WTO Condemns Brazil Industrial Policy: Brazilian Government Discusses New Subsidies Rules

According to the WTO, Brazil’s industrial programs are inconsistent with the international agreements signed by the country, in addition to providing prohibited subsidies.

Brazil’s industrial policy in check

The European Union’s (DS472) and Japan’s (DS497) disputes against Brazil’s industrial policy benefits are close to a conclusion. After almost four years since the beginning of the processes, the World Trade Organization (WTO) Dispute Settlement Body released the Panel’s report of the cases this past August, and argued that seven Brazilian programs that sought to promote technological innovation and boost exports do not comply with the Organization’s rules.

One of the main complaints was against the tax exemption granted to automotive companies that produced a percentage of their products locally. This would represent a disguised subsidy and distort international competition.

The Panel concluded that Brazil should withdraw all illegal subsidies within 90 days of the final text’s approval. On September 29th, the Brazilian government appealed to the WTO report on both cases. If the panel’s report is confirmed and Brazilian government does not comply with the WTO’s recommendation, parties could retaliate against the country. This could have direct impacts on companies doing business in Brazil.

The future of Brazilian industrial policy

The Brazilian government must now reassess its industrial policy during one of the country’s worst political and economic crises. For two years in a row, Brazil’s GDP has contracted by more than 3%. This in turn has helped drive the unemployment rate of to 13.7%. This economic contraction complicates Brazil’s ability to comply with the WTO’s requirements.

On the one hand, industrial policies have the objective of promoting innovation and productivity. On the other, policies aimed at alleviating the economic crisis should reduce government spending and increase public revenues.

The government will have to think of alternatives to tax breaks to spur industrial development, all with minimum intervention. The new policy will have to follow a more functional development policy, simplifying taxes and reducing the cost of doing business in Brazil, while supporting innovation and creating a proper environment for companies to invest in this kind of activity.

This is no easy task, especially given Brazil’s unstable economy and political scene. This task is further complicated by the lack of attention that the private sector has paid the WTO ruling thus far – even though it will need to be a major partner in drafting legislation, the public sector has largely remained uninterested in the rulings.

The Brazilian government’s ability to carry out these policy changes is further hampered by its entanglement in several ongoing corruption scandals. The government has spent the last 5 months focusing on defending President Michel Temer against two charges on corruption presented by the Attorney’s General Office. Temer’s refusal to resign has had a high cost for the country, and postponed the approval of highly important proposals for a faster economic recovery.

Now, for the next following months, the government will have to articulate to approve several unpopular measures, such as the pension reform, the postponement of salary readjustment for civil servants, and the end of benefits for several sectors. Additionally, the constant corruption scandals revealed by several plea bargains under negotiation by top politicians arrested and the upcoming 2018 presidential elections. Temer’s cabinet will continue to be affected by scandals, and changes might affect the continuity of the undergoing policies.

Starting in around April 2018, the runup to the October 2018 general elections, will further complicate the government’s agenda and make difficult to approve any proposal. It is important to note that any ministers that intend to run for the elections will have to leave their positions.

If the Minister of Development, Industry, and Trade, decides to run for instance, the ministry might be left without a clear leadership until 2019. Something that would reduce political influence in the draft of the new policy, however, without someone ahead of the ministry, the final decision over the policy would be postponed.

A new policy might take longer than expected

Brazil’s appeal of the WTO’s ruling will postpone the final decision against the programs at least 2018. Brazil might also benefit from the number of processes currently under analysis at the WTO and their constant delays – the WTO already broke all deadlines for the final report on the Brazilian cases.

The Trump administration’s recent attempt to block the appointment of new member to the Appellate Body exacerbates the likelihood of further delays. The Appellate Body is already operating with five members instead the normal seven, and will be down to four in December.

If the block continues and no new members are appointed, the delays might increase even more. This delay would allow Brazil to maintain the current policies while the appeal is processed, and would provide the government with more time to work on a long-term and sustainable industrial policy.

Amid major reformscorruption scandals, and elections, the industrial policy reformulation might not have the attention it needs to comply with the demands of the WTO. There is a high chance that any changes will have to be postponed to the next administration.

This exposes Brazil to a medium term risk of retaliatory sanctions from other countries. It is important to note, however, that this retaliation is not an immediate action and it has to be submitted to the WTO and takes a while to be settled. Without the possibility of counting on the government to focus on the discussion, the private sector and the civil society will have to participate actively in the draft of the new programs to promote innovation and productivity in the country.

 

Juliano Griebeler is an analyst at Global Risk Insights. As originally appears at: https://globalriskinsights.com/2017/12/wto-condemns-brazil-industrial-policy-brazilian-government-discusses-new-subsidies-rules-amidst-worst-economic-political-crises/

 

This column does not necessarily reflect the opinion of the editorial board or Frontera and its owners.

