Greening
farm subsidies
The next step in
removing perverse
farm subsidies
Greening farm subsidies
When a government policy is damaging both
the environment and the economy, it should be
obvious that such a policy needs reform. This
is the case with many agricultural subsidies.
However, governments around the world have
so far failed to tackle this problem, even
though the harm farm support does to an
economy has long been recognised. Now there
is growing recognition of the environmental
cost of farm subsidies. This has led to an
emerging alliance of interests keen to see
comprehensive reform.
2003
To this end, the Rural Industries Research
and Development Corporation and the
World Wide Fund for Nature (www.wwf.org.au)
have asked the Centre for International
Economics (www.thecie.com.au) to asses
why perverse agricultural subsidies persist
and how they can be removed. This study has
been published by RIRDC as part of its Global
Competitiveness R&D Program. Additional
copies of this publication may be obtained
from RIRDC by visiting their website
(www.rirdc.gov.au).
CENTRE FOR
INTERNATIONAL
ECONOMICS
RURAL INDUSTRIES RESEARCH
& DEVELOPMENT CORPORATION
RIRDC Publication No. 03/040
Greening
farm subsidies
The next step in
removing perverse
farm subsidies
2003
Greening
farm subsidies
The next step in
removing perverse
farm subsidies
2003
Prepared by
John Humphreys, Martin van Bueren and
Andrew Stoeckel
Centre for International Economics
RIRDC Publication No. 03/040
© Rural Industries Research and Development Corporation 2003
This publication is copyright. However, RIRDC encourages wide
dissemination of its research, providing the Corporation is clearly
acknowledged. For any inquiries concerning reproduction, contact
RIRDC’s Publications Manager.
ISBN 0 642 58608 X
ISSN 1440-6845
RIRDC Publication No. 03/040
RIRDC Project No. CIE-16A
Published by
Rural Industries Research and Development Corporation
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Barton ACT 2600
PO Box 4776 Kingston ACT 2604
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FOREWORD
W
hen countries are striving to achieve economic and
environmental goals politicians often have to make
difficult decisions involving trade-offs. However, no such
trade-offs are required when the decision is made to
remove perverse agricultural subsidies. Their removal
serves the interests of both economic development and the
environment. This publication presents a study of this
‘win–win’ reform.
Agricultural subsidies and their effect on economic efficiency
have long been of interest to RIRDC. This study is part of
RIRDC’s Global Competitiveness Research and Development
Program, which aims to identify important impediments to
the development of a globally competitive Australian agricultural sector and support research that will lead to
strategies for removing these impediments.
In the case of perverse subsidies — subsidies that have
negative effects on both the economy and the environment
— the interests of RIRDC dovetail with the interests of the
World Wide Fund for Nature (WWF).
WWF is committed to sustainable development and preserving our natural resources. Many agricultural subsidies
result in overproduction and inappropriate use of resources.
Removing such subsidies would provide a dividend to our
environment.
iii
FOREWORD
This publication, prepared by the Centre for International
Economics (CIE) on behalf of RIRDC and WWF, discusses
perverse agricultural subsidies and how they can be addressed.
As outlined in a previous RIRDC publication, Solving the
Problem: A Look at the Political Economy of Agricultural Reform,
reforming agricultural subsidies means solving a political
problem as there are powerful political forces that resist the
required reform. This book highlights the environmental
benefits from reform and attempts to draw out the
coalition of interests between groups promoting economic
development and those dedicated to protecting the
environment.
Not only are the common interests of these groups highlighted in this study, but a way forward that could see
meaningful change is articulated.
Simon Hearn
Managing Director
Rural Industries Research and Development Corporation
Ray Nias
Director of Conservation
World Wide Fund for Nature
iv
CONTENTS
Foreword
iii
Acknowledgments
vii
Summary
ix
1 Why examine perverse subsidies?
Win–win reforms
Roadblocks to reform
How to move forward
2 How concerned should we be?
The nature and scale of subsidies
Environmentally harmful subsidies
The economic cost of subsidies
The benefits from curbing perverse subsidies
3 Case studies of perverse subsidies
Better farming and environment without the cost
of subsidies
Underpricing water to everyone’s detriment
Supporting sugar at the expense of the Florida
Everglades
Pigging out on pig subsidies
4 Do subsidies have a role to play?
To alleviate poverty
To ensure adequate food supplies
To encourage industry
To level the playing field
To address market failure
To maintain the multifunctionality of agriculture
1
1
6
7
10
10
20
24
29
32
32
35
39
41
43
43
45
48
49
50
53
v
CONTENTS
5 How can we distinguish the good from the
bad?
Testing the subsidy
Assessing the subsidy
6 What alternatives are there to subsidies?
Improve the targeting of subsidies
Use alternative policy instruments
Promote economic growth and development
7 The next step
Establish an organisation for reform
Establish a framework for assessing subsidies
Implement reform and address adjustment issues
57
57
60
63
64
66
71
74
75
76
79
Boxes, charts and tables
1 Identifying the subsidy
2 Estimated active agricultural support in
perspective
3 Percentage PSEs for the OECD, the United States
and the European Union
4 Percentage PSE for New Zealand, Australia and
Canada
5 The mix of highly distorting and less distorting
subsidies in OECD countries, 2001
6 Economic benefit from free trade in agriculture
7 The switch between sheep and private forests in
New Zealand
8 Increasing water price for Australian rice farmers
9 Testing the subsidy’s relevance and identifying
its impacts
10 Identifying the positive and negative impacts
11 Analysing the subsidy’s costs and benefits
12 Environmental Kuznets curve
13 Decision framework at a glance
vi
11
16
18
18
19
29
34
39
58
59
61
72
77
ACKNOWLEDGMENTS
T
he authors wish to acknowledge the helpful comments
from Warwick Moss (WWF), Jeff Davis (RIRDC), Ivan
Roberts (Australian Bureau for Agricultural and Resource
Economics), Hannah Parris (Environment Australia) and
George Mina and David Morgan (Department of Foreign
Affairs and Trade). In addition, this book would not have
come together without the help provided by Kirsten Oliver
and Judy Fenelon.
vii
SUMMARY
E
ach year about US$600 billion is given as subsidies to
farmers around the world. Most of these subsidies are
provided by governments in rich economies, particularly
the United States, the European Union and Japan.
About 80 per cent of these subsidies are perverse. Not only
do they damage the environment, they also harm the
economies of those giving the subsidies as well as the
economies of other countries.
Agricultural subsidies have become so big that they have
‘poisoned’ international trade talks. Agriculture is the
sticking point in the World Trade Organization’s Doha
round of trade talks, and the impasse that has developed
midway through the talks threatens to jeopardise progress
towards a more effective international trading order.
The environmental damage caused by agricultural subsidies
includes water pollution from excess nutrient run-off,
acidification of poorly buffered natural habitats, loss of
biodiversity, and soil erosion. From prawn fishers in the
Gulf of Mexico to rice farmers in Indonesia, the environmental damage caused by perverse agricultural subsidies is
extensive, pervasive and widely reported.
The economic harm these subsidies cause to rich and poor
countries alike is also just as pervasive and just as widely
documented. Equally as well reported are those rare cases
where agricultural subsidies have been removed — to the
benefit of both the environment and economies.
ix
SUMMARY
So why do these subsidies prevail? Why, in an era of
sensitivity to the environment and the rising political
strength of the green movement, do governments knowingly
encourage damage to the environment and harm economic
growth?
What is missing is good public governance and scrutiny of
these subsidies. Good governance by policy makers dictates
that farm policies be evaluated for their benefits and costs
— environmental, social and economic — and these
appraisals be conducted in an open and transparent way by
an independent body. This is rarely done.
The nature of each subsidy, its objectives and the reasons
for its introduction need to be understood. In short, what is
required is a process by which the subsidies that do so
much harm to both the environment and economies are
separated from those whose benefits exceed their costs.
The framework and elements of such a process are spelt
out in this study.
Agricultural subsidies are either good or bad: either the
benefits exceed the costs (broadly measured), or they do
not. Negotiating over bad subsidies will not make them
good. If a subsidy has net benefits, it can be retained. If it is
harmful to the economy and the environment, it should be
abandoned.
If green organisations around the world could convince
governments to pursue the principles of good governance
and subject agricultural subsidies to an independent
systematic review process such as that outlined here, the
result would be fewer harmful subsidies and consequently
healthier environments and more prosperous economies —
a win–win situation.
x
1 WHY EXAMINE
PERVERSE SUBSIDIES?
T
he issue of agricultural subsidies is large and complex
— large to the tune of up to US$600 billion a year
worldwide1, and complex because of the many and varied
effects that these subsidies have on economies, societies
and the environment.
It is the environmental and economic effects that are the
focus of this study. A report by the International Institute
for Sustainable Development (IISD) estimates that up to
80 per cent of agricultural subsidies are ‘perverse’ 2 — they
are damaging to both the economy and the environment.
Updating the IISD study with 2001 data3, we estimate that
around US$460 billion is spent every year on agricultural
(excluding water and fisheries) subsidies that encourage
environmental damage.
Win–win reforms
With so many perverse agricultural subsidies in the world,
there is potential for ‘win–win’ reforms, where the removal
1 Based on CIE calculations detailed in chapter 2 of this book.
2 N Myers and J Kent, Perverse Subsidies: Tax $s Undercutting Our Economies and
Environments Alike, International Institute for Sustainable Development, Canada,
1998.
3 Since 1998 the percentage of ‘highly distorting’ subsidies has declined from
80 per cent to 77.6 per cent cacording to the OECD (Organisation for
Economic Cooperation and Development, Agricultural Policies in OECD
Countries: Monitoring and Evaluation, CD-ROM, Paris, 2002).
1
GREENINGfarmSUBSIDIES
of subsidies results in gains for both the environment and
the economy. This potential has not gone unnoticed by the
environmental movement. In the United States a
consortium of groups concerned about the environment
and public governance has initiated a program called
‘Green Scissors’.
Green Scissors includes groups such as Friends of the
Earth, Taxpayers for Common Sense and the Wilderness
Society, among many others. In the introduction to its 2002
report, Green Scissors declares that:
As a defender of American taxpayers and the environment,
the Green Scissors Campaign is standing up to polluting
interests and fighting to cut wasteful and environmentallyharmful spending.4
Over the past five years, virtually every major international
environmental non-government organisation has contributed
to the literature on perverse subsidies. Examples include
publications by the Earth Council, Resources for the Future,
Greenpeace International, IISD, Worldwatch Institute,
WWF and the International Union for Conservation of
Nature.5 In addition to the many environmental nongovernment organisations, the OECD, the United Nations,
4 Green Scissors Campaign, Green Scissors 2002: Cutting Wasteful and Environmentally
Harmful Spending, San Francisco, 2002, p. 1.
5 See, for example, A De Moor and P Calamai, Subsidizing Unsustainable
Development: Undermining the Earth with Public Funds, Earth Council, San Jose,
Costa Rica, 1997, C Fischer and M Toman, Environmentally- and EconomicallyDamaging Subsidies: Concepts and Illustrations, RFF Climate Issue Brief #14,
Internet Edition, Resources for the Future, Washington, DC, 1998,
http://www.rff.org/issue_briefs/PDF_files/ccbrf14_rev.pdf, Accessed 14
February 2003, and RP Steenblik, Subsidy reform: doing more to help the
environment by spending less on activities that harm it, Paper presented at
International Union for the Conservation of Nature’s (IUCN) 50th
Anniversary, Fontainebleau, France, November 1998. The WWF’s campaign
on fishing is chronicled in its website <http://panda.org/stopoverfishing>.
2
1 WHYexamineSUBSIDIES?
the World Bank, the World Trade Organization and many
economists and policy analysts have undertaken research
into the problem of perverse agricultural subsidies. This
research has identified many examples of perverse
subsidies. 6
§ In Europe, Japan and Korea in 2001 governments
provided over US$7.3 billion in support to pig farmers7,
which contributes to water pollution in those countries
and distorts trade and production.
§ In the United States the government provides price
support to sugar farmers so that the US price of sugar is
more than double the world price. This has resulted in
increased sugar production and consequently higher
phosphorous levels in the Florida Everglades, leading to
a reduction in biodiversity.
§ In New Zealand farm subsidies were encouraging
farmers to use marginal lands, use too much fertiliser
and pursue inefficient production methods. When subsidies were removed, fertiliser use decreased, trees were
replanted on marginal lands and efficiency improved so
much that farmers are now making more money using
fewer natural resources.
§ In Indonesia pesticide subsidies encouraged the use of
pesticides. This resulted in the killing of the natural
predator of the brown rice plant hopper. In two years,
the bug ruined some US$1.5 billion worth of rice.8
§ In the European Union subsidies have contributed up
to 73 per cent of cattle farming incomes9, which has
6 References for some of the following examples can be found later in this book
where they are discussed in greater detail.
7 OECD, Agricultural Policies in OECD Countries: Monitoring and Evaluation, CDROM, Paris, 2002.
8 De Moor and Calamai, p. 27.
9 OECD, Agricultural Policies in OECD Countries: Monitoring and Evaluation 2003,
Paris, 2003, p. 36.
3
GREENINGfarmSUBSIDIES
encouraged more intensive livestock production. The
most cost-effective additional food source for the
animals was often meat-based supplements 10, and so
intensified farming resulted in carnivore cows. As cows
fed on other cows, bovine spongiform encephalopathy
(BSE) or ‘mad cow’ disease quickly spread.
§ In the United States farmers receive considerable
subsidies to grow corn, but not to grow alfalfa (which
requires the use of less nitrogenous fertiliser). So more
corn is produced. The water pollution from corn
producers in the Midwest is being held responsible in
large part for the ‘dead zone’ in the Gulf of Mexico —
an expanse of water completely devoid of life to about
3 metres below the water’s surface due to toxic green–
blue algae.11
§ In Myanmar the government effectively subsidises
farming by transferring land ownership to people who
put land to productive use. This has encouraged forest
clearing.12
§ Worldwide the total value of water subsidies is
estimated to exceed US$200 billion a year. Water is
underpriced and so it is wasted. This results in higher
levels of water pollution, erosion and salinity. On a
global scale the current wastage of water may prove
unsustainable in the future as an increasing population
demands more water.
§ When Icelandic fishers did not pay for the fish they
caught they were effectively receiving a subsidy. That
subsidy resulted in overfishing and consequently to a
10 It should be noted that the price of grains was inflated due to grain subsidies,
which increased the relative cost-effectiveness of meat-based food sources —
another perverse outcome from a subsidy.
