THE WORLD BANK RESEARCH OBSERVER 1V7503 Trade Policy and Productivity Gains in Developing Countries: A Survey of the Literature Oli Havrylyshyn Iptions for Dismantling Trade Restrictions in Developing Countries Wendy E. Takacs South-South Trade: Theory, Evidence, and Policy David Greenaway and Chris Milner The Interwar Debt Crisis and Its Aftermath Barry Eichengreen and Richard Portes The Common Agricultural Policy: A Review of Its Operation and Effects on Developing Countries Ulrich Koester and Malcolm D. Bale TH{E WORLD BANK RESEARCH OBSERVER EDITORS Richard H. Snape, Ravi Kanbur COEDITORS Hans Binswanger, Vittorio Corbo ASSISTANT EDITOR Clara L. Else MEMBERS OF THE EDITORIAL BOARD Juergen Donges (Kiel Instirute of World Econom- ics, Federal Republic of Germany), Mark Gersovitz (Princeton University, United States), Bahram Nowzad (International Monetary Fund), Vittorio Corbo, Dennis N. de Tray, Enzo Grilli, Ravi Kanbur, Peter Muncie, George Psacharopoulos, Richard H. 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The World Bank Research Observer is indexed by the Journal of Economic Literature, the Standard Periodical Directory, the Public Affairs Information Service, Inc., and, online, by the Economic Literature Index and DIALOG. It is available in microform through University Microfilms, Inc., 300 North Zeeb Road, Ann Arbor, Michigan 48106, U.S.A. TuSEWORLD BANK RESEARCH 013SERVER VOLUME 5 NUMBER 1 JANUARY 1990 Trade Policy and Productivity Gains in Developing Countries: A Survey of the Literature Oli Havrylyshyn 1 Options for Dismantling Trade Restrictions in Developing Countries Wendy E. Takacs 25 South-South Trade: Theory, Evidence, and Policy David Greenaway and Chris Milner 47 The Interwar Debt Crisis and Its Aftermath Barry Eichengreen and Richard Portes 69 The Common Agriculturall Policy: A Review of Its Operation and Effects on Developing Countries Ulrich Koester and Malcolm D. Bale 95 TRADE POLICY AND PRODUCTIVITY GAINS IN DEVELOPING COUNTRIES A Survey of the Literature Oli Havrylyshyn Despite the widely accepted view that liberal, outward-oriented trade policies are superior to restrictive, inward-oriented policies, doubts about liberalization remain strong in many circles. One reason for such doubt is the dearth of re- search quantifying the large gains that liberal trade policies are said to gener- ate. The survey of the literature undertaken for this article was a review of the evidence on the link between trade policy and efficiency, or productivity, gains in developing countries. Does the literature support the view that more open trade policies bring greater efficiency? Several inferences are drawn from the literature on sources of growth-particularly with regard to increases in capac- ity utilization and economies of scale. The article also examines evidence from the few studies that explicitly try to correlate efficiency gains directly with trade policy. These studies fall into three categories: those that evaluate the effect of trade policy on market power or degree of competition; those that measure total factor productivity or technical efficiency gains and correlate these with the degree of protection; and those that estimate the aggregate ef- fects of changes in trade policy on welfare (mainly with computable general equilibrium models, which measure dynamic efficiency gains from trade). In a final section, the article pulls together the findings from the indirect and direct evidence as a basis for suggesting a number of hypotheses on the link between efficiency and trade policy. One conclusion is that country-specific analysis over time appears to be superior to cross-country comparisons. The World Bank Research Observer, vol. 5, no. I (January 1990), pp. 1-24 Net position of member -398.2 -459.8 -3,033.1 1,519.0 -40.1 434.8 487.2 924.1 -1,337.0 1008.2 n.a. > Balance per capita (ECUs) -40.6 -8.4 -49.6 26.6 -100.2 30.2 95.5 256.7 -23.7 101.8 n.a. X Balance as share of GDP (percent) -0.41 -0.07 -0.39 0.35 -1.03 0.28 0.70 4.40 -0.25 2.42 n.a. ECU = European currency unit. GDP = gross domestic product. n.a. = not applicable. Note: 1984 is selected as a representative year. O a. Inicludes tariffs, levies on agricultural products, tax-value added (TVA) shares, and financial transfers. h. Represents actual payments to the member states. Sources: Comumission of the European Communities, 1984; Statistical Office of the European CommTLnities, 1984, 1986; Audit Office of the European Communities, various years. C 9. '0 Less visible than the CAP's effects on the budget-but not less significant- are the implications for efficiency and distribution. The effects of the CAP on the allocation of resources and hence on the total income of the EC, on con- sumption patterns, on the distribution of income among individuals and among member countries, and on the EC's trading partners matter very much, measured against a norm based on free trade at world market prices where resources are valued at their international opportunity cost. The empirical studies on the costs of the CAP up to 1987, summarized by Demekas (1987) (see table 6), all convey the same message: agricultural policy in the EC