Sugar’s Brave New World

  • The rally in sugar prices that began in the summer of 2015 has lost steam. Prices are unlikely to recover to their recent peak any time soon.
  • Among the supply threats that are likely to put a cap on prices, the most important is the reform of E.U. sugar policy, which may turn the E.U. into a net exporter within a few years.
  • It is impossible at this stage to guess what Trump administration policy on U.S. sugar subsidies will be, but if it has the will, it probably has a bigger chance of effecting change than any administration in many years.
  • After its success against the European Union, the World Trade Organization is turning its attention to other sugar exporters, including India and Thailand.
  • Trends in sugar production favor big producers, whether of beet or cane. This will continue and even accelerate.

The 75% increase in global sugar prices since their most recent nadir in August 2015 has clearly been welcome to producers. But just as clearly, it hardly signals a return to the unusual prosperity of the beginning of this decade.

 

Granted, the extraordinary prices achieved in 2010 resulted from an unusual confluence of poor harvests in Brazil, China, Russia and Australia, which are, respectively, the largest, fourth-, eighth- and tenth-largest producers. In addition India, which is the largest consumer as well as the second-largest producer, imposed export restrictions that year. So the prices achieved in 2010, 2011 and 2012 were never likely to be regained, barring a similarly improbable constellation of circumstances. Nevertheless, they are quite healthy, and sugar farming is a comfortably profitable business for most producers for the first time in five years. They may not be dancing in the streets, but their increased prosperity is certainly being felt in the economies of producing nations.

The USDA expects global sugar production in the 2016/7 crop year to increase 3% to 171 million metric tonnes, but with consumption forecast to grow to 174 million, stocks will be drawn down and prices should remain firm. Much of the increased production will result from a recovery in the Brazilian crop after a weak harvest last year and increased acreage under sugar beet in the European Union, while Indian and Thai crops are expected to be weak.

However, cheap maize and several other factors seem to have put a lid on prices. Food manufacturers are switching to corn syrup, reducing consumption of cane and beet sugar, and Chinese demand has weakened as well. Some forecasters are even suggesting that surplus production could result in stock-building in the 2017/8 crop year. While 2017/8 is distant, and the outlook for both production and demand in the meantime is uncertain, at this point it does not look as though sugar prices have tremendous upside in the near term.

European Union Sugar Reform

During the 1980’s, farm subsidies under the E.U.’s Common Agricultural Policy resulted in mountainous surpluses of commodities. Disposal of these surpluses on world markets caused considerable disruption, and ultimately generated fierce opposition from Third World sugar producers in the GATT Uruguay round. A variety of reforms ensued, but sugar beet was not included in them, until, after a World Trade Organization case brought by Brazil, Thailand and Australia, in 2006 subsidized purchase prices were cut and production quotas put in place. The result, not surprisingly, was a decline in E.U. sugar production and the E.U. went from being a net exporter to a net importer.

However, this was temporary. E.U. sugar production soon adjusted to the change of regime. Further, several new members of the E.U. are significant producers, and tonnage recovered to previous levels. Since E.U. sugar farming is highly efficient, the quotas and the WTO ceiling on E.U. sugar exports began to be felt as a significant constraint on farmers, while the price guarantees became less valuable to them during the early part of this decade when free market prices were high. The E.U. has resolved to eliminate export subsidies and production quotas from September 30, 2017 (i.e., the end of the coming harvest). This will also negate the WTO export ceiling, although E.U. sugar import restrictions ─ reserving tariff-free access to whatever remains of the import market to selected former colonies and underdeveloped countries ─ will remain in place.

The USDA expects increases in acreage under sugar beet to raise E.U. production by 13% in 2017, while consumption will remain unchanged. This will put the E.U. within site of self-sufficiency. France, already Europe’s predominant producer, is expected to add the most capacity. At the same time, reforms will lift quotas on E.U. production of corn syrup, which is likely as a consequence to increase its share of the E.U. sweetener market substantially from its current 3.5%. While forecasts of farmers’ crop choices vary widely, it is quite possible that by 2019 or 2020 the E.U. will return to being a net exporter of sugar. Should this occur, the turnaround from importer to exporter would be equivalent to increasing sugar stocks in the free market by 4% or even more. There are obvious reasons why sugar prices may struggle to increase from current levels.

The Trump Administration

For all that the E.U. market reform has a certain beggar-thy-neighbor aspect to it, at least European sugar production will be on a more level playing field with world producers from September next year. Arguably, the fact that many other producers are less efficient is their problem, not the E.U.’s. The situation in the U.S. is quite different, with highly protected and richly subsidized sugar agriculture still firmly entrenched. Since it cannot meet U.S. consumption requirements and exports nothing, it has never run afoul of the WTO. However, it remains one of the most long-standing and egregious examples of American crony capitalism. In addition to direct payments from taxpayers, American sugar producers extract rents from consumers that effectively double the wholesale price of sugar compared to the global free market.

Reading the tea leaves on the new U.S. administration’s likely policies is singularly unrewarding. While at least the President-elect has not made conflicting comments about agricultural policy, he has not really made any significant pronouncements about it at all. His talk about “draining the swamp” in Washington might suggest a willingness to reconsider aspects of American farm policy such as price supports, and at least one commentator seems to think that it does. However, the first real indicator of Trump administration agricultural policy that we are likely to get will be his choice of Secretary of Agriculture.

