RIETI Policy Symposium

Agricultural Policy Reform in the 21st Century
- An Agricultural Strategy for Surviving WTO and FTA Negotiations (Summary)

Summary of Major Points of Discussions

YAMASHITA Kazuhito YAMASHITA Kazuhito
Senior Fellow, RIETI

On July 28, 2004, RIETI held a policy symposium "Agricultural Policy Reform in the 21st Century - An Agricultural Strategy for Surviving WTO and FTA Negotiations." The following is a summary of the opinions expressed during the symposium.

1. Global agricultural policy reform and Japan's policy

(1) Japan's tariff-supported agricultural policy can also be characterized as a consumer-supported policy, since the main burden is placed on the consumer.

The European Union (EU) previously set its market prices above world market levels by means of variable levies, while using export subsidies to dispose of excess production. However, under the reforms implemented in 1993, the support price on grain was lowered and direct payments were instituted to compensate farmers for the loss of income. The EU's current support price for grain, 101.31 euros ($120-$130) per metric ton, is lower than the February 2004 Chicago Board of Trade wheat market price ($139). With such prices, the EU no longer has need of tariffs or export subsidies to compete with American wheat.

The producer support estimates (PSE) developed by the Organization for Economic Cooperation and Development (OECD) measure support to agriculture by adding together transfers to farmers from consumers Formby means of tariffs (the difference between domestic and international unit prices, multiplied by number of units produced) and transfers from taxpayers in the form of subsidies and payments. In 2003, the OECD PSEs were $38.9 billion for the United States, $121.4 billion for the EU, and $44.7 billion (about ¥5.2 trillion) for Japan. Overall, Japan's PSE is smaller than that of the EU as a percentage of GDP. However, the EU has shifted away from a consumer-supported agricultural policy through the reform of its grain and beef policies (with reform of sugar and dairy products to be implemented soon), while in Japan, consumers continue to bear the overwhelming burden of agricultural protection. If we look at the breakdown of the PSEs, we see that from 1986 to 1988 the share of consumers' burden was 46% in the United States, 85% in the EU, and 90% in Japan; in 2003, the burden was 38% for the United States, 57% for the EU, and again 90% (about ¥4.7 trillion) for Japan.

(2) Problems of consumer-subsidized agriculture

Japan's consumer-subsidized agricultural policy is inefficient : When the government artificially supports domestic prices at a level higher than world market prices, the resulting increase in farm incomes amounts to only 25% of the value of the support provided, owing to high outlays for fertilizer, agrichemicals, and so forth. Japan's policy is also ineffective in that the overuse of fertilizer and agrichemicals is destructive to the environment. Finally, it is inequitable in the sense that the income of many affluent farm households is being supported by high prices that affect all consumers, including those living in poverty.

An agricultural policy that places the burden on the taxpayer allows the public to see the relationship between the policy's cost and benefits, permits the government to target support to the kinds of farming and farmers that really need it, and does away with the need for high tariffs.

(3) When protection of agriculture is slanted toward certain commodities, even greater economic inefficiencies result.An OECD index measuring differentials in commodity support gives Japan a score of 118, as compared with an average score of 75 for all the OECD countries, 59 for the EU, and 29 for the United States. Compared with other countries, Japan's agricultural protection is heavily biased toward certain products, especially rice.

(4) Substantive problems of Japanese farm industry and policy

The Agriculture Basic Law of 1961 was designed to eliminate the income differential between the agricultural and industrial sectors by reforming the structure of Japan's farm industry, i.e., lowering costs through larger-scale farming and improved productivity, expanding farmers' production options, and encouraging a shift toward commodities for which demand was expected to grow. Since income equals sales (the number of units produced multiplied by unit price) minus costs, income can be increased either by increasing sales or decreasing costs. Thus, it should have been possible to raise farm income by lowering costs through large-scale farming even in the case of rice, for which demand was stagnant.

In fact, however, rather than pursuing structural reforms, agricultural policy thereafter took the route of boosting farm incomes by raising the price of rice, for which demand was falling. Consumption dropped even further, even as production increased, resulting in rice surpluses. After more than 30 years of production set-aside, agricultural resources remained concentrated in the ever-profitable area of rice production, and Japan's food self-sufficiency ratio fell from 79% in 1960 to 40% in 2003. Meanwhile, Japan lost 2.3 million of its 6 million hectares of farmland, an area exceeding the farmland freed during the postwar agrarian reforms (1.94 million hectares). Neither statutes restricting the conversion of farmland nor zoning regulations were strictly enforced. And even though it was only rice that was being overproduced, those surpluses gave rise to the perception that Japan had too much farmland. No one seemed concerned about the disappearance of agricultural land resources vital to the nation's food security. During the food shortages of the immediate postwar period, Japan had 6 million hectares of farmland for a population of 70 million; today, it has less than 5 million hectares for a population of 130 million. The number of category 2 part-time farmers, for whom farming is a secondary job, rose from 30% at the time the 1961 law was enacted to 70% today, and the ratio of farmers aged 65 or over grew from 10% to almost 60% - testimony to the farm industry's seemingly inexorable decline.

