Agricultural Subsidies in the United States and the EU

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Table of Contents

Introduction
Economic Theory on Subsidies and Taxes
Comparison of the US and the EU Agricultural Policies
Differences between the US and the EU agricultural Policies
Similarities between the US and the EU Agricultural Policies
Effects of Agricultural Subsidies on Famers
Conclusion
References

Introduction

Subsidies are deployed as a means of boosting production, by giving financial grants from one party to another in order to increase production beyond the market equilibrium. From an economist’s perspective, funding has been adopted in different contexts to give varying implications and significance.

The Organisation for Economic Co-operation and Development (OECD) defines subsidies as “measures that keep prices for consumers below market levels, or measures that keep prices for producers above market levels” (OECD 2006, p.3).

Many economists argue that the term subsidy can be applied to mean all forms of payments made directly by a government to various producers.

In light of these explanations, this paper considers subsides as including direct means of regulating the equilibrium between consumption and supply of products and services in the market, among them being cash grants coupled with provisions of interest-free loans from the government.

Low-interests loans, tax wavering write-offs of depreciation charged on assets, rent rebates and insurance are also considered among the alternative forms of subsidy.

The main purpose of this paper is to conduct a comparative analysis of the similarities and differences between the US and the EU agricultural subsidies. The basis for this research is founded in existing literature that relate to economic theories on taxes and subsidies.

In addition, to expand on the discussion involving the similarities and differences in agriculture subsidies within the US and EU, as well as their implications on economy, a literature review of economics of subsidies and taxes will be considered first.

The paper further presents the differences between the US and the EU agricultural policies, concerning the legislation on agricultural subsidies and the critical reception towards these policies.

This section is followed by a discussion on the similarities between the US and the EU’s agricultural policies in the context of benefits to farmers and influences on income. Lastly, the effects of agricultural subsidies on famers, from the dimension of family budgets and taxes are given substantial attention.

Economic Theory on Subsidies and Taxes

To understand the economic theory on subsidies and taxes, one needs to be aware of the function of subsidy and tax accords within the area of global trade pact. One will get to understand why the government upholds such accords as well as identifying the most preferred way of handling the subsidies within the global trading schemes.

Therefore, studies pertaining to the economic impact of subsidies have provoked mixed reactions from economists. For instance, Krishna and Panagariya (2009) argue that, “subsidies are a form of protectionism or trade barrier by making domestic goods and services artificially competitive against imports” (OECD, 2006, p.236).

Such protectionism impairs the ability of consumers to consider and select imported goods and services, in their pursuit of alternative goods that are produced outside a nation’s boundaries through unethical or illegal channels (Anderson 2005, p.165). In the economic sense, subsidies are unethical because they distort the market and impose higher economic costs.

In addition to this case, there are different types of subsides that have been outlined. Amegashie identifies employment subsidies, production subsidies and export subsidies as three that are granted by governmental or non-governmental organisations (Amegashie 2006, p.8).

Export subsidies take the form of financial support that is offered by a government to exported products and services, in an effort to improve a nation’s balance of payments (Amegashie 2006, p.8). From an agricultural product context, exporting subsidies is significant in nations whose GDP is mainly derived this particular source. However, the impact of export subsidies varies.

For instance, the Court of Auditors (2003) argues that, as evidenced by the case of the EU, export subsidies may result inartificially low prices of subsidised products. Furthermore, fluctuations in milk production costs may also occur, as shown in the graph below.

Fig 1: Milk products production cost fluctuations in the EU in comparison to other parts of the world

Source: Weers and Hemme (2012, p.13)

Production subsidies have a key role to play when it comes to product yields. Production subsidies “encourage suppliers to increase the output of particular products by partially offsetting the production costs or losses” (Krishna & Panagariya, 2009, p.237). Thus, the chief aim is to create a means of expansion for the production of certain products at much lower prices than the market forces would make possible (Mankiw, 1997).

In doing so, governments also offer their support to consumers of the produced products. In an agricultural context, production subsides may also be provided by offering technical support and financial assistance to help create new agricultural firms and processing plants, possibly on a regional basis.

Moreover, employment subsides and incentives, such as social security benefits, are sometimes offered by governments to boost employment levels in certain regions and for certain industries (Szymanski & Valletti, 2005). They may also conduct research into new areas of development that would lead to more absorption of unemployed persons.

Although subsidies may be seen as a plausible way of regulating and controlling the markets, they attract controversies over their overall impacts on the performance of a nation’s economy.

Subsidies influence competitive equilibrium, and from the fundamental principles of supply/demand relationships, particularly in cases where the demand for a given product goes beyond the supply, prices normally fall. Consequently, reduction of goods supplied to levels below the equilibrium quantity results in price hikes (Covey et al., 2007, P.41).

