For nearly a decade, Brazil and the United States have been embroiled in a dispute over cotton subsidies. On April 6, 2010, the U.S. Trade Representative and the U.S. Secretary of Agriculture announced that the two countries had agreed on a path toward negotiated settlement; two weeks later a Memorandum of Understanding (MOU) was signed. Although the details have yet to be spelled out, the MOU highlights both strengths and limitations of the current dispute settlement system. On the one hand, an agreement was reached through WTO rules and a “trade war” was avoided. Moreover, the agreement shows that less powerful members of the global trading system (in this case, Brazil) can successfully argue their case in the WTO. But two key limitations were also exposed: Unless the “injured” party has enough trade leverage with the “guilty” party, authorization of countermeasures—the typical WTO remedy—is of no use. And many countries may not be able to make their case to the WTO, either because of weak capacity or because the relevant sector is too small to economically justify raising the issue.
The “Cotton Problem”
The “cotton problem” began in 2002, when Brazil and four African cotton producers (Benin, Burkina Faso, Chad, and Mali, the so-called C-4) argued that cotton subsidies caused world cotton prices to decline and reduced their export revenues.1 At the time, the value of global cotton output averaged between $25 and $30 billion and the United States (which accounts for one third of world cotton exports) supported its cotton sector to the tune of $2 to $4 billion annually. The EU gave considerable support to its cotton sector as well (around $1 billion annually, though this was applied to much less cotton and hence had a much lower impact on world prices). Given that cotton was (and still is) the key merchandise export of the C-4 countries, the subsidies raised not only issues of trade fairness but also concerns regarding their negative impact on development.2
Even though the subsidies affect all non-subsidizing, cotton-producing countries, only Brazil and the C-4 chose to bring a case to the WTO and, despite the fact that both fought the same subsidies, they chose different paths.3
The cotton initiative was the first time that the WTO had to deal with a direct compensation issue rather than the typical remedy of authorizing countermeasures.
Brazil went the traditional dispute settlement route. On September 27, 2002, Brazil requested consultations with the United States and soon the WTO’s Dispute Settlement Body established a panel to examine the issue. In its final ruling, issued in September 2004, the WTO concluded that the United States had to remove the adverse effects of the subsidies or withdraw them.4 Subsequent U.S. actions (including the removal of the step-2 payment, an export subsidy) did not satisfy Brazil. On August 31, 2009, WTO arbitrators issued awards totaling $830 million to Brazil and (effective April 7, 2010) allowed Brazil to impose countermeasures in sectors outside of merchandise trade, including intellectual property and services [emphasis added].
The C-4 brought the case of cotton subsidies to the WTO as well but, instead of joining Brazil and proceeding within the existing WTO channels, they entered unchartered territory by demanding direct compensation.5 On May 16, 2003, the C-4 launched the “Sectoral Initiative in Favour of Cotton,” demanding that countries discontinue cotton subsidies and directly compensate nonsubsidizing countries until they were removed. The rationale behind the C-4’s decision reflected (most likely) the fact that even a favorable WTO ruling would not have been of much help because of their limited trade with the United States.6
The cotton initiative was the first time that the WTO had to deal with a direct compensation issue rather than the typical remedy of authorizing countermeasures. At a WTO-sponsored workshop in March 2004, it was decided that, because of numerous practical difficulties, the cotton initiative would be dealt with in two tracks: development (compensation) and trade (subsidies). International financial institutions would help with the development component while the Doha Development Agenda (DDA) would address the trade component. Little progress has taken place on either front. In fact, it is believed that the cotton initiative may have been a key factor behind DDA’s slow progress.7
The U.S.–Brazil MOU
What triggered the U.S. agreement with Brazil? Most likely, the turning point was the authorization to impose “cross-sectoral countermeasures outside of trade in goods, specifically intellectual property and services.”8 In other worlds, the United States came to this agreement in order to prevent collateral damage. Under the MOU, Brazil will not make use of the authorized countermeasures.
More interestingly, the MOU recognizes that there are “other developing countries” that have been “injured” by the subsidies but never brought their cases to the WTO.
In return, the United States agreed to make some near term modifications (to be specified later) in the operation of its Export Credit Guarantee Program, under which private U.S. banks extend credit guarantees to approved foreign banks for purchase of U.S. agricultural products. But the concession is very small, given that most of the U.S. cotton subsidies take the form of marketing loans and countercyclical payments. These are expected to be addressed in the 2012 U.S. Farm Bill.
