The Brazil - U.S. Cotton Dispute

Prepared by William A. Gillon for

Arkansas State University Agribusiness Conference, 2005

Date of materials[1] - February 2005

Overview of the Case

In the Uruguay Round Agricultural Agreement (the "URAA") members of the World Trade Organization ("WTO") agreed to discipline agricultural subsidies.[2] In exchange for those disciplines, specified agricultural programs were exempt in Article 13 of the URAA from action under the SCM Agreement:

s “Green box” programs (such as de-coupled payments);

s Export subsidies that conform to the URAA and are only provided in accordance with a country’s schedule of commitments; and

s Other agricultural subsidies (blue and amber box), provided they conform to the URAA commitments and the level of support for a specific commodity does not exceed that decided for the 1992 marketing year.[3]

These exemptions are commonly referred to as the "Peace Clause" and were scheduled to expire for all countries on January 1, 2004.

In accordance with the dispute settlement provisions of the WTO, Brazil, in November 2002, requested consultations with the United States concerning U.S. programs that subsidize upland cotton. The consultations failed to resolve Brazil's concerns. In February 2003, Brazil formally requested the establishment of a dispute settlement panel to hear its complaint that U.S. programs that subsidize upland cotton were being operated in violation of U.S. obligations under the URAA and another WTO agreement - the Agreement on Subsidies and Countervailing Measures (the "SCM" agreement). Brazil asserted that these programs were injuring the Brazil cotton industry.

Specifically, Brazil alleges that –

1. Other U.S. cotton subsidy programs cause “serious prejudice” to the interests of Brazil, in violation of Article 5 (c) of the SCM Agreement; and

2. The U.S. cotton step 2 program and U.S. export credit guarantee programs for all commodities are “prohibited” subsidies under Article 3 of the Agreement on Subsidies and Countervailing Measures (the “SCM” agreement);

3. The so-called "Peace Clause" does not act as a bar to Brazil's claims[4].

Brazil's complaint encompasses the following:

w U.S. cotton program provisions under the Federal Agriculture Improvement and Reform Act of 1996[5] (the "FAIR" Act) - marketing loans, production flexibility contract payments, market loss assistance payments, Step 2, etc.

w U.S. cotton program provisions under the Farm Security and Rural Investment Act of 2002[6] (the "FSRIA" Act) - marketing loans, direct payments, counter-cyclical payments, Step 2, etc.

w Federal crop insurance programs applicable to cotton (authorized by the Federal Crop Insurance Act[7]).

w Export credit guarantee program for all commodities (authorized by the Agricultural Trade Act of 1978); and

w Foreign Sales Corporation Act provisions. This paper will not discuss this aspect of the complaint.

One of the most significant long-term legal impact from the Brazil - U.S. cotton dispute may be that it effectively bridges the gap between the URAA and the SCM Agreement, bringing agricultural subsidies firmly within the scope of more traditional WTO rules. Prior to the Uruguay Round, the GATT had been ineffectual in applying industrial subsidy rules to agriculture. This Panel decision, whether or not upheld on all of its most substantive points, completes the process of bringing agriculture into the WTO.

Brazil's claim against the marketing loan program, direct payments, counter-cyclical payments and crop insurance were brought under Article 5 of the SCM Agreement. A complaint involving "actionable" subsidies under Article 5 of the SCM Agreement must prove injury in order to be successful. The injury standard is one of "serious prejudice."

There is no "injury" requirement for Brazil's complaints against Step 2 and the Export Credit Guarantee Program, which were alleged to be "prohibited" subsidies under Article 3 of the SCM Agreement.

The Agreements that make up the principle WTO documents and legal standards of this case are not always drafted with the same "consistency" that typical legislation receives. The attempt by the involved draftsmen to be consistent could always be undermined by exigencies of the process, namely the need to reach an agreement across several different negotiating groups among many different countries. There are, therefore, differences in language that may or may not reflect differences in the drafters' intentions. Also, there is often a lack of explanation or negotiating history to help explain gaps or inconsistencies.

Status

The Dispute Settlement Panel hearing Brazil's complaint against the U.S. cotton program issued its decision on September 8, 2004. While the U.S. government stated the decision was "mixed," Brazil received positive findings from the Panel on many of its substantive issues. The United States filed a broad appeal challenging most of the Panel's findings. A hearing on that appeal was held in mid-December 2004 in Geneva. A decision by the Appellate Body is expected in just a few weeks.