Supposing that the bazaar for any product operates flawlessly “…at the competitive equilibrium, the overall effect of subsidies is to increase the supply of goods and services to levels above the equilibrium quantity” (Kym & Will 2011, P.1303). This move leads to an increase of costs beyond corresponding gains of the subsidy.

That is, the amount of increase is proportionate to the size of the injected subsidy and hence a “market failure or inefficiency” (Jerome et al. 2006, p.16). For this reason, some economists claim that subsidies are undesirable in a competitive market.

This claim is particularly significant in cases where foreign competition is desired. In support of this assertion, Westcott and Young (2004) argue that, instead of lowering the prices of goods and services, subsides make goods produced within a nation, cheaper in comparison to those produced in the foreign nations; hence incredibly reducing foreign competition.

In the context of agricultural goods, giving subsidies(especially in the developing nations) implies that such nations are barred from engaging in the international trade in a more competitive manner, since they receive substantially lower prices on products traded on the global market.

In economic theory, offering subsidies in the form of tax wavering is considered as an attempt of protectionism (Wyatt & Ashok, 2010, p.1927). In such scenarios, market distortion occurs, accompanied by social welfare reductions.

On the grounds of economic logic, World Bank policies advocate the total removal of subsidies offered by the developing nations, even though it has no mandate to enforce this removal (Westcott & Young, 2004, p.11).

The impact includes a reduction in revenue generated by producers operating in foreign nations, which can cause tension between the European Union and the United States, and the nations in the developing world that are known to be offering economic stimuli in the form of subsidies.

The developing nations protect their local industries against the influx of foreign products. Such foreign products cost less in the developing nations’ markets due to the economies of scale in the production processes and techniques for production used in the developed world’s industries.

In summary, subsidies can provide a short-term solution to an industry. However, on a long-term basis, they end up being unethical, often evolving into negative effects (Organisation for Economic Co-operation and Development 2007, p. 26)

Comparison of the US and the EU Agricultural Policies

The subject of subsidies and tax reduction for agricultural products is approached from different directions, yet in similar ways for both the EU and the US. Subsidising the agricultural sector is done with the ultimate objective of boosting aggregate demand or investment in the agricultural sector (Becker 2002).

In accordance to the theory of economics of subsidies, such an attempt causes the cost of production for agricultural products to be lowered for both the US and the EU. Consequently, making products become cheaper than importing them. In both the US and the EU, it is appreciated that the removal of subsidies has the impact of dampening economic activities in the agricultural sector.

This blow is dependent to certain issues associated with the agricultural sector budget balance. Appreciating the role of subsidies and taxes in shaping the agricultural sector in the US and the EU warrants consideration of the differences and similarities between their different approaches to agricultural subsidies.

Differences between the US and the EU agricultural Policies

Legislation on Agricultural Subsidies

The US and the EU have put policies in place that encourage their farmers to produce certain agricultural products at much lower costs, in comparison to the global costs of such products (Alston 2008).

Although there have been less legislative efforts to encourage the production of various products in the EU, the governing bodies have implemented policies that ensure farmers receive subsidies for producing certain commodities such as dairy products (Alston 2008).

In similar fashion, the US has created a process to facilitate subsidy offers for farmers that produce various products, mainly cotton, through legislation such as the 2010 Farm Bill (Babcock 2007.

Subsidising US cotton results in low global market prices of the crop, wherein levels of making cotton produced elsewhere is unsustainable in the market. Hence, many nations are opposed to the legislation provided in the Farm Bill 2002. For instance, Brazil challenged the US subsidies for cotton farmers at the World Trade Organisation (WTO), stating that this distorted the cotton market at an international level.

They further argued that it encouraged an increase in income to large-scale farmers at the advantage of the small-scale and poor farmers in the developing world. This case lasted from 2002 to 2008, when it was concluded with Brazil being the victor.

In support of this argument, Riedl (2008, p.316) believes that policies encouraging subsidising of the agricultural products in both the EU and the US products have an opposite impact.

However, despite the opposition to the continued indirect funding of the EU and the US farmers through subsidies, Summer (2013) proposes that it is imperative to stop offering direct incentives for production, because such a strategy for boosting production makes farmers in the US and the EU compete unfairly with others across the globe.

Critical Reception of Agricultural Policies

From the above arguments, subsidies on agricultural products, especially by major global giant producers like the EU and the US, are not received in good faith within the international arena.

In relation to this, LaBorde (2013) postulates, “a series of weather-related shocks in 2012—including severe droughts in Central Asia, Eastern Europe, and the United States—contributed to global food prices remaining high for a fifth consecutive year” (LaBorde 2013, Para.5).

Although the EU and the US do provide subsidies to different agricultural products, they have refused to heed to these calls. Rather, they have opted to increase subsidies on agricultural sectors domestically. Such strategies have long-term implications on the worldwide food systems, coupled with impairing food securities in the developing nations (Babcock, 2007: Alston, 2008).

