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Wall Street Journal

November 21, 2005

Fuzzy Trade Math

Arvind Panagariya

Trade talks at Cancun broke down principally because the G-20 group of  mainly larger developing countries rejected U.S. and EU offers on reducing  their agricultural protection. Two years later, as the Hong Kong Ministerial  approaches, agriculture remains the make-or-break issue in the Doha  negotiations. But the impasse can be broken once we clear up the  misinformation on (a) the magnitude of EU and U.S. subsidies and (b) the  level of protection through trade barriers in developed and developing  countries in agriculture. Twice recently, the New York Times has editorialized that "developed world  funnels nearly $1 billion a day in subsidies," which "encourages  overproduction" and drives down prices. The World Bank's president, Paul  Wolfowitz, similarly referred to developed countries expending "$280 billion  on support to agricultural producers" in a recent op-ed in the Financial  Times. Oxfam routinely accuses rich countries of giving more than $300  billion annually in subsidies to agribusiness.

Astonishingly, these estimates bear virtually no relationship to the  subsidies actually at the heart of the Doha negotiations. Instead, they have  their origins in the altogether different measure called the Producer  Support Estimate (PSE) and published by the Organization for Economic  Cooperation and Development. The PSE includes all measures that raise the  producer price above the world price, including border measures such as  tariffs and quotas. Most economists would find the identification of such a  measure with subsidies unacceptable.

To measure the true magnitude of subsidies that drive down world prices, we  need consider only those subsidies contingent on exports or output. When  this is done, the extent of subsidies turns out to be considerably smaller  than $1 billion per day. Thus, rich country export subsidies that have been  so much in news have considerably declined in importance recent years: they  currently amount to less than $5 billion, perhaps as little as $3 billion.  Subsidies contingent on output (called domestic output subsidies by  economists and identified as "amber box" subsidies by the WTO) are larger;  but they, too, are much smaller than commonly believed. Under the  commitments made in the Uruguay Round Agreement on Agriculture, WTO members  have achieved substantial reductions in these subsidies. The EU has made a  special effort to decouple its domestic subsidies from output as a part of  the reform of its Common Agricultural Policy.

Based on the latest data available from the WTO, domestic output subsidies  amounted to $44 billion in 2000 in the EU, $21 billion in 2001 in the U.S  and less than $15 billion in 1998 in Japan, Switzerland, Norway and Canada  combined. Recognizing that there have been no major cases of backsliding and  the EU has made further progress in decoupling its subsidies from output, we  can comfortably conclude that rich country domestic subsidies that encourage  production and lower world prices currently are substantially below $100  billion.

By focusing exclusively on subsidies, the media has distracted attention  from the critical fact that the most important obstacle to agricultural  trade comes from border barriers, also called market access measures by the  WTO. And since the developing countries are not big offenders on the subsidy  front, this focus has promoted the false impression that agricultural  protection is an exclusively rich country problem. In reality, when it comes  to border barriers, developing countries more than match developed  countries.

Among the latter, Japan and Europe exhibit high protection while U.S.  barriers are relatively low. Thus, in 2001, the trade-weighted average  tariff was 36% in Japan, 29% in the European Free Trade Area, 12% in the EU  and 3% in the U.S. Of course, these averages mask considerable variation in  protection across commodities.Among developing countries, relatively more  protected countries include South Korea with a trade-weighted average tariff  of 94% in 2001, India with average tariff of 44%, China with 39% and  Pakistan with 30%. Interestingly, protection in the developing country  members of the Cairns Group, which contains countries with greatest  comparative advantage in agriculture, is not low: in 2001, the average  tariff was 13% in Argentina and Brazil, and 11% in Malaysia, Thailand and  Indonesia.

Once we recognize that export subsidies are minuscule and trade-distorting  domestic subsidies much smaller than commonly believed, a successful Doha  bargain seems within reach. The elimination of export subsidies and  substantial cuts in domestic subsidies are feasible. But these will have to  be complemented by additional measures to make the final deal attractive to  all nations engaged in active negotiations.

The U.S. has a comparative advantage in agriculture. Therefore, it insists  on within-sector reciprocity in the form of market access in return for its  concessions on subsidies. The EU and larger developing countries including  the Cairns Group, who have high agricultural tariffs, are in a position to  offer this reciprocity. The EU lacks comparative advantage in agriculture.  Therefore, it will only be giving concessions in this sector so that it  needs cross-sector reciprocity. Here larger developing countries have a  crucial role to play. Industrial tariffs remain high in the Cairns Group  developing countries as well as in India, China and Pakistan. They can offer  the EU the necessary reciprocity.

Finally, Latin American members of the Cairns Group will clearly derive  large benefits from the rich country reductions in subsidies and tariffs in  agriculture and can therefore offer reciprocal concessions in industrial  goods and services. Other larger developing countries such as India, China,  Pakistan, Indonesia, Korea and Thailand also stand to benefit from increased  access to each other's and other developing countries' markets in industrial  goods. In addition, they can expect to benefit from the removal of  industrial-tariff peaks in the developed countries that apply with potency  to labor-intensive products such as apparel and footwear.

Thus, once we cut through the confusion created by constant references to  inflated estimates of agricultural subsidies and consider the accurate  picture, outlines of a successful negotiation do emerge. Those who consider  the barriers to a deal insurmountable need to be reminded that unlike the  Uruguay Round, which dealt with win-lose bargains such as those on  intellectual-property protection, this round is focused on trade  liberalization that largely offers win-win bargains. Both developed and  developing countries stand to reap large benefits from the removal of their  own subsidies and protection.