Trade Note March 1, 2004

Trade Note March 1, 2004 The World Bank Group www.worldbank.org International Trade Department By Donald Mitchell These notes summarize recent research on global trade issues. They reflect solely the views of the author, and do not necessarily reflect the views of the World Bank Group or its Executive Directors, or the countries they represent. Trade Note 14 Policies: Opportunity for Change Introduction is an important commodity in many countries and the source of about 7 percent of the world s calorie supplies. It accounted for 10 percent or more of total export earnings of 12 developing countries during 1995-2000. 1 Its importance as a source of foreign exchange has declined over time, partly because imports by OECD countries have declined. In the 1970s, the European Union, Japan and the United States accounted for half of the world s total sugar imports. Since then, U.S. sugar imports have declined from more than 5 million tons per year to slightly more than 1 million tons per year. The EU shifted from a net importer of about 2.5 million tons of sugar in the early 1970s to a net exporter of about 5 million tons in recent years. Japan decreased sugar imports from 2.5 to 1.5 million tons over the same period. Thus, three of the largest sugar importers in the 1970s have become self-sufficient on-balance (Figure 1). The reason these countries reduced imports was not because of gains in efficiency or a strong comparative advantage in sugar production. It was because of high protection. Producers in these countries receive more than double the world market price due to government guarantees, import controls, and production quotas. This has increased production of sugar and sugar substitutes in these countries, reduced consumption and imports, and thereby deprived lower-cost producers (many in developing countries) of export opportunities. Total government support to producer in these three countries averaged $4.4 billion during 1999-2001 Million Tons 50 40 30 20 10 0 according to OECD estimates. In comparison, total exports of sugar from developing countries averaged only $6.5 billion during the same period. The clout of the U.S. sugar industry was recently demonstrated when sugar was not included in the Australia U.S. free-trade agreement, despite the fact that sugar is an important export for Australia and has accounted for more than 1 percent of merchandise exports in recent years. The Washington Post reported (February 9, 2004) that the powerful U.S. sugar lobby and affiliated individuals and political action committees have donated $20.2 million to both political parties since 1990. Background Figure 1. World Exports & Net Imports of EU, Japan and U.S. -10 1965 1970 1975 1980 1985 1990 1995 2000 Net Imports of EU, Japan and USA World Trade occurs naturally in most foods, but it is economically extracted from only a few crops such as sugar beets, sugar cane, and corn. The common sugar, which we are most familiar with, is sucrose. It is extracted in nearly pure form from sugar cane and sugar beets. Sucrose from sugar beets and sucrose from sugar cane are chemically identical and indistinguishable. Dextrose is a sugar derived synthetically from starch (most commonly from corn), and fructose is a very sweet sugar derived from dextrose. High-fructose corn syrup (HFCS) is produced by the enzymatic conversion of a portion of the dextrose in corn syrup to

fructose, and it is used as a sugar substitute in soft drinks. The fact that identical, or nearly identical sugars can be produced from different crops provides producers and consumers with a wide range of substitution possibilities. However, it also means that sugar policies are often complex as the different industries vie for support. For example, sugar producers in the EU and Japan have been able to get legislated quotas on HFCS production in order to limit competition of with sugar. HFCS is a nearly perfect sugar substitute in uses such as soft drinks, and HFCS and other corn syrups now account for 40 percent of caloric sweeteners in Japan, and more than half of U.S. caloric sweetener consumption (Figure 2). The technique for commercial production of highfructose corn syrup was discovered in the late 1960s and was made profitable by high sugar prices in the protected Japanese and U.S. markets. But now, economies of scale, improvements in production techniques, and large installed production capacity (financed under high prices), have made corn syrups competitive with sugar from cane and less costly than sugar from beets. Million Metric Tons 12 10 8 6 4 2 Figure 2. U.S. and HFCS Consumption 0 1970 1975 1980 1985 1990 1995 2000 Source: USDA HFCS Cost of production favors producing sugar from cane, with the average cost of producing refined (white) sugar from cane costing about 14 cent per pound compared to 25 cents per pound when white sugar is produced from sugar beets (Table 1). This is one of