is inefficient in transferring income from consumers and taxpayers to farmers. To transfer one additional dollar to the farm sector costs consumers and taxpayers $1.20-$2.20. If all the money were given directly as a supplement to their income, it would more than double every (full-time) farmer's income, and that per-farmer expenditure is not only higher than actual farmer income-it even exceeds average income in the nonfarm sectors. Even budget outlays, which are only a part of the total loss of the nonfarm sectors, are already higher than net value added of the farm sector. Implications of the CAP for Developing Countries The CAP directly affects individual developing country exporters to the EC through the impact of its protective measures on prices and EC demand for spe- cific agricultural exports. Likewise, food importers get better access to EC food because food availability in the EC is improved. Thus the direct effect of the CAP certainly implies a redirection of trade flows. However, these direct effects would only be of concern for developing countries if there are consequential indirect effects which matter a great deal to developing countries. These indi- rect effects include (1) depressed world market price level and distorted price ratios on the world market, (2) increased instability on world markets and in- creased uncertainty mainly for exporting countries, and (3) preferential agree- ments and the distortions they generate. Some of the effects (such as preferential trade agreements) are positive for specific products in many developing countries. Others-arising from de- pressed world market prices and increased instability-are negative, though less visible. To assess the overall effect of the CAP on individual developing countries, its effect on world markets needs first to be investigated. The Effect of the CAP on World Agricultural Prices There are alternative approaches to quantifying the CAP's effect on world market prices, and different approaches lead to different results. The answer to the question, What would world market prices be today if the CAP had been Ulnch Koester and Malcolm D. Bale 109 Table 6. Effects of the CAP on Welfare in EC Member Countries (billions of 1980 U.S. dollars) Effect on Effect on Effect on Model Policies consumers taxpayers producers Total effect Source Commodities Countries structure considered Year (1) (2) (3) Absolute Relative Koester & Schmitz (1982) Sugar EC-9 I'E CAP 1978-79 - - - -0.4 Morris (1980) Main CAP EC-9 PE CAI' 1978 -43.5 -10.7 38.6 -15.6 -053% of commodities h EC-9 GDP Thomson & Harvey All CAP EC 9 PE CAP 1980 - - - Transfer (1981) commodities ratio of 1.77c Bureau of Agricultural All CAP EC-9 PE CAP and 1978 -35.4 -18.1 44.1 -9.4 -0.48% of Economics (1985) commodities domestic EC-9 GDP EC:-10 PE CAP anid 1983 -25.6 -20.8 39.7 -6.7 -0.32% of domestic EC-10 GDP < Buckwell and others All CAP EC-9 PE CAP 1980 -34.6 -11.5 30.7 -15.4 -0.55% of (1982) commodities EC-9 GDP a Anderson and Tyers Rice, wheat, EC-9 PE CAP 1980 -44.0 -0.9 13.9 -31.4 -1.1% of (1984) coarse grains, EC-9 GDP ruminant and ; nonruminant meat 7 Anderson and Tyers Rice, wheat, EC-10 PE CAIP and 1985 -49.0 -2.2 27.2 -24.1 -1.3% of (1984) coarse grains, domestic EC-10 GDP or ruminant and transfer ;r- nonruminant meat, ratio of 1.88c ° dairy, sugar % Spencer (1986) All CAP EC-9 GE CAP 1980 - - - Approx. -0.9% commodities of EC-9 GDP Burniaux and All CAP EC-10 GE CAP 1995 - - - -2.7% of ° Waelbroeck (1985) commodities EC-10 GDP 3 -= not available. GDP = gross domestic product. Note: See notes to table 4 for definitions of EC-9 and EC-10. a. I'E: partial equilibrium (single- or muLltisector); GE: general equilibritim. b. The Thomson and Harvey (1981) results are for 1980, but their model used data from 1975 for calibration. c. The transfer ratio is defined as the cost to the economy of increasing farmers' income by one uniit; in other words, the sum of columnis 1 and 2 divided by column 3. d. Includes change in net government revenue and profits from storage. liberal from the very beginning?, prompts quite different conclusions from the response when we ask, How might a liberalization of the CAP today affect world market prices? The answer to the first question is that the protection of EC agriculture for more than twenty years has created a positive production climate for the in- ternal agricultural sector. Resources have flowed into the sector, and the rate of induced technical change was enhanced. Higher prices increased the demand for new technologies and have led to more intensive agricultural research. Hence protectionism is partly responsible for the growth of production in the EC. EC agricultural exports would have been lower and EC agricultural imports higher with a less interventionist policy. Thus world market prices are de- pressed compared to what they might have been without the CAP. Using the second question-how liberalization of the CAP today would affect world market prices-as the point of reference leads to different infer- ences. The effect on world market prices would be different because past pro- tection influenced the rate and direction of technological