Summary of the Panel's Primary Conclusions

w The Panel found that the "Peace Clause" in the WTO Agreement on Agriculture did not exempt the cotton program from the Brazil challenge.

§ As a part of that conclusion, the Panel determined that U.S. support to cotton in the years 1999, 2000, 2001 and 2002 exceeded that level "decided" during the 1992 marketing year (the key "factual" finding needed to avoid the Peace Clause);

§ In so doing, the Panel determined that the United States could not classify the direct payment program as a "green box" program.

w The Panel determined that the aggregate impact of the U.S. marketing loan, counter-cyclical and step 2 programs during 1999-2002 caused serious prejudice to Brazil and therefore violated U.S. obligations under the WTO agreements.

§ However, the Panel also determined that the Direct Payment program did not harm Brazil's interests.

w The Panel determined that the Step 2 program (cotton) and the export credit guarantee program (cotton and other commodities) were prohibited subsidies under the WTO and called on the U.S. to correct these measures by July 1, 2005.

Immediate Implications

Paragraph 8.3 of the Panel's conclusions set out its recommendations for the U.S. to comply with its findings. The Panel recommended that the U.S. withdraw the prohibited subsidies (Step 2 and export credit guarantees) "without delay" or by the earlier of 6 months of the date of adoption of the Panel report by the Dispute Settlement Body or July 1, 2005.

With respect to actionable subsidies found to be causing "serious prejudice," the Panel recommended the United States take appropriate steps to remove the adverse effects or withdraw the subsidies. The U.S. has a reasonable period of time in which to comply with this portion of the findings.

Remedies

The WTO has no true enforcement power. The enforcement mechanism is economic leverage that can arise from a country's decision to take retaliatory trade action against a Member that does not fully comply with a dispute settlement determination.

The losing party in a WTO dispute is obligated to bring its policy into compliance with WTO rules. If the losing party fails to act, it must enter into negotiations with the complaining party to determine mutually acceptable compensation (tariff reductions, etc.). If no satisfactory compensation is agreed, the complaining party may ask the Dispute Settlement Body for permission to impose trade sanctions.

Cotton’s Rebuttal

The United States presented sound economic and legal arguments aimed at all aspects of Brazil’s claims. The U.S. arguments were consistent with long-standing U.S. interpretations of the WTO agreement, including the position that the export credit guarantee program was exempt under article 10:2 of the URAA and that the step 2 program was correctly classified as a domestic agricultural program.

Several Texas Tech agricultural economists recently completed a study detailing the impacts of U.S. cotton programs on the world market. The Texas Tech study estimated price impacts ranging from less than ½ of a percent to just over 2 percent. That’s about a quarter of a cent to 1.2 cents per pound. Similar impacts have been found by two separate studies conducted by FAO and IMF. It does not seem possible that these insignificant price impacts could be said to cause any country serious prejudice. Cotton imports by China show a far greater correlation to world cotton prices than any aspect of the U.S. cotton program.

USTR posted a document on its website that addresses the following myths put forward by Brazil and others:

MYTH	REALITY
U.S. support to cotton farmers results in low cotton prices	U.S. farm programs have not caused low cotton prices. Cotton prices have increased since 2001, despite the alleged increase in U.S. cotton support. Recent independent studies found very low price impacts from U.S. programs. Further there is a high correlation between Chinese net import levels and price movements, strongly implying that factors other than U.S. cotton programs drive world prices.
U.S. support to cotton farmers has driven up U.S. production and exports at the expense of foreign competitors	The U.S. share of world cotton production and world cotton markets has remained stable for over 30 years, and even decreased in recent years.
U.S. support to cotton farmers has insulated U.S. farmers from market price signals	U.S. cotton farmers have increased or decreased plantings of cotton similarly to cotton farmers in the rest of the world. U.S. farmers respond to expected market prices at time of planting - their planting decisions are based on price expectations, not government programs.
Large government payments to U.S. cotton farmers must have distorted trade and depressed prices	The data do not show that U.S. farm programs insulate farmers from market forces. Further, much of the current U.S. cotton program that Brazil and other critics complain about is decoupled from the production of cotton and was expressly designed not to have significant production and price effects.

