An Overview of Aggregate Studies on Agricultural Trade Liberalization

Yet, agriculture and agricultural trade are important sources of activity and income around the world, both in developing and developed countries, and agricultural markets are among the

An Overview of Aggregate Studies on

Agricultural Trade Liberalization

Xavier Maret

An Overview of Aggregate Studies

on Agricultural Trade Liberalization

Introduction

Difficulties in getting an agreement on a further liberalization of agricultural trade have prevented progress in the latest round of multilateral trade negotiations of the World Trade Organization (WTO) Existing agricultural policies have been a major obstacle to trade liberalization over the past four decades Yet, agriculture and agricultural trade are important sources of activity and income around the world, both in developing and developed countries, and agricultural markets are among the most distorted in the world, reflecting much government intervention The consequences of these distortions in terms of economic efficiency and

potential, social equity and fairness, and environmental sustainability are far reaching Economic activities and trade in agricultural products are affected not only by explicit trade interventions (such as tariffs, quotas, export subsidies), nontariff barriers, and state trading, but also by domestic policies, either specific, such as those dealing with producer subsidies and pricing, or more general, such as those regarding regulatory frameworks, property rights, and even macroeconomic management Government interventions in agriculture have aimed at addressing legitimate national concerns, such as food security, protection of rural income, and promotion of rural employment opportunities, but the political economy of agricultural policies suggests that vested interests have interfered with the policy intent and strongly influenced the decision process

Reforms of the agricultural sector and its greater integration in world trade are difficult but necessary,

particularly if issues of development, food security, undernourishment, poverty and environmental

sustainability have to be addressed Current agricultural policies in the developed world have been

increasingly incompatible with other policy objectives such as the Millennium Development Goals (MDGs).1

Moreover, the world population is targeted to reach about 8.0 billion individuals by 2030, with two-thirds living

in urban areas The resulting demand for food is likely to be boosted by rising incomes, and supply would have to increase by about 60 percent to meet world demand Developing countries will have to provide nearly all of this increase in production, mainly through intensification of agriculture and technological

progress, that is, more yield per unit of time and per unit of area These scenarios highlight the need for more efficient uses of all natural resources and fertilizers, but liberalization of agricultural trade, and the resulting gains in economic efficiency, will be another important factor in achieving the necessary transformation of the world food system

Agricultural trade liberalization should not, however, be expected to address by itself all social and

environmental problems facing developed and developing countries The promotion of trade globalization is not sufficient to ensure growth and poverty reduction, not to mention environmental quality There has been a recent recognition that “behind-the-border” reforms should accompany trade liberalization for an effective contribution to these broader goals (Hoekman, Matto, and English 2002a) These reforms include, in

particular, development of an environment that is friendly to the private sector and investment while

promoting competition, and sound financial and macroeconomic policies that support stable prices and allow competitive real exchange rates

“Behind-the-border” reforms appear even more necessary in the context of agricultural trade liberalization with a view to contributing to a more coherent policy framework and “win-win” outcomes In addition to the reforms advocated in the context of global trade liberalization, the specificity of agriculture, and particularly its direct relation to natural resources and the environment, calls for additional adjustment policies One key issue is thus to identify such complementary policies and to avoid focusing only on the negotiations of new trade rules In this context, careful analyses of the socio-economic, political and environmental

consequences of trade reforms are necessary to evaluate possible policy tradeoffs and prevent undesirable, possibly irreversible, outcomes

The purpose of this paper is to elicit a discussion of issues facing agricultural reforms and provide a

summary review of the recent literature on the aggregate impacts of trade liberalization Section I presents

1The issue of policy incoherence has been, in particular, raised in the context of policies supporting cotton in OECD countries (Baffes 2003)

some background on agriculture and its relevance to trade, poverty, food security, and the environment; section II provides a description of levels and trends in agricultural protection; section III reviews recent analyses of trade liberalization in the literature; and section IV attempts to draw conclusions and define areas

of future investigations

Background

The Economic Dimension of Agriculture

Agriculture accounts for about 4 percent of world GDP and 9 percent of global merchandise exports

Although there is a notable diversity among countries, agriculture is significant everywhere in terms of economic activity, employment, or trade It plays a particularly important economic role in developing

countries, where it generates about 12 percent of GDP, more than 50 percent of total employment, and

