Farm Programs and the
Economics of LDC Cotton
Presented at the
“International Conference on Cotton:
The Next Steps for Africa”
Woodrow Wilson Center, Washington DC
October 26, 2006
Daniel A. Sumner*
*University of California Agricultural Issues Center and
Department of Agricultural and Resource Economics, U.C. Davis
Focus
U.S. cotton subsidies depress world prices
and thereby hurt some very poor exporters of
cotton
It is important to understand why and how
much
What is happening to reduce or eliminate
these adverse effects
What more can be done
Three Cotton Subsidy Proceedings
Converge
• Brazil won its WTO cotton dispute on US cotton
subsidies, but the US is resisting implementation
– (This may not be in the overall interest of the US, but not a
surprise)
• The African cotton initiative of the Doha
Development Agenda negotiations depends in part
on the fait of the DDA
– But it can keep the pressure on the US and compensation
does not depend on the DDA
• The next US farm bill may make major subsidy
changes and can be a vehicle for additional cotton
subsidy reductions, after the WTO dispute
implementation
Why Cotton?
• It is natural that cotton has been highlighted in
both a Doha Initiative and WTO litigation as well
and US domestic pressure for reform
 Cotton has very high subsidies in the United
States, even relative to other subsidized crops
 United States has a big market share and a major
influence on world markets
 LDC farmers are significant exporters of cotton
and have suffered from price suppression caused
by subsidies
Cotton Clarifications
• Subsidies is not all there is in the cotton market. The
weather and other factors affect year to year fluctuations
and some trends.
• But, underlying all this, the subsidies keep US production
high and prices lower than the would be, especially in
years when low prices are already expected.
• Every study finds that cotton subsidies drive down world
prices. Some studies find very, very high effects of
subsidies. Others find implausibly low subsidy impacts
by only looking at a subset of subsidies or by looking at
years when high prices are already expected, or by
assuming almost all the adjustments happen in quantities
and not price.
• The bottom line, most plausible (and modal) estimates are
for substantial subsidy effects on world price.
US Farm Subsidies: Costly and Complex
• US subsidies comprised an array of programs
• Total value of subsidy varies inversely with price …
For cotton often roughly equal to the market value of
the crop $2 to $4 billion mostly tax financed.
– Marketing loan… payments on all production
– Direct payments… on historical (updated) base with some
planting restrictions
– Counter-cyclical payments…tied to price and paid on
historical (updated base) with restrictions
– Crop insurance subsidies
– Export credit guarantees for buyers of US cotton
• Focus here on the first three “farm bill” subsidies
Government Cotton Payments under the
2002 Farm Bill
Government cotton payments average about half of total
revenue for cotton farms
Target
Price – $0.724
CCP
Loan
Rate – $0.52
Market Price
Fixed payment – $0.0667
MLG/LDP
Market Receipts
}
}
Do not have to currently
produce cotton to get these
payments
}
Paid per unit of production
of cotton
(Based on a figure from Joe Outlaw Texas A&M)
Budget for Commodity Subsidies
Commodity
Share of Subsidy
Outlays
(Varies by Year)
Share of
production value
Feed grains
50%
13%
Soybeans
10%
9%
Wheat
10%
4%
Cotton
12%
3%
Rice
7%
1%
Dairy
3%
10%
Other commodities
4%
60%
Determinants of Policy Effects on World Price
1. Cotton programs provide substantial revenue that
is linked to production incentives.
 Subsidy share of revenue (about 50% for cotton in
many years)
 Degree of subsidy linkage (see subsequent slide, high for
cotton, but less for some subsidy types than others
2. Supply response in US to fall in expected per acre
revenue, large because removing subsidy would
remove 35% to 40% of effective revenue (drive
revenue below variable costs)
 The Cotton Council is right, many US cotton growers
need these subsidies to stay in the cotton business!
Determinants of Policy Effects on World Price
3. US share in world markets (40% of exports and
20% of world production)
4. Supply response and price transmission into other
countries (Likely to be small among major
producers, but not everywhere)
 The bigger the supply response the more
production growth in other countries and smaller
overall price jump
5. Demand response to price (Limited…cotton is a
unique input for many uses
Effects of Complex Subsidies:
expectations, insurance and “decoupling”
• Impacts of price contingent cotton subsidies depend
on expected price
• Expected marketing loan benefits are directly tied to
production and offset low prices. They naturally
boost production
• Some payments are not tied directly to current
production but are not divorced from production
incentives. They are not fully “decoupled”:
– Bankers more willing to finance the crop, if
grower has guaranteed cash flow
– Growers are restricted on what they can plant
– Updating…expectation that future subsidy is tied
to current production
– Counter-cyclical payments…a price hedge
Ratio of Subsidy to Value of Production
100.0%
90.0%
80.0%
2004
70.0%
2005*
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
Corn
Wheat
Cotton
Rice
Soybeans
Share of total subsidy from each program, 2005
(LDP, and CCP have largest production incentives)
Crop/program
Direct P.
CCP
LDP
Crop Ins.
(% of total subsidy for each crop)
Corn
20
32
44
4
Soybeans
57
1
2
40
Wheat
74
0
1
25
Rice
66
8
25
1
Cotton
(w/o step 2)
19
42
39
0
World Market Shares, 2005
Crop
Production
Exports
(%)
Corn
42
60
Soybeans
40
30
Wheat
12
31
Rice
2
11
Cotton
20
41
Effect of Removing Cotton Subsidy
• If we put these factors into a simulation
model to see the magnitudes we find large US
and world market impacts of removing US
cotton subsidies
• Effects would vary by year, but US
production would be 20% lower or more and
US exports fall by more
• World price would be higher by about 10%
• This price increase encourages more
production and exports from LDC producers
WTO in Geneva influences US policy
and the US influences the WTO
For farm groups in the US the WTO
seems foreign, while to developing
countries it seems based on US power,
practices and procedures
Litigation continues to be important
• It did not take much actual litigation to get
lots of attention
• One or two WTO cases, not even yet
implemented
• But, influential players (including chairs of
major committees and the Secretary of
Agriculture) rank WTO disputes as a major
driver for change in US farm subsidies
• Those writing the farm bill want to comply
with obligations and avoid more cases
WTO Implications of Litigation
• Affect process of negotiation and
agreement…more attention to specific wording
• Some implications of definition of colored boxes…
• Pressure for rules that can be predictably binding
• Credibility of WTO in small and developing
countries increased with successful developing
country cases (cotton, sugar)
• There may be additional cases, but these are hard
to develop
– Success is not a “slam dunk”
Cotton Dispute and African Cotton
Negotiation Initiative are Complements
• Efforts from Africa and other developing countries
can influence the degree of implementation
• The African Initiative can help keep the Doha round
alive, by emphasizing that the WTO can be a big win
for the poor as well as the “rich”
• The African Initiative can continue to point out that
US subsidies have unintended consequences
• Compensation for past losses still an issue that have
not been seriously dealt with
Bottom Line Effects of Removing
Cotton Subsidies
• Average gain from elimination of US subsidies
would be about $0.05 per pound
• Raise annual revenue by about $75 to $100
million or more in the C-4 countries alone
• Additional gains throughout the system
(multipliers) plus dynamic economic stimulus
• A huge benefit to some very poor people
• Challenge: insure that benefits go to growers.
Thank You
For detailed analysis, my background paper
should be available soon from the IPC
To contact me directly
dasumner@ucdavis.edu
www.aic.ucdavis.edu