Causes and Consequences of Low Prices in the Cotton Sector
Aluisio de Lima-Campos
Economic Advisor
Embassy of Brazil in Washington
Delegate of Brazil to the ICAC
Conference on Cotton and Global Trade Negotiations
Washington, DC
July 9, 2002
Causes and Consequences of Low Prices in the Cotton Sector
Aluisio de Lima-Campos
Economic Advisor
Embassy of Brazil
Delegate of Brazil to the ICAC
Conference on Cotton and Global Trade Negotiations
Washington, DC
July 8, 2002
Before I begin, I would like to say that I have been asked by the ICAC to address this
conference on the impact of low cotton prices in the cotton sector and, in that process,
report on the injury suffered, as a result of those low prices, by several producing
countries. The basis of my information on injury is the collection of country reports
produced by individual countries, in the context of the Working Group on Government
Measures (WGGM). The Standing Committee of the ICAC established the WGGM on
January of this year with the purpose of gathering more information on the effects of low
cotton prices. So, these injury reports are hopefully just the begining of our work in the
WGGM.
That said, I would like to start by saying that it is a basic and elemental notion that lower
prices for a particular commodity generate negative impacts for the producers of that
commodity. It is also true in the case of cotton that lower prices are caused by a
combination of factors. What is not clear, however, is whether the lower prices we have
seen for cotton in the last few seasons are the result of one or more dominant factors.
In attempting to answer that question, three important aspects need to be examined: the
level of prices with respect to the cost of production, the length of time prices remain low
and, most importantly, is the market sufficiently transparent to affect every agent the
same way. I would like to review these three notions and conclude with some remarks
about the impact of cotton prices on some specific countries.
According to the latest Survey of the Cost of Production of Raw Cotton, published by
the ICAC in September 2001, the net cost of producing one pound of cotton in countries
that export the fiber, excluding land rent and seed value, ranges between 68 cents in
the United States and 21 U.S. cents in Burkina Faso.
Given that the present average cotton price from the Cotlook A Index is around 42 U.S.
cents per pound it is easy to see why some higher-cost producers need subsidies to be
competitive.
According to the same survey, cotton exporting countries in Africa, Asia and Latin
America have lower costs of production than industrial countries with the exception of
Australia.
Economic theory suggests that, in an open market, at the margin, cotton production is
determined by costs. Prices tend to follow the costs of most efficient producers, and it is
expected that, over time, those producers with higher costs would eventually reduce
production. Yet, the experience of recent years shows that this notion has been highly
distorted by government subsidies in the cotton market. There is really no rational
reason for a farmer to decrease cotton production or shift into profitable crops, in
response to lower cotton prices, if his or her revenues are guaranteed by government
aid.
This season, production in non-subsidized countries like Australia and Brazil, both
among the most efficient producers, declined by 12% and 20%, respectively. In Latin
America and the Caribbean production also declined, by 24% this season. In Africa,
cotton production has been stagnant since 1997/98 at 1.8 million tons. In South and
East Asia, excluding China (Mainland), production fell by 5%, from a peak of 5.5 million
tons in 1999/00.
These statistics suggest that prices are low even with respect to most efficient
producers worldwide. Indeed, the Cotlook A Index, a measure of international prices, fell
to 35 cents per pound in November 2001, at the height of the marketing season. While
production in most developing countries and Australia has declined, production
elsewhere has more than offset such declines, despite the severe weakness of prices.
Production has increased so much elsewhere in the world, that it reached this season a
record 21.2 million tons, after four years of prices below the long-term average.
Prices today are about 42 cents per pound, still 30 cents lower than their long-term
average. As indicated earlier, this is the fourth season that prices are below the longterm average of 72 cents per pound. Further, the ICAC estimates that prices are not
expected to fully recover in the next few years. Despite an expected reduction of 9% in
world production next season and a recovery in consumption to record highs, world
stocks are not expected to decline sufficiently to move prices substantially above
current levels. The ICAC expects that the Cotlook A Index is going to be still 10 to 20
cents below the long-term average in most years this decade.
Low prices today can be attributed to a combination of factors.
