Is it time to put the cotton dispute to rest?

30 May 2014

It may be time for Brazil and the C-4 to accept the US cotton policy reforms and move on to more important issues in agricultural trade policy. 

The new US Farm Bill eliminated two subsidy programs for cotton (direct and countercyclical payments), required marketing loan rates to decline (up to 10%) with market prices, and introduced a special “revenue insurance” program for cotton, the Stacked Income Protection Plan (STAX), that complements the longstanding crop insurance program.


The new Farm Bill also introduced the Supplemental Coverage Option (SCO) program, which allows producers of cotton and other grain crops to purchase additional crop insurance at highly subsidized rates. SCO indemnity payments are triggered by lower losses than the losses needed to trigger crop insurance payments and hence lowers the insurance deductible of crop insurance. STAX works in a similar manner, but is only available to cotton producers and, unlike SCO, STAX does not require participation in the crop insurance program. Both SCO and STAX have payment limits and hence do not cover deeper losses that crop insurance are designed to cover. While cotton producers are eligible for both SCO and STAX, producers are prohibited from enrolling the same plantings in both programs. Given higher subsidies on STAX premiums and higher coverage rates, it is likely that cotton producers will elect to participate in STAX over SCO.


Meanwhile, cotton is being excluded from two other crop programs: a modified countercyclical payment program called Price Loss Coverage (PLC), which provides payments based on historic production (plantings during a set historic time period) when prices fall below target prices, and the more PR-savvy, Agriculture Risk Coverage (ARC), which provides payments when revenues falls below benchmark revenues.  The PLC program replaces the countercyclical payment program, but functions similarly. However, the PLC program has higher target prices (39 percent higher on average) and allows producers to update their historic production upon which PLC payments are calculated. Thus, the PLC has the potential to be more production distorting than the countercyclical payment program which it replaces.


Cotton was singled out for the first time in the 81 year old history of field crop subsidy programs because of the U.S-Brazil cotton dispute in the WTO. These unprecedented developments made significant progress towards reforming cotton subsidy programs.


Cotton received four times the subsidy per unit of revenue in the years of the WTO dispute relative to other crops but is now projected to have subsidy rates in line with other crops. Meanwhile, U.S world market share for cotton has fallen, and policy initiatives by China in the form of import barriers and stockholding may impact world prices much more than U.S cotton subsidies in the new Farm Bill. Thus, it may be the time to put the U.S-Brazil WTO cotton dispute to rest to maintain the credibility of the WTO dispute settlement mechanism and move onto more important issues in the Doha Round.


The US-Brazil cotton dispute


Since 2002, Brazil and four African cotton producers (Benin, Burkina Faso, Chad and Mali, called the C-4) have been embroiled with the US in a dispute over how cotton subsidies reduce world prices and unfairly hurt cotton Farmers around the world. From the beginning, the C-4 pursued a “cotton initiative” within the Doha trade negotiations, which, like the Doha negotiations, has stalled.


Brazil on the other hand chose a different path by lodging a complaint at the WTO. When Brazil first filed its complaint, other field crops had exactly the same subsidy programs. But cotton was, at that time, a particularly egregious case: cotton subsidies were about 50 percent of market revenues, significantly higher than subsidies for the other crops. After countless meetings between lawyers and government officials, the WTO panel ruled in Brazil's favor.


The country was allowed to hit back at American trade interests with taxes on imports – a judgment worth more than 800 million dollars. Brazilian officials cleverly targeted the intellectual property industry, which in turn pushed the Bush administration to seek a compromise.


In exchange for Brazilians laying down their arms, American taxpayers promised to pay Brazil 147 million dollars each year. These payments were to continue until “successor legislation” to the 2008 Farm Bill was passed, presumably when Congress would finally stop funneling excess amounts of subsidies averaging almost 3 billion dollars per year in the early 2000s to approximately 53,000 cotton farmers.


How cotton subsidies have declined


In the past, as a proportion of total farm revenue, U.S cotton farmers, compared to all other U.S crop farmers, got twice as much crop insurance subsidies (even though the rules are the same for all crops), three times as much direct payments, five times as much marketing loan deficiency subsidies and twelve times as much countercyclical subsidies (cotton loan rates and target prices were set above market prices more than other crops). Overall, cotton’s rate of subsidy averaged four times that of other crops.


