What’s Preventing Free Trade in Food

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In a perfect world, agricultural markets would respond only to the laws of supply and demand. Fundamental economic factors such as efficiency, customer preferences, and market prices would determine which crops farmers decided to plant, and how much. They would sell their harvest freely, seeking the best price in markets around the world. And they would prosper by focusing on crops that gave them comparative advantages, while unfettered competition assured adequate food supplies at affordable prices for all.

That's the theory, anyway. The realities of agricultural trade look a lot different. Despite significant liberalization since the Uruguay Round Agreements Act created the World Trade Organization (WTO) in 1994, global trade in food is far from perfectly free or efficient. Agricultural markets are routinely disrupted, often unintentionally, by policies aimed at  unrelated social and economic objectives. Warped incentives arising from these policies lead to economically irrational actions that create supply gluts and shortages, artificially raise or depress prices, and erode global living standards.

The arsenal of distortion

Agricultural trade generally faces more obstacles than trade in other products. Countries around the world meddle in agricultural markets incessantly, often to protect influential domestic producers from foreign competition and unwanted price fluctuations. Their tools of distortion range from tariffs and other import barriers to subsidies and consumption mandates.

"Every country has some politically powerful commodity that has been able to sustain high levels of protectionism," says agricultural economist Robert Thompson, a senior adviser at the Center for Strategic and International Studies, and former assistant secretary for economics at the U.S. Department of Agriculture.

Tariffs. Tariffs and other import barriers effectively close off markets to foreign suppliers by making imports more expensive than locally produced goods. Insulated from competition, domestic producers are free to raise prices.

Such policies have been distorting agricultural markets since the time of the Pharaohs. Great Britain's Corn Laws of the 19th century worsened the Irish famine by keeping low-priced foreign grain out of Ireland. Economists generally agree that the Smoot-Hawley tariffs imposed by the U.S. in the 1930s deepened the Great Depression.

"It's essentially transferring money from consumers' pocketbooks to producers," says Joseph Glauber, a senior fellow at the International Food Research Institute (IFRI) who previously served as chief economist at the U.S.D.A and chief agriculture negotiator for the U.S. Trade Representative.

Under WTO rules, developed countries have agreed to keep the overall level of tariff protection for agricultural commodities below 5 percent. But duties on individual crops can be extremely high. For example, the U.S. levies a 130 percent tariff on peanuts, Canada imposes a 270 percent tariff on dairy products, and Japan charges foreign rice importers a whopping 770 percent.

Subsidies and support. Since the 1930s—when collapsing markets inflicted widespread suffering on farming communities—many countries have buttressed agriculture against economic volatility with a complex array of price supports, direct income payments, crop insurance and other subsidies. The U.S. alone spends $20 billion annually on such measures, helping growers weather market price declines, crop failures and other setbacks.

These payments sometimes have unintended effects, as farmers make planting decisions based on subsidies rather than demand. When the government guarantees farmers a profitable price, or pays them based on production volumes, they're likely to plant more of a subsidized crop than the market needs. “The government payments speak louder than market signals,” Thompson says.

Recent decades have seen a shift away from payments tied to price or volume and toward direct income payments, which are seen as less likely to encourage overproduction. Countries in the European Union, for example, have replaced production-based subsidies with per-acre payments to farmers. This approach supports farm incomes without creating incentives to flood markets with subsidized crops. Farmers receiving such payments are more likely to let demand guide their planting decisions, rather than maximizing output of crops that generate subsidy checks.

The price of distortion

Trade policies can undermine economic efficiency in many ways. Tariffs inflate prices by limiting supply. Hundreds of billions of dollars' worth of subsidies showered on farmers in rich countries trigger supply gluts, driving down market prices and harming growers in poor countries that can't afford to subsidize crops.

Economic data illustrate the broad impact of agricultural policies, and how much they mean to farmers. A recent study by the U.S. Department of Agriculture estimates that current government support for agriculture totals 0.5 percent of U.S. GDP, or $97 billion. In the European Union, agricultural support adds up to nearly $124 billion, or about 0.7 percent of GDP. According to the International Centre for Trade and Sustainable Development, government support—including tariffs—represented 17 percent of total farm income in Organization for Economic Cooperation and Development member countries in 2015.

In most cases, tariffs have relatively little impact on the price consumers pay at the grocery store. That's because most tariffs are fairly low, and raw commodities represent a small portion of the cost of processing, packaging and distributing food. However, some tariffs drive up consumer prices dramatically. Americans pay more for products containing sugar, largely because import restrictions have lifted domestic sugar prices about 75 percent above the world market price. A study by the American Enterprise Institute estimates the annual cost to U.S. consumers at $2.4 billion to $4 billion.  High sugar costs also drive candy producers offshore, eliminating U.S. jobs.

Moreover, living standards in the developing world suffer when wealthy countries erect trade barriers. Those U.S. tariffs on sugar have locked Caribbean and Central American producers out of lucrative overseas markets, denying them opportunities to generate income that would ease poverty there.

Subsidy payments, too, can have a real impact on worldwide living standards. When overproduction by subsidized farmers in the U.S. and the EU pushes crop prices below the cost of production, unsubsidized growers elsewhere lose money. Recently, heavily subsidized European milk has been flooding into Africa at prices well below breakeven, forcing many African dairy farmers out of business. “You wreak havoc on the rest of the world economy by depressing prices overall,” says Carlisle Ford Runge, a professor of economics and law at the University of Minnesota and a former special assistant to the United States Trade Representative.

A turning point?

Until recently, agricultural trade had been steadily opening up as tariffs and other trade barriers fell and free-trade agreements connected farmers to new markets around the world. Globally, agricultural exports climbed 70 percent between 2006 and 2016, to about $1.7 trillion, WTO data show. Sales of U.S. agricultural products abroad rose to $140.5 billion last year, from $48.2 billion in 1990, as China, Mexico and other countries bought American crops in ever-increasing quantities. Emerging countries have become a key source of growth for farmers in developed economies, where food demand is relatively flat. Exports now account for 32 percent of total agricultural output in the European Union and 20 percent of U.S. farm income.

It is by no means clear how recent trade tensions will affect this long-term trajectory. In response to new U.S. trade sanctions, China, Canada, and Mexico have slapped tariffs on American soybeans, pork and other farm commodities. Chinese soybean levies alone could cost U.S. producers $14 billion while driving up prices of South American soybeans as China seeks to replace about 34 million metric tons of American imports. Discussions among the parties continue, however, keeping alive the hope of a quick resolution that would minimize the damage.

Even if current hostilities don't spark a broader turn toward protectionism, agriculture isn't likely to become an unfettered market any time soon. Powerful interest groups will continue lobbying for protection of favored sectors. U.S. corn growers, Brazilian soybean farmers and European beef producers haven't lost any political clout.

But it's not unrealistic to hope for a return to steady liberalization. The world has made great progress in reducing tariffs, the biggest impediments to free trade in farm products. "Tariffs are the best thing to go after," says the IFRI’s Glauber. "Most of the gains from liberalization come from lowering tariffs."

Subsidies and other support payments to farmers are harder to dislodge, but cause less harm if they're properly structured. By continuing to replace price- and volume-based subsidies with direct payments that don't reward overproduction, countries can maintain a healthy agricultural sector while minimizing economic distortion and maximizing the benefit to consumers. Says Glauber: “Trade allows farmers to sell their products at higher prices to consumers who pay lower prices than they would in its absence.”