On the demand side, cotton consumption has been relatively weak during the last two
years due to lower world economic growth. Nonetheless, demand for cotton is
improving due to lower prices and promotion efforts. Other things being equal,
according to the application of the ICAC World Textile Model to over 40 years of data, a
20% decline in prices leads to a 1% increase in cotton consumption. Since December
2000, cotton prices have declined by 32%. Thus, cotton consumption, which remained
at about 19.8 million tons in the last two years, is expected to increase by 2.5% to a
record 20.4 million tons in 2002/03.
On the supply side, the development of new technologies, production in new cotton
areas, and the strength of the U.S. dollar, have contributed to the rise in world stocks.
Area dedicated to cotton from genetically engineered varieties increased from 2% of
world planted area in 1996/97 to 20% today. Genetically engineered cotton can lead to
higher yields by providing better pest protection, and to lower costs per hectare.
The development of new areas of cotton, particularly in Central Brazil and Eastern
Turkey, are also contributing to higher world cotton production. Brazilian production, for
example, has recently rebounded from a record low level of 300,000 tons in 1996/1997,
as a result of large private investments in high-tech production in a new production
frontier (with ideal soil, topography and rainfall combination). Growing domestic
consumption, which had not been met by domestic production since 1991, fueled these
investments. As a result, after 10 years of lagging behind, production met domestic
consumption once again in 2001, at 900,000 tons. In Turkey, new production in what is
known as the GAP region accounts today for over 50% of production in the country,
compared to just 25% in 1994/95.
Production has also been sustained in several countries where currency devaluation
with respect to the U.S. dollar has occurred. The decline of international cotton prices in
dollars has been mitigated by currency devaluation, and, thus, has alleviated the
income of producers in exporting countries in Africa and Latin America, as well as in
Australia. The CFA Franc, the currency of Francophone Africa, devalued by 32%
against the U.S. dollar between 1998 and 2001. The Brazilian real and the Colombian
peso devalued by 90% and 50%, respectively, during the same period. Similarly, the
Australian dollar fell in value by 16% against the U.S. dollar. This, of course, has
prevented production from falling further than it has in those countries.
Despite these market factors, the most dominant cause of low prices today seems to be
government measures on cotton production and trade.
The world cotton industry is viewed by many as one of the most transparent
international commodity markets. Indeed, the cotton market has never been involved in
a commodity agreement. Nonetheless, as shown in the ICAC report on Production and
Trade Policies Affecting the Cotton Industry, prepared for this conference, government
support programs are heavily affecting the cotton market. As indicated in that document,
today 73% of world production in 14 countries is under some form of direct income or
price support.
Most developing countries, in compliance with the Uruguay Round of negotiations that
resulted in the creation of the WTO, discontinued direct price or income support in
agricultural markets during the 1990s. However, lower cotton prices during the second
half of the decade, caused by the combination of factors described earlier, as well as by
well established subsidy programs in industrial countries and China (Mainland), moved
governments in developing countries to reinstate past subsidies. Brazil, Egypt, Mexico
and Turkey, countries that had discontinued their support programs during the mid
1990s, have had to implement some form of emergency assistance to growers in order
to help them cope with the situation. This season, six additional developing countries,
Argentina, Benin, Colombia, Côte d’Ivoire, India and Mali, had to resort to direct
assistance in order to avoid a total bankruptcy of the sector.
Nonetheless, the emergency assistance being provided by these ten developing
countries accounts for just 14% of assistance provided worldwide. The remaining 86%,
which amounts to $4.2 billion, is provided by three industrial countries and China
(Mainland). The United States and China alone, the world’s two largest producers,
account for 76% of the world’s cotton production subsidies and 100% of cotton export
subsidies. In dollar terms, it should be noted, cotton export subsidies pale by
comparison with domestic subsidies.
It is estimated by the Secretariat of the ICAC that a removal of direct subsidies
worldwide would have a net positive effect of 31 cents on average cotton prices this
season. In other words, in the absence of subsidies, average cotton prices would be 73
cents per pound, which is 74% higher than the 42 cents being realized this season.
