AGRICULTURAL OUTLOOK                                        July 21, 1999
August 1999, ERS-AO-263
               Approved by the World Agricultural Outlook Board
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CONTENTS

BRIEFS
Field Crops: U.S. Soybean Acreage Increases For Ninth
Consecutive Year
Livestock, Dairy, & Poultry: U.S. Red Meat & Poultry Exports
Plateau  
Farm Finance: Potential Rise in Interest Rates: An Unwelcome
Prospect for Farm Borrowers
     
COMMODITY SPOT
U.S. Wheat Supplies Remain Large in 1999/2000

WORLD AG & TRADE
Korea's Agricultural Imports Recovering from Financial Crisis

RISK MANAGEMENT
Crop & Revenue Insurance: Bargain Rates but Still a Hard Sell

RESOURCES & ENVIRONMENT
Efforts to Reduce Greenhouse Gas Buildup Could Add Costs &
Revenue to Farming

Facing the Phaseout of Methyl Bromide

SPECIAL ARTICLE
Agriculture & the Evolution of Tariff Bargaining


IN THIS ISSUE...

U.S. Wheat Supplies Remain Large in 1999/2000

Large beginning stocks of wheat will offset a forecast decline in
U.S. production, leaving U.S. supplies at 3.4 billion bushels in
1999/2000, up slightly from last year and the highest level since
1987/88.  Declining returns in recent years have encouraged U.S.
producers to switch to other crops or leave more land fallow. 
This year farmers planted an estimated 62.9 million acres, down 5
percent from last year and the lowest since 1973.  Weather has
been relatively favorable in several states, and the all-wheat
yield in 1999 is forecast at 42.7 bushels per harvested acre,
down slightly from last year's record of 43.2 bushels.  

Although global trade will pick up while world production
declines moderately, little if any increase in world prices is
expected because major wheat exporters' supplies are large.  The
average price received by U.S. farmers is projected at $2.45-
$2.95 per bushel in 1999/2000, with the midpoint up 5 cents from
last season but down from the 1990's average of $3.38.  Mack N.
Leath (202) 694-5302; mleath@econ.ag.gov

Agriculture & the Evolution of Tariff Bargaining

Preparations have already begun for the ninth round of
international trade talks, to be launched at the World Trade
Organization Ministerial Conference in Seattle this December. 
Over the course of the previous eight rounds, countries
successfully lowered tariffs for manufactured goods from a trade-
weighted, most-favored-nation (MFN) average of over 40 percent to
about 4 percent.  While agriculture had been included in each of
the previous rounds, it was not until the Uruguay Round of
Multilateral Trade Negotiations (1986-94) that real progress was
made to negotiate overall reductions in barriers to agricultural
trade, particularly in reducing or eliminating export subsidies. 

The weight of remaining agricultural trade protection has now
shifted toward tariffs, some of which are extremely high
(although there is a growing concern about technical barriers to
trade).  A review of how reductions in tariffs for manufactured
goods was accomplished reveals some valuable lessons for future
negotiations on agricultural tariffs, which are, on average,
still much higher than those on manufactured items.   John
Wainio (613) 759 7452; jwainio@econ.ag.gov

Korea's Agricultural Imports Recovering from Financial Crisis

South Korea was the fourth-largest destination for U.S.
agricultural products in 1997, buying 5 percent of U.S.
agricultural exports.  But beginning in late 1997 and extending
into 1998, Korea experienced a major economic shock--including
devaluation of its currency, a decline in the production of goods
and services, and temporary inability to obtain credit. 
Agricultural imports fell by 28 percent in calendar-year 1998. 
The economy is now rebounding, following strong intervention by
the government and the International Monetary Fund.  Agricultural
imports are rising again, particularly beef, soyoil and soymeal,
and processed foods and beverages.  The crisis appears to have
only temporarily interrupted growth in a major U.S. agricultural
market.  John Dyck (202) 694- 5221; jdyck@econ.ag.gov

Facing the Methyl Bromide Phaseout

Public and private research programs are exploring alternatives
to methyl bromide, a widely used agricultural pesticide that is
being phased out by parties to the Montreal Protocol.  Methyl
bromide, used for over 50 years to control insects, pathogens,
nematodes, and weeds in vegetable, fruit, and nut crops, is used
for soil fumigation before planting crops and for post-harvest
fumigation of agricultural products in storage and prior to
shipment.  In 1992, methyl bromide was classified as a substance
that depletes the stratospheric ozone layer, which protects the
earth against the most harmful types of solar radiation.  
Phaseout under the multilateral Montreal Protocol exempts some
uses of the chemical.

Many U.S. users of methyl bromide are concerned that alternative
practices currently available to replace it will be less
effective, resulting in financial losses.  Some potential
alternatives are fairly well developed while others are
relatively new. Craig Osteen (202) 694-5547; costeen@econ.ag.gov


Efforts to Reduce Greenhouse Gas Buildup Could Add 
Costs & Revenue to Farming

Efforts to reduce U.S. greenhouse gas (GHG) pollution comes at a
cost to all sectors of the economy, including agriculture. GHG
emissions reduction could be achieved with a system of tradable
carbon emissions permits that would lead to increased
agricultural input costs. But a program to pay farmers to develop
emissions-absorbing "carbon sinks" on agricultural land could add
to farm income.  Shifting cropland to forest and grasses and
using conservation tillage could sequester (embed) atmospheric
carbon in soil and above-ground biomass, reducing atmospheric
GHG's.  Private industry or government could pay farmers to
engage in specific cultural practices that would remove GHG's
from the air, thus reducing the need for more costly cuts in GHG
emissions.  Howard McDowell (202) 694-5485; howardm@econ.ag.gov

Crop & Revenue Insurance: Bargain Rates but Still a Hard Sell

Federal crop and revenue insurance subsidies alter the tradeoff
between expected income and risk exposure, so operators may
attain significant risk reduction at relatively low cost, while
actually increasing expected (i.e., longrun) returns.  Government
outlays for insurance programs pay a portion of producers'
premiums on approved policies, and reimburse private insurance
carriers for the costs of selling and underwriting policies,
adjusting losses, and processing policy data.

Yet the rate of participation in insurance programs has remained
significantly less than universal for a variety of reasons--for
example, general lack of information about how insurance programs
work, the advantages they impart, and the true extent of
farm-level risk.  Randy Schnepf (202) 694-5293;
rschnepf@econ.ag.gov


BRIEFS
Field Crops
U.S. Soybean Acreage Increases 
For Ninth Consecutive Year

Planted area for the eight major U.S. field crops (corn,
soybeans, wheat, barley, sorghum, oats, cotton, and rice) totals
251.8 million acres in 1999, down more than 4 million acres from
last year when prices were higher for most crops at planting
time. Declines in wheat and feedgrains more than offset gains in
soybeans, cotton, and rice.

Estimates of planted and harvested acreage in USDA's Acreage
report were based on surveys conducted during the first 2 weeks
of June, while the March 31 USDA Prospective Plantings report
indicated farmers' crop intentions for spring plantings in 1999.
Compared with the Prospective Plantings report, planted area is
nearly 2 percent higher for soybeans but 1 percent lower for
corn. Total wheat area is essentially the same.

Harvested acreage and actual yield will be strongly influenced by
weather conditions through the growing season. Normal weather
would result in large output and stable or declining farm prices
for most U.S. field crops in 1999/2000 compared with a year
earlier (see AO June-July 1999). However, crop potential could be
reduced in the Atlantic Coastal Plains and eastern Gulf Coast if
current dry weather persists in the region. 

U.S. farmers have planted 74.2 million acres of soybeans in 1999,
a 3-percent increase over last year's record acreage. Planted
acreage has steadily increased since 1990 when the soybean
planted area totaled 57.8 million acres. Farmers are expected to
harvest 73.3 million acres, up 4 percent from the 1998 record
harvested acreage. Several factors are behind the rise in soybean
plantings, including a soybean loan rate (under the government
nonrecourse marketing assistance loan and loan deficiency payment
program) that is favorable relative to other crops (AO May 1999).

For the second consecutive year, estimated soybean acreage
increased in the Corn Belt and the Great Plains and declined in
most of the South, Southeast, and mid-Atlantic states. The
largest acreage increases were in Nebraska, South Dakota,
Missouri, and Ohio. Farmers in the largest producing states, Iowa
and Illinois, also increased soybean area this spring. States
with the largest reductions in plantings included Louisiana,
Tennessee, Alabama, and Texas. 

In most of the western Corn Belt and Great Plains states, heavy
and continuing storms during May kept producers from an early
start in planting soybeans. More favorable and drier weather in
the eastern Corn Belt and the southern U.S. allowed soybeans to
be planted at a rapid pace. Despite some early delays, planting
progress for the 1999 U.S. crop had advanced ahead of a year ago
by the first week of June. 

The increased soybean acreage has replaced some area formerly
devoted to corn. Corn plantings declined in 1999 to an estimated
77.6 million acres, down 3 percent from last year. Corn acres to
be harvested for grain is estimated to decrease to 71 million
acres, down 2 percent from 1998. Total corn acreage for Corn Belt
states, at 51.4 million acres, declined 2 percent from last year,
due in part to increased soybean plantings (AO May 1999).
Illinois and Indiana were the only two major states to show an
increase in total planted acreage from last year. 

Outside the Corn Belt, in Texas, Louisiana, and South Dakota,
acreage decreased sharply from last year's high levels. Although
rains soaked parts of the central and southern Great Plains and
western Corn Belt in late April, weather improved in early May,
and by the end of the month 96 percent of the U.S. corn crop had
been planted. USDA reported that 76 percent of the crop was in
good or excellent condition as of July 4.

Sorghum plantings dropped again in 1999 to an estimated 9 million
acres, down 6 percent from 1998, as acreage declined in most of
the major producing states due to weak feedgrain prices. This is
the lowest planted acreage since 1929. Texas, with 2.85 million
acres, has the largest reduction, decreasing 20 percent from
1998. Kansas, the largest sorghum producing state, increased
plantings 3 percent to 3.6 million acres. 

Barley plantings also declined in 1999 to an estimated 5.24
million acres, the lowest on record. The largest declines were in
North Dakota and Minnesota as farmers continue to shift away from
barley to alternative crops with higher returns such as wheat,
soybeans, and other oilseeds. Most of the 1999 barley crop was
planted late because of a wet May.

Total wheat planted acreage for 1999 is estimated at 62.9 million
acres, down 5 percent from last year. It is the lowest planted
area since 1973, and area harvested for grain is the lowest since
1988. Relatively unfavorable returns encouraged producers to
plant alternative crops such as soybeans and other crops or leave
land fallow (see the Commodity Spotlight in this issue for more
on the wheat outlook).

Cotton plantings for 1999 are estimated at 14.6 million acres, 9
percent above 1998 and 5 percent above the March Prospective
Plantings report. All major producing states except Arizona and
California increased 1999 cotton area. Although planting-time
prices were down from a year earlier, expected returns were
higher for cotton than for competing crops such as corn and
soybeans. 

Planting in the southeastern states started slowly due to a
severely dry spring, and a majority of the crop was planted
during late May and is progressing normally. However, portions of
the crops in Georgia and North Carolina are still stressed from
dry conditions that persisted during late May and early June.
Delta producers completed plantings by June 1, with the crop
developing near or ahead of normal. Crop conditions continue to
be mostly good or excellent in all the Delta states.

Texas, the largest cotton producing state, completed most
plantings by mid-June, although some replanting was necessary in
the Texas High Plains on fields damaged by hail and high winds.
At the end of June, 40 percent of the crop was rated in good or
excellent condition, and 29 percent was rated in fair condition.
In California, low temperatures and damp weather in early April
kept plantings behind normal. However, warm temperatures during
the second half of June provided good growing conditions. At the
end of June, 60 percent of the California crop was rated in good
condition. Prospects for a large U.S. crop led to a fall in
cotton prices from May to June.

Rice plantings for 1999 are estimated at 3.6 million acres, up 3
percent from 1998, with long grain acreage up 4 percent from last
year. Acreage was up from 1998 in all major producing states
except California. Relative returns were higher than for
competing crops (e.g., soybeans) when farmers made planting
decisions in February and March.  

Robert A. Skinner (202) 694-5313
rskinner@econ.ag.gov

For further information, contact: 
Mack Leath, domestic wheat; Ed Allen, world wheat and feed
grains; Allen Baker, domestic feed grains; Nathan Childs, rice;
Mark Ash, oilseeds; Steve MacDonald, world cotton; Les Meyer,
domestic cotton. All are at (202) 694-5300. 


BRIEFS
Livestock, Dairy, & Poultry
U.S. Red Meat & Poultry Exports Plateau 

U.S. red meat and poultry exports, after growing at double-digit
rates since 1986, advanced only 1 percent in 1998, reaching 8.95
billion pounds. The level of exports may increase another 1-2
percent in 1999 due in part to food aid to Russia, but will
likely decline about 2 percent in 2000. This would be the first
drop since 1985. Three factors are contributing to the slowdown:
the collapse of the Russian economy (affecting poultry and pork),
the downturn and slow recovery of Asian economies, and currency
devaluations for both importers and competitors.

U.S. pork exports will likely total 1.2 billion pounds in 2000,
down slightly from the 1998 level and the 1999 forecast. The core
U.S. markets  Japan, Canada, and Mexico are each expected to
register smaller gains in 2000 than in 1999. Secondary markets,
such as Korea, Taiwan, and Hong Kong, likely will grow this year
and remain steady in 2000 as U.S. pork prices rise. Export
prospects have dampened from the rapid gains of recent years,
because Japanese demand for U.S. pork appears to have leveled
off, and Russia has largely dropped out of the commercial market.

