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Three pillars ofagricultural supportand their impact on WTO reforms

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Ivan Roberts

© Commonwealth of Australia 2003

This work is copyright. The Copyright Act 1968 permits fair dealing for study,research, news reporting, criticism or review. Selected passages, tables ordiagrams may be reproduced for such purposes provided acknowledgment ofthe source is included. Major extracts or the entire document may not be repro-duced by any process without the written permission of the Executive Director,ABARE.

ISSN 1447-817XISBN 0 642 76475 1

Roberts, I. 2003, Three Pillars of Agricultural Support and Their Impact onWTO Reforms, ABARE eReport 03.5 Canberra.

Australian Bureau of Agricultural and Resource EconomicsGPO Box 1563 Canberra 2601

Telephone +61 2 6272 2000 Facsimile +61 2 6272 2001Internet www.abareconomics.com

ABARE is a professionally independent government economic research agency.

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forewordThe WTO membership, in its efforts to free up agricultural trade andreduce market distortions, in the present Agreement on Agriculture,addressed agricultural support arrangements under three headings or‘pillars’ — market access, domestic support and export subsidies. Thiswas an acknowledgment that there are many ways to provide protectionto farmers.

An agreement is no stronger than its weakest link. So, while the presentagreement has been relatively successful in reducing export subsidies,it has done this at a cost of markedly increased levels of domestic support,where the provisions are much weaker. There are also important linksbetween market access and the other two pillars that can markedly influ-ence the effectiveness of tariff cuts and other measures to free up trade.

In this report the interrelationships of protective and support arrange-ments under the three pillars are examined with a view to ensuring thatthe weaknesses in the present agreement are addressed in the next agree-ment that is currently being negotiated.

BRIAN S. FISHER

Executive Director

March 2003

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acknowledgmentsThe author wishes to acknowledge advice and comments from NeilAndrews, Vernon Topp, Suthida Warr, Bruce Bowen, George Mina andFrank Jotzo.

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contents

1 Interrelationships between support providedunder the ‘three pillars’ 1Objectives of trade policy reform 1Three ‘pillars’ of support 4Negotiating for more open, less distorted markets 4

2 The Uruguay Round approach to agricultualpolicy reform 6Basic model of support 6A hypothetical example of interactions between thethree pillars 11

3 Market access and export subsidies 14Using discriminatory market access measures tocounter others’ domestic protection 14Importantt characteristics of present WTO rules 15What is needed to ensure reduced marketdistortions? 16Market access 17

4 Domestic support 21Many exemptions available under domestic support 21Decoupling and distortions 25

5 Conclusions 35

Glossary 39

References 42

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BoxesKey points about the ‘three pillars’ 3

1 Measures agreed to open markets and reducedistorting support in the present WTO Agreementon Agriculture 7

2 A basic model of agricultural support 9

FiguresA US cereals – production, prices and direct support 27B EU cerials – production, prices and direct support 27

Table1 Average ‘water’ in agricultural tariffs 17

interrelationships between supportprovided under the ‘three pillars’The present WTO Agreement on Agriculture was concluded under the Uruguay Round ofmultilateral trade negotiations in 1994 and a new agreement is now being negotiated. In thecurrent agreement, measures to open markets, to reduce market distorting agricultural supportand to reduce subsidised exports are considered in three separate categories or ‘pillars’. Yetin most instances, support is actually provided by a combination of barriers against importcompetition, domestic subsidies and export subsidies. That is, the measures categorisedunder individual pillars are not independent of each other. They interact with each other toachieve one primary goal — protection to farmers.

The strength of the provisions that are designed to reduce protection in the current agree-ment is markedly different for each pillar. The provisions are strongest for direct exportsubsidies and weakest for domestic support. This inconsistency has been exploited in somemajor agricultural producing and trading countries that have restructured their supportarrangements away from export subsidies and toward particular forms of domestic support.Whether that change in orientation results in reduced market distortions depends on boththe degree to which former arrangements distorted markets and on whether the new arrange-ments are applied in ways that are less distorting.

The interactions between the provisions for each of the three pillars are increasingly beingrecognised in WTO considerations. This has especially been the case with domestic supportand export subsidies. For example, a WTO panel found that Canada was subsidising itsexports of dairy products through its domestic support arrangements for milk (WTO 1999,2002).

In this report, the interrelationships between the support provided under each of the threepillars — market access, domestic support and export subsidies — are examined. Conclusionsare then drawn about necessary actions to ensure that the current WTO agriculture negoti-ations result in a new agreement that can secure greater economic gains from more open,less distorted markets in future.

Objective of trade policy reformThe objective in reforming trade policy internationally is to increase economic benefits toparticipating countries by reducing impediments to the free flow of efficiently producedgoods and services between them. This applies to agriculture as well as other sectors.

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The trade reform objective can be broken down into:

■ reducing impediments to the free flow of goods and services in international trade; and

■ improving the economic efficiency with which goods and services are produced.

Approaches to addressing the first of these parts are straightforward conceptually, involv-ing countries reducing their tariffs and nontariff barriers, and, under the present WTOAgreement on Agriculture, increasing access through larger and less restrictive tariff rateimport quotas. However, improving the economic efficiency with which goods and servicesare produced is not so straightforward. Important aspects of such efficiency are the alloca-tion of resources within countries and between countries in ways that better reflect marketrequirements, and technical and dynamic issues such as economies of scale and the greaterreceptiveness to innovation that come with markets becoming more open.

Effective and efficient operation of markets internationally is central to achieving the poten-tial that countries have to generate income and wealth. Different countries face differingdegrees of abundance and different limits to physical resources and human skills. If they tryto produce all of their own requirements for goods and services, they deny themselves thebenefits from others being able to produce many products more cheaply and efficiently. Thisapplies in a relative sense, as explained by Ricardo in his principle of comparative advan-tage. Economies gain by concentrating their productive efforts on the goods and servicesthat they can produce relatively most efficiently while exchanging part of their productionfor items that others produce relatively more efficiently. By embracing trade through open-ing markets and pursuing policies that reduce inefficiencies in production, countries increasethe benefits from exercising rather than constraining their comparative advantage.

However, countries can make their markets more open at the same time as pursuing domes-tic support policies that ensure that many resources are used in activities in which they arecomparatively inefficient. This limits the economic benefits from their openness. For exam-ple, a country that is a high cost producer of wheat might allow full access of imports to itsmarket at the same time as directly subsidising its own production. The subsidies wouldencourage the direction of domestic resources into high cost wheat production rather thanalternatives in which the country is competitive without support. The subsidised domesticwheat production would limit the quantities imported. The country would use more of itsresources in high cost wheat production and less in producing other things from which greaterreturns would be produced per unit of inputs used — and it would import less wheat. As aresult, people in that economy would be worse off than if the domestic wheat was notsubsidised. The higher cost of producing wheat domestically would be an impost on domes-tic taxpayers whose funds would be used in higher cost activities than the alternatives avail-able. Also, people in more efficient wheat producing countries would be worse off becausethey would lose profitable market opportunities.

The message from this example is that openness to trade and domestic support policies arenot independent in their effects on trade and the generation of economic benefits — theyaffect each other.

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Key points about the ‘three pillars’

■ Having separate ‘pillars’ for market access, domestic support and exportsubsidies makes negotiations more managable and ensures that all formsof assistance are covered.

■ Support under each of the three pillars is interdependent. In essence, supportunder each pillar is substitutable for and complementary with support underthe other two. All support is essentially domestic support to farmers.

■ The strongest provisions of the present WTO Agreement on Agriculture areon export subsidies and the weakest are on domestic support. Ultimately,the outcome of the Doha Round will be no stronger than its weakest link.

■ The weaker provisions for domestic support have encouraged large increasesin domestic support as restrictions on subsidsed exports are tightened.

■ The additional domestic support has been largely in categories that areexempt from cuts or limitations, including production limiting (blue box)arrangements, decoupled (green box) payments or support classified as deminimis exemptions.

■ The rechanneling of assistance into domestic support has enabled countriesto reduce bound tariffs and export subsidies, thereby meeting WTO reduc-tion commitments under the other two pillars.

■ There is substantial unused ‘water’ in most bound tariffs, meaning that largecuts can be made to them before markets are actually opened more.

■ Most production limiting (blue box) arrangements that are exempt from cutsin domestic support lock in distorted production but are less market distort-ing than the same levels of open-ended price support.

■ Decoupling support to make it less distorting is a good idea but politicalfactors are perverting its application so that it is neither properly decouplednor as minimally market distorting as it is construed to be.

■ The present Aggregate Measurement of Support (AMS) as defined for theagreement, is virtually meaningless as a measure of actual support.Nevertheless its use is probably of some value in encouraging support awayfrom highly distorting price measures toward less distorting exempt formsof assistance.

■ A proper AMS that measures actual support would provide an acid test ofthe effectiveness of WTO rules to reduce distorting support. However, forvarious technical and political reasons, WTO members seem reluctant tocontemplate its use.

Three ‘pillars’ of support

In the present WTO Agreement on Agriculture that was concluded in 1994 under the UruguayRound, separate provisions were agreed for three categories of support — namely marketaccess, domestic support and export subsidies. For convenience these categories are termedthe three ‘pillars’ of support. The idea was that all measures that reduce economic benefitsthrough restricting and distorting markets would be subject to agreed reductions and limi-tations, as all measures would fall within at least one of these categories.

This approach has encouraged the shuffling of support between pillars toward forms ofdomestic support for which the agreement is most permissive. Perusal of the Agreement onAgriculture leads to the conclusion that one of the main preoccupations in negotiating it wasto ensure a wide range of exemptions from domestic support disciplines. The ready avail-ability of such exemptions ensures that countries are not obligated to reduce levels of supportunder the agreement.

Representatives of some countries indicate that the ability to shift their agricultural assis-tance increasingly away from price support that rests on barriers against imports and/orexport subsidies into exempt forms of domestic support is a positive thing. That abilityenables them to reform their agricultural support away from clearly market distorting pricesupport toward forms of support payments that are considered to be ‘production limiting’and ‘minimally distorting’. Others are sceptical, observing the continuing high, even record,levels of such payments that have applied since the conclusion of the Uruguay Round.Importantly, there are examples of bending the WTO rules on decoupled payments that areexempt from any limits or cuts and basing major support systems on such exemptions. Suchbehavior has resulted in linkages between the payments and production that should not existif the payments are to be genuinely minimally market distorting, not just purported to be.

Some developing countries, concerned about the adverse effects of developed countries’domestic support payments on their farmers and on their economic development, are consid-ering that they should be able to apply additional tariff barriers against imports from coun-tries that have high domestic support. This kind of defensive reaction is another example ofinteractions between the three pillars, with some countries seeking special dispensations toincrease protection through one pillar — market access — in retaliation against others’ useof support via another pillar — domestic support.

Negotiating for more open, less distorted marketsAlthough it can be appreciated that there are practical reasons for negotiating separate rulesfor each pillar, the success of an agreement depends on the overall effects of the measuresthat are negotiated for each product under each of the pillars.

More open, less distorted markets require that:

■ first and foremost, markets must be made genuinely more open — that is imports musthave greater access to markets with the additional competition impinging on levels ofprotection;

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■ actual aggregate levels of market distorting support on both a commodity specific andon an agriculturewide basis must be reduced; and

■ measures that are made exempt from cuts or limitations must actually be minimallymarket distorting, not just considered to be such.

The present agreement does not measure up very well on any of these counts, although itdoes provide some benefits.

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the Uruguay Round approach toagricultural policy reformThe approach that was adopted in the WTO Agreement on Agriculture to reduce the tradedistorting effects of agricultural protectionism is shown in box 1. In that box, the reductionsin tariffs, support levels and export subsidies that are shown are those that were agreed fordeveloped countries. The implementation period for developed countries in the agreementwas the six years from 1995 to 2000 inclusive. For developing countries, the agreed cutswere lower than for developed countries — they were generally two-thirds of those for thedeveloped countries — and the implementation period was 1995 to 2004.

