The agricultural support by a country to its agriculture could come in the form of direst and indirect interventions. These can be further divides as:
If a country is operating as a closed economy, the demand and supply curve may appear as shown in Figure-1. Curve ‘D is the demand curve and shows the quantity the local consumer is willing to buy at various prices. The demand curves slope shows that as the price goes down the customers are likely to buy more. Similarly supply curve S shows that if the price were high more supply would become available, as the producer will produce more.
In a closed economy, it is not possible to import or export "A" will be the equilibrium position in the market, since at price pe the quantity that producers are willing to supply (qs) is equal to that which consumers are willing to buy (qd).
In a free market situation, where agents can freely decide to import, export or trade locally, the tradability of agricultural commodity depends on the local price and demand, financial import parity price and financial export parity prices.
When the financial import parity price Pip is higher than the domestic price Pd imports cannot be justified. Similarly if the domestic price is higher than the financial export parity price Pep export will not be justified either. These goods are not tradable (Figure 2-A).
In Figure 2-B the exportable items are presented. The financial export parity price Pep is higher than the domestic price and there is an incentive to export. The producer increase their supply to qs from which qd is consumed domestically while (qs-qd) is for export. Domestic prices increase until "pep" is reached. Producers’ gain and consumers lose because of the price increase, which induces lower consumption and higher production. The import bill is (qs-qd).pep, the expenditure by consumers (qd.pep), and the revenue of producers (qs.pep).
Figure 2-C shows a situation when financial import parity price is lower than the domestic price, which creates an incentive to import the agricultural goods. In the importable case the domestic price falls to pip. Because of the lower price, producers reduce their supply to "qs" and consumers increase their consumption up to "qd". The gap between consumption and production (qd-qs) is imported. The import bill is (qd-qs).pip, the revenue of producers (qs.pip), and the expenditure of consumers (qd.pip).
In case of government subsidy, the domestic price to the producer goes up by the amount of the subsidy. As we have seen in Figure-1, when the price is high the producer will increase the supply (by using more crop area, intensive farming etc.) This will reduce or eliminate the need to import. Other countries, which do not subsidize their farmers and have a surplus stock, will not be able to export their crops to a country where subsidies have resulted in higher production. The surplus supply of these countries will add to the worldwide surplus plunging the prices in the international market. This is exactly what happens due to huge subsidies by US and European Union.
In a free unsubsidized market, production in US will go down, the prices will increase and imports from other countries will give a chance to the third world countries to improve their trade.
In a January 2005 report, "Global Agricultural Trade and Developing Countries", the World Bank criticized the developed countries for agricultural protectionism. The report says, Agricultural support and protectionism is hurting the economies of poor countries, as they were unable to raise exports despite increased farm productivity. Without elimination in subsidies, tariffs and other border protections by developed countries the agricultural trade deficit of poor countries will continue to increase.
Many OECD countries have imposed tariff and import quotas. This limits the imports to these countries (depriving other countries of opportunities available under free trade). Countries like Japan and Korea have both import quota and ad valorem tariff on rice imports. Figure 3 shows the effect of a tariff rate ‘t’. In absence of the tariff the domestic price will be equal to international price, Pw. With tariff ‘t’, the domestic price will increase to Pw* (1+t), domestic production will increase in response to a higher selling price from s0 to s1 (Figure-3)
The increase in domestic price will reduce consumption from d0 to d1. Due to reduced demand and tariff, the imported quantity will also decrease from (d0-s0) to (d1-s1), while the government will earn revenue as shown in the shaded area (Figure-3). The producers’ benefit from the higher prices due to the tariff, the government earns some extra revenue [Caballero et al, 1998]. The foreign countries, which could have exported their produce to the country, lose their export income and the domestic consumers are also losers because they have to pay the higher price and reduce consumption.
In a free market situation, removal of unreasonable tariff will allow the competitive producers to export their surplus goods to countries, which have shut off their markets to foreign competition. The recent WTO meeting in Hong Kong had to face the protectionist Korean farmers who wanted to keep Korea closed to rice farmers from other countries. Tariffs and quotas are against free market trade; they impact other countries by reducing their exports, creating higher surplus in world market and reducing prices even further. Poor countries, which rely mainly on agriculture, suffer because of these restrictions. US and EU subsidies, Japan and Korea basically closing their markets to agricultural imports have harmed the poor and developing countries. The subsidies have allowed overproduction in developed countries, plunging international market prices. For example, in 1994-95 four African States substantially increased their cotton exports, while due to huge surpluses and subsidies in developed countries, the price of cotton fell and their income from exports actually went down.
