The OECD PSE (Producer Support Estimate) indicator:

After the international agricultural models, misinformation continues…

The PSE (Producer Support Estimate) is an economic indicator created by the OECD to measure and compare the domestic support received by farmers in member states.

It has been evaluated every year since 1987 using a rather simple method that only takes into consideration the principal payments and support granted1 by member states to their farmers. Thus, the PSE of a country for a given year corresponds to the difference between the domestic price and the world market price multiplied by the volumes of domestic production to which are added budgetary support. If Pd is the domestic price, Pw the world price, Qd domestic production and B budgetary support, we obtain the following equation:

PSE = (Pd – Pw).Qd + B

This indicator is the main theme of the latest report by the OECD published in July 2006 entitled “Agricultural policies in OECD countries at a glance - 2006” and which depicts the agricultures of the OECD countries while focusing in particular on production subsidies. It shows that internal support within the European Union is twice as high in the United States (32% and 16% respectively), which implies, for the experts of the OECD, that the European agricultural policy is twice as distortive as the American agricultural policy.

The conclusions of this report were used as a reference by many countries during the WTO negotiations last July. The United States used them in particular to push the European Union to rapidly reform its agricultural policy, accusing the EU of being responsible for gridlock on two or three strategic issues2 necessary for the success of the Doha round.

However, it turns out that the PSE is an indicator that is just as imperfect and dangerous in the way it is used as the international agricultural models of the World Bank or the Carnegie Foundation3 because it neglects the strategic and specific aspects of agriculture and underestimates the distortions caused by American subsidies.
We therefore insist on denouncing the tendency to use this questionable indicator, which disguises reality and is a powerful propaganda tool that serves the interests of those who would stigmatize in particular the Common Agricultural Policy.


A. Highly questionable principles of construction

The PSE, like any other economic indicator is based on principles of construction that make it possible to conceive the economy of a country as a “model” from which experts can establish measurements.
However, the economic principles that serve as the basis for the calculation of the PSE are questionable and rely on an economic vision that is divorced from reality. We shall present below the five major flaws of the PSE, each one being sufficient in itself to justify excluding the PSE from the international decision-making process.

1. The PSE supposes that none of the players can influence the level of prices.

This first hypothesis implies that any change in the level of prices benefits all farmers equally.
Yet, certain players involved in processing or distribution, by the monopolistic or oligopolistic nature of their organization, can take a part of the transfers caused by a variation in prices. The method used to calculate the PSE, by excluding the power exerted by the market, which is nevertheless a reality, overestimates the transfers that go to farmers.

2. The PSE is calculated using biased estimates of domestic and world prices.

PSE levels are directly linked to domestic and world prices. However, these are influenced by factors inside and outside the agricultural sector (for example exchange rates) that the OECD experts do not take into account in their estimations.
PSE levels can thus vary considerably and artificially even if the domestic agricultural policy has not been modified.

3. The PSE is based on the hypothesis that the goods produced are homogenous.

This hypothesis, which has already been criticized by momagri in its analysis of international agricultural models, is also adopted by the PSE. It considers that all products have the same characteristics. Thus, Ukrainian and French wheat are the same, just as cotton from America is the same as cotton from Benin, an idea that is false and absurd !

4. The PSE considers that no country alone can influence world market prices (the “small country” hypothesis).

If we accept that all countries are “small countries”, i.e. none of them is able, through its policies or size, to influence world market prices, the PSE underestimates the distortions caused by certain countries.
Yet, certain countries influence world market prices directly, like the United States for cotton (via 4 billion dollars a year paid to American farmers) or New Zealand for dairy products (via Fonterra, a state-run company and export monopoly that does not abide by international rules for competition and benefits from decisive structural advantages).

5. The PSE neglects interactions between agriculture and the rest of the economy (theory of partial equilibrium).

The hypothesis of partial equilibrium means that the PSE does not take into account the economic support measures that have an impact on agricultural producers.

Thus are excluded:
- macro-economic measures that could affect the agricultural sector (like the effect of variations in exchange rates),
- public subsidies for agriculture that can have repercussions on the rest of the economy,
- policies that help all the players in the agricultural sector (producers, distributors, transport companies,…). Thus, subsidies for transport are excluded from the calculation of the American PSE because they have a global character, whereas they are taken into account for Canada because this support is specifically allocated to grain producers in the West.

B. A black box that contributes to disguise reality

In order to create an indicator that can be used to compare domestic support for farmers, the OECD experts used opaque calculation rules and gross simplifications that have made the PSE a new black box4 the results of which are only the reflection of a disguised reality.
The critical analyses carried out by momagri reveal the lack of relevance of this indicator within the framework of international negotiations.

