Rethinking world agricultural policies

Rethinking world agricultural policies

Matthew Shane

Rethinking World Agricultural Policies

In April, industrialized countries – under the auspices of the General Agreement on Tariffs and Trade (GATT) – agreed to substantially revise agricultural policies that distort trade. The agreement, a historic first for agriculture, was possible because economic conditions have changed so much over the past three decades that agricultural policies need to be brought in line with current international realities. Countries are now poised to make constructive reforms in world markets.

Since World War II, GATT has provided a legal framework for regulating international trade. Using a set of agreed-upon rules, GATT controls the degree to which countries can intervene in trade. Currently, 96 nations are members of GATT and another 31 follow its regulations. These countries account for over three-fourths of world trade.

Although GATT covers both agricultural and industrial trade, agriculture is presently exempt from many GATT rules. As a result, most governments still actively intervene in agricultural production and marketing. For example, the U.S. Government offers farmers of major commodities income support through target prices and deficiency payments. The European Community (EC) provides support to farmers through its Common Agricultural Policy, which maintains high domestic prices by controlling market access using variable levies and export restitutions. Japan gives the highest level of support to its producers, also by tight control over imports. Such policies have led to a situation in which international trade in farm products is complex and often governed by the nature of agricultural policies rather than market forces.

While agricultural support has increased during the last 25 years, protection for industrial goods has declined. Through multilateral negotiations over time, tariffs have systematically been dropped. Tariffs on manufactured goods from industrial countries went from 40 percent in the mid-1960’s to 6 to 8 percent by 1974. After the Tokyo Round of GATT negotiations, which lasted from 1974 to 1979, these tariffs were reduced to an average of only 4 to 6 percent.

On the other hand, nominal rates of protection for agricultural commodities in industrial countries rose from 21 to 28 percent between 1965 and 1974 and reached 40 percent in 1988. Indeed, the agricultural landscape does not represent anything like a level playing field (figure 1). Thus, while industrial trade is becoming more open and dependent on true economic conditions, agricultural trade is increasingly determined by the levels and types of government intervention.

The Need For Change

The major players in world agricultural trade are reconsidering the fundamental nature of agricultural policies formulated over the last 50 years.

Commodity trade grew rapidly in the late 1970’s, induced by strong demand in developing countries and by decisions in centrally planned countries to make up domestic shortfalls by buying in the international market. Rapidly increasing commodity prices accompanied this surge in trade.

The 1980’s, however, brought global commodity markets to a standstill (figure 2). Farm sectors, protected from changing world conditions and supported by government subsidies, were geared up to produce. Surpluses piled up in the face of stagnant or declining demand. As global prices fell, governments that could afford to do so further increased their support to agriculture. Only with the 1988 drought in North America did global demand exceed production and commodity prices begin returning to the higher levels of the 1970’s.

Changing conditions outside agriculture also altered the environment for agricultural trade. Growing integration of the world economy, the development of world financial markets, and the move to flexible exchange rates all had major effects on world trade. Therefore, changes in economic policies – such as those regulating the money supply and overall government spending – have a greater effect on trade-dependent sectors, such as agriculture, than on industries less reliant on trade. (See How the World Economy Affects Agriculture for more information.)

Agricultural policies that focus primarily on domestic concerns no longer suit a world of growing trade and financial integration. For example, policies that tend to raise domestic prices relative to world prices can reduce a country’s competitiveness in the international market. This was the situation between 1981 and 1985, when U.S. loan rates for wheat and feed grains became the price floor for world markets. High U.S. prices enabled our competitors to sell their exports at lower prices, thus undercutting the U.S. position in international markets. We became the supplier of last resort.

Because the agricultural policies of one nation can affect others and because the rate of intervention in agriculture is so much higher than in industrial sectors, pressure built up for agriculture to be included in the GATT framework. Discussions on agriculture are taking place as part of the Uruguay Round of multilateral negotiations scheduled for 1986 through 1990. The issue now facing global trading nations is whether they can negotiate a new world order in agriculture that will allow domestic agricultural markets to respond to global signals.

Progress is being made. At the midterm review meeting of the Uruguay Round in April, the Negotiating Group on Agriculture signed an agreement that outlined the basis for resolving some current trade problems. Participants agreed that plans should be drawn up to substantially reduce the level of trade-distorting support that countries give to their farm sectors. The agreement confirmed the goals of increasing market access and improving competition in world agricultural trade. Although not specific in its proposals, it represents a milestone in the GATT process regarding agriculture.

The Present Situation

Current agricultural policies were developed at a time when the structure of world trade and the level of national interdependence were very different. Money and goods did not routinely move across national borders. With today’s instantaneous communications and transfer of assets, the situation has changed. Farm policies designed for a past era are now having unanticipated consequences.

