In a recent ruling of significance for the evolving agricultural trade regime, a WTO Appellate Body (AB) has supported all major findings of an earlier WTO panel report which concluded that US cotton subsidies were in violation of WTO rules. At issue are 'product flexibility contracts' (PFC), 'direct payments' (DP), 'export credit guarantees' and 'step 2 marketing payments'. In a report dated March 3 2005, the Appellate Body has confirmed that certain US subsidies given to cotton farmers, such as 'product flexibility contracts' (PFC) and 'direct payments' (DP) are production and trade-distorting in nature and therefore cannot be categorized as permissible 'decoupled payments.' The AB has also supported the conclusion of the Panel Report that 'export credit guarantees' and 'step 2 marketing payments' offered to US cotton producers are prohibited export subsidies and they should be abolished with immediate effect.
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If one recalls, one of the highlights of the Cancun Ministerial meet
was a debate about how high subsidies given to cotton farmers by developed
countries are adversely affecting cotton exporters from some West African
countries. Benin, Burkina Faso, Chad and Mali pointed out that as a result
of subsidies given to cotton in richer countries, exports of these four
West African countries have suffered. They argued that subsidies given
to farmers in developed countries induce overproduction of cotton in those
countries. This surplus cotton is dumped in the international market at
an artificially cheap rate. Excess supply of cotton is driving down the
prices in the international market. Data show that between 1997 and 2002,
international prices of cotton have declined by 39 percent and cotton
prices in 2002 were at a 30 year low. Declining international prices of
cotton and increasingly lower price realization from cotton exports is
hurting cotton exporters from developing countries. The problem is more
acute for Benin, Burkina Faso, Chad and Mali because cotton is the main
cash crop as well as the most important source of export revenue for these
four countries. Based on the discussions in the Ministerial, the WTO issued
a draft ministerial declaration which, in its paragraph 27, included some
proposals about the cotton initiative. However, the draft ministerial
text ignored the concerns of developing countries and closely reflected
the US approach towards the cotton sector. The draft did not include any
firm commitment on reducing domestic and export subsidies for cotton.
It was also imprecise and vague about the treatment of US domestic and
export subsidies for the cotton sector. Due to the failure of the Cancun
Ministerial, no constructive ministerial declaration was finalized and
the draft proposal which contained the controversial paragraph on cotton
initiative was rejected. It is notable here that in the "framework"
text of the so-called July package it has been declared that cotton will
be addressed "ambitiously, expeditiously and specifically" within
the agriculture negotiations. A sub-committee has been formed to work
on "all trade-distorting policies affecting the sector", in
all three key areas of the agriculture talks — the "three pillars
of market access, domestic support, and export competition".
As a parallel initiative, in September 2002, the Government of Brazil
disputed the legal status of such subsidies under WTO and requested consultations
with the Government of the United States about prohibited and actionable
subsidies provided to producers, users and exporters of upland cotton
in USA. Consultations were held on 3, 4 and 19 December 2002 and on 17
January 2003, but failed to settle the dispute. Subsequently, Brazil filed
a case against US cotton subsidies under the Dispute Settlement mechanism
of WTO in February 2003.
In its submission to the WTO (WT/DS267/R), Brazil argued that at the core
of this case are $12.9 billion of US subsidies for upland cotton for the
years 1999-2002. According to Brazil, these subsidies increase and maintain
the production of high-cost US upland cotton, increase US cotton exports,
suppress US, world and Brazilian prices and lead to the United States
having a more than equitable share of world export trade. Brazil has also
established that the US subsidies between 1999 and 2002 caused significant
price suppression of cotton in the international market. Brazil alleged
that these US subsidies are inconsistent with various provisions of the
Agreement on Agriculture (AoA), the Agreement on Subsidies and Countervailing
Measures (SCM) and the GATT.