Since the unit cost of an agricultural commodity is the cost per hectare divided by the yield per hectare, increases in yield through the development of superior strains and other technological advances such as new varieties should have the effect of lowering the cost of farm commodities. However, chronic rice surpluses have discouraged the improvements in yield that would lead to stronger control of production levels. Consolidation of farmland also reduces costs through economies of scale. But with rice prices kept artificially high, even inefficient smallholders find it cheaper to produce their own rice than to buy; consequently, small farmers have hung on to their land, and consolidation has stalled. As a result, Japanese rice has become less and less competitive with that of other countries.

2. Agriculture in WTO and FTA negotiations

(1) Any free trade agreement (FTA) should achieve a high degree of liberalization, meeting the GATT/WTO provision calling in principle for an end to substantially all tariffs and similar trade barriers. (Some take the view that although it would be inappropriate to exclude the entire agricultural sector from such FTAs, it is necessary to consider the trade diversion effect in formulating such an agreement.)

(2) In negotiating FTAs, Japan needs to drive a hard bargain to ensure favorable business environment in East Asia. Agriculture must not be treated as a bargaining chip for achieving other goals.

(3) WTO negotiations, if asked to choose between lowering tariffs and expanding market access (tariff-rate quotas), Japan should choose tariff reduction, a policy that allows the government to support domestic production by implementing direct income payments to farmers. Retaining high tariffs only on rice imports means maintaining high domestic prices for rice. Expanding "minimum access" import quotas (tariff-rate quotas) when there is a significant gap between domestic and foreign prices would lead to a drop in domestic production and a further drop in food self-sufficiency. (If, during WTO negotiations, Japan asks for special treatment to exempt it from tariffication, it will be called on to increase "minimum access" import quotas instead.) This would be little more than a reprise of the government's past policy of maintaining artificially high prices while forcing cutbacks in production, a policy that has discouraged improvements in agricultural productivity and in fact has paved the way for a drop in food self-sufficiency.

(4) Continuing to pursue a retrogressive agricutural policy is not in the best interests of the WTO process as a whole. If farm trade negotiations come to a standstill, progress in areas that Japan needs to pursue aggressively will stall as well.

(5) While reducing tariffs, Japan needs to follow the EU's example and shift from a price-support policy, which places the burden on the consumer, to a system of direct payments to farmers, which places the burden on the taxpayer, in order to lower domestic prices.

(6) However, providing uniform, across-the-board direct payments to farmers in the manner of Japan's traditional "convoy approach," instead of targeting payments to those meeting certain criteria, would simply shift the burden from consumers to taxpayers without improving the farm industry's efficiency or alleviating the public burden. In the EU, powerful policy measures for structural reform of the farming industry were being implemented even before price supports were adopted, and considerable progress had already been made in increasing the scale of farming and improving efficiency. In Japan, the government adopted price-support policies to protect all rice farmers uniformly before it had made adequate progress with structural reforms. As a result, the inefficient smallholder-dominated structure of the Japanese farm industry remained unchanged. For this reason, Japan cannot simply approach direct payments as a way to soften the impact of lower tariffs. It is vital that the government adopt a targeted direct payment scheme tailored to its own circumstances to accelerate structural reforms. In addition to improving productivity by expanding the scale of farming, Japan must promote technological innovation to enhance the domestic farm industry's competitiveness.

(7) Japan should take advantage of the WTO negotiations to catalyze wholesale reform of the nation's farm industry. Some are of the opinion that Japan should emulate the EU and proactively pursue agricultural reforms without regard to WTO and FTA negotiations (even if exceptions are allowed for certain commodities) with the aim of addressing the domestic farm industry's inherent problems - instead of adopting policy measures only after being forced to make concessions by other countries, as in the past.

(8) It was suggested that the pace of reform in Japan lags too far behind the pace of international negotiations. In response, it was submitted that while reforms need to be accelerated, it is also necessary to follow a complete process, giving the public access to relevant information and gathering public comment and views from various stakeholders.

3. Agriculture and politics: How can we move beyond "convoy-style" agricultural policy? How to address farm industry groups' objection to "selective" policies? Are payments targeted to those farms that will assume responsibility for future food production politically feasible?