the reasons why protection is high in northern hemisphere countries such as the EU, Japan and U.S. that produce cane mostly from sugar beets. HFCS requires large investments in plant and equipment and a low-cost source of starch. The U.S. has already made such investments and is a major producer of corn which provides the starch source. Consequently, HFCS costs are competitive with sugar produced from sugar cane in the U.S. Table 1. Average Costs of Producing Cane, Beet, and High-Fructose Corn Syrup by Categories of Producers, and Actual Corn and Prices 1994/95 1998/99. Category 1994/95 1995/96 1996/97 1997/98 1998/ 99 U.S. cents per pound /1 Raw cane sugar Low cost producers 7.43 8.10 8.18 7.78 7.58 Major exporters 10.37 10.60 10.72 10.52 9.73 Cane sugar, white equiv. Low cost producers 11.02 11.75 11.84 11.41 11.19 Major exporters 14.23 14.48 14.61 14.38 13.53 Beet sugar, refined Low cost producers 21.31 23.16 23.09 21.21 22.67 Major exporters 25.47 26.87 25.90 23.56 24.75 High-fructose corn syrup Major producers 13.45 16.78 13.57 12.86 11.76 Actual Market Prices Corn 102.8 162.6 128.8 112.4 93.8 Raw cane sugar 13.53 12.23 11.21 10.71 7.05 Source: LMC International as reported in and Sweetener Situation & Outlook, Economic Research Service, USDA, September 2001. Actual market prices are from World Bank databases. Policy Changes Are Inevitable policies in the E.U. and U.S. will face increasing internal pressures for reform as imports increase under international agreements. The E.U. has committed to allow the 48 least developed countries duty-free access to its sugar market by 2009 under its Everything But Arms (EBA) initiative signed in 2001. This could result in as much as an additional 2.4 million tons of sugar imports according to recent estimates. These imports would need to be offset by about 17 percent lower E.U. production quotas or increased non-food uses such as ethanol production in order to comply with ACP/EU Protocol 2 and WTO commitments. The E.U. began negotiating Economic Partnership Agreements with 77 ACP countries in September 2002, and these Agreements could extend duty-free access to all ACP countries and allow an additional 6 million tons of sugar to enter the E.U. The enlargement of the E.U., with 10 new members scheduled to join in 2004, could further add to pressures for reform by increasing production and exports of sugar. A WTO challenge to the E.U. sugar regime by Brazil, Australia, and Thailand could lead to even more rapid changes to the sugar program if successful. 2

The U.S. also faces major challenges to its sugar program because domestic production is increasing faster than consumption, and international agreements will allow increasing imports. Mexico will be allowed unlimited dutyfree access in 2009 under NAFTA. This could lead to a surge in imports from Mexico and to building U.S. government stocks. Even before 2009, the over-quota tariff rate is scheduled to decline by 15 percent per year under NAFTA until it reaches zero in 2008, and this could lead to large imports in the next several years if world market sugar prices remain low. The free-trade agreement between the United States and five central American countries recently negotiated allows small increases in sugar imports. Policy changes will be needed to the U.S. sugar program, and they could include substantially reduced production quotas, or sharply lower sugar prices. Japan faces less pressure for reform, but it provides higher protection to its sugar producers than either the E.U. or U.S. The timing of needed E.U. and U.S. sugar policy reforms coincides with the expiration of the current E.U. sugar policy in June 2006 and the expiring U.S. Farm Bill in 2007. This provides an opportunity for coordinated reforms between these two important sugar producers. The Benefits of Reform are Substantial The benefits of sugar policy reform are substantial, and the gains are greatest under multilateral reform. According to recent studies of the global sugar and sweetener markets, the global welfare gains of removal of all trade distortions are estimated to total as much as $4.7 billion per year. In countries with the highest protection (Japan, Western Europe, the U.S., Indonesia, and Eastern Europe) net imports would increase by an estimated 15 million tons per year. World sugar prices would increase by as much as 40 percent, while sugar prices in countries that heavily protect their markets would decline. The greatest price decline would occur in Japan, where sugar prices would fall 65 percent, followed by a 40 percent decline in Western Europe, and a 25 percent decline in the United States. Brazilian producers gain the most from liberalization, around $2.6 billion per year, but this is offset by a loss of $1 billion to Brazilian consumers who pay higher prices after liberalization leaving a net gain of $1.6 billion for Brazil. One general conclusion from recent studies is that