The submission of Brazil also highlighted some interesting facts. The
submission showed that in spite of steady decline of prices of cotton
over the last few years, US planted acreage of cotton has increased. The
paper argued that without the US subsidies, many US upland cotton producers
would have to switch to crops providing a higher market return or take
marginal land out of production. Estimates published in the submission
show that without subsidies, US acreage and production of cotton would
fall considerably. In addition to falling US production, the removal of
US subsidies would also result in significant reductions in US exports
contributing to increased world prices. Calculations show that for the
period 1999-2002, in absence of subsidies, US exports of cotton would
fall from the annual actual average exports of 8.62 million bales by 41.2
per cent to 5.07 million bales. This reduction of 3.55 million bales represents
13.4 per cent of the total average world export market between 1999 and
2002. The paper argues that given the relatively inelastic demand for
upland cotton, the 13.4 per cent decrease in the supply of cotton to the
world export market would have led to an increase of cotton prices in
the international market.
A Panel was established on 18 March 2003 to consider claims by Brazil
regarding various support measures given by USA to its cotton sector that
allegedly constituted actionable subsidies. The WTO Panel report on this
dispute, which was issued on 8 September 2004, ruled mostly in favour
of Brazil and recommended that prohibited US subsidies are to be withdrawn
"without delay". The Panel came to the conclusion that US payments
to farmers, under Product Flexibility Contract (PFC) and Direct Payments
(DP) are trade distorting domestic supports. The panel also ruled that
'export credit guarantees' and 'step 2 marketing payments'[1]
given by US to its cotton producers were prohibited export subsidies and
had to be withdrawn "without delay", that is, at the latest
within six months of the date of adoption of the panel report or by 1
July 2005. The ‘Conclusion and Recommendations’ section of this Panel
report is given in the Appendix.
On 18 October 2004, the United States notified the DSB of its intention
to appeal against some of the conclusions reached by the Panel. The USA
appealed to the WTO Dispute Settlement Body and in its submission to the
WTO (WT/DS267/17, dated 20 October 2004) sought a "review by the
Appellate Body of the Panel's legal conclusion that certain U.S. decoupled
income support measures - that is, production flexibility contract payments
under the Federal Agricultural Improvement and Reform Act of 1996 ("1996
Act"), direct payments under the Farm Security and Rural Investment
Act of 2002 ("2002 Act"), and "the legislative and regulatory
provisions which establish and maintain the [direct payments] programme"
- are not exempt from actions under Article 13(a) of the Agreement on
Agriculture."
As mentioned before, the Appellate body ruled mostly in favour of Brazil
and upheld all the major conclusions of the earlier Panel Report. Taken
together, the recommendations and conclusions of the AB and the Panel
Report can have far reaching implications for future trade disputes. Apart
from giving a much tighter interpretation of permissible agricultural
subsidies (blue and green box subsidies), it appears that a long standing
question whether agricultural subsidies should be dealt with under the
SCM agreement has also been resolved. The Panel report has made it clear
that the SCM is applicable to agricultural products and the obligations
under the SCM run parallel to the AoA provisions. This is an important
verdict as the expiry of the Peace Clause[2]will
allow many countries to initiate countervailing measures against subsidized
agricultural exports. It is also worth highlighting here that this ruling
is the first ever to target domestic agricultural subsidies in the WTO.
The WTO verdict against USA has been received with cautious optimism.
The Bridges Weekly newsletter points out that while West African cotton
producing countries Benin, Burkina Faso, Chad and Mali welcomed the ruling
and urged the US to implement the decision in time for the WTO's Hong
Kong Ministerial Conference, Oxfam, has expressed concern over statements
by US government officials that say that no major reforms may be needed
to comply with the cotton ruling. It remains to be seen what actual steps
USA will take to comply with the WTO ruling, but the verdict has paved
the way for more actions against other agricultural products like sugar
and tobacco which also receive heavy subsidy in developed countries.