1. The rules and amounts used to calculate the PSE are not explicit

As we have seen, the calculation of the PSE uses a rudimentary approach that could be useful as a simplified outline if the OECD provided the methodology enabling the rules and amounts used to be appreciated.
Yet, this is not the case.
However, these details are fundamental because, as we have demonstrated in the article “X-ray of US subsidies to agriculture”5 , there is a big difference between the subsidies that are forecast and taken into account by OECD experts in their measurements and the sums that are really paid out. Indeed, the real subsidies for agriculture (around 30 billion dollars a year) have been 70% higher than the amounts initially forecast (18 billion dollars a year).

2. The PSE is based on “world reference prices” that are virtual and distortive.

PSE levels are defined according to world reference prices that are specific for each product. The credibility and accuracy of these “world reference prices” are essential because they constitute the standards of measurement used to define and compare the support granted by each OECD member state. It is therefore fundamental that the country that serves as the “standard of measurement” for a product have a production structure that is representative of the rest of the world and not be the cause of any distortions on the world market.
Yet, most of the countries that serve as a standard of measurement are the ones that cause the most instability on world markets.
Thus the price of milk in New Zealand is used as a “reference” because it is officially accepted that it is the least subsidized compared to other OECD countries. But New Zealand is the country, because of its state-run businesses and export monopolies, responsible for the depreciation of world dairy prices.
Along the same lines, prices for fodder grain (maize, ground soya meal…) in the United States are considered the “reference” while American producers receive high domestic subsidies and guaranteed export credits that are not taken into account in the calculation of their PSE.
We find ourselves in a totally absurd situation where the PSE, used to compare support granted by the different OECD countries, uses as the world reference price for each product the price in countries that, thanks to subsidies, artificially maintain low prices.
It follows from this line of reasoning that the PSE of the other countries, and in particular the European Union, is higher “by construction”.

3. The PSE compares products and systems of support that are not comparable.

The support allocated to producers is completely measured only for major products, essentially field crops, sugar, milk and meat. The OECD experts therefore must extrapolate this information to obtain the global PSE (for all the products in each country).
However, production structures are profoundly different on either side of the Atlantic, just like the systems of support, making this extrapolation meaningless!
The end result is a lack of coherency from one country to another for a certain number of measurements and therefore it is impossible to compare the different PSE, which is however one of the initial objectives behind the indicator.

4. The method for constructing the PSE considers that all support policies have the same impact.

When OECD experts calculate the PSE they do not try to find out if a given support policy has a pronounced effect on production or exchanges.
According to this line of reasoning one dollar spent on R&D equals one dollar of support for market prices!
This is why it is wrong to consider that the same PSE for several countries indicates the same level of support. The composition of the PSE varies considerably according to each country, just like its effects on production and exchanges.
What credit can we give to an indicator, which is just really an aggregate of pieces of information that do not have the same value, in comparing support in the different OECD countries?

The arguments put forward by the OECD and the United States to justify the exclusion of food aid and export credits from the calculation of the American PSE, while the theoretical description mentions them, is the following: “food aid does not influence American farm gate prices because it creates a net demand on a world level that causes a rise in world prices that benefits all producers and not only American producers”.

If this is so, why do the Americans so staunchly defend their domestic support programs at the WTO when, according to them, food aid and export credits benefit all farmers worldwide and not only American farmers?

Because in reality these measures only benefit American producers.

In fact :

- external food aid is really an export subsidy that enables American farmers to clear surplus stocks and artificially create demand that only American farmers can satisfy;

- export credits are a direct subsidy, although differed, to American farmers. The mechanism of this support functions in the following manner: when the world price is below the minimum level defined by the government for each crop, the farmer receives a subsidy. Naturally, the lower world prices, the higher the subsidy for the American farmer. Because of the lapse of time between payment of the subsidy and the moment farm production is actually sold on the world market (up to 9 months) export credits are differed support for American farmers that allow them to postpone the sale of their production until market prices are more favorable.

Thus, food aid and export credits provide support for American farmers and reduce the volatility of their future revenues. Moreover, they increase their chances of receiving the same support the following year because these two measures contribute to the depreciation of world prices.

To conclude, if food aid and export credits were included in the calculation of the American PSE and if marketing loans and countercyclical payments were accounted for according to their real value…then the PSE of the United States would perhaps be superior to that of the European Union.
However, the fragility, on both theoretical and practical levels, of this indicator pleads in favor of excluding it, purely and simply, from further use.
It is therefore vital to create a new decision-making tool for international negotiations that is faithful to the realities observed and above all transparent so as to avoid any shift in appreciation.
This is the work that momagri has undertaken with the construction of a new international agricultural model, the momagri model, and the upcoming launch of an international assessment and grading agency (the NAR agency).