13 percent of merchandise exports (Table 1) In addition, developing countries provided about 61 percent of the agricultural value added in the world and 45 percent of the world trade in food and agricultural raw materials—estimated at US$403 billion in 2001, excluding trade within the European Union (EU)—(Tables 2a-2d) In South Asia, which accounts for 22 percent of world population, nearly three quarters of the

population live in rural areas and agriculture accounts for 25 percent of GDP and 14 percent merchandise exports Similarly, in the East Asia and Pacific region, where another 30 percent of the world population lives,

30 percent of GDP and 10 percent of merchandise exports are derived from agricultural activities Sub-Saharan Africa has also a large rural population and relies for 17 percent of its GDP and 22 percent of its exports on agriculture In contrast, the Latin America and Caribbean region has only 25 percent of its

population in rural areas and 7 percent of its GDP from agricultural activities, but nearly a quarter of its exports are accounted for by agricultural products—with shares of up to 35 and 45 percent of merchandise exports in Chile and Argentina, respectively As many as 43 developing countries (mostly in sub-Saharan Africa or Latin America and the Caribbean) rely on a single agricultural commodity for more than 20 percent

of export revenues and more than half of their agricultural exports The volatility and overall decline in real prices of agricultural commodities has affected the export performance of these countries, contributing to a weaker growth performance of these countries, compared with the rest of the developing countries

With 26 percent of total arable land and 7 percent of the world’s rural population, developed countries account for 39 percent of the world’s agricultural value added, while contributing 80 percent of the world’s global GDP The weight of agriculture in the economic activities of the developed world has steadily declined over the past decades The sector generated, on average, nearly 2 percent of the GDP of developed

economies in 2000 Exports of agricultural products, evaluated at 1 percent of GDP, remain nevertheless important as they accounted for 8 percent of merchandise exports—the agricultural to total merchandise export ratios were 26, 13, 10, and 10 percent for Australia, Canada, the EU, and the USA, respectively Developed countries also account for nearly 55 percent of world trade in agricultural products (if intra-EU trade is excluded), and they support their agricultural sector considerably through various policies, such as export subsidies.2

With intra-EU trade included, world exports of food and agricultural raw materials amounted to US$552 billion

in 2001, equivalent to 45 percent of agricultural GDP and 9 percent of all merchandise exports (Tables 3a-3b).3 Agricultural trade has increased in absolute terms and relative to production over the past two decades, but its importance in total trade has declined.4 Although developing countries have increased their share in global trade in the 1970s and 1990s, developed countries still account for about 55 percent of total and agricultural exports in 2001 Transnational corporations are playing an increasing role in trade and account for an estimated 40 percent of world trade,5 but export concentration indices in food, beverages, and

2 If intra-EU trade is included in world statistics, developed countries account for nearly two-thirds of world trade

3 Exports of food were valued at US$442 billion in 2001, while exports of agricultural raw materials amounted

to US$110 billion

4 Reviews of trends in agriculture and agricultural trade are presented in Aksoy (Aksoy forthcoming 2004a) and Diaz-Bonilla (Diaz-Bonilla et al 2002)

5Clay (2004, pp 33-41) presents a review of trends in the food supply chain

agricultural raw materials are not higher than in other sectors (Table 4) As for prices of agricultural

commodities, they have fallen both in real terms and relative to the prices of manufactured products, while being highly volatile (Charts 1-4) The observed long-term deterioration of the terms of trade of primary commodities reflect a demand for these commodities that fails to keep pace with supply boosted by

technological progress, rising incomes, and competition from new products (the Prebisch-Singer hypothesis) Trade varies also considerably across commodities For cotton, rice and sugar (Tables 5-7), most of the world exports are made by a small group of countries, while the import markets do not exhibit much

concentration Some countries are highly dependent on these commodities for their exports, but economic adjustment and diversification have in general reduced over time such dependence—with the notable exception of Benin that has relied increasingly on cotton for export revenue (cotton represented more than 65 percent of the country’s value of exports in 2001, compared with 15 percent in 1980)