Mr. Trump apparently offered the position to a congresswoman and farmer from South Dakota, but she turned it down. Since then a wide number of possible appointees have been mentioned in the press. Some of them are farmers with connections to Farm Bureau or cooperative organizations, some are state agriculture commissioners and others are governors, congressmen or senators from farming states. One of them is a Democrat from North Dakota, which produces about 9% of U.S. sugar. On the face of it, none of these people seem likely to be advocates of radical change in USDA policy, but really, it is hard to say, and by all reports the field is wide open.

The sugar lobby is notoriously persuasive, but the 115th Congress may be less amenable to its charms and political donations than any in recent memory. U.S. sugar policy is a prime candidate for an iconoclastic administration to reform. There are solid grounds for believing that reform, by lowering the domestic price of a widely-used commodity, would create jobs or recapture ones that have migrated to Mexico (the fifth-largest sugar producer). This is an argument that might well appeal to the incoming administration. Reform of the U.S. sugar regime would certainly be good news for sugar exporters, and, if sufficiently radical, would probably more than offset the threat of E.U. exports on a four or five year view.

Background: Sugar Economics

Sugarcane is a semi-tropical or tropical crop, and consequently is largely a product of developing countries, although both the U.S and Australia produce it in quantity. It requires substantial rainfall or irrigation: hence its absence from the Arab peninsula, most of North Africa and Namibia. Sugar beet is a temperate zone crop, preferring cool growing conditions: where it is grown in warmer climates, such as Morocco, it is a winter crop. Consequently, sugar beet can be ─ and is ─ grown in most developed countries. Only the U.S. and China harvest globally significant amounts of both beet and cane. Beet sugar accounts for 58% of U.S. sugar production but just 8% of Chinese.

Sugar is subject to more Byzantine regulatory and protectionist regimes than any other commodity, so local pricing, not only in the developed world but in other markets such as India or Egypt, may bear little or no relationship to free market pricing. The free market price is dominated by a handful of producers, of which Brazil is by far the most influential.

Although Brazil has ample domestic demand from its population of 206 million as well as the world’s largest (and heavily subsidized) cane-derived ethanol fuel industry, which absorbs roughly half of raw sugar production, it is nevertheless overwhelmingly the largest exporter of sugar. This creates an unexpected correlation between sugar prices and oil prices: when oil prices are weak, demand for ethanol decreases, making more supply available for export as sugar.

India is the world’s second largest sugar producer, but it is also the world’s biggest consumer. Plans to mandate ethanol blending in gasoline are only likely to increase consumption. Consequently, its surplus available for export is not very large relative to the large amount of sugar it grows, and could shrink further. Its domestic market is insulated from world markets, and its current drought-induced crop shortfall caused the government to impose a 20% duty on exports in June, in an effort to contain spiraling domestic prices. This was less than a year after the Indian government ordered mandatory exports to reduce stocks. Such gyrations are typical of sugar price support regimes. It is not surprising the India has attracted WTO scrutiny.

Sugar beets are planted from seed and destroyed in the act of harvesting them. So fields under beets can easily be changed to another crop the next season, giving farmers considerable flexibility. Where I used to live in Suffolk, on the east coast of England, fields under sugar beet one year were often under wheat the next. Sugar cane, on the other hand, can be economically productive up to ten years, putting up new shoots after harvesting, although yields tend to decline after the second or third harvest. It is a seed-bearing plant, but commercial planting generally uses cuttings. Where farmers lack mechanization, removal of old plants and re-planting is quite labor intensive, encouraging them to accept lower yields, at least on parts of their fields.

All sugar beet and about half of sugarcane is mechanically planted and harvested. In addition to the obvious labor savings, mechanical production encourages frequent re-planting of cane, which maintains yields at a high level. However, manual labor still accounts for about half of world cane production. The importance of the producing country in world markets is not a decisive factor in whether the crop is mechanized: Thailand, for instance, has some 107,000 smallholders growing cane on plots that average 10 acres (4 hectares), and while mechanization is making inroads, there are still plenty of machetes swinging during harvest time. The bulk of Brazilian production is mechanized, but it still has some peasant farmers. Competitors argue that Thailand maintains its place among sugar exporters by a complex web of subsidies that offset its relative inefficiency. It is expected that Brazil will bring it before the WTO, possibly in conjunction with other producers.

In sugar production, the big get bigger. Mechanization is one factor, both encouraging and enabling increased farm size, but the cost of fertilizers, pesticides and, increasingly, hybrid and genetically modified stock, make it fairly clear that the future belongs to large producers. This is equally true of beet as of cane: the trend toward increased yields (weather permitting) in the European Union results from superior stock, just as it does in Brazil. In the long run, small farmers are at increasing risk of being marginalized if subsidies are removed. Preferential quotas granting some Caribbean and African producers tariff-free access to the E.U. market (which even after reform will trade at a premium to free market sugar) may keep them afloat for a while. But the economics of sugar are as unforgiving as the labor of producing it manually. One silver lining: sugarcane is nitrogen-fixing, so soils that have been under cane, in some cases for centuries, are not depleted.

 

John Abbink is Principal at Apeiron LLC.