The leaking on July 27th of a WTO compliance panel report to the U.S. and Brazilian governments that the U.S. had not fully complied with a March 2005 WTO ruling concerning certain U.S. government cotton support programs is the latest event in a five-year WTO process. The report is expected to be officially released to other WTO members about October 1. In August of 2006 Brazil had requested the compliance panel because it believed that the U.S. had not fully complied with the March 2005 ruling that U.S. domestic programs disadvantaged growers in other countries.

The process began in September 2002 when Brazil asked for consultations with the U.S. concerning the impact of domestic programs for cotton. A WTO dispute resolution panel was established in March 2003 that led to the March 2005 ruling. The dispute process will likely end in February or March of 2008 when the U.S. either agrees to fully implement the ruling or Brazil requests authorization from the WTO to apply trade sanctions. Also, in mid-July Brazil filed a new WTO case alleging that total U.S. payments for all domestic agricultural support programs have exceeded WTO commitments. That case will move through the WTO process on a separate track.

The original ruling found that the U.S. cotton Step 2 program was a prohibited export subsidy; the U.S. ended that program effective August of 2006. U.S. agricultural export credit guarantee programs were also ruled to be export subsidies. That was expected to be resolved in a Doha Round agreement, but slow progress in the negotiations has held that up. Payments under market price based programs were ruled to cause “serious prejudice” against producers in other countries and have “adverse affects.” No major action has been taken on this, but the recently passed House farm bill does modestly reduce the target price for cotton. The ruling also implied that prohibiting planting of fruits and vegetables on base acres makes all of the direct payments subject to the current amber box limit of $19.1 billion per year. No action has been taken on that issue.

The arguments in the cotton case are based on market activity and domestic support programs of the late 1990s and 2000-2003. Those are increasingly irrelevant in the current market conditions. U.S. cotton acreage planted in 2007 is down 28 percent as producers planted more corn because of higher market prices. U.S. cotton exports are down this marketing year and government payments to producers are declining. Strong arguments can be made that these market conditions will continue over the next few years.

The hope of the last few years was that a successful Doha Round agreement and a 2007 farm bill would allow negotiators to work out the cotton issues without continued litigation at the WTO. Since that is not happening, the WTO dispute resolutions process continues. Options for the U.S. are clear. The subsidies can be eliminated, reduced or de-linked from production (decoupled as direct payments or as conservation payments). The U.S. and Brazil can also negotiate compensatory payments to offset the adverse effects or Brazil can choose trade retaliation consistent with WTO rules.

As a promoter of more open trade and a rules-based trading system, the U.S. should not simply run-out-the-clock and allow Brazil to choose trade retaliation. The ruling by the compliance panel is not a great surprise, and the U.S. has between now and early next year to craft an effective response. The WTO dispute resolution process is a backward looking process based on the conditions when the case was filed, and the U.S. has to deal with the facts in the case as filed.

Now is the time for the governments of the U.S. and Brazil and the cotton industries in both countries to come to the table to negotiate a compromise based on the facts in the case with an eye toward the new market realities. As Senate Agriculture Committee Chair Tom Harkin (D-IA) said in a press release, “While, of course, the United States needs to defend our programs in the WTO, we also must recognize reality, solve the problems in our programs and move on. It is far more important to prepare for the future so American agriculture can succeed in this new century than to continue fighting losing cases before the WTO.”

The U.S. does have a couple of conditions moving in its favor. First, the WTO process is slow and does not guarantee reforms at the end of the process. Just retaliating against other exports from the U.S. to Brazil does not help cotton producers in Brazil and other countries. Second, while the new market realities are not technically part of the cotton case, they will begin to influence thinking about the case as it drags on.

While the farm bill that recently passed the House is far from what other countries would like, the reality is that it will provide less support for cotton and other crops compared to the costs of producing those crops than provided under the 2002 farm bill. As time goes by, it will be harder to make arguments about the trade distorting nature of U.S. farm programs.

All of U.S. agriculture has a huge stake in finding a compromise on the cotton case within the WTO policy framework. How it is resolved will influence both the second Brazilian case and a similar case brought by Canada. Also, non-agriculture industries in the U.S. are growing increasingly impatient with agriculture blocking progress in the Doha Round. The recent decision in the House to tax businesses to find funds to pass the 2007 farm bill has added fuel to that fire. Now is the time for U.S. agriculture to control the agenda or allow someone else to fashion a deal.