II. Agreement on Agriculture

PURPOSE

The objective of this module is to provide basic information concerning the provisions on export subsidies under the GATT and the Agreement on Agriculture and to summarize the experience so far in this area. This module also discusses related issues in the context of the next round from the standpoint of the developing countries, particularly net food importers.

CONTENTS

3.1 Introduction

3.2 Economic consequences of export subsidization

3.3 GATT rules on export subsidies

3.4 Export subsidies in the Agreement on Agriculture (AoA)

3.5 Experience with the use of export subsidies

3.6 Issues for the next round of negotiations

KEY POINTS

• Export subsidies increase the share of the exporter in the world market at the cost of others, tend to depress world market prices and may make them more unstable because decisions on export subsidy levels can be changed unpredictably.
• GATT export subsidy rules define what is an export subsidy and include export subsidy reduction commitments
• Early data on export subsidy use under the AoA of the UR indicate that subsidized exports of several products were small relative to what were allowed, though utilization rates for dairy products and various meats were quite high.
• A number of issues surrounding export subsidies will be on the agenda for the next round of negotiations and these are discussed in the module.

3.1 INTRODUCTION

Export subsidies now face constraints

GATT Article XVI recognizes the possibility of harmful effects for other contracting parties of export subsidies granted by a contracting party, but export subsidies were permitted before the Uruguay Round in the case of "primary products", conditional upon the observance of an "equitable" share of world trade. As it proved to be difficult to define the term "equitable" in practice, agricultural export subsidies proliferated and the practice became a major source of international trade disputes.

Although the Uruguay Round Agreement on Agriculture still permits export subsidies on agricultural products, constraints have been imposed on the practice. This outcome is considered to be one of the most important results of the agreement in view of the potentially disruptive effects that export subsidies can have on world markets.

This module addresses the following topics:

• the economic consequences of export subsidization;
• GATT rules on export subsidies;
• export subsidy rules in the Uruguay Round Agreement on Agriculture;
• experience with the use of export subsidies; and
• issues for the next round of negotiations.

3.2 ECONOMIC CONSEQUENCES OF EXPORT SUBSIDIZATION

Economics has hardly anything nice to say about export subsidies. The practice is condemned for its inefficiencies and high costs to both consumers and tax payers in the subsidizing country. For the vast majority of developing countries, these negative effects are not of any direct significance as they do not subsidize exports. However, they are affected indirectly in several ways.

In general, export subsidies increase the share of the exporter in the world market at the cost of others, tend to depress world market prices and may make them more unstable because decisions on export subsidy levels can be changed unpredictably.

Export subsidy effects on developing countries

The indirect effects, largely working through world markets, impact various categories of countries differently. First, subsidies clearly hurt "other agricultural exporters", by cutting their market shares and reducing export earnings. These include, for example, countries belonging to the Cairns Group of agricultural exporters, but also many others. The strongest opposition to this practice has come from this group of countries.

Second, export subsidies do benefit those countries where there is little corresponding production of the subsidized products or their close substitutes. In this case, subsidies represent income transfers from the subsidizing country to consumers in the importing countries. In general, export subsidies may have overall welfare gains for importing countries with very low levels of self-sufficiency, as consumer gains should more than offset producer losses, although the extent to which export subsidies destabilize markets influences this calculation.

The assessment of the impact on the third category of countries, i.e. where self-sufficiency levels of the subsidized products or their close substitutes are high, is more complex. Where export subsidies depress world market prices, and where these prices are transmitted to domestic markets, producers would lose and consumers gain. A dark side of this effect is where there is a cumulating of these producer losses over time, as prolonged depressed prices and the resulting low returns undermine investment in agriculture, slowing down the growth of the sector. Net welfare loss is generally expected to be higher, the greater is the degree of self-sufficiency. Many developing countries belong to this group and almost all of them produce basic foods, which are the main products receiving export subsidies.