11 The Economist, ‘The dead zone’, 24 August 2002, p. 28.
12 TR Young, Examples of Various Kinds of Incentives and Disincentives, IUCN
Environmental Law Center, Bonn, 2001.
4
1 WHYexamineSUBSIDIES?
dwindling stock of sea life. Since introducing a system
that puts a value on fish catches (effectively abolishing
the subsidy), fish exploitation has declined and economic
efficiency has improved.13
§ In Tunisia subsidies have promoted the intensification
of livestock production (primarily of sheep and goats)
and have kept livestock numbers above the appropriate
carrying capacity of the land. This overstocking has led
to a deterioration of Tunisia’s rangelands, which make
up nearly 20 per cent of the country’s total land area.14
§ In China fertiliser subsidies have contributed to
increased fertiliser use, which has been held responsible
for half of the local groundwater stocks being contaminated above the tolerance level. 15
§ In the Netherlands subsidies support its large dairy
herd16, which is the main agricultural cause of nitrate
and phosphate-based water pollution and ammoniabased acidification of poorly buffered natural habitats.
§ In the United Kingdom subsidies contribute to more
intensive agriculture, which has negatively affected several
species of upland birds and ground-nesting birds.17
13 B Runolfsson and R Arnason, ‘Evolution and performance of the Icelandic
ITQ system’, Icelandic Economic Papers (University of Iceland), February 1996,
http://www.hi.is/~bthru/iceitq1.html, Accessed 17 February 2003, and
B Runolfsson, ‘Fencing the oceans: a rights-based approach to privatising
fisheries’, Policy (Centre for Independent Studies of Sydney), Autumn 1998,
http://www.cis.org.au/Policy/autumn98/aut9804.htm , Accessed 17 February
2003.
14 Z Partow, and S Mink, ‘Tunisia: livestock policies and environmental impacts
during economic adjustment’, in W Cruz, M Munasinghe and JJ Warford
(eds), The Greening of Economic Policy Reform, World Bank, Washington, DC,
1997, pp. 165–88.
15 Myers and Kent, p. 44.
16 D Abler, A synthesis of country reports on jointness between commodity and
non-commodity outputs in OECD agriculture, Paper prepared for the OECD
Workshop on Multifunctionality, Paris, 2–3 July 2001.
17 Abler, p. 20.
5
GREENINGfarmSUBSIDIES
§ In North America pesticide use, which is subsidised by
government, is considered to be a factor in the decline
in the populations of honeybees and other pollinators. 18
Roadblocks to reform
Despite efforts to expose the environmental and financial
costs of subsidies, agricultural subsidies remain as high as
ever, with 30 per cent of farm revenue in OECD countries
coming from government subsidies.19 Even in Germany,
where a member of the Green Party is now Minister for
Consumer Protection, Nutrition and Agriculture, there is
little momentum towards reform. There are a variety of
reasons for the persistence of subsidies.
§ Industries that enjoy support are reluctant to give it up.
§ Views on the role of government in particular sectors
are entrenched — for example, the public financing of
irrigation and drainage.
§ Subsidies themselves create a pool of money that
recipients can use to influence the political process that
channels money to them in the first place.
§ Bureaucracy itself can be an obstacle. Government
departments and agencies have vested interests in maintaining industrial support programs.
§ Countries are unwilling to be the ‘first mover’ in dismantling subsidies, as they believe this could put them
at risk of being uncompetitive with countries that opt to
maintain support programs.
§ People working in subsidised industries can become
‘trapped’ because they have specialised skills and cannot
be readily re-employed in other industries. The low
mobility of the affected labour force itself becomes a
18 Abler, p. 20.
19 OECD, Agricultural Policies in OECD Countries, 2002, p. 163.
6
1 WHYexamineSUBSIDIES?
barrier to reform, making structural adjustment painful
and politically unpopular.
§ People may have an inherent opposition to change and
a fear of the unknown consequences of reform.
Over time it is common for a complex web of subsidy
programs to develop, often with one subsidy being used to
compensate producers or consumers for the disadvantages
caused by another subsidy applied elsewhere. Instead of
addressing the cause of the problem, policy makers often
use band-aid solutions such as more subsidies or costly
clean-ups.
How to move forward
In all but a handful of countries, progress towards agricultural subsidy reform has been modest. Despite overwhelming evidence of the effects of perverse subsidies, they
are not being removed. The problem is political — the lack
of an appropriate organisation armed with a transparent
framework and a mandate to review and reform agricultural
subsidies.
For countries to reap the benefits of agricultural subsidy
reform, good institutions (the organisation, framework and
mandate) need to be established to impose discipline on
governments. Their mandate should be to review all agricultural subsidies with a view to abolish bad subsidies for
economic and environmental gain. Their framework should
help to systematically identify bad subsidies, identify
alternative ways to achieve social goals, and identify
mechanisms for smoothly dismantling bad subsidies.
This study proposes a way forward in establishing such
institutions and thereby improving public governance. In so
doing, it provides ammunition for green groups and others
7
GREENINGfarmSUBSIDIES
who are interested in fighting against perverse agricultural
subsidies.
We start out by defining the various forms of subsidy given
to agriculture and diagnose how they ultimately damage the
environment and distort economic activity. A compelling
case is made for addressing perverse subsidies and taking
steps to remove them. We examine a number of cases where
subsidies are causing significant environmental, economic
and social costs — for the benefit of a privileged few. We
also note some situations where the removal of agricultural
subsidies has led to better environmental and economic
outcomes.
The report then summarises the various reasons advanced
for maintaining agricultural subsidies. We consider how
robust these reasons are, pointing out weaknesses in some
of the arguments. Not all subsidies are perverse, and we
explore the circumstances where there may be a role for
subsidies.
To determine whether a subsidy is good or bad requires
some sort of ‘benefits test’. Subsidies can be put through a
screening process that assesses their benefits and their costs
and allows us to identify subsidies that should be reformed
or removed. If a subsidy is in place for a good reason and
passes the benefits test, it could be maintained.
For that to be so, however, yet another hurdle has to be
cleared. While there may be a good reason for maintaining
a subsidy — say, to meet an environmental objective — it
is possible that an alternative policy could achieve that
objective at a lower cost. We explore several alternatives
that can be pursued to achieve environmental, social and
economic objectives without the problems associated with
subsidies.
8
1 WHYexamineSUBSIDIES?
We conclude the report by discussing the institutional
arrangements required to address and progress agricultural
subsidy reform.
The key to achieving lasting reform is to introduce political
discipline and good public governance. This can be
achieved by having a dedicated organisation with a mandate
for reform and a transparent framework. This is likely only
if there is a degree of political pressure from interest groups
and the community.
9
2 HOW CONCERNED
SHOULD WE BE?
A
gricultural subsidies transfer wealth from one or more
groups in society to farmers. These transfers are
through either direct intervention by governments or less
transparent, indirect means.
In many instances, transfers are a result of well-intended
policies to assist an ailing rural economy. However, subsidies
mostly induce unwanted side effects. These effects include
environmental damage, economic inefficiencies and ongoing
burdens on the taxpayer and/or the consumer. Often these
costs are not explicit and are therefore poorly understood
by governments.
This chapter outlines the various types of subsidy and
highlights the estimated cost of global agricultural support.
The case for eliminating perverse subsidies is then made.
The costs of these subsidies, which cause both economic
and environmental harm, are too large to ignore. And the
benefits of tackling this problem are demonstrably real, as
highlighted in examples of the environmental and economic
benefits resulting from perverse subsidies being removed.
The nature and scale of subsidies
The most obvious forms of agricultural subsidy are those
that involve direct monetary payments by governments to
farmers. However, there are many other forms of subsidy,
10
2
How CONCERNEDshould we be ?
some of which are quite subtle, but nevertheless important
to consider because of the costs they impose.
To measure a subsidy, it is necessary to have a benchmark
— the situation in an undistorted market. A subsidy
changes incentives and causes people to do things differently
from what they would do in an undistorted market. Chart 1
shows the process for identifying subsidies, which is a
necessary precursor to any attempt at evaluating them.
The nature of subsidies enables them to be categorised into
two broad groups: active and passive. Active subsidies
result from direct government intervention. Passive subsidies
arise from the failure of governments to price resources
correctly. An example of a passive subsidy to farmers is the
1
Identifying the subsidy
What are the benchmarks?
§ Prices in a competitive world market
should equal the cost of production
Is the industry being subsidised?
§ Distorted product price
§ Reduced input costs
No
Analysis complete
Yes
What is the nature of the subsidy?
§ Active — government intentionally
Passive
transfers funds to producers
§ Passive — government fails to price
natural resources correctly
Explore ways to
price resources
correctly
Active
What type of subsidy is it?
§ Provides direct financial support
§ Increases farm revenue
§ Decreases farm costs
11
GREENINGfarmSUBSIDIES
pricing of irrigation water below the cost of supply — a
common occurrence in many countries.
Active agricultural subsidies
An active agricultural subsidy is any form of government
intervention that directly supports agricultural producers. In
OECD countries total ‘active’ support to agriculture in
2001 amounted to US$311 billion, 1.3 per cent of OECD
gross domestic product (GDP).20 Together with subsidies
in developing countries, the total may be more than
US$350 billion.21
There are three broad types of active subsidy — direct
financial transfers and tax concessions that boost farmers’
incomes, government intervention that increases farm
revenue (the income received from product sales) and
government intervention that reduces production costs.
Direct financial transfers
The most transparent support for farmers is direct
government transfers. Such transfers include direct payments
as well as preferential taxation treatment. Direct payments
to farmers in OECD countries in 2001 amounted to
US$85 billion. 22
These forms of subsidy are frequently linked to the level of
farm output or to the amount of inputs used. From an
environmental perspective, subsidies linked to production
have the most potential to result in environmental
degradation through overproduction. In OECD countries
20 OECD, Agricultural Policies in OECD Countries, 2002, p. 176.
21 Myers and Kent, p. 43, point out the difficulty in determining the exact level
of support in developing countries, but suggest a realistic ‘guesstimate’ of at
least US$50 billion.
22 OECD, Agricultural Policies in OECD Countries, 2002, p. 158.
12
2
How CONCERNEDshould we be ?
payments based on outputs or inputs used amounted to
nearly US$34 billion (40 per cent of direct financial
transfers) in 2001. Subsidies based on area planted or
animal numbers maintained totalled US$29 billion (34 per
cent of direct financial transfers) in OECD countries.
Subsidies are also linked to farm processes. Support has
been provided to farmers on the condition that they do not
farm or that they destroy their crop. For example, in Wales
one farmer was paid by the European Union to grow flax,
harvest it and then destroy it. One year, when the farmer
destroyed his crop before harvesting it, the European
Union took him to court where the case was described as
‘scarcely believable’.23
The least distorting subsidies are those based on input
constraints or on historical entitlement. In OECD countries
in 2001 these amounted to US$19 billion (22 per cent of
direct financial transfers).
Government intervention that increases farm revenue
Governments can boost farm revenue by increasing the
price of commodities sold or by helping farmers to sell
more product into a sheltered market.
Commodity prices can be boosted artificially by installing a
price floor. This can be achieved by directly controlling
price or by manipulating supply. Another course of action
is to reduce competition by imposing import tariffs and
other non-tariff barriers on goods produced in other
countries. Doing so increases the price of those goods in
the domestic market. In 2001 price support for farmers in
OECD countries amounted to US$145 billion. 24
23 C Pye-Smith, The Subsidy Scandal: How Your Government Wastes Your Money to
Wreck Your Environment, Earthscan Publications, London, 2002.
24 OECD, Agricultural Policies in OECD Countries, 2002, p. 158.
13
GREENINGfarmSUBSIDIES
Policies that assist farmers to sell more output include
government procurement programs and regulations that
offer producers an increased level of market power. For
example, sales tax exemptions on certain farm commodities
can be used to encourage consumers to purchase more
farm output.
Alternatively, a government may use more direct regulations
that force consumers to purchase certain goods or
technology, or the government itself may purchase certain
goods or technology. For example, in Tanzania the
government gave preference to local lime producers when
purchasing raw materials to be used in constructing a new
airport runway. The increased demand for lime led to
increased lime production. As the lime was created by
burning coral, the increased production led to increased
stress on coral reefs in coastal waters off Tanzania. 25
Government intervention that decreases farm costs
A more subtle way for a government to subsidise farmers is
to decrease their costs. Supplying public infrastructure or
other services at no cost to users, or at below cost, is one
common example.
Other support mechanisms include preferential loans,
research and development subsidies, subsidised inputs and
exemptions from environmental standards that apply to
other industries. Examples are fertiliser and pesticide subsidies, which are especially common in the developing world.
As already noted, in China fertiliser subsidies have resulted in
increased fertiliser use, which has been held responsible for
half of the local groundwater being contaminated above the
tolerance level.
25 Young, p. 12.
14
2
How CONCERNEDshould we be ?
Passive agricultural subsidies
Because passive subsidies are caused by an absence of
government measures, they are often difficult to observe
and even harder to quantify. Myers and Kent estimate that
passive agricultural subsidies, excluding water subsidies,
could be in the order of US$250 billion a year.26
A passive subsidy results in a producer not facing the full
cost of production. This is generally because a producer is
allowed to do something that affects other people, but is
not forced to pay for the cost of that effect. In economic
terms, such an effect is referred to as an ‘externality’.
A common example of an externality is the pollution of a
publicly owned lake by producers. If the producers do not
have to pay to clean up the pollution, they do not count the
cost of pollution in their production costs. Consequently,
from society’s point of view, they produce too much. The
cost of their pollution paid for by other people (the
government or the community) is a passive subsidy to the
producers.
To remove this subsidy, the government should try to
ensure producers pay for the costs they impose on society.
This could be achieved by introducing private ownership of
the lake, by charging the producers a fee for polluting the
lake or by requiring them to pay for the clean-up of the
pollution. All of these methods force producers to consider
the cost of pollution when they make their production
decisions.
The largest passive subsidy for farmers arises from their use
of water. Worldwide passive water subsidies have been
estimated at US$175 billion a year.27 (More details on water
subsidies can be found in chapter 3.)
26 Myers and Kent, p. xvii.
27 Myers and Kent, p. xvii.
15
GREENINGfarmSUBSIDIES
While it is important to consider passive subsidies, this
report focuses on active subsidies — the result of conscious
policy decisions by government.
