It is Time for Domestic Sugar Policy Reform

Testimony of Professor David Orden*

United States Senate Committee on Agriculture, Nutrition and Forestry

July 26, 2000

Good morning. I am David Orden, professor of agricultural and applied economics at Virginia Tech and an author of the recent book Policy Reform in American Agriculture. This morning I am here to speak with you about the need for reform of the sugar program. Sugar policy is at a crossroads at the turn of the millennium. The traditional form of program management has run out of room to operate. A new approach to domestic sugar policy is needed. This is a policy that allows greater market flexibility, while retaining the framework and terms of our existing border measures and international commitments.

To achieve this new policy, we must look beyond the two main options that have dominated the sugar policy debate. These options have been either to retain the current program instruments, or to eliminate outright domestic support and import restrictions. Neither option is viable. The reforms that are required are steps that call for less market intervention, yet provide some direct support to producers. These steps have been taken progressively for other field crops since the 1960s. It will take courage to apply these measures to sugar, but it is time to do so.

Current Policies Are Out of Operating Room

Sugar policy has operated through a combination of loan rates at which stocks can be forfeited to the CCC, and border controls intended to keep market prices above the loan rates by restricting imports.¹ There is a pure arithmetic limit to this method of operating sugar policy: if imports are constrained to zero, then policy instruments other than border measures must be brought into play to sustain price-supporting loan rates against market pressure for lower domestic prices. The United States also has negotiated limits to this method of operating sugar policy. We are committed not to bring low-tariff sugar imports all the way to zero in the WTO, and to growing Mexican access under NAFTA.²

Until this year, it has been possible to maintain domestic market prices for sugar at levels commensurate with legislated loan rates without stock forfeitures, while imports have exceeded the minimum international access commitments.

This year is different. Domestic supply has expanded compared to demand putting downward pressure on prices. The Department of Agriculture has purchased some sugar to relieve this market pressure, and forfeitures of additional sugar are expected, even with only the minimum imports to which the United States is committed. Thus, domestic sugar policy has run out of room to operate in its usual manner. Farmers face uncertainty in the market and the traditional policy instruments are under stress.

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* Department of Agricultural and Applied Economics, Hutcheson Hall, Virginia Tech,

Blacksburg, Virginia 24061. (540)-231-7559; email: orden@vt.edu.

One path for sugar policy is an attempt to hold up the level of prices through current loan rates and constraints on domestic supply. Stocks can be accumulated by the CCC, and if that is not enough marketing allotments or acreage restrictions can be re-legislated, or paid land diversions can be adopted. But these are the types of government storage and supply-control measures that Congress has progressively abolished for other crops.

The alternative to the current program offered by critics of sugar policy is likewise ill-advised: to unilaterally eliminate all domestic support and simultaneously increase imports until U.S. prices fall to world price levels. This is too draconian a short-term shift from past rules.

Instead, a new sugar policy is called for. This policy would avoid government entanglement in the sugar market in the short run, provide more market flexibility overall, and seek multilateral agricultural trade policy reform that will include sugar in the long run. It is a policy path of progressively converting sugar policy to direct payments.

Objectives of a Direct Payments Policy

Let me highlight five positive objectives of a direct payments policy. The policy should:

1. Free up prices to allow the domestic market to clear and set stocks valuation in response to supply and demand

2. Avoid out-dated interventions either through government involvement in purchases, forfeitures, stockholding, and stocks disposal, or through resort to government-managed domestic marketing allotments or production quotas

3. Reduce incentives for oversupply relative to demand either by domestic producers or by foreign suppliers with access to the U.S. market under existing international commitments

4. Provide adjustment compensation to farmers in the short run

5. Create a sustainable long-run policy with greater market orientation, more open trade, and a reasonable safety net for producers

Two New Sugar Policy Options

With these objectives in mind, I call your attention to two basic options for sugar policy. These are options for domestic policy reform. They can be carried out within the context of current international commitments and with no change in border measures. For this reason, they are not subject to the objection that domestic producers would be exposed to unfair competition from abroad.