Since, according to the ICAC, the econometric models used to calculate this subsidy
impact on prices already takes into account market factors, such as changes in demand
and in non-subsidized production, this impact of 74% on prices is net of most market
factors I have just discussed and thus almost entirely attributable to government
subsidies.
Through the Working Group on Government Measures, originated from a mandate from
the ICAC’s Plenary, several member governments of the ICAC have reported their
assessment of the injury caused by low cotton prices. Argentina estimates that lower
prices resulted in a decline of $225 million in gross revenue per year over the last three
years and that the country lost $500 million as a result of declines in exports related to
lower prices during the three-year period. Brazil estimates that the injury caused by low
prices this season alone is $640 million. In Colombia, the loss between 1991 and 2001
is calculated at $570 million and in India the loss in the value of production is estimated
at $1.3 billion this season.
The level of injury caused to producers and export dependent countries by the collapse
of cotton prices is particularly severe. According to ICAC estimates, the loss to the
economies of producing countries this season caused by the decline in nominal cotton
prices to their lowest level in three decades is $14 billion. The accumulated loss over
the last four seasons, from the same ICAC estimates, is $34 billion. Since these very
high numbers do not take into account losses in employment and in related industries,
these are still quite conservative estimates.
Ladies and gentlemen, in conclusion to the main question raised at the beginning of my
presentation, the recent dramatic decline in international cotton prices has a dominant
cause and, undoubtedly, it is not a market factor. I hope that the facts discussed here
today, have clearly established, to your satisfaction, that the decline in prices can
unquestionably be attributed, in its greatest measure, to government subsidies, to both
production and exports of cotton, in major producing countries. I would also hope to
have conveyed that the injury caused by these low prices to developing countries has
been significant.
The future, I am sorry to say, does not look any brighter on this matter. Recent
developments indicate that things are likely to get worse before they get any better. The
U.S. farm bill, for example, will make an additional $180 billion in subsidies available to
American farmers starting this season. Of those, according to the ICAC, based on
government disbursements in previous years, 36 billion could be paid to U.S. cotton
farmers over the next 10 years. If this continues, subsidy-free production in developing
countries will become less and less feasible, as long as the alternative is total
bankruptcy of those countries’ own cotton industries. Barring any significant change of
circumstances, I am sorry to say, the present trend is going in the opposite direction of
free and fair trade and towards increasing financial burdens for developing countries.
As I indicated earlier, developing countries are, in general, the most cost-efficient
producers of cotton and, as such, they are ready to compete fairly in the market place.
And they should be allowed to do so. What they cannot do and should not attempt do is
compete with developed countries’ Treasuries.
Ladies and gentlemen, there is a perverse cycle in motion playing havoc with the
markets. As all of us involved in cotton matters know, governments of the very top
producing countries are protecting their respective domestic producers from market
forces, through massive government subsidies, that are leading to higher world
production and, in turn, to lower prices and then again to even higher subsidies. For the
sake of a healthy world cotton industry and to alleviate the injury that is being inflicted
on the economies of developing countries, I strongly suggest that we work hard and
together at the regional and multilateral levels to ensure that these unfair practices are
terminated for good, in the shortest feasible time. Thank you.
NET COST OF PRODUCTION
(Selected Countries)
Cents/lb
70
35
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B
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F.
Sy
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0
COTLOOK A INDEX
US Cents per pound
120
100
80
60
40
20
80/81
84/85
88/89
92/93
96/97
00/01
DIRECT SUBSIDIES
TO PRODUCTION IN 2001/02
er
O
th
Eg
yp
t
il
ra
z
B
Tu
rk
e
y
a
di
In
EU
C
hi
na
(M
U
SA
L)
Billion U.S. dollars
2.5
2
1.5
1
0.5
0
INJURY CAUSED BY
LOW COTTON PRICES
(Selected Countries)
Country
Million U.S.
Dollars
Argentina
Brazil
Colombia
India
Uzbekistan
$1,175
$ 640
$ 570
$1,300
$1,479
Period
1999/00-2000/01
2001/02
1991-2001
2001/02
1998-2001