Basic model of supportSupport for agricultural products by a particular country can be provided using a myriad ofmeasures. However, these are categorised for convenience into three groups under the threepillars in the present WTO Agreement on Agriculture:

Market access: Such measures include taxes on imports (for example tariffs) or other restric-tions on access to the country’s market that limit competition from imports and enable domes-tic producers to obtain prices from domestic consumers that exceed prices on the worldmarket. The higher prices are the equivalent of a consumer funded subsidy to producers.

Domestic support: This includes government (taxpayer funded) outlays to supplement farm-ers’ incomes, market interventions or subsidies to increase the prices they receive, and provi-sion of services that might otherwise need to be paid for by farmers themselves, or governmentinduced reductions in input costs.

■ To these can be added support that arises from powers that governments can confer onindustries to control supplies flowing to the domestic market, enabling exporting indus-tries to charge prices to domestic consumers that can be as high as import parity, ratherthan the lower export parity prices. Those powers can arise through supply controls orlevies on domestic sales. These powers can also enable domestic prices to rise aboveimport parity, but only if exercised in conjunction with charges or restrictions on imports,and, if the country is an exporter, export subsidies. These arrangements provide produc-ers with the equivalent of subsidies funded by domestic consumers that are supplementedby taxpayer transfers if export subsidies are used.

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Box 1: Measures agreed to open markets andreduce distorting support in the present

WTO Agreement on Agriculture

Under the Uruguay Round of multilateral trade negotiations, separate disciplines were negoti-ated for market access, domestic support and export measures.

On market access:■ Nontariff barriers that previously existed were converted to tariff equivalents as at a spec-

ified base period of 1986–88 — a process called tariffication. The resultant tariffs werebound in the WTO and, along with existing tariffs, were then reduced over the implemen-tation period by an average of 36 per cent, with minimum cuts for specific tariff items of15 per cent.

■ For items that were subject to tariffication, minimum access levels for imports were to risefrom 3 per cent to 5 per cent of base consumption, and current access levels were assured.These measures were implemented through applying tariff quotas (reduced tariffs on importsup to specified quantities, with the normal tariff applying for additional imports).

■ The tariff cuts and tariff quotas have been applied at the individual product or tariff linelevel.

On domestic support:■ Levels of nonexempt forms of domestic support were determined for agriculture as a whole

for each member country in what is termed an Aggregate Measurement of Support (AMS).This AMS has been termed ‘amber box’ support and was subject to an agreed reductionof 20 per cent from its 1986–88 base level, over the implementation period. The AMS wascalculated on a commodity specific basis with the amounts being summed and then addedto non commodity specific nonexempt support to give the AMS for agriculture. There aretwo constituents of the AMS. One is price support determined from differences betweenadministered support prices and fixed external reference prices, multiplied by quantitieseligible for support. The other is nonexempt domestic subsidies.

■ A range of support payments was exempted from any limitation or reduction. These fellinto two categories. One was support under production limiting arrangements, termed ‘bluebox’ exemptions. The other, termed ‘green box’ support, was support through governmentservices, support for stockholding for food security purposes, domestic food aid, and arange of payments including decoupled income support, government assistance to incomeinsurance and safety net programs, drought relief, structural adjustment payments, invest-ment aids, environmental programs and regional assistance.

■ In addition, where each of commodity specific and non commodity specific support fellbelow a specified proportion of the value of production (5 per cent for developed countriesand 10 per cent for developing countries), the support was exempted. This was termed deminimis exemptions.

On export subsidies:■ The volume of subsidised exports was to be reduced by 21 per cent and budget outlays on

export subsidies by 36 per cent on an individual commodity basis. The reductions werefrom levels in a base period of 1986–90 and were applied over the same implementationperiod as the commitments on market access and domestic support.

Export subsidies: These include payments that are contingent on products being exportedor measures that have similar effects. There can also be an element of export subsidisationin like measures that include concessional export credits and some forms of food aid thatdivert quantities away from the domestic market and onto export markets. By so doing, theyrestrict volumes on the domestic market and enable internal prices to rise above export parity.The subsidy elements for these measures are funded partly by government outlays thatprovide the incentives to export products at prices below domestic levels, and partly throughhigher domestic prices paid by consumers.

The main ways in which all these measures work are by transferring funds from domesticconsumers to producers, by transferring funds from taxpayers to producers, or by the govern-ment providing concessionally priced or free goods or services that would otherwise beprovided to producers by markets at competitively determined prices.

One of the most important observations about these support arrangements is that the sameproduction, consumption and trade effects can be obtained in many ways through importmeasures, domestic support measures, export subsidies and combinations of these measures.In fact, it is possible to replicate the same production, consumption, price and trade effectswith combinations of domestic subsidies and taxes as with market access restrictions andexport subsidies. Furthermore, and central to the purpose in this report, it is possible to substi-tute domestic support measures for market access measures or export subsidies. Not only isit possible, but there have been some major such substitutions in large agricultural produc-ing and trading countries, both in the name of reforming policies and to comply with thevarious elements of the WTO Agreement on Agriculture.

A simplified diagrammatic depiction and explanation of the kinds of interrelationshipsbetween market access restrictions, including tariffs, domestic support and export subsidies,is given in box 2.

This observation about the substitutability of domestic support measures for both marketaccess arrangements and export subsidies is relevant in the contexts of the present Agreementon Agriculture and for the present WTO agricultural negotiations. This is because agree-ment in the Uruguay Round on agriculture could only be reached by exempting a wide rangeof domestic support measures from any limitations or reductions.

In particular, the European Union has significantly reoriented its support for some commodi-ties (cereals and beef) away from price support underpinned by export subsidies and marketaccess limitations and into blue box support through production limiting arrangements thatare exempt from limitations or reduction under current rules.

Similarly, the United States has reoriented much of the distorting deficiency payment andexport subsidy support it had previously used for grains to exempt green box support throughwhat the United States considers to be decoupled domestic support payments that are deemedto be minimally market distorting.

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Box 2: A basic model of agricultural support

The main effects of various forms of agricultural assistance are depicted in the following figurethat indicates a simplified static version of supply and demand conditions for a product in asmall country — that is, one where changes in policies have a minimal impact on world marketand price conditions. For simplicity, the figure does not take account of costs of transport to orfrom that country. In the figure, the supply curve for the industry SS slopes upward to the right,depicting increases in production as prices rise. The domestic demand curve DD slopes down-ward to the right, indicating that people consume more as prices fall.

Price support underpinned by tariffs and export subsidiesIt is assumed initially that this country would be an importer of the product at the world pricePw. As shown, the quantity imported would have been Qa–Qb, the quantity by which the quan-tity produced domestically (Qb) falls short of the quantity consumed domestically (Qa).

The government of this country decidesthat it should support its producers of thisproduct by ensuring that they receive aprice, Pi, that is above world market prices.The method chosen to do this is to restrictcompetition from imports that would other-wise have maintained internal prices at theworld price Pw. The restriction on importscould either be through limiting importsdirectly or by imposing an import tariff ofPi–Pw (distance eh). Here, it is assumedthat the tariff option is used.

However, internal prices cannot rise abovePa, the price at which this country wouldbecome fully self sufficient. If producerswere to receive prices above Pa, theywould produce surpluses above domesticconsumption that would have to beexported at the world price Pw, which isbelow Pa. For the domestic price to reach the chosen level of Pi, the tariff would need to becomplemented by another form of support for exports that covered the difference between theinternal price and the world price. Initially, it is assumed that this difference is covered by anexport subsidy of Pi–Pw (fg). (In practice the unit export subsidy would need to cover freightas well, resulting in the unit export subsidy exceeding the import tariff.)

The supported price Pi, therefore needs both the tariff and the export subsidy to sustain it, andthe country changes from being an importer of this product (quantity Qa–Qb) to an exporter(quantity Qc–Qd). The budget cost of the export subsidies would be the area efgh while domes-tic consumers would have to pay the area jehi to domestic producers in the form of price support.

Direct subsidies to producersAfter some time, the country’s government decides that it no longer wishes to impose the highcost of this support on its consumers, but it is prepared to finance the full support through thebudget. To do this, it changes its means of support away from price support that was under-pinned by a tariff and an export subsidy, to budget funded direct subsidies to producers. To

Continued ➮

1 A basic model: differing ways to provide the same level of support to agricultural producers

Price

Quantity

Pij

i

S

SD

D

gh

e f

Pa

Pw

QbQd Qa Qc

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ensure that producers receive the price Pi, the unit payment would need to be Pi–Pw on the fullquantity produced Qc.

Some of the key effects of substituting these direct subsidies that apply to all production, forthe previous price support would be:

■ the country’s producers would continue to produce at the point f on the industry’s supplycurve (quantity Qc), just as they had when receiving price support underpinned by tariffsand export subsidies — they would now receive the same price but it would be underpinnedby the direct subsidies;

■ the need to maintain the tariff would disappear, and internal consumption prices would beallowed to fall back to the world price Pw;

■ the country would remain an exporter, the extent being Qc–Qa — as shown, consumptionwould rise from Qd to Qa (however, if slopes for the supply and demand curves differedfrom those shown in the figure, the country might revert to becoming an importer); exportswould be less than with the tariff and export subsidy based price support, because theconsumers would now pay only the world prices and their consumption would be higherthan when the internal consumer price was Pi ; and

■ domestic subsidies would cover the difference between the internal supported price or unitreturn to producers and the world price faced by consumers, and would also cover the gapbetween producer prices Pi and the world price for exports. Consequently, there would beno need for export subsidies.

Substitutability and complementarity of support mechanismsFrom the foregoing, it can be seen that countries have substantial flexibility in the way theysupport their farmers.

By changing from a system of price support that depends on tariffs and export subsidies to oneof direct price-linked subsidies of the same extent, a country can reduce or eliminate both itsimport tariffs and export subsidies without affecting either the support to producers, or theirproduction. This is very important in the context of the WTO Agreement on Agriculture, asnegotiated cuts to both tariffs and export subsidies are from base levels reached in previousperiods. A country with high tariffs and export subsidies in the base period can obtain creditfor reducing or eliminating tariffs and export subsidies by substituting domestic subsidies forthem. However, the domestic subsidies would be subject to the rules or reductions negotiatedfor domestic subsidies.

If the cuts to, or elimination of, tariffs provide actual cuts that exceed agreed reductions fromWTO negotiations, the change in form of support could build substantial unused ‘water’ intobound WTO tariff level entitlements providing a possibility for future increases in tariffs.

As shown in this box, the support on the country’s production would remain distorting after achangeover from price support to subsidies. However, the consumption distortion would beeliminated. Consequently, the change from tariff and export subsidy based price support todirect subsidy support of the same extent would reduce policy induced market distortions. Evenso, significant distortions would remain relative to the situation with no support where the coun-try would be an importer.

The straightforward comparisons in this box do not take account of many real world complex-ities about the forms in which subsidies might be provided. The extent of the production distor-tion arising from support can be reduced by production limiting arrangements such as area set-aside programs or by delinking support from production, prices or input use or prices. Theseissues are addressed later in this report.

A hypothetical example of interactions between the threepillarsThe following is a hypothetical example (but one based loosely on actual policy mecha-nisms applied in the European Union and United States) of the interactions between thethree pillars of market access, domestic support and export subsidies. It shows the implica-tions of substituting exempt domestic support for a combination of market access restric-tions and export subsidies that had provided substantial price support. The country providessubstantial support, and is a net exporter.

The situation before a change in forms of support■ In this hypothetical example, the country was a relatively large net exporter of a prod-

uct ‘A’ and supported its price at an administratively set level of 150 units/tonne.

■ The world market price for A (cif landed) for imports into this country was 100 units/tonne, at a particular time. At the same time, the fob (free on board) price obtainable forexports of A from the country was 80 units/tonne. The difference between import andexport prices arises from freight costs (freight needs to be paid for any imports into thecountry, whereas exporters from this country need to pay freight on their own exports— hence the export prices obtainable are below the prices paid for imports).

■ The internal price was maintained above the world price by a combination of tariffs onimports that prevented imports undercutting the supported price, and export subsidiesthat enabled the country’s exports of A to be sold at the world price.