Marketing loans (loan deficiency payments)

This policy would operate similar to other marketing loans. It is a minimal change that would free up sugar prices on the consumption side, while retaining the current loan rates to provide price guarantees to producers. With lower domestic market prices when supplies are large, sugar use would expand, helping bring supply and demand into balance. This change in policy would help restore market equilibrium in circumstances, like this year, when supply exceeds demand.

The cost of a marketing loan program for each penny of payments per pound of sugar is around $180 million, assuming full participation at recent levels of output. Because of the concentration in sugar production, the distribution of marketing loan payments would by skewed, unless some payment limitations are enforced.³ Nonetheless, for each penny of taxpayer cost, more than that penny is saved by sugar consumers. This shift of the support burden from consumers to taxpayers yields a net gain. There is a beneficial distributional effect as well, since low-income consumers spend a higher proportion of their income on food than high-income consumers, while those with high incomes pay a larger share of taxes.

Marketing loan payments would be an entitlement to farmers, and would vary with market conditions, so the total budget cost of a marketing loan program is not predetermined. If supply and demand dictated market returns below loan rates, then consumers would reap the benefits of low prices, while producers would receive some support. Conversely, if markets offer returns near or above the loan rate, then government payments decline accordingly.⁴

Introduction of marketing loans would provide a price guarantee for domestic producers, but would have a different--and from U.S. producers' perspective, beneficial--effect on production incentives abroad. In particular, it would reduce export incentives in Mexico. Market prices, not the loan rates, would become the return to Mexican suppliers as they gain full access to the U.S. market by 2008. If market conditions dictate prices below loan rates, this would dampen Mexican investment in export production capacity.

Marketing loans would also ease adjustment to future multilateral trade liberalization. Domestic sugar producers would be ensured of compensation for any decline in prices if WTO negotiations or other trade agreements result in larger quantities of sugar imports by the United States as one part of a broad-based expansion of market access for agriculture.⁵

Thus, marketing loans achieve some but not all of the positive objectives of a direct payments policy, while providing a guaranteed price to producers. Marketing loans should appeal to producers for this reason.⁶

Fixed direct payments and lower loan rates

To guarantee prices to producers at current loan-rate levels under a marketing loan approach may turn out to be unfeasible. If the principal market force putting downward pressure on prices is farmers' increased ability to supply sugar when current loan rates set the price incentive for production, then a marketing loan program with current loan rates will prove to be expensive every year.

An alternative direct payments option is to implement fixed direct payments based on historical production, and lower loan rates. Under this approach farmers would have a choice about whether to continue to produce sugar, but still receive payments. Price incentives determining production decisions would be market-based, with loan rates lowered to below expected market prices in most years. A safety net could be provided by accompanying the fixed direct payments with a marketing loan program based on the lower loan rates. These are not new policy instruments, but their application to sugar would be new.

A practical difficulty in implementing a fixed direct payments policy is determining the initial support expenditures. If existing loan rates are reduced, payments could be set as high as the differences between the old and new values. But market prices might not fall as much as the loan rates, or if they do, might not remain at those levels. In any case, the level of direct payments has to be determined in advance of market outcomes that are hard to forecast.

One option Congress should consider is a "25/50" proposal: reduce loan rates by 25 percent and provide fixed compensation payments of 50 percent of the change in loan rate. Loan rates would be reduced from $0.18 to $0.135 for raw cane sugar, and from $0.229 to $0.172 for refined beet sugar. Initially, the payments could be made on an emergency basis, similarly to market loss payments made for other crops because of low agricultural prices. Payments would be based on average production during 1997-99. Estimated cost would be around $450 million per year if there is full participation. And with compensation payments enacted as emergency spending, the option would be retained to reduce or eliminate the payments in the 2002 farm bill, or to convert them to a more permanent basis.

