Here too, ask students to compare this to the tariff of a large country.

Now the country is large enough to affect world prices, so the Foreign import demand curve is negatively sloped. The analysis should be compared to that of an import tariff in a large country in Section 4 of Chapter 8.

1. Effect of the Subsidy
The Home export supply curve shifts down. The world price falls, while the Home price increases by less than the subsidy per unit: Home suffers a deterioration of the TOT, so that part of the benefit of the subsidy to Home producers is being shifted to Foreign consumers, who pay a lower price. Exports increase.
a. Home Welfare
As in the small country case, Home consumer surplus decreases, Home producer surplus increases, and the government loses revenues. However, the fall in the TOT also reduces export revenues.
b. Foreign and World Welfare
Home loses, while Foreign gains. However, there is a deadweight loss to the world, caused by the fact that the TOT loss to Home is not perfectly offset by the TOT gain to Foreign.
Could export subsidies be used to transfer wealth from rich to poor countries? Yes, but it would be more efficient to give cash transfers, since they would avoid the deadweight loss of the subsidies.

So now there is also a TOT loss.

Home loses, but Foreign gains because of the TOT effect. So why not use export subsidies as a reason to redistribute income from rich to poor countries?

Answer: Because it would be more efficient just to give cash transfers. This is where the U.S. and EU have parted ways.

Use these tools to look at who would gain and who would lose from the abolition of export subsidies debated at the WTO. Gainers: Agricultural exporting developing countries would benefit from higher prices; developed countries would benefit from the elimination of the deadweight and TOT losses. Losers: Agricultural importers, particularly the poorest countries.Food Aid reduces local agricultural prices and hurt local farmers. Europe argues it would be better to buy food from local farmers and then distribute it to the poor. However, the U.S. still provides a lot of food aid, and it is unlikely that the WTO will agree to abolish it.

Students will ask why the U.S. and EU have these policies, if they cause an overall loss in welfare. The answer is that farmers lobby.

Although it is true that very poor agricultural importers would be hurt by the increase in prices if these subsidies were abolished.

Who Gains and Who Loses?

Now that we have studied the effect of export subsidies on world prices and trade volume in theory, we return to the agreements of the Hong Kong meeting of the WTO in December 2005 and ask: Which countries will gain and which will lose when export subsidies (including the “indirect” subsidies like food aid) are ever eliminated?

Gains The obvious gainers from this action will be current agricultural exporters in developing countries such as Brazil, Argentina, Indonesia, and Thailand, along with potential exporters such as India and China. These countries will gain from the rise in world prices as agricultural subsidies by the industrialized countries—especially Europe and the United States—are eliminated. These countries will gain even more when and if an agreement is reached on the elimination of agricultural tariffs in the industrial countries, including Japan and South Korea, that protect crops such as rice. Both of these actions will also benefit the industrial countries themselves, which suffer both a deadweight loss and a terms-of-trade loss from the combination of export subsidies and import tariffs in agriculture. Farmers in the industrial countries who lose the subsidies will be worse off, and the government might choose to offset that loss with some type of adjustment assistance. In the United States and Europe, however, it is often the largest farmers who benefit the most from subsidy programs, and they may be better able to adjust to the elimination of subsidies (through switching to other crops) than small farmers.

Losses Which countries will lose from the elimination of export subsidies? To the extent that the elimination of export subsidies leads to higher world prices, as we expect from our analysis (in Figure 10-2, the price would rise from P* to P^W), then the food-importing countries, typically the poorer non-food-producing countries, will lose. This theoretical result is confirmed by several empirical studies. One study found that the existing pattern of agricultural supports (tariffs and subsidies) raises the per capita income of two-thirds of 77 developing nations, including most of the poorest countries, such as Burundi and Zambia.3 This result is illustrated in Figure 10-3. Panel (a) shows net agricultural exports graphed against countries’ income per capita over the period 1990 to 2000. The poorer countries (i.e., those lower on the income scale on the horizontal axis) export more agricultural products and therefore would benefit from a rise in their prices. But for food exports in panel (b), rather than total agricultural exports (which includes non-food items like cotton), it is the middle-income countries that export the most. Panel (c) shows that poor countries are net importers of essential food items such as corn, rice, and wheat (summarized as “cereal exports”) and would be harmed by an increase in their world price. Many of the world’s poorest individuals depend on cereal crops for much of their diet and would be especially hard hit by any increase in those prices.