The Social Dimension of Agriculture

Agriculture plays a social role, not only as a provider of food but also a source of income and living, that goes beyond its economic dimension An estimated 70 percent of the poor in developing countries live in rural areas and are very dependent on agriculture for their living and income.6 This underscores the need for sustainable growth of the agricultural sector to reduce poverty, ensure food security, and slow migration flows

to urban areas The contributions of agriculture to poverty reduction have a potential to be considerable The number of people living on less than US$1 a day in developing countries declined from 1.5 billion in 1981 to 1.1 billion in 2001, equivalent to a reduction by almost half of the share of poor people in the global

population, from 40 to 21 percent (Table 8) However, performance has been uneven across regions and time Rapid economic growth in East and South Asia contributed to pull 500 million people out of poverty in those two regions Dramatic progress was achieved by China alone, which increased GDP per capita five times since 1981 and reduced its number of poor by 600 million to slightly more than 200 million in 2001, or from 61 to 17 percent of its population The performance of other regions was bleaker, with the proportion of poor having grown or fallen slightly in many countries of sub-Saharan Africa, Latin America and Eastern Europe and Central Asia Moreover, the reduction in the absolute number of poor people occurred mainly in the 1980s, as the reduction in the number of poor was limited to 120 million between 1990 and 2001

Food security and a successful war on world hunger also depend on the performance of agriculture The Food and Agriculture Organization (FAO) estimates that 95 percent of the 840 million people chronically undernourished worldwide in 1999-2001 lived in developing countries.7 Here again, the observed decrease of only 20 million people since 1990 owes much to China (58 million), while numbers have continued to rise in Africa In addition, the global performance has been erratic with the number of undernourished people increasing by 18 million in developing countries between 1995-97 and 1999-2001 The pace of reduction would have to reach 24 million per year, almost 10 times the performance realized since 1990, if the goal of the World Food Summit of halving the number of undernourished people by 2015 Among the main factors affecting food security are HIV/AIDS and water By 2020, the HIV/AIDS epidemic will have claimed one-fifth

or more of the agricultural labor force in sub-Saharan Africa As for water, drought was listed as a cause of 60 percent of food emergencies for the three most recent years for which data are available Only 17 percent of global cropland is irrigated, but it produces 40 percent of the world’s food Irrigation increases yields of most crops by 100 to 400 percent and has been linked to lower rates of poverty and undernourishment For countries where hunger is most prevalent, agriculture represents 30 percent of GDP and the share of

agricultural products in merchandise exports and trade increase to over 20 percent Levels of hunger and poverty differ nevertheless among countries with similar levels of agricultural trade, suggesting that the impact of trade on food security also depends on other factors, such as markets and institutions Engaging in agricultural trade is associated with less hunger and not more More robust agricultural growth would

contribute both to reduce hunger and increased integration in international trade

Agriculture and the Environment

6 The share of off-farm income in rural households tends, however, to increase with a country’s level of development—from 77 percent in Ethiopia and Malawi to 24 percent in Mexico (Aksoy forthcoming 2004a)

7 Of this number, about 170 million are children under 5 years of age (International Food Policy Research Institute 2002) Yet, per food capita production has grown 16 percent faster than population since 1970, the total production of foodstuff tends to globally surpass total consumption, and there is enough food in the world for everyone to have 3,500 calories a day (Clay 2004)

The dependence of agriculture on natural conditions and its overall reliance on land, water, and fertilizers have a direct impact on environmental quality While these factors provide incentives for resource

stewardship that may induce farmers to protect environmental quality, the evidence is that these incentives are not strong enough in most countries, and the existing literature concludes on a need for some form of environmental regulation (Lichtenberg 2002) Yet, the theoretical interactions between agricultural, natural resource, and environmental policies, such as the impact of price support programs on the environment, are complex They do not lead to simple conclusions and require sound empirical studies as input for policy design The liberalization of agricultural trade adds an additional dimension to these policy requirements and needs This issue is of particular importance for developing countries, where agriculture has specific

peculiarities that need special attention These characteristics include the role of farm-households, factor-market interlocking, endogenous and evolving institutions, and the dynamics of the environmental base of agriculture (López 2002) Most developing countries are, indeed, located in tropical or sub-tropical areas where ecological conditions are more fragile than in temperate areas; in particular, soils are of a poorer quality, more prone to erosion, less able to retain nutrients, and subject to threshold effects that could rapidly lead to irreversibility of soil degradation This fragility, which relies on fallow periods for biomass regeneration and restricts the possibilities for agricultural intensification without major investment, is often exacerbated by institutional limitations, such as access to land and common property regimes, as well as registration and enforcement of property rights