Two other elements of the agreement tell a more interesting story. The MOU establishes a fund for technical assistance and capacity-building related to Brazil’s cotton sector. The $147 million annual fund will continue until either the United States passes the next Farm Bill or the United States and Brazil mutually agree upon a solution to the dispute. Thus, the United States will compensate Brazil’s cotton sector until the subsidies are dealt with—which is what the C-4 asked for but never received.
More interestingly, the MOU states that “the fund may also be used for activities related to international cooperation in the cotton sector in sub-Saharan Africa, in Mercosur members and associate members, in Haiti, or [in] any other developing country as the parties may agree upon …” In effect, this recognizes that there are “other developing countries” that have been “injured” by the subsidies but never brought their cases to the WTO.
Broader Implications
From the perspective of the world trading system, the MOU is a step in the right direction. It makes progress toward addressing two key shortcomings of the current trading system: the inability of less powerful trading partners to bring their cases to the WTO and the need to broaden “sentencing” to include compensation when countermeasures are not applicable.
However, the effect of the MOU is likely to be very limited. First, it is questionable whether Brazil needs technical assistance or capacity-building any more than, say, Zambia, Uganda, or Haiti (which is not even a cotton producer). Second, the support that can be provided to the other (40 or so) cotton-producing developing countries is entirely inadequate given the resource envelope of the MOU.
For the United States, not having subsidies at all would have been best; or, as a second best, phasing them out as the U.S. General Accountability Office recommended fifteen years ago.
What would have been a better approach? For the United States, not having subsidies at all or, as a second best, phasing them out as the U.S. General Accountability Office recommended fifteen years ago.9 For the C-4 (and other cotton producing developing) countries, joining forces with Brazil in its dispute settlement case may have been most beneficial. Going forward, until WTO rules are reconfigured to address the dispute settlement system’s shortcomings, the smallest and poorest developing countries should align their interests and form coalitions with the more powerful developing nations. Of course, such opportunities may not be available, underscoring the need for a reform of the dispute settlement system that includes monetary compensation as a remedy.
John Baffes is a senior economist in the World Bank’s Development Prospects Group. The views expressed are of the author, not the World Bank.
1. A “behind the scenes” detailed account of the cotton dispute can be found in a Harvard Business School case study by Katherine Milligan, Ray Goldberg, and Robert Lawrence.
2. For a discussion on the cotton trade policies and global market trends see “The Cotton ‘Problem’”, pp. 109–144.
3. A full discussion of the timetable can be found in John Baffes (2007), “Cotton Developments in West Africa: Domestic and Trade Policy Issues and the WTO.” in WTO Rules for Agriculture Compatible with Development, pp. 211–239, J. Morrison and A. Sarris, eds. (Rome: The Food and Agriculture Organization of the United Nations).
4. Details regarding the dispute can be found in Daniel A. Sumner (2006), “Reducing Cotton Subsidies: The DDA Cotton Initiative.” in Agricultural Trade Reform and the Doha Development Agenda, Kym Anderson and Will Martin, eds. (Washington DC: The World Bank).
5. The C-4 countries were aided by the Geneva-based NGO IDEAS.
6. Moreover, many developing countries already impose high tariffs for tax revenue purposes. So, imposing even higher tariffs as a countermeasure would effectively reduce imports to zero.
7. For progress on the cotton initiative see discussion at the conference “A US-Africa Dialogue on Cotton Trade” co-sponsored by the Carnegie Endowment for International Peace and IDEAS, July 20, 2009.
8. For some early thoughts on this see Paschal G. Zachary (2005), “100 percent Rotten.” Business 2.0. December, pp. 148–154.
9. See United States General Accounting Office (1995), “Cotton Program: Costly and Complex Government Program Needs to Be Reassessed.” RCED-95-107, June 20. Report to the Honorable Richard K. Armey, United States House of Representatives. Washington, D.C. The report argued that (p. 3): “The cotton program has evolved over the past 60 years into a costly, complex maze of domestic and international price supports that benefit producers at great cost to the government and society. From 1986 through 1993, the cotton program’s costs totaled $12 billion, an average of $1.5 billion a year. Moreover, the program is very complex, with dozens of key factors that interact and counteract to determine price, acreage, and payments and to restrict imports. The severe economic conditions and many of the motivations that led to the cotton program in the 1930s no longer exist … The [U.S.] Congress could, for example, reduce or phase out payments over a number of years, perhaps over the life of the next [1996] farm bill.”
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