In theory, importing countries could take advantage of the income transfers by capturing them at the border in the form of tariffs, at the same time maintaining higher prices in domestic markets. However, such action has to be consistent with other commitments on the type and level of tariff measures. Moreover, there may be difficult political economy considerations to resort to this option in practice.

Finally, where the widespread use of export subsidies destabilizes world markets, which is likely, food importing countries face additional transaction costs in trying to cope with these unstable markets.

3.3 GATT RULES ON EXPORT SUBSIDIES

GATT rules were inadequate

GATT Article XVI - subsidies - addresses the issue of subsidies in general as well as on exports. While it called upon contracting parties to cease to grant either directly or indirectly any form of subsidy on the export of non-primary products, an exception was made for primary products¹. An export subsidy was said to be subsidized when the export price is lower than the comparable price charged for the like product in the domestic market.

In the case of primary products, it is stated that "contracting parties should seek to avoid the use of export subsidies on the export of primary products". It is further said that if a contracting party grants directly or indirectly any form of subsidy which operates to increase the export of any primary product from its territory, such subsidy shall not be applied in a manner which results in:

"that contracting party having more than an equitable share of world export trade in that product, account being taken of the shares of the contracting parties in such trade in the product during a previous representative period, and any such special factors which may have affected or may be affecting such trade in the product".

Thus, export subsidies on agricultural products were permitted, subject to this condition. The remedy to subsidized exports is addressed by Article VI - anti-dumping and countervailing duties. This article did not make a distinction between a primary and a non-primary product, which would mean that countries were always permitted to take countervailing measures against subsidized export of even the primary product where the above condition (i.e. "equitable share in world trade") is violated. In fact, several disputes related to agricultural subsidies were brought to the GATT.

3.4 EXPORT SUBSIDIES IN THE AGREEMENT ON AGRICULTURE

What constitutes an export subsidy?

Article 8 of the Agreement on Agriculture (AoA) - export competition commitments - provides the overall rule by stating that each Member undertakes not to provide export subsidies otherwise than in conformity with this Agreement and with the commitments as specified in that Member's Schedule. Its Article 9.1 defines various types of export subsidies that are disciplined (Box 1). Article 9.2(a) simply states that, subject to some flexibility provided for in 9.2 (b), the maximum quantity of the product in respect of which export subsidies may be granted and the maximum level of outlay for such subsidies are specified for each year in the Member's Schedule. These articles also imply that a Member that has no export subsidy commitment in the Schedule is not allowed to introduce them in the future.

Box 1: Types of export subsidies subject to reduction commitments

Source: Article 9.1 of the Agreement on Agriculture.

The main provisions on export subsidies

These are summarized in Table 1.

Table 1: The main provisions of the Agreement on Agriculture on export competition

The base period for computing export subsidies is 1986-1990. This differs from the 1986-88 base period used for several other provisions of the AoA, and perhaps reflects the desire of the negotiating parties to establish a higher base since export subsidies were increasing during this period. On top of this, a "front loading" accord was negotiated which allowed them to use the 1991-92 period as the starting point for reductions, if higher, although the end-point remained that based on the 1986-90 base period level. This front loading provision proved to be particularly useful in the case of wheat, rice, vegetable oils and some meats (see Table 1).

The reduction rates to apply to the base period levels are 36 percent on outlays with initial cuts of at least 6 percent in the first year and equal annual reductions over the five subsequent years, and 21 percent on the quantity with reductions staged in similar proportions. The rules do not say anything about per unit subsidy rates in any year (e.g. US$15 per ton) - which may mean that the rates may be varied provided that the maximum limits on both the outlay and volume are respected. Some flexibility is provided by Article 9.2(b) in that in any year a country can exceed, within limits, the prescribed level of subsidy, provided specified cumulative criteria are met. This allows countries to build up "credit" in terms of subsidy allowances in years when international or domestic market conditions favour lower subsidization, for use in subsequent years. There seems to be some confusion with the interpretation of this flexibility, and has been discussed several times at the WTO Committee on Agriculture.