change and thereby altered the structure of the agricultural sector. In the EC the gap in efficiency between efficient and less efficient farms has increased over time. A reduction in the level of agricultural prices would not simply cause a move down the sup- ply curve; it would lead to structural change in the agricultural sector as effi- cient farmers expanded to absorb the land, machinery, and workers released as the less efficient farmers moved out of agriculture. The result in the long run would be an increase in supply even in some instances in which prices de- clined. The hypothesis cannot be tested against EC data because EC agriculture has never experienced such a significant change. But the experience of New Zealand (an industrial country that recently undertook a major liberalization) and of Germany (which instituted smaller changes) may be instructive. In New Zealand, price reductions in real terms ranged from 15 to 63 percent for indi- vidual agricultural products from 1984 to 1986. But aggregate agricultural sup- ply still grew, although at different growth rates for individual commodities (Koester 1988). The structural effect-the increase in efficiency-apparently offset the effect of lower prices. In Germany, real wheat prices declined by 22 percent between fiscal 1980-81 and fiscal 1986-87, and real agricultural prices fell by 15 percent over the same period. But wheat production increased by 27 percent, and total agricultural production (in grain equivalents) in- creased by 12 percent over the period, despite the introduction of a milk quota system in 1984. There are some indications that EC agriculture might react similarly. EC ag- riculture is inefficient (in the economic meaning of the term): the sector could produce more with less labor and capital if less efficient farms were overtaken by more efficient farms. In the long run, however, the sector's production would most likely grow more slowly or even decline, because agricultural land would be used less intensively and more land would be allocated to Ulrich Koester and Malcolm D. Bale 1ll nonagricultural use. And agricultural research would become less profitable, so that the effect of technical change would become less over time. The recent experience of New Zealand indicates that the composition of agricultural supply may change rapidly if the overall price level drops and rel- ative prices change. Hence if the CAP is liberalized some short-run effects on world market prices may show up, particularly in those markets in which EC demand on the world market changes owing to adjustment in internal demand. World market prices for animal feed would be affected the most quickly, and possibly hit hardest, in the short run. Because of high internal grain and livestock prices, the EC imported 37.8 million tons of animal feed in 1984, of which 60 percent originated in developing countries. These imports would fall in response to lower world prices. Short-run losers from this change in the world market price would be the oil cake-exporting countries such as Argentina, Brazil, India, Indonesia, Malaysia, and the Philippines and the main cassava-exporting countries such as Indonesia and Thailand. Gainers in the short run would be the oil cake-importing economies such as the Republic of Korea, Mexico, and Venezuela (Matthews 1985b, p. 21). But even the short-run losers could ultimately gain from such an EC policy if they adjusted their policies and output mix to respond to improved access to EC markets. Benefits could even show up in those markets in which world market prices dropped in the first place as a result of changes in the EC's pat- tern of protection. Currently EC tariffs escalate the more heavily processed the product. For example, the tariff on soybeans is 0 percent, on soymeal 7 percent, on crude soybean oil 10 percent, on refined soybean oil 15 percent, and on margarine 25 percent (Moyes 1988, p. 9). Liberalization of the CAP would give exporters of animal feed, such as soybeans, an opportunity to export more pro- cessed soybean-based products to the EC, given some internal adjustment by the developing country exporters. Furthermore, the effects of the CAP on developing countries depend on how other countries react to policy change in the EC-especially the other main ac- tor on world agricultural markets, the United States. The relation between United States and EC agricultural policy is illustrated in figure 2 and described in the following. The United States protects domestic sugar producers by imposing an import quota on sugar. Domestic sugar prices go up, which creates a market for sugar substitutes such as isoglucose and sweetener. Isoglucose production (from maize) yields the by-product corn gluten, a protein-rich animal feed, which, when mixed with a cheap carbohydrate, is a perfect substitute for cereals. The direct effect of these policies on the world market is that prices and trade vol- umes for sugar and protein feed are depressed. The high grain prices in the EC, combined with low prices for corn gluten, create a market for cassava, to the advantage of developing country exporters. And low feed prices in the EC