Similarities between the US and the EU Agricultural Policies

Benefits to Farmers

According to Westcott and Young (2004), one of the major similarities between subsidies of the agricultural sectors in both the US and the EU is that subsidising has resulted in lowering the costs of production. In fact, “in 2005, the US government gave farmers agricultural subsidies amounting to$14 billion and in the European Union, dairy farmers received subsidies amounting to $47 billion” (Westcott & Young 2004).

This equates to more than the sum earned by every person (on average) in the developing nations. This explicitly implies that the US and the EU farmers were able to produce their products much cheaper than those outside of their countries because of government subsidies.

Consequently, based on research by Drabenstott (2008), and the U.S. Department of Agriculture, Economic Research Service’s (2007), foreign traders found it difficult to introduce their products into these two markets, since the price of the subsidised farm products were lower than those they could sell their products at, even for them to break even.

Although such subsidies resulted in stimulation of, and therefore, over-production of subsidised agricultural sector products, farmers in the US and EU benefited in that they were able to place their surplus products in the market in higher quantities. This case meant that the consumption of the products also increased.

Influences on Income

In 2002, cotton farmers in America earned much of their revenues from the country’s administration through subsidies brought into force under provisions of the Farm Bill (Morgan, Gaul, & Cohen 2009). These subsides also stimulated overproduction of cotton in 2002. Much of this excess production was sold to the global markets at much lower prices well below the break-even points of cotton farmers in the developing world.

Similarly, in the EU, in 2004, £3.30 was spent in the exportation of sugar worth£1(Oxfam International 2004, p.39). Although, the subsidies had a positive impact on the incomes earned by EU farmers, global market distortions occurred. Subsidies for agricultural products in the US and the EU have an overall impact of protecting revenue losses that are likely to be encountered by EU and the US farmers.

However, in the US for instance, farm subsidies favour large-scale farmers over small-scale ones, with non-farm families’ incomes being negatively impacted (see Fig 2). This situation is inappropriate, especially considering that most of the farm families are located in rural areas where the cost of living is lower.

Fig 2: Differences between incomes for large farms and small farms in the US

Source: (Becker 2002)

Effects of Agricultural Subsidies on Famers

Family Budgets

Farm policies that are realised through subsidies are meant to provide relief on farmers’ household budgets. Unfortunately, they produce opposite effects, as Becker (2002) states they, “harm family farmers by excluding them from most subsidies, encouraging the merging of family farms, and raising land values to levels that prevent young people from entering farming” (p.17).

This suggests that agricultural subsidies fail to provide relief to the struggling farmers, especially those who are new to farming, because overproduction results in low prices of agricultural products. In turn, the net effect on the capacity to fund family budgets is minimal.

Tax

Farm subsidies have the overall impact of increasing the cost of living through increased taxes. As the economy for both the US and the EU continues to boom, congress also increases the subsidies offered to farms.

Wyatt and Ashok (2010) support this assertion by claiming, “After averaging less than $14 billion per year during the 1990s, annual farm subsidies have topped $25 billion in the current decade since the passage of the 2002 farm bill, the most expensive farm bill in American history” (Wyatt & Ashok 2010, p.1931).

This argument implies that all spending by the federal governments has to be funded by taxes levied from citizens. In the US, Morgan, Gaul, and Cohen (2009) put the costs of farm subsidies at $216 per household in the form of yearly taxes, with an additional extra charging of $104 per household as escalated food prices.

Conclusion

The central purpose for enacting farm subsidy policies is centred on the need for alleviating poverty among rural farmers, and provision of food security by encouraging over production. Noting this purpose, the paper argues that scrutiny of the impact towards agricultural subsidies from an economic perspective, fails to contend with this aim.

This is because such policies result to disadvantaging small-scale farmers outside the EU and the US, since the subsidies result in over production. The repercussion is to lower the prices of products in the global market, with the result that farmers’ operations in other nations without the subsidies never break even. Within the US and the EU, subsidies create an imbalance of income between families that own farms and those that do not.

Agricultural subsidies make families that own farms to earn higher incomes compared to those that do not own farms, yet families owning farms live in the rural areas where the cost of living is low.

Hence, overall, farm subsidies have negative impacts on a nation’s economy, even though farmers (especially large-scale farmers) benefit incredibly from higher incomes. The underlying issue however, is that this is achieved at the expense of the smaller farmers operating in the same global market, who do not enjoy farm subsidies.

References

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Babcock, B 2007, Money for Nothing: Acreage and Price Impacts of U.S. Commodity Policy for Corn, Soybeans, Wheat, Cotton, and Rice in American Enterprise Institute, The 2007 Farm Bill and Beyond, AEI Press, Washington, D.C.

Becker, E 2002, ‘Land Rich in Subsidies and Poor in Much Else’, The New York Times, January 22, pp.17-18.

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