U.S. imports of pork products are expected to rise about 11
percent in 1999, about the same as last year, leveling off in
2000 at about 780 million pounds. While a double-digit increase
during a period of very plentiful domestic supplies and low
prices seems paradoxical, it is explained by a strong dollar
relative to the Canadian dollar (Canada accounts for 70 percent
of U.S. imports) and high European Union export restitutions
(Denmark accounts for 19 percent of U.S. imports). In addition,
as the Canadian pork industry restructures, it is becoming more
competitive with the U.S. In contrast to the U.S., Canadian
producers continue to boost hog production, with January-March
sow farrowings up 6 percent from a year ago and intentions for
April-June up 4 percent.

U.S. broiler exports are expected to total 4.6 billion pounds in
2000, down about 1 percent from the 1999 forecast level. Exports
to the Baltic States are expected to decline from this year's
exceptional growth. After growing rapidly since the late 1980's,
broiler exports have hovered between 4.5 and 4.7 billion pounds
since 1997 and the collapse of the Russian market. 

U.S. turkey exports are forecast at 400 million pounds in 2000,
about even with the 1999 forecast. Gains in sales to Mexico and
some Asian countries, chiefly South Korea, are expected to offset
reduced shipments to Russia and other Eastern European countries.
Because Mexico is the leading buyer of U.S. turkey (56 percent of
exports in 1998), its economy will largely determine the level of
U.S. turkey exports. Mexico's Gross Domestic Product is forecast
to grow a relatively healthy 2-3 percent in both 1999 and 2000.
U.S. exports to Korea, which was a major market for U.S. turkey
before economic adversity struck in 1998, could rebound sharply
if the Korean economy continues to improve in 1999 and into 2000
(see World Agriculture and Trade). Export prospects to South
Korea are better for turkey and for pork domestic turkey
production is limited, and turkey imports are rebounding from the
sharp declines in 1996 and 1997.

U.S. beef exports are projected at 2.3 billion pounds in 2000,
down 6 percent from the 1999 forecast. The expected drop in U.S.
beef production next year will be greater than the decline in
domestic 

For further information, contact:  Leland Southard, coordinator;
Ron Gustafson, cattle; Leland Southard, hogs; Mildred Haley,
world pork; Jim Miller, domestic dairy; Richard Stillman, world
dairy; Milton Madison, domestic poultry and eggs; David Harvey,
poultry and egg trade, aquaculture.  All are at (202) 694-5180.


BRIEFS
Farm Finance
Potential Rise in Interest Rates--
An Unwelcome Prospect for Farm-Sector Borrowers

Despite interest rates on farm loans declining in first-quarter
1999, farm-sector borrowers seeking new loans may face somewhat
higher interest rates later in the year. Increasing demand for
loans plus a recent action by the Federal Reserve Board to raise
short-term market interest rates albeit a modest 0.25
percent may reverse the downward trend of the last 2 years. 

Changes in interest rates affect the farm sector's interest
expenses and asset values, farmers' choices of loan maturities
and repricing intervals the period from the date the loan is
made until the first date the interest rate may be adjusted and
their ability to restructure loans. Lower rates help to reduce
farm expenses and encourage loan refinancing, allowing farmers to
use equity built up over time 

in homes and farm real estate to provide liquidity. Increases in
market interest rates raise farm lenders' cost of funds, which is
passed on to farmers in the form of higher rates on new loans,
and raise the indexes used to adjust outstanding variable-rate
loans. 

The market value of farm assets is inversely related to interest
rates. A rise in market interest rates would not only increase
farm business and household interest expenses, but also reduce
the market value of farm-sector assets and farmer net worth,
making it more difficult for farmers to qualify for new loans and
refinance old loans. Real estate refinancing tends to fluctuate
with changes in mortgage interest rates. Home mortgage
refinancing is already slowing because of rising mortgage
interest rates. Increases in farm real estate interest rates
would reduce the potential for farm real estate refinancing
needed by farmers experiencing financial stress.

The majority of farm real estate loans are balloon notes loan
payments are applied to interest only, leaving a large final
principal payment with a term of 5 years at most. Farmers who
have balloon notes, and must pay off outstanding balances with
lump-sum payments or else refinance, are especially vulnerable to
the risk of rising interest rates.

Any increase in interest rates would be especially unwelcome
given the current situation in the farm economy. Trends in
commodity prices and farmland values offer little optimism for
the farm sector during the remainder of the year. Many areas are
reporting stable or even declining farmland values, with
expectations of further declines if commodity prices do not
improve. Data on lending in the Upper Midwest show increased
borrowing and loan renewals or extensions, as well as an increase
in the percentage of farmers at their debt limit. Meanwhile,
repayment on farm loans has slowed. In Iowa, about 20 percent of
farm borrowers at agricultural banks, 10 percent of Farm Credit
System borrowers, and about 30 percent of Farm Service Agency
borrowers will require major loan restructuring in order to
continue operations.

Another indication of the current farm financial stress in the
Midwest is the increase in applications to Illinois' State
Guarantee Program for Restructuring Agricultural Debt, which
helps farmers refinance their loans. To qualify, a farmer must
have a debt-to-asset ratio between 0.4 and 0.65 (a ratio above
0.4 is considered an indicator of potential financial stress, and
over 0.65 indicates too high a risk of default). By mid-1999,
applications to the Illinois program had already reached four
times the total for last year.

About 10 percent of U.S. farmers in 1997 had debt-to-asset ratios
at or above the 0.4 threshhold, and higher interest rates could
increase the proportion of heavily indebted farmers. Farmers with
an income shortfall unable to pay off old short-term loans or
qualify for new ones if interest rates should rise may be able
to roll over unpaid operating loans into long-term debt, perhaps
with FSA-guaranteed loans. However, some farmers who might not be
able to project adequate cash flow to work out their indebtedness
by restructuring may choose to risk drawing on assets not related
to the farm business e.g., personal savings or retirement
funds while others may choose instead to liquidate.

Ted Covey (202) 694-5344
tcovey@econ.ag.gov  


COMMODITY SPOTLIGHT
U.S. Wheat Supplies Remain Large In 1999/2000

Large beginning stocks (up nearly one-third) will offset an
forecast decline in U.S. wheat production, leaving U.S. supplies
at 3.4 billion bushels in 1999/2000, up slightly from last year
and the highest level since 1987/88. U.S. wheat production in
1999 is projected down 9 percent from last year because of lower
harvested area and slightly lower yields. 

Production and imports will almost satisfy projected domestic use
and exports during 1999/2000. Relatively large carryover stocks
will be reduced only slightly from 945 million bushels in
1998/99, the highest since 1987/88.

Domestic demand is projected down as weak corn prices and large
corn supplies keep wheat feeding in check. Food use is expected
to increase modestly after a year of stagnant use in 1998/99.
Exports in 1999/2000 are expected to rise 10 percent from the
disappointing 1998/99 total that included a substantial quantity
of food aid. 

While wheat prices strengthened in fall 1998 as USDA announced
donation programs, prices have weakened since the November peak.
For 1999/2000, a more usual price pattern is expected, with
prices reaching their seasonal low during harvest and increasing
as the marketing season progresses. The average price received by
farmers is projected to range from $2.45 to $2.95 per bushel. The
$2.70 midpoint is up only 5 cents from the 1998/99 estimate, and
down sharply from the 6-year average of $3.49 (1990/91-1996/97). 

Lower acreage and yields are projected to reduce U.S. wheat
production to 2.33 billion bushels in 1999. U.S. farmers planted
an estimated 62.9 million acres, down 5 percent from last year
and the lowest since 1973. Declining returns in recent years have
encouraged producers to switch to other crops or leave more land
fallow. The all-wheat yield in 1999 is forecast at 42.7 bushels
per harvested acre, down from last year's record 43.2 bushels.

USDA forecasts 1999 U.S. winter wheat production at 1.67 billion
bushels, down 11 percent from 1998. Harvested area totals 35.6
million acres, also down 11 percent from 1998. Based on
conditions as of July 1, the U.S. winter wheat yield is forecast
at a record 47 bushels per acre. 

The winter wheat crop survived the winter well, and spring
precipitation has been above average in several areas in the
central and southern Plains. A mild winter followed by generally
favorable spring weather pushed crop development slightly ahead
of normal. Above-average precipitation in many growing areas
during June led to harvest delays and raised concerns about
potential effects on protein levels and quality. Warm, dry
weather allowed rapid harvest progress in early July, and as of
July 11, 70 percent of the winter wheat had been harvested,
compared with 74 percent on that date in 1998 and a 5-year
average of 66 percent.

Hard red winter (HRW) wheat production is projected at 1.03
billion bushels, down 150 million 
from 1998. In Kansas, the largest wheat producing state, the crop
is projected to total 423 million bushels, down from 495 million
a year earlier. Forecast harvested acres are down 9 percent,
while the forecast yield of 46 bushels per acre is down from the
1998 record of 49 bushels. Yields are projected to set records in
Nebraska and Texas and match last year's record in Colorado.

Production of soft red winter (SRW) wheat is projected at 443
million bushels this year, slightly above last year. White winter
(WW) wheat production is projected at 199 million bushels in
1999, down 22 percent from 1998 and the lowest since 1991. The WW
wheat crop in the Pacific Northwest appears to be well below
average, with projected yields down in Idaho, Oregon, and
Washington. 

Unlike other classes of wheat, durum plantings are up 9 percent
in 1999 from the previous year to 4.05 million acres. An
attractive crop revenue insurance program may have affected
plantings. North Dakota is the leading durum producing state,
accounting for about 85 percent of the acreage in 1999.  Durum
wheat production in 1999 is pegged at 132 million bushels, down 9
million bushels from 1998. If imports of durum and durum products
reach the projected level of 32 million bushels, total supply
will exceed projected use, and projected ending stocks will
increase to 92 million bushels in 1999/2000, the highest since
1986/87. 

Production of other spring wheat (i.e., nondurum) is projected at
527 million bushels in 1999, down marginally from last year.
About 52 million bushels of this is white spring wheat, while the
balance will fall in the hard red spring class. Plantings of
other spring wheat are projected to total 14.96 million acres in
1999, down 1 percent from 1998. Minnesota, Montana, North Dakota,
and South Dakota are the leading states for other spring wheat
acreage, and together account for about 90 percent of the acreage
in 1999. 

The Northern Plains region, particularly North Dakota, has been
plagued by excessive rainfall at many locations, causing delays
in planting durum and "other spring" wheat crops. Due to
excessive moisture, some fields in North Dakota will likely
remain idle or be seeded to forage or cover crops. USDA plans to
recheck some of the planted acreage figures reported in June for
North Dakota. Any updates will be published in the August Crop
Production.

Mack N. Leath (202) 694-5302
mleath@econ.ag.gov

World Wheat Stocks to Drop 
In 1999/2000

World wheat stocks are forecast to drop 13 million tons in
1999/2000, the largest reduction since 1994/95. Since 1970,
global wheat stocks have declined by more than that amount only
five times. World wheat production is declining by 13 million
tons at the same time that foreign consumption is relatively
stable. The global ending-stocks-to-use ratio is expected to drop
to 21 percent, almost as low as the 19.8 percent reached in
1996/97, and prices that season reached very high levels.
However, little, if any, increase in world prices is expected in
1999/2000 because major wheat exporters' supplies are large. 

World wheat production is projected down 2 percent from the
previous year to 575 million tons in 1999/2000. Low wheat prices
in the international market during 1998/99 have been a
disincentive for producers in many countries. Additionally, the
European Union (EU) increased its area set-aside from 5 to 10
percent. 

Unfavorable weather has reduced production prospects in several
countries. Drought has affected much of the Middle East, with
reduced winter wheat production prospects in Turkey, across
Jordan, Syria, Iraq, and into Iran. Additionally, drought has
damaged wheat crops in Spain, Portugal, and Morocco. 

Some countries expect to harvest larger crops in 1999/2000,
partly offsetting these declines. In China, the world's largest
wheat producer, a dry fall planting season was followed by the
driest winter on record in parts of the North China Plain. But
production is expected to increase slightly, as much of the crop
is irrigated, limiting the damage done by drought. Despite
dryness in key winter wheat areas, wheat production in the Newly
Independent States (NIS) of the former Soviet Union is expected
up 5 million tons, rebounding from the previous year's severe
drought. India, the first country to harvest wheat during the
marketing year, has enjoyed excellent growing conditions, and is
reportedly harvesting record production. 

Major exporters Argentina and Australia are expecting a modest
increase in wheat production because of the low profitability of
alternative uses for the land. Very low prices for oilseeds and
feedgrains (also wool in Australia) are expected to support wheat
plantings that were under way in June and early July. 

The large beginning stocks held by exporters Australia, Canada,
the EU, and the U.S. are expected to limit early-season price
strength. While beginning stocks are down from a year earlier in
the NIS, China, and Iran, wheat prices in these countries are
generally isolated from world markets. Therefore, the tightening
of world supplies only indirectly affects world prices. 

World wheat consumption in 1999/2000 is projected at 588 million
tons, down 2 million from a year earlier. Global food, seed, and
industrial consumption of wheat in 1999/2000 is expected to grow
slowly, gaining less than 1 percent, somewhat less than the
4-million-ton growth in 1998/99. Global feed and residual use is
projected to fall by 5 million tons. 