in- crease the exportable surplus of grains, further lowering world grain prices, with a positive effect for some developing countries (importers) and negative 112 The World Bank Research Observer, vol. 5, no. I (January 1990) Figure 2. EC and U.S. Protection of Agricultural Thade and Its Effect on World Market Prices Effect on world market prices -- ~~~~~~~~~~Actions in the Actions in the EC Of Ec-policy Of U.S. policy United States Price support _ Decline of Decline of Import quota for grains, meats, grain, meat, sugar prices for sugar and dairy and dairy prices Increase in internal sugar prices Imports of f Increase in animal feed animal feed prices Further Isoglucose decline of production sugar prices becomes profitable Decrease in Further decline demand for of grain prices feed grain 4 Increase in Further decline Decline of By-product corn production of of meat and prices for gluten feed meats and dairy prices protein feed comes on dairy the market T ~ ~ ________ + Imports of corn _ Exports of corn gluten feed gluten to the EC for others (exporters). In addition, EC production of dairy and livestock prod- ucts increases, adding to further distortions on world markets. The effects of EC protection on developing countries, then, depend partly on the structure of protection in other countries-above all in the United States. And how a policy shift in the EC might affect individual developing countries depends materially on how each adjusts its internal policies to any resulting change in world market prices. Such a change is unlikely to show up over the first few years, but world market prices will certainly be affected after full ad- justment in the EC has taken place. In sum, the net results of a liberalization of CAP are impossible to predict because they will be determined by numerous possible policy reactions of other countries and by the developing countries themselves. Ulrich Koester and Malcolm D. Bale 113 Some Empirical Estimates The uncertainties just described obviously limit the value of empirical work on the potential effect of changes in the CAP on world market prices. And use- ful prediction is also hampered because most of the available research has employed partial equilibrium models, which do not allow for full efficient ad- justment throughout the economy, whereas the effects described here can clear- ly be captured only in a general model. With these caveats in mind, the results of estimates (presented in table 7 along with an estimate of change in EC prices) must be regarded as merely indicative of what might happen to world prices after a longer period of adjustment in EC agriculture. The results of the estimates of world prices differ significantly because of differing assumptions about supply and demand reactions in the EC and its trading partners. Matthews (1985a) underestimates the degree of protection, mainly for cereals, because he uses the EC cost, insurance, and freight price (which includes full insurance, shipping, and delivery charges) as the relevant world market price whereas the free on board price would have been more appropriate since the EC is an exporter of wheat and barley. Anderson and Tyers (1984), conversely, overestimate the degree of protection for cereals be- cause they assume the EC threshold price is the relevant EC market price, whereas in fact EC market prices are lower than threshold prices because of internal surpluses. The results nevertheless confirm the CAP's depressing effect on world market prices. Table 7. Projected Changes in World Market Prices Arising from Liberalization of the CAP (percent) Change in world market prices Anderson Change in Product Matthews and Tyers Koester EC prices Wheat 1.4 13.0 4.6 -19.7 Barley 12.4 16.0 - -31.6 Rice 0.2 5.0 - Sugar 2-12 - 9.7 -20.4 Beef 5.5 17.0 10.5 -34.0 Mutton and lamb 5.0 - - Poultry 10.3 1.0 6.2 -30.0 Pork 7.8 1.0 5.5 -49.3 Butter 20-25 - 28.3 -46.9 Skim milk powder 15-20 - - -45.1 -= not available. Sources: Change in world prices: Matthews, 1985a, p. 141; Anderson and Tyers, 1984, p. 374; Koester, 1982, p. 237. Change in EC prices: Buckwell and others, 1982. 114 The World BankResearch Observer,vol.5,no. 1 (January 1990) A liberalization of the CAP would reduce welfare in net food-importing countries and enhance it in net food-exporting countries (see the results derived by Matthews for EC grain trade liberalization shown in table 8). Effects on welfare arise flrom changes in benefits to producers and consum- ers as well as from changes in terms of trade. EC protection of grain is partic- ularly important both because grain is a keystone in EC agricultural production and also, for trading partners and especially for developing countries, because it is the most heavily traded temperate-zone product. Some models of agricultural trade changes in the EC take into account the interdependency between markets. The work of Tyers and Anderson (1988) in- cluded seven product groups, and the International Institute for Applied Systems Analysis (IIASA) model incorporated ten groups, including the nonag- ricultural sector. Tyers and Anderson estimated a 15 percent increase in world market prices for the aggregate