European Affairs

European Affairs

Spring 2003

 

Trade Relations
Farm Subsidies: Unlike the U.S., the EU Is Heading in the Right Direction
By Corrado Pirzio-Biroli and Tassos Haniotis

 

It is no secret that any discussion of the European Union's Common Agricultural Policy (CAP) in the United States usually generates an air of desperation among experts and non-experts alike. This automatic reaction reflects long-standing convictions about who is good, who is bad and what is ugly in U.S.-EU agricultural trade relations. Today those attitudes, based on old concepts of a CAP that no longer exists, are out of date.

Even the strongest convictions have to pass the reality test. And it is now more important than ever to base the U.S.-EU dialogue on facts, especially recent facts. As we approach the World Trade Organization ministerial meeting in Cancun later this year, we must understand where the European Union and the United States are coming from if we are to focus on what we can realistically achieve together.

With the European Commission once again proposing CAP reforms, the stakes for the policy and for EU agriculture have never been higher. CAP reforms have certainly taken place in the past. The policy has been adapted as a result of previous EU enlargements, WTO negotiations and Intergovernmental Conferences (although the current Constitutional Convention is admittedly a novelty). Never before, however, has the EU faced all three such challenges simultaneously – a fact that has not escaped the EU Heads of State and Government.

At four recent EU summit meetings, the leaders have taken decisions with clear consequences for the CAP. The Berlin Summit of March 1999 called for a review of agricultural policy in the main arable crop and livestock sectors; the Gothenburg Summit of March 2001 agreed that EU agricultural policy should promote sustainable development; the Brussels Summit of October 2002 established a financial ceiling for CAP direct aids and market measures until 2013; and the Copenhagen Summit of December 2002 took the historic decision to admit ten new member states, mainly in Central and Eastern Europe.

The Brussels Summit stands out for one particular novelty. It fixed the long-term financial outlook for CAP expenditure before a decision about the future shape of the policy. The spending ceiling means that the agricultural budget can increase by no more than 15 percent, even though it must accommodate 50 percent more farmers and the costs of any further reforms. This will inevitably mean substantial reductions in farm support in real terms in the current 15 EU member states.

This compulsory limit on financial resources, so different from the conditions that led to the 2002 U.S. Farm Bill, lies at the center of the current debate over the CAP. The debate concerns four main issues:

The fundamental question is how can EU agricultural policy simultaneously promote a competitive agriculture and the highest environmental, food safety and animal welfare standards. This question is neither academic, nor pertinent only to the European Union. It is at the heart of policy choices all over the world. Answers to it, however, differ greatly as a result of variations in geography and demography.

The Commission's answer is that these objectives cannot be met simultaneously unless CAP instruments are adapted so that they not only serve farmers, but also consumers and taxpayers. This is the aim of the latest reform proposal.

"The EU farm budget can rise by only 15 percentalthough there will be50 percent more farmers"In order to enhance the competitiveness of EU agriculture, the proposed market measures would close the gap between hitherto higher European domestic support prices and world market prices, partially compensating producers with direct aids.

In order to make agriculture more market-oriented and sustainable, all direct payments would be converted into a single payment to each farm. These payments would be determined by the level of support that farmers received in the 2000-2002 period. They would be conditional on compliance with environmental, food safety, animal health and welfare and occupational safety standards, as well as good agricultural practices.

Finally, the Commission wants to achieve a better balance between the different kinds of support. It is proposing to shift funds from market support to rural development, to offer greater incentives for farmers to meet higher standards, and to fund additional market reforms through the redistribution of direct aids from larger to smaller farms.

In the cereals sector, where the reform process is well advanced, the proposed additional price cut is small. For dairy products, on the other hand, where reform has not yet started, the proposed drop in support prices goes farther than was agreed in 1999.

"The WTO negotiations on agriculture are not about farm policies, but about farm trade"Such a significant decline in price support for dairy products will require compensation for the producers. More funds will also be needed to strengthen rural development. In order to free funds for these priorities, the Commission is proposing to cut direct aids by up to 19 percent, depending on farm size.

In this context, it is important to clarify the European Union's views on the main elements of the current negotiations on agriculture in the World Trade Organization. These negotiations are not about farm policies; they are about trade. Further commitments in the negotiations should focus on reducing trade distortion, and providing incentives for less trade distorting policies.

This is what was agreed in the Uruguay Round Agreement on Agriculture (URAA). The WTO ministerial meeting in Qatar in 2001, which launched the current Doha Development Round, agreed to continue the process. And this is what is achievable, whereas the abolition or drastic reduction of agricultural subsidies is not.

Unfortunately, this is not the approach taken in the draft paper on negotiating modalities proposed by the chair. In the developed world, countries that have moved in a direction consistent with what was agreed in the previous round are penalized, while those that reversed direction are rewarded.

In the developing world, those that need a boost to reap the benefits from trade find themselves treated like more developed, or fully developed econo-mies. And finally, those such as the European Union that are concerned with enhancing the provision of public goods, from environment to food safety, see their non-trade concerns ignored and their concerns about the potentially negative impact on trade worsened.

Take for example the area of export competition. Clearly the issue is not just EU export subsidies. These have already been brought under control and are declining as a result of EU internal reforms that have already been agreed. The extent to which they are further reduced, or eliminated, cannot be viewed in isolation, but is directly linked to how all forms of trade distorting support for exports are disciplined, including all those used by other agricultural exporters.

Although disciplines for State Trading Enterprises (STEs) are clearly mentioned in the draft text, enormous loopholes are still allowed for two methods used by the United States to subsidize agricultural exports – export credits and abuse of food aid for surplus disposal. The latter has no direct relationship to need, and clearly depresses food prices.