It is Time to Reform Sugar Policy

I have argued briefly that it is time to reform sugar policy. Existing policy operates through loan rates intended to set a price floor and import controls that have kept domestic market prices up. Under these policies, sugar imports spiraled downward when HFCS displaced sugar consumption in the 1980s, and import levels have been managed to support domestic prices ever since. Adjustments to larger domestic supplies relative to domestic demand have been pushed onto foreign suppliers, but the room to do this has run out.

It is time to adopt polices for sugar that allow more domestic market flexibility in the short run, and can facilitate multilateral trade liberalization in the long run. If excess supplies relative to demand in 2000 were a passing phenomena, perhaps the traditional policy instruments of stock accumulation or marketing allotments could be brushed off and used effectively. But for many reasons it is likely that often there will be large supplies at current domestic price levels.⁷ Under this circumstance, the storage and production control approaches will eventually fail.

If sugar markets were more open worldwide, a case could be made for full elimination of domestic support and border constraints. Such open markets remain an elusive long-term goal of international negotiations, so an interim policy is needed.

Domestic policy can be reformed to provide market flexibility and producer support within the context of existing international commitments. I have outlined applications to sugar of direct payment policies that can achieve these objectives. Thank you for your attention. I will be happy to respond to any questions.

Reference Notes

¹ The economic effects of sugar production under high domestic prices maintained by import restrictions have been evaluated in numerous studies. Specific outcomes differ with 1) world market conditions (which have varied markedly, in part due to the interventions in the United States and elsewhere), 2) how responsive production and demand are to prices (supply and demand elasticity assumptions), and 3) other aspects of model specification. An overall message of these studies is that price support policies generate aggregate gains for producers (which can be large per farm because of concentrated production), aggregate losses to consumers (small on a per-capita basis), and net losses to society.

While it is beyond the scope of this testimony to reconcile the results of various empirical analyses, three careful recent studies illustrate the types of results often derived. Borrell (1999) utilizes a detailed multilateral model delineating 24 countries/regions and seven classes of sweeteners to examine the long-run price, trade and welfare effects of full liberalization of world sugar markets. In his analysis, multilateral liberalization results in a 25-percent decline of the U.S. sugar price, while the world price rises by 38 percent. U.S. imports increase around 5 million metric tons with liberalization. Consumer gains are nearly $1.2 billion for the United States, while U.S. producer income falls by $0.7 billion, leaving a net estimated gain of $0.5 billion. Worldwide net gains are nearly $5.0 billion.

Haley (1998) constructed a more detailed U.S. model with separate short-run (processing capacity fixed) or long-run (processing capacity adjustable) supply functions for nine domestic regions, and a complex three-stage demand structure for six types of industrial sweetener users and a two-stage structure for non-industrial sweetener consumption. Foreign excess supply is compressed into an aggregated elastic upward-sloping function. For a unilateral liberalization by the United States, Haley also finds a domestic price decline of around 25 percent. His equations yield a fairly price-responsive (but still inelastic) demand structure. When the U.S. price falls, domestic production declines by 2.5 million tons (28 percent) in the long run. Demand expands nearly proportionately to the price decline, so imports rise by almost 5 million tons, causing the world price to nearly double. Haley estimates smaller consumer gains ($0.67 billion) and total producer losses ($0.64 billion) than does Borrell for multilateral liberalization. Haley notes that his demand structure is the most obvious difference between his study and those indicating larger distributional and net effects from changes in sugar policy.

The most recent modeling study of the economic effects of the sugar program was conducted by the GAO (2000). The study utilizes the CARD global sugar model from Iowa State University, augmented to include domestic supply linkages to the corn, HFCS and wheat markets, and to evaluate separate effects on domestic cane and beet producers, corn producers, sugar beet processors, HFCS producers, and cane refiners. The GAO estimates that the sugar program cost domestic sweetener users $1.5 billion in 1996 and $1.9 billion in 1998, while cane and beet producers received benefits of about $0.8 billion in 1996 and $1.0 billion in 1998. For unilateral U.S. liberalization, this study finds that domestic raw and refined sugar prices fall around 40 and 25 percent, respectively, while world prices rise 10 to 20 percent. With highly inelastic supply and demand assumptions, domestic harvested acreage falls by less than 5 percent, while imports rise by 1.1 to 1.6 million tons.