■ Imports were excluded from the market by tariffs that needed to be at least 50 units/tonne— that is, the difference between the internal supported price and the cif import price.

■ Unit export subsidies at the time needed to be 70 units/tonne, to cover the differencebetween the internal supported price and the price receivable for exports.

■ Although this country was an exporter under these support arrangements, it would, overtime, become an importer if its market became fully open and if the support for produc-tion of A were completely removed. However, if current prices or alternative forms ofsupport to producers were maintained at relatively high levels, but prices to consumerswere to fall to world market levels, the country would still be an exporter.

A change in forms of support■ It was decided to change forms of support so that internal prices for A would be reduced

to 110 units/tonne. To compensate for the price reduction, farmers would be paid directcompensation payments of 40 units/tonne each season. Those payments were structuredin a way (production limiting or deemed to be minimally market distorting) to ensurethat they were exempt from any limitations or reductions under the WTO Agreement onAgriculture. At the same time, the production support was structured in such a way thatdid not reduce production enough for the country to change from being an exporter toan importer.

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Implications of the change for WTO commitments■ Under the initial arrangements, the total tariff needed to defend the supported price was

50 units/tonne. Tariffs above that level would, in principle, prevent import competition.If the year considered was regarded as the base period for tariffication under WTOarrangements, that tariff would be considered to be the bound base tariff.

■ Similarly, the base export subsidy rate would be 70 units/tonne.

■ Under the present WTO arrangements for domestic support, all of the initial price supportwould be nonexempt amber box price support. The contribution of support for A to thetotal Aggregate Measurement of Support (AMS) for the country’s agriculture wouldhave been 70 units/tonne (the extent to which the internal price exceeded export parityfor this exporting country) multiplied by the quantity eligible for support. The supportedquantity should be the total production of A, as all production of the item received thesupported price.

■ As a result of the change in the form of support, the tariff needed to defend the lowersupported internal price would fall from 50 units/tonne to 10 units/tonne — a decline of80 per cent. The unit export subsidy required would fall from 70 units/tonne to 30units/tonne — a reduction of 57 per cent.

■ As the country’s bound tariff in the WTO would remain at 50 units/tonne, and only 10units/tonne are now needed to support the new lower price, there would now be 40units/tonne of ‘water’ or unused capacity in the country’s bound tariff. This means thatthe country’s bound tariff would need to be reduced by 80 per cent before there wouldbe further reductions in applied tariffs. Importantly, it also means that, whereas it requireda tariff of above 50 units/tonne to exclude price-based import competition, it would nowrequire tariffs that were only above 10 per cent to accomplish the same degree of importexclusion. That does not mean that the tariff cut was not beneficial as is indicated in thenext point.

■ The market would have been made only nominally more open by the change that reducedthe tariff. For this market, that would not result in imports, in fact, as the support toproduction would continue to be sufficient for the country to remain an exporter despitethe stimulus to domestic consumption from the lower internal prices. Nevertheless thehigher domestic consumption resulting from the reduced internal price would havereduced the volume of subsidised exports.

■ Given that commitments on tariffs are only on bound tariffs, negotiation of further reduc-tions in applied tariffs to open up this market would have been made more difficult. Thisis because of the large amount of water in the tariff that would need to be eliminatedbefore imports could enter at or below the internal supported price and be competitivewith domestic production. Substantial reductions would need to be made to bound ratesbefore further reductions in applied tariffs and in actual import competition could occur.

■ The country would have greatly reduced its need for explicit export subsidies and wouldtherefore have been able to meet even relatively large WTO commitments to reduceexplicit export subsidies.

■ The role of export subsidies in covering the gap between high internal returns and thoseobtainable on exports through the lower world export price would have been taken over

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substantially by the direct support payments on the equivalent of the part of productionthat was exported.

■ Effectively, this country would have been able to meet commitments to substantiallyreduce its AMS, tariffs and the value of its export subsidies, and create a substantialbuffer in its bound tariff against future negotiated reductions. In this instance, it wouldhave achieved these things through reforms in domestic support for which the only ‘cost’,in WTO terms, would have been the need to structure the compensation payments inways that ensured that they were classified as exempt.

The final outcome of changing the form of support on reducing market distortions dependson two main factors:

■ the reduction in the economic costs to consumers that resulted from government inter-vention because prices had moved closer to the world market levels. This change wouldreduce market distortions in the agricultural sector. However, part (even a large part) ofthese savings in costs to the particular economy would be replaced by the costs of rais-ing the additional taxes required to make the ongoing compensation payments and theadministrative costs in distributing them.

■ the extent to which the exempt compensation payments were in fact less distorting toproduction, exports and market prices than the equivalent amount of the initial pricesupport.

This example shows some of the main interdependencies between tariffs, domestic supportpayments and export subsidies. It shows that changes away from price support to domesticsupport through direct payments can reduce explicit export subsidies. It also shows thatsubstituting domestic subsidies for market price support that was underpinned by tariffs andexport subsidies can reduce costs to consumers and agricultural market distortions arisingfrom agricultural support. That is, the support through direct payments would be less marketdistorting overall than price support of the same amount.

Note that, although the tariff required to defend the new lower internal supported price ismuch lower than previously, and the lower price that is much closer to world market pricesrepresents a worthwhile reform, there would be no increase in actual import access. Thechangeover in support arrangements results in substantial unused water in bound tariffs with-out increasing actual access of imports to the market. That water in the tariff means thatlarge reductions in bound tariffs would need to be negotiated in future if further inroads wereto be made into protection for this country.

Whereas the lower internal prices through tariff and export subsidy reductions clearly reducesdistortions to agricultural markets, the extent to which production distortions might bereduced depends on the nature of the exempt payments and the responses of producers tothe changed incentives.

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market access and exportsubsidiesUsing discriminatory market access measures to counterothers’ domestic protectionDynamic international linkages can arise or be triggered between domestic support, exportsubsidies and import barriers. For example, if importing countries were to seek to increasetheir import tariffs or nontariff barriers against imports from countries that provide substan-tial domestic support, there could be important effects for trade and its associated economicbenefits.

In this context, the concern of the importing countries could arise because the domesticsupport provided by the particular exporting country was so large and apparent. Yet, in someinstances, that support may have become so large because it was replacing price support thatwas previously provided in a less transparent manner through barriers to market access and/orexport subsidies. Depending on the extent of the domestic support, the change may evenhave reduced the market distortions arising from the support and had a less adverse effecton farmers in other countries.

The effects of countries responding to others’ domestic support by selectively increasingbarriers against imports from the countries imposing the support depend on a range of factors.Important among these are:

■ the number of responding countries and the extent of their demand;

■ the extent of the barriers that they impose against imports from countries that providedomestic support; and

■ the extent of production and exports of the countries that provide the domestic supportand that of other exporting countries.

If an individual large importing country’s government decided to place an additional barrieragainst imports of a particular product that is exported from a country that provides only asmall proportion of world trade, the effect on world markets and prices could be minor. Theformer imports from the supporting country could be easily replaced by greater imports fromelsewhere. The imports could be diverted from other markets, making space in those othermarkets for the quantities that were displaced. Levels of tariffs paid by other supplying coun-tries on imports into the country providing the additional barrier would be unaltered. Soaggregate world import demand and exportable supplies would be unaltered.

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If, however, a large proportion of importing countries — for example, all developing coun-tries — decided simultaneously to erect additional import barriers against exports from asmall export supplier, there would be some, although not large, reductions in world pricesas a result. However, the effects on the small exporter could be significant, especially if therewere few markets outside those erecting additional barriers against its product. That smallexporter would need to sell on a small set of residual, possibly distant, markets and if it weredependent on exports, the cost of supporting its industry at previous levels would rise. If itdid not increase its support further, its production and overall exports would fall. Such devel-opments would provide minor gains to other exporting countries. However, the world marketwould not be greatly affected.

But there could be major implications if the importing country or countries imposing theselective barriers were very large or dominant in world imports and the exporting countrieswere also large producers and dominant suppliers to world markets. The barriers by the largeimporters could result in large reductions in their intake from the high support, large export-ing countries — quantities that could be only partially replaced by other smaller exportingcountries that would divert quantities from the smaller markets. The displaced exports fromthe large supporting countries would be diverted onto the smaller third country import marketsthat would become more heavily supplied. The overall impact would be an immediate reduc-tion in world import demand, lower import volumes by the large countries imposing theselective barriers, and depressed world market prices.

If the exporting countries that were providing the domestic support responded by furtherincreasing support to maintain returns to their own producers, thereby maintaining theiroverall exports into the longer term, the situation would be one of reduced overall importdemand that was not matched by a commensurate long term reduction in exportable supplies.The outcome would be increased protection in both large exporting and importing countriesand for the world overall. World market prices would be reduced over the long term, adverselyaffecting nonsupporting exporters. The additional support would create extra distortions inresource use, thereby reducing global economic welfare.

Important characteristics of present WTO rulesAn important characteristic of the present arrangements in the WTO Agreement onAgriculture is that separate, and apparently independent commitments could be made foreach of the three pillars. However, the lines of distinction are blurred between the pricesupport element of the AMS under the domestic support category and the market access andexport subsidy pillars. This blurring comes about because price support is usually providedby limiting market access and by the use of export subsidies or like measures. That is, theimport barriers and export subsidies are the measures used to provide price support. So itmay be argued that the three pillars have not been treated in a fully independent manner.

Some may even argue that the price support element of the AMS has been double countedin the system for support reduction. This is because price support is an integral part of thedomestic support AMS but, at the same time the two pillars that make price support effec-tive are market access limitations and export subsidies. It may be contended that if marketaccess reforms were sufficient to allow lower barriers against imports, and export subsidies

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were reduced, the resultant price support would already have been reduced, making it unnec-essary to include price support in the AMS. However, as will be discussed later, it can bedifficult to guarantee that the kinds of tariff cuts — that is, cuts to tariffs that are bound inthe WTO — that could be negotiated in the WTO will actually reduce the effectiveness oftariffs in providing price support.

Nevertheless, there are some means of providing price support that are clearly generated bydomestic support measures that are not underpinned by market access limitations and exportsubsidies. These include measures applied by exporting countries to raise internal supportedprices from export parity prices to approach higher import parity levels. Such measures caninvolve levy/refund arrangements on domestic and export sales or controls on productionor sales through quota arrangements or government sponsored or private monopolies thatlimit supplies flowing to the domestic market, thereby supporting domestic prices aboveexport parity. Those arrangements are clearly market distorting domestic support that wouldnot be covered by rules on market access and might also be constructed to avoid rules onexport subsidies.

What is needed to ensure reduced market distortions?Before considering measures to limit market distortions, it is desirable to indicate the kindsof market distortions that arise from government support and protection. Broadly, marketdistortions arise when the intervention results in levels of production, consumption, exports,imports and prices that differ from levels that would apply with competitively structuredmarkets without the protective or support-providing interventions.

To ensure success in obtaining economic gains from less distorted markets for agriculturalcommodities, three main developments are necessary:

■ there must be actual reductions in barriers against imports that enable the competitionfrom imports to reduce internal market prices to closer to world market prices;

■ there must be reductions in actual levels of market distorting domestic support; and

■ there must be reductions in actual levels of export subsidies.

The most important word in each of these three conditions is ‘actual’. In economic terms,gains will only be obtained when commitments erode the market protecting and productionsupport arrangements that actually apply.

In examining the effects of the present WTO Agreement on Agriculture, it is critical to under-stand that many, even most, of the commitments that are made are not to reduce actual barri-ers to trade or to reduce actual market distorting domestic support. They are to reduce theclosest proxies to these barriers that the membership can agree on. The WTO is a consen-sus body. The members have widely differing agendas ranging from pursuit of the economicbenefits from more open markets to protection of domestic industries and cultural heritage.Because of this, the parameters that can be agreed on for reduction will be compromises,and agreed cuts to these parameters often only indirectly or partially address economic distor-tions. Indeed, some members will only agree to cuts in particular parameters if they cannegotiate sufficient freedom to substitute other forms of support.