Food Aid What about indirect subsidies such as food aid? The United States has been a principal supplier of food aid, which it uses for both humanitarian purposes and to get rid of surpluses of food products at home. No country will argue with the need for donations in cases of starvation, as have occurred recently in the Darfur region of Sudan and in 1984 in Ethiopia, but the United States also provides food shipments to regions without shortages, an action that can depress local prices and harm local producers. European countries stopped this practice many years ago and argue that it is better to instead have United Nations relief agencies buy food from local farmers in poor regions and then distribute it to the poorest individuals in a country. In this way, the European countries boost production in the country and help to feed its poorest citizens. In the Hong Kong talks, the European Union insisted that the indirect subsidies to regions without shortages be eliminated.

Even though the proposals from the Hong Kong talks were never ratified and the elimination of tariff and subsidies in agriculture has not occurred, the Doha Round of negotiations is still ongoing and some progress has been made toward the goal of replacing food aid with efforts to increase production. In 2009, the Group of Eight (G8)4 countries pledged to increase funding for agricultural development by $12 billion per year, as described in Headlines: G8 Shifts Focus from Food Aid to Farming. This pledge represents a shift in focus away from food aid and toward agricultural sustainability in developing countries. As the Headlines article describes, this approach is a major shift in focus for the United States, where 20 times more money has been spent on food aid than on projects to increase local production.

There is a better way of helping them.

The G8 announces policies to encourage agriculture in developing countries, rather than providing food aid.

G8 Shifts Focus from Food Aid to Farming

The G8 countries will this week announce a “food security initiative,” committing more than $12 [billion] for agricultural development over the next three years, in a move that signals a further shift from food aid to long-term investments in farming in the developing world.

The US and Japan will provide the bulk of the funding, with $3–$4 [billion] each, with the rest coming from Europe and Canada, according to United Nations officials and Group of Eight diplomats briefed on the “L’Aquila Food Security Initiative.” Officials said it would more than triple spending….

The G8 initiative underscores Washington’s new approach to fighting global hunger, reversing a two-decades-old policy focused almost exclusively on food aid. Hillary Clinton, US secretary of state, and Tom Vilsack, the agriculture secretary, have both highlighted the shifting emphasis in recent speeches.

“For too long, our primary response [to fight hunger] has been to send emergency [food] aid when the crisis is at its worst,” Ms. Clinton said last month. “This saves lives, but it doesn’t address hunger’s root causes. It is, at best, a short-term fix.”

Washington’s shift could prove contentious in the US, as its farmers are the largest exporters of several crops, including soyabean and corn. The US is the world’s largest donor of food aid—mainly crops grown by US farmers, costing more than $2 [billion] last year.

The Chicago Council on Global Affairs, a think-tank, estimates that Washington spends 20 times more on food aid than on long-term schemes in Africa to boost local food production. US annual spending on African farming projects topped $400 [million]in the 1980s, but by 2006 had dwindled to $60 [million], the council said in a report this year….

Source: Excerpted from Javier Blas, “G8 Shifts Focus from Food Aid to Farming,” Financial Times, July 6, 2009, p. 1. From the Financial Times © The Financial Times Limited 2009. All Rights Reserved.

An article skeptical of whether the G8 will implement these policies.

Hunger and Food Security Back on Political Agenda

Global food security is a political and economic priority for the first time since the early 1970s. That should be the key message from the decision by the G8 group of leading economic nations to endorse a “food security initiative” at their meeting in Italy this week. But this welcome decision needs to be followed up by further significant policy change at national and international level if food security is to be achieved for the world’s growing population over the coming decades….

It is reported that the initiative will involve a commitment of $12 billion for agricultural development over the next three years. But before giving three cheers for the G8, two critical questions must be answered. Is the $12 billion additional resources or a repackaging of existing commitments? How can this initiative feed into sustained policy change aimed at increasing food security at household, national and global level?

©2008 Olle Johansson, and PoliticalCartoons.com

Policy change is necessary in many countries which are currently food insecure. Investment in agricultural and rural development has been shamefully neglected over the past 30 years. Donors, including the World Bank, also bear responsibility for this. There must now be an acceptance that budget allocations to agriculture must increase and must be sustained…. The history of such summits is not good: the gap between the promises and subsequent actions is great. At the first such summit in 1974, Dr. Henry Kissinger made the pledge that “within 10 years, no child will go to bed hungry.”

The G8 food security initiative at least provides a positive backdrop to the summit. It should provide an opportunity to many developing countries to commit to the type of policy change necessary to increase their own food security. With one billion hungry people in the world, with growing populations and with the threat that climate change presents to agricultural production capacity, such a commitment is both critical and urgent. It is good politics and good economics to do so.

Source: Excerpted from Tom Arnold, “Hunger and Food Security Back on Political Agenda,” The Irish Times, July 8, 2009, electronic edition.