Scale of agricultural subsidies worldwide
Subsidies are expensive. We estimate that active and passive
agricultural subsidies combined amount to US$600 billion a
year. This includes active subsidies of US$106 billion from
the European Union, US$79 billion from Japan and Korea
and US$95 billion from the United States. 28
In terms of their cost per person, the biggest offenders are
Switzerland and Norway (table 2). The governments of
2
Estimated active agricultural support in perspective
Total, per person and as a percentage of GDP
Australia
Canada
Czech Republic
European Union
Hungary
Iceland
Japan
Korea
Mexico
New Zealand
Norway
Poland
Slovak Republic
Switzerland
Turkey
United States
Total
As proportion of GDP
Per person
US$m
%
US$
1 177
5 154
689
105 624
708
124
59 126
19 736
7 892
143
2 385
1 797
186
4 672
6 287
95 259
0.3
0.7
1.2
1.4
1.4
1.6
1.4
4.7
1.3
0.3
1.4
1.0
0.9
1.9
4.3
0.9
61
168
67
281
72
439
467
417
81
37
531
47
34
650
94
346
Source: OECD, Agricultural Policies in OECD Countries: Monitoring and Evaluation,
Paris, 2002, pp. 176–7.
28 OECD, Agricultural Policies in OECD Countries, 2002, p. 176.
16
2
How CONCERNEDshould we be ?
both of these countries spend more than US$500 per
person on agricultural support, while the total value of
production per person in places such as Nigeria remains
around US$250 a year.
Another way to express the scale of subsidies is in terms of
the percentage producer support estimate (PSE).29 This
measure is defined as the value of subsidies given to farmers
as a percentage of the total value of farm product. In
OECD countries on average the percentage PSE for all
commodities is 31 per cent.30 In Iceland, Japan, Korea,
Norway and Switzerland the percentage PSE is around or
above 60 per cent.
Historical trends in the use of agricultural subsidies
Agricultural subsidies have been a significant part of most
developed economies since the early part of the 20th century.
In the early stages of the General Agreement on Tariffs and
Trade (GATT) primary products were generally exempt
from the rules regarding subsidies. So agricultural production
remained distorted and trade tensions rose.
The Uruguay round of trade talks (1986 to 1993) was a
serious attempt to tackle the issue of agricultural subsidies.
However, despite concluding with specific disciplines on
domestic support for agriculture, the results have been
mixed.
Encouragingly, countries converted non-tariff barriers to
tariff barriers and decreased export subsidies. However,
since 1988 there appears to have been little progress in
reducing domestic support levels.
29 The authors are aware of the problems associated with using percentage PSEs to
show the size of the distortion. The size of the distortion should be measured as
the difference between the levels of support between different industries.
30 OECD, Agricultural Policies in OECD Countries, 2002, p. 161.
17
GREENINGfarmSUBSIDIES
Between 1989 and 2001 there was effectively no reduction
in the percentage PSEs for the OECD as a whole, the
United States and the European Union, with support falling
until the mid-1990s and then rising again (chart 3).
However, the percentage PSEs for New Zealand, Australia
and Canada indicate some successful reform, most notably
in New Zealand (chart 4).
3
60
50
40
European Union
30
OECD
20
10
United States
0
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
Producer support estimate (%)
.
Percentage PSEs for the OECD, the United States and
the European Union
Data source: OECD, Agricultural Policies in OECD Countries: Monitoring and
Evaluation, CD-ROM, Paris, 2002.
.
4
Percentage PSE for New Zealand, Australia and Canada
Producer support estimate (%)
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
40
Canada
30
20
10
Australia
New Zealand
0
Data source: OECD, Agricultural Policies in OECD Countries: Monitoring and
Evaluation, CD-ROM, Paris, 2002.
18
2
How CONCERNEDshould we be ?
Not visible in aggregate subsidy measurements is the shift
towards less distorting subsidies. While such a shift is a
promising start, it has been small. In most OECD
economies, percentage PSEs split between ‘highly distorting’
subsidies and ‘less distorting’ subsidies show a dominance
of highly distorting subsidies (chart 5).
The OECD defines highly distorting subsidies as output
subsidies, direct input subsidies and price support.
Unfortunately, these subsidies are the most popular, making
up 77 per cent of total value of agricultural subsidies in
OECD countries in 2001.
It should be noted that less distorting subsidies continue to
distort behaviour and many lead to perverse environmental
outcomes. Some less distorting subsidies are still linked to
production, but to a lesser extent. The line between highly
distorting and less distorting subsidies is a blurred one. For
example, while a subsidy based on beef production is
classified as highly distorting, a subsidy based on the
number of cows kept is not. The real difference between
such subsidies is marginal. Subsidies based on area planted
The mix of highly distorting and less distorting
subsidies in OECD countries, 2001
70
60
50
Less distorting
Highly distorting
40
30
20
10
0
Au
st
r
C alia
an
a
C da
ze
ch
E
H U
un
I c gry
el
an
Ja d
pa
Ko n
r
M ea
ex
ic
o
N NZ
or
w
P ay
ol
Sl a n
ov d
ak
Sw ia
is
Tu s
rk
ey
U
SA
O
EC
D
Producer support estimate (%)
.
5
Data source: OECD, Agricultural Policies in OECD Countries: Monitoring and
Evaluation, Paris, 2002, p. 158.
19
GREENINGfarmSUBSIDIES
or animal numbers amount to 13 per cent of the value of
subsidies in OECD countries.
Over the past 15 years the European Union has reduced its
reliance on highly distorting subsidies from over 95 per
cent to around 70 per cent.31 However, 25 per cent of EU
subsidies are based on current area planted and animal
numbers, which are considered less distorting. Consequently,
despite its reforms the link between EU subsidies and its
production levels remains strong.
While the European Union’s progress in moving away from
highly distorting subsidies has been slow and mixed, some
countries continue to argue in favour of ‘coupled’ (highly
distorting) subsidies as the only way to achieve some political
goals. For instance, Norway, where subsidies make up over
65 per cent of total farmers’ income, argues that there is a
risk ‘that attempts to disassociate the public good … from
the agricultural production itself will have a negative effect
on the quality of the landscape’.32
Environmentally harmful subsidies
Distortions caused by agricultural subsidies often have
environmental consequences. As described earlier, when
both the economic and environmental consequences of a
subsidy are negative, that subsidy is considered perverse.
But not all environmental consequences of subsidies are
negative — as will be seen later. However, as subsidies shift
resources away from their optimal use, they often do cause
unintentional damage to the environment.
The most distorting subsidies — those that are directly
linked to production levels — encourage unsustainable
31 OECD, Agricultural Policies in OECD Countries, CD-ROM, 2002.
32 O Flaten, Norwegian Comments to Session 6 on Policy Measures, OECD Posted
Paper, 2001, http://www1.oecd. org/agr/mf, Accessed 17 February 2003.
20
2
How CONCERNEDshould we be ?
production methods and the wasteful use of scarce
resources. But all subsidies — whether linked to production
or not — improve the financial viability of farming and so
indirectly encourage farm production.
While all subsidies have the potential to be perverse, price
support is the most common form of subsidy, and its
effects are often perverse — as is apparent in the case of
US sugar subsides featured in the next chapter.
In some instances, subsidies (including many subsidies
considered less distorting) encourage overproduction and/or
greater intensification of farming, which leads to environmental damage. Consider the impact of support given to
pigmeat producers in OECD countries, also featured in the
next chapter. As noted in chapter 1 other examples of the
environmental costs of more intensive farming can be found
in the Netherlands, Tunisia and the United Kingdom. And
there are many other examples covering most agricultural
industries. 33
The significant consequences of subsidies influencing
production are also realised through quite subtle ways —
recall their link to the spread of ‘mad cow’ disease in
Europe and the ‘dead zone’ in the Gulf of Mexico.
Agricultural subsidies that are linked to production not only
lead to increased production, but also encourage farmers to
intensify their use of inputs. Farming inputs such as fertiliser
and pesticides can often have a negative environmental
outcome, an example being the loss of pollinators in North
America.
Agricultural support given in the form of exemptions from
strict environmental standards applied to other sectors has
an explicit link to the environment. A good example of this
33 W Martin and LA Winters (eds), The Uruguay Round and the Developing Economies,
World Bank Discussion Paper 307, World Bank, Washington, DC, 1995.
21
GREENINGfarmSUBSIDIES
has been highlighted by the World Resources Institute in
the differences between regulations for point source
pollution and non-point source pollution.
Point source pollutants, generally factory discharges, are
heavily regulated. However, regulation for non-point source
pollutants, generally from farms, is much lighter. Indeed,
the World Resources Institute notes that ‘abatement
programs for non-point source pollution occur mainly
through subsidy programs’.34 Instead of introducing environmental regulations, the government gives farmers more
money.35 The report of the institute goes on to reveal that
agriculture is the biggest source of pollutants for rivers and
lakes in the United States.
Perhaps the largest effect of subsidies on the environment
is due to the link between subsidies and waste. As described
in the next section, subsidies distort economic behaviour
and restrict agricultural trade. This leads to waste, as more
inputs are used than would be the case in an undistorted
market to produce the same amount of output.
Using estimates produced by Frankel and Romer, it is
reasonable to assume that a 1 per cent increase in trade will
result in a 2 per cent decrease in waste.36 If subsidies were
removed and international agricultural trade increased by
5 per cent, waste could go down by as much as 10 per cent.
34 P Faeth, Fertile Ground: Nutrient Trading’s Potential to Cost-Effectively Improve Water
Quality, World Resources Institute, Washington, DC, 2000, p. 10.
35 It can be argued that non-point source pollutants are exempt from strict
regulation because of the difficulty in enforcement. This is a reasonable
defence of the subsidy. However, the point of this discussion is to show the
size and types of agricultural subsidy, not to defend them.
36 JA Frankel and D Romer (‘Does trade cause growth?’, American Economic
Review, vol. 89, no. 3, 1999, pp. 379–99) use an innovative technique to show
the causal link between trade and income per person. A Stoeckel, KK Tang
and W McKibbin (Productivity, Risk and the Gains from Trade Liberalisation,
Pelham Paper no. 9, Melbourne Business School, 1999) used this information
to assume a 1:2 ratio between trade and labour productivity. We have taken
labour productivity to be a measure of waste in production.
22
2
How CONCERNEDshould we be ?
That is, the same level of output could be produced with
10 per cent less inputs. In a world with a rapidly growing
population and limited natural resources, reducing waste
should be an important priority to ensure that development
is sustainable.
All subsidies to farmers, whether linked to production or
not, result in higher land prices and subsequently make
environmental preserves and national parks more expensive.
New Zealand provides an example of the impact of subsidies
on land values, as will be seen later.
In addition to the direct links between subsidies and
environmental degradation, there are indirect links.
§ Agricultural subsidies divert public expenditure from
potentially valuable environmental programs. More
generally, subsidies can be a significant fiscal drain on a
country’s economy, thereby hampering the development
of new technologies for dealing with environmental
problems.
§ Subsidies create a distorted market instead of a competitive one. Competitive markets tend to stimulate
innovation, and often environmental improvements
depend on technological change.
§ Domestic subsidies in developed countries can have
adverse impacts on the environmental performance of
developing countries. Overproduction caused by subsidies in the developed world has to be disposed of, and
this may result in excess product being ‘dumped’ in
developing countries, undermining their economies and
destabilising their agricultural export markets. In turn,
this often robs developing countries of the very tools
with which they can improve their environmental
performance.
§ Subsidies make most people poorer, which may inhibit
their ability to better manage their environment.
23
GREENINGfarmSUBSIDIES
§ Sometimes the cost of environmental degradation is
hidden because control regimes are in place to manage
the impacts. However, such regimes are costly and
society may be better off removing the cause of the
problem (that is, the subsidy) than addressing the
symptoms.
In this chapter so far, we have focused on the negative
environmental impacts of subsidies. This is not to say that
some subsidies do not have a role to play in encouraging
environmental improvement. Indeed, many countries are
now using agri-environmental support programs that
provide assistance to farmers who ‘do the right thing’ and
look after the environment. These types of policy are
discussed further in chapter 4.
The economic cost of subsidies
The distorting effects of subsidies on the economy are well
known. While the budgetary cost of subsidies is their most
visible cost, their economic consequences go much deeper.
Domestic economic effects of subsidies
Subsidies change the price signals in an economy. Prices are
important in a market economy as they provide information
and create incentives. In an undistorted market, if a product
becomes scarcer the price will rise and people will generally
purchase less of it.
A well-functioning price system will ensure that producers
produce what consumers want and that products will be
made using as few resources as possible.
However, if the government changes the relative prices of
different products, resources (land, labour and capital) may
not be used in the activities most valued by society.
24
2
How CONCERNEDshould we be ?
Resources will be used inefficiently and producers may
produce the wrong things. In short — there will be waste.
Distorted use of labour and capital
By subsidising agriculture and artificially increasing the
profit from farming, governments are encouraging people
to pursue farming instead of being involved in other
industries. Some people may well be better at building
houses or teaching, but the artificially high farming profits
attract them to agriculture.
The same is true for capital. People will invest in farming
instead of more productive pursuits if farm returns are
made to look higher because of subsidies.
Increased land prices
Because subsidies artificially make farming more profitable,
land prices increase. By distorting input prices, producers
use an inefficient mix of inputs. Farmers may choose to
farm more intensively, and alternative uses for farmland
(for example, retaining forests for biodiversity, recreational
or aesthetic reasons) become more expensive than they
would otherwise be.
The artificial inflation of land prices can be seen in France,
where support has been capitalised into land values. The
OECD reports that land prices in regions with subsidised
irrigation have increased at more than double the national
average increase. 37 Also, when subsidies were removed in
New Zealand, land prices initially fell by 40 per cent. After
the reforms, much ‘marginal’ land was returned to forestry
and many farmers diversified into ecotourism, which had
become relatively more profitable (see chapter 3 for more
detail).
37 OECD, Improving the Environment Through Reducing Subsidies – Part III: Case
Subsidies, OECD, Paris, 1999.
25
GREENINGfarmSUBSIDIES
Europeans note that their direct payments to the beef
sector provide ‘incentive towards intensification’ 38 and their
support through prices and product-specific payments ‘may
discourage farmers from more environmentally friendly
production methods’.39
Distorted food prices
Subsidies also lead to changes in output prices. If the price
of a product is kept artificially high, consumers may switch
to alternative products. If they are not able to, they will
have less money to spend on other products or to save. In
the case of agricultural subsidies, this can be particularly
hard on the poor, who use a significant portion of their
income on buying food.
In 1996 it was estimated that food subsidies add US$617 in
Japan to the average consumer’s food bill each year,
US$767 in Norway and nearly US$1000 in Switzerland.40 It
is estimated that consumers in the United States pay around
US$500 million a year in higher prices for their peanuts
because of the government peanut program.41
Increased tax burden
Taxes must be raised to fund subsidy programs and this is
another burden on a country’s economy. Tax effectively
decreases the size of the market economy and replaces it
with government spending. However, it is not a direct
exchange, as the market economy shrinks by around
38 Commission of the European Communities, Communication from the Commission
to the Council and the European Parliament: Mid-Term Review of the Common
Agricultural Policy, COM(2002) 394, Brussels, 10 July 2002, p. 16.