The combination of large wheat supplies in major exporting
countries, prices near historical lows (when adjusted for
inflation), and tight supplies in several importing countries is
expected to boost 1999/2000 world trade 1 percent to 100 million
tons (July/June marketing year). The U.S. is expected to capture
a significant part of the increased trade, with exports up 2.5
million tons to 31.5 million and share of world wheat trade up
slightly to 31 percent. 

During the first part of 1999/2000, U.S. exports will be boosted
by large shipments of aid announced the previous year.
Early-season commercial sales for 1999/2000 are running behind
levels of a year earlier. There is little incentive for importers
to forward contract for 1999/2000 shipments if they believe wheat
prices will remain closer to the current cash price than to the
futures contract price. Crop conditions look favorable in most
exporting countries, and importers can wait for harvest-time lows
to make purchases.

Australia and Canada are each projected to increase wheat exports
in 1999/2000 because of higher supplies and growing world demand.
Australia is expected to increase exports by 2 million tons to
17.5 million while Canada's exports are projected to rise 2.5
million tons to 16.5 million. Argentina's wheat exports are
expected to decline 0.5 million tons to 8 million, despite
increased production. Argentina's harvest does not begin until
November, and the export pace from July 1999 until November is
expected to be very light, because the reduced 1998 crop was
shipped out rapidly. 

The EU is expected to maintain wheat exports at around 16 million
tons in 1999/2000. Lower production and increased domestic use
are expected to modestly tighten EU wheat supply and demand. But
with large beginning stocks of over 20 million tons, the EU
Commission is expected to maintain the pace of exports. 

Kazakstan has had favorable rains to date and is expected to
boost exports because of increased production. However, drought
is expected to reduce exports from Turkey. Wheat exports out of
Eastern Europe are expected to decline because of reduced
production and increased transportation costs as a result of war
damage on the Danube River. 

Reduced production is expected to drive Pakistan and Morocco to
increase imports in 1999/2000, each by 0.3 million tons. Pakistan
is not expected to match the previous year's record production,
and Morocco suffered from drought this winter. Several countries,
such as Egypt and the Philippines, are expected to increase
imports slightly to maintain consumption growth. North Korea is
projected to boost wheat imports by 0.4 million tons, continuing
to draw on food aid. 

Ending stocks held by the five largest wheat exporters
(Argentina, Australia, Canada, the EU, and the U.S.) are
projected to decline from 56 million tons in 1998/99 to 51
million in 1999/2000, but to remain more than 30 percent above
the previous 5-year average. Despite a small rise in world wheat
trade, the large ending stocks projected for these exporters in
1999/2000 would limit price increases.  

Edward W. Allen (202) 694-5288
ewallen@econ.ag.gov

COMMODITY SPOTLIGHT NOTE

The crop and marketing year for U.S. wheat supply and demand is
June-May.  The international trade marketing year is July-June. 
Marketing years vary by country.  1 metric ton equals 36.74
bushels.

COMMODITY SPOTLIGHT BOX 
The Middle East & North Africa Region Suffering From Severe
Drought

In 1999, a number of countries in the Middle East/North Africa
region are suffering one of the worst droughts in decades. This
has reduced grain crops in Iran, Iraq, Turkey, Jordan, Israel,
and Syria and has devastated production in Morocco, where
near-record grain imports are forecast. It has also affected
production of other crops such as cotton and sugar cane, which
are harvested in the fall.  

Partly because of drought in this region, world wheat trade in
1999/2000 is expected to total 100 million tons, about the same
level as estimated for 1997/98 but up slightly from last year.
Imports by countries in the Middle East and North Africa are
forecast to rise to 32 million tons in 1999/2000, up 3.5 million
from 1998/99.

Western Iran's wheat producing area has received about 25 percent
of its normal rainfall since September 1998. As a result, the
Iranian wheat harvest is forecast at 8.5 million tons in
1999/2000, down from an estimated record 12 million in 1998/99
and the 1994-98 average of 11 million. Iran's wheat imports for
1999/2000 are likely to reach 6 million tons, double the amount
imported in 1998/1999. 

Iraq's wheat production is forecast down to 0.8 million tons,
compared with an estimated 1.3 million in 1998/99.  The shortage
of herbicides and the means to spray them has exacerbated the
effects of the drought. Imports are forecast at 2.5 million tons
in 1999/2000, which may not be enough to maintain its rationing
system, which provides 19 pounds of flour per capita per month. 

The wheat crop in southwest Turkey also suffered from drought.
Early forecasts of a second record 18.5 million-ton crop have now
been scaled back to 16.5 million, closer to recent averages.
Exports are expected to drop by 50 percent.

The drought impact in Jordan is so severe that the United Nations
Food and Agriculture Organization has called for emergency food
aid. Water consumption has been drastically cut, and Jordan is
receiving supplementary water from Syria. The Jordanian wheat
crop is expected to be less than half of last year's 55,000 tons.
Imports are forecast up 7 percent from 1998 to a near-record
750,000 tons. In neighboring Israel, the wheat crop (at 80,000
tons) is the second smallest since 1964. Imports, mostly from the
U.S., could reach 1.2 million tons, 12 percent above the 1994-98
average. 

In Syria, drought conditions have significantly reduced the wheat
harvest, which is estimated at 2.5 million tons, down 40 percent
from 1998. While domestic consumption of wheat is forecast at 3
million tons, large stocks will be drawn down to offset the gap. 

Morocco has been devastated by another drought, the fifth this
decade. Production of wheat is forecast at 2 million tons, down
from 4.4 million in 1998 and about half of the average annual
production in the last 5 years. Imports are estimated at 2.5
million tons, about 10 percent above last year. Consumption
remains at 5.6 million tons, and stocks are expected to be drawn
down by more than half to around 1 million tons in order to avoid
larger imports.

Michael Kurtzig (202) 694-5152 and Edward W. Allen (202) 694-5288
mkurtzig@econ.ag.gov 
ewallen@econ.ag.gov


WORLD AGRICULTURE & TRADE
Korea's Agricultural Imports 
Recovering from Financial Crisis

In 1997, South Korea was the fourth-largest destination for U.S.
agricultural products, buying 5 percent of U.S. agricultural
exports. Beginning in late 1997 and extending into 1998, Korea
experienced a major economic shock including devaluation of its
currency, a decline in the production of goods and services, and
temporary difficulty in obtaining credit. What was the
significance of the economic shock to Korea's agricultural trade,
and what does the future hold?

Korea's financial crisis hit hard in November 1997, when the
value of the won, and confidence in Korea's financial situation,
went into free fall. By January 1998, the won lost more than 50
percent of its year-earlier value in U.S. dollar terms. Korean
banks seemed close to insolvency, and credit from both Korean and
foreign sources became extremely difficult to obtain. Interest
rates more than doubled in January, to more than 25 percent.
Without affordable access to credit, the economy began to
stagger. 

Strong intervention by the government and the International
Monetary Fund, including measures to restore credit, gradually
rebuilt confidence in Korea's economy. The value of the won
increased after January 1998, and currently lies 30 percent below
its pre-crisis level. While gross domestic product
(inflation-adjusted) declined 5.8 percent in 1998, it is expected
to grow by more than 4 percent in 1999.

Despite containment of the crisis, total imports declined 35
percent calendar-year 1998. The dollar value of Korea's
agricultural imports fell by 28 percent, or $2.6 billion. The
volume of most major agricultural imports also fell, but not by
as much. U.S. agricultural exports to Korea dropped 22 percent
(by about $640 million). 

Several factors explain much of the decline in agricultural
trade. The Korean economy, and most of its consumers, became
poorer in 1998 because of rising unemployment, reduced asset
value, and lower salaries. What money they had was worth less at
the border, effectively raising the price of imported goods
relative to domestic products. With most importers short on cash,
the inability to get credit severely limited transactions early
in 1998. 

The economic setback in Korea explains only part of the decline
in the value of trade in 1998. Also contributing were weak global
commodity prices, due mostly to bumper crops around the world, a
supply-side result that had little to do with the financial
crises. But in most cases, the loss in buying power of the won
outweighed the dollar decreases in world commodity prices, and
import unit values in won were higher in 1998 than in 1997. 

The year-to-year drop in agricultural imports understates the
full impact of the financial crisis because it fails to capture
potential trade gains lost when Korea's economy plunged into
recession. Korea was a rapidly expanding economy, and demand for
imported agricultural products grew in most years. Before the
crisis, for example, USDA projected that Korea's beef imports
would rise 30,000 tons in 1998; instead, they dropped 92,000
tons. Pork imports were expected to double in 1998, the first
year of liberalized trade in frozen pork. But imports fell 11,000
tons. Likewise, trade in processed and high-value agricultural
products in general had been expected to increase rather than
fall. 

Examination of several of Korea's major commodity markets
illustrates the ways in which economic weakness, global price
changes, and other forces have affected Korea's agricultural
imports in 1998 and 1999.

Imported Beef Demand 
Dropped Sharply 

The financial crisis intensified what was already a cyclical
downturn in Korean cattle prices that began in June 1997, with
cattle farmers facing higher imported feed prices and high
interest rates after November. Following devaluation, beef
imports became more expensive and were arriving in a market where
the domestic cattle price was in a downward spiral. With the
price advantage of imported beef diminished and turmoil in the
credit market making it difficult for private-sector importers to
arrange for imports, beef trade dried up in early 1998. 

Imports by the government trading entity continued, but Korea's
WTO-mandated quota of beef imports was not filled in 1998, and
import volume dropped by about 45 percent from 1997 levels. U.S.
beef exports to Korea dropped 41 percent. Imports have been
rebounding strongly in 1999, but are not equal to the pace of
pre-crisis imports in the January-May period. Growth should
increase through the rest of 1999, since credit issues are
resolved, demand is rising, and Korean production is now falling
after the intense slaughter of 1997/98.

The economic crisis may have strengthened Korea's pork sector.
Before the crisis, Korea's industry was preparing for a possible
doubling of imports after frozen pork trade was liberalized in
July 1997. However, devaluation dramatically changed the
industry's prospects as pork imports became more expensive and
pork exports more competitive. 

Korea had enjoyed some success in filling the gap left in Japan's
supply when Taiwan ceased pork exports after a foot-and-mouth
disease outbreak in early 1997. The won's devaluation in late
1997 and 1998 meant that Korea's pork was cheaper in Japan
relative to domestic Japanese product and U.S. product. While
Korean feed costs were higher because of devaluation, the cost of
labor and processing (in terms of foreign currencies) declined,
and the volume of Korean exports grew by 65 percent. 

Unlike in the cattle industry, there was no sharp cyclical
downturn for swine, and pork imports did not have to confront
sharply declining domestic prices. Frozen pork imports were
virtually unchanged in quantity, although they dropped in dollar
value. In the first 5 months of 1999, pork imports have soared to
record levels, finally reflecting the liberalization of trade in
frozen pork that took place in mid-1997. Korea will import and
export different cuts of pork, based on the disparity of
preferences between Korea and its trading partners.

Total consumption of the three main meats declined by 2 percent
in 1998. Poultry meat, consumed heavily in restaurants, declined
by 12 percent. Beef, the most expensive meat, dropped 10 percent
(despite sharply lower prices), while pork consumption grew by
over 8 percent. While pork prices fell less than beef prices,
pork was still the cheaper meat. In 1999, a recovery in consumer
confidence is expected to send people back to restaurants,
benefiting meat consumption, especially poultry and beef.

Grain used for feed in the October 1997-September 1998 marketing
year is estimated down only 5 percent. Korea's imports of grains
for feed in January-December 1998 actually rose slightly over
1997 levels. This level of use and trade, given the financial
difficulties that traders faced, might not have been possible
without the allocation of guarantees by the U.S. government early
in the crisis. U.S. credit guarantees for 3.2 million tons of
corn enabled Korean importers to overcome a lack of affordable
credit, especially in the first half of 1998. Chinese corn
exports to Korea declined in 1998 because credit could not be
arranged. 

Because Korea's animal producers are almost totally dependent on
imported feedgrains, they would have to reduce herd sizes if
grain import flows are interrupted. Feed use for Korea's swine
industry was stable, partially offsetting declining feed use for
beef cattle. Prospects for 1999 and later years are mixed.
Recovering poultry meat consumption will be partly satisfied by
domestic production and therefore imported feeds, but much of
Korea's consumption growth will be satisfied by imported meats
and dairy products rather than domestic production. Feed wheat
from Eastern Europe continues to displace some corn in early
1999.

Crisis Altered Structure 
of Oilseed Industry

The crisis made it more likely that Korea will import vegetable
oils and meals in the future, rather than oilseeds. Two out of
the three Korean soybean crushing companies went into bankruptcy
protection in early 1998. The crushing companies terminated
credit sales, and Korea's feedmills, unable to import meal freely
because of a general lack of credit, were left with reduced
prospects for domestic and imported supplies. When U.S.
government credits enabled them to buy U.S. meal, imports from
the U.S. soared to over 300,000 tons, compared with almost no
trade in 1996 and 1997. 

Now it will be more difficult for Korean soybean crushers to
convince feedmillers to buy domestic meal at prices higher than
import prices, since domestic supplies failed at a critical
moment. Increasingly, Korea is turning to meal imports, which
exceeded domestic production in 1996 and 1998. Korea's imports of
soymeal increased by over 25 percent in 1998. Similarly, soyoil
imports are replacing domestic production. Korea's soy oil
imports rose 8 percent in 1998 despite the difficult economic
climate and higher world prices (in dollar and won terms).
Imports of soybeans for crushing declined by 12 percent. So far
in 1999, imports of soyoil and soymeal are up dramatically from
the high levels of 1998, and soybean imports have dropped by
another 17 percent. The profitability of crushing is likely to
decrease in the coming years, given agreed-on annual reductions
of soyoil tariffs between now and 2004.