Trends in agricultural land use have been towards greater land expansion and intensification (WWF 2000) Land conversion has halted in the industrialized countries but continues to take place in developing

countries, where land in crop production accounts for 30 percent of total land with rainfed crop potential and

is expected to expand by 5 percent of the total land balance—to 850 million ha—over the period 1990-2010 However, there is little possibility of expansion in some regions and land expansion for agricultural use will have to compete with other uses or take place in marginal areas, further stressing the environment Water use and management is another concern related to expected agricultural growth, as agriculture accounts already for about 70 percent of water consumption worldwide and water use through irrigation is likely to increase further, with a potential of creating or exacerbating water shortages in some parts of the world As for fertilizer and pesticide use, their increasing use in developing countries may lead to further resource degradation in non-temperate climate areas Consequently, the diversity of situations in terms of agricultural development and related environmental issues favors a country-by-country approach to assess the impact

of trade liberalization and the necessary policy responses

Agricultural Protection

Overview

Agricultural markets are characterized by widespread distortions and market imperfections Up to the 1990s, industrial countries have in general protected their agriculture while developing countries have taxed it by following import-substitution strategies (Krueger, Schiff, and Valdes 1992) The switch to export-promotion policies in developing countries, the 1994 conclusion of the Uruguay Round Agreement on Agriculture (URAA) in the context of the multilateral trade negotiations of the General Agreement on Tariffs and Trade (GATT), and the inception of reforms in developed countries have brought some positive but limited changes

in this situation

The "disarray" observed in agricultural world markets in the 1970s and 1980s as a result of policy distortions has persisted up to now The following stylized facts have characterized agriculture:

- High level of domestic support to agriculture, particularly to producers in OECD countries Although

total OECD support declined from 2.3 and 1.2 percent of GDP, it accounted for 52 and 48 percent of the total value of production in 1986-88 and 2000-02, respectively Both domestic support and border protection led to increasing amounts of surplus production that were disposed of in world markets through export subsidies

- High volatility of agricultural prices Policies protecting domestic producers by guaranteeing some

mimimum domestic price preclude the possibility of adjustment of domestic supply and demand to

world market price fluctuations As a result, the domestic economy does not contribute to dampening world market shocks, and international prices become more volatile Examples of such insulation policies include the variable import levies of the EU, where duties vary inversely with movements in world market prices in order to maintain a fixed internal price State trading enterprises also vary their mark-ups on imports to generate similar effects

- Downward pressures on world and domestic prices Export subsidies tend to depress world market

prices and exacerbate the secular decline in commodity prices Consequently, they compromise agricultural production and threaten the livelihoods of many producers and exporters in the rest of the world, while making many developing countries increasingly dependent upon cheap food

imports

- Misallocation of resources and efficiency losses Market distortions have barred countries with a

comparative advantage in the production and export of tradable agricultural commodities from exploiting this advantage, with resulting losses in production, employment, and export revenues Concurrently, substantial levels of government support have allowed many countries with less comparative advantage to produce at highly inefficient levels

GATT rules have been largely ineffective in disciplining key aspects of agricultural trade Exports and

domestic subsidies remained prevalent in many areas of agricultural trade and stricter discipline on import restrictions was not implemented The 1986-94 Uruguay Round negotiations brought some change in this situation by making agriculture trade an effective part of the multilateral trading system Although not much real progress has been achieved since the approval of the URAA (Srinivasan 2003; Organisation for

Economic Co-operation and Development 2001), the effective bringing of agricultural policies into trade negotiations—through the commitments of reducing export subsidies, domestic support and import duties on agricultural products—have introduced a framework for future progress and been a significant first step towards reforming agricultural trade.8 The process of agricultural tariffication, that is, to convert all border measures into their tariff equivalent, was a key element of the URAA Both developing and developed countries were, however, able to set high tariff equivalents under the URAA, which weakened their respective commitments to reduce the average bound tariffs by 20 and 36 percent, respectively, over a 6-year period, with minima reductions of 10 and 20 percent, respectively, over a 10-year period The URAA also included a special agricultural safeguard (SSG) to protect against sudden surges in import volumes and introduced tariff rate quotas (TRQ) to improve access for exporters.9 Issues of domestic support were set up in the context of amber, blue and green boxes with main commitments to reduce trade-distorting domestic support in the amber box that is the principal contributor to the “total aggregate measurement of support” (Table 9) Annex 1 presents the March 1, 2004 situation of various agricultural trade restrictions (World Trade Organization 2004)