Additional Specifics of Decision

The WTO panel made findings that side with Brazil on many of its claims and other findings that agreed with arguments made by the United States:

w The panel found that the "Peace Clause" in the WTO Agreement on Agriculture did not apply to a number of U.S. measures, including (1) the domestic support measures outlined above and (2) export credit guarantees for cotton, other "unscheduled commodities" and rice (a "scheduled commodity").

w The panel found that export credit guarantees for "unscheduled commodities" (such as cotton and soybeans) and for rice are prohibited export subsidies. The panel also found that Brazil had not demonstrated that the guarantees for other "scheduled commodities" exceeded U.S. WTO reduction commitments and therefore breached the Peace Clause. Further, Brazil had not demonstrated that the programs threaten to lead to circumvention of U.S. WTO reduction commitments for other "scheduled commodities" and for "unscheduled commodities" not currently receiving guarantees.

w The panel found that U.S. domestic support programs that were linked to price (i.e., marketing loan, counter-cyclical, market loss assistance, and Step 2 payments) caused significant suppression of cotton prices in the world market in marketing years 1999-2002 causing serious prejudice to Brazil’s interests.

w The panel determined that certain U.S. domestic support programs that were not linked to price (i.e., production flexibility contract payments, direct payments, and crop insurance payments) did not cause serious prejudice to Brazil’s interests because Brazil failed to show that these programs caused significant price suppression.

w The panel also found that Brazil failed to show that any U.S. program caused an increase in U.S. world market share for upland cotton constituting serious prejudice.

w The panel did not reach Brazil’s claim that U.S. domestic support programs threatened to cause serious prejudice to Brazil’s interests in marketing years 2003-2007. The panel declined to find that U.S. domestic support programs per se cause serious prejudice in those years.

w The panel also found that Brazil had failed to establish that FSC/ETI tax benefits for cotton exporters were prohibited export subsidies.

w Finally, the panel found that Step 2 payments to exporters of cotton are prohibited export subsidies, not protected by the Peace Clause, and Step 2 payments to domestic users are prohibited import substitution subsidies because they were only made for U.S. cotton.

Definitions

Peace Clause - Article 13 of the URAA is commonly referred to as the Peace Clause. Generally, as long as a WTO Member is meeting the criteria set out in Article 13, such as domestic support and export subsidy reduction commitments, other WTO Members are prohibited during the implementation period of the URAA from challenging those domestic support or export subsidy measures through the WTO dispute settlement process.

Unscheduled commodities - products for which the United States is not permitted to provide export subsidies because they are not set out in the export subsidy part of the final U.S. WTO schedule which the United States filed in 1994. "Scheduled commodities" are set out in the U.S. schedule, and the United States is permitted to provide export subsidies up to the scheduled level. Besides rice, U.S. "scheduled commodities" are wheat, skim milk powder, coarse grains, butter, bovine meat, other milk products, poultry meat, vegetable oils, live dairy cattle, cheese, eggs, and pigmeat.

Serious Prejudice

There is very little precedent available that helps define what is meant by “serious prejudice.” The U.S. brought forward strong economic arguments showing that the U.S. cotton program has not injured Brazil’s interests. Brazil, of course, argued the opposite. Brazil argued that the nature of U.S. cotton payments, whether decoupled from planting or specifically linked to production, is irrelevant. Brazil claimed that the PFC payments and the marketing loss assistance payments under the FAIR Act and the direct and counter-cyclical payments in the new farm law still cause growers to produce additional acres of cotton, and therefore, Brazil alleged, the payments really aren’t “decoupled.” Brazil argued that marketing loan gains cause low prices rather than low prices causing increased marketing loan gains. Brazil also claimed that the U.S. holds a disproportionate share of the world market in cotton fiber and that U.S. subsidies must remain high because the U.S. is a high-cost cotton producer.

Reports were cited to the Panel showing world price impacts from the U.S. cotton program that ranged from 2% to 26%. The high numbers were from Brazil's economic expert and from an ICAC analysis and studies based off of the ICAC analysis. The Panel explicitly stated it did not rely on Brazil's economic analysis.

Additional Resources

The WTO website is an excellent source of additional information on dispute settlement and other aspects of the World Trade Organization. Its URL is www.wto.org.

USTR also maintains a comprehensive dispute settlement discussion on its website: www.ustr.gov/Trade_Agreements/Monitoring_Enforcement/Dispute_Settlement/Section_Index_text.html.