39 Commission of the European Communities, p. 8.
40 Myers and Kent, p. 37.
41 Pye-Smith, p. 78.
26
2
How CONCERNEDshould we be ?
$1.20–1.40 for each $1 the government has to spend.42
Taxes are costly to administer and collect and can often
lead to changes in relative prices, which further distorts the
way resources are used.
Rent-seeking behaviour
Subsidies also cause rent-seeking behaviour — another
distortion. Government subsidies give people and businesses
an alternative way to make money. They can make money
by producing for the market or by accessing government
subsidies. So people dedicate time and money to both
activities. With more subsidies comes more lobbying, which
in turn leads to more subsidies. The time and money spent
lobbying the government for subsidies are wasted.
Total economic effect
The combined effect of the above distortions is generally a
net loss to the economy. While one particular area or
industry may benefit from a subsidy, the cost of that
subsidy to the rest of the economy will outweigh that benefit.
As already noted, subsidies are particularly distorting and
inefficient when they are linked to output or the use of
inputs. For example, by underpricing water horticulture is
practiced in arid regions at great cost. And subsidies on
42 In Canada, B Fortin and G Larcroix (‘Labour supply, tax evasion and the
marginal cost of public funds: an empirical study’, Journal of Public Economics, vol.
55, 1994, pp. 407–31) estimate the ‘excess burden’ of a dollar tax to be between
39 and 53 cents. In New Zealand, W Diewert and D Lawrence (‘Excess burden
of taxation in New Zealand’, Economic Record, vol. 71, 1995, pp. 121–31)
estimate the cost to be 18 cents. In the United States, DW Jorgenson and K-Y
Yun (The Excess Burden Of Taxation in the US, Discussion Paper No. 1528,
Harvard Institute of Economic Research, November 1990) estimate 38 cents.
In Australia, HF Campbell and KA Bond (‘The cost of public funds in
Australia’, Economic Record, vol. 73, no. 220, 1997, pp. 22–34) estimate between
19 and 24 cents.
27
GREENINGfarmSUBSIDIES
product prices caused ‘butter mountains’ and ‘milk lakes’ in
Europe in the 1970s and 1980s.
According to the OECD43 the overwhelming majority of
agricultural subsidies are inefficient because most provide
support to producers indirectly through their inputs and
outputs rather than directly in the form of income.
However, even direct income support will have many of
the economic negatives described above.
Sometimes agricultural subsidies are defended as a measure
to assist the poor. However, in practice they do not tend to
provide that assistance. Not only can subsidies hurt the
poor by requiring higher taxes and increasing prices, but a
large proportion of the support generally goes to the
wealthier farmers. Chapter 4 considers this issue in further
detail.
International economic effects of subsidies
While agricultural subsidies are generally introduced with
domestic considerations in mind, they play a significant role
in distorting international trade.
Subsidies act as a form of ‘protection’ from competition.
Protection helps producers who are less efficient, at the
expense of producers who are more efficient. This is harmful to all countries concerned, but is particularly deleterious
for agricultural producers in developing countries.
Compared with developed countries, developing countries
are often more reliant on their agricultural industries for
national welfare. For example, agriculture makes up 2.2 per
cent of France’s economy and employs 3.5 per cent of its
43 OECD, Agricultural Policies in OECD Countries, 2002.
28
2
How CONCERNEDshould we be ?
workforce, while it makes up 35 per cent of the Bangladesh
economy and employs 60 per cent of its workforce.44
It makes sense for many developing countries to specialise
in agriculture at their stage of development as they can
often produce farm products at a lower cost than can
developed economies. They can export their surplus
produce and import foreign goods to increase their
standard of living.
However, these gains from trade are currently being
restricted, as agricultural subsidies around the world curtail
agricultural trade. Using a global trading model, the
International Monetary Fund showed that all countries win
from the removal of agricultural subsidies (table 6). It
6
Economic benefit from free trade in agriculture
Change in GDP
%
United States
Australia, New Zealand and Canada
Japan and South Korea
European Union
China
South Asia
East Asia and the ASEAN group
Brazil
Rest of Latin America
North Africa and Middle East
Sub-Sahara Africa
0.10
1.11
0.56
0.41
0.42
0.20
0.17
0.72
0.54
1.24
0.81
Source: International Monetary Fund, World Economic Outlook: Trade and Finance,
Washington, DC, September 2002, p. 85.
44 Centre for International Economics 2003, The Political Economy of Beef
Liberalisation: A Collection of International Papers, A study prepared for the Five
Nations Beef Group as part of the Magellan Project, Canberra, 2003, and
Department of Foreign Affairs and Trade, Bangladesh, Country, Economy and
Regional Information, Commonwealth of Australia, Canberra, 2002,
http://www.dfat.gov.au/geo/bangladesh/bangladesh_country_brief.html,
Accessed 14 February 2003.
29
GREENINGfarmSUBSIDIES
estimated that GDP could be 1.24 per cent higher in North
Africa and the Middle East, 0.81 per cent higher in SubSahara Africa and 0.41 per cent higher in the European
Union.
Agricultural subsidies hurt the nation that imposes them,
and they hurt all agricultural trading partners, including
some of the poorest countries on earth.
The benefits from curbing perverse
subsidies
Until the Uruguay round of the GATT, interest in reforming
subsidies at the multilateral level was driven mainly by
concerns about trade and competition. Furthermore,
governments and multilateral institutions largely dominated
policy development and the setting of priorities. Nowadays,
people both inside and outside of government are taking a
keener interest in the effects that subsidies can have on the
environment.
There is good reason for non-government environmental
organisations to be involved in the debate on subsidies.
With up to 80 per cent of all agricultural subsidies being
perverse, there are potentially enormous gains to be made
for the environment — and the global economy — from
removing these subsidies.
The benefits are not just wishful thinking, as several
countries have successfully dismantled support mechanisms
and experienced win–win results for the economy and the
environment. The best example is New Zealand, where
reform was undertaken quickly and comprehensively and
has resulted in improved efficiency, afforestation and
greater environmental care (see chapter 3).
Indonesia is another country that has benefited from
removing a perverse subsidy. Since withdrawing the subsidy
30
2
How CONCERNEDshould we be ?
for pesticides, their use has fallen, the population of the
natural predator of the brown rice plant hopper has
increased and rice production has grown.45 At the same
time, Indonesia has saved US$100 million a year through
not providing subsidy payments.
Bangladesh offers another example. It has reduced fertiliser
subsidies, which has resulted in a 4 per cent saving in their
national budget.46 Tunisia has also benefited from reducing
the levels of its agricultural subsidies, which had led to
excessive environmental damage by its grazing industry.
Despite the sizeable benefits from dismantling perverse
subsidies, globally reforms have been slow — even nonexistent in some countries. We suggest that this is because
of a lack of good public governance. In later chapters, we
propose a way to tackle this problem, but first we look at
several high-profile cases of perverse subsidies before
exploring the reasons given for maintaining subsidies.
45 De Moor and Calamai, p, 27.
46 RN Stavins, Experience with Market-Based Environmental Policy Instruments,
Discussion Paper No. 00-09, Resources for the Future, Washington, DC,
2000.
31
3 CASE STUDIES OF
PERVERSE SUBSIDIES
N
o matter how strong the abstract case against perverse
agricultural subsidies might be, nothing beats real
world experience to drive home the nature of subsidies and
their effects.
There are many examples of perverse subsidies in the world
today. Unfortunately, there are too few examples of
countries that have removed perverse subsidies and have
reaped the economic and environmental benefits.
The four examples in this chapter are some of the high
profile cases studies of perverse subsidies. The examples of
worldwide water subsidies, pig subsidies in Europe, Japan
and Korea and sugar subsidies in the United States show
the results of perverse subsidies. The first example — New
Zealand farming — shows the benefits that can be gained
by removing perverse subsidies.
Better farming and environment
without the cost of subsidies
New Zealand provides a good news story. By the early
1980s agricultural support in that country had increased to
40 per cent of the gross income of sheep and beef farmers.
Farm subsidies accounted for 14 per cent of the government
budget and 6 per cent of gross national product.
Then the government decided to reform the farm sector,
removing minimum prices for wool, beef, sheepmeat and
32
3
CaseSTUDIES
dairy products, and phasing out land development loans,
fertiliser and irrigation subsidies and subsidised credit. The
percentage PSE fell from 20 per cent in 1986 to 2 per cent
by 1991 and is now less than 1 per cent. The remaining
subsidy is directed towards research and development.
The removal of subsidies coincided with the appreciation
of the New Zealand dollar, falling commodity prices,
increasing farm costs, as well as high inflation and high
interest rates. Official predictions were that 10 per cent of
farms would fail and many feared the destruction of
traditional family farming in the long term.
The reality has been quite different. While farmland prices
initially did drop and 1 per cent of farms faced forced sales,
the initial adjustment was smaller than anticipated and the
long-term outcomes have exceeded expectations.
Economic outcomes
Since 1986 the size of the agricultural sector (in constant
dollar terms) has increased by 40 per cent. Farming output
as a percentage of GDP has increased since subsidies were
removed as economic growth in the agricultural sector has
outpaced growth in the New Zealand economy as a whole.
The return on capital in agriculture is similar to that in
other developed countries and farmers have been able to
maintain a good standard of living.
The number of full-time farm workers has increased and
the meat industry has moved from being one of the least
efficient in the world to the second most efficient. Before
subsidies were removed, agricultural productivity increased
by 1 per cent a year. Since 1986 it has averaged 5.9 per cent
a year. Sheep farming provides an excellent example of
what has been achieved in terms of productivity. Lamb
carcass weights have risen by 13 per cent since 1986 and
while sheep numbers have decreased by 29 per cent lamb
production has increased by 35 per cent.
33
GREENINGfarmSUBSIDIES
Environmental outcomes
The removal of agricultural subsidies in New Zealand has
led to a ‘win–win’ outcome, with both economic and
environmental benefits.
The improved economic efficiency has led to growth in
output and a decline in sheep numbers. This decline (chart 7)
has resulted in less pressure on the land.
The removal of subsidies has also resulted in a reduction in
the use of inputs. Most especially, the use of fertiliser has
declined and there was a halt to land clearing and overstocking, which had been responsible for widespread soil
erosion. Stock raising has been shifted to more appropriate
lands, and previously cleared hills have been replanted with
trees. In 1984 the total area of private planted forest area
was 500 000 hectares. By 2001, there were 1.7 million
hectares (chart 7).
Many farmers have diversified into rural tourism and now
have a keener interest in environmental issues.
The switch between sheep and private forests in
New Zealand
70
1800
Area of private forests
80
1600
Number of sheep
1400
60
1200
50
1000
40
800
30
600
20
400
10
200
00
20
98
19
96
19
94
19
92
19
90
19
88
19
19
19
0
86
0
Private forest area (000 ha)
90
84
Sheep numbers (million head)
.
.
7
Data source: Meat & Wool Innovation, Sheep & wool: New Zealand and its wool,
http://www.mwi.co.nz/sheep_wool/NzandWool.html, Accessed 14 March 2003.
34
3
CaseSTUDIES
Conclusions
Following the removal of perverse agricultural subsidies
New Zealand has realised better economic outcomes, a
better managed environment and a strong rural community.
The Federated Farmers of New Zealand (Inc) explain how
‘subsidies restricted innovation, diversification and productivity by corrupting market signals and new ideas’, which led
to a ‘wasteful use of resources, with a consequently negative
impact upon the environment’. 47
The removal of the agricultural subsidies has allowed
farming industries to better respond to market signals and
has reduced the impact of farming on the environment.
Instead of leading to the ruin of the agricultural sector, the
lack of subsidies has enabled farming to grow from strength
to strength. As the Federated Farmers of New Zealand
says, farmers ‘have prospered and are determined never
again to be dependent upon government handouts’. 48
Underpricing water to everyone’s
detriment
Water subsidies are a major part of the agricultural subsidies
story. While water is an industry itself, it is also a major
input to the agricultural sector, agriculture being the largest
single customer of water supplies.
Worldwide, agriculture accounts for 65 per cent of the total
volume of water used (90 per cent in many developing
countries), which is understandable when you consider that,
on average, to produce a tonne of grain requires 1000
tonnes of water, and to produce a tonne of beef requires
47 Federated Farmers of New Zealand (Inc), Life After Subsidies: The New Zealand
Farming Experience – 15 Years Later, Wellington, 2002, p. 4.
48 Federated Farmers of New Zealand (Inc), p. 1.
35
GREENINGfarmSUBSIDIES
100 000 tonnes of water.49
This water is heavily subsidised. In 1996 only one country
in the world, Israel, had its water price at higher than one
quarter of the marginal cost of supply.50
In the United States the annual irrigation subsidy from
underpricing has been estimated at between US$2 billion
and US$2.5 billion.51 Worldwide the total cost of water
subsidies, including passive subsidies, is estimated to exceed
$200 billion a year.52
This subsidisation means that water resources are not being
used in the best way and in the best places, and water
supplies are being overused and insufficiently protected.
This is leading to significant environmental problems.
The low cost of water provides little incentive to use
efficient irrigation schemes. In Israel, where water costs are
relatively high, farmers typically use ‘drip irrigation’, which
cuts water losses by half.53 Inefficient irrigation schemes
contribute to problems of salinity, which affects 25 per cent
of irrigated land in China and the United States and 21 per
cent in Pakistan. 54
The low cost of water decreases the costs involved in
polluting that water and so effectively encourages water
pollution. Increased pumping of underpriced groundwater
can lead to land subsidence and water-logged soil,
increasing erosion.
49 Myers and Kent, p. 101.
50 Myers and Kent, p. 103.
51 A De Moor, Perverse Incentives: Subsidies and Sustainable Development – Key Issues
and Reform Strategies, Earth Council, 1997, http://www.ecouncil.ac.cr/rio/
focus/report/english/subsidies/ , Accessed 3 February 2003, p. 14.
52 Myers and Kent, p. xvii.
53 Myers and Kent, p. 113.
54 De Moor, p. 13.
36
3
CaseSTUDIES
In addition to these direct effects — pollution, erosion and
salinity — there is the longer term issue of water availability.
