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Is free trade really free?

Bharat Jhunjhunwala | August 14, 2003

Prime Minister Vajpayee and his team are seeking greater access to the food markets of developed countries like the US in the forthcoming Cancun ministerial summit of the World Trade Organisation.

The underlying belief is that free trade will open up new markets for the farmers of developing countries, lead to an increase in the prices of their produce and bring prosperity.

The hard reality, on the other hand, is that global prices of major agricultural produce -- coffee, sugar, edible oils and so on -- have been declining and the farmers of developing countries are coming under increasing pressure.

The belief of our negotiators is that the situation will change for the better once these problems have been sorted out. But will it?

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It is interesting that the US is leading the effort to further liberalise global agricultural trade. The US WTO Agriculture Proposal includes elimination of export subsidies and export monopolies, regulation of export credit activity, reduction of all agricultural tariffs to less than 25 per cent and limiting the use of trade-distorting domestic support to 5 per cent of the total value of agricultural production.

The US target is the European countries who are allowed much greater levels of trade-distorting domestic support under WTO rules because of the higher baseline in the late eighties.

A US government document laments, "Specific caps on the use of export subsidies were derived from export subsidy activity between 1986 and 1990.

Consequently, the European Union has recourse to extensive use of export subsidies, and spent over $ 2 billion in 2000. The US also has the ability to use substantial amounts of export subsidies for certain products.

However, the US only spent $ 20 million in 2000." The US proposal would be music to ears of Indian negotiators.

Yet it seems that much of the benefit from the opening of the world food markets till now has accrued to the US. Sophia Murphy of Institute of Agriculture and Trade Policy points out that US company "Cargill is one of the top two exporters of soybeans from the US, Argentina and Brazil, who between them dominate world supply.

Cargill supplies to about 30 per cent of the world market. Cargill is a major corn exporter and importer around the world, buying, shipping and milling grain in more countries than there are WTO members."

Despite leading in the opening of its agricultural markets, the US continues to be a major beneficiary while many developing countries continue to find themselves in dire straits. Where is the catch, then?

It seems that the basic idea of what constitutes "trade-distorting" support is the culprit. The problem lies in the impact of "Green Box" subsidies on which there is no limit in the current agreements and none is contemplated in the coming negotiations.

The agricultural subsidies are divided in Green, Blue and Amber Boxes.

The US is willing to remove all Amber Box subsidies. However, it says that no limits should be imposed on the Blue and Green Box subsidies, which are not trade distorting.

The logic is that payments and infrastructure to farmers to keep their lands idle and uncultivated; do not directly affect the price of production. Here lies the catch.

The cost of production includes variable and fixed costs. The farmer continues to incur fixed costs such as those relating to the maintenance of tractors, land taxes, prevention of land erosion and so on, even if he keeps his fields idle because his entitlement to Blue and Green Box subsidies is contingent on this.

His decision to produce or not is dependent only on the level of variable costs. Let us say the fixed cost of cultivating a kilo of wheat is Rs 10 and the variable cost is Rs 5.

If the world price is Rs 8 per kilo then, logically speaking, the farmer should not cultivate wheat. But the farmer is provided with Green Box subsidies for keeping his fields idle.

Thus, it is profitable for him to produce wheat if he can get a little more than the variable costs. It becomes profitable for the US farmer to produce wheat even if the world price is lower than the total cost of production.

This is the reason that the US continues to dominate the world agricultural markets despite having made a cut in the Amber box subsidies.

The US proposals say that Green Box subsidies should be maintained: "Non-trade distorting support generally consists of measures delinked from production incentives, such as food stamps, research, extension, pest and disease control, and delinked direct payments. There are no caps on non-trade distorting support."

Thus, Murphy says, "American farmers have not responded to the collapse of world commodity prices by reducing supply. If anything, acreage under production has increased.

It is hardly ever worth leaving land idle, since even idle land incurs maintenance costs for the landowner. In the short to medium term, the pressure on farmers is to sow, however low prices go. It makes economic sense to increase production to spread the cost of working the land over more acres."

The farmers of developing countries cannot compete with those of the US because their governments do not have the capacity to provide subsidies to nullify the incidence of fixed costs.

Free trade is 'unfree' because US farmers have to bear only the variable costs while those of the developing countries have to bear both variable and fixed costs.

The US strategy is to agree to phase out Amber Box subsidies. But by continuing to provide huge Blue and Green Box subsidies it can still dominate the world food markets and make the developing countries dependent for their food requirement on the US.

Vajpayee and his team are barking up the wrong tree in asking for greater access to the food markets of the developed countries. This demand will be met as evinced by the US proposals. The gains from free trade, however, will accrue only when Green Box subsidies are also removed.

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