Liberalizing Agriculture

Arvind Panagariya

From Foreign Affairs, December 2005 -- WTO Special Edition

Summary:  Agriculture will be the make-or-break issue in Hong Kong. On the surface, obstacles to an agreement seem insuperable. But a careful examination of the current agricultural trade regime reveals that prospects for an agreement are not as bleak as they appear.

ARVIND PANAGARIYA is Professor of Economics and Jagdish Bhagwati Professor of Indian Political Economy at Columbia University.

Sugar is highly protected in virtually all major developed and developing countries. It is subject to the following MFN rates, for example: 72 percent in South Africa, 60 percent in India and Japan, 56 percent in high-income developing Asia, 43 percent in the United States, 23 percent in Central America and the EU (and 74 percent in other European countries), 18 percent in China, and 17 percent in Argentina and Brazil. Thus, reforming tariffs on sugar will require virtually all WTO members to liberalize. The EU and the United States are major offenders, but others -- including developing countries -- are not without blame.

Although bound tariffs are much higher than applied tariffs worldwide, the gap is much larger in developing countries. In developed countries, the average bound rate is nearly twice as large as the applied rate; in developing countries, it is two and a half times larger. Bangladesh offers the most egregious example: its average bound rate is more than ten times the average applied rate. India, Pakistan, and sub-Saharan Africa also have bound rates more than three times as large as their applied rate. Therefore, unless tariff cuts are deep, and the special treatment that privileges developing countries to lower cuts is checked, there will be little reduction in the applied rates in many developing countries.

WINNERS AND LOSERS

Such tariffs, export subsidies, and domestic subsidies have two features in common: they raise prices received by producers in the countries providing them and lower prices in the world market. For example, a tariff or export subsidy set by the EU diverts sales from the EU to the world market, thereby raising the internal EU price and lowering the world price. An EU output subsidy increases the output of the product in the EU and lowers the unit price in the EU and in the rest of the world by less than the subsidy per unit, causing the EU producers' prices and revenue to rise.

Producers in the country employing these interventions necessarily benefit because both the unit price they receive and the total quantity they sell rise in all cases. Not surprisingly, they oppose dismantling these instruments. Countries that import the products subject to these interventions also benefit from reduced world prices. Poor countries that enjoy duty-free access to the markets of tariff-levying countries also benefit because they are able to sell their exports at these countries' internal prices. Thus, they have the same protection as the producers of the tariff-levying countries and are winners, not losers, in the current agricultural regime. This is particularly the case with LDCs, which enjoy duty-free access to the EU market under its Everything But Arms initiative. On the other hand, food-exporting countries such as the members of the Cairns Group, which includes the world's most competitive agricultural producers, are hurt by lower world prices and therefore have the greatest incentive to seek liberalization. For the same reason, the overall impact of the interventions, especially of subsidies, is also negative on the EU. In technical jargon, the terms of trade deteriorate for the EU.

These observations yield some key conclusions. The common assertion that agricultural liberalization in rich countries would bring large benefits to LDCs is mistaken. These states -- many of them poor African countries -- benefit from the current regime because they can sell their exports at the high EU prices and buy imports at the low world prices. (Cotton is perhaps the sole exception: U.S. subsidies hurt poor countries because the EU tariff on cotton is zero and therefore its internal price for cotton is the same as the world price.) Gains to those developing countries not in the Cairns Group would accrue principally from their own liberalization. The principle of comparative advantage applies just as much to agriculture as to industry. Moreover, because developing countries do not currently enjoy trade preferences in one another's markets, they stand to gain from access there.

Meanwhile, liberalization in developed countries would principally benefit them. Ending their agricultural subsidies would eliminate not only inefficiencies but also the losses from the spillover of the subsidies to the importing countries. Cutting tariffs will generate benefits for their consumers by lowering prices. And countries with a comparative advantage in agriculture -- mainly developed countries such as the United States, Canada, Australia, and New Zealand as well as the richer developing countries in the Cairns Group such as Brazil, Argentina, Malaysia, and Indonesia -- would benefit from the higher world prices that would follow liberalization in the developed countries.

Gains from the removal of subsidies under the Doha Round, moreover, are likely to be much smaller than previously thought. For one thing, negotiable subsidies have never been as large as has been publicized, and they have declined in importance over the years. Today, export subsidies are in the $3 billion to $5 billion range and domestic subsidies subject to negotiations are well below $100 billion. These numbers are not insignificant, but they are much smaller than commonly believed, making tariffs the more serious barrier to agricultural trade.

Numerous estimates by economists support these conclusions. Careful research shows that the gains to developing countries outside of the Cairns Group from developed-country liberalization would be meager, and that countries that today enjoy preferences in the rich-country markets typically would lose from such reform. Developing countries, especially small ones and those with high initial protection of their own, would benefit more from their own liberalization.

WHAT IS TO BE DONE?