What do the current WTO proposals mean to ...

November 23, 2005

What do the current WTO proposals mean to Canadian Agriculture? R. S. Gray and W. H. Furtan*

R. S. Gray and W.H Furtan are Professors in the Department of Agricultural Economics at the University of Saskatchewan

Introduction In some Canadian quarters the current United States (US) and European Union (EU) trade proposals are being heralded as good news for Canada’s farm economy. While we support free trade and believe free trade would be good for Canadian farmers, these proposals do not meet muster of free trade. First, the cuts in subsidy caps proposed would not result in a decline in US or EU production, thus no increase in the world price of farm commodities. Second, the tariff cuts suggested would not open up world markets due to the protection for ‘sensitive’ products. Finally, the proposals would mean the end of the Canadian Wheat Board (CWB). While the time may have come for more changes to the CWB (see Furtan 2005), the removal of the single-desk selling authority as suggested in

“While we support free trade and believe free trade would be good for Canadian farmers, these proposals do not meet muster of free trade.”

the trade proposals without a lot more thought and consideration given to what takes its place would be very poor policy for those many western Canadian grain farmers who use and value its services. The current proposals would place a large cost on Canadian farmers, particularly western grain producers, while delivering few if any economic benefits in return. A significant portion of Canada’s wealth originates with international trade. Agriculture is no exception to this rule, particularly the grains and oilseeds sector. For example, over the ten year period 1994-95 to 2003-04 Canadian farmers grew an average of 23.9 million tonnes, of wheat of which 16.8 million tonnes or 69.8% were exported.1 The closure of the US and other markets to Canadian beef in May 2003 due to the detection of BSE in one Canadian cow demonstrated that sector’s dependence on trade. In contrast, some farm products, such as dairy and poultry, which operate under a supply managed system in Canada, are protected from international competition by high tariffs.

* Senior authorship is not assigned 1 Data comes from the website www.cwb.ca

Canada Rural Economy Research Lab

What do the current WTO proposals mean to Canadian Agriculture? These producers want the tariffs to remain as they are currently. It is for these reasons that the WTO negotiations are delicate for Canadian politicians and important to Canadian agricultural producers. The purpose of this essay is to discuss what the current WTO agriculture proposals

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mean to Canadian farmers. We focus on two proposals, that of the US and the EU. Other groups of countries such as the G-10, G-20, and G-33 also have made proposals to the WTO as to how the agriculture trade rules might be changed.2 Other players, such as Brazil, India, and China, are important, however given the economic size of the US and EU, and the fact that they both provide substantial economic support to their farmers; the latter will largely determine the parameters of any new agricultural trade agreement. Any trade agreement arising from the Hong Kong ministerial meetings, or shortly thereafter, will likely lie somewhere between the US proposal and EU proposal.3

“A significant portion of Canada’s wealth originates with international trade.”

The US and EU proposals The most important consideration when evaluating the proposals by the US and EU is to determine the difference between the allowable level of distorting subsides and the actual usage level. For example, Nair et. al. 2005 estimate the permitted level of US distorting subsidies to be in the range of US$45 billion and US$49 billion. The US is currently using less than 50 percent of this range of allowable distorting subsidies. A similar situation exists in the EU. For there to be any impact on agricultural commodity prices the actual level of distorting subsidy must decline and not just the allowable level – implying that allowable subsidies must decline by well over 50% to have any tangible impact on US and EU producers. The US proposal offers a cut of 53% to the overall cap on US distorting agricultural subsidies, which means US farmers, will face a minimal cut back in support. First, all the fixed payments schemes not tied to production such as the direct payments program are considered ‘decoupled’ and are not subject to any reduction. Second, the loan deficiency payments scheme for all crops will remain. The one program that may get cut back is the counter-cyclical payments for pre-1996 program crops (e.g. wheat, corn, cotton etc) due to 2

The makeup of these groups can be found on the World Trade Organization website www.wto.org. Both of these proposals are complex. In this essay we provide a very brief and summarized view of what they mean to Canadian farmers. 3

