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The milk wars resume? – getting to grips with dairy export subsidies

04 June 2009

On 22 May 2009, the US announced the reintroduction of dairy export subsidies,  claiming that its hand was forced by similar EU measures from January 2009. The New Zealand media responded with indignant protests against “protectionism”. The Dominion Post headline declared “Trade Wars: Kiwis’ standard of living at risk”; the New Zealand Herald and the Otago Daily Times reiterated fears of a costly trade war between the US and the EU, with New Zealand caught in the middle.

Is this hyperbole or a bona fide disaster? In this feature we look at what the US has done, whether it is legal and what are its implications for the world trading system.

What is the new US measure?

Specifically, the US Agriculture Department announced new subsidy allocations (the first since 2002) under its Dairy Export Incentive Program (DEIP) for the period from July 2008 to June 2009 for: (a) skimmed milk powder (68,201 metric tons); (b) buttermilk (21,097 metric tons); (c) various cheeses (3,030 metric tons); and (d) certain other miscellaneous products. Any qualifying US exporter of those products to specified countries (which include the key markets in Asia, Latin America and Africa) during the specified period can now apply prior to the end of June 2009 for a “bonus payment” under the DEIP, which has the effect of subsidising the export prices received.

Is the new US measure illegal under WTO rules?

No, it is not. This requires a little explanation. The basic purpose of the WTO rules on goods is threefold: first to remove quantitative restrictions on imports and replace these with tariffs; second to gradually reduce and eventually remove those tariffs through negotiation rounds, such as Doha; and third to discipline and gradually remove domestic support and subsidisation. The WTO Agreement on Subsidies and Countervailing Measures (the SCM Agreement) divides subsidies into different categories, of which export subsidies are identified as the worst offender and absolutely prohibited. Thus, in the ordinary course, where a WTO Member imposes and does not immediately withdraw an export subsidy, any other Member can request authorisation to impose countermeasures.

This discipline does not, however, apply to agricultural products, which are regulated by the WTO Agreement on Agriculture. From its very inception, this Agreement was recognised as a fudge. Articles 3, 9 and 10 provide that:

  • Members may impose agricultural export subsidies specified in Article 9 to the extent permitted in the Member’s Schedule of Commitments annexed to the Agriculture Agreement

  • the maximum permitted extent of such subsidies (both in terms of expenditure and quantity of subsidised product) must be decreased each year between 1995 and 2000, resulting in a total reduction of 36% of expenditure and 21% of quantity of subsidised product, as compared to the Member’s initial commitments, and

  • Members must not circumvent their export subsidy commitments by using forms of export subsidies, or non-commercial transactions, not listed in Article 9.

The US’s DEIP scheme clearly involves Article 9 export subsidies. The US’s final quantity commitment levels for the relevant products are: skimmed milk powder (68,201 metric tons); (b) buttermilk (21,097 metric tons); and (c) various cheeses (3,030 metric tons). That is, the US’s recent announcement is that it will now allocate the full quantity of permitted export subsidies on those products. Provided that in doing so, the US does not exceed its maximum levels of expenditure for those products, its announcement would appear to be WTO-compliant.

This may not leave countries like New Zealand without potential recourse. First, there is the right to take a WTO complaint if the US subsidies cause “serious prejudice” to New Zealand’s dairy export industry, for instance by displacing New Zealand’s exports in a third country market (SCM Agreement, Articles 5 and 6.3(b)). Secondly, the GATT (Article VI) and the SCM Agreement (Part V) provide a unilateral ‘self-help’ remedy of countervailing duties where the effects of subsidisation are felt in the market of the injured state. Countervailing duties are typically imposed where the subsidised product affects the domestic market of the injured state. Thus, imposition for displacement in a third party market only would be controversial and possibly illegal. Moreover, imposing countervailing duties is cumbersome and would in any event require robustly demonstrating a causal link between the new US subsidies and injury to dairy NZ producers.