The Community’s Common Agricultural Policy was designed to stimulate domestic output and generate revenue at a time when EC countries were net importers of agricultural commodities. More recently, however, this policy has contributed to substantial gains in production. The Community is now a surplus producer and major subsidizing exporter, helping drive world prices down. Agricultural export subsidies equal 70 percent of the EC’s total budget.

The United States, on the other hand, saw itself as a major supplier of grains and oilseeds to the world market. It extrapolated the trends of the late 1970’s and designed an agricultural policy, the Agricultural and Food Act of 1981, that would be consistent with strong global demand and continued inflation. Conditions changed, however, and the legislation reduced U.S. competitiveness in world markets and generated record stocks and farm subsidy payments.

In the post-World-War-II era, the Japanese have provided their producers with support prices that far exceed world market levels. Current support rates for rice and wheat surpass world prices by fivefold. Instead of being major rice importers, they are not only self-sufficient in rice, but they occasionally export it as well. By holding domestic prices far above world rates, Japan also imports much less wheat and fewer livestock products than it would otherwise. But Japanese consumers pay dearly for this intervention.

In the United States, the bulk of direct farm income support, called deficiency payments, does not lead to higher consumer costs for major crops. This is an stark contrast to the EC and Japan, where the hidden cost of agricultural policies results in very high retail prices.

Many policies no longer achieve the objectives for which they were designed. In the EC, the United States, and Japan, only about 70 percent of direct government budget outlays for agriculture get passed on the farmers in the form of higher farm incomes.

Not only are policies not meeting their objectives, they are expensive. In the mid-1980’s when U.S. budget outlays for agricultural support averaged almost $20 billion annually, EC budget outlays equaled or exceeded that. Individual EC governments spent an additional $10 billion on farm subsidies, and consumer costs – in the form of higher food prices – exceeded budget outlays. (U.S. budget expenditures for farm programs are expected to be below $15 billion in 1989.) In Japan, where most of the cost of agricultural support is borne by consumers, costs averaged over $900 per nonfarm family in 1986. Budget expenditures on agricultural support programs in industrial countries amounted to approximately $60 billion in 1986.

In addition to slashing these large government and consumer costs, there are other benefits to be gained from reforming agricultural policies. Government intervention in the farm sector has led to a misallocation of resources. The support given to agriculture has diverted investments from other industries. Letting resources flow to their most productive use could increase the overall gross national product. The budget savings could then be used to support farm incomes in a nondistorting way. This could be done by making payments to farmers that do not depend on production or raise market prices. Consumers would be better off because prices for agricultural products would be lower, and industries would be more competitive.

According to research by ERS economists, the overall benefits of liberalizing agricultural trade could equal $33 billion per year for industrial countries. The EC would be the largest beneficiary, with more than $12 billion in annual benefits. The United States and Japan would also realize substantial benefits, $8.6 billion and $6.3 billion, respectively. However, these figures probably underestimate the long-term dynamic benefits by up to three times. Cumulative benefits could well reach $100 billion. That is about equal to the gross national product of approximately half the nations of the world.

Prospects for Change

Many developing countries have moved toward more market-oriented policies as a way to solve their debt problems. They are reducing trade barriers and making their export sectors more competitive by depreciating overvalued currencies. In the long term, this will lead to more efficient allocation of resources. In some cases where governments had implicitly taxed their farmers, this reorientation could result in expanded agricultural production. In other instances where the goal was agricultural self-sufficiency, production might decline. In all cases, policy reforms should induce greater openness, further increases in global trade, and more efficient use of world resources.

The United States has already begun to separate income payments from production in its grain programs, thus eliminating some of the distorting effects of our farm policies. Furthermore, support for farmers has been cut back since 1986. In contrast, the EC and Japan have increased support to their farmers (figure 3). People in these countries who want to keep existing farm programs could make change very difficult. For instance, recent election losses by the ruling party in Japan can be partly explained by the way voters reacted to the concessions Japan has been making to the United States in opening beef and citrus markets to international competition.

Global agricultural markets are at a crossroads. Policies centered solely on domestic concerns no longer work. They have led to wide swings in world commodity stocks, alternating years of surpluses with periods of dangerously low reserves. Forces outside of agriculture have changed the trade environment and are pressing for a more global approach. Reform will lead to freer agricultural trade and markets where trade is closely tied to fundamental economic factors, a benefit to all nations.

Reference

Roningen, Vernon and Praveen Dixit.

Economic Implications of Agricultural

Policy Reform in Industrial Market

Economies, AGES 89-36. ERS,

USDA, August 1989.

PHOTO : Figure 1. The World Agricultural Playing Field is Uneven

PHOTO : Figure 2. World Agricultural Exports Expanded Rapidly in the 1970’s, But Stagnated in the 1980’s

PHOTO : Figure 3. U.S. Support for Farmers Has Declined Since 1986

COPYRIGHT 1989 U.S. Government Printing Office

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