Viable Agricultural Policy for the WTO/FTA Age

Senior Fellow, RIETI

Japan should transform its agricultural policy to cease price supports backed by tariffs on products such as rice and use direct payments to compensate farming households that are affected by reduced prices. This would not only overcome immediate obstacles to trade negotiations, but also reduce the burden on the Japanese public, lead to greater competitiveness in agriculture, and offer benefits to consumers.

Former Agricultural Basic Law originated from structural reform

The Fifth WTO Ministerial Conference held in Cancun in September 2003 broke down due to serious opposition among the parties, chiefly over agriculture. Japan was unable to accept the draft statement agreed by the U.S. and the EU stating that agricultural tariffs above a certain level (eg 100%) would be disallowed.

Likewise in free trade agreement (FTA) negotiations, which require abolition of tariffs on substantially all of the trade items, Japan's negotiations with Mexico have run into trouble over agricultural products. More FTA negotiations are looming on the horizon, firstly with Korea and then with major exporters of agricultural products such as Thailand, Malaysia and the Philippines. With Japan unable to display leadership in WTO talks and incapable of concluding FTAs due to agricultural issues, criticism is being directed at the agricultural sector. The government has responded by convening meetings of the Investigative Council on Basic Problems Concerning Food, Agriculture and Rural Areas to set about reviewing agricultural policy.

The 1942 Food Control Law, often regarded as emblematic of Japan's agricultural policy of producer protection, was a piece of wartime legislation enacted to protect consumers by aiming to distribute scarce foodstuffs equitably among the population. In fact, rice prices in Japan were lower than those in international markets until the beginning of the 1950s.

There are two ways of increasing agricultural incomes: raising prices and reducing production costs. The former Agricultural Basic Law (1961) set out down the latter path, reforming the small-holding-based agricultural structure to improve agricultural incomes by reducing costs through expanding the scale of farms and improving productivity.

In reality, however, agricultural policy followed the path of lifting incomes by raising rice prices. The result was that consumption decreased, production increased, and a rice surplus emerged. Even after the Food Control Law was abolished in 1995, rice prices were maintained by production set-aside programs.

Increases in production per unit (yield from a given piece of agricultural land) resulting from technological advances such as improved rice varieties boost the productivity of land and eventually reduce costs. However, producers disliked increases in production per unit that would lead to stronger control of production levels and increase of areas under set-aside programs. Furthermore, in an environment of high rice prices, part-time farmers with small holdings and high production costs found that producing rice for their own consumption was cheaper than buying it, and so did not lease out their land.

In the absence of any reform of this kind of small-holding-based agricultural structure, Japan became less internationally competitive in agriculture. Over the last 40 years the size of the average farm has increased by 150% in France, but only by 36% in Japan (17% excluding Hokkaido). Rice is protected by a 500% tariff and domestic rice prices are six times higher than international prices. Producer Support Estimates (PSE), which were developed by the Organisation for Economic Cooperation and Development (OECD) as an index to measure agricultural protection, are calculated on the total amount of taxpayer-funded subsidies or payments to farming households plus the consumer burden imposed by tariffs (the gap between domestic and international prices multiplied by the volume of production). During the period between 1986 and 2002, the proportion of consumer burden in PSE dropped from 47% to 39% in the U.S. and from 85% to 57% in the EU, while remaining at 90% in Japan.

Reliance on Tariffs: An Agricultural Policy Peculiar to Japan

By relying on tariffs, Japan has created an agricultural policy that places an extremely large burden on consumers. In 1992, the EU greatly reduced its reliance on tariffs by reducing price support and introducing direct payments based on the area of land farmed, to the point where it could compete with U.S.-produced wheat on a zero-tariff basis. In 1996, the U.S. also introduced direct payments with no link to production or prices. Both these systems involve direct payments that do not need to be reduced according to the WTO Agreement on Agriculture.

In order to overcome the obstacles to WTO and FTA negotiations and become more internationally competitive, Japan should reduce prices and introduce direct payments similar to those in the EU.

The first step is to reduce rice prices to market levels by phasing out production controls. A U.S.-style direct payment would be made to farms above a certain size (eg 10 hectares in Hokkaido and 3 hectares in the rest of Japan) that would be affected by the drop in prices, to sufficiently compensate them for lost income. The essence of direct payments is that, unlike price supports, assistance is targeted and inappropriate assistance is not given to farming households which are unaffected by lower prices (eg part-time rice producers whose income from agriculture does not exceed ¥100,000 and part-time rice producers whose gross income is already well in excess of that of a wage-earning household).

It is not sufficient simply to reduce rice prices to market levels. The prices of rice and other agricultural products must also be reduced to meet the maximum tariff level of 100% envisioned to result from WTO negotiations (in other words, double the international price level) and then further reduced with the aim of matching international prices. To that end, it is necessary to introduce direct payments that will have structural reform effects.