of seven commodities in 1988-90 if the CAP were liberalized. But the results do not allow us to draw conclusions about the effect of a CAP liberalization on the developing countries because the product groups included-(1) wheat, coarse grain, rice, and meat; and (2) dairy prod- ucts and sugar-are mainly products of which the developing countries are net importers. The results of the IIASA model indicate that, in aggregate, developing coun- tries might lose from a liberalization of the CAP. Grain prices would rise, con- sumption would fall, hunger would increase. But the findings are questionable. First, on the evidence of an anomalous aggregate supply response observed in New Zealand, and given the present structure of EC farming, the predicted de- cline in EC production is not certain. Second, developing countries' agricultural Table 8. Effects on Welfare of EC Trade Liberalization in Cereals (millions of U.S. dollars) Country group Wheat Maize Barley Rice Total' Net exporters Industrial countries 99 45 41 2 186 Developing countries 5 8 3 3 19 Low income 0 0 0 1 2 Middle income 0 2 3 1 6 High income 5 6 0 0 12 Net importers Industrial countries -44 -36 -40 -1 -121 Developing countries -87 -8 -33 -4 -143 Low income -41 -6 -2 -1 -50 Middle income -15 -3 -3 -1 -21 Note: Based on 1980 prices and quantities and on estimated elasticities for 1980. a. Total includes minor cereals. Source: Matthews, 1985a, p. 120. Ulricb Koester and Malcolm D. Bale 115 export sectors and the corresponding EC import regime are not adequately cov- ered in the models. Third, the derived effects on hunger are based on the assumption that changes in world market prices will be passed on to the do- mestic markets, so that hunger may even increase in a country whose income has risen as a result of changes in the terms of trade. Burniaux and Waelbroeck (1985) conclude the opposite: that developing countries would gain from EC liberalization. Their conclusion may partly be the result of the inclusion in their calculations of fruits and vegetables, impor- tant exports of developing countries to the EC, vvhich would, they predict, re- ceive a 16.3 percent boost in price. The available empirical estimates, then, are markedly divided on how devel- oping countries as a whole would be affected by changes in the terms of trade following CAP liberalization. The main shortcomings of the models are: (1) the final stable equilibrium in EC production is not easily modeled and therefore not accurately predictable; (2) the export commodities of developing countries are not analyzed at a sufficient level of disaggregation to provide useful results; (3) the models do not take into account the present negative effects of tariff escalation, an integral part of EC protectionism, on further-processed products; (4) the conclusions are based only on price effects; they do not explicitly take into account the CAP'S effect on the stability of world market prices and the increase in uncertainty owing to the operation of the CAP. The last is a signif- icant flaw, since the detrimental effect of instability and increased risk on pro- duction may be especially harmful for developing countries. The CAP and Instability in World Market Prices Empirical research (Koester 1982 and Bale and Lutz 1979) has shown that the CAP has increased instability on world markets because of the price- insulating policy and inadequate stockpiling within the EC. In ensuring that domestic prices vary only marginally from year to year, the CAP removes the incentive for private traders within the EC to hold carryover stocks. And since domestic prices are completely disconnected from world market prices, and private exporters always receive an export subsidy to make up for the differ- ence between domestic and world market prices, expectations about world market prices are irrelevant for private EC stockholders (Koester 1982). It is likely, too, that the EC's stockpiling behavior has an effect on stock- holding in non-EC countries. Uncertainty about future world market prices in- creases stockholding in the rest of the world, so that, in contributing to greater uncertainty on world markets, the EC has affected stockholding in non-EC countries. The annual EC policy and pricing exercise produces uncertainty be- cause decisions are unpredictable and have a significant effect on world prices. Thus through its policies, the cost of holding stocks larger than would be held if the EC did not insulate its agriculture is thrown onto the rest of the world. 