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What do the current WTO proposals mean to Canadian Agriculture? the cut in the US aggregate measure of support (AMS) limit.4 However, if the US administration wished, as has been suggested by some United States Congress members, to maintain the funding magnitude to farmers they may be able to do so by converting some currently distorting payments into non-distorting fixed payments. The major benefit of the US proposal in terms of commodity prices is that the cut in support will stop any further increase in the magnitude of subsidization. The US proposal suggests the EU cut the trade-distorting subsidy cap by 75 percent. The EU has rejected this and has offered to cut subsidies by 70 percent. While this number is large it is unlikely to have much, if any impact on the level of commodity prices for the same reason that the US subsidy cut will do little to change prices. The EU would need to cut trade-distorting subsidy cap by 80 percent before the actual level of support

“The most important consideration when evaluating the proposals by the US and EU is to determine the difference between the allowable level of distorting subsides and the actual usage level.”

falls. The EU like the US has not been using all its “subsidy room” available from the last WTO agreement. In addition, the EU has made a number of changes in the Common Agricultural Policy in 2004-05, which reduces the level of trade-distorting subsidies. The EU allows member countries to use a combination of non-distorting fixed land payments and a continuation of a lower level of commodity price support. Because of these changes, without a required deep cut in subsidies (i.e. over 80%), they are unlikely to be required to alter their current program.

Canadian grains and oilseeds sector Canada is being asked to reduce its level of distorting subsidy cap by 31% in the US proposal and by 50% in the EU proposal. Both levels of required reduction in the overall level of trade distorting domestic support would allow for the existing income support system (i.e. Canadian Agriculture Income Stabilization) and crop insurance scheme to remain in place under most circumstances. The year 2000 is the most recent year for which a Canadian WTO domestic support notification is available. Canada used only a small portion of its $4.3 billion AMS limit in that year. However, we estimate that in 200304, Canada used a significantly higher portion of its AMS, mainly due to payments in

4

Aggregate Measure of Support (AMS) is one measure of the trade distorting subsidy. For a detailed description of the various measures of support and how they are calculated see Ingco and Nash 2004.

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What do the current WTO proposals mean to Canadian Agriculture?


response to the BSE situation. The impact of the proposals on recent levels of support is shown in Table 1. Table 1: Impact of US and EU domestic support proposal on Canadian spending limits $million Canadian

Type of spending

AMS

Current spending limit 4,301

2000 notified levels 848

Recent year assuming 80% of AMS used 3,440

1,207

1,207

243

243

2,298

4,890

US proposal of 31% cut

EU proposal of 50% cut

6,254

4,531

De minimus*

“The major impact of the US and EU proposals on Canadian support levels would be to limit the growth of trade distorting subsidies.”

non1,587 productspecific Product1,587 specific Blue Box** 1,587 Overall 9,063 Source: www.wto.org.

* De mininus are subsidies that are less than 5% of the total value of agriculture production in the case of non-product-specific subsidies or less than 5% of the value of production of that product in the case of product-specific subsidies. The de minimus limits were calculated using the values of agriculture production notified by Canada in its 2000 domestic support notification. ** Blue Box payments are a special exemption from AMS commitments included in the WTO agreement that covers payments made under production-limiting programs, provided that such payments are based on fixed areas, crop yields, or livestock numbers, or, if the payments are variable, on 85 percent of the base level of production

The major impact of the US and EU proposals on Canadian support levels would be to limit the growth of trade distorting subsidies. However, it may not be possible for Canada to support the CAIS program, crop insurance and introduce a BSE payment like it did in 2003-04 under the EU proposal. The proposed cut in US and EU subsidy caps levels mean very little to Canadian crop producers and will certainly not result in a significant increase in the world price of agricultural commodities.

