X-ray of US subsidies to agriculture

The aim of agricultural negotiations at the World Trade Organization (WTO), currently taking place, is the liberalization of international agricultural exchanges, by abolishing support (export subsidies and domestic support) and protection (trade barrier) systems.
However, the agricultural agreement, at this provisional stage, obtained in December 2005 in Hong Kong, concerns export subsidies and not the system of American support to agriculture1, whose consequences strongly affect prices and therefore international agricultural exchanges.
This note aims to present the mechanism of American support in detail and to show how it destabilizes agricultural exchanges, to the detriment of other countries in the world.

I / The support system

The American government support system directly concerns farmers1 incomes. It is defined by the Farm Bill.

A - The Farm Bill

Support to agriculture has always been one of the priorities of the American government, the first aid program dating back to 1776. This was aid given to American farmers to enable them to settle in areas around the country. All subsequent programs have had the same objective: to increase the competitiveness of American agriculture and protect the income of American farmers, agriculture always having been considered as a sector of geostrategic priority.
At present, all American measures for aid to agriculture are contained in a legislative text drawn up in 2002 entitled “Farm Security and Rural Investment Act” 2 more commonly known as the Farm Bill. This law is applicable for a period of six years and contains ten support programs.
One of the objectives of the 2002 Farm Bill was to allocate subsidies to ensure that the farmer received a price ex-farm, which was higher than the world price, and therefore guarantee a minimum turnover. It introduced new clauses to the earlier 1996 Farm Bill, notably a more substantial environmental section, and a counter-cyclical system of payments guaranteeing a price objective for the farmers regardless of the market price. This marked the return of a more interventionist policy.
This system anticipated a minimal global budget of 180 billion dollars over ten years (an increase of 78% of total agricultural expenditure compared with the 1996 Farm Bill), adaptable to world price levels.

In reality, sums allocated to agriculture have been higher (around 30 billion dollars per year).

Three types of aid are granted 3 :

1. Aid linked to production: 143 billion dollars over 10 years
which can be broken down into three support categories:

> Direct payments, representing 40 billion dollars over 10 years, which is 28% of the aid,
> Marketing loans or “commercial support loans” representing 63 billion dollars over 10 years, which is 44% of the aid,
> Counter-cyclical payments, representing 40 billion dollars over 10 years, which is 28% of expenditure,

2. Environmental aid: 21.4 billion dollars over 10 years
This has five main programs :

> The Conservation Security Program (CSP),
Its objective is to encourage American farmers to adopt production practices which are beneficial to the environment, by paying them subsidies.
> The Environmental Quality Incentive Program (EQIP)
The main objective is to help farmers conform to existing environmental legislation.
> The Conservation Reserve Program (CRP)
The government makes annual payments to farmers, who in exchange, withdraw certain areas from production. The total eligible surface area is a maximum of 16.3 million hectares.
> The Farmland Preservation Program (FPP)
The objective is to help conserve farmland. Areas which have historical or archaeological interest are eligible.
> The Grassland Reserve Program (GRP),
This new program concerns a maximum surface area of 0.83 million hectares, and the subsidy is fixed at 75% of the value of the pastureland. The objective is to subsidize restoration activities.

Environmental aid has increased considerably since the last Farm Bill in 1996. It has in fact been multiplied by five.

3. The other programs (credit, research and popularization, domestic food aid): 15.6 billion dollars over 10 years.

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It is important to understand that this “global budget” based largely on world prices (because of aid linked to production), in fact represents only a “minimum budget”. It can be much higher if prices are lower than anticipated, which has been the case since 1999.
Therefore, sums allocated to farmers by Washington within the framework of the Farm Bill are in fact around 30 billion dollars a year, which is an increase of more than 60% compared with the sum initially allocated.

In this note, we will deal only with aid linked to production for two main reasons :
> It represents the largest part of aid allocated within the Farm Bill (80% of the initial budget),
> It is central to issues concerning international exchange.

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B - Aid linked to production

1. Direct payments
Direct payments were introduced by the 1996 Farm Bill. They constitute a fundamental element of the revenue of American farmers, who receive these payments regardless of what is effectively planted on their land during the year, except for fruit and vegetable crops.
Because of this, they are not supposed to directly influence standard production and are considered as “decoupled” aid, which means it is not linked to the volume of production. This title is given by the World Trade Organization (WTO) as they have a non-distortive impact on international exchange.
Direct payments attributed to a farm are obtained by multiplying the rates of direct payment (fixed by the Farm Bill by region and by crop), by 85% of the basic surface area and the observed crop yield. In the 2002 Farm Bill, the rates of direct payment were increased for all products (wheat, maize, cotton and rice) by an average of 13%. Soybean was eligible for this aid for the first time.