protection in the world sugar market is imposed by developed countries at great cost to themselves and those developing countries with the economic potential to expand exports. The nature of reforms can have very different consequences for developing countries. If existing polices in the E.U. and the U.S. are adjusted to accommodate higher imports from EBA, NAFTA and other policies, many low-cost producers, such as Brazil, will lose because they do not currently have large quotas and are not included in the EBA, ACP, or NAFTA countries. A better alternative is to push for full liberalization of the world sugar market in order to allow efficient producers to expand production and exports, and allow consumers in protected markets to benefit from lower prices. This may also make policy change more palatable because no country is being singled out for reform. It has the advantage of somewhat higher world prices from coordinated liberalization to soften the adjustment for producers in protected markets. While change will not be easy, a coordinated liberalization has substantial advantages over marginal adjustments which keep existing sugar policies in place but allow larger imports. But, Not All Countries Will Gain From Reform A number of countries have preferential access to the E.U. or U.S. sugar markets through the ACP/EU Protocol or the U.S. sugar import program (Table 2). These countries receive the high internal price on exports allowed by quotas and this preferential access is valued at about $0.8 billion per year when compared to world market prices. The largest quota holding countries and their annual quota to the E.U. and U.S. markets are shown in Table 2. The value of this preferential access is less than it appears, because many of these producers have high production costs and would not produce at world market prices. Further, world market prices would rise by as much as 40 percent after full liberalization which would partially offset the loss to producers of high prices in preferential markets. The net loss to these 3

exporting countries from full liberalization is estimated to total $0.45 billion per year. Countries that are low cost producers with small E.U. or U.S. quotas relative to their total exports would benefit from reform because they would gain more from increased exports and the rise in world market prices than they would lose from preferences. These countries include Australia, with a U.S. quota of 87 thousand ton compared to total exports of more than 4 million tons; Brazil, with a U.S. quota of 152 thousand tons compared to total exports of more than 13 million tons; and Thailand with an E.U. quota of 14 thousand tons compared to exports of 3-4 million tons. Countries with no quota to the E.U. and U.S. markets, such as Sudan, would benefit from both higher exports and higher world prices. Other forms of compensation may also be available to countries for the loss of quotas. Those could include more broad based economic support such as those being considered by the European Union in its Economic Partnership Agreements now being negotiated. Table 2. Countries with large quotas to EU and U.S. sugar markets EU Quota Holders U.S. Quota Holders Quota Share of Exports from Quota 2000/2001 Share of Exports from Mauritius 491,031 17.3 Dominican 185,335 9.5 Rep. Fiji 165,348 20.7 Brazil 152,691 3.3 Guyana 159,410 28.0 Philippines 142,160 0.1 Jamaica 118,696 5.4 Australia 87,402 1.5 Swaziland 117,845 11.9 Guatemala 50,546 7.8 Barbados 50,312 9.5 Argentina 45,281 0.2 Belice 40,349 19.2 Peru 43,175 0.2 Trinidad & 43,751 0.9 Panama 30,538 2.0 Tobago Zimbabwe 30,225 3.2 El Salvador 27,379 2.1 Malawi 20,824 6.0 Colombia 25,273 1.6 Source: USDA, ERS, and Sweetness Situation and Outlook Yearbook, June, 2003 Employment in Industries Estimates of employment in developing countries sugar industries can be developed from various reports, surveys, and industry statements. Such estimates (Table 3) show considerable crosscountry consistency among high and low cost producers. For example, Brazil, Guyana and South Africa are known to be among the lowest cost producers and the raw sugar production per industry employee for these countries is estimated to range from 16.3 to 19.9 tons. In contrast, countries that are known to be high cost producers such as Fiji, Kenya and Mauritius have production of 7.0 to 8.3 tons of raw sugar per industry employee. Based on these estimates, an additional million tons of sugar production from a low cost sugar producing developing country would generate about 55,500 direct employment jobs. If the production came from a high cost producer, the same million tons of production would generate about 128,000 direct employment jobs. Additional indirect employment jobs would also be generated in transportation and related industries, but no attempt was made to estimate these jobs. Based on these estimates, an increase of 15 million tons of sugar imports