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Lecturer 10
Export Subsidies in Agriculture
WTO and Agricultural Export Subsidies
 An export subsidy is payment to firms for every unit exported (either a fixed
amount or a fraction of the sales price). Governments give subsidies to encourage
domestic firms to produce more in particular industries.
 Europe maintains a system of agricultural subsidies known as the Common
Agricultural Policy (CAP).
 Other countries maintain similarly generous subsidies. For example, the U.S.
pays cotton farmers to grow more cotton and subsidizes agribusiness and
manufacturers to buy the American cotton.
 Indirect Subsidies Included in the Hong Kong export subsidy agreement is the
parallel elimination of indirect subsidies to agriculture.
 Domestic Farm Supports Another item mentioned in the Hong Kong agreement
is domestic farm supports, which refers to any assistance given to farmers, even
if it is not directly tied to exports.
 Cotton Subsidies Finally, export subsidies in cotton received special attention
because that crop is exported by many low-income African countries and is highly
subsidized in the United States.
Other Matters from the Hong Kong WTO Meeting
 Issues related to export subsidies were also discussed at the 2005 Hong Kong
meeting, in addition to the elimination of the subsidies themselves. One of
these issues is the use of tariffs as a response to other countries’ use of
subsidies.
 Tariffs in Agriculture Export subsidies applied by large countries depress
world prices, so that exporting countries can expect tariffs to be imposed on
the subsidized products when they are imported by other countries.
 Issues Involving Trade in Industrial Goods and Services There was also an
agreement to discuss opening trade in service sectors, which would benefit the
industrial countries and their large service industries.
 Finally, there was agreement to allow 97% of imported products from the
world’s 50 least developed countries (LDCs) to enter WTO member markets
tariff-free and duty-free.
Developing Countries Split over WTO Farm Protection
 The world’s poorer countries are divided over proposals for a new global trade
deal
- Developing countries can declare products “special” to shield them from
full tariff cuts in the interests of food or livelihood security or rural
development.
 Speculation swirled in the WTO corridors that China would declare rice, cotton
and sugar special products, hurting rice exporters like Thailand and cotton
exporters from West Africa.
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Current proposals for the special safeguard mechanism would have seen 82
percent of China’s agricultural imports.
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Farmers in South Korea, along with those in Japan, Europe and the United States,
benefit from an intricate system of tariffs and subsidies that keeps prices for their
crops high, but in some cases, lowers prices in the rest of the world.
The lower world price hurts farmers in land-rich developing countries like Brazil,
India, China and some African nations (such as South Africa) by making it harder
for them to export their own agricultural products.
On the other hand, the lower world prices due to existing tariff and subsidy
regimes are a benefit to land-poor developing countries that import agricultural
products. As such, they will be hurt if prices end up rising due to agricultural
reforms in the WTO.
Many strong interests in many different countries must be balanced when
discussing each nation’s agricultural trade policies.
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Why countries subsidize some industries
 The primary reason that countries subsidize agricultural exports is political: such
subsidies benefit a group in society (farmers) that the government wants to
support.
 Some high-technology industries also receive generous subsidies. For example,
Airbus in Europe and Boeing in the U.S. have received various types of
government assistance. For high-tech industries, it is sometimes thought that the
use of export subsidies can give a domestic industry a strategic advantage in
international competition. That is, rather than being just politically motivated,
legislators often believe that subsidies to high-tech industries might raise their
profits and benefit the exporting country.
Export Subsidy
• Export subsidy is a payment by the government to a firm or individual that ships a
good abroad
• When the government offers an export subsidy, shippers will export the good up to
the point where the domestic price exceeds the foreign price by the amount of the
subsidy.
• An export subsidy unambiguously leads to costs that exceed its benefits.
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Agricultural Export Subsidies in a Small Home Country
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Exports rise as a result of the subsidy, from X1 to X2 in panel (b).
The Home export supply curve shifts down by exactly the amount of the subsidy
since the marginal cost of a unit of exports decreases by exactly s.
As in the case of a tariff, the deadweight loss as a result of the subsidy is the
triangle (b + d), the sum of consumer loss b and producer loss d.
Non-Tariff Barriers
Loss from subsidy in SOE
Fall in Consumer Surplus:
- (a +b)
Rise in Producer Surplus:
+ (a + b + c)
Payment by Gov’t for subsidy
- (b + c + d)
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Net effect on Home Welfare:
- (b+d)
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Agricultural Export Subsidies in a Large Home Country
Here an export subsidy raises prices in the exporting country while lowering them in the
importing country.
• In addition, and in contrast to a tariff, the export subsidy worsens the terms of trade.
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In the world market, the Home subsidy shifts out the export supply curve from X
to X − s, reflecting the lower marginal cost of exports.
 As a result, the world price falls from PW to P*. The Foreign country gains the
consumer surplus area e, so the world deadweight loss due to the subsidy is the
area (b + d + f).
 The extra deadweight loss f arises because only a portion of the Home terms-oftrade loss is a Foreign gain.