Tariff reduction The second major form of economic protection offered farmers are tariffs on imported goods that compete with their products. Both the US and EU proposal allow for some “sensitive products” to remain protected with very high tariffs. These are products for which countries do not wish to remove economic protection for political and security -4-


What do the current WTO proposals mean to Canadian Agriculture? reasons. The US proposal allows for 1 percent of dutiable tariffs to qualify as “sensitive products” while the EU suggests 8 percent of exiting tariff lines are eligible as “sensitive products”. The US does not use tariffs to the same extent as the EU and Canada with some notable exceptions being orange juice, dairy, and sugar tariffs. Generally speaking, tariff reduction by Canada for example, leads to an increase in the access to the Canadian market by other countries, which is the key benefit being sought by exporting countries. Canada’s exporters would gain with tariff reductions elsewhere. Basically, the US proposal requires an 85-90 percent cut in the highest tariffs and smaller cuts in lower tariffs. The EU proposal requires a 60 percent cut in the highest tariffs. Tariffs are important inhibitors to market access for a number of crops such as wheat and soybeans produced in Canada. The EU has a 59% tariff on imported wheat (the tariff does not apply to high quality wheat) while Japan has a wheat tariff of 252% (Nair et.

“Both the US and EU proposal allow for some “sensitive products” to remain protected with very high tariffs.”

al. 2005). In the case of soybeans Korea has a 487% tariff. Finally, for beef, the EU has a 108% tariff and Korea 40%. These tariffs must be lowered for Canadian producers to gain economic benefit from improved market access. Tariff protection is a key part of Canadian farm policy. Tariffs are particularly important to farmers who produce the supply managed products including dairy, eggs, chicken, turkey, and hatching eggs. Without the high tariffs that limit imports of cheaper products (of like quality), the supply managed system would not support the current level of domestic prices in these sectors. If tariffs were completely removed, the price of supply managed products would decline to international levels. Quota values would disappear and the supply control system used by the Canadian producers of these products would be inoperable. Some argue that the supply managed systems can remain in place if there were modest tariff reductions. That is, tariffs could be reduced without harming producer income. However, many producer groups fear that if tariff protection starts to erode they will very soon lose all meaningful protection. Under the US proposal, the dairy and perhaps a couple of other supply managed sectors will be able to survive intact, but not all of them. With the EU proposal, most if not all supply managed sectors will continue to operate under the current policy framework. Any proposal that eliminates part of the supply managed system will be very contentious in Quebec and Ontario because these provinces have the majority of the supply managed system. -5-


What do the current WTO proposals mean to Canadian Agriculture? Other important parts of the proposals The US and EU proposals contain an export competition pillar, which, in addition to State Trading Enterprises such as the CWB, includes export subsidies, export credit and food aid. An agreement to eliminate exports subsidies is positive from a grains and oilseeds perspective, as are tighter disciplines on the use of export credit programs. In the previous Uruguay Round of Trade Agreement Canada eliminated its grain and oilseed export subsidy called the Crow Rate. The EU continues to use export subsidies on grains today. The US currently uses export credit programs with very generous repayment periods as a market development tool. Finally, the US proposal on food aid would not significantly impact their ability to continue to use food aid programs as a market development tool.

Canadian Wheat Board “These are products for which countries do not wish to remove economic protection for political and security reasons.”

Under both the US and EU proposals, the single-desk selling authority of the CWB is to be discontinued. The loss of the CWB single-desk status will result in a cascade of events that will fundamentally alter the economics of grain production in western Canada. Some of these effects will be immediate while other effects would take years to manifest themselves. The immediate direct effect will be the loss of premiums gained in many export markets. Currently, the CWB can effectively negotiate with some customers who prefer Canadian wheat or barley. If the CWB loses its status as the only seller of Canadian wheat and barley, the market would develop many different sellers of Canadian wheat and barley. Customers of Canadian wheat and barley will then be able to choose among the many sellers of Canadian wheat and barley who will compete to make the sale. The result will be a lower sales price and the loss of the price premium. Several economic studies have estimated that the loss of these price premiums will lower farm gate prices from $10 to $25 per tonne (Kraft, Furtan, and Tyrchniewicz, 1996: Schmitz, Gray, Schmitz, and Storey, 1997). With the loss of the single-desk selling authority, the current price-pooling mechanism could not continue. The reason lies with the fact that producers will be able to enter or exit the price-pool at any time depending upon if the spot prices are moving up or -6-