Wheat for milling, raw sugar for refining, corn for sweetener
production, and soybeans for food use together represented 13
percent of Korea's total agricultural import value in 1997. When
the economic crisis hit, GSM guarantees restored Korea's access
to U.S. wheat, corn, and soybeans. Australia and Canada also
provided credit assistance. The import volume of these
commodities changed very little in 1998, although world price
declines reduced the dollar value of imports.  In early 1999,
volumes have lagged behind those in the same period in 1998, but
should end the year at levels similar to recent years.

Inputs for nonfood manufacturing accounted for about a quarter of
the value of all agricultural imports in 1997: hides for tanning;
cotton, wool, and silk to be spun into yarn; natural rubber; and
raw furs. In 1998, the import volume of all these input
commodities declined due to credit problems both for Korean
importers and for domestic and export buyers of Korean products
made from these raw materials. Manufacturers reportedly drew down
stocks as much as possible to avoid new purchases. 

Korea is one of the world's largest importers of hides, and the
largest market for U.S. hide exporters. Despite GSM credit
assistance, U.S. export volume of whole cattle hides to Korea
dropped 35 percent in 1998, a contributing factor in the very low
prices for hides at U.S. slaughter plants. Imports have grown
slightly in 1999, but remain far below 1997 levels. U.S. exports
of cotton to Korea increased both in volume and value, aided by
the GSM program. Total cotton imports fell in 1998, but not as
dramatically as imports of other industrial inputs. Imports in
1999 have increased somewhat, but the long-term trend is for
continued decline.

The value of Korea's imports of processed foods and beverages
fell by over 40 percent in 1998. Although relatively new to
Korea, these products accounted for 11 percent of total
agricultural imports in 1997. Imports of processed foods and
beverages had been insignificant until Korea began reducing trade
barriers in 1989. Since then, imports have grown quickly,
including items such as fruit juices, chocolate products, wine,
beer, sausages, noodles, dairy foods, frozen french fries, cola
bases, seasoning mixtures, tomato paste, ketchup, and canned
vegetables and fruits.

Declining volume accounted for most of the decrease in total
value of processed food and beverage imports in 1998. During the
crisis, supermarket sales held up well while consumption in
restaurants fell as consumers stayed home to save money. In
addition, imports regarded as luxuries, or as discretionary
purchases, declined sharply in volume: wine (73 percent), beer
(84 percent), mineral and aerated water (58 percent), jams and
jellies (78 percent), ice cream (69 percent), and biscuits (70
percent).

Imports of processed foods and beverages have grown in almost all
cases in the early part of 1999, but had not reached 1997 levels
through May. Processed food imports, the most income-sensitive,
are closely tied to modernization of the food retailing sector,
which stalled during the crisis. As investment in hyper- and
supermarkets resumes, consumer demand for diversity and
convenience will lead to strong growth in imports of processed
foods and beverages.

Agricultural Imports to Rebound

With economic growth resuming and credit becoming widely
accessible, Korea's agricultural imports are rebounding sharply
in 1999 and are expected to grow in coming years. Trade barriers,
such as quotas, tariffs, and technical barriers, have recently
fallen and are scheduled to fall even more. The crisis delayed
many initiatives to increase imports in response to the new
opportunities, but Korea's recovery of stability and prospects
for growth will allow new imports to emerge rapidly. 

The lower level of Korea's won helps domestic production and
hurts imports. As long as Korea's currency buys less than it did
two years ago, Korea's imports will be less than previously
expected. However, the cost of agricultural production in Korea
is still so much higher than in exporting countries that imports
are viable. Many foods will be more efficiently produced outside
Korea, stimulating imports.

Parts of Korea's manufacturing sector will again slip in
international competitiveness as it regains economic vitality and
lowers trade barriers. Higher income implies higher labor costs,
and any industry heavily dependent on relatively unskilled labor
will consider leaving Korea. The impact on agricultural imports
will be mixed. Spinning and tanning will continue a gradual shift
out of Korea, following footwear and textile production to other
parts of Asia, Latin America, and Africa, reducing demand for
cotton and hide imports. Soybean imports for crushing are likely
to continue falling, replaced by meal and oil imports. 

Other commodities have strong prospects for rapid growth. Meat
consumption is still growing, and several factors indicate that
the market for meats has not yet matured. Domestic prices are
still relatively high, especially for beef, and meat marketing
still faces infrastructural and legal constraints, such as
government restrictions on the location of retail sales and on
the choice of firms that can import beef. As prices decline and
marketing practices modernize, meat consumption and imports will
increase. Greater reliance on meat imports will reduce growth in
Korea's feed imports, but this simply shifts the location of
animal feeding to major producers like the U.S. not the amount
of feed necessary to provide Korea with increasing amounts of
meat. The outlook for imports of processed products and beverages
is bright, and shipments will tend to come from competitive
producers, such as the U.S., as trade barriers fall and the
consumer economy once again prospers.  

John Dyck (202) 694-5221 and Sophia Huang (202) 694-5225
jdyck@econ.ag.gov
sshuang@econ.ag.gov
Based in part on information and analysis from the Foreign
Agricultural Service (USDA) in Seoul, Korea.

BOX--KOREA
South Korea's Economy: Reviewing the Rebound

Korea's battered economy has bottomed out.  After a drop of
almost 6 percent in output in 1998, the Korean economy is
expected to grow more than 4 percent in 1999 and in 2000. 

Several factors are responsible for recovery, including improved
credit availability, easing of monetary policies, and renewed
investor confidence.  The value of the Korean won also has risen
more than 40 percent since the early stages of the financial
crisis in January 1998, as foreign capital has started to flow
back into the country.  The government budget deficit is expected
to increase to 5.5 percent of Gross Domestic Product, with
government spending further stimulating the economy.  With a
stronger economy and increased investor confidence, Korean
foreign reserves now stand at $61 billion, compared with $18
billion at the end of 1997 when the crisis hit.

Financial and corporate restructuring is proceeding, although
restructuring of the five largest chaebols (large conglomerates)
is slow.  Another concern is high unemployment, about 6.4 percent
this year.  Whether this recovery will be sustained depends on
progress in these as well as other areas of the economy. 
Suchada Langley (202) 694-5227; slangley@econ.ag.gov 

BOX--KOREA
Settling a Beef Between the U.S. & Korea

In April 1999, the U.S. government requested a dispute settlement
panel from the World Trade Organization, stating that Korea had
failed to implement parts of earlier agreements. The request
cited several areas of concern, including restrictions on retail
sales of imported beef, markups applied to imported beef prices
by the government, restrictions on which private-sector groups
could import, delays in soliciting bids to buy under the quota,
establishment of minimum import prices, manipulation of imported
beef volume allowed to go to market, and denial of import
approvals. The request also stated that Korea's government
support to domestic cattle producers exceeded limits established
in the Uruguay Round Agreement on Agriculture.

Korea accounted for almost 15 percent of U.S. beef exports in
1995, and its 1998 share (under 8 percent) was well below what
would have been expected if trade barriers fell. High-potential
domestic consumption and a poor resource base for cattle raising
in Korea make it likely that free trade would result in large
amounts of beef imports from major producers like the U.S.

BOX--KOREA
GSM Credits Spur U.S. Agricultural Exports

Late in December 1997, USDA offered a $1-billion allocation of
credit guarantees under the GSM-102 program (GSM is General Sales
Manager at USDA). These guarantees are used by importers to
secure credit so that they can buy U.S. agricultural products.
While GSM's relatively long repayment period (up to 2 years) held
some attraction for Korea in the pre-crisis years, use had been
declining as commercial credit became more plentiful. 

In the past, GSM credits had been assigned to bulk input
commodities, such as cotton and corn. In 1998, the program was
designed with portions of the total allocated to meats and other
consumer items, in addition to bulk commodities. By the end of
fiscal year 1998, applications for GSM guarantees totaled $1.38
billion out of $1.5 billion made available for Korea a high rate
of use. The 1997/98 financial crisis demonstrated how useful the
program could be when other credit sources are not available.

NOTE: For more information on Korea's agricultural trade,
policies, and outlook, visit Economic Research Service's briefing
room at http://www.econ.ag.gov/briefing/region/korea/


RISK MANAGEMENT
Crop & Revenue Insurance: Bargain Rates but Still a Hard Sell

This article continues Agricultural Outlook's series on risk
management. 

Risk management in agriculture is aimed, in general, at attaining
a desired combination of risk and return. Some producers strive
to obtain the highest possible return for an acceptable level of
risk, while others may seek to minimize the risk associated with
a desired level of return. The ability of different strategies to
reduce risk, and the cost of adopting different risk management
strategies, varies with each individual situation. But whatever
approach is taken, implementation of most risk- reducing
strategies involves some tradeoff between expected income and
risk exposure.

Federal subsidization of crop and revenue insurance programs
alters the tradeoff so that operators may attain significant risk
reduction at relatively low cost, while actually increasing
expected (i.e., long-run) returns. Yet the rate of participation
in insurance programs has remained significantly less than
universal, with about 61 percent of eligible acres insured in
1998. This may be because the potential benefit of insurance is
largely unrecognized and undervalued, or other factors may be at
work in the farm operator's decisionmaking process.

In agriculture, as in most other industries, the activities
associated with the highest expected returns are often associated
with the greatest level of risk. As a result, a producer may be
forced to forego those activities with the most potential for
profit in favor of other activities with lower but less risky
returns.

For example, corn production might promise a farm the highest net
returns per acre if favorable weather is combined with heavy
input use. However, unfavorable weather could result in low
yields and large losses, and gambling on favorable weather by
putting all the farm's acreage into corn may be a perilous
undertaking for all but the most financially secure operations. A
risk-averse producer confronting this situation may be inclined
to opt for lower potential profit by partially diversifying the
acreage into soybeans and some other grains with lower input
costs (e.g., oats, wheat, or sorghum). If, instead, that
risk-averse producer faces price prospects that are particularly
poor and off-farm employment opportunities exist, renting out or
fallowing a large portion of the acreage and devoting a share of
household labor time to earning off-farm wages may be a preferred
strategy.

The level of risk an individual is willing or able to bear varies
with the person's financial situation, attitude toward risk,
availability of other opportunities, and ease of transitioning to
alternative activities. A variety of strategies is available to
enable agricultural producers to achieve an acceptable balance
between expected return and risk.

But some risk-reducing strategies may involve substantially lower
expected net returns for example, diversifying production to
grow some commodities where returns per acre may be lower but
less variable. On the other hand, competitive risk transfer
markets e.g., futures and options exchanges or agricultural
insurance programs provide a means of lowering risk with little
change in expected net returns. Purchasing crop or revenue
insurance is a risk transfer strategy that can be used to obtain
varying degrees of revenue-risk reduction at very low cost. A
distinguishing feature of this strategy is the Federal subsidies
available to crop and revenue insurance market participants.

Subsidies Lower Premiums for Crop & Revenue Insurance

Crop and revenue insurance are low-cost tools to help farmers
guard against risk of revenue losses due to yields and prices
that fall short of planting-time expectations. Crop yield
insurance provides payments to producers when realized yield
falls below the producers insured yield level, whereas crop
revenue insurance pays indemnities based on revenue shortfalls
that result from yield or price shortfalls. But unlike most other
risk management tools, crop and revenue insurance also provide a
special case where income risk is reduced and expected returns
are increased because of Federal government intervention in
premiums charged to farmers. The Federal Crop Insurance
Corporation (FCIC) provides subsidies to private companies,
eliminating much of the delivery cost and underwriting risk from
premiums, and helping to ensure that premiums are a close
representation of longrun expected indemnities. In addition, the
FCIC subsidizes producer premiums to lower the cost of acquiring
insurance so that, in the aggregate, total expected returns over
the long term are greater than farmers' total actual premium
costs. In other words, a dollar's worth of expected return can be
purchased for less than a dollar of premium. 

Substantial taxpayer dollars have been expended over the years to
make insurance available on a widespread basis and to increase
producer participation in insurance programs. Between 1981 and
1998, Federal risk management outlays included $5.7 billion in
producer premium subsidies, $3.9 billion in administrative
reimbursements to private insurance deliverers (plus another $1.6
billion in other administrative costs), and $3 billion in net
underwriting losses, which, in the absence of Federal risk
sharing, would have been borne by the private companies selling
the policies.

Since passage of the 1994 Federal Crop Insurance Reform Act,
total insurance-related outlays have averaged nearly $1.4 billion
per year, with premium subsidies comprising the bulk of the
transfer. The premium subsidy share of those outlays has also
increased. The larger outlays are due in large part to a
significant rise in participation. Insured acreage peaked at 75
percent of eligible acres in 1995 when participation in crop
insurance was mandatory for farmers to be eligible for other
Federal program benefits e.g., deficiency payments. The
mandatory participation requirement was dropped for 1996 and
subsequent years, and as a result, participation has declined.

What makes government-subsidized insurance such a good deal?
Under most private insurance programs e.g., automobile,
homeowners, health premiums are set to include all expected
indemnities (payments made on qualifying losses), plus all the
costs of administering the policies, plus a reasonable profit. If
premiums fall short of this goal, the company loses money and
must either raise premiums or go out of business. Competition
among private companies helps to minimize increases in profit
margins, keeping premium increases down.