Agricultural activities and trade have been the subject of countless measures to protect domestic producers, promote exports, or favor consumers (Reed 2001; Houck 1992) From simple tariffs, quotas, and export subsidies to more sophisticated measures such as deficiency payments, flexible subsidies, preferential agreements and tariff rate quotas, the arsenal of agricultural trade measures has been varied Their effects can be difficult to analyze, such as in the context of the common agricultural policy of the European Union or the various Farm Acts in the USA More information is available on the agricultural support policies of the member countries of the Organisation for Economic Cooperation and Development (OECD) than on those of the developing countries, where only tariff data are usually available However, even in the context of

developed countries, the protection regimes are complex with, for example, counter-cyclical protection

8Reviews of agriculture and trade negotiations under the GATT and the WTO are provided in Sumner and Tangermann (Sumner and Tangermann 2002), Asksoy (Aksoy forthcoming 2004), and the FAO (The Food and Agriculture Organization 2000) The specific issues of market access, domestic support and export subsidies are discussed in a series of trade notes issued by the World Bank (de Gorter et al 2003a; de Gorter, Ingco, and Ignacio 2003b; de Gorter, Ingco, and Ruiz 2003c)

9 The tariffication of non-tariff barriers led to concerns about prohibitive tariff rates and reduced access to exporters Under a TRQ, trade up the quota limits is to take place at minimal or low tariff rates—below the most-favored-nation (MFN) rates—while the MFN rate applies to trade above that level In practice, not all TRQs were actually used and relatively little additional market access was created because of the way the TRQs were implemented (The Food and Agriculture Organization 2000)

programs and specific duties that make it difficult to calculate average tariffs and effective protection Thus, although generalizations and regional aggregations are informative,10 an extensive knowledge of agricultural protection and promotion policies at the country and commodity level remains necessary to fully assess the effects of trade liberalization

Agricultural Support in OECD Countries

The OECD provides regular reports with a comprehensive coverage of its members’ agricultural protection and policies since 1987 (Organisation for Economic Co-operation and Development 2003a, 2003b).11 This monitoring and evaluation of agricultural policy developments relies on various indicators, such as the Producer Support Estimate (PSE), the Consumer Price Estimate (CSE), and the Total Support Estimate (TSE).12 The PSE is the main indicator and represents the value of gross transfers from taxpayers and consumers to support agricultural producers, measured at the farm-gate level, arising from policy measures, regardless of their nature (Annex 2) A major component of the PSE is the Market Price Support (MPS), which is the value of gross transfers to agricultural producers limited to policy measures creating a gap between domestic producer prices and reference prices of a specific commodity, that is mostly tariff barriers and export subsidies Additional indicators based on the PSE are used to evaluate progress towards the market orientation of agriculture: (i) the %PSE, which is a measure of support to producers as a share of farm receipts; (ii) the Nominal Protection Coefficient (NPC) which is a measure of market protection defined

as the ratio between the average prices received by producers and border prices; and (iii) the Nominal Assistance Coefficient (NAC) which is a measure of market orientation defined as the ratio between actual farm receipts with support and farm receipts that would be generated in markets without support Finally, the Total Support Estimate (TSE) measures the overall transfers from agricultural policy—the sum of the PSE, the General Service Support Estimate (GSSE) and consumer subsidies—and evaluates those as a

percentage of GDP (%TSE)

Total support to agriculture has declined in relative terms but remains high across OECD countries (Tables

10 to 13) Despite reductions under the URAA, agricultural tariffs remain several times higher than tariffs on manufactured goods (International Monetary Fund 2002) In addition, recent policy initiatives in the OECD have provided mixed signals about the prospects of reform The TSE amounted to US$315 billion in

