Trade & Globalization: Is Free Trade Beneficial?

Trade & Globalization:Is Free Trade Beneficial? Robert L. Thompson Gardner Professor of Agricultural Policy University of Illinois September 13, 2005

Outline of Presentation • Globalization is here to stay • Why free trade? • Importance of assistance to facilitate/smooth the transition/adjustment • Current WTO ag trade negotiations • Current politics and looking towards Hong Kong

Globalization • Increasing integration of economies (from the most local level) around the world • Trade • Technology/knowledge • People/labor • Financial capital • Result of technological advances that reduce cost and increase speed of international transactions • Creates unprecedented opportunities for specialization and exchange of goods and services (global sourcing & supply chains) • Exposes previously isolated markets to competition

Why Trade? • Increase standard of living by obtaining goods that others can produce at lower cost in exchange for things we can produce relatively cheaper • By lowering the cost of living, makes a household’s purchasing power stretch further • Increases a country’s GNP by employing its land, labor & capital where they are most productive

Then Why Do Governments SeekSelf-Sufficiency & Restrict Ag Trade? • National security (security of food supply, esp. after wars when hunger occurred) • Protect existing/create new jobs • Favor to rent-seekers • Benefit friends and relatives • Response to bribery • Response to campaign contributions • Low public profile because, while benefits are concentrated, costs are diffuse. • For example, the US sugar program may give each grower over $100,000 per year while costing the average consumer only an additional $12 per year.

U.S. Producer Support, 2001-2003(Percent of gross farm receipts) Source: OECD PSE database

Ag Commodity PAC Contributions to Federal Candidates, 2004 Election Cycle Source: Center for Responsive Politics (Federal Election Commission data)

World Agriculture in Disarray* • In most high income countries, farmers are few in number, but have large political clout • Subsidize agriculture, distorting relative returns to various outputs and induce larger total investment in agriculture relative to other sectors. • In many low income countries the political clout is in the cities, and the numerically larger group of farmers has little political clout • Food policies turn the terms of trade against agriculture to keep urban food prices low, reducing the incentive to invest; agriculture underperforms relative to its potential. *Title of an excellent study by D. Gale Johnson.

OECD Producer Support Estimates, 2004, in Percent Source: OECD Agriculture Directorate

Average Producer Support in OECD Countries, 2004, in Percent Source: OECD Agriculture Directorate

Divergent Relative PSEs Distort Mix of What’s Produced Where, 2003

Domestic Effects of Protection and Subsidies to Agriculture • Increase total investment in agricultural sector relative to other sectors of the economy • Distortions in relative prices distort what gets produced where. • Inflate price of land and other fixed assets • Largest producers and farm land owners get most of the benefits • Retain too many people in agriculture • Out-migration is normal and essential. • Effects of trade liberalization are often confused with adjustment that occurs normally during economic development.

External Effects of Ag Protection and Subsidies • In net importers, smaller imports result in lower world price than would otherwise be the case, e.g. US sugar & dairy and Japan rice • In net exporters, larger production and exports depress world market price below where it would otherwise be, e.g. US cotton and EU sugar • Notes: • Important to distinguish between long-term downward trend in world price and effects of subsidies • Non-tariff barriers to imports may reduce domestic price variability while increasing volatility of world market prices received by other countries’ farmers.

OECD Policies Depress Commodity Prices Below Long Term Trend Source: World Bank. Global Economic Prospects 2002, Chap. 2.

Why Is It So Difficult to Reduce Ag Subsidies & Liberalize Trade? • Benefits are capitalized into land values, so value of land would fall. • Farmers who borrowed heavily to buy land likely to go bankrupt. • Many farmers’ retirement savings are in their land. • Labor adjustment difficult • Specialized skills become redundant or worthless. • Retraining may be costly (or impractical for older people). • Adjustment may require physical relocation • May be both monetarily and emotionally costly • Greed • Rent seekers don’t give up their rents without a fight. • Politicians likely to lose campaign contributions and/or bribes.

Gains from Trade Liberalization • Economic theory tells us that the gains of the gainers exceed the losses of the losers • It does not tell us there are no losers! • The challenge is to define policy interventions to compensate losers for their losses: • to facilitate the adjustment • to neutralize opposition of politically powerful opponents who could stop liberalization dead

Anti-Globalization Activists:An Unholy Alliance • Socialists who prefer public-sector to private- sector solutions and oppose big business, especially multinational firms and large scale commercial farms • Labor unions whose main interest is preserving jobs in protected sectors, often at very high cost per job saved • “Environmentalists” whose main goal is to impede/stop economic growth and population growth • “Consumer Organizations” whose efforts usually reduce consumer choice, often at higher cost, e.g. oppose ag chemicals and GMOs (advocate “natural” foods, e.g. “organics”, “free range” poultry and livestock, etc.) • Farm organizations that seek to preserve sub-economically small family farms • Many churches and development NGOs seeking “social justice” for the poor (in both high & low income countries)

Trade Liberalization and Poverty • A more open trading environment can stimulate faster economic growth • Trade a more powerful engine of growth than aid • Trade liberalization creates both winners and losers, with the gains of the gainers exceeding the losses of the losers • Who the losers are matters: the rich and powerful? or the politically weak poor? • For trade liberalization to benefit the LDC poor, need pro-poor development strategy, adjustment assistance, and green box public good investments.

