Trade-distorting Domestic Support: Alternatives for Product-specific Disciplines

1 May 2007

Setting product-specific spending caps on agricultural subsidies based on how adversely they affect international prices would provide a means to reduce trade distortions caused by domestic support policies.

The WTO cotton and sugar panels introduced two new parameters for product-specific agricultural subsidy disciplines. The first, particularly evident in the case of cotton, is that farm subsidies that result world market distortions are subject to the Agreement on Subsidies and Countervailing Measures, particularly when they cause serious prejudice. Second, the panels found that some domestic support can act as export subsidies and therefore such subsidies must be eliminated.

However, the jurisprudence does not specify how the adverse market effects of domestic support could be eliminated, or propose any criteria that would assist in determining whether the reform of a programme found to be WTO-inconsistent has effectively eliminated the trade-distorting element of the subsidy. The Doha Round negotiations provide a valuable opportunity to craft disciplines that will lead to minimising trade-distorting effects of product- specific domestic subsidies, improving the provisions of ‘substantial reductions in tradedistorting domestic support’ as established in the negotiating mandate.

One way to tackle the problem would be to set product-specific caps on trade-distorting subsidies based on Blue and Amber Box spending notified by WTO Members.2

We selected the US as a case study for this analysis because its price support programmes are highly concentrated on a few products. Moreover, the country is a significant global exporter of the commodities concerned and US spending on agricultural subsidies is considerably higher during years when global prices are low for these commodities, generating considerable negative impacts on the world market. Furthermore, in the Doha Round negotiations the US has shown great reluctance to accept product-specific disciplines that go beyond spending caps based on a 1999-2001 reference period (the base period is still a major bone of contention in the negotiations).

Averaging recent data, the products analysed in the table below represent about 75 percent of all US agricultural price support programmes.

Defining Caps Based on Price-distortion

The depressive effect of subsidies on global pricing is an appropriate indicator for the establishment of product-specific disciplines for three reasons. First, it is a reliable indicator of serious prejudice as defined in Article 6 of the Agreement of Subsidies and Countervailing Measures (SCM Agreement) and shown by the cotton case; second, it negatively impacts all international suppliers who export at market prices (i.e., no discrimination between exporters), and; third, it increases the volatility of a product’s international price, thus affecting world importers as well.

Although the SCM Agreement acknowledges that trade-distorting subsidies do lower world prices, it does not establish what level of trade-distortion would be considered to cause adverse effects to other countries’ exports. Furthermore, none of proposals currently on the table in the Doha Round agriculture negotiations address the maximum acceptable trade-distortion that any specific subsidised product could be allowed to cause to world markets.3

Establishing product-specific caps based on applied levels of the aggregate measurement of support (AMS) – or anti-concentration disciplines for the Blue Box – does not in itself guarantee that these subsidies will be disciplined according to their market impacts. Therefore, we propose that whatever the form of the new subsidy spending ceilings (whether individual, or combined for both categories), the value should be determined on the basis of the price distortion the subsidised product causes on world markets.

Daniel Sumner’s analysis of the impact of US subsidies on global prices for agricultural commodities has demonstrated that they most likely depressed world prices for maize (by ten percent), wheat (by eight percent) and rice (by six percent).4 As a contribution to the Doha Round negotiations on product-specific domestic support, we suggest that caps on such subsidies should be set on the basis of a maximum decline of two percent in world prices.

Global Product-specific Caps

Table 2 (see PDF) shows the amount of trade distorting US domestic subsidies that would result in a distortion of two and four percent in world prices. To calculate the impact of a country’s domestic subsidy on world prices, we based ourselves on a world supply and demand economic model for agricultural products that receive subsidies. We have assumed a low product price scenario based on the fact that US trade-distorting subsidies rise when prices decline. The proposed ceilings for product-specific domestic subsidies are thus intended to control oversubsidisation when world prices are low.

The calculations presented in Tables 1 and 2 are based on the following trade-distorting subsidies: marketing assistance loans and other programmes of lesser value notified as AMS support; marketing loss assistance from 1998 to 2001, and; counter-cyclical payments since 2002. Production flexibility contracts up to 2001 and direct payments as of 2002 were not included in our study. The inclusion of these programmes in the trade-distortion calculation would almost certainly have resulted in lower product- specific caps than we have proposed here.

The caps we propose for product-specific subsidies are based on the value that corresponds to a two-percent world market price distortion. We understand that a higher level of distortion would not be acceptable in setting product-specific subsidy disciplines in the Doha Round negotiations. The four-percent distortion figures in the table were only included to provide a comparison against other values. While this is a high level, such distortions have occurred several times during the implementation period of the Uruguay Round Agreement on Agriculture.

Table 2 shows a fairly strong correlation between the amount of subsidies that may distort world prices by about two percent and the value of ten percent of US production (between 1999 and 2005) for each of the products included. This correlation provides the basis for suggesting an easily measurable, and applicable, criterion for product-specific disciplines to subsidies applied by developed countries. In other words, using the calculated values for a two-percent market distortion as a reality check against any other possible criterion for capping product-specific AMS and Blue Box support, it appears that ten percent of a product’s value of production is an appropriate joint ceiling.

The ten-percent product-specific cap has an additional advantage compared to the twopercent price distortion criterion: complex calculations are necessary to estimate the impact of subsidies on world prices, which would require negotiators to take into account several parameters. Limiting product-specific subsidies to ten percent of the good’s value of production over a determined time period would simplify their task and possibly generate workable new proposals.

Final Comments Whether joint or individual Amber and Blue Box product- specific caps will be established, it is clear that spending limits must fall between the values of a two-percent contribution to world price distortion and a ten-percent share of the exporting country’s value of production for the product concerned. These criteria are essential for achieving a substantial reduction of the negative impacts that domestic subsidies have on world markets when international prices are low.

Given the complexity of calculating the trade-distortion caused by domestic subsidies, we suggest that the ten-percent of production value parameter should be the main criterion for determining a joint product-specific cap. When compared with the two-percent price distortion calculated in this study, this measurement passes the reality check, particularly when prices are low. It is also coherent with the de minimis limit established for developed countries in the Uruguay Round. It should be noted that a joint cap must be applied in conjunction with product-specific de minimis support to avoid loopholes when Blue Box and below de minimis payments are cumulated.

If a product-specific cap of this order of magnitude were established in the negotiations, the attractiveness of litigation based on serious injury would decrease. This would provide predictability for developed countries and ensure that domestic policies are consistent with WTO rules on agriculture, as well as those on subsidies and countervailing measures.

Marcos Jank is President of the Institute for International Trade Negotiations (ICONE) in São Paulo. Cinthia Costa is Senior Researcher and Quantitative Analysis Co-ordinator, and André Nassar is the institution’s General Manager.

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