On market access, again the issue is not finding a formula that will best suit the interests of major exporters. If this is really a development round, the interests of the less competitive and least developed developing countries must be addressed. That is the best way to maximize benefits from trade liberalization globally.

Unfortunately, these needs are not only being ignored, they have even been neglected in analyses that claim to identify such potential gains. All present models used to estimate the gains fail to account for the preferences granted by the largest agricultural importer from developing countries, the European Union.

The EU market is actually far more open than its average standard duty rates indicate, because of the large preferences the Union grants to developing countries. The result is an overestimation of the level of EU border protection and a serious bias in the expected gains and losses from a liberalized trade environment.

There is also confusion over the complex issue of domestic support and its linkage to trade distortions. Part of this confusion is due to the way in which domestic support is measured. Under the URAA, the WTO established clear, commonly agreed rules on domestic support, distinguishing policies according to their trade-distorting impact.

The so-called Aggregate Measure of Support (AMS) listed all the areas in which the participating countries had agreed to reduce subsidies and set ceilings for future financial support. Two exemptions were allowed, both of which are being contested in the current round. These are the so-called Blue Box, containing less trade-distorting measures, and the de minimis clause. This clause allows non-product specific support to be exempted from reduction commitments if it accounts for less than five percent of the total value of agricultural production.

During the 1990s, the European Union moved toward less trade-distorting support both with respect to its overall domestic support and with respect to its AMS ceiling, while the United States moved in exactly the opposite direction. The EU move toward less trade distorting forms of support is evident from its budget, which shows that export subsidies and market support fell during the last decade, while direct aids and rural development measures increased.

This policy difference is even more evident if one looks at the direction of U.S. domestic support under the previous Farm Bill. Not only has the level of U.S. domestic support consistently increased in recent years, but it has managed to stay within the AMS ceiling thanks only to the de minimis loophole.

"The U.S. has used a loophole to keep its subsidies within internationally agreed limits"In 1999, U.S. farm support classified as de minimis was equal to 51 percent of notified U.S. AMS support measures subject to reduction commitments. With a U.S. AMS ceiling of $19.9 billion in 1999, total notified U.S. trade-distorting domestic support was $24 billion, of which $7.4 billion came under the de minimis clause. The bulk of this was to compensate a few specific crops for prior market price declines.

With one-third of U.S. domestic support falling under this loophole, one wonders what de minimis really means. This is why we have proposed the abolition of this loophole for all developed countries.

Experts at the Organization for Economic Cooperation and Development in Paris have recently analyzed the trade effects of different farm policies. Their studies conclude quite persuasively that the trade-distorting impact clearly diminishes as the emphasis shifts from measures of price, input, or output support to payments according to area or animal (the core of the European Union's present system). The effect is even greater when payments are decoupled from production.

Thus, if the trade distorting effect of farm price support is 100, the OECD has calculated that the effect of decoupled direct payments is seven, that is to say minimal. It is, therefore, not only unfortunate, but actually a mistake, to omit the trade distorting impact of policies from the draft WTO paper on negotiating modalities.

Let us take a look at the contested exemption of EU supports in the Blue Box. Since 1992, the European Union has moved toward less-trade distorting policies, shifting a significant part of its domestic support from the Amber Box (containing the most trade-distorting measures) to the less distorting Blue Box.

The most recent WTO notification showed EU Amber Box measures at €48 billion, compared to a WTO ceiling of €69 billion, and the EU Blue Box at almost €20 billion. On the basis of past decisions, and the fact that it operates under clear budgetary ceilings, one can expect that EU domestic support will further decrease by 2007. This trend will be strengthened if new CAP reform proposals are agreed.

This path of EU policy reform conforms precisely with the provisions of the URAA. While the pace of reform may be slower than some would have liked, the direction is clear. Yet the proposed draft text on negotiating modalities considers the Blue Box roughly as trade distorting as the Amber Box, while the OECD analysis indicates that Amber Box measures are four times more distorting.

By contrast, while the recent U.S. Farm Bill increases all trade distorting measures (loan rates, yield and area updates, ex ante counter-cyclical measures), the United States is only slightly affected by the draft modalities because proposed changes in the de minimis exemption would have little impact. The Food and Agricultural Policy Research Institute, in an analysis for the U.S. Congress, has estimated that this clause will continue to account for a substantial part of future U.S. farm expenditure.

To sum up, all policies are not the same with respect to trade distortion, and all parties have not moved in the same direction. We expect recognition of both facts in the debate on negotiating modalities. This is a reasonable request.

As will others, the European Union will clearly continue to support its agriculture, and has set a budget to that effect until 2013. But the European Union's key objective is to make support less and less trade distorting. We can only hope that our partners understand how difficult this is, and that they recognize that the European Union is taking positive steps in the right direction. The alternative is not less aid, but more trade distortion.

The European Union hopes that the United States can join in a common effort to reduce the trade distortion effects of agricultural policies, while preserving a productive and sustainable agricultural economy and vibrant rural areas.

Ernest H. Preeg is Senior Fellow in trade and productivity at the Manufacturers Alliance/MAPI. He was the William M. Scholl Chair in International Business at the Center for Strategic and International Studies from 1988-1998. Previously, he spent 25 years as a Foreign Service Officer, including as a member of U.S. delegations to the Kennedy and Uruguay Round GATT negotiations. His book, From Here to Free Trade in Manufactures, is scheduled to be published by MAPI in July.