TCS Daily

Europe's Good Idea

By Kevin Hassett - September 11, 2003 12:00 AM

CANCUN, Mexico --While the journalists covering the WTO have focused on the sniping of delegates, they have missed one of the major stories of this meeting. Such an oversight is understandable, since few covering the event are trained in economics. But stop the presses! Representatives of the European Union showed up at the WTO meeting Wednesday with a good idea! Indeed, if the Europeans are serious about implementation of a radical reform they discussed, then the harm from EU agricultural subsidies could be almost eliminated.


While there has been lots of talk about reducing agricultural subsidies in the developed world, the action has been disappointing. Price supports are the rule rather than the exception throughout the agricultural sector. These price supports lead to domestic overproduction. The overproduction is then dumped in the developing world and the system sets off a death spiral where discouraged African farmers close up shop and move to the city to find work.


While subsidies exist in the U.S. on important crop such as cotton, the scope and scale of European subsidies has made them one of the key issues here in Cancun. One of the objectives of the representatives of developing countries attending this WTO meeting in Cancun has been the elimination of these terrible subsidies. Less-developed nations are often the low cost producers of agricultural products. If allowed to compete on a level playing field, they could capture market share and export income, and start off at last on the road to prosperity. In the past, the objective of eliminating the subsidies has met intense resistance because of the incredible political might of the farmers and agribusinesses in Europe. So what is one to do?


The Europeans have happened upon a simple solution. Rather than supporting prices for agricultural products and inducing overproduction, they propose to just give farmers the money at least for some of their spending. Why does this work? An experience I had with my son a couple of years ago provides the intuition.


Our church supplied families with empty Christmas stockings in early December. Families then filled the stockings with presents, and the church delivered the stockings to needy children. After a trip to Toys-R-Us, my son and I headed back to the church with our stocking and he turned to me and said, "Dad, wouldn't the children be better off if we just gave them the money? How do we know what they really want?"


His comment, of course, points out one of the more important results in economics (and reminds of the hazards of living with an economist). In most circumstances lump sum transfers that just hand recipients the money are much more economically efficient than transfers that are tied to prices or quantities. If we give a child a free toy, he is not as happy as he might be if we gave him the same amount of money and let him pick out his own toy. Similarly, if Europeans enjoy having pleasant looking farms dot the countryside, then the optimal policy is to give farmers money that has no strings attached.


How would it work? Suppose that there is a sugar beet farmer in Sweden who has received an average of 100,000 Euro subsidy over the past few years. He earned that subsidy by producing tons of sugar beets and selling them at an artificially high price. If he, alternatively, is handed the money regardless what he produces, then he will study world agricultural prices and consult land use specialists, and produce whatever it is optimal for him to produce. If he has lousy land, he might even decide to produce nothing. The key point is that the economic and agricultural fundamentals are the only things that matter for his decision at the margin. The subsidy makes him better off, but no longer alters the world price of sugar.


If every subsidy to agriculture were handled in this way, then farmers in Europe would be much better off. Instead of receiving lots of money if they do one specific thing, they receive lots of money and then choose to do what is best for them. If every subsidy to agriculture were handled in this way, then consumers in developed nations would be much better off. They would no longer have to pay artificially high prices for their favorite agricultural products. If every subsidy to agriculture were handled in this way, then producers in developing nations would also be much better off. Their cost advantage would turn immediately into export share.


So if most everybody is made better off by this policy change, why hasn't it happened already? Easy! There is one set of individuals made worse off by the policy: Politicians. In the current system, politicians run a welfare program for farmers and agribusinesses and get to pretend that they are really supplying "price stability" and other sound-bite worthy benefits. In return for managing the scam, they get large cash contributions from their agricultural clients. If price supports are changed to lump sum "welfare" payments, then the agricultural sector might feel happier, but voters will see agricultural policy for what it really is. When that happens, the transfers will become politically unsustainable and the money machine will stop working.


So the EU proposal, if we take it seriously, is an effective and clever scheme to destroy agricultural subsidies. Which means that the EU should be praised. Representatives from around the world should jump at the chance to get a commitment from the EU to move as much of their agricultural program as possible into the "nondistorting" pile before they understand what they have done.


TCS Daily Archives