For developing countries, the reduction rates required are two-thirds of those of the developed countries and the implementation period is ten years rather than six. In the case of least developed countries (LDCs), no reduction is required. In addition, for these countries, the provision of export subsidies to reduce marketing costs and transport and freight costs (i.e. subsides classified under (d) and (e) in Box 1 above) are permissible.

Export credits and food aid

Export credits and food aid cannot be used to circumvent export subsidy commitments

These are addressed by Article 10 - prevention of circumvention of export subsidy commitments - and reflect a concern that Members will find ways of concealing export subsidies behind other guises. Export credits provide one such possibility, the concern here being that they may conceal an element of price or interest rate subsidy (i.e. charging less than the market rate of interest). Article 10.2 calls upon Members to work towards "internationally agreed disciplines" with respect to export credits and insurance programmes, and to conform to these disciplines once they are agreed. This work is going on at the OECD Secretariat.

Article 10.4 makes reference to food aid and again seeks to avoid possible circumvention of export subsidy commitments. It stipulates that food aid: (a) must not be tied in anyway; (b) must be conducted according to the conventions of the FAO Sub-committee on Surplus Disposal; and (c) must conform to Article IV of the Food Aid Convention (FAC). The latter implies that food aid must be supplied as either donations of food or cash to purchase food; sales of grain for the (non-convertible) currency of the recipient country; or credit sales with subsidies meeting specific criteria. The negotiations for a new FAC have been concluded in 1999.

Commitments on export subsidization

Table 2 below shows the quantities of commodities that are permitted to be exported with subsidies. It further shows that subsidized exports could be substantial for many products even by the year 2000 - over 10 percent of the 1992 world trade for all products with the exception of rice, sheep meat, vegetable oils and oilseeds. Annex Table 1 provides additional information on committed outlays on export subsidies, by country and commodity. Only eight developing countries have export subsidy commitments.

Table 2: Subsidized export reduction commitments by product

Source: The first five columns are from WTO (1999), Table III.4. The last column is computed.

3.5 EXPERIENCE WITH THE USE OF EXPORT SUBSIDIES

Export subsidy commitments underused to date...

More complete data on the extent to which eligible countries made use of export subsidies are available only for 1995 (Table 3). The 1996 data reported in the table are based on far fewer notifications and so may not reflect the true picture. In 1995, subsidized exports of several products, notably field crops, were fairly small relative to what were allowed - about 13 percent of the permitted levels in the case of cereals (6 percent of wheat, 27 percent of coarse grains and 13 percent of rice), 11 percent of vegetable oils and 15 percent of sugar. By contrast, utilization rates were very high for dairy products and various meats - as high as 80 percent in the case of cheese and other milk products.

Table 3: WTO export subsidy commitments and actual outcomes, 1995 and 1996

Source: WTO (1997). Export Subsidies: Background paper by the Secretariat. November 1997. The table is based on notifications received by the Secretariat up to 27 October 1997. It takes into account only those export subsidy reduction commitments for which a notification has been received for that year. The 1996 results are based on far fewer number of notifications - hence, the annual commitment levels are much lower. Note that the quantities reported in Table 2 refer to all commitments irrespective of whether or not a notification was made by November 1997.

...but this may reflect high world prices in early years

The very high world market prices could have been the main reason for the low utilization rates in the case of cereals. Some concerns have been expressed that utilization rates could increase substantially when world market prices decline, as in 1998 and 1999, but this is yet to be confirmed. Subsidies could also rise in these years if countries utilize some of their "unused" subsidies from earlier years. By contrast, utilization rates were very high in the case of dairy products, despite the relatively firm world market prices. This could be an indication of the subsidies responding more to structural surpluses than changing world market prices.

3.6 ISSUES FOR THE NEXT ROUND OF NEGOTIATIONS

As developing countries prepare for the next round, a number of considerations may be taken into account in this area.

• Impact on world agricultural markets and food security
• Export prohibitions and taxes
• Clarifying the use of export incentive schemes
• State trading enterprises
• Special and Differential Treatment
• Continuing the reform process- the future of export subsidization?