Direct payments = Rate of direct payments * basic surface area * 0.85

* Observed yield

2. Marketing loans
As farmers' revenue depended directly and too much on agricultural market prices, which were by nature volatile, the government decided, in 1996, to set up a mechanism guaranteeing a minimum turnover for American cereal, cotton and oilseed farmers.
This mechanism, called “marketing loans” is based on the allocation of loans by the Ministry of Agriculture for a nine-month period, which enables American farmers to defer the selling of their produce, if prices are lower than floor rates (the loan rate or the “intervention price”). This floor rate, fixed by the Farm Bill differs according to the region and the crop.
The amount of the marketing loan for a farm is the difference between the “intervention price” and the market price, multiplied by the volume of production of the crop concerned.

Marketing loans = (intervention price – market price) * volume of production

To receive marketing loans, the American farmer has two alternatives:

a. Opt for a loan by fixing the value of his production at the “intervention price”. He will then reimburse this loan by selling his produce at market price and therefore benefit from an indirect subsidy (or marketing loan gain) equal to the difference between the loan and the result of the sale.

b. Opt for immediate direct aid (or loan deficiency payment), which is the choice of 90% of American farmers, of an amount representing this difference at the time of request.

In this way, the system guarantees a minimum turnover for American producers, which encourages them to produce and sell their crops regardless of the evolution of market prices.
Consequently, marketing loans have a direct influence on standard production and are therefore considered as “coupled” aid by the WTO, which means they are linked to the volume of production, in the domestic support category4.
It must be noted that they have a determining influence on world prices, as American farmers can make a living from their production regardless of world price levels.
Thus, marketing loans, by encouraging production, artificially inflate supply and lead to a permanent slump in prices. It is therefore fundamentally an anti-competitive system (Cf. part II: The consequences of this kind of aid system for crops).

3. Counter-cyclical payments

The counter-cyclical payment system, created by the 2002 Farm Bill, institutionalized what was called “emergency aid” from 1999 to 2001.
The payments ensure that producers have even more stable incomes by establishing minimum security for agricultural incomes in the event of drastic price reductions. They are linked to the registered surface area and to reference yields and are therefore complementary to marketing loans which vary according to standard production, and so cannot protect American farmers' income against natural catastrophes for example.
In practice, they are paid to the farmer as soon as the market price goes below the adjusted price objective. This is equal to the price objective, fixed by the Farm Bill so that it covers the average cost of production per crop, less the direct payments.
The amount of counter-cyclical payments is fixed in two stages: first the unitary counter-cyclical payment is calculated, and this serves as a basis for defining the total amount a farm receives.

The unitary counter-cyclical payment (UCP) is equal to the adjusted price objective, less the market price and the marketing loans. It makes up the difference between the price which is effectively received by the farmer (the sum of the market price, the marketing loans and the direct payments) and the price objective fixed by the Farm Bill.

UCP = Price objective – [Direct payments + Marketing loans + Market price]

The global sum of the counter-cyclical payments, calculated on the basis of 85% of the surface area just like direct payments, is equal to the unitary counter-cyclical payment multiplied by the registered surface area and by the reference yields.

Counter-cyclical payments = UCP * registered surface area * 0.85 * reference yields

The three aids linked to production enable the American government to guarantee a price level ex-farm for its farmers, regardless of the world price and therefore to protect their income.

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C - How the support system functions: taking wheat as an example

The three cases presented below indicate the amount of the payments granted to an American wheat producer, according to three market price hypotheses :

1. Market price < intervention price< adjusted price objective
2. Intervention price < market price < adjusted price objective
3. Intervention price < adjusted price objective < market price

The price objective, the intervention price and the direct payment rates are fixed by the 2002 Farm Bill as follows :
> Price objective of wheat: $144/t
> Intervention price of wheat: $101.3/t
> Direct payment rates: $19.11/t
The adjusted price objective is equal to the price objective ($144) less the direct payments ($19.11), which makes $124.89, and the hypotheses of surface area and yield correspond to the observed average in 2003.

1. Case 1: market price < intervention price < adjusted price objective

Let us consider that the market price of wheat is $80/t.
The market price is therefore lower than the intervention price, which in turn is lower then the adjusted price objective ($124.89/t).

The three levels of support are calculated as follows :

Direct payments = Direct payment rates * Basic surface area * 0.85 * Observed yield
= 10.23

The direct payments are $10.23

Marketing loans = (Intervention price – Market price) * Production = (101.3 – 80)
= 21.3

The amount of the marketing loans is $21.3/t

UCP = Price objective – [Direct payment rates + Marketing loans + Market price]
= 144 – [19.11 + 21.3 + 80]
= 23.59

Counter-cyclical payments granted = UCP * registered surface area * 0.85
* Reference yield (2002)
= 31.76

The counter-cyclical payments are $31.76/t

The total subsidy received by the farmer is therefore equal to the sum of the direct payments, the marketing loans and the counter-cyclical payments, which makes a total of $63.29.

The final amount received by an American wheat farmer will be $143.29 (current market price plus the total subsidy), instead of $80, a guaranteed price which is 79% more than the market price.

