U.S. Cotton Subsidies: Drawing a Fine Line on the Degree of Decoupling

Journal of Agricultural and Applied Economics, Apr 2007 by Schmitz, Andrew, Rossi, Frederick, Schmitz, Troy G

The impact of the U.S. cotton policy depends on several interrelated factors: how input subsidies interact with producer price supports, producer price expectations, and the extent to which price supports are decoupled from production. Cotton subsidies have a direct impact on world cotton prices, depending on the extent to which price supports are coupled to production. At one extreme, there is a price impact of 12.4% when producers make decisions at the loan rate, but the average price impact is 20.9% when producers make decisions based on the target price. Results are presented for intermediate cases of decoupling.

Key Words: cotton, counter-cyclical payments, decoupling, loan rate

JEL Classifications: Q17, Q18, Q25, Q28

Global interdependence in the digital age has resulted in the creation of many new and important trade linkages, trade associations, and trading agreements. As global trade has increased, however, so has the recrimination and incidence of trade disputes. The Canadian investigation into U.S. corn dumping complaints (Elliott) offers a simple example of cross-border friction in the trade of feed grains. Additional tensions on a wider international scale are exemplified by the separate cases that Brazil has brought to the World Trade Organization (WTO); one in which European Union sugar policy is targeted (Powell and Schmitz 2005), and the other being their successful suit against subsidies provided by the government of the United States to the U.S. cotton industry. These challenges have not only highlighted the North-South contention over agricultural trade concessions, but they also illustrate the intense nature of trade issues and negotiations; the ramifications of which can have severe consequences for producers, consumers, and governments worldwide. For example, the WTO decision has important implications for the future of a new U.S. farm bill. Also, because of its high profile defeat in the WTO, debate over the U.S. cotton program has been reignited in academic circles, with the subsequent examination of the alleged economic inefficiencies and rent-seeking behavior resulting from trade-distorting agricultural policies.

In this paper, even though we specifically model the impact of U.S. cotton subsidies on the world price of cotton, this model has applicability to U.S. agricultural policy in general. This paper builds on earlier work by Schmitz, Schmitz, and Dumas and Rossi, Schmitz, and Schmitz. The model is comparative static in nature and reflects the main policy instruments affecting U.S. cotton production, exports, and world prices. The two previous papers modeled the U.S. cotton market under the strong assumption that cotton producers base their production on the target price set forth under the U.S. cotton policy. As such, results derived under this assumption approximate an upper bound of price and quantity impacts due to U.S. cotton subsidies. While these models incorporate water subsidies along with price support instruments, we did not include other elements, such as crop insurance. In contrast, in this paper we model the other extreme casewhere U.S. cotton farmers respond to the marketing loan rate price rather than the target price in decision making-and include other subsidy instruments previously ignored in our earlier work (e.g., crop insurance). By so doing, we compare the theoretical extremes of the distortionary impacts of U.S. cotton policy. Furthermore, we provide an intermediate scenario where producers respond to price guarantees above the loan rate. This is important because there appears to be little agreement as to producer behavior regarding the response to support prices. Do producers respond to the target price, the loan rate, or neither? How producers respond clearly affects the degree to which policy is decoupled from production.

Other researchers also have examined the distortionary impacts of cotton subsidies. Poonyth et al., for instance, employ a comparative-static, partial-equilibrium global trade model to focus on the impact that aggregated global cotton subsidies have on world prices, production, trade, and welfare, whereas our model focuses specifically on the impact of removing U.S. cotton subsidies. Another major difference is that their work does not include water subsidies. Sumner and Pan et al. both utilize econometric models, which is very different from the approach used in this paper to estimate how the removal of U.S. cotton subsidies would affect U.S. production quantities and the world price of cotton. They do not include water subsidies in their analyses either. While we recognize that Brazil's WTO case against the United States did not address the impact of water subsidies, input subsidies have in general become a focus of the wider WTO framework for resolving trade disputes. With reference to the cotton case, as this paper clearly shows, if one does not include the impact of water subsidies on cotton production and prices, one underestimates the price impact of U.S. cotton price support programs. Moreover, water subsidies alone can be price and trade distorting even in the absence of price supports (Rossi, Schmitz, and Schmitz).