Does Trade Liberalization Hurt the Environment? • There is no reason it should nor evidence that it does • In fact, attempts to achieve self-sufficiency where no comparative advantage exists are more likely to be both economically wasteful and environmentally unsustainable.

Global Trading Environment Impedes LDC Poverty Reduction • OECD protectionist barriers to LDC goods reduce their foreign exchange earning capacity & economic growth. • Food aid is most available in years of OECD surplus, not LDC deficit. • Depressed world market prices reduce returns to poor farmers, increasing their poverty, and slowing agricultural and national economic growth. • Widespread poverty in LDCs impedes growth in their food demand, preventing them from fulfilling their potential as growth markets for ag.

Developing Countries’ Own Policies Impede Their Development • Corruption and/or macroeconomic instability • Lack of definition or enforcement of property rights and contract sanctity • Underinvestment in public goods, such as rural infrastructure, education and R&D. • Cheap food policies to keep urban consumers quiescent – often reinforced by food aid or subsidized exports from OECD • Lack of technology adapted to local agro-ecological conditions (soils, climate; slope)

Free Trade Agreements vs. Multilateral Trade Liberalization • FTAs are clearly second best – but often better than no liberalization (e.g. the huge success of free trade among the 50 United States!) • Questionable tactic as practiced today • Generally leave out agricultural trade liberalization (“leave it for the WTO”) • Risk addressing other sectors’ problems and losing leverage from them in the WTO

World Trade Organization • An informal association of 148 countries which meets periodically (“rounds of negotiations”) to review/revise the rules of international trade • Its Secretariat, in Geneva, organizes these negotiations and a dispute settlement process to resolve differences among members over whether these rules are being broken • Dispute settlement panels & an appellate body interpret agreements and build up a body of case law (necessary when wording is fuzzy) • WTO cannot force any country to change its policies, but it can authorize the victims of violations to collect compensation via import duties on the violator’s exports

Uruguay Round Agreement on Agriculture: Accomplishments • Increased market access as % of consumption • Reduced export subsidies (value & volume) • Converted all non-tariff barriers to tariffs • Required scientific basis for all SPS barriers • Acknowledged that some domestic agricultural subsidies can distort trade and categorized them by degree of trade distortion: • “Green box” = non trade distorting investments in public goods and decoupled income transfers • “Amber box” = trade-distorting (bound and reduced) • “Blue box” = trade-distorting, but offset by production controls or set-asides

But the Uruguay Round Did Little to Liberalize Agricultural Trade • Uruguay Round established a useful framework • But, it did little to open markets, and OECD countries are still spending over $750 million per day subsidizing their farmers • Doha Round needs to be more ambitious than the Uruguay Round by closing loopholes and tightening disciplines to prevent circumvention of the intent of the agreement.

Why the Focus on Developmentin the Doha Round? • Developing countries are the only potential growth markets of the future -- but only if they enjoy broad-based economic growth -- which will come only if they are allowed to export what they produce relatively most efficiently. • Developing countries now make up the majority of WTO members. There will be no agreement in the current trade negotiations until they feel there is something of value in it for them (unlike past trade agreements). • It’s the right thing to do!

Key Outcomes Developing Countries Need from OECD Countries • A more open trading environment that can stimulate faster economic growth • Market access for goods in which developing countries have a comparative advantage • Eliminate import barriers and domestic and export subsidies which depress world market prices and increase their variance • Foreign aid and international lending for investment in necessary infrastructure, technology, know-how, etc. and to facilitate adjustment.

Key Players in Doha Round Agricultural Negotiations • United States • European Union • G-20 (Brazil, India, China, S. Africa, +) • Cairns Group (Australia, New Zealand, +) • G-10 (Japan, Korea, Norway, Switzerland,+) • Other developing Countries (the majority of members, but heterogeneous interests)

Doha Round Agricultural Agreement: What Is Possible? • Eliminate all forms of ag export subsidies • Reduce trade-distorting domestic subsidies (highest the most, but exceptions possible) • Reduce tariffs (highest the most, but exceptions allowed if increase minimum market access) • Tighten definition of what subsidies are “non-trade distorting” • Allow developing countries smaller cuts over longer period (definition? exempt LDCs completely? exempt “sensitive products”?)

Minimalist Outcome Possiblein Hong Kong • Tariff cuts from bound, not applied, tariffs (& no cap) • No increase in minimum market access • Cuts in domestic ag supports smaller than presently unused “capacity” (or increase the cap!) • Cuts to be made from product aggregates, not individual products • Redefine blue box to include countercyclical payments • Everyone’s most-subsidized commodities avoid cuts by being categorized as “special products” • Developing countries overuse new “sensitive products” • Least-developed countries don’t have to do anything

WTO Ag Negotiations Hung Up on Who Goes First • U.S. has proposed reducing its ag subsidies substantially, but only if other countries provide much greater access to their markets. • The EU is proceeding with its reforms, including sugar, while the US reversed course in the 2002 farm Bill • Developing countries won’t open their markets as long as world market prices are depressed by ag subsidies in OECD countries (and they have more than half of the votes in the WTO) • Despite rhetoric at July 2005 G-8 Summit, no more progress in WTO ag negotiations occurred this summer. • After almost losing CAFTA-DR vote, other countries doubt U.S. ability to deliver on commitments. • Unclear that U.S. negotiators have authority to strike meaningful deal.

Trade & Globalization: Is Free Trade Beneficial?