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In the Uruguay Round Agreement on Agriculture, the only commitments that have stronglyand directly addressed actual levels of clearly market distorting measures were those onexport subsidies. Even then, the reductions in levels of export subsidies could be replacedby increases in various forms of exempt domestic support. What then do the commitmentsactually refer to?

Market access

Bound tariff levelsOn market access, the commitments in the present agreement are to reduce ‘bound’ rates oftariffs, not actual applied rates. The bound rates are maximum tariffs that the members agreeshould not be exceeded. If these maximum rates markedly exceed applied rates, or ‘effec-tive’ rates necessary to defend the current extent to which internal prices exceed world marketlevels, large reductions can be negotiated in those maximum rates without making any differ-ence to actual applied rates or to levels of market access. Because of this ‘water in the tariff’it can require large reductions in the bound rates before any or much reduction can be madeto ‘effective’ rates. Where the cuts do nothing but eat into the water in the tariff, there is,however, some potential contingent benefit in terms of making markets more open as coun-tries have less leeway to increase their future applied tariffs.

Some idea of the extent of this water in the tariff at the end of the implementation periodfor developed countries (around the year 2000) in the present WTO Agreement on Agriculturecan be gained from table 1 that is drawn from Podbury and Roberts (2003). This table coverswheat, rice, coarse grains, sugar, beef, dairy products, palm oil, soybean oil and soybeans.Overall, the study from which the table is drawn involved 106 observations for importingcountries that constitute the world’s largest importers and potential importers of these prod-ucts. The table shows the calculated percentages of unused water for groups of bound tariffs.For example, for products with bound tariffs that are within the range of 15 per cent to 30per cent, the average amount of unused water in the tariffs was calculated to be 50 per cent.The analysis showed very high average levels of water in the tariff over all ranges, withlevels being particularly high where the bound rates are between 150 per cent and 300 percent.

For all of the ranges of bound tariffs shown in table1, the average amount of water in the tariffexceeded the average cut to bound tariffs in theUruguay Round for developed countries of 36 percent. For medium to high and for extreme tariffs,the average amount of water in the tariff wasaround 50 per cent, whereas for relatively hightariffs (in the range of 150–300 per cent) it was 75per cent.

It was found from the analysis that an across theboard tariff reduction in bound tariffs of 36 percent, the average for the Uruguay Round, would

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1 Average ‘water’ in agriculturaltariffs

Average waterin the tariff

%Bound tariff range0–15 per cent 3715–30 per cent 5030–60 per cent 4860–150 per cent 48150–300 per cent 75300 per cent + 54

Source: Podbury and Roberts (2003º.

reduce average effective protection by only 8 per cent, with 70 per cent of the observationsnot being affected by the cuts at all. If the average cut to bound tariffs were reduced to 20per cent, the actual average cut in effective protection would be only 4 per cent. Clearly,large reductions from existing bound tariffs will need to be negotiated this time around ifmore than token gains in market access are to result.

While the extent of water in bound tariffs greatly reduces the extent to which given percent-age cuts or formula based cuts can be made to actual levels of protection, it is less of anobstacle for some commodities than for others. Podbury and Roberts (2003) concluded thatmore scope exists for reducing protection for butter, cheese and beef than for the other agri-cultural products considered. Sugar and rice have high levels of protection but also highlevels of water in their tariffs. Consequently, large cuts are necessary to advance trade signif-icantly, but there is a potential for substantial gains in trade if sufficiently large reductionscan be agreed. For coarse grains, soybeans, soy oil, milk powders and to a lesser extent alsowheat and palm oil, the amount of water in the tariff is very large relative to effective protec-tion levels. This means that there is limited scope for further opening markets through reduc-tions in bound tariffs.

The extent of water in agricultural tariffs represents a major disappointment from the UruguayRound negotiations. The idea in tariffication was to convert actual nontariff barriers as atthe commencement of the round into tariff equivalents that could be bound in the WTO andnegotiated down.

How then did the final outcome result in so much water in agricultural tariffs? One reasonis that many bound tariffs were in place at the commencement of the round and they alreadycontained substantial amounts of unused capacity or water. Another was the practice agreedfor developing countries whereby they were allowed to nominate ‘ceiling bindings’.Developing countries were given the flexibility to offer ceiling bindings on products that didnot have bound tariffs (Young 1994). These ceiling bindings could be higher than theSeptember 1986 applied tariffs, and some developing countries nominated ceiling bindingsthat were extremely high and well in excess of their applied tariffs.

Also, there were problems of representativeness with the process of tariffication. The tariffequivalents of nontariff barriers were determined from the difference between external andinternal prices in the base period 1986–88. However, that was a period of abnormally lowworld market prices and high price support. Additionally, members had a substantial degreeof latitude in determining basing points and ‘representative’ qualities for internal and exter-nal price quotations. These various factors gave members substantial freedom to build paddinginto their tariffs and were labeled ‘dirty tariffication’ by Ingco (1994). They contributed tothe substantial water that has been built into bound tariffs. In addition, a special loading wasallowed in EU tariffs for ‘Community preference’, further building water into tariffs for thatlarge entity (Agra Europe 1993).

As explained in the previous section and in box 1, a substantial part of the water in the tarifffor some commodities in some countries has arisen through the substitution of domesticsupport via direct exempt domestic support payments, for price support. This was the case,for example, with cereals and beef in the European Union. To the extent that the practice of

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substituting exempt domestic support payments for market price support is abetted in thepresent WTO agreement, it will create additional water in the tariff. As a result, even largercuts in bound rates will be necessary if they are to have any impact in opening marketsfurther. In a sense, the increased difficulty in obtaining extra access to these markets becauseof the additional water created in the tariff is part of the ‘price’ being paid by potential supply-ing countries for the change away from market price support toward less market distortingforms of domestic support.

Finally, and importantly, a number of countries have unilaterally set their applied tariffs atlevels well below their bound rates. This represents voluntary trade liberalisation, with theeconomic benefits that it brings. In some instances, these countries may wish to maintaintheir bound tariff levels to meet contingencies such as to enable them to increase tariffstemporarily to restrain a surge in import competition.

Clearly, it will require large cuts to bound tariffs for most products if meaningful increasesin market access are to flow from cuts agreed in the present negotiations.

Tariff quotasAs well as reductions in tariffs, expansion of tariff quotas provides opportunities for increas-ing market access under the present WTO Agreement on Agriculture. Minimum and currentaccess commitments were to be met through members applying tariff quotas whereby reducedtariffs applied for imports up to a specified quantity. They could then charge their generaltariff, with its upper limit being the bound rate for imports beyond the quota quantity.

One important consideration with tariff quotas is that they represent commitments to allowaccess to the market for up to the specified tariff quota quantities. They do not usually repre-sent a commitment to actually import the full tariff quota quantities — just to allow accessat the within tariff quota tariff. One characteristic of tariff quotas has been that the degreesto which the tariff quota quantities have been filled has varied widely depending on a widerange of contributing factors. Sometimes, administrative arrangements have limited orprevented imports. Sometimes, the within quota tariffs have been too high to enable quotasto be filled. In other instances there has been insufficient import demand or exportable suppliesto fill the quotas. However, substantial numbers of tariff quotas have been filled. Whethertrade can be expanded much further via tariff quotas depends on the limiting factors in eachinstance. The avenues for trade expansion include increasing tariff quota quantities, reduc-ing within quota tariffs and improving administrative arrangements. To overcome particu-lar limiting factors and expand imports under tariff quotas, it is important that those particularfactors are addressed. It is all very well, for example, to expand tariff quota volumes. However,if current tariff quotas are not being filled as a result of a relatively high within quota tariffsor because of overrestrictive administrative arrangements, the expansion of tariff quotavolumes will be a useless exercise. It would require reductions of within quota tariffs or lessrestrictive administrative arrangements.

Tariff quotas provide a means to lever otherwise closed or relatively closed markets opensomewhat. However, they can also be used by countries that wish to manage their markets,to restrict import competition and to maintain internal supported prices. Tariff quotas are a

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market management tool and can, within limits, advance benefits from trade. They are nota substitute for reduced general tariffs that allow trade to flow. However, where little, if anyreal opening of markets can be achieved through reductions that could be agreed in boundtariffs, tariff quota expansion is at least an avenue for achieving increases in market accessor, at the very least, to prevent reductions in access.

In terms of economic effects, the proof of whether tariff quotas are effective in reducingmarket distortions rests on whether any resultant expansion in imports is reflected in inter-nal market prices to consumers and/or producers that are closer to world market prices. Iflarger quantities of products enter the market via tariff quotas but other arrangements suchas domestic subsidies or export subsidies prevent any change in production, internal pricesand consumption, the larger imports will be accompanied by a similar increase in exportablesupplies. World trade and market prices would not be less distorted as a result of the‘improved’ market access. Because of this, increases in access through tariff quotas aloneneed to be accompanied by reductions in market distorting domestic support and/or reduc-tions in export subsidies if reductions in market distortions are to be assured.

Domestic supportDomestic support is probably the weakest of the three pillars in terms of arrangements thatensure reduced market distortions. However, that observation needs to be tempered if WTOprovisions encourage a change in forms of support away from highly market distortingmeasures into measures that are less market distorting. Such encouragement has, in fact, beenoccurring in some countries, especially the European Union and the United States, althoughthe degree to which the changed measures are less market distorting is far from clear.

In particular, the domestic support rules encourage countries to channel their support awayfrom price support that is underpinned by market access restrictions and export subsidies,and into support through production limiting arrangements, decoupled income supportpayments and other payments not directly related to production or prices. The success orfailure of the present WTO Agreement on Agriculture hinges largely on whether thesechanges have in fact been reducing the market distortions flowing from agricultural assis-tance in large high-support agricultural producing countries including the European Unionand the United States.

The main domestic support provisions in the agreement involve:

■ a wide range of support arrangements designated as exempt under production limitingarrangements and measures that are designated as minimally market distorting;

■ commitments to reduce market distorting support for agriculture as a whole, as measuredby the Aggregate Measurement of Support (AMS), and not for individual commodities;and

■ an AMS that provides a very poor and potentially malleable indicator of the actual levelof market distorting support, particularly in its treatment of price support, the mainconstituent of this support for many countries.

All three of these elements have been important in the overall structure of the WTOAgreement on Agriculture.

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domestic supportMany exemptions available under domestic supportThe extensive range of exemptions has provided countries that had high levels of pricesupport underpinned by barriers to market access and export subsidies (see the hypotheti-cal example in chapter 2) to rechannel such support into exempt domestic support. That hasbeen the case extensively for the European Union which has reoriented much of its pricesupport and a large part of its export subsidies for cereals and to a lesser extent for beef, intosupport under production limiting arrangements (blue box exemptions). It has also enabledthe United States to divert its export subsidies for cereals into what it considers to be decou-pled minimally distorting support (green box exemptions).

The inclusion of the extensive green and blue box exemptions in the agreement and the wideuse of these exemptions by the largest two agricultural exporters, the European Union andthe United States, effectively represents an acceptance and adoption of a ‘second best’approach to agricultural and trade reform. The most direct and only certain way to achievesubstantial reductions in market distortions is to reduce levels of market barriers and govern-ment subsidies.

However, if that cannot be done because of political pressures, a second best approach is tocontinue to provide support, but in ways that are less market distorting. The most importantwords in the previous sentence are ‘are less market distorting’, not just indicated in the provi-sions of the agreement to be production limiting or minimally market distorting. Many ofthe support payments that may be categorised within the green box as minimally marketdistorting are demonstrably significantly market distorting. Take, for example, regional subsi-dies that enable agricultural activities to be pursued north of the arctic circle or in deserts.Without the support, production in such areas would be minimal, but with it, productioncould be appreciable. The same kinds of observations, whereby production can be increasedbecause exempt payments can be made with investment aids and also, as discussed else-where in this report, with payments that are deemed to be decoupled, but are applied in waysthat provide incentives to produce more.

The idea of exempting production limiting arrangements like area reduction programs mightseem superficially reasonable given that countries using them are attempting to reduce thedistortions that their support policies have on markets. However, if the extent of support andthe associated market distortions were large, as is the case where countries have had highlevels of continuous price support over decades, the mere application of some restrainingmeasures to attenuate part of the distortions might limit the production distortions only

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partially. Production could remain far higher even after application of the measures than ifthe high and continuous support had not been applied in the first place.