Impact on world agricultural markets and food security

Interests of net food exporters and importers can differ

As said in Section 3.2, very few developing countries provide export subsidies and so the disciplining of this practice has little direct consequence for them. But it is important that they are aware of the effects felt indirectly. The effect on net food-exporters is the most obvious one - export subsidization by others hurt them in terms of market share and export earnings. For others, the degree of self-sufficiency in food is an important parameter to consider - large food importers may face an increased import bill once subsidies are withdrawn. But this short-term loss must be weighed against longer-term gains that should come from less-distorted world markets. In addition, all importers may face higher import costs in terms of coping with instabilities in world markets due to the subsidies.

Of course, the extent to which removing or reducing export subsidies will raise international prices is an empirical issue, and may not be very significant. And irrespective of the medium to long-term advantages of subsidy removals for food importers, the short-term costs of higher world prices may be substantial for many of the low-income countries. It is for this reason that some mechanism to respond to this possibility needs to be built-in within the package of agreements. The Marrakesh Ministerial Decision has certain provisions in this regard, but there is a need for clarification on its implementation².

Export prohibitions and taxes

Should export taxes be treated symmetrically?

The converse of export subsidies - export taxes and restraints - received relatively little attention in the Uruguay Round. Article 12 - disciplines on export prohibitions and restrictions - calls upon Members, with respect to new restrictions on foodstuffs, to give "due consideration" to the food security concerns of importing countries, and paragraph 1(b) requires adequate notice and consultation prior to the implementation. Developing countries are exempt from these provisions unless they are regular food exporters.

It is questionable whether the latitude regarding these restraints will continue beyond the next round. But there is an asymmetry here. It seems unreasonable to expect net food-importers to face further depressed world prices (due to export subsidies) during periods of relative abundance of traded food commodities, and increased import bills due to export taxes and restrictions during periods of relative scarcity. The food security implications of this possibility would seem unacceptable, and the possible tightening up of provisions on export subsidies to also include taxes and prohibitions in one package would seem to be a reasonable topic for future negotiations.

The other side of the coin is that restrictions on the use of export taxes would be a serious issue for many developing countries, since a narrow tax base makes such a revenue source an attractive option. If the provisions are strengthened on export prohibitions and taxes, it may be necessary for developing countries to obtain exemptions in this respect.

Clarifying the use of export incentive schemes listed in Subsidies Agreement

Subsidies Agreement covers other types of export subsidies

There is a lack of clarity regarding the status of subsidies which are not listed in Article 9.1 of the AoA. Article 10.1 stipulates that such subsidies shall not be used in a manner which might lead to "circumvention of export subsidy commitments" but it is not clearly stated whether everything else is prohibited. From the standpoint of the developing countries, there is a need for clarifying the relationship between agricultural subsidies under the AoA and those listed in the Subsidies Agreement.

The latter, in Annex I, lists various incentive schemes aimed at export-oriented enterprises. In principle, under Article 3.1(a) of the Subsidies Agreement, these subsidies are prohibited, but developing countries may have access to them under the special and differential treatment provisions of Article 27 of the Agreement. In particular, such subsidies can continue to be used by the least developed countries, while other developing countries have a grace period of up to eight years. The question is whether it is correct to refer to the Subsidies Agreement for export assistance to agricultural products not explicitly mentioned by the AoA? Are these permitted for those countries that have zero subsidy commitments within the AoA?

State trading enterprises

STEs may cross-subsidize exports

The role of state trading enterprises (STEs) has attracted some attention as regards the compatibility of their "operations" with the guidelines set in GATT Article XVII and the new Understanding³.^..For exporting STEs, the concern revolves around the competitive advantages they might have due to their relationship with the government:

• the possibility of subsiding export sales from the proceeds of monopsonistic rents;
• greater opportunity for discretionary pricing facilitated by domestic price pooling; and
• increased scope for offering favourable long-term agreements with importing countries.