APPENDIX
UNITED STATES - SUBSIDIES ON UPLAND COTTON
Report of the Panel
I. CONCLUSIONS AND RECOMMENDATIONS
1.1 In light of the findings above, we conclude as follows:
(a) Article 13 of the Agreement on Agriculture is not in the nature of
an affirmative defence;
(b) PFC payments, DP payments, and the legislative and regulatory provisions
which establish and maintain the DP programme, do not satisfy the condition
in paragraph (a) of Article 13 of the Agreement on Agriculture;
(c) United States domestic support measures considered in Section VII:D
of this report grant support to a specific commodity in excess of that
decided during the 1992 marketing year and, therefore, do not satisfy
the conditions in paragraph (b) of Article 13 of the Agreement on Agriculture
and, therefore, are not exempt from actions based on paragraph 1 of Article
XVI of the GATT 1994 or Articles 5 and 6 of the SCM Agreement;
(d) concerning United States export credit guarantees under the GSM 102,
GSM 103 and SCGP export credit guarantee programmes:
(i) in respect of exports of upland cotton and other unscheduled agricultural
products supported under the programmes[3],
and in respect of one scheduled product (rice):
- United States export credit guarantees under the GSM 102, GSM 103 and
SCGP export credit guarantee programmes are export subsidies applied in
a manner which results in circumvention of United States' export subsidy
commitments, within the meaning of Article 10.1 of the Agreement on Agriculture
and they are therefore inconsistent with Article 8 of the Agreement on
Agriculture;
- as they do not conform fully to the provisions of Part V of the Agreement
on Agriculture, they do not satisfy the condition in paragraph (c) of
Article 13 of the Agreement on Agriculture and, therefore, are not exempt
from actions based on Article XVI of the GATT 1994 or Articles 3, 5 and
6 of the SCM Agreement;
- United States export credit guarantees under the GSM 102, GSM 103 and
SCGP export credit guarantee programmes are provided by the United States
government at premium rates which are inadequate to cover long-term operating
costs and losses of the programmes within the meaning of item (j) of the
Illustrative List of Export Subsidies in Annex I of the SCM Agreement,
and therefore constitute per se export subsidies prohibited by Articles
3.1(a) and 3.2 of the SCM Agreement.
(ii) however, in respect of exports of unscheduled agricultural products
not supported under the programmes[4]and other
scheduled agricultural products:
- the United States has established that export credit guarantees under
the GSM 102, GSM 103 and SCGP export credit guarantee programmes have
not been applied in manner which either results in, or which threatens
to lead to, circumvention of United States export subsidy commitments
within the meaning of Article 10.1 and that they therefore are not inconsistent
with Article 8 of the Agreement on Agriculture;
- in these circumstances, and as Brazil has also not made a prima facie
case before this Panel that the programmes do not conform fully to the
provisions of Part V of the Agreement on Agriculture, this Panel must
treat them as if they are exempt from actions based on Article XVI of
the GATT 1994 and Article 3 of the SCM Agreement in this dispute.
(e) concerning section 1207(a) of the FSRI Act of 2002 providing for user
marketing (Step 2) payments to exporters of upland cotton:
(i) section 1207(a) of the FSRI Act of 2002 providing for user marketing
(Step 2) payments to exporters of upland cotton is an export subsidy,
listed in Article 9.1(a) of the Agreement on Agriculture, provided in
respect of upland cotton, an unscheduled product. It is, therefore, inconsistent
with the United States' obligations under Articles 3.3 and 8 of the Agreement
on Agriculture;
(ii) as it does not conform fully to the provisions of Part V of the Agreement
on Agriculture, it does not satisfy the condition in paragraph (c) of
Article 13 of the Agreement on Agriculture and, therefore, is not exempt
from actions based on Article XVI of the GATT 1994 or Articles 3, 5 and
6 of the SCM Agreement;
(iii) section 1207(a) of the FSRI Act of 2002 providing for user marketing
(Step 2) payments to exporters of upland cotton is an export subsidy prohibited
by Articles 3.1(a) and 3.2 of the SCM Agreement.