Loss from subsidy LOE
Fall in consumer surplus:
– (a+b)
Rise in producer surplus:
+(a+b+c)
Revenue cost of subsidy:
–(b+c+d+e)
------------------------------------------------------Net effect on Home welfare – (b+d+e)
Who Gains and Who Loses?
 We return to the agreements of the Hong Kong meeting of the WTO in December
2005 and ask: Which countries will gain and which will lose when export
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subsidies (including the “indirect” subsidies like food aid) are eliminated by 2013?
Gains Current agricultural exporters will gain from the rise in world prices as
agricultural subsidies by the industrialized countries—especially Europe and the
United States—are eliminated.
Losses The food-importing countries, typically the poorer non-food-producing
countries, will lose. This theoretical result is confirmed by several empirical studies.
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Food Aid Even though the proposals from the Hong Kong talks were never
ratified, and the Doha Round of negotiations is still ongoing, some recent progress
has been made toward the goal of replacing food aid with efforts to increase
production.
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Agricultural Production Subsidies
 Suppose the government provides a subsidy of s dollars for every unit (e.g., ton of
sugar in our example) that a Home firm produces.
 This is a production subsidy because it is a subsidy to every unit produced and not
just to units that are exported.
 There are several ways that a government can implement such a subsidy.
 The government might guarantee a minimum price to the farmer, for example,
and make up the difference between the minimum price and any lower price for
which the farmer sells.
 Alternatively, it might provide subsidies to users of the crop to purchase it, thus
increasing demand and raising market prices; this would act like a subsidy to
every unit produced.
Production Subsidies in Agriculture
 The agreements reached in Hong Kong distinguish between export subsidies in
agriculture – which will be eliminated – and all other forms of domestic support.
 The reason this distinction is made is that other forms of support in agriculture are
expected to have less impact on exports than do direct subsidies. Therefore, there
is less impact on other countries from having domestic support programs when
compared to export subsidies.
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Suppose that the government provides a subsidy of s dollars for every unit (e.g.
ton of sugar in our example) that a Home firm produces.
This is a production subsidy because it is a subsidy to every unit produced, and
not only to units that are exported.
ways that a government can implement such a subsidy:
o guarantee a minimum price to the farmer and make up the difference
between the minimum price and any lower price that the farmer sells for.
o provide subsidies to users of the crop to purchase it, thus raising market
prices and acting like a subsidy to every unit produced.
These policies all fall under Article XVI of the GATT - partner countries should
be notified of the extent of such subsidies, and where possible, they should be
limited.
In HK, the WTO members further agreed to classify countries according to the
extent of such subsidies, with the EU classified as having a high level of
production subsidies, the U.S. and Japan having a middle level; and all other
countries having low subsidies.
Future discussion will determine the timing and extent of cuts in these production
subsidies.
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Effect of a Production Subsidy in a Small Home Country
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Applying a production subsidy of s dollars per unit produced will increase the price
that Home firms receive from PW to PW+s.
This price rise leads to an increase in Home supply from S1 to S2.
The consumer price at Home is not affected, and neither is demand, which stays at
D1.
DWL of the subsidy for a small country is the area c.
Exports rise due to the production subsidy, from X1 to X2 in panel (b), though the
increase in exports is less than for the export subsidy.
Home Welfare:
Change in consumer surplus: none (because demand is not affected)
Rise in producer surplus:
+(a+b)
Revenue cost of subsidy:
– (a+b+c)
--------------------------------------------------Net effect on Home welfare – c
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Effect of a Production Subsidy in a Large Home Country
If we drew a downward sloping Foreign import demand curve in panel (b), then the
increase in supply due to the production subsidy would lower the world price. But that
drop in world price would be less than the drop that occurred with the export subsidy
because the increase in exports under the production subsidy is less.
Notice that the rise in the quantity of exports due to the production subsidy, from point B
to C in Figure 10-4, is less than the increase in the quantity of exports for the export
subsidy, from point B to C shown in Figure 10-1.
With the export subsidy, the price for Home producers and consumers rose to PW + s, so
exports increased because of both the rise in quantity supplied and the drop in quantity
demanded. As a result, the export subsidy shifted the Home export supply curve down by
exactly the amount s in Figure 10-1. In contrast, with a production subsidy, exports rise
only because Home quantity supplied increases so that export supply shifts down by an
amount less than s in Figure 10-4.
If we drew a downward-sloping Foreign import demand curve in panel (b), then the
increase in supply as a result of the production subsidy would lower the world price. But
that drop in world price would be less than the drop that occurred with the export subsidy
because the increase in exports under the production subsidy is less.
To sum up, production subsidies in agriculture still lower world prices, but they lower
prices by less than export subsidies. That is the reason that the WTO is less concerned
about eliminating production subsidies and other forms of domestic support in
agriculture. These policies have a smaller impact on world prices, and as we have also
shown, a smaller deadweight loss as compared to that of export subsidies.
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Other Trade Policy Instruments
 Export credit subsidies
• A form of a subsidized loan to the buyer of exports.
• They have the same effect as regular export subsidies.
 National procurement
• Purchases by the government (or public firms) can be directed towards
domestic goods, even if they are more expensive than imports.
 Red-tape barriers
• Sometimes governments place substantial barriers based on health, safety and
customs procedures.