Under most private insurance policies:
Total premiums = expected indemnities + administrative costs +
profit margin

Under the FCIC-backed crop insurance program, government payments
to insurance carriers are used 
to ensure that total premiums are set to cover expected
indemnities only, which reduces the premiums paid by farmers.
Federal crop insurance subsidies are designed, in large part, to
equate premium rates with the long-term chance of loss. 

Under FCIC-backed crop insurance:
Total premiums  =  expected indemnities 

To achieve this objective, USDA's Risk Management Agency (RMA),
through the FCIC, subsidizes the private insurance companies that
sell and deliver crop and revenue insurance, by reimbursing them
for the costs of selling and underwriting policies, adjusting
losses, and processing policy data. The government also lowers
the risk associated with underwriting crop and revenue insurance
by sharing the risk of loss (and the possibility of gain) on
policies sold by private companies.

To encourage producer participation in agricultural insurance
markets, the government also pays a portion of producers'
premiums on FCIC-approved policies, ranging from 13 to 100
percent depending on the type of insurance and the coverage
option chosen. The premium subsidies are based only on the yield
portion of federally-backed insurance policies. Subsidies on
revenue insurance plans are limited to the amount payable if the
producer had elected the yield-based coverage. From 1981 to 1994
these subsidies averaged about 25 percent of total premiums.
Beginning with the Federal Crop Insurance Reform Act of 1994,
government subsidies have averaged about 50 percent of total
premiums across all policies comprised of a 100-percent share of
premiums for minimum catastrophic coverage (CAT) and a 40-percent
share of premiums for additional yield loss "buy-up" protection.

Under actuarially fair insurance rate setting where total
premiums equal indemnities paid out, and the insurance program
"breaks even" the premium subsidies represent a positive
expected benefit to producers who purchase insurance. In other
words, with the government paying part of farmers' insurance
premiums, expected net returns per acre are greater with
insurance than without.

How does this work? If the insurance company writing the policy
and the producer buying the policy have equal information about
risk, and if the insurance premium is set to correctly reflect
that risk, then the premium should exactly equal the expected
indemnity. With no government subsidy, the producer would pay the
full premium and no expected benefit would ensue beyond being
able to transfer some production risk. However, when the
government subsidizes a portion of an actuarially fair premium,
the producer pays less than the full premium but still can expect
to obtain the full indemnity. Thus, a dollar of a farmer's
premium returns more than a dollar of expected benefit over the
long run. 

A measure of the actuarial success of premium rating for crop
insurance is the loss ratio total indemnities paid divided by
total premiums received. Because rates are set to reflect the
longrun chance of loss, actuarial fairness equates to a loss
ratio of approximately 1.0. However, in any given year, the loss
ratio for a crop in a specific area is unlikely to equal exactly
1.0, due to variations in weather. In a year with extremely
unfavorable weather, the sum of crop and revenue insurance
policies would be expected to show a loss ratio greater than 1.0,
implying net underwriting losses (although reimbursement
subsidies to private companies for administrative costs could
potentially make up for the losses). In years with more normal
weather, a loss ratio less than 1.0 may result, with net
underwriting gains.

From 1981 through 1993, annual loss ratios (based on total
premiums, including subsidies to producers) exceeded unity,
suggesting that ratings on subsidized insurance were not
actuarially sound. Since 1990, many features of the FCIC-backed
crop insurance program have been improved in an "actuarial"
sense. For example, rates have been raised, and more stringent
penalties for yield data inadequacies have been imposed on
insured farmers. These changes, in combination with several years
of moderate weather, have helped to improve loss ratio
performance significantly since 1993. In addition, private
companies have been asked to bear a greater share of the
underwriting risk, while reimbursement for administrative costs
has declined.

From the producers' point of view, the relevant ratio is based on
actual premiums they pay the farmers' cost after subtracting out
the Federal subsidy portion of the premium. The ratio based on
the producer-paid premium has exceeded unity in every year since
1981 with the exception of 1994 when it dipped below unity. Since
1995 the national aggregate producer-paid indemnity/premium ratio
has averaged nearly 1.77, implying that $1 of premium has bought
$1.77 of expected indemnity benefit "on average," plus some
additional unquantified "benefit" from risk reduction. 

If federally subsidized crop and revenue insurance is such a good
deal, why don't all eligible producers take advantage of it? 
While the answer to this question is debatable, there are several
possible reasons why participation in crop and revenue insurance
programs is less then universal (in 1998 about 65 percent of
acreage planted to major field crops was insured). A key to
understanding these reasons rests on the premise that risk-averse
farmers can be expected to purchase correctly rated insurance
(where the premium accurately reflects the true risk of loss),
and both insurer and insured regard the premium as accurately
reflecting risk.

Under this premise, there are several characteristics of crop and
revenue insurance programs that help explain less-than-universal
participation. First and foremost, it is likely that many farmers
simply do not believe that expected indemnities exceed their
producer-paid share of the premium. These farmers believe
(rightly or wrongly) that premium rates fail to reflect their
specific situation. In other words, many farmers feel that the
premium rates they face (or the processing fee in the case of CAT
coverage) overstate their risk of loss. Imperfections in the rate
setting scheme probably make this true for some, while others may
be poorly informed about the true extent of farm-level risk.

There may also be some misunderstanding or general lack of
information concerning how crop and revenue insurance programs
work and the advantages they impart, as well as the true extent
of farm-level risk. This problem is compounded by the growing
array of available insurance products, which strengthens the
perception that crop and revenue insurance programs, like many
other risk management programs, are too complicated to understand
and use correctly. 

Other reasons that are frequently cited as contributing to
less-than-universal participation in subsidized crop insurance
include:

(1) An operator's overall level of wealth can have a strong
bearing on risk decisionmaking. For many large commercial
operations with substantial equity values, the potential
magnitude of a crop loss relative to the equity base may be very
small, so the incentive to buy insurance is low.
(2) Management objectives such as profit maximization or
enterprise growth may supersede risk management goals and
diminish the demand for insurance.
(3) Many farmers have some ability to reduce yield and revenue
risk through the use of alternative strategies stable off-farm
wage opportunities or diversification of on-farm
activities which may be more cost-effective under some
circumstances. Some farms may reduce yield risk simply by
altering cultivation and crop management practices, at lower cost
than the producer-paid share of the premium on a crop insurance
policy.

Finally, many researchers have cited the frequent use of Federal
ad hoc disaster assistance payments (from 1988 through 1994 and
again in 1998) as a principal deterrent to purchasing crop
insurance. Why pay a premium for something that you would likely
get for free? 

Do FCIC Subsidies Alter
Producer & Carrier Behavior?

The goal of FCIC subsidies is to alter behavior namely, increase
participation in crop and revenue insurance markets. If
successful, this contributes to the higher goal of encouraging
farmers to reduce their risks, thereby increasing the viability
of agriculture and reducing the need for publicly-funded disaster
assistance programs. But do FCIC subsidies have other
consequences? The answer appears to be yes, for several reasons.

First, when viewed as an increase in expected revenue, the
subsidy provides not only an incentive to purchase insurance, but
also to marginally expand area under crop production, since a
producer's total expected return increases with every insured
acre. 

Second, since premium subsidies are calculated as a percent of
total premium, and premiums are higher for production on riskier
land, the subsidies are weighted in favor of production on land
with the greatest yield variability. As a result, subsidies may
encourage production on land that might otherwise not be planted.
And to the extent that yield risk varies across both crops and
fields, distortions are likely to occur across both regions and
commodities. 

Third, in the absence of FCIC subsidies, crop insurance premiums
would include markups for the insurance companies' administrative
costs and profit margin. These added costs could make premium
rates prohibitively expensive in high-risk areas. If higher
premium rates discourage participation, such areas would be less
attractive markets to private companies selling the policies. To
this extent, Federal subsidies increase the likelihood of
insurance delivery, and consequently production, in high-risk
areas, such as various locations in the Great Plains.  

Randy Schnepf (202) 694-5293 and Richard Heifner (202) 694-5297
rschnepf@econ.ag.gov
rheifner@econ.ag.gov

RISK MANAGEMENT BOX
How Are Insurance Premium Rates Set & Subsidies Applied?

An insurance premium is the amount an individual or business pays
for purchase of insurance. For crop and revenue insurance,
premiums are generally expressed on a dollars-per-acre basis, but
are calculated as a percent of the total liability. Total
liability is the maximum loss exposure of the insurer the amount
of indemnity payment required if yield were to fall to zero.

Because premiums for crop and revenue insurance are designed to
cover losses over time, insurers project yield and revenue
distributions to show expected losses and payouts at different
levels of insurance guarantees. Premium rates are determined by
several factors: 

* the type of crop, size of insured unit, and coverage level
selected; 
* the farm's loss experience and APH (actual production history)
yield; and 
* the county yield and its historical variability.

For a given crop at a given price, premium rates are highest for
land where risk of production loss is greatest i.e., where
yields are the most variable. 

USDA's Risk Management Agency (RMA) subsidies encourage
participation in crop insurance by reducing producer premiums.
The amount of the subsidy depends on the type of insurance and
the coverage level in accordance with the 1994 Federal Crop
Insurance Reform Act. For minimum CAT (catastrophic)
coverage i.e., 50-percent yield coverage at 55 percent of the
expected harvest-time price the premium is entirely subsidized,
and a policy may be purchased for a small processing fee. At
higher levels of coverage referred to as "buy-up"
coverage subsidies are calculated in accordance with yield/price
rules:

Calculation of "buy-up" coverage subsidy:
* Yield/price guarantees below the 65/100 level (65-percent yield
coverage at a 100-percent price coverage election) are subsidized
at a rate equivalent to CAT coverage, and  
* Yield/price guarantees at or above 65/100 level are subsidized
at a rate equivalent to a 50/75 guarantee.
For each of the above two ranges the subsidy is first calculated
as a fixed amount. That amount is then applied to the higher
premiums associated with higher coverage levels.

Thus the subsidy share of the premium rate declines as coverage
rises, with the exception of a kink at the 65/100 coverage
break-point where the subsidy share attains a maximum value of
nearly 42 percent of the premiums. Premium subsidies are also
available for revenue insurance but are based strictly on the
yield portion of coverage. As a result, revenue insurance
subsidies are generally a lower proportion of total premium than
their yield-based crop insurance counterparts.


RESOURCES & ENVIRONMENT
Efforts to Reduce Greenhouse Gas Buildup Could Add Costs &
Revenue to Farming

International concern that human activities have enhanced the
natural greenhouse effect of the earth's atmosphere by
substantially increasing concentrations of greenhouse gases, and
that additional warming of the Earth's surface and atmosphere may
adversely affect natural ecosystems and humankind prompted
negotiation of the United Nations Framework Convention on Climate
Change (UNFCCC).  The UNFCCC was ratified by the U.S. on October
15, 1992 and put in force on March 21, 1994.  The U.S. and other
developed countries that were parties to the treaty were
committed to "...adopt national policies and take corresponding
measures on the mitigation of climate change, by limiting its
anthropogenic [manmade] emissions of greenhouse gases and
protecting and enhancing its greenhouse gas sinks and
reservoirs."  (Article 4, paragraph 2a.)

Concern that the voluntary approach under the UNFCCC has not
resulted in sufficient GHG emissions reduction or development of
adequate emissions-absorbing terrestrial sinks could lead to
further clarification in subsequent international agreements or
national-level programs to control emissions without any
additional treaty.

Several key features that national-level programs or
international agreements would  likely include are:
1) national GHG emission reduction targets, particularly for
carbon dioxide (CO2), the most prominent GHG;
2) programs to encourage development of emissions-absorbing land
"sinks" to sequester carbon; and
3) an emissions permit trading system for meeting emissions
reduction targets.

How to Reduce U.S.
GHG's at Lowest Cost

Two strategies to lower atmospheric concentrations of GHG's are
abatement (reducing GHG emissions into the air) and sequestration
(taking GHG's out of the air and retaining carbon in the soil or
in above-ground biomass).  Because carbon dioxide accounts for
over 80 percent of U.S. GHG's, carbon compounds are a logical
policy target.  National policies to reduce carbon emissions
could include regulation of fuel and other fossil energy use, or
a system of tradable carbon emissions permits that would be
issued by the government to manufacturers of energy and
energy-intensive products--such as fuel, electricity, and
selected chemicals.  National policies to mitigate GHG's could
include a program to establish GHG sinks, whereby carbon would be
accumulated in agricultural soils, through land use changes and
forestry practices.  A system of tradable carbon permits would
increase agricultural input prices and decrease farm income,
while carbon sequestration could provide a valuable role for
agriculture to play in an overall national GHG reduction policy.

Any GHG reduction strategy would come at a cost to all sectors of
the economy, but a system of tradeable carbon emissions permits
would be a relatively flexible approach, still meeting the goal
of lower GHG emissions, but at less cost.  Key to determining the
magnitude of carbon permit prices in the U.S. would be the
initial allocation of carbon permits consistent with desired GHG
emission reduction, and the extent of allowable carbon permit
trading.  Prices of carbon permits (1 permit = 1 allowable ton of
carbon emissions) would be higher with fewer permits issued,
reflecting greater reductions in acceptable GHG emissions.

If a permit system is implemented within the U.S., an initial
emissions permit allocation that reflects the national reduction
target could be made to manufacturers of energy and
energy-intensive products.  Then, a mechanism could be created
for firms to trade CO2 emissions permits in order to lower the
costs of reducing net GHG emissions.  With permit trading
allowed, companies with the ability to reduce emissions at
relatively lower cost could sell their excess emissions rights to
those whose costs of reducing emissions exceed the permit
purchase price.  Permit trading would help achieve emissions
reduction at the least cost per ton of carbon and at least cost
to the overall economy.  But permit prices would be lower if
international permit trading were allowed and if opportunities to
manage resources for carbon sequestration were broadened.

