International Affairs specialist Karen Poreh on farm subsidies and free trade in the Americas

Could Washington do more for free trade in the Americas?

The US and Europe inch towards a free-trade agreement. Progress can seem slow, but a deal appears inevitable. Why is there no such optimism that the US can complete a comprehensive free trade agreement in the Americas? After all, tariffs between Europe and the US are already rather low. Couldn’t there be more gains by freeing comparative advantages in the Western Hemisphere?  Alas, since the Free Trade Agreement of the Americas (FTAA) fell apart in  2005, the idea seems to have been abandoned in favor of small scale bilateral agreements.

The FTAA aimed to reduce tariffs in the Western Hemisphere, promoting trade in the Americas. The major concern among the developing countries was the US’s agricultural subsidies- an issue that remains unresolved even domestically. The Obama administration has voiced a desire to advance “common prosperity and… expand investment to create new jobs” through expanded trade.  If there is any silver lining to sequestration, the US now has an opportunity to reduce some of the barriers for free-trade relationships with major Latin American partners such as Brazil.

Amidst the current budget deficit discussions, the US Congress is proposing to eliminate direct payment subsidies to American crop farmers. Under the 2008 Farm Bill, the US Department of Agriculture (USDA) has paid anywhere between US$10 billion to $30 billion in subsidies annually to farm businesses or farm owners. Farm subsidies come in multiple forms, such as direct payments, marketing loans, disaster aid, and insurance. They are based on historical measures of acreage and not on contemporary crop output. As a result, subsidies create enormous economic inefficiencies including barriers to free trade with Latin America.

Farm subsidies and direct payments were created during the depression to protect an ailing industry. Today, however, farmers enjoy steady profits and high commodity prices. Under current policy, most direct payments help only a few farm owners who earn more than the average American. Because payments do not change with production levels, they essentially supply farmers with excess cash and distribute taxpayer money to a small group of already-successful individuals.

Direct payments coupled with marketing loans hinder fair trade. American farmers continue production even when costs are high because they have government support. This often leads to artificially lower prices on crops such as cotton and sugar, providing American farmers with an unfair advantage in the world market. This hurts trading partners like Brazil, who must reduce crop prices to compete with American markets even when costs remain high. Brasilia perceives an unfair playing field, and this inhibits stronger free-trade relations between the two countries.

Latin America is ready to trade- So what is causing the traffic jam on legislation?

In fact, in 2010, the Obama administration settled an international trade case against U.S. cotton subsidies with Brazil by agreeing to pay US$147.3mn annually. Brazil threatened to levy tariffs against American products such as software, and the WTO agreed with this measure. The administration’s response highlighted the importance of preserving strong free-trade relations with our neighbors, and the settlement underscored the wasteful spending of protectionist policies in the US.

A Textbook Example of Inefficiency  

The arguments for and against free trade are not novel. While lower commodity prices help Americans in the short run, limitations on fair trade hurt consumers in the long run. Subsidizing agriculture has its normative economic reasoning – protecting our citizens from unemployment when their industries are ailing. Yet, the cotton industry does not fall into this category. The US is the second largest exporter of cotton in the world, and the majority of US subsidies are transferred to a small minority of American cotton farmers. Policies that block free trade help a few at the expense of many. Open markets and trade liberalization have historically increased living standards and ensured greater global  production as developing countries improve their output.

Industry experts generally concur that removing direct payments would not drastically hurt farmers. According to the USDA, these direct payments make up 5 percent of farmers’ gross income, but will cost the government about $46 billion over the next ten years. Taxpayers will not enjoy all these savings, however, because reformed aid will be supplied to farmers in the form of insurance or disaster relief. These subsidies will provide a social safety net for farmers, making total savings a little over $27 billion dollars.

While eliminating direct payments reduces inefficiencies, Congress could and should remove other forms of subsidies as well. Removing the marketing loan provision would further correct inefficiencies and reduce the fiscal deficit. A fairer compromise between farmers and taxpayers would consist of a policy that grants subsidies based on production and natural disasters. These subsidies distort prices less than current policy and protect farmers. By keeping insurance and disaster relief programs, farmers will remain protected if economic conditions worsen. Eliminating direct payments and marketing loans will promote fairer trade and pricing of goods.

If the US truly believes in free trade, perhaps it should give up protecting a home field advantage.

Karen Poreh is a Research Assistant at the Philip Merrill Center for Strategic Studies. She is also completing a Masters Degree at the Johns Hopkins School of Advanced International Studies.  

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