Furthermore, the potential of countries to vary levels of area reduction programs means thatfarmers are likely to ensure that they have sufficient capacity to maximise their productionwhen area reduction percentages are set at minimum levels. This issue about productioncapacity assumes further importance given the potential of countries to switch support struc-tures away from blue box production limiting arrangements to green box decoupled arrange-ments as is discussed below in the context of such a change by the United States.

Similarly to production limiting blue box exempt arrangements, the idea of exempting decou-pled green box income support arrangements would be entirely reasonable if such paymentswere in fact actually minimally market distorting. It is possible, in principle, to design suchdecoupled support arrangements that should not have large distorting effects on markets,prices and trade. However, it is much more difficult, in fact, in the political climate underwhich such support arrangements are developed, to ensure that such arrangements are infact either properly decoupled or minimally market distorting (see section below on decou-pling and distortions).

Given the levels of water in the tariffs after the Uruguay Round, and the substitution ofexempt domestic support for export subsidies, it can be argued that the main policy changearising from that round was the second best substitution of less distorting forms of supportfor more highly distorting forms. The key questions concerning whether this change hasreally represented much progress toward less distorted markets are:

■ whether the exempt forms of support adopted have, in practice, been much less distort-ing than what they replaced; and

■ whether support levels have declined much as a result of the agreement.

Whether support levels have declined as a result of the agreement depends on the initial orbase level against which recent support is compared. Average support in OECD countriesfor 1999–2001, as measured by the producer support estimate (PSE) was 33 per cent of thesupported value of production, compared with 38 per cent for 1986–88, the base period formany elements of the Uruguay Round agreement (OECD 2002). That is, there was a smallreduction in support from its 1986–88 levels. But 1986–88 was not a time of representativeagricultural support — far from it. It was a time when agricultural support was at its high-est for at least half a century. That is, any reductions from the agreement were from recordlevels and support remained high by any historical benchmark.

After some reduction in the mid-1990s, when world market prices for agricultural productswere relatively high, support in the developed countries rose in the late 1990s to levels compa-rable with those in the base period (OECD 2002 and previous). Furthermore developments,like the highly protectionist 2002 US farm bill and the extension of the European UnionsCommon Agricultural Policy to previously lower support acceding central and easternEuropean countries, are likely to maintain high levels of agricultural protection. It is clear,however, that levels of support that are deemed in the agreement to be market distorting have

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declined from their peak levels in the mid-1980s — because of substitution of exempt formsof exempt blue and green box support for export subsidies and price support.

Exemptions and the European UnionThe exempt forms of support applied for arable crops (cereals, oilseeds and protein crops)by the European Union since the MacSharry reforms in 1992 would have been less marketdistorting than if the open ended price support provided before that time had been extendedat previous levels. The change involved a marked reduction in internal support prices thatwas compensated for by direct payments. The arrangements have been accompanied by areaset-asides. As well as lower internal prices, the change has resulted in increased levels ofinternal consumption of these products and a levelling off of what had previously been arising trend in subsidised EU export surpluses. The consumption increase for domesticallyproduced cereals has been relatively large, reflecting both the lower prices and the greatercompetitiveness of domestic cereals relative to imported feed inputs such as manioc andcorn gluten that were used in compounded cereal substitute feeds.

The change from open ended price support to lower support prices and compensationpayments appears to have been less effective in combating support induced productionincreases. EU production of cereals in particular has continued to increase despite very largereductions in internal prices since 1992. For example, EU-15 wheat production rose froman average of 85 million tonnes for the period 1990–92 to an average of 100 million tonnesfor 2000–02. At the same time (average for 2000–01), internal market prices fell by 30 percent in nominal terms and 45 per cent in real terms.

Although some of the production increase can be attributed to productivity growth, somewould have resulted from areas being locked in via incentives in the compensation paymentsthat are made on areas actually planted. There is partial decoupling in the compensationarrangements, with payment bases for yields being held constant at pre-1992 levels.Nevertheless the continuing upward march of production suggests that the maintenance ofsupport levels, as opposed to price support, has locked in the substantial production capac-ity resulting from decades of high open-ended support. The growth would have been atten-uated somewhat by the area reduction programs that appear to have been about 50 per centeffective. That is, a 10 per cent program results in about a 5 per cent cut in production fromwhat it would have been without the set-asides. Given the rising trend in production, areareduction programs have acted to slow the growth in production rather than to reduce produc-tion.

Overall, the reduced consumption distortion from these reforms, along with the area reduc-tion programs have been important in restraining EU cereal surpluses, enabling directlysubsidised exports to be managed within the WTO limits on export subsidies. Neverthelessthe incentives inherent in the direct payments appear to be sustaining a large part of the EUproduction distortions.

For EU cattle, the headage payments that are exempted under ‘production limiting’ arrange-ments appear to be anything but production limiting. The number of animals eligible for thebovine males program is not limited to numbers on farms prior to the payments being

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instituted in 1992. Where numbers of animals were below the maximum that could be claimedper farm, farmers have had an incentive to expand their stock of animals held up to the limitson which payments are made, and breeders have an incentive to meet the demand createdby that incentive. As such, the incentives in the program have been to encourage expansionof animal numbers initially and then to lock production in at around the levels that are consis-tent with the maximum number of animals that is eligible for payments. Those numbersreflect the very high levels of support for several decades as well as the incentives inherentin the headage payments.

Exemptions and US agricultural supportSince 1996, US support arrangements for the major farm program crops, wheat, feed grains,rice, cotton and now also soybeans, have been heavily oriented toward WTO exempt measuresthat enable high and increasing levels of support to be provided free of any limitations. Atthe same time, the United States has been providing some forms of domestic support thatare clearly market distorting and it appears likely that it will be necessary for it to use mostof its permitted present AMS entitlements in some future years.

In the 2002 US farm bill, provision was made for arrangements that would maintain USagricultural support in most years at around levels that had been much higher since 1998than in any previous period, at least in nominal terms. The only period when US supportwas comparable with those high levels was the mid-1980s, at around the time when the baselevels were determined for the WTO Agreement on Agriculture.

The situation regarding the market distorting properties of US farm program support is prob-ably best considered in the context of measures in the 2002 farm bill. Support for farmprogram crops under the bill takes three main forms:

■ fixed direct payments

■ countercyclical payments

■ loan deficiency payments.

The fixed direct payments would be the most decoupled of these payments, as they do notvary with farmers’ production levels or the prices they receive. These payments are deter-mined at fixed rates per bushel or other production units and paid on past commodity specificfarm program area bases and past program yields. Farmers do not need to plant anything toreceive these payments, and they can plant any crops other than fruit and vegetables, andstill receive the payments on their original commodity bases.

Even though these payments are the most decoupled of the three forms of support mentioned,the actual degree to which they have been decoupled has been markedly eroded by an optionin the 2002 farm bill that permits farmers to update their area bases from bases that weredetermined before the 1996 farm bill, to average levels from 1998 to 2001.

The countercyclical payments are structured so that when world market prices fall, theyincrease and when world prices increase, they decline. That is, they are related to worldmarket prices. One of the fundamental criteria for exemption of payments under the WTO

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Agreement on Agriculture on grounds of decoupling is that payments must not be relatedto internal or external prices (para. 6 Annex 2 to the WTO Agreement on Agriculture).

However, the structuring of these payments might raise doubts about whether the paymentsare related to market prices. This is because under the arrangements for US farm programsupport since 1996, farmers have been able to claim support payments determined from theirpreviously established bases for a particular commodity, even if they subsequently producedother commodities. It is not clear yet under which category the United States would try tonotify these countercyclical payments in their notifications of domestic support to the WTO.However, their clear links to prices would suggest that they could not be considered decou-pled. The nearest precedent would be the categorisation of the crop market loss assistancepayments under the 1998 and 1999 emergency packages as de minimis exempt non commod-ity specific support. Whether or not they are included in future US AMS levels would havea large influence on whether the agreed US AMS limit might be breached.

Decoupling and distortionsThe idea of considering certain forms of payments to be decoupled rests on the ability ofgovernments to provide support in ways that are in no way related to production, prices orinput use. Because support is not related to production, prices or input use, it is contendedthat it does not affect the key market variables including production, consumption, trade andprices and does not distort trade. That is, production and trade would be much the same asif no support were provided. Essentially, if farmers received support only through thesepayments, they would respond in their production decisions only to world market prices, asthey would if no support were provided. That is, the support would be minimally marketdistorting.

However, the links between support payments and production are often unclear. This is espe-cially the case when there has been an established system delivering high support for manyyears, as has applied for decades in both the United States and the European Union. Thatsupport will have been responsible for higher investment and capital stocks in the supportedindustries than otherwise (Roberts et al. 1999). That investment extends beyond on-farmprivate investment and can include larger transport and storage infrastructure and produc-tion-influencing public utilities such as public water storage and channeling and also researchand development of varieties and production methods that can stimulate output.

Expenditures on those capital stocks and other items represent sunk cost, meaning that ifsupport is subsequently removed or replaced by payments that are deemed to be decoupled,that capital will continue to be used and to influence production for a considerable time. Thelegacy is likely to be higher production for a considerable period. If, in the period after thechange, farmers had reason to believe that they could update the bases on which their ‘decou-pled’ payments were made, to obtain larger future payments, the support arrangements wouldcontinue to encourage production. Or if farmers believed that they would lose future paymententitlements if they reduced plantings or production, they would have reason not to reduceplantings or production, even if market prices fell greatly. Under such conditions, the paymentswould not be properly decoupled. Also, there are income and wealth effects from the

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payments that would increase investment and production (Hennessey 1998; Tielu and Roberts1998).

In US farm programs, issues concerning adjustment or nonadjustment of farm bases aredebated, and usually changed in each farm bill — that is, every five years or so. Consequentlythere are strong grounds for expectations by farmers that if they increase their plantingsand/or yields now, they will receive larger future payments. The updating of bases in the2002 farm bill would have fueled those expectations. In that bill, growers were given theoption to update their area bases for both countercyclical payments and ‘decoupled’ fixedpayments from pre-1996 levels to the average for 1998–2001. They were also enabled toupdate their yield bases for countercyclical payments.

The ability to update bases means that the payments could not be considered to be properlydecoupled, and also not minimally market distorting. Nevertheless they would be less marketdistorting than the same amount of open-ended direct price support — as would also havebeen the case before 1996 when the production increasing effects of support payments werelimited through the use of compulsory acreage reduction programs.

The uncertainties surrounding the contention that decoupled payments are minimally marketdistorting and can therefore be used without limit and still not distort markets weaken theconfidence that many WTO members can have in the exemption arrangements that form akey part of the present domestic support rules. If such payments are genuinely minimallydistorting irrespective of their size, the issue might be of little concern. However, that hasnot been the case so far with the way the payments are being applied in the United States,the only member that has widely claimed many of its support arrangements to be decou-pled.

The expectations that bases can be changed in future arise largely from systems of policydevelopment that apply in the United States and elsewhere, and the influence that farm groupscan have on support outcomes. If farmers believe that they can exert influence politically toincrease future support bases and levels by planting more now, they are likely to increasetheir plantings now in response to the expected future benefits. Or if they believe that couldlose present government benefits if they plant less now, they will maintain plantings. Theirlikely responses to expectations of future support are spelled out by Tangermann (2003,p.13) in the following terms:

‘The growing use of decoupled support measures in OECD countries should limit thetendency for marginal increases in support to add to the already large distortions in worldmarkets. However, unflinching farm support has provided farmers with an incentive tomake sure that planted area (or the number of livestock) does not fall. If the rules changefrom one year to the next, yet support is nevertheless fundamentally guaranteed, farm-ers will be reluctant to take steps that could ultimately deprive them of support. Henceproduction in those OECD countries with high support has not adjusted downwards assupport has shifted to more decoupled measures, and recent reforms are unlikely toreverse the accumulated impacts that decades of support have had on producers’ incen-tives. The key point is that while a reorientation of support is itself significant, the effectsare stronger if there is also a reduction in the overall level of support.’