Studies suggest that agricultural sinks could sequester about
60-64 mmt of carbon at an annual cost of about $1.5 billion. 
Private industry could arrange to pay farmers to sequester
carbon, allowing a firm to stay within its emissions limit or
meet a portion of its emissions reduction by purchasing a
certifiable ton of sequestered carbon to offset a ton of emitted
carbon.  Credits for carbon sequestration in agricultural land
sinks could also be established as a marketable commodity to be
traded along with carbon emissions permits.

Farm policy could also be key to providing incentives to develop
carbon sinks.  The government could provide financial and
technical assistance to farmers who wish to establish carbon
sinks.  In addition, a government carbon sequestration program
could be devised to contract with landowners to engage in
specific cultural practices that would remove GHG's from the air,
thus reducing the need for more costly cuts in GHG emissions.

Agriculture Could Share
GHG Reduction Costs

The net economic impact of a GHG  reduction strategy on U.S.
farmers would depend on the mix of policies and  programs chosen
to achieve GHG reduction goals.  For example, implementation of a
carbon permit system would raise fuel prices and add to farm
production costs, although payments to manage farmland as carbon
sinks would add to farm revenue.  In 1996, farmers spent $28.7
billion (about 18 percent of total cash expenses) for
carbon-intensive manufactured inputs--fuels, oils, electricity,
fertilizer, and pesticides for which prices would likely increase
with carbon permit prices.   In addition, U.S. farmers spent
$11.5 billion (7 percent of cash expenses) on machine hire and
custom work and on marketing, storage, and transportation--all
services with significant energy requirements.

USDA's Economic Research Service (ERS) used a regional
agricultural sector model to analyze the economic impact of an
illustrative set of carbon emissions permit prices on U.S.
agriculture.  A carbon emissions permit program is assumed to
raise input prices according to carbon embodied in the inputs and
the carbon permit prices.  Effects of energy cost increases on
agriculture--livestock and 10 selected major crops--are estimated
for three scenarios of carbon permit prices that would be
determined, in part, by three levels of emissions permit trading:
1) a carbon permit price of $14 per metric ton of carbon,
assuming full international emissions permit trading;  2) a
carbon permit price of $100 per metric ton, assuming limited
international emissions permit trading; and 3) a carbon permit
price of $200 per metric ton, assuming no international emissions
permit trading.  The carbon permit price would be expected to be
on the low side with increased possibilities for permit trading
and with increased incentives to reduce GHG emissions and
sequester carbon.

A system of carbon permits would increase agricultural production
costs, reduce commodity supplies, and increase prices and value
of production.  The negative effects of cost increases on income
are partially offset by commodity price and revenue increases. 
The estimated impact on agricultural income is minimal under the
lowest carbon permit price of $14 per metric ton.  At this level,
net cash returns are estimated to decline less than a half
percent, and commodity prices increase by a half percent or less.

As the carbon permit price increases, the impact on income is
more pronounced, particularly for irrigated and
chemical-intensive cropping systems.  With a $100 carbon permit
price, net cash returns decline about 2 percent.  Price increases
range from less than a half percent for soybeans, 1 percent for
wheat, about 3 percent for feed grains, and 3.5 percent for rice. 
Prices for milk, hogs, and broilers increase by about one
percent, and beef prices increase by about 2.5 percent.  With a
$200 carbon permit price, net income and price effects are about
double the effects of the $100 price.

With a carbon permit price of $14, land planted to the 10
selected crops declines by about 800,000 acres, about 0.2
percent.  Plantings of three commodities--feed grains, wheat, and
hay--fall by about 200,000 acres each; about 100,000 acres of
soybeans are taken out of production; and land planted to rice,
cotton, and silage drops a total of 100,000 acres.  As the carbon
permit price increases, soybean and hay acreage reductions
decrease in relative importance because other crops higher in
energy content (requiring more fuel and fertilizer inputs) incur
greater cost increases.  With carbon permit prices of $100 and
$200, total planted acreage is reduced by 5.4 million and 10.7
million acres.  Almost all land taken out of production is land
that has been tilled conventionally (with or without moldboard
plows); the costs of conventional tillage are more affected by a
carbon permit system than are generally less energy-intensive
conservation tillage systems. 

In the long term, economic adjustment would dampen the effect of
production cost increases arising from a system of carbon
permits.  Results of the analysis indicate that the sector would
respond to increases in energy costs by reducing input use, by
altering management practices to include less energy-intensive
practices, by changing crop mix, and by taking marginal (less
profitable) land out of production.

Farmland Management:
A Tool for GHG Reduction

Most U.S. agricultural soils have the potential to accumulate or
sequester carbon through changes in land use and management. 
During the first 20-40 years under conventional tillage, the
original carbon level of soil declines by 30-60 percent and then
stabilizes at a new lower equilibrium.  Because a great majority
of U.S. cropland has been in production for many decades, large
initial releases of carbon from that land have already occurred,
and current releases are very low--estimates range between 2.7
and 15 million metric tons (mmt) annually.  On land with
carbon-depleted soil, shifting from conventional tillage to
permanent grasses or no-till systems can result in soil carbon
accumulation of up to 2,000 lbs. per acre per year.  To return
soils to their maximum carbon-carrying capacity takes about 50
years.

Conversion of marginal cropland and pasture to forest offers
potential for agricultural carbon sinks.  One study estimates
that establishing a forest incentive program for reducing GHG's,
patterned after the Conservation Reserve Program (CRP), could
sequester about 44 mmt of carbon on some 22 million acres at a
cost of $456 million annually at about $10/mt of carbon.  More
land could be converted and carbon sequestered, but at increasing
cost per metric ton.  Pastureland would be the source of most of
the land converted to forest.

Although forests generally sequester more carbon and above-ground
biomass than grassland, grassland soils are often higher in
carbon content than forest soils.  Grassland soil carbon is
primarily a function of root mortality.  Grass roots are thin,
compact, and can extend to a depth of a meter or more.  Forest
soil carbon, on the other hand, is primarily a function of tree
litter and fine root turnover near the surface.  On land that was
once prairie or is otherwise ill-suited to forestation,
converting cropland to grasses sequesters carbon more
economically and efficiently than forestation.

Studies of cropland conversion suggest that a 25-million-acre
CRP-like program to plant marginal cropland to grasses could
sequester about 8.6 mmt of carbon per year in the Great Plains. 
In the 18th CRP sign-up period (October-December 1998), mean land
rental payments for states in the Great Plains ranged from about
$32 to $40 per acre.  With a similar payment rate for creating
carbon sinks, a rough cost estimate of government outlays to
shift 25 million acres from cropland to grasslands would be $800
million-$1 billion per year. 

Use of conservation tillage, particularly no-till, can increase
carbon levels in cultivated soil.  Shifting 20 million acres from
conventional tillage into no-till would annually sequester
between 6.9 mmt and 11.3 mmt of carbon, according to soil
scientists  Kern and Johnson.  ERS estimates that, between 1989
and 1996, planted cropland using conservation tillage increased
from 71.7 million acres (26 percent of planted acres) to 103.8
million acres (35 percent of planted acres), with no-till
accounting for nearly all the increase.  In 1996, acreage under
no-till alone accounted for 15 percent of total planted acreage.

The cost of providing farmers with incentives to shift an
additional 20 million acres into no-till is speculative, because
sorting out the relative importance of multiple factors
contributing to use of no-till is difficult.  An incentive
provided in the Food Security Act of 1985 (and continuing through
the 1996 Farm Act) links agricultural program payment eligibility
to adoption of conservation systems on highly erodible land
(HEL).  "Conservation compliance" requires farmers with HEL to
implement conservation plans--such as the adoption of
conservation tillage--if they wish to receive USDA program
benefits.

Conservation tillage can be more profitable than conventional
tillage under some conditions.  But factors such as the higher
level of management skills needed, capital outlays for new
machinery, and the long-term nature of the decision appear to be
hindering further adoption.  So it is likely that the mitigation
of GHG emissions via expanded use of conservation tillage would
require additional economic incentives.

Farmers Could Bank
On Carbon Sinks

Agriculture could benefit from a national greenhouse gas
emissions reduction strategy that includes a significant role for
terrestrial (land) carbon sinks.   Carbon sinks require land, and
farms account for almost half of all U.S. land in the contiguous
48 states.  Given appropriate economic inducements, significant
areas could be managed to increase carbon stored in soils and in
above-ground biomass.

The role of terrestrial carbon sinks in mitigating GHG emissions
is in the early stages of development.  If carbon sinks are to be
established by planting cropland to forest or grass or by
expanding adoption of conservation tillage, then policies to
promote agricultural carbon sinks must provide producers with
incentives to enter into longrun land management commitments. 
Studies by both ERS and other observers conclude that the changes
would have to remain in effect for extended periods of time
(perhaps a minimum of 20 years) to prevent re-release of carbon
sequestered in soils or biomass. 

To assess how government policies might address carbon
sequestration through agriculture, it is helpful to view land
ownership as a bundle of separate interests (claims), each
conveying the right to use a parcel of land in a particular way 
(e.g., a utility easement or mineral rights).  The set of
interests associated with any given parcel may be held by one
agent (e.g., the farm operator or landowner) or may be
distributed among multiple agents (public and private). The
market value of any interest reflects expectations about the
present value of all current and future uses the interest allows.

Establishing agricultural GHG sinks within a market framework for
carbon emissions permits would create a new economic interest in
farmland--the right to manage it for increased carbon content. 
Landowners and farmers could then choose to sequester carbon if
its net returns exceed those from other uses over some relevant
time horizon.  The general idea is that firms with high emissions
reductions costs, such as electric power generators, would
mitigate the environmental impacts of their emissions by
contracting with other firms (such as farms) to engage in
specific sequestration activities.  If the price of carbon
emissions permits were sufficiently high, it is conceivable that
firms would find it economical to pay farmers to sequester enough
carbon to significantly offset national GHG emissions.  In the
case of lower-than-desired levels of carbon sequestration, the
government could assess whether or not the social benefits of
sequestering carbon are sufficient to justify government
expenditures to increase land in agricultural carbon sinks.

If government outlays are determined to be justified, carbon
sequestration could become an explicit conservation objective of
farm policy, implemented with new or existing programs. 
Conservation programs authorized in the 1996 Farm Act encourage
farmers and ranchers to reduce soil erosion, protect wetlands,
improve water quality, and enhance wildlife habitat.  USDA
conservation program incentives for farm owners and operators
include annual rental payments to landowners for retiring
environmentally sensitive lands, cost-share assistance to
establish practices that reduce environmental damage, and
opportunities for education and technical assistance.  

If promoting carbon sequestration were to become an explicit goal
of USDA conservation policy, these tools could be modified or
expanded to encourage the adoption of agricultural practices that
increase the quantity of carbon stored in soils and biomass, and
to help satisfy possible emissions reduction requirements. 
Unlike other conservation programs, all of which are either
short-term or contain release clauses, any policies promoting the
exit of agricultural land from production for as long as 25 years
would need to be further evaluated under different future global
food security and price scenarios.

Howard McDowell (202) 694-5485, Jan Lewandrowski (202)
694-5522, Robert House (202) 694-5480, and Mark Peters (202)
694-5487
howardm@econ.ag.gov
janl@econ.ag.gov
rhouse@econ.ag.gov
mpeters@econ.ag.gov

RESOURCES & ENVIRONMENT BOX

How ERS Estimates Ag Sector Costs from a Carbon Permit System

To estimate cost increases from a system of carbon permits, ERS
uses a U.S. regional agricultural sector model designed for
general-purpose economic, environmental, and policy analysis of
the U.S. agricultural sector.  The model represents agricultural
markets and production enterprises in considerable detail and all
elements of the model are calibrated to the latest available
baseline, geographic, and cost of production data.  The model is
linked with regularly updated USDA production practice surveys,
and geographic information system (GIS) databases, such as the
National Resources Inventory.

The model predicts how changes in farm resources, environmental
or trade policy, commodity demand, or technology will affect
supply and demand of crops and livestock, farm prices and income,
use of production inputs, participation rates and government
expenditures for farm programs, and environmental indicators
(such as erosion, nutrient and pesticide loadings, greenhouse
gases and others).

To calculate the increase in input prices caused by a carbon
permit system, ERS multiplies the carbon embodied in each input
by the carbon permit price, and then applies the increased input
prices to each of the nearly 1,000 production systems contained
in the model.  The model determines how supply and use adjust to
return commodity and input markets to equilibrium. The resulting
changes in supply, use, acreage, price and other market
indicators form the basis for determining the impacts of a carbon
permit system on the agriculture sector. 


RESOURCES & ENVIRONMENT
Facing the Phaseout of Methyl Bromide

With the agricultural pesticide methyl bromide being phased out
by parties to the Montreal Protocol, public and private sector
efforts are underway to develop effective alternatives. Methyl
bromide is an agricultural pesticide that has been used for over
50 years to control insects, pathogens, nematodes, and weeds in
vegetable, fruit, and nut crops. It is used for soil fumigation
prior to planting, post harvest fumigation of agricultural
products in storage and prior to shipment, and for
government-required quarantine treatment of commodities to
prevent the spread of pests.

