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Understanding the impact of cotton subsidies on developing countries

Research reports

Written by Sheila Page

Cotton trade and production are highly distorted by policy. More than one-fifth of world cotton producer earnings during 2001/02 came from government support to the sector. Support to cotton producers has been greatest in the US, followed by China and the EU. For 2001/02, US combined support to the cotton sector was US$2.3 billion. The EU’s support (to Greece and Spain) totalled US$700 million and China provided US$1.2 billion. Subsidies encourage surplus cotton production, which is then sold on the world market at subsidised prices. This has depressed world cotton prices, damaging those developing countries which rely on exports of cotton for a substantial component of their foreign exchange earnings. A number of West and Central African countries raised the issue of the abolition of cotton subsidies at the WTO in May 2003. Cotton subsidies also form the basis of a WTO dispute brought by Brazil against the US on 26 April 2004 in which the panel ruled in favour of Brazil. The expansion of cotton cultivation in many developing countries has played an important role in reducing poverty, where scope for replacing cotton by other crops is limited. These gains have been threatened by the fall in world prices for cotton. Cotton is a minor component of economic activity in industrialised countries, accounting for only 0.12% of total merchandise trade, but its production plays a major role in some Least Developed countries in West and Central Africa. In Benin, Burkina Faso, Chad, Mali and Togo cotton accounts for 5-10% of GDP, more than one-third of total export receipts and over two-thirds of the value of agricultural exports. Even in Côte d’Ivoire and Cameroon (both classified as developing, not Least Developed), which are among the largest African cotton producers, cotton production accounts for 1.7% and 1.3% of GDP. Cotton is also a major component of total exports for a number of non-African developing countries. Cotton exports in Uzbekistan, Tajikistan and Turkmenistan account for 45%, 20% and 15% of total merchandise exports and make a significant contribution to GDP in these countries (8% in Uzbekistan and Tajikistan; 4% in Turkmenistan).

In attempting to model the impact of cotton subsidies on production and export earnings in developing countries, the problem is how to determine:
1) the size of the effects of removing subsidies;
2) the distribution of these effects among producer countries; and
3) the distribution of these effects among groups of poor people within these countries.

One way to analyse the first two issues is to assume a single, unitary market for cotton, in which buyers choose among essentially homogeneous consignments of lint from different producing countries primarily on the basis of price. The removal of subsidies reduces the price received for cotton by producers in subsidising countries. As a consequence, world supply of cotton contracts (subject to assumptions regarding the elasticity of cotton supply in subsidising countries) and the world price of cotton increases (subject to assumptions regarding world elasticities of cotton demand) which induces a positive supply response from non-subsidising countries (subject to assumptions regarding the elasticity of cotton supply in non-subsidising countries).

Models of this type tend to conclude that US subsidies, by virtue of their absolute magnitude (see Chapter 3), are particularly damaging to production and export earnings in developing countries and that, in contrast, the impact of EU support to the sector is relatively small. Such findings are often used to justify protectionist stances within the EU where support to the cotton sector has a significantly positive impact on EU cotton production, but is argued to have minimal impact on developing-country producers.

There are, however, some uncertainties and difficulties in this approach. In this work we analyse two of these.

First, a key question concerns the structure of the world market for cotton lint. If the assumption of a single, homogeneous global market for cotton is relaxed and, instead, it is assumed that a perfectly fragmented market exists, in which cotton-producing countries can only trade with existing trade partners, countries only benefit from reductions in subsidies if they are already competing in a segment of the market whose production is currently subsidised. This has implications for the impact on cotton price and for the distribution of benefits from the removal on subsidies. In order to investigate where cotton falls on the continuum of a fully fragmented to a unitary market, we discuss the markets for cotton in Chapter 2.

Secondly, the ability of developing countries to benefit from the removal of cotton subsidies in the US, China and the EU depends on how strongly they are able to increase output of (and secure demand for) their cotton in response to a higher price. To understand this more fully, we examine in Chapter 5 demand and supply conditions for cotton in the major producer (developing) countries.

Our model, presented in Chapter 4, is an adaptation of the model developed by Goreux (2003), reworked to take these additional factors into consideration.

Ian Gillson, Colin Poulton, Kelvin Balcombe and Sheila Page