It is worth noting that this measure hurts Australian farmers just as much as New Zealand farmers, despite the US-Australia FTA. Although that Agreement prohibits the imposition of agricultural export subsidies between the two countries (Article 3.3), it does not prevent either country from utilising its WTO export subsidy entitlements with respect to other export destinations.

What does the US measure mean for the world trading system?

New Zealand Trade Minister Tim Groser called the US measure a “short-sighted response” and a “set-back which will be damaging to world markets”. It seems there are three key concerns:

  • that, in the short term, the introduction of dairy export subsidies may further depress world dairy prices, thus harming non-subsidised dairy exporters, such as New Zealand and Australian farmers

  • that the US response to the similar – but less extreme – EU measure in January 2009 may trigger a further retaliation from the EU, with the risk of starting a trade war, and

  • perhaps most importantly, that the EU and US decisions may signal a lack of willingness to come to terms in the ongoing Doha agriculture negotiations, for which a primary objective is the total elimination of agricultural export subsidies by 2013.

Direct effect on world prices?

In itself the US move is unlikely to have a sustained effect on dairy prices, given the small absolute quantities involved. John Key was reported as saying on 25 May 2009 that the US measure needed to be put into perspective, and that it was “a small move at this point”. In the short term, however, the US action may spook the market.

Risk of sparking dairy trade war?

On 23 January 2009, the EU announced the reinstatement of export subsidies in the form of refunds for skimmed milk powder (5,612 tonnes), butter (2,229 tonnes) and butteroil (80 tonnes) as well as for cheese. This was the first such announcement since June 2007 as, in the intervening period, world dairy prices have been high. However, the new measure did not come close to utilising the EU’s maximum permitted entitlements and was stated to apply only “as long as market conditions so dictate”.

The fact that the US has now allocated its entire permitted export subsidies on those products may well encourage the EU to raise its levels of export subsidies – which it can lawfully do to the extent of 243,300 tonnes of skimmed milk powder, 366,100 tonnes of butter and butteroil and 305,100 tonnes of cheese. This is the risk of a dairy trade war which, if begun in earnest, could lead to other countries reinstating export subsidies for those products. In addition, there are a number of other agricultural products to which export subsidies could also be applied if a wholesale trade war did escalate.

This risk is real, but should not be overestimated. The EU and the US have very recently reached an initial agreement in their 20-year dispute over access of US beef to Europe caused by the EU’s objection to growth-promoting hormones. And, in general terms, both the EU and the US have sent messages – consistent with the conclusions of the G-20 summit – warning that increased protectionism would be detrimental to the world economy. Some may see a form of hypocrisy in major producers decrying protectionism whilst reverting to an infamously trade-distorting mechanism. This was certainly the message conveyed by 29 countries led by Brazil and Australia at the WTO General Council meeting on 27 May. Others may perhaps see realpolitik in action.

Effect on Doha agriculture negotiations?

The real problem is the old chestnut: the need to reform the ineffective WTO agriculture rules through the Doha round. And here, Dr David Walker – the third consecutive Chairperson of the WTO Agriculture Committee from New Zealand, after Tim Groser and Crawford Falconer – will have his work cut out. Recent drafts from that Committee have indicated that progress is being made slowly but surely. As to agricultural export subsidies, the present plan is that developed country Members shall eliminate all remaining entitlements by the end of 2013, with a 50% reduction in permitted expenditure by the end of 2010. Dr Walker will be hoping that this ambitious target is still achievable and that the recent moves by the EU and the US indicate short-term posturing, rather than a longer-term change of strategy.

Next steps

Minister Groser has said that he will seek to follow up this issue in his forthcoming meetings with the US Trade Representative and Secretary of Agriculture at the Cairns Group Ministerial meeting in June. Although the Minister feels strongly about this issue, it remains to be seen how hard he will press – his first priority is to reinvigorate Trans-Pacific Partnership Agreement negotiations involving the US, whose participation is presently under review by the Obama Administration.