(f) concerning section 1207(a) of the FSRI Act of 2002 providing for user
marketing (Step 2) payments to domestic users of upland cotton: it is
an import substitution subsidy prohibited by Articles 3.1(b) and 3.2 of
the SCM Agreement;
(g) concerning serious prejudice to the interests of Brazil:
(i) the effect of the mandatory price-contingent United States subsidy
measures - marketing loan programme payments, user marketing (Step 2)
payments, MLA payments and CCP payments -- is significant price suppression
in the same world market within the meaning of Article 6.3(c) of the SCM
Agreement constituting serious prejudice to the interests of Brazil within
the meaning of Article 5(c) of the SCM Agreement;
(ii) however, Brazil has not established that:
- the effect of PFC payments, DP payments and crop insurance payments
is significant price suppression in the same world market within the meaning
of Article 6.3(c) of the SCM Agreement constituting serious prejudice
to the interests of Brazil within the meaning of Article 5(c) of the SCM
Agreement; or
- the effect of the United States subsidy measures listed in paragraph
7.1107 of Section VII:G of this report is an increase in the United States'
world market share within the meaning of Article 6.3(d) of the SCM Agreement
constituting serious prejudice within the meaning of Article 5(c) of the
SCM Agreement.
(h) concerning the ETI Act of 2000:
(i) Brazil has not made a prima facie case before this Panel that the
ETI Act of 2000 and alleged export subsidies provided thereunder are inconsistent
with Articles 10.1 and 8 of the Agreement on Agriculture in respect of
upland cotton;
(ii) with respect to the condition in Article 13(c)(ii) of the Agreement
on Agriculture, as Brazil has also not made a prima facie case before
this Panel that they do not conform fully to the provisions of Part V
of the Agreement on Agriculture in respect of upland cotton, this Panel
must treat them as if they are exempt from actions based on Article XVI
of the GATT 1994 and Article 3 of the SCM Agreement in this dispute.
1.2 Under Article 3.8 of the DSU, in cases where there is an infringement
of the obligations assumed under a covered agreement, the action is considered
prima facie to constitute a case of nullification or impairment. We conclude
that, to the extent that the United States has acted inconsistently with
the covered agreements, it has nullified or impaired benefits accruing
to Brazil under these agreements.
1.3 In light of these conclusions:
(a) we recommend pursuant to Article 19.1 of the DSU that the United States
bring its measures listed in paragraphs 8.1(d)(i) and 8.1(e) above into
conformity with the Agreement on Agriculture;
(b) as required by Article 4.7 of the SCM Agreement, we recommend that
the United States withdraw the prohibited subsidies in paragraphs 8.1(d)(i)
and 8.1(e) above without delay. The time-period we specify must be consistent
with the requirement that the subsidy be withdrawn "without delay".
In any event, this is at the latest within six months of the date of adoption
of the Panel report by the Dispute Settlement Body or 1 July 2005 (whichever
is earlier);
(c) pursuant to Article 4.7 of the SCM Agreement, we recommend that the
United States withdraw the prohibited subsidy in paragraph 8.1(f) above
without delay and, in any event, at the latest within six months of the
date of adoption of the Panel report by the Dispute Settlement Body or
1 July 2005 (whichever is earlier); and
(d) we recall that, in respect of the subsidies subject to our conclusion
in paragraph 8.1(g)(i) above, pursuant to Article 7.8 of the SCM Agreement:
"7.8 Where a panel report or an Appellate Body report is adopted
in which it is determined that any subsidy has resulted in adverse effects
to the interests of another Member within the meaning of Article 5, the
Member granting or maintaining such subsidy shall take appropriate steps
to remove the adverse effects or shall withdraw the subsidy."
Accordingly, upon adoption of this report, the United States is under
an obligation to "take appropriate steps to remove the adverse effects
or ... withdraw the subsidy".