 20% lower or more and US exports fall by more • World price would be higher by about 10% • This price increase encourages more production and exports from LDC producers

16. WTO in Geneva influences US policy and the US influences the WTOFor farm groups in the US the WTO seems foreign, while to developing countries it seems based on US power, practices and procedures

17. Litigation continues to be important • It did not take much actual litigation to get lots of attention • One or two WTO cases, not even yet implemented • But, influential players (including chairs of major committees and the Secretary of Agriculture) rank WTO disputes as a major driver for change in US farm subsidies • Those writing the farm bill want to comply with obligations and avoid more cases

18. WTO Implications of Litigation • Affect process of negotiation and agreement…more attention to specific wording • Some implications of definition of colored boxes… • Pressure for rules that can be predictably binding • Credibility of WTO in small and developing countries increased with successful developing country cases (cotton, sugar) • There may be additional cases, but these are hard to develop • Success is not a “slam dunk”

19. Cotton Dispute and African Cotton Negotiation Initiative are Complements • Efforts from Africa and other developing countries can influence the degree of implementation • The African Initiative can help keep the Doha round alive, by emphasizing that the WTO can be a big win for the poor as well as the “rich” • The African Initiative can continue to point out that US subsidies have unintended consequences • Compensation for past losses still an issue that have not been seriously dealt with

20. Bottom Line Effects of Removing Cotton Subsidies • Average gain from elimination of US subsidies would be about $0.05 per pound • Raise annual revenue by about $75 to $100 million or more in the C-4 countries alone • Additional gains throughout the system (multipliers) plus dynamic economic stimulus • A huge benefit to some very poor people • Challenge: insure that benefits go to growers.

21. Thank You For detailed analysis, my background paper should be available soon from the IPC To contact me directly dasumner@ucdavis.edu www.aic.ucdavis.edu