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EU Subsisdies Order sample essay

1. Introduction

The European Union introduced the Common Agricultural Policy (CAP) in the 1950s, which was aimed at encouraging better productivity in the food chain to ensure that consumers had a stable supply of affordable food and that the EU had a viable agricultural sector. This was essential in post WW2 Western Europe, where societies had been damaged by years of war and the agricultural sector crippled.

The CAP in the pre 1990s period offered subsidies and guaranteed prices to farmers by having the EU buy agricultural products whenever the prices fell below specified support levels, in order to provide a production incentive for food products. This policy was backed by tariffs which offset the difference between European and world agricultural prices in order to prevent the CAP from drawing in large quantities of imports. Furthermore, financial assistance for farming investment was provided to facilitate the restructuring of farming, ensuring that farms developed in size, management and technology, improving efficiency and productivity. (Leguen de Lacroix, 2004)

Krugman writes that since the 1970s, the support prices set by the European Union was so high that Europe which would have been an importer of most agricultural products under free trade, was producing more agricultural products than consumers were willing to buy. This resulted in the EU being obligated to buy and store huge quantities of food, and at the 1985, European nations had stored 780,000 tons of beef, 1.2 million tons of butter and 12 million tons of wheat. This forced the EU to adopt a policy of subsidizing agricultural imports to dispose of this surplus stock and production, in order to avoid unlimited growth in stockpiles. (Krugman and Obstfeld, 2006)

He further records the CAP as costing European taxpayers a staggering $50 billion in 2002, which does not include the indirect costs to food consumers as a result of higher prices. Government subsidies to European farmers were also equal to about 36 percent of the value of farm output, twice the U.S figure.

The EU (European Trade) Commission announced that it would be phasing-out all export subsidies currently granted to exporters in the European Union in 18 December 2005. In this paper, the possible effects of this phasing out of export subsidies will be discussed and analyzed, together with the policy implications and appropriate policy changes that should be made along with the phasing out of export subsidies.
A Theory of Export Subsidies

Here a theory of export subsidies will be discussed within the field of international economics, in order to analyze the effects of export subsidies in theory on trade and economies, as well as to construct a framework from which the phasing out of the EU export subsidies can be discussed.

The application of an export subsidy is just like any other subsidy – the exporters receive a higher price (by the amount of the subsidy) than what is actually paid by the foreign purchaser.

Given this price obtainable for the exported good, producer of the export good in question will not sell in the domestic market at any lower price, so, assuming that consumers are prevented from buying from foreign suppliers at lower world prices, the domestic price facing both producers and consumers is driven up by the subsidy. This tells us that the prices faced by the consumer of agricultural products within the European Union are artificially inflated through the use of export subsidies.

The application of export subsidies to large and small countries is different in theory. We consider the EU to be a “large country” with the power to influence world prices (of the export good). In this case, the increase brought about by the subsidy results in a fall in the world price of the export good – which results in a deterioration in the EU’s terms of trade. In the exporting country, consumers are hurt due to the raise in prices, producers gain, and the government loses because it must expend money on the subsidy. Hence an export subsidy must always reduce economic welfare, and will do so to a larger extent the larger is the country since this will result in a greater adverse terms of trade effect.
Removal of the EU Export Subsidy

One of the main criticisms of the EU CAP is the charge of “dumping”, or the exporting of goods at prices far below the cost of production, which Oxfarm claims depresses and destabilizes markets for non-subsiding exporters, especially those in the developing world. It suggests that the EU export subsidies should be removed so that such practices would not be so prevalent.

However, the EU export subsidies cannot be eliminated without changing agricultural policies which encourage and boost production. Removal of export subsidies without agricultural policy reform would cause a build up of unmanageable stocks of beef, coarse grains and dairy products, which is costly to the Government. The Government would also incur huge losses if these stocks had to be disposed of on the domestic market.

Therefore the removal of export subsidies would have to be accompanied by agricultural reform, which could take many forms. An example would be the implementation of production control through strict production quotas to eliminate surplus production due to the export subsidy, stricter than those that already exist through the CAP. Another policy option would be to reduce support prices.

The effects of this would be to increase domestic consumption due to the reduced prices consumer have to pay in the domestic market, as well as a reduction in domestic agricultural production due to the lower price producers receive. Hence the need for export subsidies would diminish, as the potential for a build up of agricultural stock would be reduced.

According to a study by Stout, Leetmaa and Normile, the elimination of EU support prices, with tariffs to protect agricultural products against import competition remaining in place, the largest impact within the EU would take place in the diary, coarse grain and beef markets. This is expected since these sectors are where the highest levels of price support are found, and for these agricultural products, as domestic prices fall, production and hence exports decline subsequently. This reduction in EU exports would have the effect of driving up world prices, increasing convergence between previously-distorted EU prices and world prices.

The same study referenced above also studied the scenario in which the tariffs which protects the agricultural markets from import competition are eliminated. Such a policy initiative would allow the EU to import agricultural commodities at the world prices, in turn driving down the domestic EU prices of commodities, which are currently protected by heavy tariffs. The impact of tariff elimination would be felt the hardest in the markets where import tariffs are the highest, for example, the sugar, dairy, beef, corn and rice markets.

According to another study by the OECD, the elimination of export subsidies has major consequences for much of the EU dairy and livestock product markets. As analyzed previously, the removal of export subsidies would lead to falling domestic prices, production and hence exports, as well as higher domestic consumption of these commodities. The study by OECD also documents that unsubsidized exports rise to replace the subsidized exports, as EU domestic price falls and the world price increases.

The OECD writes that the consequence of export subsidy elimination for a commodity is an increase in the world price of the same commodity, as pointed out earlier. Here the OECD carries out a more exhaustive study into this effect, concluding that the magnitude of this effect on world prices depends on the importance of subsidized exports relative to the total volume of trade, and might be offset by cross-commodity effects. There effects are illustrated in the diagram below:

The OECD also notes that EU meat exports are small relative to world totals and that not all of its export are subsidized. However the EU dairy product export market is a different story, compromising a much larger share of world markets, with most exports being subsidized. Hence the largest impacts would be felt in the diary markets, with world dairy prices increasing as subsidized exports are eliminated.

Finally, the OECD recommends that the appropriate policy response together with an export subsidy elimination, which has the fewest market distorting consequences, is to completely abandon price supports, making use of export subsidy eliminations as an opportunity to accomplish such an aim. This is in agreement with the findings by Stout, Leetmaa and Normile.

References

Leguen de Lacroix, Eugene, ‘The Common Agricultural Policy Explained’, European Communities, October 2004

OECD, ‘A Forward-Looking Analysis of Export Subsidies in Agriculture’, Organisation for Economic Co-operation and Development

Oxfarm Briefing Paper, ‘Stop the Dumping : How EU agricultural subsidies are damaging livelihoods in the developing world.’, Oxfarm International

Stout, Jim., Leetmaa, Susan. And Normile, Mary Anne. ‘Evaluating EU Agricultural Policy Reform Using the EU WTO Model’, Economic Research Service, USDA, Washington, DC

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