The impact of agricultural subsidies on global welfare.

Recent trends in trade liberalization and the increasing global nature of the world economy have sparked much debate as to whether globalization is a vehicle for growth and development or a bane to society. The debate is not simply one between the informed and the uneducated. Some of the most respected economists in the world disagree as to the impacts of globalization. Stiglitz (2002) refers to "the devastating effect that globalization can have on developing countries." On the other hand, Bhagwati (2004) holds that globalization can be beneficial for both developed and developing countries. He postulates that, for this to occur, there must be a set of new policies and institutions that will help developing countries handle increased volatilities resulting from globalization.

The agricultural sector is a central part of this issue, as the provision of agricultural subsidies has been a point of debate during recent trade negotiations. Most countries use some form of subsidies to protect their agricultural sector. Table 1 shows the levels of domestic subsidies provided to producers in selected developed and developing countries, The subsidy levels in developing countries are much lower than those in developed countries, even though agriculture typically comprises a greater proportion of the GDP in developing countries than developed countries. The total spending on domestic subsidies was $72 billon in the United States, $75.7 billion in the European Union (EU), and $25.1 billion in Japan in 2001. In addition to domestic subsidies, export subsidies have been used to increase and promote exports. Of the countries shown in table 2, export subsidies are exclusively used by the EU.

Developing countries strongly oppose domestic and export subsidies by developed countries. Since developing countries cannot afford to support their producers at the levels of developed countries, subsidies tend to limit fair competition. In general, both domestic and export subsidies distort production patterns. Some argue that subsidies given to producers in developed countries have resulted in overproduction and lower world prices of agricultural goods, which have been harmful to agriculture in developing countries. Others have argued that although subsidies distort trade flows, they have been beneficial for consumers in both exporting and importing countries, resulting in a net increase in global welfare, especially in developing importing countries (Bhagwati 2004). This is mainly because subsidies lower world prices for agricultural goods.

Under the Doha trade negotiations of the WTO, the United States, EU, and other countries, including Brazil and India, have called for steep cuts in domestic subsidies and the elimination of export subsidies. For example, the United States proposed a 60% cut in the payment cap, while other countries are calling for even greater cuts. Furthermore, the EU called for eliminating export subsidies by 2012. However, their proposal is contingent on the United States restricting its export credits.

In order to better understand the impacts of the agricultural subsidies on global welfare, this study will seek to accomplish two objectives. First, it will analyze changes in the distribution of social welfare among consumers and producers in both exporting and importing countries resulting from reductions in subsidies. Second, this analysis will assess the impact of subsidies on domestic production, consumption, and trade for the United States and the rest of the world (ROW).

Although considerable research has examined the impact of agricultural subsidies on domestic producers, relatively little has been done to determine the impact of subsidies on trading partners. Houck (1992) analyzed theoretically the impacts of domestic and export subsidies on trade flows but provided limited analysis on changes in social welfare in exporting and importing countries. In a series of articles, Alston, Carter, and Smith (1993, 1995) and Gardner (1995) examine the role of subsidies in providing support to domestic producers. These analyses did not consider the impact on trading partners. The impact of export subsidies on competing countries is considered by Leathers (2001), but only as a means to determine the optimal subsidy level.

The impact of the U.S. Export Enhancement Program on welfare in competing countries is examined by Anania, Bohman, and Carter (1992). Their analysis concludes that, although the United States gains with respect to quantity exported, neither the United States nor any of the other exporting countries experience welfare gains. Brander and Spencer (1984) note that, although export subsidies can be welfare enhancing in unusual circumstances, one country gains only at the expense of another.

Abbott, Paarlberg, and Sharples (1987) demonstrate that targeted export subsidies can improve the welfare of the subsidizing country by exploiting differences in excess demand elasticities. Welfare effects for other countries were not reported. Bohman, Carter, and Dorfman (1993) examined targeted export subsidies from a general equilibrium perspective. They conclude that certain conditions may improve the welfare of the subsidizing country and that subsidized countries can potentially experience welfare gains as a result of the subsidized exports.

From an empirical perspective, Sumner (2005) concluded that removing U.S. subsidies would allow the world price of corn to rise 9% to 10%, the world price of wheat to rise 6% to 8%, and the world price of rice to rise 4% to 6%. This is due mainly to a decrease in U.S. production under a free trade option.

Welfare Distribution of Domestic and Export Subsidies

Domestic and export subsidies given by exporting and importing countries affect the optimal utilization of resources in producing agricultural goods and distort trade flows (Heckscher-Ohlin). The extent of distortion depends upon the size of the country providing the subsidies. This section focuses on the provision of domestic and export subsidies of an exporting country.

If a small exporting country gives domestic and/or export subsidies, these subsidies do not affect the ROW, since increases in exports due to the subsidies are not large enough to influence the world price. It is assumed that the small exporting country faces a perfectly elastic import demand from the ROW. For instance, a domestic subsidy provided through a target price system, which has been used by the United States, sets the producer price (price received by farmers) at some desired level, while the domestic price (price paid by consumer) remains at the world price level. The subsidy increases domestic production, but domestic consumption remains the same. This results in an increase in exportable surplus. In the case of a small exporting country, the increased exportable surplus will not affect the world price or distort the flow of agricultural commodities (Houck 1992; Koo and Kennedy 2005).

The main purpose of export subsidies differs from the domestic subsidy program. The export subsidy is designed to increase exports by providing a subsidy to exporters. Such an export subsidy might take various forms such as a cash payment to exporters upon shipment of their agricultural goods, a rebate or exemption from a domestic sale and excise tax, or subsidized access to credit which lowers export costs (Houck 1992). The provision of an export subsidy by a small exporting country does not affect the world price of agricultural commodities.

Consider a large exporting country facing a downward sloping import demand schedule from the ROW. Domestic subsidies given to producers in the exporting country increase its domestic production. Increased production raises the aggregate supply of the commodity in the world market and lowers the world price. Similarly, if a large importing country gives domestic subsidies to its producers, domestic production increases. The result is a decrease in the country's imports as well as a drop in the aggregate demand for the commodity in the world market, also lowering the world price. In both scenarios, subsidies given by a large country distort trade and lower world prices. For example, domestic subsidies in developed and developing countries, including the EU, Japan, South Korea, and the United States, have led to the overproduction of agricultural commodities. As a result, world prices have decreased below the cost of production in many countries. The WTO ruling on the subsidization of U.S. cotton production reflects the impacts of domestic subsidies on the world cotton industry (Sumner 2005).