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

Thus, for a given export demand elasticity (Exd), a given a specific domestic supply-price elasticity (Es) and production point (q*), we illustrate a model in which two plausible extreme specifications are represented. One, which we refer to as the target-linked specification, is based on using the net target price (P^sub s^) to derive the intercept and slope of the subsidized supply curve S'. The other specification, which we refer to as loan-linked, relies upon the loan rate (P^sub l^) to derive the intercept and slope of the subsidized supply curve S'^sub o^. The effect of using the loan rate rather than the net target price causes the subsidized supply curve to change from S' to S'^sub o^ by shifting downward and rotating clockwise. Essentially, the initial free-trade equilibrium price P^sub f^, derived from the intersection of the target-linked unsubsidized supply curve S and the total demand curve T^sub D^, moves downward along the total demand curve to establish a smaller free-trade price P^sub f^ and smaller freetrade quantity q along the loan-linked unsubsidized supply curve S^sub o^.

Note that all references to "free trade" prices and quantities in this paper are made with the understanding that such theoretical prices and quantities are calculated given the absence of U.S. cotton policy distortions. We do not account for distortions caused by the cotton policies of other nations, and acknowledge that our 'free trade' prices and quantities are affected by distortions caused by countries other than the United States.

This theoretical analysis shows that there can be a significant difference in the impact of policy depending on which assumption is made concerning producer supply response. As mentioned previously, marketing loan payments are widely regarded as coupledand Figure 2 clearly exhibits this, as S'^sub o^ at point z corresponds to the assumption that producers are basing their production decision on the loan rate. If, on the other hand, production decisions are actually based on the net target price, then this would essentially quell the debate as to whether DPs and CCPs are truly "decoupled" or not-regardless of the fact that they are calculated at 85% of base acres. As producers can update their base acres under the 2002 FSRI (Westcott, Young, and Price), an incentive exists for them to maintain production levels-and perhaps even increase them over time (Goodwin and Mishra). Indeed, Sumner (p. 21) states that the anticipation by producers of frequent baseacre updating means that CCPs ". . . are almost fully tied to production, although operating with a lag."

However, the target-linked specification in our model framework clearly represents an extreme coupling scenario. What happens, for example, if the degree of coupling is lessened by removing DPs from the coupled model? This case also can be depicted in Figure 2, where the corresponding price and supply curve is now given by P^sup *^ and S'^sub *^. The price chosen by producers is now above the loan rate and below the net target price. One can discuss additional policy instruments within the context of Figure 2. This model is flexible because it allows one to determine the impact of either an individual or a group of policy instruments. The results presented below are given for specific crop years covering the period 1999-2000 to 2003-2004, and therefore the given supply parameters vary by year.