116 The World Bank Research Observer, vol. 5, no. I (January 1990) Determinants of Change and Policy Options The 1980s have seen sonme changes in the CAP, largely driven by budgetary concerns. Before the 1980s the policy had changed little. This section looks at what may determine future changes and what form and direction they are like- ly to take. The Impetus for Change Several potential motivations for change exist. The objectives of policymakers may change for two reasons. First is that en- vironmental effects are becoming more important in decisionmaking. Those often called Greens advocate a policy that leads to less intensity of production, fewer so-called agricultural factories (which should be taxed), and more family-owned farms (which should be subsidized). Large-scale production of livestock would be forbidden, and land subsidies would be given as compen- sation for farming activities that enhance the environment. Second is a shift in perception of the goal for agricultural income. In the 1950s and 1960s, policy- makers aimed at parity of per capita income in agriculture with income outside agriculture, an objective that turned out to be unattainable. The goal now is relative parity: the change in agricultural income should be the same as the change in nonagricultural income. Financial constraints have changed. In every EC country, budget pressures are a driving force for policy change. The commission's access to financial re- sources increased significantly in 1986 and 1988, but further increases beyond the present agreed ceiling are unlikely to be feasible politically. This constraint holds for the commission budget but not for policy measures financed directly by individual member countries, an important qualification discussed in the following. International commitments are a pressure for change. Article 16 of the GATT in particular constrains the CAP. This article permits subsidies on exports of primary products only if these do not bring the country concerned a more than equitable share in world trade in that product. To avoid breaking this rule, the EC will have to take specific measures to manage domestic markets. Prices may have to be reduced to curtail production growth arising from technological change if domestic demand does not expand sufficiently. This constraint may be binding. Changes may occur in the decisionmaking process itself. The specifics of the decisionmaking process in the EC may be a principal determinant of the way the CAP will go (see Petit 1985). The unanimity rule has meant that changes in the CAP may arise because they are in the interest of an individual country rather than of the EC as a whole. As the number of members has increased, the divergence of interests has increased. This, in fact, along with the recent acceptance of majority rule by the Council of Agricultural Ministers, has Ulrich Koester and Malcolm D. Bale 117 strengthened the influence of the commission. Even so, given the binding bud- get constraint, if individual members find majority decisions unacceptable from their national point of view, the tendency to nationalize agricultural policies will continue. Policy instruments are becoming less effective and less appropriate. This is especially true of price supports, as the main instrument of agricultural income policy, and of variable levies, as the main border measure. Price support policy has become less effective because (1) the enlargement of the EC from six to twelve members has made European agriculture more heterogeneous-it is harder to achieve the same agricultural income target in all EC countries; and (2) EC agriculture now relies more on purchased inputs and rented land, so that more of the benefits of price support are going to inputs and less to farm operators than in earlier years. Policy Options: Prospects and Possibilities Some authors, however, see little prospect for fundamental change. They ar- gue that "despite all the comment, all the criticism, all the ideas on reform, the policy is fundamentally unaltered" (Fennell 1987, p. 62). This is true in many respects, but there have been some straws in the wind of change: in 1984 sup- port prices were lowered for the first time (by 0.5 percent); since then, support prices have been lowered in three years, by 0.3 percent (1986), 0.2 percent (1987), and 0.1 percent (1988) and increased only once, by 0.1 percent (1985) (Commission of the European Communities 1989). Thus real support prices have declined at approximately the rate of inflation. Other changes have been less positive. The financial crisis of the CAP has saved expenditure at the EC level but switched the spending to national budgets. The spending of countries such as Germany has increased steeply since 1984. Likewise, the acreage set-aside pro- gram, in shifting expenditure from the EC to national budgets, will encourage the tendency toward uncontrolled nationalization of agricultural policies in the EC (Koester 1981). The CAP, in its present form, must change as experience with fine-tuning the policy demonstrates that its costs, in their totality, cannot be contained. One direction for change-a move toward opening agriculture to world market forces-is attractive to many economists but finds few supporters elsewhere. Not only farmers but also countries that may lose by the redistribution of costs and benefits oppose such a reform. The most recent experience suggests that the set of policy instruments may be expanded. The steps in this direction have a common feature: they have strong effects on distribution and efficiency. For example, the quota system adopted to reduce the milk surplus cut production on small farms by less than that on large farms, and the cereal levy does not apply to small producers and those in less advantaged areas. Consequently, operators of