2000-02, equivalent to nearly 50 percent of the total value of production at farm gate Around three-quarters went

to producers and 17 percent went to general services, including sector-wide policies and institutional services such as research, education, inspection and control, and marketing Total support to agriculture declined from 2.3 percent of the OECD GDP in 1986-88 to 1.2 percent of GDP in 2002, but with wide variations across countries Compared with the 1986-88 period, 2000-02 was characterized by a lower overall level of support to producers This progress reflects movement towards policy measures that are less production and trade distorting, mainly as a result of the implementation of the URAA since 1995 Support to farmers (PSE) reached US$235 billion, which represented 31 percent of total farm receipts (%PSE) in the OECD area, compared with 38 percent in 1986-88.13 The share of output-based support (MPS and output payments) and input subsidies declined from 90 percent in 1986-88 to 76 percent of producer support in 2000-02 These measures distort considerably production and trade, and usually also fail in transferring income to farmers or

in targeting the provision of environmental benefits The share of these measures in producer support varies across countries, with sizeable progress being made in some countries to lower the reliance on such

distorting measures

Significant differences remain across countries and commodities The level of support measured by the

%PSE varied in 2002 from 1 percent in New Zealand to 18 percent in the USA, 36 percent in the EU, and over 70 percent in Norway and Switzerland By commodity, support ranged from an average of 6 percent for wool, to 48 percent for sugar and milk, and 80 percent for rice Variation in commodity support levels has decreased since 1986-88 in most OECD countries, but has increased in the EU, Japan and Korea

10 For a review of trends and data issues in agricultural trade policies, see Aksoy (Aksoy forthcoming 2004b)

11 Between 60-70 percent of domestic agricultural output is covered Food processing, seafood, and cotton are excluded, among others

12 WTO’s aggregate measure of support (AMS) is very similar in concept to the OECD’s PSE A criticism of some methodological aspects of the PSE calculation is provided in Reimer (Reimer 2002)

13 In real terms, the PSE for the OECD area as a whole dropped by 27 percent between 1986-88 and

2000-02 (Organisation for Economic Co-operation and Development 2003c)

Prices received by OECD farmers in 2002 were on average 31 percent above world prices, a significant reduction from the mid-1980s when producer prices were 57% higher (with large variations in the

intermediate period, and the lowest price gap being recorded in the mid-nineties) Thus, the cost of the price support program falls disproportionately on low-income consumers who spend a larger share of their income

on food Farmers in many OECD countries remain shielded from world market signals Whereas prices received by farmers in Australia and New Zealand were, on average, the same as those at the border, they were 10 percent higher in the United States, 35 percent higher in the European Union, and more than 100 percent higher in Iceland, Japan, Korea, Norway and Switzerland Yet, it is estimated that only about 25 cents out of every dollar spent on producer support actually benefits the producer, and the largest farms (the top 25 percent of farms ranked by turnover) collect more than half and as much as 90 percent of support provided by governments The increasing diversification of income sources for small and medium-sized farms has also allowed farm households to reach incomes that are comparable to other households and to remain in the sector

Agricultural Support in Non-OECD Countries

While OECD countries have slowly adjusted since the 1980s (Organisation for Economic Co-operation and Development 2000b),14 developing countries have made more significant progress in reducing, if not

reversing, the negative protection of their agricultural sectors In addition of measures correcting anti-export biases and exchange rates misalignments, eliminating import licensing and export taxes, and reducing trade restrictions, the average tariff on agricultural products was reduced from about 30 percent in 1990 to

18 percent in 2000 This rate, however, remained significantly higher than the average tariff of 11 percent on manufactured products in 2000 Moreover, the structure of tariff rates worldwide, in particular the existence of tariff peaks, tariff escalation and high tariff dispersion, continues to pose problems (Organisation for

Economic Co-operation and Development 2003d) Finally, the performance of agriculture in developing countries still faces the consequences of the large market distortions in developed countries, and local political decision-making remains influenced by food security concerns

Agricultural subsidies in non-OECD countries are not as extensive as in OECD countries, while applied tariff barriers are similar on average (IMF 2002) These trade barriers have been an impediment to South-South trade and contributed to depressing world prices while increasing their volatility The overall extent of

agricultural support remains, however, difficult to assess and making generalizations would be hazardous Yet, two of the most important agricultural markets in the world, China and India, have curtailed massive government interventions