Methyl bromide has been classified as a substance that depletes
the stratospheric ozone layer. The ozone layer protects the earth
against the most harmful types of radiation from the sun, so
depletion of this layer may increase the incidence of skin
cancer, sunburn, eye damage, and other adverse effects. To
address these potential dangers, an international agreement, the
Montreal Protocol, was reached in 1987 to control or phase out
use of chemicals that may be contributing to loss of the ozone
layer. Methyl bromide was included in this agreement in 1992 and
is now subject to an international phaseout.

Many U.S. users, including growers and the food industry, are
concerned that alternative practices currently available to
replace methyl bromide use will be less effective, resulting in
financial losses. In response to these concerns, USDA, the
Environmental Protection Agency, state universities, and private
firms are working to develop new alternatives. As part of USDA's
contribution to this effort, the Economic Research Service has
cooperated with the National Center for Food and Agricultural
Policy (NCFAP) and the University of Florida in analyzing the
economic tradeoffs of these alternatives and of the phaseout
itself.

U.S. Use Heaviest
In Florida & California

Most methyl bromide is used in the U.S. for soil fumigation prior
to planting crops to control a broad spectrum of insects,
pathogens, nematodes, and weeds. NCFAP estimates that about 35
million pounds of active ingredient are used for that purpose
annually. Use on tomatoes accounts for 30 percent of the total,
strawberries for 19 percent, and peppers for 14 percent. Another
16 percent is used on perennial crops, such as almonds, grapes,
peaches, nectarines, plums, prunes, and walnuts. Ornamentals and
nursery crops, including strawberry and fruit tree transplants,
rose plants, and tobacco seedlings, account for 6 percent. The
remainder is used on other vegetable crops. 

California and Florida are the states with the largest methyl
bromide use in the U.S. Over 90 percent of Florida's acreage in
fresh-market tomatoes, strawberries, and peppers was treated in
1996, the most recent year for which data are available.
Cucumbers, squash, and watermelons that are double-cropped with
tomatoes or peppers in Florida also benefit from this use of
methyl bromide. Over 75 percent of eggplant acres in Florida were
treated in 1996, although this accounts for only a small amount
of the methyl bromide used in the state. 

In California, growers treated 90 percent of strawberry acres in
1996. Methyl bromide is also widely used to control soil pests
from previously planted perennials before replanting orchards and
vineyards. Agricultural nurseries use the pesticide to produce
vigorous transplants of strawberries, perennials, and other
crops, and to meet a California requirement that transplants be
pest-free for transporting. Most producers of organic
strawberries in California use transplants grown in soil treated
with methyl bromide.

Post-harvest treatments with methyl bromide protect the quality
of commodities in storage and allow handlers to meet FDA sanitary
standards. Large quantities of dates, figs, raisins, almonds, and
walnuts produced in California are routinely treated before and
periodically during storage. Walnuts exported for European
holiday markets are treated to meet import standards. Methyl
bromide is also used to treat mills, ships, and structures for
pest control.

Many governments require quarantine treatments with methyl
bromide for imports of food and other commodities to prevent the
spread of damaging pests. Fresh fruit imported from Chile,
including grapes, peaches, nectarines, and kiwifruit, accounted
for over 85 percent of the value of food imports required to
receive methyl bromide quarantine treatments for entry into the
U.S. in fiscal year 1996. Methyl bromide is also used as a
domestic quarantine treatment for such crops as citrus produced
in Florida and Texas and for blueberries produced in the
Southeast before shipment to western states. 

In recent years, some U.S. exports of sweet cherries, peaches,
nectarines, plums, prunes, apricots, dates, dried prunes,
walnuts, oak logs, cotton, rice, and tobacco were treated to meet
the requirements of importing countries. In addition, California
strawberries exported to Japan are treated for quarantine pests
not found in that country.

Montreal Protocol
Controls Phaseout

Under the Montreal Protocol, methyl bromide consumption is being
phased out internationally. The treaty, signed by over 160
countries, controls the global production and trade of
ozone-depleting substances. Methyl bromide was classified as an
ozone depleting substance in 1992. In 1997, Parties to the
Montreal Protocol agreed that methyl bromide consumption (defined
in the Protocol as production plus imports minus exports) should
be phased out by 2005. The reduction will take place in stages: a
25-percent reduction from a 1991 baseline in 1999; a 50-percent
reduction in 2001; a 70-percent reduction in 2003; and a
100-percent reduction in 2005. Developing countries agreed to
freeze methyl bromide use in 2002 at a 1995-98 average and to
reduce consumption from that baseline by 20 percent in 2005.
Developing countries will reach 100-percent reduction in 2015. 

The treaty exempts quarantine and preshipment uses from the phase
out. It remains unclear which post-harvest uses will be
classified as preshipment this term and its temporal limitations
have yet to be defined. The treaty also allows countries to
exempt critical uses after 2005, if a country determines that no
technically and economically feasible alternative is available
with acceptable health and environmental effects and that
significant market disruption would occur if methyl bromide were
unavailable. The country would have to take technically and
economically feasible steps to minimize methyl bromide use and
emissions and conduct research on developing and deploying
alternatives.

In the U.S., the Montreal Protocol is implemented through the
Clean Air Act. In December 1993, EPA issued a regulation under
the Clean Air Act that would terminate U.S. production and
importation of methyl bromide by January 1, 2001. The regulation
required a more rapid elimination schedule than the Montreal
Protocol and did not exempt preshipment, quarantine, or critical
uses. U.S. grower and industry groups argued that the regulation
gave foreign competitors an unfair advantage in growing and
storing crops, which would disrupt international trade. Many
agricultural scientists argued that developing cost-effective
alternatives required more time. As a result, Congress amended
the Clean Air Act in October 1998 to harmonize the U.S. phaseout
with the Montreal Protocol. 

Limited Alternatives
Concern Users

Public and private research programs, including potential
suppliers, are examining a variety of potential alternatives,
some fairly well developed and others relatively new. Studies of
preplant uses that measure performance in terms of yield have
focused on Florida tomatoes and California strawberries; fewer
studies have been conducted for other vegetables, orchard crops,
vineyards, ornamentals, and nursery crops, leaving uncertainty
about the relative performance of potential alternatives for
these crops. These studies also have focused on older, registered
pesticides; less yield performance information is available for
other alternatives. Uncertainties also continue about weed
control alternatives that might complement practices that control
other pests to achieve the broad-spectrum control offered by
methyl bromide use. 

Based on available performance studies and researcher judgments,
the most likely chemical alternative for most preplant uses is
Telone (1,3-D and chloropicrin) or chloropicrin in combination
with a pesticide such as pebulate (Tillam), napropamide
(Devrinol), or metam sodium (Vapam).  Metam sodium might be used
where preplant use of Telone is restricted. To provide better
pest control, a year of fallow may be needed with chemical
alternatives for some California perennial crops. 

Agricultural scientists have been examining a variety of
nonchemical methods, and some may have an important role in the
future. Currently, scientists at the University of Florida and
USDA's Agricultural Research Service indicate that solarization,
a technique that traps solar heat with transparent film to
suppress soil pests, may be feasible on limited acreage for fall
tomato production. Steam, which requires boilers and other
equipment to heat the soil, may be a feasible alternative for
greenhouse production of some ornamentals.

In most cases, researchers expect currently available
alternatives to be less effective than methyl bromide.
Researchers expect lower yields for tomatoes, strawberries,
peppers, eggplants, second crops in Florida double-cropping
systems (cucumbers, watermelons, or squash), perennials,
ornamentals, and nursery crops. Over time, increasing
infestations of pests currently controlled by methyl bromide
could lead to larger yield losses. 

In addition, Federal and state regulations could limit or ban the
use of currently available chemical pesticides, forcing growers
to use less effective alternatives. California currently has
township-level use restrictions for Telone and may limit
chloropicrin use due to concerns about air quality. California
nursery industry representatives and researchers indicate that if
neither methyl bromide nor Telone were available, growers could
not sell nursery stock when nematodes are found in the soil,
making orchards less productive and profitable. 

In 31 Florida counties, Telone use is restricted to certain soil
conditions to protect groundwater. Where Telone use is allowed,
the high cost of personal protective equipment required for
working with Telone, and the difficulty of recruiting labor to
wear the equipment in hot weather, might cause growers to use a
broadcast application system, which could be less effective than
more labor-intensive traditional methods. Moreover, napropamide
and pebulate, herbicides that could be used with Telone to
replace the weed control provided by methyl bromide, have Federal
label restrictions that could prevent their use in Florida.
Several new chemical alternatives that might reduce the financial
impacts of methyl bromide loss, such as basamid (already
registered for nonfood use), methyl iodide, and propargyl bromide
must await registration under the Federal Insecticide, Fungicide,
and Rodenticide Act (FIFRA).

For post-harvest uses on dried fruits and nuts that might not be
exempt from the phaseout, phosphine is the most likely
alternative, but phosphine treatments require more time than
methyl bromide to be effective, which could lead to lost
marketing opportunities. For example, walnut industry
representatives argue that if currently available alternatives
such as phosphine were used, some walnuts could not be processed
quickly enough for holiday-season shipment to European markets.
Losing that market would result in a loss of high-value sales and
would divert these walnuts to domestic markets, increasing the
supply and thereby reducing domestic prices. 

Phosphine may also have a detrimental impact on the flavor of
walnuts. Adding further to the costs of phosphine as a methyl
bromide alternative, storage facilities using the chemical
require better sealing to prevent leakage and require protection
of electrical equipment from the corrosive effects of phosphine. 

EPA has proposed restrictions on phosphine that could prevent use
in some storage facilities, in response to concerns about acute
toxicity and the danger of worker and bystander exposure. EPA
extended its review schedule to consider public input and examine
more options to reduce risks and intends to revise the proposal
in August 1999. 

Economic Estimates Help
Target Mitigation Efforts

Based on current knowledge about alternatives to methyl bromide,
the planned phaseout will cause substantial short-term losses to
U.S. producers and consumers of crops treated with methyl
bromide. This situation will last until more cost-effective
alternatives are made available. NCFAP researchers estimate that
the net annual loss from banning methyl bromide for preplant use
on selected crops would be about $450 million $200 million for
annuals (strawberries, tomatoes, and other vegetables), $140
million for perennial crops, and $110 million for ornamental and
nursery crops. 

NCFAP also estimates that phosphine use for post-harvest
treatments that might not be exempt from the phaseout would
increase costs for dates, figs, prunes, raisins, and walnuts by
$2 million. Impacts on these post-harvest uses would actually be
greater than that amount because the estimate doesn't include
costs of retrofitting storage facilities, increasing storage
time, or altering processing to accommodate longer treatment
times, and for losses from missed market opportunities or
detrimental flavor impacts on walnuts.

In estimating the costs of phasing out methyl bromide, University
of Florida and NCFAP researchers modeled markets for
strawberries, tomatoes, and other vegetable crops commodities
that are among the largest users of methyl bromide. They
estimated that if currently available alternatives were used,
U.S. production of tomatoes, peppers, eggplants, and strawberries
would decline, especially in states dependent on methyl bromide
use. The University of Florida study estimated that Florida and
California would each lose about $200 million in f.o.b. (gross
shipping point) revenues. As a consequence, U.S. consumers would
face higher prices and reduced supply.

The models also estimated the U.S. would increase imports of
Mexican-produced tomatoes, peppers, and eggplants. While Mexico
does not currently have a large share of the U.S. fresh
strawberry market, the methyl bromide phaseout could create
opportunities for Mexico or other countries to increase
production for the U.S. market. Mexico is much less reliant on
methyl bromide for producing these crops than Florida or
California, and as a developing country, is not required under
the Montreal Protocol to phase out methyl bromide completely
until 2015. Thus, the phaseout will have little immediate effect
on Mexican costs and yields. For consumers, increased imports
from Mexico would have a positive effect, by reducing U.S. price
increases and supply losses.

These estimates can help target efforts to mitigate the economic
impact of phasing out methyl bromide uses by showing which
reductions in use will cause the greatest losses. Focusing on the
larger aggregate impacts emphasizes the effects on such crops as
strawberries, tomatoes, peppers, and perennials, which use
relatively large quantities of methyl bromide. Since the
proportional impact on smaller uses could be severe despite small
absolute losses, calculation of returns per pound of methyl
bromide, and comparison to the next best alternative, also helps
identify significant potential problems. 

For preplant uses, NCFAP researchers estimated the highest
returns per pound of methyl bromide for strawberries in Florida
and California; wine grapes, almonds, perennial nurseries, sod
and flowers in California; tomatoes or peppers double-cropped
with watermelons, cucumbers, or squash in Florida; and tomatoes
in southern California. Estimates of impacts for these uses range
from about $10 to $95 per pound of methyl bromide. (An impact of
$0 per pound means that there is an equally cost-effective
alternative.) Post-harvest uses, which account for relatively
small quantities of methyl bromide, are also particularly
valuable if commodities left untreated would be excluded from
high-priced markets or face discounted prices because of poor
quality.

Results of NCFAP and University of Florida studies point to
progress in developing alternatives that will reduce the impacts
of methyl bromide loss for some uses. The NCFAP impact estimate
of $450 million for preplant use, for example, is considerably
less than an estimate of about $800 million for the same uses
made in 1993 by the National Agricultural Pesticide Impact
Assessment Program. Similarly, University of Florida researchers
estimated a decline in f.o.b. revenues from Florida tomatoes in
1995 of about $400 million, but currently estimate a decline of
about $70 million. The reductions in yield loss estimates are the
result of new research that showed the relative effectiveness of
the Telone-plus-pebulate combination as an alternative to methyl
bromide, but pebulate might not be available unless regulatory
issues are resolved. However, the current University of Florida
study also indicates that alternatives for fruit and vegetable
crops must be even more cost-effective than currently expected if
methyl bromide-reliant regions are to maintain market shares
within 10 percent of their current levels. This result shows a
need for further research to develop alternatives.