small farms with a substantial nonfarm income receive propor- 118 The World Bank Research Observer, vol. 5, no. 1 (January 1990) tionately greater benefits. These policies retard structural change and discrim- inate against larger farms--further attenuating the efficiency objective of the CAP and the competitiveness of European agriculture. The expanded set of policy instruments is a further impetus to renational- ization of agricultural policies. The richer countries with smaller agricultural populations can afford to pay more to farmers than poor countries with large agricultural populations. The cost of a national agricultural support program to an individual country is less than the cost to the EC of disposing of the sur- plus that such programs generate. Thus individual EC countries can support their farmers and create surpluses, whose cost of disposition is shared by all EC members. Not only will increased national programs require a higher EC budget, but they will affect the willingness of countries to finance the EC bud- get. Radical change in the CAP will be needed to forestall its collapse if present policies continue. All of the numerous proposals for reforming the CAP have a common ele- ment: the substitution of direct transfers for price support. The rationale for this proposed solution is that divorcing farm production decisions from the level of income support aims the policy directly at the target (that is, adequate agricultural supply and income) while eliminating, among other things, indirect distortions of price supports. So far such solutions have been rejected by farm- ers and policymakers, largely because direct transfers of income make so trans- parent the costs to taxpayers and consumers. Taxpayers might, on becoming aware of the size of the transfer, demand tighter limits on the quantity trans- ferred. Yet with countries outside the EC also opposing the CAP in its present form, and the emphasis given to agriculture during the current round of GATT nego- tiations, there is a chance that changes will occur-although the changes are most likely to be marginal ones that respond to specific concerns but do little to address the structural problem. For economists observing the evolution and cost of the CAP it is remarkable that such large annual expenditures can be made without any corresponding structural adjustment in agriculture being re- quired as part of the support. It is important for developing countries as a group to present at the forthcoming trade talks a well-reasoned proposal for reform of the CAP that offers them increased access to the EC market. This is no small task, for two reasons. First, arguments based on worldwide efficiency and economics have swayed EC policymakers little in the past-though this may be changing as the detrimental effects of CAP on world agriculture and on EC welfare are becoming more widely understood within the EC. And second, disparate interests within developing countries prevent them from presenting a unified position. For example, the North African countries with preferential access to the EC for fruit and vegetables would presumably be reluctant to see that preference generalized to all developing countries. But even with the prospect of change in the CAP, developing countries are well advised to be cautious when formulating development plans and when Ulnch Koester and Malcolm D. Bale 119 investing in agriculture. It is not realistic to assume that output destined to be exported to the EC will have unlimited access or even the same access it now enjoys. However desirable that outcome, it is likely to be a long time in com- ing. In the meantime it is incumbent upon policymakers and negotiators in de- veloping countries to understand as fully as possible the operation of and motivation behind the CAP so that they can argue their case in an informed way in international and bilateral fora. The current GATT round will provide an occasion not only for them to use their knovvledge and skills but also for EC policymakers to view EC agriculture in the larger global context. Perhaps with these two influences, more fundamental changes in the CAP are possible. Note Ulrich Koester is a professor of agricultural economics at Kiel University, Federal Republic of Germany. Malcolm Bale is a senior economist in the Latin America and Caribbean Regional Office of the World Bank. References The word "processed" describes works that are reproduced from typescript by mimeograph, xerography, or similar means; such works may not be cataloged or commonly available through libraries, or may be subject to restricted circulation. Anderson, Kym, and Rodney Tyers. 1984. "European Community Grain and Meat Policies: Ef- fects on International Prices, Trade, and Welfare." European Review of Agricultural Econom- ics 11:367-94. Audit Office of the European Communities. Various years. Annual Report of the Budget. Offi- cial Journal of the European Community. Brussels. Bale, Malcolm D., and Ernst Lutz. 1979. "The Effects of Trade Intervention on International Price Instability." American Journal of Agricultural Economics 61:348-50. 1. 