Precipitated by biofuel policies, crop prices tripled in 2008 and again in 2011, with volatility in between. This generated record farm incomes and hence direct payments became politically embarrassing and thus eliminated in the new Bill. Because target prices/loan rates generated few subsidies in the era of high prices for commodities other than cotton yet the political desire to transfer income to farmers remained, the revised countercyclical program (PLC), SCO, STAX and ARC were introduced to complement the pre-existing crop insurance program that is now much more prominent.


Crop insurance subsidies in recent years have become the biggest spending category US$ 7bnin total not including the approximately 5 billion dollars that the government pays to crop insurance companies to administer and deliver the program). The CIP has been continually expanded in recent Farm Bills by moving from yield to revenue insurance (which in itself almost doubled the subsidy), increasing the number of eligible crops, and increasing subsidy rates to farmers, insurance companies and their agents. This, combined with high market prices that increase participation rates (by giving incentive to farmers to purchase the most expensive insurance available with lower deductibles), has added to federal spending and production distortions. Although not part of the original US-Brazil cotton dispute, crop insurance now accounts for about 47 percent of total cotton subsidies (up from an average of 9 percent before 2009).


In the last five years, cotton subsidies have averaged about 12 percent of total market revenues, significantly lower than 50 percent in the years of the Brazil WTO cotton dispute. Allowing the cotton loan rate to fall with market prices, and excluding cotton from the PLC and ARC subsidy programs, means future cotton subsidies relative to other crops should continue to decline even if all crop prices fall towards historical levels. Subsidy rates for U.S cotton are projected to be well below subsidy rates for all of agriculture in OECD countries. The impact of any U.S cotton subsidy on world markets is also declining.  U.S cotton production was 12.4 percent of the world total in 2011, down from 20 percent in 2000.  


The way forward


A major controversy in last year’s House legislation was a seemingly mundane detail of a “reference price floor” of 69 cents per pound as part of STAX, which was below the previous cotton target price. Brazilian government officials protested loudly and threatened to re-open the WTO dispute should this proviso become law. Consequently, the reference price for cotton was dropped from STAX. The six principal subsidy programs for cotton that Brazil claimed were in violation of U.S domestic subsidy commitments in the WTO did not include crop insurance subsidies. If the crop insurance program is an issue, then Brazil should have screamed louder when it protested the minimum price in STAX. As a consequence of exclusions, special provisions, and no minimum price for STAX, analysis indicates subsidy rates for cotton payments will now be in line with that of other crops.


This provides a golden opportunity for Brazil and C-4 to consider locking in these major U.S cotton policy reforms by agreeing to drop their respective cotton disputes. Cotton has been a critical concern for countries at the WTO and a leading symbol for what is wrong with farm trade policy in general. After years of negotiations and the U.S-Brazil framework agreement to reduce cotton subsidies, the United States has now made good its promise to reform cotton policies. While the cotton policy reforms may help to resolve the U.S-Brazil cotton case, in an ironic twist, Congress has put in place subsidy programs for other crops that invite more trade disputes. Therefore, instead of cotton being a poster child for what is wrong with farm trade policy; it is beginning to look like a poster child for other sectors to reform equally.  


Brazil should accept this new legislation as a sufficient resolution to the dispute because the U.S has effectively reformed its cotton program. Meanwhile, the U.S could repair many rifts by agreeing to limit payments to what they were in 2010 or 2008 (1.6 billion dollars, well above projected cotton subsidies) as a group of cotton producing West African countries proposed at the last WTO Ministerial in 2011.


Seasoned agricultural economists predicted right to the end that cotton would not be singled out in the new Farm Bill. But cotton was singled out and this provides further evidence that the U.S reformed cotton policies in an unprecedented manner. Failure of Brazil and the C4 to accept the reforms would jeopardise the credibility of the WTO’s trade dispute mechanism and incentives to reform farm policy in the future will be severely diminished.

Authors: Harry de Gorter, Professor, Charles H. Dyson School of Applied Economics and Management, Cornell University.  Jaclyn D. Kropp, Assistant Professor, Department of Food and Resource Economics, University of Florida 

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