Several efforts are underway to design transition strategies that
will help producers adjust to the methyl bromide phaseout and
mitigate its economic impact. Research to develop new
alternatives as well as new methods for using currently
available alternatives more effectively continues. To address
regulatory issues, USDA and EPA conducted a series of meetings
with researchers and users in the spring and summer of 1999 to
assess which pesticide alternatives might need label or
registration changes in order to make them available to growers.

In the end, if economically feasible and environmentally
acceptable alternatives are not available for some uses in 2005,
they might be exempted from the phaseout. However, efforts to
reduce methyl bromide use and emissions and to develop
alternatives would have to continue.  

Craig Osteen (202) 694-5547 and Margriet Caswell
costeen@econ.ag.gov


SPECIAL ARTICLE
Agriculture & the Evolution of 
Tariff Bargaining

This is the first of two articles on tariffs and the World Trade
Organization (WTO). The second will profile tariff schedules of
selected WTO members. 

Preparations have already begun for the ninth round of
international trade talks, which will be launched at the World
Trade Organization (WTO) Ministerial Conference in Seattle this
December. While agriculture had been included in each of the
previous rounds, it was not until the Uruguay Round of
Multilateral Trade Negotiations (1986-94) that real progress was
made to negotiate overall reductions in barriers to agricultural
trade. The Uruguay Round created the WTO, which replaces the
General Agreement on Tariffs and Trade (GATT) as an institutional
framework for overseeing trade negotiations and adjudicating
trade disputes.

Over the course of the previous eight rounds, countries
successfully lowered tariffs for manufactured goods from a
trade-weighted, most-favored-nation (MFN) average of over 40
percent to about 4 percent. A review of how this was accomplished
reveals some valuable lessons for future negotiations aimed at
achieving similar cuts in agricultural tariffs, which are, on
average, still much higher than those on manufactured items.  

Tariff Bargaining in Previous Rounds

A variety of bargaining approaches has been used in previous
trade rounds. In the first round (Geneva, 1947), negotiations
took a bilateral approach, despite the multilateral setting. 

Each country drafted request-and-offer lists that contained the
tariffs it would like other countries to reduce and/or bind and
the concessions it was willing to make in exchange. (Tariffs are
"bound" when a country agrees not to raise them above a certain
level, subject to a penalty) Negotiations were conducted
country-by-country and item-by-item, focusing on products for
which the two countries were mutual principal import suppliers.
Early on, countries agreed that they would extend concessions to
all participants, whether or not those countries made any
reciprocal concessions, thus ensuring that the negotiations
achieved some of the benefits of multilateralism. This practice,
now codified in the GATT's most-favored-nation (MFN) clause,
ensured that concessions between principal suppliers would not
discriminate against other suppliers.

The first round reduced average U.S. industrial tariffs by almost
20 percent. About 54 percent of U.S. dutiable imports were
subjected to tariff cuts, with the weighted-average reduction
equal to 35 percent. Even though the MFN practice meant that the
benefits of concessions could not be restricted to principal
suppliers, they were kept largely among the negotiating parties.
For example, an estimated 84 percent of U.S. imports subjected to
tariff cuts came from the 22 other participants in the
negotiations. 

Measured in terms of trade volume subjected to tariff concessions
and the average depth of tariff reduction achieved, the next four
rounds of negotiations yielded disappointing results. For the
U.S., these rounds achieved average tariff reductions between
just 2 and 4 percent on dutiable imports. Among the reasons for
the poor outcomes were the limited objectives of some of the
rounds and the limited authority accorded to the U.S. negotiators
by Congress. 

The request-and-offer form of negotiating also largely inhibited
the success of these rounds. As more countries joined the talks,
negotiating item-by-item with principal suppliers proved to be
increasingly slow and cumbersome, making further cuts in tariffs
more difficult to achieve. It also became increasingly difficult
for negotiators to monitor the multilateral balancing
possibilities on thousands of items for dozens of countries. 
Many of the tariffs that had been cut in the early rounds
continued to be high enough to provide a comfortable cushion
against import competition. As this cushion was slowly removed,
the protected industries, which had come to rely on the higher
prices generated by tariffs, began vigorously to resist further
tariff reductions. 

By continuing the strategy of negotiating reciprocal concessions
with other main trading partners, governments sought to assure
their constituents that the economy as a whole would not lose by
binding or lowering tariffs. The principal-supplier method of
negotiating supported the pervasive belief that every dollar
increase in imports should be balanced with a dollar increase in
exports. Reducing one's trade barriers was considered a
concession that had to be compensated by equivalent concessions
from other countries, a tenet that continues to influence today's
negotiations. 

While tariffs on industrial goods were whittled away during the
first five rounds, the issue of agricultural trade barriers was
scarcely touched. Agricultural trade was subject mainly to
nontariff barriers (NTB's) such as quotas, many of which were
tied to specific domestic policy objectives. Their removal or
reduction would have required changes in domestic policies as
well, something few countries were willing to address in what
essentially were trade talks. 

The sixth round, dubbed the Kennedy Round (1963-67), saw the
first serious attempt to subject agricultural products to
disciplines that had been applied to trade in other goods for
many years.  Before the round began, the U.S. suggested that all
NTB's in agriculture be converted to tariffs, which would then be
reduced by 50 percent and bound. This position which never made
it into the U.S. proposal was considered a non-starter by the
European Economic Community because it was incompatible with the
use of variable levies (under which the import duty is the
difference between a fixed reference price and a fluctuating
import price). In the end, even though agriculture had been given
high priority during the Kennedy Round, little was accomplished
in liberalizing agricultural trade.

In contrast to the efforts for agriculture, negotiations to
reduce tariffs on industrial goods were highly successful, in
large part because of a major shift from a bilateral to a
multilateral negotiating approach. Early in the round,
participants agreed to a 50-percent across-the-board reduction in
industrial tariffs for all but a bare minimum of protected
products. They then negotiated further exceptions. 

This approach gave an early boost to the negotiations by
providing an initial major step forward, then focused the round
on negotiating minor steps backward. Compared with the modest
cuts achieved by the principal-supplier, item-by-item approaches
of the previous rounds, this approach, even after all the
exceptions were negotiated, succeeded in reducing industrial
country tariffs on manufactured items by an impressive 35 percent
on average.

In the seventh round, the Tokyo Round (1973-79), the
across-the-board reduction technique (with exceptions) was
continued, although considerable debate surrounded the choice of
tariff-cutting formula to be used. One of the problems, whose
roots could be traced in part to the principal-supplier approach
to negotiating tariff reductions, was that many countries now had
significant dispersion across their industrial tariff rates,
meaning a low overall average coupled with occasional very high
rates, or tariff peaks. In the past, when a country had tariffs
that were sufficiently high to preclude any trade taking place,
there was no principal-supplier with which to negotiate
reductions. And since countries tended to be strongly influenced
in their negotiations by the amount of actual trade subject to
the tariff barrier being discussed, these high tariffs might
escape any cuts. Actual, rather than potential, trade was much
more influential in determining which tariffs would be targeted
for reduction, since it provided a convenient way to estimate
costs and benefits of the negotiations.

To address the tariff dispersion that existed, the European
Community proposed that, instead of a linear cut as imposed by
the Kennedy Round, a nonlinear "harmonization formula" be used.
This formula yielded small average cuts, but included deeper cuts
for higher tariff rates. The U.S., however, preferred a larger,
but equal cut in tariffs. The Tokyo Round languished for over 2
years, until a compromise tariff-cutting formula (the Swiss
formula) reduced tariff disparities between and within countries.
As a result of this compromise, the Tokyo Round succeeded in
cutting global industrial tariffs an estimated 30-35 percent, and
the MFN tariff rates on imports of manufactured items were
estimated to average 4.9 percent in the U.S., 6 percent in the
European Community, and 5.4 percent in Japan. 

The Tokyo Round was notable in several other respects. It was the
first round to formally recognize that trade flows are affected
by the close link between domestic and trade policies.
Acknowledging this connection laid the groundwork for steps that
would be taken in the Uruguay Round to begin reducing protection
in the agricultural sector. It also introduced the sectoral
approach to negotiating, in which barriers to trade affecting a
particular sector would be discussed in isolation rather than in
conjunction with all sectors. This approach, while not successful
in reducing agricultural trade barriers during the Tokyo Round,
would be used again in the Uruguay Round (1986-94) to finally
subject agricultural trade to the sorts of disciplines that had
applied to other traded goods for many years. 

The success of the Uruguay Round is predicated largely on its
treatment of NTB's in the agricultural sector. Since the early
years of the GATT, NTB's had been regarded as much more trade
restricting in agriculture than tariffs. More than 30 years had
passed since the U.S. had first proposed in the GATT that
agricultural NTB's be converted to tariffs before the signatories
to the Uruguay Round Agreement on Agriculture (URAA) agreed to do
just that. Countries further agreed that these new tariffs, as
well as any other existing tariffs, would be progressively
reduced to a final, bound rate. 

The guidelines used, for both calculating the tariff equivalent
of existing NTB's and for reducing tariffs, offered broad
accommodations for countries to design tariff structures that
would provide ample protection for politically sensitive
commodities while concentrating cuts on commodities which they
themselves were not producing or were not producing on a
competitive basis. (For an explanation of how "tariffication" was
achieved, see AO December, 1998). Nevertheless, simply replacing
NTB's with nondiscriminatory bound tariffs was a huge step
forward. It served to renew and affirm each member country's
commitment to GATT principles and set the stage for negotiation
of further cuts in agricultural tariffs.

Maintaining Momentum for the Next Round

Although the scope of the next round of talks is yet to be
defined, agriculture will once again have a central place on the
agenda. As part of the URAA, countries agreed to begin
negotiations by the end of 1999 in order to continue the process
of substantially reducing support and protection in the
agricultural sector. Agricultural negotiations are expected to
focus on continuing the reform process which began under the
Uruguay Round by expanding market access, reducing or eliminating
export subsidies, and further disciplining the use of
trade-distorting domestic subsidies.

In the area of market access, the weight of remaining protection
has now shifted toward tariffs, some of which are extremely high
(although there is a growing concern about technical barriers to
trade). Negotiators will confront the task of addressing these
high tariffs. Of course, not all countries have high agricultural
tariffs, nor are all agricultural commodities subject to high
tariffs. So, while the overall level of protection is high
relative to that in manufacturing sectors, it is also highly
uneven across countries and commodities. 

Based on the level of cuts in tariffs on manufactured goods
achieved in past rounds, an across-the-board approach has
achieved the greatest success. If all parties were to make an
early commitment to a significant across-the-board cut in
tariffs no country has done so negotiators would likely
concentrate on other issues of contention in the agricultural
sector. Some observers have suggested simply repeating the level
of tariff cuts of the last round, which equaled 36 percent on
average. Early acceptance of such a proposal might allow cuts to
be implemented soon enough to provide a seamless continuation of
the URAA reforms. (The last installments of tariff reductions are
in 2000 for developed countries.)

Tariff escalation when tariffs are low or zero on primary
products, then increase as the product undergoes additional
processing can be a significant bias against trade of the
processed product. If countries cut the rates on raw materials by
a greater amount than the processed product, this could increase
the level of tariff escalation. Should countries agree to an
initial across-the-board cut in tariffs but then negotiate
exceptions, minimizing exceptions in those cases where tariffs
are already very high is another option.

Some observers have advocated that tariff dispersion and
escalation be reduced through a harmonization formula, as used in
the Tokyo Round, to subject higher tariffs to larger percentage
cuts. However, past experience shows that reaching agreement on a
formula would also require a great deal of negotiation. 

A drawback to a linear tariff cut is that it does not reduce the
dispersion of tariffs. On the other hand, it does reduce
dispersion of import prices. For example, a 50-percent cut in
tariffs yields a 2.4-percent cut in the import price when the
initial tariff equals 5 percent, and yields a 16.7-percent cut in
the import price when the tariff equals 50 percent. Therefore,
the potential increase in imports is likely to be proportionately
larger for countries with high tariffs than for those with low
tariffs when both groups reduce tariffs by the same percentage.
The exception is when even a large cut in a tariff still results
in a rate high enough to prohibit imports from taking place. 

The history of past GATT rounds reveals how negotiating
approaches have changed through the years. The earliest rounds
adopted a bilateral negotiating stance conducted on an
item-by-item basis. As the number of countries participating in
negotiations increased, the focus switched from issues that
mainly affected mutual trade between principal suppliers to one
that achieved a multilateral balance of concessions. At the same
time, the negotiating approach changed from item-by-item to an
across-the-board basis. Later talks experimented with
sector-by-sector approaches to bargaining. 

Unlike the early rounds, which benefited from an overriding
objective to reduce and bind tariffs, later rounds have been
increasingly broad and complex, encompassing more participants
and issues. What all the rounds have had in common, however, is a
tendency for the pursuit of reciprocity to govern the size and
extent of tariff cuts that countries are willing to concede. 

The URAA would have been less successful if it had not been part
of an overall package of results addressing a wide range of
issues and sectors. The challenge this time will be to set up a
broad-based but manageable process that yields results in a short
time period (e.g., 3 years) in order to avoid losing the momentum
of reforms generated by the Uruguay Round.  

John Wainio (613) 759 7452
jwainio@econ.ag.gov


END_OF_FILE