981. "Price Distortions in Agriculture and Their Effects: An International Compari- son." American Journal of Agricultural Economics 63:8-22. Buckwell, A. E., D. R. Harvey, K. J. Thompson, and K. A. Parton. 1982. The Costs of the Com- mon Agricultural Policy. London: Croom Helm. Burniaux, Jean-Marc, and Jean Waelbroeck. 1985. "The Impact of the CAP on Developing Coun- tries: A General Equilibrium Analysis." In C. Stevens and J. Verloren van Thematt, eds., Pres- sure Groups, Politics and Development. London: Hodder and Stoughton. Commission of the European Communities. 1984. Annual Economic Report 1984-1985. No. 22. Brussels. . 1988. Die Lage der Landwirtschaft in der Gemeinschaft. Bericht. 1987. Brussels. . 1989. Official Journal of the European Community 32:C128/10. Demekas, D. G. 1987. "The Effects of the Common Agricultural Policy of the European Com- munities: A Survey." International Monetary Fund, Washington, D.C. Processed. Eisenkraemer, Klaus. 1980. "Gibt es politisch realisierbare Alternativen zur derzeitigen EG-Agrarpolitik?" Alternativen zur EG-Preispolitik. Loccumer Protokolle 5:50-69. FAO (Food and Agriculture Organization). Various years. Trade Yearbook. Rome. Fennell, Rosemary. 1987. "Reform of the CAP: Shadow or Substance?" Journal of Common Mar- ket Studies 26, no. 1:61-77. 120 The World Bank Research Observer, vol. 5, no. i (January 1990) Koester, Ulrich. 1981. "Requisites and Possibilities of a Controlled Nationalization of Agricul- tural Policy." Intereconomics 2:61-65. . 1982. Policy Options for the Grain Economy of the European Community: Implications for Developing Countries. International Food Policy Research Institute Research Report 35. Washington, D.C. . 1988. "Comments on R. Lattimore, B. Ross, and R. Sandrey, Agricultural Policy Re- forms in New Zealand." Paper presented at Twentieth International Conference of Agricul- tural Economists, Buenos Aires, August 24-31. . 1989. "Financial Implications of the EC Set-Aside Programme." Journal of Agricultural Economics 40:240-48. Koester, Ulrich, and P. M. Schmitz. 1982. "The EC Sugar Market Policy and Developing Coun- tries." European Review of Agricultural Economics 9:181-202. Matthews, Alan. 1985a. The Common Agricultural Policy and the Less Developed Countries. Dublin: Gill and Macmillan. . 1985b. "The CAP and Developing Countries: A Review of the Evidence." In C. Stevens and J. Verloren van Thematt, eds., Pressure Groups, Politics and Development. London: Hodder and Stoughton. Morris, C. N. 1980. "The Comrmon Agricultural Policy." Fiscal Studies 1:15-35. Moyes, A. 1988. Common Ground: How Changes in the Common Agricultural Policy Affect the Third World Poor. Oxford: Oxfam. OECD (Organisation for Economic Co-operation and Development). Various years. Trade by Commodities. Series C. Paris. Petit, M. 1985. Determinants of Agricultural Policies in the United States and the European Community. International Food Policy Research Institute Research Report 51. Washington, D.C. Spencer, J. 1986. "The European Economic Community: General Equilibrium Computations and Economic Implications of Membership." In J. Piggot and J. Whalley, eds., General Equilibri- um Trade Policy Modeling. New York: Cambridge University Press. Statistical Office of the European Communities. 1984. Eurostat, Revue 1973-82. Luxembourg. 1986. Eurostat, Revue 1975-84. Luxembourg. Various years. Analytische Ubersichten des Aussenhandels. Nimexe. Brussels. Various years. Eurostat, Analytical Tables of Foreign Trade. Luxembourg. Thomson, K. J., and D. R. Harvey. 1981. "The Efficiency of the Common Agricultural Policy." European Review of Agricultural Economics 8:57-83. Tracy, Michael. 1982. Agriculture in Western Europe. Challenge and Response 1960-1980. 2nd ed. New York, London: Granada. Tyers, Rodney, and Kym Anderson. 1988. "Liberalizing OECD Agricultural Policies in the Uruguay Round: Effects on Trade and Welfare." Journal of Agricultural Economics 39:]L97-216. von Alvensleben, Reimar. 1981. "Probleme der EC Marktpolitik bei Obst und Gemuxse." In In- stitut fuir Gartenbau6konomie, Gegenwartsfragen der Gartenbauokonomie. Forschungsberich- te zur Okonomie im Gartenbau 36:181-205. Hannover. . 1982. "The EEC Agricultural Policy and World Trade in Fruit and Vegetables." Institut fur Gartenbauokonomie, Hannover. August. Processed. von Alvensleben, Reimar, Hans-Christoph Behr, and Hans-Harald Jahn. 1986. "Fruit and Veg- etables in the European Community." In Malcolm D. Bale, ed., Horticultural Trade of the Expanded European Community: Implications for Mediterranean Countries. Washington, D.C.: World Bank. Ulrich Koester and Malcolm D. Bale 121 Recent Publiications for the Uruguay Round The Uruguay Round of multilateral trade negotiations, begun in 1986, aims to strengthen the world's trading systems, established 40 years ago with the General Agreement on Tariffs and Trade (GATT). The Round offers developing countries the opportunity to expand their participation and influence in the GATT system. A Research Inventory for the Multilateral Trade Negotiations, 1990 Jalaleddin Jalali, editor A guide to the recent economic research relevant to the issues being negotiated. 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