President of Burkina Faso was forced to complain Several Central and West African countries are victims of injustice by the US and the EU. These countries subsidize their agricultural producers, ignoring the rules of the WTO. Such practices are undermining the fragile national economies of countries that depend on cotton.
In the 1996 Agreement on Agriculture (AoA) in Uruguay, it was decided that World Trade Organization (WTO) member countries will reduce agricultural support and protection policies substantially and will not use arbitrary health and environmental regulation to restrict agricultural trade. The Uruguay AoA allowed some kind of supports called ‘green box supports’ while the categories not acceptable under the AoA agreement were called ‘Amber Box Supports.
The truth is that all OECD countries including EU and US continued to provide both types of supports and use protectionism to restrict imports into their regions. The worldwide subsidy amounts to $300 billion. United States subsidizes its former to the tune of $20 billions. In 2002 the international price of cotton was $0.42 per pound, the US target price for cotton in the same year was $0.724 per pound. Without this subsidy the farmers would have chosen other crops and reduced cotton plantation. This would have increased international market price and benefited poor countries. The subsidies create distortions in world prices of agricultural products and have the impact of an unfair competition.
Two kinds of supports are being provided to the producers, adding to the revenues of the producers by direct payments or by reducing their costs by input subsidies [Caballero et al, 1998]. These subsidies on a domestic level have the impact of moving a country from being a net importer (S1) to being self-sufficient (S2) and eventually becoming a net exporter (S3) in the case of a tradable commodity (Figure-4).
In a situation where the price is free trade market price Pw has established a domestic demand Q2, direct and indirect subsidies to the producer will effect future production. If the price is maintained the same demand will also remain the same at Q2, production will increase, reducing imports and even to the extent of that a net importing country may become a net exporter. The government has to bear the cost of the subsidy and the countries exporting their produce loose their trade.
The graphical representation presented above show the impact of government policies in agricultural sector on the agricultural sector in that country. The changes, the subsidies and protectionism by one country have an impact on other countries as well as world prices of the produce. Massive export subsidies, direct and indirect subsidies to the farmers have had a major impact on worldwide prices of agricultural produce. Third world countries expecting to improve their trade by exporting to developed countries find that the increase productivity has not yielded the expected returns as international market prices are falling due to export surpluses. Protectionism, tariffs and quotas are increasingly limiting their exports and reducing their income.
The losses to poor countries in lost foreign exchange by the subsidies and protectionism of the OECD countries runs into billions. [Cultivating Poverty, 2002] estimates that in 2001-2 estimates that without the price drop of 11 cents per pound attributable to subsidies African countries would have earned $302 million more for the cotton crop. This amount appears to be tiny compared to the $4billion spent on US subsidy to cotton farmers, but we have to appreciate that the total GNP of cotton producing African countries is low.
The $50 million lost by Burkina Faso, for example would have added 2% to the gross national income of the country. The kind of subsidies being provided by United States is considered violation of the spirit of AoA Uruguay by many countries. Brazil sued US for providing subsidies to bring the plight of developing countries into the limelight. The Brazilian Government has claimed that its cotton sector has sustained serious losses as a result of US subsidies, and that these subsidies include prohibited export measures. That claim is fully justified. African governments would be equally justified in claiming serious injury [Cultivating Poverty, 2002].
One thing is certain that agricultural support by a country and closing its doors to imports from developing countries impacts world market and is preventing poor countries from developing their economies.
We calculate the financial import parity price by first choosing a domestic wholesale reference market, for instance the wholesale market of the capital city, where imported goods are supposed to enter into competition with locally produced equivalent goods. We then add to the border price (CIF in this case) all port charges after the import touches the dock, any domestic tariffs and other taxes or fees, duties or subsidies, and the transport and marketing costs from the port to the market of reference. The result is the import parity price at the market of reference. If we further want to obtain the import parity price at the farm-gate, we subtract the transport and marketing costs that farmers have to pay to put their produce in the market of reference. If there is any industrial transformation, we calculate the raw crop equivalent as in the export parity case. [Caballero et al, 1998]
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