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In both the United States and the European Union, the main countries that have been chang-ing their farm support increasingly to WTO exempt arrangements, production of the supporteditems appears to have responded little to the changeover from price support. Aggregate USplantings of wheat, feed grains and soybeans have hardly changed since the mid-1990s,despite very large changes in real prices while EU production of cereals has continued itsrelentless increases. The actuality conforms to Tangermann’s observation that productionhas not adjusted downward as support has shifted toward more decoupled measures. Thatis, under these circumstances, the so-called decoupled payments have not been minimallymarket distorting. Rather, they are locking in the often large market distortions from accu-mulated former clearly market distorting support (figures A and B).

The uncertainties involved with decisionmaking now in response to expected futureprogram benefits pose difficult problemsfor those trying to model or measure theeffects of imperfectly decoupled arrange-ments such as those in the US farm bill. Atone end of the spectrum, analysts mightclaim that as long as the arrangements werenotified to and accepted by the WTOmembership as decoupled, the paymentswould not influence production or worldmarket prices. This legalistic interpretationwould probably be challengable becauseof the provision that for payments to bedecoupled, base periods must be fixed —not able to be updated. This has clearly notbeen the outcome under US conditions.

At the other end of the spectrum, it mightbe claimed that the structuring of supportin these ways was merely to obtain exemp-tions from WTO domestic support disci-plines and the support would be similarlydistorting to coupled production support.Neither of these extreme positions is likelyto fully reflect the actual situation.

Sumner (2002) suggested an approach forindicating the kinds of production distor-tions that could result from farmers’ expec-tations of base changes for such payments.Note that this would address only the issueof base changes, and not the income andwealth effects that could increase produc-tion also. His suggested approach is todetermine the net present value to farmers

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A US cereals In 2001 US dollars

1990 1992 1994 1996 1998 2000

Support through direct payments (US$/tonne produced) a

Farmgate price (US$/tonne )

Production (index)

0

25

50

75

100

125

B EU cereals In 2001 euros

1990 1992 1994 1996 1998 2000

Support through direct payments (euro/tonne produced) a

Farmgate price (euro/tonne )

Production (index)

0

50

100

150

200

a Direct support includes deficiency payments up to 1995 andpayments made on historical bases from 1996 (productionflexibility contract payments and crop market loss assistancepayments from 1998). The payments from 1996 areindependent of production but are expressed here per tonneproduced to give an idea of relative magnitudes.Data sources: OECD PSE database (production and prices),FAOstat database (area).

a Direct support mainly consists of payments based onplanted area and are independent of yields. They are thereforeonly partly decoupled.Data sources: OECD PSE database (production and prices),FAOstat database (area).

of the expectation that future updating of support bases would occur and that payment rateswould be updated. Farmers would then respond to those expectations in their current produc-tion decisions. He provided an illustrative example in which he estimated the extent to whichexpected base adjustment might influence production relative to production incentives tieddirectly to current production. To do this he used a discount return rate of 10 per cent a yearover five years, and subjective assessments of probabilities that US farm programs wouldstill exist, the probability that updating of bases would occur and expectations of supportpay rates being changed from current rates.

Using this method he estimated that the likelihood of base adjustment could result in aproduction incentive of 27 per cent of those from payments tied directly to current produc-tion. He acknowledged the subjectivity inherent in assessing the probabilities.

It would appear that a discount rate of 10 per cent would be excessive, especially at a timewhen official US interest rates are below 2 per cent, as they currently are. Using lowerdiscount rates and still credible subjective probabilities for the other elements consideredcould give estimates of the production responsiveness effects of base adjustment being almost50 per cent of those from payments tied directly to current production.

What all this means is that the direct payments would still have a substantial boosting effecton production, or at least a large effect in preventing downward adjustment of production.However, they should be markedly less market distorting than direct production or pricerelated support. The countercyclical payments maintain direct links to market prices andwould be more distorting, at least for the overall group of farm program products. In addi-tion, the income and wealth effects of the payments on investment and production wouldfurther increase or lock-in production, thereby depressing world prices.

The other major element of farm program support in the 2002 US farm bill — loan defi-ciency payments — is clearly market distorting and is acknowledged as such. These arepayments that cover the difference between a minimum US domestic support price, the loanrate, and world market prices when world prices are below the loan rate. By covering thisdifference, such payments directly encourage US production and further depress worldmarket prices. These payments are currently included as distorting support under the AMS.

It is not really possible to appraise clearly whether US support for its farm program cropsis now more or less market distorting than applied before the Uruguay Round was concludedin 1994. Until 1996, the farm programs operated on a combination of clearly production-encouraging deficiency payments, loan rates and loan deficiency or marketing loan payments,along with acreage reduction programs that usually ranged between about 5 per cent and 25per cent of farmers’ area bases. The acreage reduction programs ameliorated the productionencouraging effects of the loan rates and deficiency payments.

The loan rates and loan deficiency payments have continued to apply. However, since 1996,the acreage reduction programs have been discontinued, removing their limitations on distor-tions arising from the wide range of support measures employed. The previous clearly distort-ing deficiency payments have been replaced by somewhat less distorting, but still appreciablydistorting, direct and counter cyclical payments. So there has been some qualitative change

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in the form of support payments in a way that might make them somewhat less productionstimulating than the former deficiency payments. However, the effects of this qualitativechange would probably have been at least counteracted by the discontinuation of the acreagereduction programs.

Summary of effects of exemptions under production limiting arrangementsand under decoupling criteria in the European Union and United StatesThe production limiting arrangements so far applied by the European Union appear to havebeen significantly less market distorting than if the same amount of support had continuedto be provided using the open ended, clearly market distorting full price support that appliedbefore 1992. They have represented a policy reform that has enabled the European Unionto manage its surpluses and contain its subsidised exports within the limits under the UruguayRound agreement. However, the support system remains production distorting. The waterbuilt into the European Union’s bound import tariffs as a result of the change toward lowerinternal prices and direct producer payments, now makes it more difficult to negotiate actualcuts in barriers to market access and to open the market to greater import competition.

The change toward partially decoupled support arrangements for farm program crops in theUnited States should result in less production distortion than open ended price support ofthe same incidence. However, all of the forms of support are being applied in ways that arestill distorting. The incidence of payments has increased greatly since 1998 when the firstof the four annual emergency support programs was applied and the higher levels have beenlocked in by the 2002 farm bill. Furthermore, the change in the form of payments has beenimplemented along with elimination of acreage reduction programs that previously restrainedthe distortions from farm program crop support. The combination of assured high supportthat is countercyclical to price movements and lack of acreage reduction programs appearsto be a recipe for maintaining high levels of market distortion.

Domestic support limitation for agriculture in totalThe agreed cuts and limits in the AMS for domestic support under the present WTOAgreement on Agriculture are for agriculture in aggregate, not for individual commodities.This means that reductions that may be made to the AMS for individual commodities can,along with the aggregate limits faced by members, enable them to increase nonexempt formsof domestic support to other commodities. Therefore members have much more flexibilityto increase levels of protection for ‘sensitive’ commodities than if the disciplines werecommodity specific.

Another weakness from the aggregation of AMS support has become evident from the abil-ity of members to redefine their support parameters so as to virtually eliminate price supportfor particular products. As will be indicated in the following section, this has been done forrice by Japan. Because the AMS is aggregated and countries can, under some conditions,radically reduce specific commodity AMS levels through definitional changes that have noactual effect on market distortions, scope can be opened up to increase market distortingforms of domestic support for other commodities.

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Defining and limiting market distorting domestic support (the AMS)The scope of what is considered to be domestic support and how it is defined for the purposesof reducing market distortions is one of the main elements of the WTO Agreement onAgriculture.

Three issues are of particular importance when considering the treatment of market distort-ing domestic support in the agreement. They are:

■ the inclusion of price support as an element, for many members the largest single element,of domestic support, when most price support is usually provided through market accesslimitations and export subsidies;

■ the way the AMS is defined and the ability of members to ‘define away’ their AMScommitments; and

■ the potential for countries to structure their support in ways that are exempt from domes-tic support disciplines while, in fact being market distorting.

Inclusion of price support in domestic supportThe basic questions can be asked, ‘what constitutes domestic support and how different isit from support provided through limitations on market access and export subsidies’. Theanswer to this question is that, in effect, all agricultural support is domestic support. Theobjective in the support is to assist domestic producers. The main differences between whetherthe support is provided by price support or subsidies from governments is in which groupsin society pay to provide the support. If the means of assistance is price support, the fund-ing group will be domestic consumers and, if an element of export subsidy is involved,domestic taxpayers as well. If it is domestic subsidies, the cost falls on taxpayers. But in allinstances it is domestic support paid from domestic sources to domestic producers.

The categorisation of support methods in the WTO Agreement on Agriculture into threecategories involving market access, domestic support and export subsidies is highly artifi-cial, especially where price support is involved. That is because, in most instances, domes-tic support through price support depends for its effectiveness on market access limitationsand/or export subsidies.

It may be considered that by dividing support up into market access, domestic support andexport subsidies and treating each separately, it should only be necessary to include domes-tic subsidies and price support that is not underpinned by market access limitations and/orexport subsidies, in the category of domestic support. Under this interpretation, price supportshould be adequately covered by the negotiations on market access and export subsidy pillars.

However, the realities in the WTO system for agriculture could greatly inhibit progresstoward less distorted trade if price support that is underpinned by market access limitationsand/or export subsidies were excluded from domestic support. It is possible to negotiatelarge reductions in bound tariffs without advancing import demand at all because of the copi-ous water in most agricultural tariffs. Also, export subsidies can be reduced, but replacedby much increased levels of domestic support that are structured in ways to make them

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exempt. And much of the support that has been exempted from cuts or limitations on groundsof being production limiting or decoupled is neither, although it would be less distortingthan the same amount of open ended price support.

Because of these weaknesses, there is a case to have a measurement of support under at leastone of the pillars that provides a good indicator of actual total levels of market distortingsupport. Only if that measurement of support is reduced can it be considered with confi-dence that overall levels of market distorting support have been reduced.

Ability to define away large parts of the present AMSWithin the structure of the present WTO Agreement on Agriculture, the AMS might beconsidered to fill this role of an indicator of actual market distorting support. In concept,having an AMS that included both price support and market distorting domestic subsidiesshould provide an indicator of actual levels of market distorting support that should be subjectto agreed reductions. If, because of water in the tariff and other factors, there was little ifany reduction in market price support that was underpinned by market access limitations,that lack of success should show up in the measure of actual market price support and in theAggregate Measurement of Support. In a strong agreement, action would then be needed toaddress the weakness of the market access disciplines or other measures, either throughproviding greater access to imports or reducing market distorting subsidies. However, suchan eventuality has so far been prevented because of the way the AMS is defined.

In the present agreement, price support within domestic support for particular commoditiesis defined as the administered support price minus a constant external reference price, set atthe average for the base period 1986–88, multiplied by the quantity eligible for support. Theindividually calculated commodity specific AMS levels are not subject to limitations. Theyare aggregated, with the totals subject to cuts and limits.

Such arrangements have many weaknesses and inconsistencies if it is to be considered thatthe AMS should credibly measure the actual level of distorting support:

■ The AMS is an aggregated, across agriculture measurement that does not capture econom-ically costly disparities in support between individual commodities.

■ Under the AMS, the price support element for individual commodities depends on theexistence of administered support prices. Such official or formalised prices are not neces-sary to provide a desired level of support or protection — that can be done via tariffprotection and/or export subsidies. In fact, Japan claimed in its 1998 WTO notification,that it no longer used an administered support price for rice, thereby reducing its aggre-gate AMS from 3171 billion yen to 766 billion yen (WTO 2000, 2001a,b). At the sametime, it did not reduce its actual support for rice at all, the internal support being under-pinned by tariff quota and tariff arrangements. This huge reduction in aggregate AMSgives Japan the ability to provide extreme levels of nonexempt domestic support forother commodities if it wishes, making its AMS commitments under the Uruguay Roundvirtually meaningless.

