Subsidies encourage overproduction of agricultural products and depress world prices. By offering producers a higher price than the prevailing one on world markets, producers can profitably flood markets with surplus crops. American farmers, for example, receive up to 73% more than the world market price for their crops. As a more extreme example, in the UK, each ton of wheat and sugar is sold on international markets at an average price of 40% to 60% below the cost of production. Indeed, for every dollar earned by OECD farmers, 23 cents comes from government policies. Facing such artificially competitive goods, countries without subsidized production are essentially shut out of world markets, deleteriously affecting their economies. Development-focused nongovernmental organizations have lambasted developed countries for their exclusionary policies. As an Oxfam report exclaims, “the harsh reality is that [developed nations’ trade] policies are inflicting enormous suffering on the world’s poor. When rich countries lock poor people out of their markets, they close the door to an escape route from poverty.” While this statement is exaggerated, and the domestic policies of developing countries themselves play the greatest role in determining the welfare of their respective people, the economic pain caused by the distorted trade practices of the OECD rich nations is indeed significant.
Agriculture has historically been the foundation of developing economies. It provides food, security, creates employment, and generates local capital. Statistically, agriculture provides employment to about 60% of the labor force of the average developing country and contributes one quarter of GDP. Agricultural exports amount to about 15% of total merchandise trade. World market prices for agricultural commodities have followed a general downward trend over the past several decades due to increases in efficiency and yield, but significantly exacerbated by the subsidies in the developed world. In the short run, one could argue that the low prices for imported staple foods benefit consumers in developing countries, but they also lead to an increased dependence on imports to ensure national food security, increasing vulnerability to world price changes and exchange rate volatilities.
Even more importantly, lower prices for crops translate into lower incomes for farmers in the developing world. Studies by the International Food Policy Research Institute concluded that lower prices resulting from protectionism and subsidies by OECD countries cost developing nations $24 billion annually in agricultural income, and because developing countries are particularly dependent on agricultural income, the income lost due to subsidies in the developed world is likely to have very large multiplier effects throughout developing economies. Further studies have shown that a reduction of agricultural subsidies and implicit trade barriers by OECD nations would produce substantial benefits for both developing nations and developed nations alike. If high income countries liberalized their trade policies, their welfare would rise by almost by almost $32 billion, and the welfare of developing nations would rise by $12 billion and net agricultural trade would triple. Notice that most of the benefits of liberalization accrue to the developed world. This is because their consumers are footing most of the bill in the form of tax dollars and higher domestic prices.
Agricultural subsidies in developed countries have a particularly strong economic impact when they are provided for crops also grown in developing countries. A couple examples will help illustrate this point. Sugar is an agricultural product in which developing countries have a distinct cost advantage to producers in the OECD due to their suitable climates and supply of cheap labor. However, farmers in the developing world face steep competition from the heavily subsidized sugar coming from American and European ports. From 1991 to 2001, support to OECD sugar producers averaged $6.35 billion, which is just slightly less than the combined value of developing nations’ sugar exports which total to about $6.5 billion per year. Due in large part to this support, the share of developed countries’ exports in the world sugar market has risen, and consequently, the share of exports from developing countries has declined from 71 percent during the period from 1980 to 1985, to only 54% of world sugar exports in the period from 1995 to 2000.
Cotton provides an even more powerful example. Ten million people in Western and Central Africa depend directly on cotton production for their livelihood. Cotton accounts for 40% of exports in Burkina Faso and Benin and 30% of exports in Uzbekistan, Chad, and Mali, and cotton production alone in these countries amounts to over 5% of GDP. It is thus a very important source of income, and any fall in the world price of cotton, such as the fifty percent decline since the mid 1990s, will have a pronounced negative ripple effect throughout these economies. Despite this decline in price, American cotton production grew 42% between 1998 and 2001 and presently accounts for 20% of world cotton production. Coupled with this increase in production, U.S. cotton subsidies have doubled since 1992. America’s 25,000 cotton farmers now take in $230 for every acre of cotton planted, totaling to $3.6 billion in subsidies, more than the entire GDP of Burkina Faso. It is estimated that the elimination of U.S. cotton subsidies would reduce American production by 25%, reduce exports by 40%, and increase world cotton prices by 12%. All of this would lead to about an $80 million gain in producer surplus for the five key cotton exporting nations of Africa.
While the trade policy of the developed world does not intentionally seek to hamper the trade and economic welfare of developing countries, it does so implicitly by providing domestic agricultural subsidies to the very goods which developing countries export, causing significant economic suffering in those countries. Perhaps, when considering how we can influence and spur the growth of the world’s developing nations, before turning our efforts overseas, we should first focus our attention on how we are contributing to the problem — not the solution –at home.