If prices drop, part-time small-holders will relinquish their holdings, but the capacity of full-time farmers who lease this land to pay rent will also diminish, and agricultural land will go uncultivated. If EU-style direct payments based on land area are made to full-time farms above a certain size, it will augment their ability to pay rent and agricultural land will start to become concentrated into the hands of farmers. Such direct payments have the direct effect of reducing costs by easing rent payments and the indirect effect of reducing costs by increasing farm sizes and productivity through the concentration of agricultural land, which allows the government to make financial savings.

If assistance is not targeted at the full-time farming households that will be responsible for future food production, the effects of structural reform will disappear. However, there is no reason for agricultural associations to oppose the selective targeting of farming households, since part-time farmers will also benefit from a portion of the direct payments in the form of rent increase.

According to PSE figures, the burden on the Japanese public from agricultural protection amounts to ¥5 trillion in the form of price support through tariffs and ¥500 billion in taxpayer-funded subsidies. After pesticides and fertilizers have been paid for, less than one quarter of price support contributes to the income of farming households. WTO negotiations do not demand the complete abolition of tariffs on agricultural products and most FTAs allow exceptions for agricultural products, but even if domestic prices were to be reduced to match international prices, it is calculated that direct payments amounting to ¥1.75 trillion (one quarter of ¥5 trillion + ¥500 billion) could maintain farm household incomes at their current level.

In fact, when I made estimates based on certain assumptions, I found that if tariffs on all agricultural products from rice paddies, horticultural land and pasture were set at the maximum level of 100%, direct payments of ¥1.1 trillion would be required, and even in the extreme scenario of zero tariffs, direct payments would only amount to ¥1.8 trillion. The national agriculture budget is ¥2.4 trillion, or ¥3 trillion if the expenditures of local governments are included. If direct payments could be made from the agricultural budget, the ¥5 trillion onus on consumers - equivalent to the Japanese consumption tax of 2% - would be slashed, greatly easing the burden on the Japanese public.

In WTO negotiations, Japan and the EU have been in accord in advocating a multifunction approach that considers the importance of production in areas other than agriculture, such as cultivation of aquatic resources. However, cooperation broke down because of the differing measures being sought in negotiations - Japan advocated tariffs, while the EU advocated direct payments. If Japan is to cooperate with the EU, it should adopt a policy stance consistent with that of the EU.

Turning the fiscal burden of agricultural policy into consumer benefits

Agricultural protection has largely been backed by tariffs, which place a heavy burden on consumers. To free ourselves from this millstone, agricultural policy must be transformed. Switching from price supports to taxpayer-funded measures is a fundamental requirement for implementing policies that are not subject to reduction commitments in WTO negotiations ("Green Box" policies).

With consumer-funded measures, it is unclear who is carrying the burden of payment, but with taxpayer-funded measures the relationship between costs and benefits is clear to the public. Price supports are counterproductive and unfair, since they place a burden on hard-pressed consumers while benefiting wealthy land-owning part-time farmers. Direct payments funded by taxpayers, on the other hand, do away with this distortion and enhance economic well-being, while at the same time targeting benefits at farms and farmers who really need assistance. This is in line with global trends in agricultural policy.

Agricultural policy needs to be reformed, not just for the sake of WTO and FTA negotiations, but also for the sake of the Japanese public and consumers. Japan has a food self-sufficiency ratio of just 40%. Agricultural land, which is essential for national food security, now amounts to only 4.8 million hectares - just enough to feed the nation if production were entirely turned over to sweet potatoes. The number of persons engaged in farming has dropped drastically, from 14 million to 2.8 million. (There are 3 million farms in Japan, and due to the increase in the number of small holdings cultivated on a part-time basis with no professional farmer involved, there are now fewer farmers than farms.) Households that pursue farming as a sideline and derive most of their income from nonagricultural activities comprise 70% of all farming households, and almost 60% of farmers are aged over 65. This situation creates concerns about the stability of food supplies to consumers.

If agricultural land is concentrated in the hands of farmers through direct payments, the nation will foster farming households that can take responsibility for supplying food, as well as cut expenses by increasing the size of farms. Such a move will reduce costs and transform the fiscal burden imposed by current agricultural policy into benefits for consumers. This is an agricultural policy that puts consumers first. Isn't it time to return agricultural policy to the long-ignored reformist roots of the former Agricultural Basic Law?

>> Original text in Japanese

* Source: "Keizai Kyoushitsu" column, Nihon Keizai Shimbun, December 22, 2003.

December 22, 2003 Nihon Keizai Shimbun

February 16, 2004

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