■ The applied administered support prices that are used have differing functions in differ-ent industries and in different countries. Some are targets for actual market prices. Some

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are minimum prices to place a floor under producers’ returns as applies for US milk.Some are just guides for market prices, with a view to managing actual market prices ataround various adjustable percentages of the guide price. Because of these differences,the administered support prices do not even provide a good indicator of support prices.

■ The constant external reference price is not representative of actual external prices atany time other than in the base period.

■ There are ambiguities in interpretation of what is meant by the quantity eligible forsupport that is used in calculating commodity specific AMS levels. Some countries inter-pret the relevant quantities as only the amounts purchased into intervention by govern-ment agencies or which are indicated to be eligible for support under national legislation.Others interpret the quantity eligible for support as total production where interventionunderscores the entire internal price structure.

■ Finally, as indicated above, there are reasons to believe that some of the major forms ofsupport that are exempted from the AMS under both the blue and green boxes are beingapplied in ways that are in fact market distorting, though less so than open ended pricesupport. This is another reason why the AMS does not measure actual levels of marketdistorting support.

Domestic support has become the growth area for agricultural assistance, especially in devel-oped countries. This appears to have arisen because of a combination of these definitionalweaknesses, the degree of tolerance provided in allowing exemptions of many forms ofgovernment payments from the AMS, and the degree of success in the Uruguay Round inreducing permitted subsidised exports — as well as a strong, ongoing demand for protec-tion.

Improving the AMSIf a true AMS could be constructed on a commodity specific basis, measuring actual levelsof market distorting support, it would provide the true test for success of the agreement inreducing distorting protection. If AMS levels exceeded agreed commitments of declininglevels of market distorting support, it would mean that inadequate steps had been taken inmaking markets more open, in reducing export subsidies, in reducing market distorting subsi-dies, or a combination of these. In such a role, the AMS would act as an indicator of crosscompliance of the measures in the various pillars that could be used to trigger additionalmeasures to bring the member into compliance.

It is easy to be critical of the present AMS because of its inadequacies as a measurement ofactual market distorting support. However, it is more difficult to construct a true measure-ment of support that would be acceptable to the WTO membership. Part of the reason liesin technical difficulties in identifying representative internal and external prices for someitems in some countries. Also, there would be reluctance by some members to make commit-ments to reduce their AMS levels for future years given that they could not control externalmarket prices — people are reluctant to make commitments that they fear they might not beable to keep, even if they try. But in some instances, the reason why members would bereluctant to accept a real AMS is that they prefer the present malleable AMS arrangements

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that enable them to maintain or even increase actual protection for ‘sensitive’ commoditieswhile at the same time technically meeting their commitments to reduce protection.

Structuring support to maximise exemptionsMany countries have complex industry support arrangements that incorporate a mix ofmeasures, some of which may be considered to be market distorting within the present defi-nition of the AMS and some of which may be considered to be exempt under de minimisprovisions or under the blue or green boxes. The approach in the WTO Agreement onAgriculture has been to attribute particular characteristics to particular forms of support,with some being considered market distorting and nonexempt and others being less or mini-mally distorting and exempt.

By structuring only part of support for particular items to be nonexempt, maximum use canbe made of the nonexempt AMS allowance for the country. For example, AMS support canbe concentrated increasingly in a few ‘sensitive’ commodities, thereby taking maximumadvantage of the aggregated nature of the present limits on AMS support. Additional supportcan then be structured in ways that meet, or are construed to meet, the criteria for exemp-tion. Some can be commodity specific distorting support that can be exempted under the deminimis allowance. Some can be non commodity specific distorting support that can also beexempt under de minimis. Some could be blue box exempt and some green box exempt.

If part of the support for a commodity is deemed decoupled and thereby minimally marketdistorting and exempt under these conditions, it becomes almost a contradiction of terms,as it becomes part of a system of support that is obviously market distorting. However, thatdecoupled part of the support that is not linked to production, prices or inputs is considerednot to contribute to the distortions.

US farm program arrangements provide an example of using multiple forms of support,some of which are within the AMS and some of which are exempt. As US support forprogram crops is structured under the 2002 farm bill, there is a base level of payments thatis deemed decoupled along with countercyclical payments and loan deficiency paymentsthat are distorting. So aggregate payments move countercyclically in a distorting manner,but the constant base decoupled element is considered not to contribute to the distortionsand is exempt. Clearly, total payments under such conditions would be distorting and theso-called decoupled part would contribute to the distortions. This is apart from the fact thatUS farmers have had the option to update their area bases for the so-called decoupled directpayments, which runs counter to the decoupling provision in the WTO Agreement onAgriculture that bases should be fixed.

The de minimis exemption rules in particular can be manipulated to provide high levels ofexemptions for what is clearly market distorting support. The exemptions for de minimissupport apparently exist to provide members with a ‘cushion’ of a small degree of distort-ing support without it being subjected to limitation or reduction. Distorting support can beprovided to individual commodities taking care not to exceed de minimis limits while makingsure to utilise as much commodity specific de minimis exemptions as possible.

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Non commodity specific distorting support can be provided to a subset of commoditiesproduced in a member country for which there is relatively little support for other commodi-ties. Because the country can claim non commodity specific de minimis exemptions up to agiven percentage of the total value of its agricultural production (5 per cent for developedcountries), the concentration of support in just a subset of commodities can allow a muchlarger share of support to the assisted group of products to be exempt under the non commod-ity specific de minimis provision. For example, the US farm program crops (wheat, feedgrains, rice, cotton and now soy beans) constituted 23 per cent of the value of US agricul-tural production in 2000 (ERS 2002; US Department of Agriculture 2001). Because lowlevels of non commodity specific support are provided to other commodities, the effectivenon commodity specific exempt support for farm program crops can be up to almost 20 percent of the value of the commodities involved and still fall within the limits for non commod-ity specific exemption.

A large part of overall US program crop production and support is for commodities that areclose substitutes in both land use and end use. This is especially so for wheat, feed grainsand soybeans. Having support to agriculture concentrated in just a few major commodities,as is the case in the United States, can greatly weaken the effectiveness of the limitationsunder the non commodity specific de minimis exemptions. This weakness is already beingexploited by the United States in its notifications of the WTO of crop market loss assistancepayments to program crops under the 1999 emergency program as exempt non commodityspecific de minimis support (WTO 2003).

Apart from several of the farm program crops being close substitutes, both in land use andin consumption, the emergency program support that is claimed to be exempt under the noncommodity specific de minimis exemption is determined from individual commodity bases.This could raise doubts about whether such support is indeed non commodity specific orwhether it should be designated commodity specific. It would probably be argued by somethat even though the payments were determined from individual commodity bases, farmerscould plant other crops and still receive the support — in short, such support could beconstrued to be non commodity specific. Whether particular forms of support are consid-ered to be exempt or nonexempt has become an issue of definitional subtlety rather thanbeing a reflection of the fundamental effects of the support on production, prices and markets.

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conclusionsThe division of agricultural support into three discrete groups of measures — market access,domestic support and export measures — in the present WTO Agreement on Agricultureprovides a means of making negotiations more managable. It also ensures that all forms ofassistance are accounted for in at least one group.

However, in reality, much agricultural support is provided through the interaction of marketaccess, domestic support and export subsidy measures. Market access limitations and, insome conditions, export subsidies are widely used to underpin internal domestic supportprices. Under such conditions measures affecting any one of these three discrete groups willaffect the others — none of the three is independent of the others. In the final analysis, allsupport is domestic support in the sense that it is provided to assist a country’s farmers.

As well as the three groups of measures being used in interdependent ways, they are substi-tutable for each other. For example, increased domestic support, such as through subsidies,can be readily used as a substitute for assistance to producers through internal market pricesupport that previously depended on market access barriers and/or export subsidies. That is,market access barriers and/or export subsidies can be reduced but support to producers canbe maintained at previous levels by substituting with additional domestic subsidies.

The present WTO Agreement on Agriculture has stronger provisions for reducing exportsubsidies than it has for increasing market access and reducing domestic support. It hasencouraged the substitution of domestic support for export subsidies that has enabled majordeveloped countries to meet their export subsidy commitments. Such substitution has beenespecially encouraged by the exemption of many forms of domestic support from any cutsor limitations under categories considered to be production limiting or minimally marketdistorting.

This rechanneling of support into domestic subsidies has enabled the countries doing it torely less on high import tariffs for their industry protection as well as to reduce their exportsubsidies. Because base tariffs were set at pre Uruguay Round Agreement (1986–88) levelsand included the previous high price support, the substitution of domestic support for inter-nal market price support has enabled some large countries to meet their commitments ontariff reductions as well as on export subsidies. It also builds in extra, unused ‘water’ inbound tariffs — the gap between the bound tariff and the level of actual price support thatthe country provides — that enables relatively large cuts to be made in bound tariff ratesthat do not improve market access or impinge on remaining levels of price support at all.

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5

A further interrelationship that is important occurs within the domestic support category,namely the ability to reduce AMS price support levels by substituting exempt forms ofdomestic support that enable reductions in administered support price levels.

These interlinkages and substitution possibilities provide routes for reforms through rechan-neling assistance from highly distorting price support into exempt domestic support that isconsidered to be production limiting or minimally distorting. To the extent that the inducedchanges in forms of support actually reduce market distortions, they represent benefits fromthe agreement.

The key issues then become whether and how the induced changes have been applied inpractice and how much, if at all, they reduce actual market distortions. There is an impor-tant distinction here between whether the exempt measures meet, or might be construed tomeet, the conditions for being production limiting or minimally distorting in the WTOAgreement on Agriculture, and whether they are actually production limiting or minimallymarket distorting.

The actual extent to which market distortions are reduced in practice depends on severalfactors. These include the extent of support categorised as production limiting or minimallydistorting, the nature and extent of any production limitations, and whether exempt supportcategorised as minimally distorting is applied in ways that are actually minimally distort-ing.

Some EU subsidies, such as headage payments for male cattle and for sheep that are exempton grounds of being production limiting are not production limiting at all — at the very least,they lock in production at around levels induced by high support over several decades.Nevertheless, they would be less distorting than open ended piece support of the same inci-dence. For cereals, the EU arrangements maintain incentives to maximise permissible plant-ing. However, they are less distorting than price support of the same incidence because ofarea reduction programs and reductions in distortions to domestic consumption that havehelped to contain exportable surplus volumes within WTO agreed limits.

The United States has widely substituted support that might be construed as decoupled forother forms of support, including export subsidies (wheat) and deficiency payments, for itsfarm program crops — wheat, feed grains, rice, cotton and now also soybeans. The 2002farm bill provides for growers to update their payment bases, which compromises the actualdegree to which the payments could be actually minimally market distorting. Updating ofbases provides incentives to expand production in expectation of further future updates. Atthe same time the 2002 farm bill provides for very high potential levels of direct and coun-tercyclical payments relative to levels applying before 1998. These payments would be lessmarket distorting than open ended production and price linked support of the same inci-dence. However, it is not really possible to determine whether current US policies are lessdistorting than previous arrangements as acreage reduction programs that provided a coun-terpoise to the distorting effects of previous support have been discontinued since 1996.

Benefits from the present WTO Agreement on Agriculture have hinged largely on the degreeto which it has induced substitution of less trade distorting forms of exempt domestic support

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for previously more distorting price support, especially that from export subsidies. Therehave also been some minor gains in market access, primarily through tariff quotas.

However, the changes have built considerable water into bound tariffs, making it more diffi-cult to negotiate further increases in market access that actually reduce protection levels.

The present agreement’s structure that independently addresses market access, domesticsupport and export subsidies does not ensure reductions in market distortions although itdoes encourage substitution of less distorting forms of support for more distorting ones. Thisis because of:

■ weaknesses in definitions of production limiting arrangements and of some forms ofsupport that is construed to be minimally market distorting;

■ lack of limitations on the extent of support categorised as production limiting or mini-mally distorting but which is in fact still significantly market distorting;

■ there being no guarantees that reductions in bound tariffs will be sufficient to reduceactual tariff induced levels of protection.