The United Nations, the WWF and the Worldwatch
Institute, among others, suggest that future water scarcity
may reach crisis levels. While sceptics, such as Bjorn
Lomborg, question whether there will be a crisis, they
generally agree that water management needs to be
improved.55
Basically, the world has 12 500 cubic kilometres of fresh
water a year available. Currently worldwide about half of
that is withdrawn and around a fifth is used.56 The problem
is that, with the population of the world increasing and
people getting richer, the demand for water will increase
while the supply is relatively fixed (desalination of sea water
notwithstanding).
One part of the solution to this problem is to improve
water management. And the most important step in
encouraging sustainable water use is to remove the current
water subsidies so that consumers (most especially farmers)
face the real cost of their actions.
Recent reforms in Australia represent a shift in the right
direction. As in many countries, Australia’s water supplies
were substantially under government control and significantly subsidised. This resulted in ‘a continuance of low
value water use, wastage and a denial of access to high
value users’. 57 That is, environmental and economic costs
were high.
55 B Lomborg, The Skeptical Environmentalist: Measuring the Real State of the World,
Cambridge University Press, 2001.
56 Lomborg, p. 150.
57 J Tisdell, J Ward and T Grudzinski, The Development of Water Reform in Australia,
Cooperative Research Centre for Catchment Hydrology, 2002,
http://www.catchment.crc.org.au/pdfs/technical200205.pdf, p. 76.
37
GREENINGfarmSUBSIDIES
In 1994 the Council of Australian Governments endorsed a
framework of initiatives for the water industry. This included
pricing reform based on the principles of full cost recovery
and making subsidies transparent. The resulting marketbased system, which relies on a regime of transferable water
property rights, is leading to better water management.
The environmental benefit of such reform is clear, with
‘sufficient price signals [promoting] the conservation of
water, reducing over-use and resultant impacts of salination,
water-logging and environmental degradation’.58 The
economic benefits followed also, as those producers that
valued water more highly were able to purchase water
credits from low value users, and so the input was used
more efficiently.
One example of this improvement can be seen in the
activities of the Australian rice industry. It is one of the
largest users of water in Australia, using more water per
hectare than the industries producing cotton, grapes, other
fruit, sugar, vegetables and other grains.
During the 1990s several reforms affected the use of water
by rice farmers, including increases in the price of water.
For rice farmers in the Murray River region, prices moved
from around A$6 a megalitre in 1992 to over A$15 a
megalitre by 1996 (chart 8).
The increases in the price of water have made a difference.
From 1991 to 2001 water use on Australian rice farms
dropped from 15 megalitres a hectare to 11 megalitres a
hectare, as rice farmers responded to prices that better
reflect the true cost of water.
58 Tisdell, Ward and Grudzinski, p. 77.
38
3
8
CaseSTUDIES
Water price for rice farmers ($/ML)
.
Increasing water price for Australian rice farmersa
16
14
12
10
8
6
4
2
0
1992
1993
1994
1995
1996
1997
1998
a Murray River region only.
Source: NSW Agriculture, Farm enterprise budget: irrigated Murray summer crop
gross margins – rice, http://www.agric.nsw.gov.au/reader/925, Accessed 14 February
2003.
Supporting sugar at the expense of
the Florida Everglades
One of the most obvious examples of perverse subsidies is
the price support given to sugar producers in the United
States. This support ensures that US consumers pay at least
twice the world prices for sugar products, with one report
putting the cost to consumers at US$1.9 billion a year.59 In
addition to price support the US government offers special
loans and in 2000 it paid sugar producers over US$400
million of taxpayers’ money for forfeited and surplus sugar.
The US sugar support program is achieving its first goal —
of maintaining a sugar industry that is larger than it would
otherwise be. Since the introduction of the current program
in 1981 the area under cultivation has increased from
180 000 acres to 500 000 acres in 2002.60 However, the
59 Pye-Smith, p. 63.
60 Pye-Smith, p. 63.
39
GREENINGfarmSUBSIDIES
support is going primarily to rich farmers, is distorting the
economy, and costing consumers and taxpayers many
millions of dollars. The largest 33 sugar growers receive over
US$1 million each in benefits each year. 61
The subsidy distorts the economy by providing the wrong
price signals. One consequence of this is that confectionary
manufacturers moved to Canada where they can purchase
sugar at international prices. 62
In addition to the domestic economic effects, the expansion
of US sugar production has come partly at the expense of
foreign sugar producers, often in poorer Caribbean and
South American countries.
However, these economic costs are only part of the bigger
picture. Environmental groups have been up in arms over
the effect that the sugar industry is having in Florida, where
the sugar farmers divert water from the Florida Everglades
and return it with increased phosphorous levels.
The water coming off the cane fields contains around
100 parts per billion of phosphorous, which is up to
10 times more than the preferred level. This has serious
consequences for the periphyton (a mix of algae and
bacteria) that is the basis for life in the Everglades:
The microscopic organisms that feed on the periphyton are
food for fish and amphibians, and these in turn sustain the
rich bird life, not to mention alligators, snakes, and other
creatures. 63
In places where phosphorous levels are highest, the water
birds and most other creatures have disappeared.
The sugar industry claims to be cleaning up after itself.
However, huge amounts (US$8–11 billion) of taxpayers’
61 Pye-Smith, p. 76.
62 Myers and Kent, p. 38.
63 Pye-Smith, p. 69.
40
3
CaseSTUDIES
money have been, or are about to be, dedicated to ‘fixing’
some of the problems attributed to the sugar industry.
In its own defence, the US sugar industry points to sugar
subsidies in Europe and Japan. Indeed, sugar retails in
France at a price 74 per cent higher than in the United
States, and in Japan the price is 167 per cent higher. 64
However, the fact that somebody else is doing worse is
cold comfort to US consumers or the Florida Everglades.
Whatever the sins of other countries, if subsidies are
leading to negative economic and environmental outcomes
— as the US sugar subsidies are — they should be removed.
Pigging out on pig subsidies
Support for the pigmeat industries in OECD countries as a
group is significant (percentage PSE of 16 in 2001),
although not as high as that for beef (percentage PSE of
36) and sheepmeat (percentage PSE of 55).65 This OECD
figure for pigmeat masks much higher levels of support in
some OECD nations, especially Japan and Switzerland
(percentage PSE of more than 40 per cent), but also Korea,
Norway and the European Union (percentage PSE of 20 per
cent or more).66
The OECD claims:
This pattern of support for pigmeat, in terms of the level and
composition, influences production patterns and places
greater pressure on the environment than if they were not in
place. 67
64 Pye-Smith, p. 75.
65 OECD, Agricultural Policies in OECD Countries, 2002, pp. 162–3.
66 OECD, Agricultural Policies in OECD Countries, 2002.
67 OECD, Agriculture, Trade and Environment Linkages in the Pig Sector: Summary and
Conclusions, Joint Working Party on Agriculture and the Environment,
COM/AGR/CO/ENV/EPOC(2002)93, Paris, 2002, p. 6.
41
GREENINGfarmSUBSIDIES
Pig production is linked to the environment through water
pollution. This pollution arises from the nutrients in pig
manure, principally nitrogen and phosphate. It is estimated
that a sow in Europe excretes 32 kg of nitrogen a year.68
Not all countries have the same level of risk regarding the
nitrogen balance of their water, with some of the highest
risk countries being Japan, Switzerland, Korea, Norway and
many nations in the European Union.
The OECD notes that the ‘countries where the potential
risk of nitrogen water pollution is the highest are also those
with the highest level of support to pig producers’.69
There would be pressure on the environment from pig
farming even without agricultural subsidies. However, the
subsidies contribute to poor decisions about location and
production levels, which ultimately increase the pressure on
the environment.
It should be noted that pig production is closely linked to
the cereal industry, which is also a recipient of subsidies.
Reforms that have reduced cereal prices in the European
Union have lowered input costs for pigmeat producers,
encouraging even more production. This highlights the
links between subsidies and how subsidising one industry
can affect other industries.
68 European Environment Agency, Emission Inventory Guidebook, 3rd edn, ch. 10
(Agriculture), European Environment Agency, 2002, http://reports.eea.
eu.int/EMEPCORINAIR3/en/tab_content_RLR, Accessed 27 January 2003.
69 OECD, Agriculture, Trade and Environment Linkages in the Pig Sector, p. 6.
42
4 DO SUBSIDIES HAVE A
ROLE TO PLAY?
A
gricultural subsidies are introduced for a variety of
reasons, some of which may be well founded.
However, most are not. In many instances subsidies are
designed to benefit specific groups of people who lobby
hard to obtain or retain support. In many cases the
subsidies prevail long after the original objective has
become redundant or outdated.
In this chapter some of the common reasons given to
justify subsidies are assessed. This assessment assists us in
differentiating between good and bad subsidies in the
following chapter.
To alleviate poverty
It is common for developing countries to subsidise their
agricultural input or output prices as a means of boosting
farm incomes and alleviating poverty. Subsidies are also
used to buffer against sharp losses in currency purchasing
power and to compensate rural industries for high taxes
imposed on them.70 This rationale is equally true for
developed countries.
While poverty, income instability and income inequality are
important social issues to address, it is unlikely that
agricultural subsidies are the best way to do this. Initially, it
should be understood that farmers in developed countries
70 De Moor and Calamai, p. 25.
43
GREENINGfarmSUBSIDIES
are generally not poorer than the average citizen. The OECD
notes that in the Netherlands, Denmark, France, Finland
and Belgium the incomes of farm households were significantly above the national average (in the Netherlands, some
2.5 times the average). In most other OECD countries, farm
household incomes are roughly comparable with average
household incomes, Portugal being the major exception
(where farm household incomes are less than half the
average household income).71
Even if it is accepted that farmers need special income
support, only around 20–25 per cent of agricultural subsidies
actually reach the farmer, with much of the benefit going to
non-farming land owners and input suppliers.72
Further, of the money that does reach the farmers, in many
instances the subsidies do not go to the poor farmers for
whom they are intended. For instance, in Canada, Japan,
the European Union and the United States, over 60 per
cent of total support goes to the largest 25 per cent of
farms.73 During 1999, only 21 per cent of India’s kerosene
subsidies reached the poorest 30 per cent of households.74
Steenblik cites evidence to support the proverbial 80:20
rule 75 — that is, 80 per cent of agricultural support goes to
the wealthiest 20 per cent of farmers.
71 S Tangermann, Agricultural policy reform: why wait?, Presentation to the Australian Agricultural and Resource Economics Society, Canberra, 6 March 2003.
72 Tangermann.
73 Tangermann.
74 S Gupta, M Verhoeven, R Gillingham, C Schiller, A Mansoor and JP Cordoba,
Equity and Efficiency in the Reform of Price Subsidies: A Guide for Policymakers,
International Monetary Fund, Washington, DC, 2000, http://www.imf.org/
external/pubs/ft/equity/index.htm , Accessed 20 November 2002.
75 RP Steenblik, Previous multilateral efforts to discipline subsidies to natural
resource based industries, Paper prepared for the Fisheries Development and
Co-operation Task Force of the Pacific Economic Co-operation Council
workshop ‘The Impact of Government Financial Transfers on Fisheries
Management, Resource Sustainability and International Trade’, Manila, 17–19
August 1998.
44
4
Subsidies’ ROLE?
The real problem with using agricultural subsidies to solve
poverty is that the policy instrument (agricultural subsidies)
and the policy objective (reduced poverty) are not directly
related. It is more efficient and effective to introduce
policies directly related to the policy objective — direct
income support, for example.
It makes little sense to provide subsidies on the basis of
inputs used or production levels, if the policy’s objective is
to reduce poverty. Welfare payments should be made on
the basis of income and/or wealth, not fertiliser use or litres
of milk produced. By doing that, the policy instrument (the
transfer of money to poor people) is linked directly to the
policy objective of reducing poverty.
Direct income support measures are more effective at
dealing with poverty, and will not produce the same level of
distortions and inefficiencies as agricultural subsidies do.
It is acknowledged that the removal of subsidies from an
industry that has become dependent on financial support
can cause hardship. Making the transition from dependence
on, to independence from, subsidies can be frightening for
workers employed in a supported industry. It is important
that policy makers and the general public understand not
only the potential long-run benefits of subsidy reform, but
also about ways to make the transition to a more sustainable
future less painful.
To ensure adequate food supplies
Food security has been used as an argument for retaining
subsidies for agriculture. Some countries believe that selfsufficiency is needed to ensure that their citizens will have
physical and economic access to adequate food supplies. In
a recent report food security was raised as an ongoing
45
GREENINGfarmSUBSIDIES
concern by four OECD countries — Japan, Korea, Norway
and the Netherlands. 76
Self-sufficiency means that food needs are met from
domestic supplies as far as possible, with as few imports as
possible.
Food security in crisis situations
It is important from a viewpoint of national security to
have contingency plans for unlikely events such as a lack of
foreign food supplies. This can occur because of war,
sanctions, climate change or ecological crises. However, this
does not necessarily imply that self-sufficiency needs to be
maintained in perpetuity, and it is likely that such a policy
would be counterproductive. It would divert resources away
from more valuable industries, decreasing national wealth
and future industrial capacity.
A cheaper alternative to self-sufficiency is self-reliance, where
a country maintains a capacity to grow food, but does not
rely on that capacity when better options are available, such
as trade. Self-reliance requires a country to be able to shift
resources into agriculture if that becomes necessary to meet
food requirements. Alternatively, or perhaps in addition, a
country could maintain food reserves to be used if foreign
supplies were stopped.
Maintaining or encouraging trading relationships rather
than resorting to self-sufficiency can build mutual interdependence and cooperation, and help to foster social,
cultural and economic ties between nations. Being reliant on
other countries for food is a force for peace. Countries with
vested interests in the peaceful productive advancement of
other countries are less likely to turn to aggression when
disputes arise.
76 Abler, p. 4.
46
4
Subsidies’ ROLE?
Food security outside crisis situations
The larger a market, the less impact any single supply shock
has. For example, if Korea relied solely on domestically
produced beef and adverse weather conditions reduced
local beef supplies by 50 per cent the impact on food
availability and price would be significant.
However, if Korea had some domestic beef production but
traded freely on the international market, adverse weather
conditions in Korea would have little impact on the worldwide availability or price of beef. Its food security would be
better maintained by being a part of the international
community and thereby pooling the risk of food supply.
Further, trade liberalisation increases growth and production,
increasing potential food supplies. In its comprehensive
review of food security issues, Australia’s Department of
Foreign Affairs and Trade reported that ‘broad-based trade
liberalisation is an important vehicle for economic growth’,
which ‘makes a major contribution to food security’. 77
The impossibility of total self-sufficiency
The discussion so far on self-sufficiency has assumed that it
is a viable option. While it is possible for a nation to become
more self-sufficient, total self-sufficiency in the modern world
is no longer a viable option.