² The Uruguay Round GATT Agreement on Agriculture guaranteed minimum agricultural market access under low-tariff TRQs, together with limited commitments to expand this access and to reduce high (often prohibitive) over-quota tariffs through 2000. Sugar imports by the United States exceed the general TRQ minimum market-access guarantees of 3-5 percent of domestic consumption. The U.S. made a commitment instead to a minimum sugar TRQ of 1.256 million short tons raw value. (A commitment to imports of 1.25 million tons had previously been included in the 1990 farm bill.) U.S. imports were expected to continue to exceed this level, so the Uruguay Round commitment by the U.S. was not viewed as a significant trade liberalization step. The Uruguay Round Agreement also prohibits introduction of new export subsidies. This precludes the United States from adopting a European Union (EU) type of regime, both importing sugar under high domestic prices to meet its Uruguay Round commitment and selling domestically-produced sugar at a lower world price with an export subsidy.

Under NAFTA, agricultural products are included in the long-run goal of eliminating barriers to trade with Mexico. Elimination of agricultural trade barriers is being accomplished over adjustment periods of five to fifteen years, with the most highly-protected commodities in each country subject to the longest phase out of that protection. For sugar, complex adjustment-period rules were first negotiated to postpone a common market between Mexico and the United States. These rules were revised in a "side letter" detailing adjustment-period commitments between the two countries. Thus, issues arise concerning the operative rules during the adjustment period to 2008, and with respect to the final agreement for elimination of sugar trade barriers.

U.S.-Mexican sweetener trade flows during the adjustment period have remained mired in conflict. Mexico protects its sugar sector, and under this regime Mexican output increased from a low level of 3.8 million metric tons raw value in 1994 to over 5 million tons by 1998. As Mexican sugar output has expanded, different views have emerged about the commitments in NAFTA and the side letter regarding duty-free Mexican access to the U.S. market under a TRQ. Meanwhile, the high U.S. tariffs on sugar imports outside of TRQs have been falling for Mexico under NAFTA: from 16 cents/pound in 1994 to 12.9 cents/pound in 2000 for raw sugar, with further declines scheduled in following years and the over-quota tariff to be eliminated completely in 2008.

While much of the recent U.S.-Mexico disputes and consultations over sugar has focused on short-term access questions, the common market that emerges in 2008 looms ever closer on the horizon. Once the tariff phase out is completed, NAFTA and the side letter contain no explicit trade restraints, other than imposition by Mexico and the United States of a common external tariff. In principle, if Mexican sugar production were to exceed domestic consumption at that time, the full excess could flow into the U.S. market.

³ The average payment per farm by state per penny of marketing loan would be, for sugarcane: Florida $279,600; Hawaii $584,615; Louisiana $45,815; Texas 19,417; and for beets: California $20,045; Colorado $7,660; Idaho 15,940; Michigan $7,870; Minnesota $16,780; Montana $9,690; Nebraska $9,970; North Dakota $17,230; Ohio $1,820; Oregon $8,140; Washington $41,030; and Wyoming $9,100. These calculations are based on 1999 production levels and the 1997 Census of Agriculture estimates of the number of farms growing sugarcane or sugar beets, as reported by GAO, Table 3, June 2000.

⁴ The basic comparison is between the return from forfeiture versus the return from selling in the market. The return from forfeiture is the cane or beet sugar loan rate (which are subject to slight regional adjustments). For raw cane sugar, the return from selling is the market price less interest paid on the loan, transportation costs incurred moving sugar to the refiner, and some location discounts charged by refiners. For beet sugar, the return from selling is the market price less interest paid on the loan and certain cash discounts. The difference between these returns vary by region. See GAO, Appendix II, July 1999.