2. Case 2: intervention price < market price < adjusted price objective

Let us consider that the market price of wheat is $120/t.
The intervention price is therefore lower than the market price, which in turn is lower then the adjusted price objective ($124.89/t).
The three levels of support are calculated as follows :

Direct payments = Direct payment rates * Basic surface area * 0.85 * Observed yield

The direct payments are therefore $10.23

No market loans are granted as the market price is higher than the intervention price.

UCP = Price objective – [Direct payment rates + Marketing loans + Market price]
= 144 – [19.11 + 0 + 120]
= 4.89
Counter-cyclical payments granted = UCP * Registered surface area * 0.85 * Reference yield
= 6.58

The counter-cyclical payments are $6.58/t

The total subsidy granted to the American farmer is $16.81, which gives him a final total of $136.81 instead of $120, a guaranteed price which is 14% more than the market price.

3. Case 3: intervention price < adjusted price objective < market price

Let us finally consider that the market price of wheat is $130/t.
The intervention price is therefore lower than the adjusted price objective of $124.89/t, which in turn is lower than the market price.

The three levels of support are calculated as follows:

Direct payments = Direct payment rates * Basic surface area * 0.85 * Observed yield

The direct payments are therefore $10.23

No market loans are granted as the market price is higher than the intervention price.

No counter-cyclical payments are granted as the market price is higher than the adjusted price objective.

The total subsidy granted to the American farmer is $10.23 which gives him a final total of $140.23 instead of $130, a guaranteed price which is 8% more than the market price.

Therefore, regardless of world wheat price levels, subsidies granted to American farmers always give them a higher price ex-farm.

Recap:
> Case 1: market price of wheat = $80 ;
> Case 2: market price of wheat = $120 ;
> Case 3: market price of wheat = $130.

II. The consequences of this kind of aid system for crops

A - The system set up by the Farm Bill encourages dumping on an international scale

According to the APAC 5 (Agricultural Policy Analysis Center), the United States, because of the Farm Bill system, dumps on an international scale (a situation where the selling price is lower than the production costs) which helps American production, especially in exports.

Environmental aid (greatly increased since the 1996 Farm Bill) also contributes to this, as it influences exported products.

In the study entitled “Rethinking US agricultural policy: Changing course to secure farmer livelihoods worldwide” dated 30^th January 2004, APAC experts show that for the year 2002, the selling prices of wheat and cotton were on average 40% lower than production costs.

Because of this system, American producers were able to sell, for example, 45% of their maize production (in 2002) on the world market at two-thirds of the cost price.
The situation has evolved since then as support has increased, because the United States have extended criteria for the eligibility of marketing loans, reinforced certain support measures by institutionalizing counter-cyclical payments, and introduced these payments into the field of dairy farming.
The cost of a system like this is very high but the United States has always invested to support American agriculture, regardless of budget deficiency.

« The Farm Bill will strengthen the farm economy over the long term. It helps farmer independence, and preserves the farm way of life for generations. It helps America's farmers, and therefore it helps America» (G.W. Bush).

It is therefore unlikely that the Farm Bill, the terms of which will be revised in 2007, will receive a reduction in public funding.

B - A system unchallenged by the WTO

The Farm Bill system, apart from the fact that it encourages dumping on an international scale, is likely to exceed the level of subsidies authorized by the WTO (5% of total agricultural production), which has never been challenged by the WTO.

Brazil's recent victory, however, over the United States at the WTO concerning the problem of cotton was an exception.
The main reason is due to the fact that WTO classification of the different aid programs within three boxes, orange (distortive aid), blue (aid linked to production levels for which commitments on reduction have been made) and green (non-distortive aid), does not reflect the real distortions of certain support mechanisms, such as marketing loans.

They are in fact classified in the orange box of domestic support and were not discussed at the last WTO Summit in Hong Kong which focused on export subsidies.
However, by maintaining low prices, they make American production very competitive on the domestic market (by preventing access to the market of foreign products) and on the export market (by constituting a form of export subsidy), as well as having an impact on livestock farming where low cereal prices act as a reliable support.
Marketing loans are therefore not only a distortive domestic support; they are also a form of export subsidy and trade access barrier.
However, marketing loans, which will no doubt be questioned as domestic aid, will probably be replaced by another system with similar effect.

American governments, in this way, always have a “head start” in international negotiations. This is not the case for the European Union, which is permanently open to criticism, although a reform of the Common Agricultural Policy in which agricultural support will be rapidly reduced is underway.

It is for this reason that WOAgri considers the Farm Bill, as it currently exists, to have a destabilizing effect on the world market and that it is important to convince the United States to change the system and set up a new world regulation system.

1 Cf WoAgri article on WTO negotiations in Hong Kong: “Be careful that a smoke-screen agreement does not become a fool's agreement ! » (www.woagri.org)
2 Or Security for farms and rural investment law
3 The distribution given here refers to the minimum budget of 180 billion dollars for ten years
4 Domestic support comprises, with access to the market and export subsidies, the three support categories defined by the WTO
5 The APAC is an American research center attached to the University of Tennessee specialized in American agriculture issues
6 « Repenser la politique agricole américaine : Changer la donne pour assurer un revenu aux agriculteurs du monde entier »