Agricultural Subsidies Under Decoupling

• Published date: 16 October 2007
• Pages: 131-148
• DOI: https://doi.org/10.1016/S0193-5895(07)23006-4
• Date: 16 October 2007
• Author: Andrew Schmitz,Frederick Rossi,Troy G. Schmitz

AGRICULTURAL SUBSIDIES

UNDER DECOUPLING

Andrew Schmitz, Frederick Rossi and

Troy G. Schmitz

ABSTRACT

Following the World Trade Organization (WTO) ruling favoring Brazil

over U.S. cotton growers, the debate continues over the impact of U.S.

farm policy. For U.S. cotton policy, the price impact depends on several

factors, including the extent to which it is decoupled from production. The

impact on world cotton prices under decoupling (the loan rate is used in

supply response analysis) is much less than under coupling (the target

price is used in producer production decisions). Also, the welfare impacts

are very different. Using cotton as an example, the welfare cost of U.S.

cotton policy is much less under a decoupled program.

INTRODUCTION

A major contributing factor to the breakdown of the Doha Round of

negotiations in Cancun in September 2003 was U.S. farm policy. The victory

of Brazil in its challenge through the World Trade Organization (WTO) over

subsidies provided to the U.S. cotton industry warns of the high stakes

involved for producers, consumers, and governments worldwide. For

example, the Step 2 cotton subsidy was recently terminated by the U.S.

Research in Law and Economics, Volume 23, 131–148

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ISSN: 0193-5895/doi:10.1016/S0193-5895(07)23006-4

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government as part of the WTO ruling. Additional trade tensions have been

created due to Brazil’s case in the WTO over sugar policy in the European

Union (Powell & Schmitz, 2005) and Canada’s investigation into U.S. corn

dumping complaints (Elliott, 2005). Such attention has renewed the debate

over alleged economic inefficiencies and rent-seeking behavior resulting from

trade-distorting agricultural policies, particularly sinceU.S. cotton policy was

identified as the main source of the impasse at Cancun (Laws, 2004).

Rossi, Schmitz, and Schmitz (2005) model the impact of U.S. cotton

policy on world trade and world prices by incorporating three important

policy instruments: a water subsidy, a counter-cyclical payment (CCP)

scheme, and a guaranteed loan rate. They make a crucial assumption

(referred to as ‘‘coupling’’) that producers respond to the target price when

making production decisions. This is a rather strong assumption, and

building a model using the target price as the basis for production decisions

implies a high degree of coupling relative to CCPs and direct payments.

Some have argued (e.g., Gardner, 2002) that producers make production

decisions based on prices that are slightly higher than the loan rate rather

than the target price. However, modeling U.S. cotton subsidies using prices

at or near the loan rate implies a low degree of coupling, which we refer to as

‘‘decoupling’’. Schmitz, Rossi, and Schmitz (2007) model the price impacts

of U.S. cotton policy under this decoupling assumption, and compare the

results to different coupled scenarios.

In this chapter, we revisit the work by Schmitz et al. (2007) and investigate

the welfare impacts of U.S. cotton policy under two extreme cases: producer

decision making at the loan rate or the target price. We do not analyze in-

between scenarios where producers, for example, respond to an intermediate

price; nor do we include water subsidies either. Our intent is to provide

upper and lower bounds on the welfare impact of U.S. cotton policy, as

derived from price-support subsidies. This is very different than our earlier

work, which focused on the price impact of U.S. cotton policy. The impact

on world cotton prices is much smaller under the loan rate supply response

framework as opposed to the target-price specification.

In our model, we choose a specific time period (2001/02) and focus on the

impact of decoupling, but one can easily apply the same model to different

time periods. The size of the impact of U.S. cotton policy depends on the

year(s) chosen for the analysis. For example, if this model is applied to data

for the crop year 2002/03, the impact of the price and economic efficiency of

U.S. cotton policy is much smaller than when applied to 2001/02 data. Even

so, our general result holds that the impact of U.S. cotton policy depends

critically on what assumption is made concerning producer price expectations.

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