(1) Japanese agricultural policy must distance itself from the farm lobby. The government must end its "business as usual" approach to agricultural policy and begin a new chapter. The only way is to adopt a system of direct payments with clear-cut criteria for eligibility. Agreement between the ruling parties and the cabinet is more important than agreement between the ruling and opposition parties. It will not do for members of the ruling parties to contradict the prime minister's statements. It is necessary to build a political and economic consensus within the ruling parties and the cabinet.

(2) The situation has changed over the past decade or so; there are no longer sacred cows in agricultural policy.

(3) We should begin by delineating the ideal policy, without regard to political feasibility, and let the debate proceed from there.

4. Funding agricultural policy: Can the Agriculture, Forestry, and Fisheries budget, currently tied up with a variety of vested interests, be overhauled?

The public will lose confidence in agricultural policy unless the government clearly communicates the need for a major shift in the structure of the agriculture budget. The nation is not in a position to raise additional tax revenues to finance agricultural policy reform. Furthermore, if funding is sought outside the current budget, reform will not have achieved the goal of lightening the public burden.

5. Policy goals and policy design

(1) Japan must find a new way of preserving its farm industry and rural communities. The time has come for a decisive policy shift. We must move quickly to formulate concrete policies in the three areas of providing income stability for farmers, maintaining farmland, and protecting the environment. More specifically, we need policies that foster the development of efficient and stable farm-management entities under land-use regulations that emphasize efficient use of farmland. However, this alone will not suffice to protect and preserve our rural areas. For this, it will be necessary to act separately to put together a new rural policy and ensure that it is clearly understood.

(2) As the OECD has stressed, farm policies need to be targeted directly at the source of the problem. A price policy that might be expected to have a positive effect becomes inefficient, ineffective, and inequitable when applied to all producers equally. One of the basic principles of economic policymaking is to tackle a given problem with a policy that offers a direct solution. Yet instead of a raising farm incomes directly, Japan followed the indirect approach of price supports (in the past by raising rice prices under the food control law; and now by limiting production to keep prices high). The unintended consequences have included such serious side-effects as a decline in Japan's food self-sufficiency and declining competitiveness in the international marketplace.

(3) Industrial and economic policy should be kept separate from social and regional policies. Industrial and economic policy should focus on fostering competitive farmers; social and regional policies should be carried out separately. Government policy should treat farming like any other industry and design agricultural policy with a view to improving competitiveness and efficiency.

(4) Environmental problems are linked to externalities associated with farm production. From the standpoint of economics, such problems should also be dealt with directly; any attempt to address them by regulating trade in goods is inappropriate.

6. Determining eligibility for direct payments

(1) While the need to target direct payments to serious farmers was acknowledged, it was also pointed out that part-time farmers play an important role in rural communities through the upkeep of irrigation ditches, farm roads, and the like, and that some funds should be allocated for community farming which include part-time farmers.

(2) The response to this argument was as follows:
a. In order to make rural communities appealing places to live and work, it is first necessary to educate its members in farm management. Current policy is not designed in such a way as to bring about structural reform. Structural reform cannot move forward unless payments are targeted toward certain types of farm operators. It is necessary to select those agricultural entities that approach farming as a business enterprise and to remove the obstacles to their market participation and business activity.

b. A full 64% of Japan's rice farmers pursue farming as a sideline to supplement their main source of income. The total annual income of such farmers averages ¥7.92 million, of which only ¥120,000 comes from farming. Surely this supplementary income does not merit government protection. The annual income of these part-time farming households far surpasses that of regular wage-earning households, which averages only ¥6.62 million. It would be hard to convince the public of the need to provide direct compensation to part-time farmers who have the safety net of another job or business.

c. Community farming cannot survive for long without leaders. Farming is organized in different ways depending on whether there is a local leader. Farmland should be managed by the community, while farm operations must be in the hands of a responsible full-time farmer.

(3) To help community farms develop into legal business entities, it may be helpful to borrow the American concept of the LLC, or limited liability corporation, to serve as a model for business entities in the farm industry. (In an LLC, a category of business common in such labor-intensive industries as farming, owners have limited liability, as in a joint-stock corporation, but transfer of ownership interest, internal decision making, et cetera., follow the model of a partnership.)

(4) The eligibility criteria for direct payments should be clear-cut. Without specific criteria, there will be confusion in the program's local administration. Eligibility should be based on acreage, not on whether the operator is an officially classified as a designated farmer by local governments. The operators of a farm above a certain minimum acreage could be a company or corporation. (The management stabilization measures carried out under the rice policy reforms implemented two years ago provide criteria based on acreage: four hectares or more everywhere but Hokkaido, and 10 hectares or more in Hokkaido.)