To have a totally self-sufficient agricultural sector, a country
would have to be self-sufficient in all of the sector’s inputs
such as fertiliser, seed stock, tractors, oil and stock feed.
Further, to be self-sufficient in tractors a country would
have to be self-sufficient in rubber, engines and steel. In
reality, in the modern world of trade nobody is totally selfsufficient.
77 Department of Foreign Affairs and Trade, Food Security & Trade: A Future
Perspective, AGPS, Canberra, 1996, p. x.
47
GREENINGfarmSUBSIDIES
For example, Japan subsidises its corn syrup industry,
which uses 3 million tons of corn a year imported from the
United States. 78 More generally, the ‘Japanese agricultural
sector is energy-dependent and all but a fraction of Japan’s
oil requirements is imported’.79
And there are other examples. The European Union
subsidises its beef industry, and feeds the cattle with stockfeed imported from South America. The United States
subsidises its sugar producers who use tractors that run on
oil imported from the Middle East.
The reality of the modern world is that all countries are
reliant, to some degree, on other countries. Trading food in
the international market increases quality and price stability
and results in lower price levels during peace time. National
security requires self-reliance, not self-sufficiency.
To encourage industry
Time and again, governments attempt to guide industry
behaviour and ‘support’ businesses that are deemed to have
good future prospects, but need help to get started. More
often than not, such a policy has proved counterproductive
as governments are not good at ‘picking winners’. Support
for agricultural industries is no exception.
While governments may want to encourage successful
businesses, the reality of a market economy is that successful
businesses are not the ones that need support. If a business
needs support, it is unlikely to be the sort of business that
taxpayers should support. Successful businesses require risks
78 H Fukuda, J Dyck and J Stout, Sweetener Policies in Japan, United States
Department of Agriculture, SSS-234-01, 2002, http://www.ers.usda.gov/
publications/SSS/sep02/sss23401/sss23401.pdf, Accessed 16 February 2003.
79 ABARE (Australian Bureau of Agricultural and Resource Economics) 1988,
Japanese Agricultural Policies: A Time of Change, Policy Monograph No. 3, AGPS,
Canberra, 1988, p. 305.
48
4
Subsidies’ ROLE?
to be taken. Governments generally minimise their exposure
to risk because of the additional political risk they face if
they are seen to be supporting the wrong industry.
It is sometimes argued that a business will be successful if
only it could be given help to start up. This ‘infant industry’
argument has some merit in theory. However, it suffers
three significant problems.
§ The government is not in a position to judge which
infant industries should be supported until after they
have succeeded or failed.
§ Infant industries that receive support often never ‘grow
up’, but become dependent on subsidies — ‘corporate
welfare’.
§ All subsidies have to be paid for. A subsidy provided to
one business or industry has to be paid for by a tax on
someone else and any advantage that is passed to one
business or industry is going to make life harder for
other businesses or industries.
There is one sort of industry support that may be justified
— support for research and development (R&D). The
potential merits of targeted support for R&D are covered
later when market failure is considered.
To level the playing field
Countries providing subsidies seem to be unwilling to be
the first to make a move in dismantling them, as this could
put them at risk of being uncompetitive with countries that
opt to maintain support programs. In other words, the
removal of subsidies by one country may upset the ‘level
playing field’ and provide an unfair advantage to farmers in
countries that retain support measures.
For this reason, most trade reform is pursued in a multilateral framework, where all involved countries commit to
49
GREENINGfarmSUBSIDIES
reducing their support. The issue of agricultural subsidies is
central to the current Doha round of the WTO. If
liberalisation can be achieved through the WTO, the
‘problem’ with making the first move is overcome.
However, irrespective of the outcome of the Doha round,
concern about a level playing field is often misplaced.
International trade models indicate that reducing domestic
farm subsidies benefits a country even if other countries do
not do likewise. The International Monetary Fund suggests
that the welfare benefits from worldwide liberalisation of
farm trade would be US$128 billion a year, US$24 billion of
which would go to developing countries.80 More importantly,
it shows that only a little over a quarter of the gain to
developing countries comes from liberalisation undertaken
by high-income countries. The rest comes from their own
liberalisation.
To address market failure
The most convincing argument used to defend the use of
agricultural subsidies is that there is an ‘externality’ problem
in the market for agricultural products, and government
action is required to address this problem. This occurs
when the activities of producers result in a benefit or a cost
to society that is external to their main business. Such
benefits and costs are called externalities. 81
It is important to note that agricultural subsidies are only
one way of dealing with a market failure. For instance,
instead of offering a subsidy to change the behaviour of
farmers, the government could use a tax.
80 International Monetary Fund, p. 85.
81 Externalities occur because the benefits and/or costs of an activity do not
accrue to a single person or entity. More information on externalities is
available in any microeconomics text, such as E Mansfield, Microeconomics,
Norton, New York, 1994.
50
4
Subsidies’ ROLE?
If farmers are producing a public benefit, there may be a
case for the government to offer a subsidy to encourage
them to continue producing the benefit. More often than
not agricultural subsidies are an inefficient and ineffective
way of inducing farmers to supply public goods. This is
especially true when the link between agricultural production
and the public good is weak. (Chapter 6 looks at alternative
policy instruments that could be used.)
We now consider three types of externality — economic,
environmental and social — that may need to be addressed.
Economic externalities
Economic externalities occur when the activities of one
person or entity have an economic or financial impact on
other groups outside the market process. This is often the
case when public infrastructure is created. For example, if a
farmer builds a road within a region to a local town and
others from within and outside that region can use it,
everyone benefits. Because of such positive externalities,
governments tend to fund, build and maintain the roads.
One example of a public good that may justify a subsidy is
R&D. Because not all of the benefits of R&D go to the
person or group that invests in the R&D, the market may
not produce enough R&D. Consequently, it may be
appropriate to subsidise agricultural R&D.
An example can be found in Australia. Some agricultural
regions are facing increasing levels of salinity, which is
damaging the economy and the environment. Research into
salinity is partly a public good, as all farmers can take
advantage of any reductions in salinity that may result.
Hence, the government is involved in funding the National
Dryland Salinity Program.
In many instances, more R&D would lead to better
economic outcomes (as resources are used more efficiently)
51
GREENINGfarmSUBSIDIES
and better environmental outcomes (less harmful ways are
discovered to achieve economic objectives).
Environmental externalities
It is sometimes argued that an undistorted market will not
produce enough environmental services, such as fresh air
and clean water. In chapter 2 we showed that agricultural
subsidies often result in harm to the environment. However,
this need not be the case. In some circumstances subsidies
can be used to encourage more sustainable farming practices
and can result in better environmental outcomes.
Views on the effects of agricultural subsidies differ considerably between countries providing high levels of support
and countries providing low levels of support. In a recent
OECD report82 countries with highly subsidised agricultural
sectors, such as Japan, Korea, Norway, Belgium, Greece and
the Czech Republic, stress the positive impact that farm
production has on biodiversity. However, countries providing low levels of agricultural support, including Australia
and New Zealand, stress the negative impact of farming on
biodiversity. Interestingly, the message of perverse subsidies
is getting through to some countries providing high levels of
support, with the United States, France, Finland and the
Netherlands all recognising a negative relationship between
agriculture and biodiversity.
Subsidies that are linked to the level of production are
unlikely to produce better environmental outcomes and
most agricultural subsidies are linked to production in some
way. Even some subsidies not directly linked to production
levels can have perverse environmental consequences. This
highlights the need to determine what effects agricultural
subsidies are really having.
82 Abler, p. 4.
52
4
Subsidies’ ROLE?
Social externalities
Some groups argue that the agricultural market does not
produce enough social benefits, such as countryside
amenity, tourist attractions, social diversity, strong rural
communities and historical preservation. Concern about
such benefits is most common in countries with high levels
of agricultural support. In a review of country concerns
about non-commodity farm outputs, the OECD noted that
only Belgium, Japan, Korea and Norway raised the issue of
‘cultural heritage’. 83
The effect of agricultural subsidies on such social outputs is
difficult to assess. In some cases, agricultural subsidies may
help to increase the social benefits, but may result in
economic and environmental costs. Once again, this highlights the need for a systematic review of all agricultural
subsidies to determine how large these benefits and costs
are. In other cases, agricultural subsidies may be an ineffective way of achieving social goals. If the link between
the social objectives and agricultural production is weak,
alternative policies are likely to be more cost effective.
To maintain the multifunctionality of
agriculture
‘Multifunctionality’ is a relatively new word that has been
used when arguing for agricultural support in some
countries that heavily subsidise their farming sectors —
France, Switzerland and Japan, for example.
The argument quite rightly starts by recognising that
farming is not simply about farm output. Agricultural
producers and rural townships also produce non-commodity
outputs. Generally, it is argued that these outputs include
environmental externalities, social externalities and food
83 Abler, p. 4.
53
GREENINGfarmSUBSIDIES
security — already discussed. However, the prominence of
the multifunctionality argument warrants special attention.
Proponents of multifunctionality argue that agricultural
subsidies should be provided to farmers to ensure that they
continue to produce the many non-commodity benefits.
There is a fear in some countries that the removal of
subsidies would result in a reduction in these benefits.
However, it is often the case that the link between farming
and the multifunctional benefit is not strong or clear. For
example, it is not obvious how increased pig production in
Europe will result in greater biodiversity, aesthetic beauty
or social diversity. What is more certain is that subsidies for
the pig industry in Europe have distorted prices and
decreased efficiency while increasing water pollution in
countries that already have high levels of nitrogen in the
water (see chapter 3).
The problem is the link between the policy objective and
the policy instrument. For agricultural subsidies to be a
good policy instrument, the non-commodity benefits must
correlate with agricultural production. In the language of
the OECD, there needs to be a high level of ‘jointness’
between the commodity and non-commodity farm outputs.
The OECD produced an analytical framework for multifunctionality 84, which suggests that four questions need to
be answered when considering the need for subsidies to
maintain non-commodity outputs.
§ Is there a strong degree of jointness between agricultural
commodity production and the non-commodity output?
§ If there is a strong degree of jointness, is the jointness
inherent or can it be altered through changes in farming
practices, technologies, or non-agricultural provision of
the non-commodity output?
84 OECD 2000, Multifunctionality: Towards an Analytical Framework, COM/AGR/
APM/WP(2000)3/ FINAL, OECD, Paris.
54
4
Subsidies’ ROLE?
§ Assuming there is a strong degree of jointness, is there a
market failure associated with the production of the
non-commodity output, or do private markets exist and
function well?
§ If there is a market failure, is government action
required or are there non-governmental options?
In many instances, the non-commodity benefits of farming
can be achieved in a better way. One approach is to
‘decouple’, where possible, the subsidies from agricultural
production and decrease the potential for economic and
environmental harm (discussed further in chapter 6).
Some countries providing high agricultural support insist
that production-distorting subsidies are necessary because
there is a high degree of jointness between the commodity
and non-commodity benefits. 85 For example, in Japan the
level of rice production is linked with flood prevention.86
Another example is the cultural value (‘way of life’) of
farming and rural communities in France.
However, some commentators suggest that the multifunctional effects of subsidies are quite different. Martin
Wolf posits that the European Union’s Common
Agricultural Policy results in a huge financial cost, a burden
on poor consumers, higher land prices, greater farm
intensity, environmental damage, lower food quality, greater
price volatility and decreased incomes for developing
countries. 87
The question remains: how large are the benefits and do
they outweigh the potential economic and environmental
costs? In France, how much are people willing to trade off
85 Abler.
86 Y Nakashima, Multifunctionality: Applying the OECD Framework, A Review of
Literature in Japan, OECD, Paris, 2001.
87 M Wolf, ‘Weeding out farming subsidies’, Financial Times, 5 November 2002,
www.ft.com, Accessed 5 November 2002.
55
GREENINGfarmSUBSIDIES
cheaper food, lower taxes and potential environmental
benefits in order to maintain the potential multifunctional
benefits of farming?
To answer such questions, governments need a dedicated
and systematic review process that can distinguish between
good subsidies and bad subsidies.
56
5 HOW CAN WE
DISTINGUISH THE
GOOD FROM THE BAD?
D
iscussions about agricultural subsidies can become
confusing. On one hand, many subsidies lead to
economic inefficiency and environmental harm (as outlined
in chapters 2 and 3). On the other hand, many subsidies are
defended on the grounds that they produce benefits for
society (as outlined in chapter 4). Honest policy makers have
the difficult task of separating the good from the bad, and
less scrupulous policy makers can use the confusion to mask
alternative political agendas or to favour particular groups.
In the end, theory is not sufficient. Theoretically, we can
show that farm subsidies lead to more intensive agricultural
production and environmental degradation. We can also
show that farm subsidies sometimes provide benefits, such
as preserving a way of life in farm communities. However,
this theory is of limited use without some hard analysis.
What is needed is a process to determine whether the
benefits of farm subsidies are worth the costs involved. If
they are not, they should be removed.
Testing the subsidy
The first step in reviewing an agricultural subsidy is to
define its nature — whether active or passive (as discussed
in chapter 2). Then it needs to be put into context and its
relevance tested (chart 9).
57
GREENINGfarmSUBSIDIES
It is important to identify why the subsidy was introduced
and to determine whether that reason is still relevant. Good
analysis is impossible without a clear understanding of the
subsidy’s objectives.
As noted in chapter 4 agricultural subsidies have been
introduced to alleviate poverty, provide for national security,
help businesses, provide a level playing field, support
multifunctional benefits and fix market failures. If they did
achieve all of these objectives, they might well be considered
one of the greatest human achievements. However, all too
often, agricultural subsidies fail to achieve their stated
objectives and actually result in harmful outcomes. And in
9
Testing the subsidy’s relevance and identifying
its impacts
What is the policy objective of the
subsidy?
§ Environmental, social, economic?
Is the objective still relevant?
No
Remove subsidy
Yes
Is the objective being achieved?
Yes
What are the unintended impacts?
§ Positive or negative?
§ Economic or environmental?
Analyse the benefits and costs
58
No
Remove subsidy
and explore
alternatives
5 DISTINGUISHgood fromBAD?
some instances they may be in place to achieve objectives
that are no longer relevant. In these cases the subsidy has
no benefits and should be removed.
If the objective is still relevant and the subsidy is providing
some benefit, the subsidy should progress to the next stage
of review, when its unintended consequences, which may
be negative, are identified. A matrix can be used to
systematically record the positive and negative impacts of
the subsidy according to whether they are environmental or
economic (table 10). For the purposes of this analysis,
economic benefits include economic development and
poverty alleviation.