⁵ While the outcome of the current WTO agricultural negotiations cannot be prejudged, it is reasonable to expect that a modest goal to expand TRQs multilaterally will be adopted. An increase of TRQs by 50 percent as a share of domestic agricultural markets would raise low-duty market access minimums from 5 to 7.5 percent of consumption. An equivalent expansion factor applied to the U.S. minimum import commitment for sugar would raise the obligation to 1.884 million tons. An increase of one-fourth would raise the minimum access commitment to 1.565 million tons. Such minimum import levels did not seem to threaten the U.S. sugar program when the Uruguay Round was completed, but are not being achieved in 1999 and 2000. Over-quota tariffs are also likely to be negotiated down, making circumstances more likely under which imports outside of the TRQ are possible.

⁶ With marketing loan payments tied to production, they count in the U.S. aggregate measure of support and do not qualify as a non-distorting WTO "green box" policy. To limit budget exposure and reduce production incentives, one option would be to limit loan deficiency payment eligibility to average production levels from the three-year period 1997-99. This would provide compensation related to market price levels for historical production, but would make the market price, not the loan rate, the incentive determining decisions about additional production. Such a "limited" loan deficiency payment program would require recourse loans for the output not eligible for payments (in order to avoid possible forfeitures). This program would therefore be different from current loan programs for other crops.

⁷ Domestic sugar production has shown an upward trend throughout the 1990s that is particularly steep since 1997. Over the full period, cane output has increased primarily due to high yields in Florida and rising acreage and yields in Louisiana. Beet output has increased due to increased acreage in the upper Midwest, and due to recently high yields. Domestic sugar consumption has also grown in the 1990. Whether there is downward pressure on domestic prices in the future given international import commitments depends on this supply/demand balance. It is likely that supply will exceed demand in many years if the current sugar program is continued with loan rates at existing levels. Proposals to shift to direct payments to support sugar producers have been made before, but never in circumstances with such persistent prospect for pressure of supply on demand and no room to cut imports.

References

Borrell, Brent. "Sugar: The Taste Test of Trade Liberalization." Paper presented at the World Bank/WTO Conference on Agriculture and New Trade Agenda in the WTO 2000 Negotiations, Geneva, Switzerland, October 1999.

GAO. "Sugar Program: Supporting Sugar Prices Has Increased Users' Costs While Benefiting Producers." GAO/RCED-00-126, June 2000.

GAO. "Sugar Program: Changing the Method of Setting Import Quotas Could Reduce Cost to Users." GAO/RCED 99-209, July 1999.

Haley, Stephen L. "Modeling the U.S. Sweetener Sector: An Application to the Analysis of Policy Reform." Working Paper 98-5, International Agricultural Trade Research Consortium, July 1998.

Haley, Stephen L. "U.S.-Mexico Sweetener Trade Mired in Dispute." Agricultural Outlook, September 1999.

Jabara, Cathy and Alberto Valdes. "World Sugar Policies and Developing Countries." In The Economics and Politics of World Sugar Policies (Stephen V. Marks and Keith E. Maskus, eds.). Ann Arbor: University of Michigan Press, 1993.

Krueger, Anne. "The Political Economy of Controls: American Sugar." NBER Working Paper W2504, November 1991.

Orden, David. "Agricultural Interest Groups and the North American Free Trade Agreement." In The Political Economy of American Trade Policy (Anne Krueger, ed.). Chicago: University of Chicago Press, 1996.

Orden, David, Robert Paarlberg and Terry Roe. Policy Reform in American Agriculture: Analysis and Prognosis. Chicago: University of Chicago Press, 1999.

Schmitz, Andrew. "The U.S. Sugar Program under Price Uncertainty." Occasional Paper, American Enterprise Institute, November 1984.

Sturgiss, Robert, Heather Field and Linda Young. "1990 and U.S. Sugar Policy Reform." ABARE Discussion Paper 90.4. Canberra: Australian Government Publishing Service, 1990.

USDA. A Report of the Special Study Group on Sugar of the U.S. Department of Agriculture. Washington D.C.: U.S. Government Printing Office, February 1961.

USDA. "Sugar and Sweeteners Outlook Report." Washington D.C.: Economic Research Service, May 2000.