Aggregate Outcomes of Trade Liberalization

Trade Liberalization and Prices

The real income effects of trade liberalization result from the changes in allocative efficiency and the terms of trade (TOT) The removal of market distortions allows for a reallocation of economic resources and factors of production to their most productive use These benefits accrue largely to the liberalizing country and include the budgetary savings from removing agricultural support, while the terms of trade will be affected by the changes in export prices of a country compared with its import prices

By removing export subsidies and import restrictions, trade liberalization eliminates the wedge created between world prices and the domestic prices that are received by producers or paid by consumers, and it reverses the welfare losses resulting from these restrictions Simple partial equilibrium analysis provides some intuition on the expected effects of trade liberalization within a country, other things being equal A small country that introduces a tariff or quota on the imports of a commodity, or guarantees high domestic prices to producers through a variable import levy scheme, does not affect the world price of that good but

14Australia and New Zealand are notable exceptions and practically eliminated all forms of agricultural support or protection as early as the mid-1980s

raises the domestic consumer and producer price above the international price Accordingly, domestic production increases, while imports and national consumption of that good decline Producers are better off and consumers worse off, resulting in a net welfare loss to society despite the government revenue

generated by the import restrictions (Figure 1 of Annex 3).15 If the importing country is large and has an effect

on world prices, the above-mentioned import restrictions to protect local producers will reduce demand and depress somewhat the world price In this case, the increase in the domestic price resulting from a tariff will not be as important as in the case of a small importer The removal of import tariffs and quotas in a large importing country will reverse these price changes, with a consequent increase of international prices and reduction of domestic prices in that country

For a small exporting country, the introduction of an export subsidy or a guaranteed producer price through a variable export subsidy does not affect the international price However, domestic prices increase, leading to higher domestic production and exports, as well as lower domestic consumption, and a net welfare loss If a production subsidy is implemented, it does not affect the world price and the price to be paid by consumers, but prices received by producers are higher and the resulting increase in production is entirely exported If the exporting country is large and has an influence on world prices, export subsidies will depress the

international price, and the resulting increase in the domestic producer price will not be as high as in the small exporter case (Figure 2 of Annex 3) The elimination of export subsidies would increase world prices and reduce domestic prices in large exporting countries

The concurrent elimination of tariffs in importing countries and export subsidies in exporting countries of a specific commodity would increase world prices, but the impact on domestic prices is not well defined Under this reform, domestic producer and consumer prices could go up or down to adjust to the new world price, depending on the relative weight of the initial tariff/subsidy on the domestic markets (Figure 3 of Annex 3) As

a result, there is uncertainty in the trade liberalization effects for a country, unless the export-promoting and import-restricting measures are clearly identified and compared for a given commodity Moreover, the

analysis shows that removing tariffs in importing countries while maintaining subsidies in exporting countries (or the reverse policy) could have a welfare-reducing impact for the world as a whole, a typical case of second best economic theory, which argues that partial removal of distortions could be welfare reducing The intuition is that a tariff provides domestic protection to local farmers of one country and partially reverses the impact of subsidies given in the other country; as a result, the world’s welfare loss is not as large when tariffs are used to retaliate against subsidies Finally, the analysis highlights the potentially important impact of trade liberalization on government revenue (tariffs) and expenditure (subsidies), and policy responses to these budgetary shocks may be needed to preserve and ensure a sustainable fiscal policy

Trade Liberalization, Growth, Poverty, and the Environment

There is broad agreement among economists that full liberalization of trade will improve welfare, but

controversy exists about the distribution of the benefits and about the effects of piecemeal reforms (Karp and Perloff 2002; Bacchetta and Jansen 2003) Several reasons account for the variety of results First, there is the theory of the second best, which argues that a move towards free market may reduce welfare in the presence of other distortions Second, the complexity and the interactions of agricultural distortions are difficult to model and result in uncertain supply and demand elasticities, and hence in uncertain effects of policy changes Finally, the causality relationships between economic growth, trade, poverty, and the

environment are still actively researched, while the identification of the winners and losers is complex

Common wisdom is that trade liberalization contributes to helping the poor as a result of its positive

relationship with growth and the subsequent link between growth and poverty reduction (Hoekman et al 2002c; Berg and Krueger 2003; Collier and Dollar 2002) Integrated economies tend to grow faster by being able to benefit from their comparative advantages and increased efficiency in resource allocation Changes