in highly protected markets following full liberalization could generate between 832,500 and 1,920,000 jobs if the sugar was produced in developing countries. The net global employment effect would be less because there would be some loss of jobs in the highly protected markets. In the United States, for example, there are an estimated 9,000 sugar beet producers who produce half of the countries sugar. Many of these jobs would be lost. However new jobs would be created to accommodate processing of raw cane sugar imported to replace the decline in sugar produced from beets. Table 3. Raw sugar produced per sugar industry employee, selected developing countries. Direct Employment (growers and factory) Tons of Raw Produced Per Employee Tons of Raw Produced Average 1999-2000 Low Cost Producers Brazil 1,100,000 19,485,000 17.7 Guyana 18,000 293,072 16.3 South Africa 130,000 2,589,667 19.9 High Cost Producers Fiji 40,500 336,333 8.3 Kenya 69,000 485,333 7.0 Mauritius 65,000 529,299 8.1 Other Producrers Malawi 17,000 200,667 11.8 Mexico 300,000 5,069,233 16.9 Notes and Sources: Production is the 3 year average of raw sugar production during 1999-2001 from FAOSTAT. Employment comes from various sources (see World Bank Policy Research Working Paper 3222, February 2004). 4

Conclusions Increasing pressures to reform sugar policy in highly protected markets such as the E.U. and U.S. stem from budgetary pressures, EU expansion, and international commitments associated with NAFTA and the EBA. Thus, the chances for global policy reform are better than they have been for several decades. The current round of multilateral trade negotiations offer an excellent opportunity for developing countries to push for global sugar policy reform. Such reforms would create jobs in developing countries, improve their foreign exchange earnings and benefit consumers in highly protected markets who pay several times the world market price for sugar. Countries with high protection will likely need to devise policies to assist countries and/or producers for the loss of quota or protection. Polices need to be designed to avoid continued support to sugar production, but provide support to sugar producers during an adjustment period. This type of adjustment has already been used in the United States for peanut producers. Like sugar, the edible peanut program faced the threat of increased imports due to WTO and NAFTA agreements. In the 2002 U.S. farm bill, the loan rate for edible peanuts was cut by half compared to the mid-1990s, production quotas were eliminated, and direct cash payments were made to producers. The payments consisted of deficiency payments if prices fell below the new lower loan rates, decoupled direct payments, and countercyclical payments. In addition, quota holders were compensated for their loss of quotas with direct payments. A similar program is needed for sugar. However, reform of the sugar program in the U.S. and Japan may also require policies to assist industries now dependent on distorted sugar policies, such as HFCS. Finally, unwinding the system of protection and support would require new policies in some developing countries. On the one hand, some high cost producers might be able to raise productivity; on the other, some industries in these countries may experience contraction. Policies that encourage investments to increase productivity and assist in the shift of resources to other, more internationally competitive activities may be in order. Development assistance can play a supportive role in all of these areas. 1 The 12 countries and the average share of export earnings derived from sugar during 1995-2000 were: Gambia (91%), Reunion (63%), Cuba (41%), Saint Kitts and Nevis (37%), Fiji (25%), Belize (25%), Guyana (24%), Mauritius (21%), Swaziland (17%), Dominican Republic (14%), Guadeloupe (12%), Barbados (11%). 2 The ACP/EU sugar protocol was initially signed at the first Lomé Convention in 1975. It gave preferential access to the European Union s sugar market and its high prices to 46 countries from Africa, the Caribbean, and the Pacific (ACP) plus India. Suggested Reading Borrell, Brent and David Pearce, : the taste test of trade liberalization, Center for International Economics, Canberra & Sydney Australia, September 1999. Sheales, Terry, Simon Gordon, Ahmed Hafi, and Chris Toyne, International Policies Affecting Market Expansion, ABARE Research Report 99.14, November 1999. Wohlgenant, Michael K., Effects of Trade Liberalization on the World Market, FAO. 1999. United States Department of Agriculture, Economic Research Service, and Sweetener Situation and Outlook Yearbook, June 2003. This Trade Note was written by Donald Mitchell, Lead Economist in the Development Prospects Group. It was based on World Bank Policy Research Working Paper 3222 and can be found at http://www.worldbank.org/propsects, and the Trade Note can be downloaded at http://www.worldbank.org/trade. 5