Virtually all model-based analyses of the cotton subsidy issue discussed in this paper - as well as the ATPSM model used here for further fresh analysis - are based on the familiar multi-region, partial equilibrium, static world trade models. Those familiar with this framework know well how these models work and what types of data, parameters and assumptions are required - the main building blocks of these models. It is important that these blocks are understood well, before discussing the ATPSM results in the next section. The following brief account of how all these models work will highlight the important factors that drive the results.
Figure 1 provides a graphical illustration of such a model, the three panels showing price-quantity graphs based on supply-demand interactions: the left panel (Figure 1a) represents a cotton-subsidizing country, the right panel (Figure 1c) represents a non-subsidizing country and the middle panel (Figure 1b) the world market as a whole.
In figures 1a, and 1c, the lines Si and Di (i=1,2) denote domestic supply and demand curves (domestic prices and domestic quantities) for cotton in each of the two countries. In the middle figure, the line
ES1 denotes the excess supply of cotton of country 1, while the line ED2 denotes the excess demand for cotton for country 2 (the lines represent functions of world prices and traded quantities). The intersection of these lines in the middle panel indicates that equilibrium in the world market in the absence of any intervention by the two countries would obtain at a price P. Under these conditions of no interventions, and under the assumption that transmission of world prices to the domestic market is perfect, the domestic prices in the two countries are equal to world prices, and the quantity traded is equal to OE in the middle figure, which is equal to exports of AB=OE from country 1 and imports of CD=OE from country 2.
Consider a policy that results in a price increase to the producers of cotton in country 1. Suppose that this policy results in a wedge between the international market price and the domestic producer price in country A which affects both producers and consumers equally. Such a policy, for instance, could be a domestic minimum price policy. Assume also that the transmission of world prices to the domestic market is only affected by this policy and nothing else. The result of this policy is to shift the excess supply curve of the exporting country to the right of its original position as illustrated by line. The excess demand curve of the importing country remains unaffected. The new world market equilibrium is at a lower price equal to P'. With this lower international price the domestic producer and consumer prices in country 1 are equal to, where t is the proportional wedge between international and domestic price in the subsidising country. In country 2, of course, the domestic producer and consumer prices are equal to the new depressed international prices, namely P'. Under this policy regime in country 1, production in country 1 increases from OB to OB', production in country 2 is reduced from OC to OC', and exports of country 1 increase from OE=AB, to OE'=A'B'. If there are other exporting countries (not shown here), that do not interfere in their domestic cotton market, the lower world price would result in lower production and exports. In other words the subsidy of one country increases the export share of the subsidising country and decreases it for the other non-subsidising competing exporters.
Suppose now that the support policy in country 1 affects only the producer price, leaving the consumer price unaffected. This, for instance could be so if the policy involves a producer subsidy only. Suppose that the proportional wedge between the international price and the domestic producer price in country 1 is the same as in the first example. In this case the excess supply of country 1 shifts to the right, similar to the previous case, but by a smaller amount, because the demand side of the market is not equally disturbed by the policy. In figure 1b, this reduced excess supply shift is illustrated by line. The consequence of this policy is that the world price is reduced to P'', which is larger than the price P' that would have resulted if both producer and consumer prices were affected equally. In country 1, the domestic price to consumers is P'', which is smaller than the price, while the domestic producer price is. Under this policy regime, exports of country 1 would be equal to OE''=A''B'', and production in country 1 would be equal to AB'' which is larger than the production OB' achieved with the uniform price policy. Production in country 2 would be equal to OC'', which is larger than OC', but still smaller than the free trade amount OC.
The above diagram and analysis make clear the following points. First policies that increase cotton producer prices in one country tend to depress world prices as well as prices in non-subsidising countries. Second, the production of cotton is increased in the subsidising country and reduced in the non-subsidising country. Third, the subsidy policies increase world trade. Fourth, exports by the subsidising country are increased at the expense of exports by non-subsidising countries. Fifth, depending on the extent of transmission of international signals to domestic markets, domestic farm prices are reduced in all non-subsidising countries, while farm prices are increased in the subsidising country. Finally, support policies in any producing and trading country are bound to induce adjustments in all other trading countries, leading to a new world equilibrium. This new equilibrium will entail welfare gains and losses by various groups within each country, depending on the magnitude of the quantity and price adjustments.
It should be clear that reversal of some policies, such as reduction of domestic support, is bound to lead to opposite results from those that were illustrated above. The effects are symmetrically opposite to those under the supports, under the assumption that no irreversible developments have taken place because of the supports. This, however, is by no means a trivial assumption. Long term support for a product is bound to lead to induced technical innovation that may permanently alter costs of production and other supply factors in the subsidising country. These effects are much more difficult to identify, however, and are normally neglected in analyses of the effects of agricultural subsidies.
The above framework also makes clear that any empirical assessment of policy interventions will depend on the following four sets of parameters/assumptions that are key to the results in models of this type.
The next section discusses these four factors with respect to cotton, and discusses their use in the recently used models that analysed the cotton subsidy issue. This review also provides the basis for the ATPSM application in the subsequent section.
 The price wedge does not
have to be proportional, it could just as well be additive, depending on the
particular type of policy.|