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Wall Street Journal
November 21, 2005
Fuzzy Trade Math
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.