(5) Where the scale of farming has already expanded considerably as in Hokkaido, and the selection of eligible farms becomes difficult, it may be helpful to adopt the French system of providing incentives for people to quit farming.

7. Treatment of mountainous areas unsuited to large-scale farming: How to deal with mountainous areas in which such adverse conditions as sloping or fragmented plots make large-scale farming impossible

(1) The potential merits of mountain agriculture need to be considered. In the Chugoku region, where much of the farmland is situated on hillsides, there are cases in which rice farmers with a scale of 10 to 20 hectares of farmland take advantage of a longer cultivation season resulting from differences in altitude (the transplanting season may be up to two months long, for example).

(2) When grain and beef prices in the EU were cut between 1993 and 1995 under the MacSharry reforms, a direct payment scheme covering all areas within the EU was adopted. Nonetheless, it was impossible to fully compensate farmers in certain areas with unfavorable farming conditions. In these areas, direct payments for disadvantaged regions were gradually increased from 101 euros per hectare] in 1992 to 123 euros in 1993, 124 euros in 1994, and 150 euros in 1995. Naturally, structural reforms need to be pursued in mountainous regions and other areas of limited arability, but in instances where natural conditions prevent farmers from keeping up with the pace of cost-cutting elsewhere, the rate of direct payment for disadvantaged regions should be increased.

8. Production control for rice

(1) In support of continued government production controls, it was argued that without such controls, the supply of rice would swell by 3.5 million tons and rice prices would crash. Japanese farmers do not behave in conformity with demand and supply conditions; even if rice prices fall, part-time farmers will not relinquish their land.

(2) On the other hand, the following points were raised in support of suspending production controls:
a. The farming industry should function according to free-market principles (the agricultural cooperatives, which are important economic entities, must also be reformed). Henceforth the government needs to focus on promoting cultivation of rice and other commodities that will sell. Some farmers are already moving to skirt production controls. People who farm as a sideline earn only ¥120,000 from farming on average. The solution is to target direct payments to those who are most affected by price drops, namely, full-time farmers.

b. Japanese agricultural policy has ignored basic economic principles far too long. Farmers themselves say that those who farm as a sideline would rent out their land if the price of rice dropped below ¥11,000 to ¥12,000 per 60 kg.

c. If Japan's intention is to cut domestic prices to conform to international norms, then price controls for the sake of higher prices should obviously be discarded.

9. What form should direct payments take: decoupled payments linked to past income (no connection to production and thus ineffective as a tool of structural reform), payments based on acreage, or compensation for income lost through price drops?

(1) Consideration should be given to payments designed to help close the gap between conditions for production in Japan and other countries, as well as to payments to mitigate income fluctuations.

(2) As production controls are phased out and rice prices gradually fall to a level consistent with balanced supply and demand, full-time farmers with a certain minimum acreage who are affected by the price drops should be provided with "decoupled" direct payments (covering 85% of income lost through price declines), which have no effect on production and prices and can compensate sufficiently for lost income - not direct payments based on acreage, part of which will go to pay rent on farmland leased to farmers. As prices drop as a result of the suspension of production controls and smallholders relinquish their land, acreage-based direct payments to farmers meeting a minimum acreage requirement will help those farmers pay the rent on their farmland. This will accelerate the shift of farmland from smallholders to business-oriented farmers, and costs will drop. This sort of direct payment works both directly, by in effect lowering the rent farmers pay and thereby causing a downward shift in the supply curve; and indirectly, by promoting liquidity of farmland and thereby expanding the scale of farming, raising productivity, and causing the supply curve to bulge toward the lower right. This will cause prices to fall to international levels or to a level equivalent to a 100% tariff.

10. Direct payment for the preservation of farmland, irrigation ditches, and other agricultural resources (multifunctionality)

(1) It was suggested that support of full-time farmers alone will not preserve Japan's rural communities; for that purpose, it will be necessary to implement separate direct payments aimed at the preservation of Japan's farmland, irrigation ditches, and other agricultural resources.

(2) To this it was countered that direct payments to full-time farmers will cause land rents to rise, increasing profits of landowners, who can use that money for preservation of farmland, irrigation ditches, and other agricultural resources. Payments for preservation of resources could be considered in situations where finances permit, but when funding is limited, it should be focused on direct payments that will contribute to structural reform.

11. Farmland system

Zoning regulations regarding farmland should be strengthened, and the LLC should be recognized as one of various types of farming entities.