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.

That agriculture remains the most contentious issue on the table is unfortunate. After all, the progress made during the last decade suggests that further liberalization in this sector should be within reach. For instance, the export subsidies that were the center of attention not long ago are now in the $3 billion to $5 billion range. Domestic subsidies subject to WTO discipline are down to well below $100 billion. Some may complain that the United States and the EU have inappropriately shifted many trade-distorting subsidies into the green or blue box. But even if this is so, the adversely affected member countries can challenge such moves through the WTO dispute-settlement body, as Brazil recently did successfully with some U.S. cotton subsidies.

What could be a realistic way to conclude the Doha Round? Export subsidies are perhaps the most straightforward issue to tackle. Given their insignificant level today, eliminating them by 2010, as proposed in the latest U.S. offer, is possible. Admittedly, the economic benefits of such a reform are likely to be small, but it would give participants in the negotiations a significant psychological boost by ending an entire category of subsidies.

As for domestic subsidies, the first point to emphasize is that there remains a significant gap between bound and applied amber-box subsidies. Based on the latest data available, this gap was approximately 35 percent for the EU in 2000 and 25 percent for the United States in 2001. It is safe to assume that these gaps are larger today. Given this fact, the current U.S. proposal that the United States reduce these subsidies by 60 percent and the EU reduce them by 80 percent is achievable: in effect, it is less than meets the eye, because the reductions in the applied rates would be substantially smaller.

A different issue pertaining to domestic subsidies concerns the de minimis and blue-box subsidies. The aim now must be to end both these measures to achieve a clean subsidy regime. De minimis subsidies are clearly trade-distorting and should be phased out. As regards the blue box, the objective of the reform should be to simply eliminate the category, moving the subsidies that distort trade to the amber box and those that do not to the green box. These reforms will increase transparency by simplifying the subsidy structure, as has been done with subsidies on manufactures.

Ideally, the regime would contain just two categories of subsidies. One category -- the new green box -- would contain measures such as income-support payments and agricultural-research subsidies that do not distort trade. These would be unrestricted, because the provision of subsidies that do not affect production and trade should be an internal matter. The second category, the red box, would contain measures that do distort trade, such as output subsidies and price supports, and therefore would be prohibited.

The largest potential gains for all parties involved, especially developing countries, however, would come from lowering border barriers, mainly tariffs. In the August 2004 Framework Agreement setting the detailed terms of the Doha negotiations, member countries accepted the principle that high tariffs should be subject to deeper cuts than low tariffs. This makes sense for two reasons. first, because higher tariffs have a larger gap between the bound and applied rates, higher cuts will be needed to achieve cuts in the applied rates. Second, cutting higher tariffs more and lower tariffs less will reduce the large variations in tariff rates across commodities.

The current disagreement surrounds the extent of the cuts. The United States proposes that the top tier of bound tariffs be cut by 90 percent, with average cuts of 75 percent. The EU has suggested a less ambitious approach that cuts the highest bound tariffs by 60 percent, with average cuts of 46 percent. (The G-20 is arguing for average tariff cuts of 54 percent.) The EU has also put forward a proposal to allow countries to designate up to 8 percent of imports as "sensitive" and exempt them from the bulk of the cuts. The United States proposes to limit such exceptions to just 1 percent of the products.

U.S. insistence on larger tariff reductions and fewer exceptions is justifiable for at least two reasons. First, shallow cuts in bound rates would leave the actual tariffs unchanged, especially for high tariff rates. A long list of sensitive products would likewise allow countries to exclude entirely the products with highest tariffs and therefore forego the largest potential trade gains from liberalization. Second, Washington believes that by exempting LDCs from reciprocity obligations under the Framework Agreement, it has already made a major concession and needs reciprocity on agricultural tariffs from the EU, Japan, and more advanced developing countries if it is to persuade its own farmers to give up their subsidies and protection.

On the other hand, the EU also needs compensation for its concessions. Recall that at Cancún it dropped investment, competition policy, and government procurement from the Doha agenda. And because the EU does not have a comparative advantage in agriculture, it is naturally seeking cross-sector reciprocity in the form of liberalization in industrial products and services. The next step in breaking the U.S.-EU impasse is to put offers on industrial products and services on the table quickly. This would be a step forward: the elimination of tariff peaks in developed countries and liberalization by developing countries in trade in the industrial sector promise gains commensurate with agricultural liberalization.

But for tariff reductions to really be beneficial, action will be required of both developed and developing countries. The gains to developing countries from lowering border barriers will be minuscule if reform is limited to developed countries. Unfortunately, the Framework Agreement has already done a disservice to LDCs by exempting them from liberalizing agriculture. Their own liberalization could have at least partially counteracted the adverse effects of diminished access to developed-country markets caused by preference erosion and rising health and safety standards on their exports, a handicap the bigger and more developed Cairns Group exporters, which are better able to handle such protectionist tactics, do not face to the same degree. LDCs wishing to minimize the damage from this well-intentioned but misguided exemption would be well advised to liberalize unilaterally and seek as much technical assistance as possible from developed countries and international financial institutions to meet the health-and-safety standards importing countries impose. The Framework Agreement also allows developing countries to declare certain products "special" and apply a safeguard clause to prevent import surges. If the list of special products is too long and the safeguard too easy to invoke, any liberalization achieved in developing countries will be undermined.