Tightening up definitions and setting limits on payments might address the first two of theseweaknesses. However, ensuring cuts in actual tariff protection is problematic if negotiationsare to reduce bound maximum tariffs and not applied tariff levels, because of substantialwater in most tariffs. Large cuts will be needed for many items even to eliminate presentwater in the tariffs, let alone to impinge on tariff induced effective protection.

Conceptually, achieving an outcome that ensures reductions in market distorting supportrequires proper measurement of what constitutes market distorting support overall for eachcommodity, after all of the shifting around of support arrangements between pillars that thesystem induces. That measurement of support should then be subject to negotiated reduc-tions. Only through such proper measurement can anyone know the final outcome of thevarious measures in each of the three pillars, how they interact and the extent to which theindividual disciplines affect the overall level of distorting support. Essentially the role ofthis measurement of distorting support should be to ensure cross compliance between themeasures in the three pillars to ensure that real cuts in protection are delivered.

The AMS plays this role of an overall measurement of support in the present agreement.However, it is does it unsatisfactorily for a wide range of reasons including aggregation ofcommitments, unrepresentativeness of both internal administered prices and external refer-ence prices in measuring price support and a proven ability of members to manipulate AMSlevels through minor definitional changes. As a measure of actual levels of market distort-ing support, the AMS is virtually meaningless.

While there are gross inadequacies in the present AMS, its use is probably of some value inencouraging support away from highly distorting price support underpinned by market accessbarriers and/or export subsidies toward less distorting exempt forms of support.

Development of a real AMS that indicates actual levels of distorting support including pricesupport determined from actual internal and external market prices, and agreeing on cuts to

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it would provide a means of ensuring reductions in actual market distorting support. It wouldprovide the acid test of whether the cuts to the various pillars of support were effective, withnoncompliance triggering remedial measures. However, for various technical and politicalreasons, WTO members seem reluctant to move away from the present ramshackle AMSsystem.

There are several approaches that might be pursued in the present negotiations to bring aboutreductions in costly, market distorting support. Three such approaches could be:

■ to accept the structures and definitions in the present agreement as they are and negoti-ate further reductions in barriers to market access, market distorting domestic supportand export subsidies — basically by extrapolating the kinds of cuts made under thepresent agreement;

■ to tighten up criteria and definitions and to pursue new approaches such as progressivetariff reduction formulas to ensure that the agreement reduces actual barriers to tradeand reduces market distorting support to the extent that this could be agreed; or

■ to pursue either of the above approaches, and supplement them with additional meansby which countries whose farmers are disadvantaged by others’ support can retaliatemore than at present. One means could be by permitting additional barriers againstimports of the products from countries with high levels of market distorting support.

The first approach would enable high support countries that wished to remain so to continueto work the system and make only marginal real reforms to reduce actual market distortionsflowing from their policies. One example of such reforms would be to agree on reductionsin bound tariffs that impinged only minimally on actual support levels. Another would beto eliminate safety net administered support prices that have long been below actual supportedmarket prices for a particular product in order to obtain AMS credits to support othercommodities or for the country to stay within the AMS limit. Nevertheless, there would besome benefits of the same nature as those from the Uruguay Round from encouraging changesin forms of support from highly distorting measures to forms that were somewhat lessdistorting.

To the extent that the second approach can be pursued, it holds a promise of achieving signif-icant benefits from trade. If successful, it would ensure marked actual reductions in barri-ers to trade, and exemption only of domestic support measures that actually were minimallymarket distorting, not just construed as such, from cuts or limitations.

The third approach would induce additional effects beyond those for the first two. It wouldadd further dangers to realising the benefits from trade in agricultural products. The worldprice depressing and destabilising effects of the support in present subsidising countrieswould be exacerbated by a further world price depressing and destabilising effect from reduc-tions in world import demand. A result would be lower aggregate world incomes and lowerincomes in most WTO member countries.

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glossaryAggregate Measurement The measured level of domestic support that is subject to

limitations and reductions under the WTO Agreement onAgriculture. It is applied for a member’s agriculture as awhole but is determined from the sum of commodity specificAMS levels and non commodity specific nonexempt support.Commodity specific AMS levels are the sum of price supportand nonexempt commodity specific subsidies, less specificagricultural levies or fees paid by producers. In turn, pricesupport is the difference between administered support pricesand constant external reference prices (import parity for netimporters and export parity for net exporters) that are main-tained at the average for the 1986–88 base period, multipliedby the quantity of production eligible to receive the admin-istered support prices.

applied tariff The actual tariff rate that is applied to imports at a particu-lar time.

base period The time period(s) agreed during the negotiations as the basison which all reductions and commitments are made. For theWTO Agreement on Agriculture, the base period for marketaccess and domestic support commitments is 1986–88; forexport subsidy commitments, the base period is 1986–90).

bound tariff rate The maximum tariff rate that a WTO member undertakes toapply. The bound rate provides a ceiling which applied tariffrates cannot exceed except by negotiations, with compensa-tion for affected trading partners.

‘blue box’ exemption Within the WTO Agreement on Agriculture, support underproduction limiting programs is exempted from the AMS fordomestic support if certain conditions are met. Those condi-tions are: (i) such payments are based on fixed area andyields; or (ii) such payments are made on 85 per cent or lessof the base level of production; or (iii) livestock paymentsare made on a fixed number of head.

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of Support (AMS)

ceiling bindings For the WTO Agreement on Agriculture, developing coun-tries had the flexibility to offer ceiling bindings on productssubject to unbound ordinary customs duties. These boundtariffs could be higher than the September 1986 applied tariff(the rate at which developed countries were required to bindwhere products were subject to customs duties only at thattime).

decoupling The provision of support to producers which is not linked tovariables which affect markets including production, prices,trade or factors used in production. Such support is lessmarket distorting than support which is linked to those vari-ables.

de minimis exemption Under the WTO Agreement on Agriculture, support can beexcluded from the calculation of the AMS and exempt fromreduction commitments for domestic support if that supportis below a set proportion of the value of the relevant agri-cultural production. That proportion is 5 per cent for indus-trialised countries for each of product specific and nonproduct specific support. For developing countries, the rateis 10 per cent for each of those two categories.

export subsidies Government payments or other financially quantifiable bene-fits provided to domestic producers or exporters contingenton the export of their goods or services.

‘green box’ exemptions Under the WTO Agreement on Agriculture, certain measuresmeeting specified criteria are exempt from domestic supportreduction commitments. These conditions are set down inAnnex 2 of the agreement. The measures were agreed to beminimally trade distorting.

implementation period The period over which the provisions of an agreement areput into effect. For the WTO Agreement on Agriculture, theimplementation period is from 1995 to 2000 inclusive forindustrialised members and from 1995 to 2004 for develop-ing members.

minimum access A minimum quantity of imports that is to be allowed accessto a market. In the WTO Agreement on Agriculture, it wasagreed that minimum access should be 3 per cent ofconsumption in the base period, 1986-88, rising to 5 per centof base period consumption by the end of the implementa-tion period.

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multilateral trade Seven Rounds of Multilateral Trade Negotiations have beenheld under GATT auspices since 1947. Each Round repre-sented a discrete and lengthy series of interacting bargainingsessions among the Contracting Parties in search of mutu-ally beneficial agreements looking toward the reduction ofbarriers to world trade.

tariff A duty (or tax) levied upon goods transported from onecustoms area to another. Tariffs raise the price of the importedgoods, thus making them less competitive within the marketof the importing country.

tariff quota Application of a reduced tariff rate for a specified quantityof imported goods.

above tariff quota tariff The tariff rate that applies for quantities of imports other thanthe specified quantities entering within a tariff quota.

in tariff quota tariff The reduced tariff rate that applies for the specified quanti-ties that enter within a tariff quota.

tariffication Conversion to tariff equivalents of nontariff measures apply-ing to particular products and the opening of current or mini-mum access opportunities for these products.

World Trade Organisation The institution established at the beginning of 1995 to covera range of objectives concerning international trade. Itsubsumes the General Agreement on Tariffs and Trade whichwas formed in 1947. Its objectives include: to set rules forinternational trade and trade related activities; to provide aforum to negotiate trade liberalisation multilaterally; to settletrade disputes between contracting parties; to provide infor-mation on trade and trade policies; and to cooperate withother multilateral institutions (Anderson 1996, p. 6).

WTO Agreement on The agreement on agriculture that was negotiated in theUruguay Round and that was ratified in 1994.

The above definitions for base period, ceiling bindings, export subsidies, multilateral tradenegotiations, and tariff quota are drawn from, or based on Young (1994).

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negotiations

(WTO)

Agriculture

referencesAgra Europe 1992, ‘EC maintaining its own version of tariffication’, Agra Europe, Tunbridge

Wells, England, no. 1486, 4 September, p. P/2.

Anderson, K. 1996, ‘Why the world needs the GATT/WTO’, Chapter 1, Strengthening theGlobal Trading System: from GATT to WTO, ed. K. Anderson, Centre for InternationalEconomic Studies, University of Adelaide.

Ingco, M. 1995, Agricultural Trade Liberalisation in the Uruguay Round: One Step Forward,One Step Back? Policy Research Working Paper 1500, International Economics Depart-ment, International Trade Division, World Bank, Washington DC, August.

Hennessy, D.A. 1998, ‘The production effects of agricultural income support policies underuncertainty’, American Journal of Agricultural Economics, vol. 80, no. 1, pp. 46–57.

OECD (Organisation for Economic Cooperation and Development) 2002, AgriculturalPolicies in OECD Countries: Monitoring and Evaluation, Paris.

Podbury, T. and Roberts, I. 2003, Opening Agricultural Markets through Tariff Cuts in theWTO, ABARE eReport 03.2, FIRDC publication 03/011, Canberra (www.abareconom-ics.com).

Roberts, I., Podbury, T., Freeman, F., Tielu, A., Vanzetti, D., Andrews, N., Mélanie, J. andHinchy, M. 1999, Reforming World Agricultural Trade Policies, ABARE Research Report99.12, RIRDC Publication no. 99/96, Canberra.

Sumner, D. 2002, Implications of the US farm bill of 2002 for agricultural trade and tradenegotiations, Paper presented at the 5th Annual Symposium of the Australian Agriculturaland Resource Economics Society, University of New England, Armidale, February.

Tielu, A. and Roberts, I. 1998, Farm Income Support: Implications for Gains from Trade ofChanges in Methods of Support Overseas, ABARE Current Issues 98.4, Canberra, August.

Tangermann, S. 2003, Trade reform: debating the issues: the OECD perspective, Paperprepared for Outlook 2003: Gateway to Rural and Regional Business, Paper presented atthe Outlook 2003 conference, Canberra, 4–5 March (www.abareconomics.com).Tielu, A.and Roberts, I. 1998, ‘Farm income support: implications for gains from trade of changesin methods of support overseas’, ABARE Current Issues, no.98.4, August, Canberra.

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US Department of Agriculture 2001, Agricultural Statistics, Washington DC.

WTO (World Trade Organisation) 1999, Canada- Measures Affecting the Importation ofMilk and Exportation of Dairy Products, Report of the Panel, WT/DS103/R, WT/DS113/R,Geneva, 17 May.

—— 2002, Canada – Measures Affecting the Importation of Milk and Exportation of DairyProducts: Second Recourse to Article 21.5 of the DSU by New Zealand and the UnitedStates, AB-2002-6, Report of the Appellate Body , WT/DS103/AB/RW2,WT/DS113/AB/RW2, Geneva, 20 December.

—— 2000, Notification: Domestic Support: Japan: 1997, Committee of Agriculture,G/AG/N/JPN/47, Geneva, 21 February,.

—— 2001a, Notification: Domestic Support: Japan: 1998, Committee of Agriculture,G/AG/N/JPN/61, Geneva, 28 February.

—— 2001b, Notification: Domestic Support: Japan: 1998, Committee of Agriculture,G/AG/N/JPN/62, Geneva, 1 March.

Young, E. 1994, Uruguay Round Outcomes: Agriculture, Agriculture Branch, TradeNegotiations Division, Department of Foreign Affairs and Trade, Canberra.

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