What do the current WTO proposals mean to Canadian Agriculture? down during the crop year. This will guarantee that the price-pool has a low value and will thus be unattractive to producers. Today, farmers in the CWB region have options to exit the price-pool while still allowing the CWB to sell the grain and maintain the single desk. In this regard, the CWB has implemented a number of flexible pricing options that provide producers with similar options they have in an open market – fix a price and lock in a basis at any time during the crop year and thus earn a return that is either higher or lower than the pool return. As can be seen in Table 2 below, the vast majority of farmers have not chosen these options (fixed price (FPC) and basis contracts (BPC)). Rather, they have chosen to go with price pooling as the key service in terms of marketing their crops through the CWB. While this may change over time as farmers become more familiar with these price flexibility programs, it is clear that price pooling is and will continue to be a key service that farmers demand. However, it is also clear that this service will not be available if either the current US or EU proposal become reality.

“Tariff protection is a key part of Canadian farm policy.”

Table 2: Use of Fixed Price Contracts and Basis Payment Contracts by farmers (tonnes and percentage) Payment system 2001-02 2002-03 2003-04 Price-pool

18,684,301 99.2%

13,281,929

FPC/BPC

152,151

149,019

0.8%

98.9% 1.1%

18,274,035 164,006

99.1% 0.9%

Source: CWB Annual Reports.

The incentive to undertake costly market development for Canadian grains will also change considerably if the EU or US offers become reality. With single-desk status, the CWB can make a long term investment in a potential customer knowing that if a market develops, these sales will benefit Canadian producers. In an open market these incentives no longer exist because any market developed by one firm can easily be stolen by another who is selling the same product. There are at least three important components to controlling the cost of grain handling and transportation in which the CWB currently plays an important role. These are costs associated with the handling of grain by grain companies, railway costs, and producer cars. Under the current system with the removal of the single-desk selling authority the CWB will be in direct competition with multinational grain companies who also act as -7-


What do the current WTO proposals mean to Canadian Agriculture? agents of the CWB. In this situation, one would clearly question why they would be willing to handle the CWB product at competitive rates? In reality, companies would have a strong incentive to circumvent CWB sales, knowing that if they do not offer to put the grain in port position, this will force the buyers of Canadian grain to the private trade. With the CWB out of the picture, the export of grain will quickly become dominated by multinational grain companies with a smaller presence by Canadian companies, and some inland producer associations. In the short run, excess capacity at inland positions would keep elevation margins slim, but margins could increase at port as companies strategically limit their capacity in order to increase terminal margins. Price transparency would be become a major issue for producers in the absence of the CWB. Prior to the establishment of the CWB, commodity exchanges played a significant role in creating price information. It is unclear how price signals would be established in the absence of the CWB. With the lack of a sizable domestic market for wheat and the

“Under both the US and EU proposals, the single-desk selling authority of the CWB is to be discontinued.”

concentration of grain firms, it is unlikely that a viable commodity futures market for export wheat would be established. In the absence of such a market, firms would contract with producers, who would have very little information about basis levels. The most profound affect of CWB elimination would occur in grain transportation. The current rail car allocation process is heavily dependant on the CWB contracting and attaining capacity from key service providers using the clout of significant volume to drive lower costs. However, in a competitive commercial export environment the railways will argue for, and likely achieve, a market based system of car allocation and freight rate determination, where each company bids for limited rail capacity. The commercially based grain transportation system used in the United States has resulted in the North Dakota and Montana freight rates being nearly double current Canadian freight rates. If similar freight rates were to occur in Canada this would reduce farm gate price by another $20-$30 per tonne (to view US rates see https://www.bnsf.com). The potential loss of the single-desk selling authority is the most important and immediate part of the US and EU trade proposals. The CWB is a vitally important institution for the western Canadian grain economy. The loss of the single-desk selling authority would essentially leave western Canada at the whim of multinational grain

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What do the current WTO proposals mean to Canadian Agriculture? companies that would view Canada as simply one additional “origin” in multiple-origin contracts. Western Canada would become a residual supplier to the world market.