Some subsidies have negative environmental and negative
economic impacts and, as seen earlier, are defined as
perverse subsidies.
Subsidies with positive economic and positive environmental
outcomes are clearly good. One example could be a subsidy
for research and development.
Subsidies that have ‘mixed’ impacts — economic or
environmental benefits, but not both — are more difficult
to assess. An objective assessment requires winners and
losers to be identified, and the net impact of the subsidy to
be closely scrutinised. For instance, people may value a
certain environmental outcome at more than $1 million
dollars, but less than $100 million dollars. If a subsidy
10 Identifying the positive and negative impacts
Positive
economic (ü)
Negative
economic (û)
Positive
environmental (ü)
üü
üû
Negative
environmental (û)
ûü
û û (perverse)
59
GREENINGfarmSUBSIDIES
provided that environmental outcome at a cost of
$1 million88, it would be a good subsidy, but at a cost of
$100 million it would be a bad subsidy.
The need to make such decisions is unavoidable. In some
European countries, subsidies are providing social benefits
and environmental costs. Farm communities are being
maintained, but farm practices are increasing pollution.
What is needed is analysis to show how big the social
benefits are and how big the environmental costs are. Not
having that information is a real obstacle to reform.
If governments were held to high levels of public
accountability and made to show both the costs and the
benefits of the subsidies they provide, the perverse subsidies
could be removed more easily.
Assessing the subsidy
All potential benefits and costs of an agricultural subsidy —
economic, social and environmental — have to be
identified before an assessment can be made of whether its
benefits exceed its costs. During an assessment the relative
sizes of these impacts are determined and the winners and
losers from the subsidy identified (chart 11). 89 The
assessors need to be aware of relationships between
different subsidies as a subsidy may exist to offset the
consequences of another subsidy.
The process of assessment should include consultation with
all affected parties and be transparent with the results
contestable. To assess agricultural subsidies in a transparent
and consistent way requires a common decision-making
framework. Passing all subsidies through such a framework
88 This cost should include not only the fiscal cost of the subsidy, but all costs
associated with the subsidy as outlined in chapter 2.
89 In doing this analysis, it is important to include all flow-on benefits and costs,
remembering that the cost of a subsidy is more than simply its fiscal cost.
60
5 DISTINGUISHgood fromBAD?
11 Analysing the subsidy’s costs and benefits
How large are the benefits and
costs?
Who wins and who loses
domestically and internationally?
Do the costs exceed the
benefits?
No
Yes
Remove or reform subsidy
§ Establish who will lose from
subsidy reform
§ Consider multilateral agreements
and adjustment issues
§ Explore alternative instruments
Could the objectives
be achieved in a more
cost-effective way?
Yes
No
Retain subsidy
would be one of the most productive steps that could be
taken toward weeding out perverse subsidies.
If, as Myers and Kent have suggested, up to 80 per cent of
subsidies are perverse, most subsidies could be expected to
have costs that outweigh the benefits. Those that do would
fail the net benefits test and should then be removed or
reformed — to the benefit of the environment as well as
the economy.
Of course, there is a technical problem in valuing environmental and social benefits and costs, but such estimates are
now routinely made.90 So this is not an excuse for avoiding
the process of measuring benefits and costs.
90 For more information on methods of valuing environmental and social goods,
see J Bennett, M Van Bueren and S Whitten, Estimating society’s willingness
to pay to maintain viable rural communities, Paper presented at the 46th
Conference of the Australian Agricultural and Resource Economics Society,
Canberra, February 2002.
61
GREENINGfarmSUBSIDIES
However, certain characteristics of a subsidy make it more
likely to be good or bad, even though there is no straightforward link between the size and type of support, the
nature of the industry and the environmental impact.
Besides the size of the subsidy, the characteristics to
consider include:
§ the mechanism through which an industry is subsidised
(for example, direct payment or price support)
§ the conditions that must be met for the subsidy to be
activated
§ the input and final product markets the subsidy will
affect
§ whether there are substitute technologies, products or
services available with more favourable environmental
impacts
§ the prevailing taxation regime
§ the regulatory and institutional framework in which the
subsidy operates, and
§ the local and biophysical characteristics of the
environment affected.
As noted previously, subsidies are more likely to be
perverse (bad) if they target inputs such as fertiliser, affect
industries that are already polluting or resource intensive,
and/or influence production capacity.
Even if a subsidy’s benefits exceed its costs, there is
another question to answer: is there another policy that
could better achieve the desired outcome? That question is
addressed in the next chapter.
62
6 WHAT ALTERNATIVES
ARE THERE TO
SUBSIDIES?
A
gricultural subsidies are put in place to achieve certain
economic, social and/or environmental objectives.
But even ‘good’ subsidies may not be the best way to
achieve specific policy objectives. Alternative policies need
to be considered.
There are three types of alternative policy that could be
used. The first, already touched on in chapter 4, involves
decoupling the subsidy from agricultural production and
improving the link between the policy objective and the
policy instrument. That is, the government could continue
to provide a subsidy, but ensure that the subsidy more
directly targets what it wants to achieve.
The second alternative is to use a different policy instrument,
such as pollution taxes, environmental regulations, education
campaigns or property right allocations.
The third alternative is to develop an operating environment
that is conductive to economic growth. According to some
studies, stronger economic growth will do more to improve
social and environmental outcomes than will subsidies. 91
91 T Nankivell, Living, Labour and Environmental Standards and the WTO, Staff
Working Paper, Productivity Commission, Canberra, 2002.
63
GREENINGfarmSUBSIDIES
Improve the targeting of subsidies
Currently, subsidies are used as a broad and cumbersome
measure to address worthy goals. While agricultural subsidies
may help to achieve certain social objectives, they also have
many unintended consequences.
Increase transparency
The key to improving subsidies is to introduce a transparent
decision-making framework for policy makers. If the policy
objectives can be clearly identified, specific policies can be
formulated to directly address those objectives.
For instance, if society wants to encourage farmers to plant
attractive trees to improve the aesthetic appeal of rural
communities, a subsidy specifically for planting attractive
trees should be considered. By clearly identifying the
objective, the appropriate policy becomes clear.
Such policy transparency is opposed by some. De Jasay
attributes much of the opposition to pride, where transparent transfers would make farmers ‘feel they would be
reduced to national pensioners, recipients of alms’.92 Some
commentators are less generous, suggesting that ‘the policies
of protection owe their existence to deceit’. 93 Martin and
Winters point out:
The switch to non-distorting or de-coupled policies was an
anathema to the producers of these crops [peanuts, rice and
sugar] because these policies would have exposed the extent
of the income transfers and the distribution of the benefits,
neither of which would be politically popular. 94
92 A De Jasay, ‘What price pride?: On the hidden costs of economic illiteracy’,
Reflections from Europe, Library of Economics and Liberty, 2003, http://
www.econlib.org/ library/ Columns/y2003/Jasaypride.html, Accessed 10
April 2003.
93 A Stoeckel, Solving the Problem: A Look at the Political Economy of Agricultural
Reform, RIRDC Publication No. 00/124, Canberra, 2000, p. 26.
94 Martin and Winters, p. 21.
64
6
WhatALTERNATIVES?
The European Union is pursuing a policy of decoupling its
subsidies from production levels and is substituting less
distorting subsidies. In the Mid-Term Review of the
Common Agricultural Policy the Commission of the
European Communities states that it prefers a ‘decoupled
system of payments per farm, based on historical references
and conditional upon cross-compliance to environmental,
animal welfare and food quality criteria’. 95
Unfortunately the EU reforms to date have been moderate.
As noted in chapter 2 most support remains highly
distorting and linked to production levels. Further, most of
the less distorting subsidies in the Common Agricultural
Policy remain linked to production levels and so continue
to distort the allocation of resources among competing uses.
Instead of maintaining high support and slightly changing
its form, the European Union would be better off
implementing a systematic, transparent and ongoing review
of all of its agricultural subsidies against economic and
environmental criteria. This process would help to ensure
that the best policy that could be used to achieve objectives
was in place.
Provide direct income support
Social goals such as poverty alleviation and the protection
of minority and/or disadvantaged groups are legitimate
political objectives.
EU policy makers declare that a central goal of their
agricultural policy is to maintain ‘a fair standard of living
and income stability for the agricultural community’.96
However, it must be questioned whether agricultural
subsidies, especially those that result in environmental
damage, are the best way of achieving that goal.
95 Commission of the European Communities, p. 3.
96 Commission of the European Communities, p. 2.
65
GREENINGfarmSUBSIDIES
Agricultural subsidies are a costly and inaccurate method of
addressing poverty. Many people recognise that often it is
the large or wealthy farmers who benefit most from
subsidies. A better solution is to directly assist people who
are in poverty. This approach is more effective in helping
the poor and produces fewer negative side effects. The
International Monetary Fund suggests that, when blunt
instruments of income assistance such as farm subsidies are
removed, ‘measures should then be targeted at smaller, less
wealthy producers and those rendered unemployed by
reforms’.97
If it is not possible for poverty to be addressed through
welfare policies, one option is to means-test recipients of
agricultural subsidies to at least ensure that money is not
being transferred to those not in need.
Use alternative policy instruments
Subsidies are a popular form of government intervention
because the idea is easy to sell to those people who will
receive the subsidy. However, subsidies are not always the
most appropriate or effective policy and it may be that
taxes or regulations would better enable objectives to be met.
Environmental taxes
Subsidies encourage certain behaviours and taxes discourage
other behaviours. This is one reason why governments tend
to subsidise education and tax smoking.
The use of taxes and subsidies to solve market failures is
generally accepted in economics. If a business or individual
is doing too little of a socially good thing, they can be
offered a subsidy to do more of it. If a business or
97 Gupta, Verhoeven, Gillingham, Schiller, Mansoor and Cordoba, p. 9.
66
6
WhatALTERNATIVES?
individual is doing too much of a socially bad thing, they
can be taxed so that they do less of it.
If governments are trying to discourage behaviour that
leads to pollution, a tax on pollution is likely to be more
effective than an agricultural subsidy. The idea that a
producer should pay for their environmentally damaging
behaviour accords with the ‘polluter pays principle’. 98
A potential solution to damage to public water supplies
caused by fertiliser run-off is a pollution tax. The OECD
explored such an option for controlling nitrogen emissions
in the Netherlands and showed that a pollution tax leads to
less pollution and can also lead to better economic
outcomes.99
One advantage of a tax over a subsidy is that it does not
require a benchmark. A subsidy does require a benchmark,
which can result in perverse incentives. For instance,
producers have an incentive to perform badly in the base
year so that the ‘reform’ targets are easier to achieve.
Producers who perform well in the base year are punished
with more difficult reform targets.100
Direct regulation
The government also has the option of simply regulating
business and individual behaviour. This solution does not
try to improve the incentives faced by farmers, but simply
overrides their incentives by imposing a general rule.
98 D Pearce, A Markandya and EB Barbier, Blueprint for a Green Economy, Earthscan
Publications, London, 1989.
99 J Helming and F Brouwer, ‘Environmental effects of changes in taxation and
support to agriculture’, Improving the Environment Through Reducing Subsidies Part
III: Case Studies, OECD, Paris, 1999, pp. 79–105.
100 M Ribaudo, RD Horan and M Smith, Economics of Water Quality Protection from
Nonpoint Sources: Theory and Practice, Agricultural Economic Report No. 782,
United States Department of Agriculture, Washington, DC, 1999.
67
GREENINGfarmSUBSIDIES
There are many reasons to believe that regulation may not
be the best way to change behaviour. For instance,
regulations are necessarily quite cumbersome and do not
respond well to changing environments. They can have
significant policing and compliance costs. Further, they are
generally a one-size-fits-all approach, while taxes and
subsidies still allow for some diversity. That said, in some
instances direct regulation may be a preferable alternative to
subsidies, and it should not be ruled out a priori.
One example of successful regulation (though not an
agricultural example) is the international action taken on the
use of chlorofluorocarbons (CFCs) and other ozonedepleting gases. The use of CFCs grew significantly during
the 1960s to a peak of over 1200 thousand tons in the late
1980s. This resulted in the ozone layer breaking down,
leading to increased eye diseases (cataracts), skin cancer and
photoaging (wrinkling and premature aging of skin).101
According to the United Nations the 1987 Montreal
Protocol (and its subsequent amendments and adjustments)
established ‘legally binding controls on the national
production and consumption of ozone-depleting gases’. 102
The United Nations goes on to explain that the Montreal
Protocol has led to a reduction in ozone-depleting gases in
the atmosphere. By 2050 the buildup of these gases should
have been reversed to levels that existed in the 1970s.103
The ozone-depleting gas regulation has proven successful.
Not only has the environmental damage been stopped, but
it is being reversed. Further, there has been a net economic
benefit as the cost of regulation has been lower than the
benefits from a smaller ozone problem. However, it is
101 Lomborg, p. 273.
102 DW Fahey, Twenty Questions and Answers About the Ozone Layer, United Nations
Environment Programme, Les Diablerets, Switzerland, 2002, p. 28.
103 Fahey, p. 30.
68
6
WhatALTERNATIVES?
questionable how well this process can be extended to
environmental problems associated with agriculture.
Environmental issues related to agriculture are more often
local and specific, and broad regulation may not be the best
solution.
Property rights
It can be argued that, instead of the government trying to
solve market failures, it should try to remove the market
failures. This can be done by extending and clarifying
property rights. People who own property have a strong
incentive to look after that property and to control and
manage its use.
Elephants in Zimbabwe (prior to the recent civil unrest in
that country) provide a good example of this principle.
Poaching in many parts of Africa has caused a serious
decline in the number of elephants. However, in Zimbabwe
the government effectively handed ownership of elephants
to local landowners and community groups under a project
called Communal Areas Management Program for
Indigenous Resources (CAMPFIRE).
The owners of the elephants are able to make money out of
the elephants by allowing limited trophy hunts. This means
that the owners have a strong incentive to prevent illegal
poaching and to protect the elephants. Jacomea Nare from
CAMPFIRE claims that ‘[t]he poaching and illegal hunting
has stopped completely, because everyone in the community
is a policeman now’.104 In one of their fact sheets,
CAMPFIRE explains that people have started to set aside
land for elephants and villagers have arranged food
104 Quoted in T Rembert, ‘Opening the ivory door: an exercise in democracy pits
conservation against animal rights’, E Currents (CAMPFIRE Association of
Zimbabwe), vol. ix, no. iv, 1998, http://www.emagazine.com/july-august_
1998/0798curr_ivory.html, Accessed 14 February 2003.