15 If a deficiency payment system is used to guarantee a level of producer prices, that is compensations are made by the government to the producer for the difference between a set price and the world price, the domestic consumer price remains equal to the world price and there is no change in consumption, but imports are reduced as a result of the stimulated production Variable levies and deficiency payments isolate domestic prices from variations in international prices

in per-capita income have proven to be the main determinant of poverty changes, and there has been no empirical evidence of a direct relationship between openness and income distribution Yet, in the short run, trade liberalization may not have a poverty-reducing impact by affecting negatively the sources of income of the poor and increasing the prices of the goods they consume the most On the one hand, the impact of trade liberalization on the sources of income will be, in general, more important than the price impact as these sources of income tend to be limited and not very diversified On the other hand, the urban population

of countries that are net food importers will be faced with large price increases and welfare losses In

addition, the pace and process of economic adjustment resulting from trade liberalization, which includes the reactions of market intermediaries and the producers’ supply response, may be impaired by weak signals, uncertainties, and risk aversion behavior that may lead to some period of unstability and affect the poor A careful analysis of the trade liberalization impact is thus required to help design policies that would protect the poor (McCulloch, Winters, and Cirera 2003)

As regards the environment, the economic analysis of the environmental impacts of trade liberalization has developed recently but remains limited.16 Theoretical outcomes of this general equilibrium approach suggest that globalization would increase demands on natural resources in countries with a comparative advantage in activities based on natural resources (such as Latin America and Sub-Saharan Africa), while it would reduce environmental pressures in countries that have comparative advantages in labor-intensive industries (such

as Asia) Moreover, soil degradation is likely to be exacerbated in poor areas where market failure is more prevalent, while it may be reduced in less poor areas where credit markets are more accessible to producers and land property rights better defined More generally, empirical research has supported the theoretical results that trade liberalization can harm the environment of countries with a comparative advantage in polluting industries and improve the local environment elsewhere The literature, however, indicates that the costs of additional abatement measures are likely to be smaller than the welfare gains of trade and could be financed out of those gains Thus, combining trade and environmental reforms could allow for raising

incomes without compromising the natural environment, and there would be no conflict between trade and the environment

Aggregate Outcomes of Trade Liberalization

Research on the aggregate impacts of the liberalization of agricultural trade developed in parallel with the Uruguay round negotiations in the late 1980s Advancements in computer technology and software allowed for the analysis of more sophisticated models Partial equilibrium models—exemplified by the work of

Anderson and Tyers (Anderson and Tyers 1989, 1990)—came into competition with computable general equilibrium (CGE) models that can take into account economic structure and more complex interactions between goods, factors, and countries Hertel provides a review of the modeling experiments and results at that time in an OECD/World Bank book dedicated to the “state of the art” analysis of agricultural trade liberalization and its impact on developing countries (Hertel 1990; Goldin and Knudsen 1990) In concluding his review, he states: “In his survey of recent studies of agricultural trade liberalization, Bruce Gardner ends

on a rather pessimistic note He finds little consistency in the estimated world price effects of industrialized market economies liberalization across different studies… My assessment of what is basically the same group of studies, is more optimistic Given their rather different structures and assumptions, the relative

uniformity of world price effects once one has controlled for the assumed level of support is striking That is,

due to the dramatic variation in measured farm subsidies over the decade of the 1980s, the base year chosen seems to explain most the differences across studies… Where large discrepancies in projected world price effects persist, this is often due to the way policies are modeled.” Similar comments and conclusions can be derived from a review of more recent studies on the impact of trade liberalization (Nash 2003)

The sophistication of CGE models applied to the study trade liberalization since the late 1980s has increased considerably The number of sectors and regions/countries is larger; policies—such as tariff quotas—are better parametrized and modeled; regional focuses have been developed beyond the global outcome; dynamic frameworks are studied; and the analysis can accommodate endogenous technological progress Hertel provided in 2002 another review of recent developments of CGE models in which he (i) identified

16 In-depth reviews of this research are presented in Copeland (Copeland and Gulati 2004) and Nordstrom (Nordstrom and Vaughan 1999) The OECD has recently published the proceedings of a conference on this subject (Organisation for Economic Co-operation and Development 2000a) López has contributed to

interesting applications of these models in the case of Ghana and Côte d’Ivoire (López 1997, 1998)