Conclusions The trade proposals are still a moving target. However, we draw some general conclusions for Canadian agriculture. •

In terms of increased prices for the grains and oilseeds sector, Canada would gain little if anything from the proposed US and EU reductions in the level of subsidies. The only real benefit is they would stop the growth in the US and EU subsidy level. In addition, it does not stop the growth in decoupled payments such as the EU single land payment or US direct payment program, which has an impact on the wealth level of the land owners.

•

The proposed tariff reductions do have the potential to significantly impact the supply managed system. The tariff reductions asked for in the US proposal would mean the end of supply management for some commodities, while under the EU proposal, most supply managed systems would remain intact. In terms of increased market access for Canadian products, the tariff reductions do not go far enough to generate much new revenue. Finally, some markets may remain closed because of the remaining protection for ‘sensitive’ products.

•

The Canadian Wheat Board is significantly impacted under both proposals. As they stand both proposals will see an end to single desk-selling as Canadian producers now know. This will mean the end of the CWB with very significant and negative implications for the competitiveness of western Canadian agriculture.

Given that these current proposals will fundamentally alter the western grain marketing system and potentially alter the supply managed system, while getting so little in return, it is not surprising they are panned by organizations like the Canadian Federation of Agriculture. Canadian policy makers face the choice of going for a minimal deal, somewhere between the US and EU proposal, which will cost Canadian farmers, or trying to further draw out trade talks.

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What do the current WTO proposals mean to Canadian Agriculture? References Canadian Wheat Board, Annual report and statistical tables, various years Furtan, W. H. 2005. Transformative Change in Agriculture: The Canadian Wheat Board. The Estey Centre Journal of International Law and Trade Policy, Vol. 6, No. 2, pp 95-107.

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Ingco, M, D., and J. D. Nash. Eds. 2004. Agriculture and the WTO: Creating a trading system for development, The World Bank, Washington, DC. Kraft, D.F., W.H. Furtan, and E.W. Tyrchniewicz. 1996. Performance Evaluation of the Canadian Wheat Board. Winnipeg, MB: Canadian Wheat Board. Nair, R., C. Chester, D. McDonald, T. Padbury, D. Gunasekera, and B. Fisher. 2005. Timing of the US farm bill and the WTO negotiations: A Unique Opportunity, ABARE eReport 05.11, Canberra. Schmitz, A., R.S. Gray, T.G. Schmitz, and G.G. Storey. 1997. The CWB and Barley Marketing: Price Pooling and Single-desk Selling. Report prepared for the Canadian Wheat Board. Winnipeg, MB: The Canadian Wheat Board. Media Contact Dr. R. S. Gray Professor and Head Department of Agricultural Economics University of Saskatchewan Phone (306) 966-4026 Fax (306) 966-8413 [email protected] C-RERL’s mission is to inform public policies designed to stabilize and enhance rural communities throughout Canada, and in Saskatchewan in particular. C-RERL is directed by Mark Partridge, the Canada Research Chair for the New Rural Economy at the University of Saskatchewan. Mike St.Louis is the manager of C-RERL. Mike is an experienced GIS specialist capable of performing spatial analysis. C-RERL is open to partners in research and clients from the provincial government. Individuals or groups are invited to explore the capabilities of the facility and to utilize the services available through joint projects, contract research, or on a fee-for research basis. Demonstrations of the features of the lab are available upon request and questions regarding its use and potential are welcome. For more information, please visit the CRERL website at http://www.crerl.usask.ca. Canada Rural Economy Research Lab (C-RERL) Department of Agricultural Economics University of Saskatchewan 3D31 Agriculture Building 51 Campus Drive Saskatoon, SK S7N 5A8 Canada Phone: 306-966-2965 Fax: 306-966-1345 Email: [email protected]

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Mark Partridge, Ph.D. Canada Research Chair in the New Rural Economy Department of Agricultural Economics 3C66 Agriculture Bldg. University of Saskatchewan 51 Campus Drive Saskatoon, SK S7N 5A8 CANADA Phone: 306-966-4037 Fax: 306-966-8413 Email: [email protected]