69
GREENINGfarmSUBSIDIES
deliveries for elephants in times of drought.105 The results
speak for themselves. Since the introduction of
CAMPFIRE in 1989, Zimbabwe’s elephant population has
risen from around 37 000 to around 70 000.106 Botswana
also allows elephants to be commercially harvested, and has
seen a similar increase in elephant numbers.107
This is in stark contrast to Kenya, which has pursued a
policy of regulation and ‘collective’ ownership of elephants.
Since its ban on hunting, the Kenyan elephant population
has fallen from 140 000 to 16 000. Similar decreases have
been seen in other countries that have banned hunting,
such as Tanzania and Uganda.108
Another example of property rights being used to achieve
environmental ends is in the fishing industry in Iceland. By
not having to pay for the fish that they caught, Icelandic
fishers had been receiving a passive subsidy. That subsidy
resulted in overfishing and a dwindling stock of sea life. By
replacing this passive subsidy with a property rights system,
Iceland has reduced exploitation of its fish stock and seen
an improvement in economic efficiency. 109
In these examples, establishing and enforcing private
property rights has resulted in better outcomes than direct
regulation or subsidies produced. However, property rights
may not be a feasible option in all circumstances, especially
where such rights are difficult to allocate or enforce.
105 CAMPFIRE (Communal Area Management Programme for Indigenous
Resources), Sharing the Land: People and Elephants in Rural Zimbabwe, Fact Sheets
No. 7, Zimbabwe, 2003, http:// www.campfire-zimbabwe.org/facts_07.html,
Accessed 14 February 2003.
106 Rembert.
107 T Cowen, ‘Public goods and externalities’, The Concise Encyclopedia of Economics,
Web edn, Library of Economics and Liberty, 2002, http://www.econlib.org/
library/Enc/PublicGoodsandExternalities.html, Accessed 14 February 2003.
108 Cowen.
109 Runolfsson and Arnason, and Runolfsson.
70
6
WhatALTERNATIVES?
Promote economic growth and
development
One potential method of achieving economic, environmental
and social objectives — most often promoted by economists
— is through stronger economic growth. In brief, it is
argued that economic growth is not in competition with
sustainable development, but rather that economic growth
is the best way to promote sustainable development.
The idea that economic growth is naturally sustainable is
sometimes referred to as ‘weak’ sustainability. 110 This view
is not widely shared in the environmental movement. For
example, Kenneth Lux suggests that sustainable development is impossible until the profit motive is abolished.111
More often it is suggested that the profit motive is useful,
but not sufficient for sustainable development.
The benefit of economic growth to sustainable development
and environmental outcomes rests largely on the idea of the
environmental Kuznets curve (see box 12). Some economists
argue that economic growth leads to a short-run decrease in
environmental quality, followed by better environmental
quality in the long run. Such a pattern is detectable in many
developed countries. For example, levels of sulphur dioxide
and smoke in London increased more than tenfold in the
300 years to the mid-nineteenth century. Since that point,
however, the levels have fallen off dramatically and are now
lower than at any time since the Middle Ages.112
110 J Pezzey and M Toman, Sustainable Development: Making Sense of “Sustainability”,
Issue Brief no. 02–25, Resources for the Future, Washington, DC, 2002,
www.rff.org/Johannesburg/Issuebriefs/joburg18.pdf, Accessed 4 April 2003.
111 K Lux, ‘The failure of the profit motive’, Ecological Economics, vol. 44, no. 1,
2002, pp. 1–9.
112 Lomborg, p. 164.
71
GREENINGfarmSUBSIDIES
While there is evidence to suggest the Kuznets curve holds
in some cases, there are some pollutants, such as carbon
dioxide, that do not seem to follow the rule. That is,
pollution levels continue to increase with economic growth.
In these instances, some form of intervention may be
necessary.
Supporters of the economic growth and ‘weak’ sustainability
argument suggest that policies introduced to help the
environment in the short term may lead to lower economic
growth and lower environmental outcomes in the future.
They therefore argue that even good subsidies will produce
bad outcomes in the end. Such arguments also generally
stress the likelihood that governments will be seduced by
bad subsidies as they prize political ends more highly than
good policy, and so it is safer to simply reject all subsidies.
The economic argument of ‘weak’ sustainability is controversial. A paper by Resources for the Future reflects a
more common environmentalist position. The authors
12 Environmental Kuznets curve
The American economist Simon Kuznets suggested in 1955 that
there was an inverted U-shaped relationship between wealth and
income inequality. He argued that, as gross national product per
person increased, inequality would initially increase to a maximum
point and then decrease. This idea has been extended to other
phenomena, such as environmental outcomes.
Pollution
National income
There is some empirical evidence to
suggest that pollution increases in
the early stages of development, but
decreases after a certain income
level is reached. Such a relationship
between national income and the
environment has become known as
the environmental Kuznets curve.
Source: M Gillis, DH Perkins, M Roemer and DR Snodgrass,
Development , W.W. Norton & Company, New York, 1996.
72
Economics of
6
WhatALTERNATIVES?
suggest that, although the economic analysis is meaningful,
‘government intervention … may well be needed to achieve
sustainability’. 113
The nature of subsidies was well illustrated by the United
States Environmental Protection Agency in its review of
policy instruments available for protecting the environment.
Listing the benefits and costs for each instrument, the only
benefit listed for subsidies was ‘politically popular’.114 This
re-enforces our assertion that the most significant remaining
obstacle to the reform of agricultural subsidies is political
— the lack of an independent institutional framework to
review agricultural subsidies.
The next chapter discusses the step that needs to be taken
to bring about reform.
113 Pezzey and Toman, p. 4.
114 United States Environmental Protection Agency, The United States Experience
with Economic Incentives for Protecting the Environment, EPA-240-R-01-001
Washington, DC, 2001, p. 31.
73
7 THE NEXT STEP
T
hanks to the research of various groups — from the
OECD to WWF — information on perverse subsidies
is now more readily available. The analysis is there, but the
institutional framework necessary to address the issue of
subsidies is not.
What is missing in each country is an organisation that can
systematically and transparently review agricultural subsidies
— identify and analyse their benefits and costs so that the
country can choose the right policies to achieve its
economic, social and environmental objectives.
Such a conclusion echoes the recommendations of an
Earth Council report. It suggested that governments need
to ensure greater transparency in subsidy policies, develop
alternative policies to achieve environmental and economic
objectives, and place the burden of proving that subsidies
should be maintained on those who prefer the status
quo.115 The result of pursuing such a system would be less
waste, less environmental damage and governments being
able to pursue their countries’ goals at a lower cost.
The challenge for green groups and others interested in
reforming perverse subsidies is to turn the rhetoric into
action by encouraging governments to accept the political
discipline of good public governance and due process in
reviewing agricultural subsidies.
115 De Moor.
74
7
TheNEXT step
Several environmental groups have been lobbying their
governments for the removal of damaging subsidies, though
reform so far has remained modest.
Green Scissors in the United States reports that 24 government programs have been cut since the beginning of its
campaign, saving US taxpayers more than US$26 billion. 116
However, agricultural subsidies remain high, with the US
percentage PSE higher now than it was 10 years ago.
With the noticeable exception of New Zealand, and to a
lesser degree Australia, subsidy reform has been slow, often
with two steps forward being followed by one step
backwards. Governments with no institutional framework
in which to assess subsidies are able to avoid making tough
decisions, which means the significant gains from reform
are not being realised.
What is needed is an institutional framework that focuses
governments on a systematic review of their agricultural
subsidies. Green groups need to pressure governments to
accept, establish and support the necessary framework to
expose the nature of perverse subsidies and to remove them.
What follows are the essential elements of such a framework.
Establish an organisation for reform
Governments should establish an organisation that is
responsible for systematically assessing agricultural subsidies.
Such an organisation must be professional, well respected
and consistent in its approach. It must conduct its reviews
of subsidies through an open and transparent process. The
nature of this organisation will depend on the country in
which it is located. Some countries may need to create a
116 Green Scissors Campaign, p. 2.
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GREENINGfarmSUBSIDIES
new organisation, while others may choose to invest
additional responsibility in an existing organisation.
Whatever is done, it is vital that a politically independent
group is entrusted with a mandate for systematically reviewing agricultural subsidies. It is not enough for politicians to
have subsidies addressed in an ad hoc way.
One example of an independent organisation created to
undertake a set of systematic reviews is the National
Competition Council, established by the Australian government. This council was given a mandate to review all
government legislation to ensure it passed certain criteria
that related to competition. Potentially, a similar organisation
(National Subsidy Review Board) could be commissioned
with the responsibility for reviewing and (if necessary)
reforming or removing agricultural subsidies. The exact
nature of the organisation is something best determined in
consultation with all stakeholders (governments, environmental groups, farmers, etc).
The creation of an independent organisation with a
mandate to reform agricultural subsidies is only one half of
the solution to the problem of persistent perverse subsidies.
The other half, of equal importance, is to ensure that the
organisation has an appropriate framework with which to
consider the subsidies. The framework must assess the
economic, environmental and social consequences of
agricultural subsidies.
Establish a framework for assessing
subsidies
The previous chapters established what needs to be done to
assess agricultural subsidies — from identifying the subsidy
through to testing whether it is good and considering
alternatives. (For a summary see chart 13.)
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TheNEXT step
13 Decision framework at a glance
What are the benchmarks?
NATURE
Is the industry being subsidised?
No
Analysis complete
Yes
What is the nature of the subsidy?
Explore ways to
price resources
correctly
Passive
Active
What type of subsidy is it?
RELEVANCE
What is the policy objective of
the subsidy?
Is the objective still relevant?
No
Dismantle subsidy
Yes
Is the objective being achieved?
No
Dismantle subsidy
and explore
alternatives
No
Can objectives be
achieved in a more
cost-effective way?
Yes
What are the unintended impacts
of the subsidy?
IMPACTS
How large are the benefits and
costs?
Who wins and who loses
domestically and internationally?
Do the costs exceed the
benefits?
ACTION
Yes
REMOVE OR REFORM
SUBSIDY
Yes
No
RETAIN
SUBSIDY
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GREENINGfarmSUBSIDIES
The first part of the decision framework (chart 1) helps to
identify the subsidy. The nature of the subsidy needs to be
determined — including whether the subsidy is active or
passive, exactly what sort of subsidy it is and what it is
affecting. At this point it is important to determine how the
subsidy is linked to farming practices, if at all.
The second part of the framework (chart 9) considers the
policy objective, whether a subsidy is the appropriate
instrument to achieve that objective and the subsidy’s
unintended impacts. It is vital to determine whether the
objective is still relevant. If it is, the subsidy should be
assessed to see how effectively it is achieving the objective.
The final part of the framework (chart 11) explains how a
subsidy should be assessed to determine whether it is
producing more benefits than costs. To do this, all of the
positive and negative impacts — environmental, economic
and social — should have been identified. The assessment
process should consider how significant each effect is and
who the winners and losers from the subsidy are. It should
then be possible to determine whether the subsidy passes
the net benefits test.
If the subsidy does not pass that test, it should be removed
and alternative policies should be considered to achieve the
policy objective. Even if the subsidy does pass the benefits
test, alternative policy instruments should be considered to
see whether there is a better way of achieving the objective.
If there is no better way and the subsidy is a good one, the
subsidy should be retained. Otherwise, the subsidy should
be reformed or removed. A clear benefit from this process
is that public policy instruments can be better aligned with
public policy objectives.
Such an assessment framework would be a valuable tool for
identifying the appropriate public policy. If used by an
independent organisation with a mandate for reform, its
value would be significantly magnified.
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TheNEXT step
Implement reform and address
adjustment issues
Once the decision has been made to reform (or remove) an
agricultural subsidy, there are several ways to achieve it and
adjustment issues must be considered. While subsidy reform
will benefit society as a whole, there will be losers from the
reform who should not be forgotten.
One way to bring about reform is to ‘fast track’ it, as done
in New Zealand. Effectively the New Zealand government
decided to rip the ‘bandaid’ of subsidies off quickly —
providing short-term pain, but ensuring quick adjustment.
Despite difficult international conditions at the time, this
approach seems to have been effective. 117 However, this
may not be a feasible approach in other countries, especially
where the farm lobby maintains a strong influence on the
government.
Another way is to undertake quick reform but offer one-off
‘adjustment’ payments to compensate for the ‘pain’.
Another way is to offer a clear and detailed reform agenda
over an extended period, which would allow farmers to
adjust to the coming changes.118
The correct adjustment arrangements will be specific to each
country and to each industry. In considering this issue, the
International Monetary Fund concluded that the speed of
reform should be dictated by a number of elements119
including:
§ fiscal considerations (the size of the subsidies and the
potential for savings)
117 Federated Farmers of New Zealand.
118 The International Monetary Fund suggests that such a process decreases the
probability that the reforms will be unwound (Gupta, Verhoeven,
Gillingham, Schiller, Mansoor and Cordoba.).
119 Gupta, Verhoeven, Gillingham, Schiller, Mansoor and Cordoba, ch. 4.
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GREENINGfarmSUBSIDIES
§ the availability of social protection instruments and
administrative capacity, and
§ the willingness of governments to act on a technically
sound reform package.
It is vital that the framework adopted addresses adjustment
issues in its design. If agricultural subsidy reform is not
managed appropriately, the necessary political support will
diminish and the potential economic and environmental
gains may not be realised.
Achieving a political commitment to reform will be difficult,
but the economic and environmental dividends will be
worth it.
Groups committed to a better environment and/or a
stronger economy should unite in demanding that governments around the world pay serious attention to reforming
their agricultural subsidies.
80
Greening
farm subsidies
The next step in
removing perverse
farm subsidies
Greening farm subsidies
When a government policy is damaging both
the environment and the economy, it should be
obvious that such a policy needs reform. This
is the case with many agricultural subsidies.
However, governments around the world have
so far failed to tackle this problem, even
though the harm farm support does to an
economy has long been recognised. Now there
is growing recognition of the environmental
cost of farm subsidies. This has led to an
emerging alliance of interests keen to see
comprehensive reform.
2003
To this end, the Rural Industries Research
and Development Corporation and the
World Wide Fund for Nature (www.wwf.org.au)
have asked the Centre for International
Economics (www.thecie.com.au) to asses
why perverse agricultural subsidies persist
and how they can be removed. This study has
been published by RIRDC as part of its Global
Competitiveness R&D Program. Additional
copies of this publication may be obtained
from RIRDC by visiting their website
(www.rirdc.gov.au).
CENTRE FOR
INTERNATIONAL
ECONOMICS
RURAL INDUSTRIES RESEARCH
& DEVELOPMENT CORPORATION
RIRDC Publication No. 03/040
Greening
farm subsidies
The next step in
removing perverse
farm subsidies
2003