An interesting drama has just played out in Geneva, with potentially significant implications for the ongoing Doha Round trade negotiations. A judgement has finally been made by the World Trade Organisation's Dispute Settlement Body in a case brought by Brazil against the US on cotton subsidies.

This is a dispute of long standing, and indeed the cotton subsidies provided by the US government have been a focus of much outcry at several Ministerial meetings of the WTO. Brazil first organised a complaint about these subsidies in 2002, when it was joined by a number of other developing countries including India. In 2004, the WTO ruled in Brazil's favour, accepting that around $3 billion that was paid to US cotton farmers amounted to a violation of WTO rules and artificially suppressed international prices of cotton.

Despite that verdict, the US government continued with its subsidies, and while it changed the names of some and rearranged others, it even added some more, on the grounds that the earlier payments were WTO-compatible and the new payments came under the acceptable "Green Box" that is allowed under WTO rules. Brazil persisted with its complaint, which was supported by the WTO again in 2005, to the extent of allowing Brazil to retaliate by imposing some trade sanctions on the US. At that point, however, Brazil chose instead to arrive at a negotiated settlement with the US, which is its largest trading partner.

This did not work either, so Brazil once again approached the WTO in 2006. However, it agreed to suspend the arbitration process while the WTO examined whether the US had complied with earlier rulings against its subsidies. Meanwhile, in 2007 the US Farm Bill implicitly mocked this process by blatantly confirming the existing subsidies and adding more. When the US lost is appeal in the WTO in October 2007, Brazil asked for the arbitration process to resume.

The final verdict in this long saga has now been pronounced, with the WTO agreeing with Brazil that the US cotton subsidies violated various elements of the Agreement on Agriculture and caused "serious prejudice" to potential exports of cotton of other countries (including Brazil) by depressing prices. It also noted that the US had refused to comply with several earlier rulings of the Dispute Settlement Body. It therefore allowed Brazil to retaliate, to "suspend concessions or other obligations" on US trade equivalent to up to 147.3 million dollars (103 million euros) a year. In addition the WTO said it would allow sanctions, in an annual amount to be determined according to a specific mathematical equation, for US cotton subsidies that breached trade rules, calculated at 147.4 million dollars for 2006. While this is significantly less than the $2.5 billion worth of sanctions that Brazil had sought, it is significantly more than what the US had been willing to concede.

What is the essence of the Brazilian case against the US? While it may seem like a specific issue, in fact it has much wider relevance to the agricultural negotiations in the Doha round of WTO talks. US cotton subsidies have been among the most contested issues in these negotiations. And the ruling in turn has significant implications for the future pattern of trade disputes since it allows for cross-retaliation in services trade.

The United States is the world's largest cotton exporter, exporting at least half of its annual cotton crop. In 2001-2003, U.S. cotton exports accounted for 40 per cent of world trade, and it is estimated that US cotton subsidies averaged $3 billion per year in this period. In an earlier submission to the WTO, Brazil had claimed that an even larger amount, close to $12.5 billion, had been provided as cotton subsidies by the US government between 1999 and 2002. This would amount to more than 130 per cent of the value of production in the US.

These subsidies artificially increased cotton production in the US, stimulated exports and therefore depressed the world market price of cotton. The impact of such subsidies on prices and world market share of other exporters is obvious given the dominant position of the US in world cotton exports.
Some of the main subsidies that have been at the heart of the dispute are the following:

• Direct Payments, based on the value of production and yields during a previous production period. The US Government had argued that this support is 'decoupled' from production, and therefore eligible for the permissible Green Box, but actually it links payments to recent output levels.
    
• Counter-cyclical payments, triggered by lower world prices, thus enhancing production at the very time it would otherwise be declining.
    
• Loan Deficiency Payments and Marketing Loan Gains, triggered when world prices fall below $0.52 per pound.
    
• Step 2 subsidies, which aim to keep US export prices in line with low-cost competitors and are provided both to exporters of US cotton and to domestic mills using US cotton, so as to eliminate differences between US internal prices and the international price. The US argued that under WTO rules, these are not export subsidies, because they do discriminate between exporters and domestic users. But actually, despite their relatively small size, these are among the most damaging subsidies, because they give US exporters a clear advantage over their competitors.
     
• The Export Credit Guarantee Program (ECGP), under which importers can borrow in dollars at US interest rates, and banks lending to them have the loans guaranteed by the US government. This gives American exporters an enormous advantage over rival exporters in countries with shortages of hard currency and high interest rates.

The US government had further argued that it should be a beneficiary of the so-called "Peace Clause" that was agreed upon when the Agreement on Agriculture was adopted at the end of the Uruguay Round in 1994. This was an agreement between governments not to challenge each other's agricultural subsidies, subject to a proviso that 'such measures do not grant support to a specific commodity in excess of that decided during the 1992 marketing year.' However, since the level of subsidies the US provided to cotton farming in 2001 was double that provided in 1992, the US had lost any claim to such "Peace Clause" protection.

It is often believed that US farm subsidies go towards supporting small family run farms, but actually they mainly support large corporate farming. While the average subsidy per acre of cotton amounted to $230 in 2001, around half the farms did not receive any subsidy. According to US Department of Agriculture data, the largest ten per cent of farms receive two-thirds of all the subsidies going to agriculture, and nearly three quarters of the cotton subsidies. In 2001, the largest ten cotton farms received $21 million in subsidies. On corporate farm alone – Tyler Farms based in Arkansas, covering 40,000 acres - received $6 million in cotton subsidies in that year.

To put these numbers in perspective, US cotton subsidies in 2001 were estimated to be more than the entire GDP of Burkina Faso, a country in which more than two million people depend on cotton production and over half of the cotton farmers live below the poverty line. They were three times more than the entire USAID budget for Africa's 500 million people. Oxfam has estimated that the value of the cotton subsidies amounted to one-fourth of the value of all American aid to the continent. They also administered what amounts to a significant external shock to cotton producing countries of Sub-Saharan Africa, who also happen to be among the heavily indebted poor countries. Thus, Burkina Faso lost 1 per cent of GDP and 12 per cent of export earnings; Mali lost 1.7 per cent of GDP and 8 per cent of export earnings; and Benin lost 1.4 per cent of GDP and 9 per cent of export earnings. ("Cultivating Poverty: The impact of US cotton subsidies on Africa", Oxfam Briefing Paper No 30, 2003)

It is obvious from this that Brazil is not the only country suffering from the adverse impact of US cotton subsidies, nor even the worst affected. Yet, while these other countries have frequently complained about this in WTO meetings, they not brought a case against the US in this matter. There are several reasons for this. There is enormous expense involved in bringing such cases to the WTO, which can be exorbitant for a small poor country. These countries are typically dependent upon the US for aid or debt relief, and therefore try to avoid antagonising the US government. Most of all, since the US has such a poor track record of following WTO rules, it is not clear how even winning the case would help. The WTO would allow the countries concerned to impose some sanctions on US exports, but given existing power equations these are most unlikely to occur.

This is why the recent ruling in the Brazil-US dispute is going to attract so much attention among many smaller WTO members. A crucial aspect of the ruling is that it allows Brazil to impose some sanctions on services and intellectual property activities as well. It is being reported that as a result Brazil is preparing to infringe patents on US pharmaceutical products as part of its retaliation. This will open up a whole new range of possibilities in terms of developing country responses at the WTO. This space is definitely worth watching.

September 08 , 2009.