The problem arises because: (i) STEs are usually created in order to undertake trading activities in a way which private companies would not, i.e. their objectives are likely to differ by design from those of commercial criteria; and (ii) it is, in any case, very difficult to test for "commercial" behaviour.

As far as developing countries are concerned, there are not many cases where exporting STEs might be seen as posing a serious constraint to more "open" trading in international markets. In addition, it would be unfortunate if future negotiations led to binding provisions that circumscribed the ability of developing country STEs to operate effectively as these play a certain important food security role. Moreover, being small trading nations, STEs can also provide them with the economies of scale to compete effectively in international markets.

Special and Differential Treatment

Use of export subsidies by developing countries

Few developing countries subsidize their agricultural exports and the great majority will not be able to do so in the future on account of the AoA. Few can afford to subsidize their exports in any case. In view of this, one of the SDTs, the lower reduction rate, has little practical value for most of the developing countries as there is nothing for them to reduce. But there are some SDTs that could be useful. One of these is the AoA exemption to them on marketing costs and internal transport and freight costs. The other SDT that could be useful is permitting them to use the types of export incentive schemes listed under Annex I of the Subsidies Agreement. In the past, one of the main arguments in favour of the developing countries maintaining the opportunity to subsidize their exports in the short-term was the need for supporting infant industries. This argument can still be valid in the field of agricultural trade and these types of incentive schemes continue to have relevance, as these allow targeting export incentives to agro-enterprises.

Continuing the reform process- the future of export subsidization?

Is continued exemption for export subsidies in the interests of developing countries?

In conclusion, the developing country negotiators may need to decide for themselves whether to press for an end to this practice, or to continue export subsidization beyond the Uruguay Round. Some of the key considerations to be taken into account in that assessment were discussed above. In closing, it may be important to note that one major problem with this component of the AoA is that it effectively favours those countries that have been prior users of export subsidies - and in fact, the greater the use during the base period, the higher is the permitted level of subsidization in the implementation period - while others are prohibited to resort to this trade instrument. As it stands, only a small number of the developing countries have access to this provision. This unfairness provides the strongest rationale for eliminating this practice. Moreover, it may not be out of place to ask for how long into the future should a particular historical record be used as a rationale for continuing some of the practices that are not healthy to world markets?

REFERENCES

Carson, C. 1998. The Uruguay Round Agreement on Agriculture. OECD Workshop on Emerging Trade Issues in Agriculture. Paris.

Croome, J. 1998. The Present Outlook for Trade Negotiations in the World Trade Organisation. Economic Research Service, US Department of Agriculture.

FAO. 1998. The Implications of the Uruguay Round Agreement on Agriculture for developing countries: A Training manual, by S. Healy, R. Pearce & M. Stockbridge. Rome.

GATT. 1994. The Results of the Uruguay Round of Multilateral Trade Negotiations: The Legal Texts. Geneva, the GATT Secretariat.

Josling, T. 1998. The Uruguay Round Agreement on Agriculture: A Forward-Looking Assessment. OECD Workshop on Emerging Trade Issues in Agriculture. Paris.

Konandreas, P, Lindland, J. & Pearce, R. 1997. The Uruguay Round and Agriculture in Southern Africa. Rome, FAO.

WTO. 1999. Guide to the Uruguay Round Agreements. WTO Secretariat and Kluwer Law International. Geneva.

WTO. 1997. Export subsidies: Background paper by the Secretariat. Prepared for WTO Committee on Agriculture. Geneva.

Annex Table 1: Outlays on export subsidies and reduction rates by Country (US$ million)

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¹ A primary product was defined to be any product of farm, forest or fishery, or any mineral, in its natural form or which has undergone such processing as is customarily required to prepare it for marketing in substantial volume in international trade (Ad Article XVI).

² The issues on this Decision is dealt with separately in a companion Module.

³ An Understanding on the Interpretation of Article XVII is now part of the Uruguay Round agreement. This establishes a working definition of state trading enterprises and sets up notification procedures designed to ensure transparency in their operation.