To no ones great surprise, the World Trade Organization (WTO) Appellate Body of three judges agreed with the original decision released last September on Brazils claim that the U.S. was subsidizing cotton production inconsistent with its obligations under the WTO. They rejected all 19 U.S. claims of error against the original ruling. Despite the significance of the ruling, it does not change the fundamentals of the WTO negotiations.

One issue in the ruling will need to be addressed before the WTO negotiations are completed. Step 2 payments for domestic cotton use and cotton exports were ruled to be prohibited subsidies. The export credit programs for commodity products were also ruled to be export subsidies. The U.S. has until July 1, 2005 to make changes. Since the Step 2 program only applies to cotton, stopping its use could be straight forward.

Changes in the export credit programs will be more wide ranging. Since the programs apply to many commodities and are operated on a fiscal year basis, quick change in the programs would impact the established buying plans of a host of importing countries. Also, the export credit programs have been part of discussions outside the WTO for several years. The WTO framework agreement reached last summer calls for credit programs to be limited to six months at interest rates that are not subsidized. The proposed changes in the export credit programs are part of broader discussions on export subsidy programs. Unilateral changes on U.S. export credit programs would leave the U.S. at a negotiating disadvantage on export subsidies.

For the rest of the cotton programs covered by the ruling, Brazil and the U.S. have 15 months to negotiate a settlement. If the ongoing WTO negotiations follow the timeframe recently suggested by Acting U.S. Trade Representative Peter Allgeier, an agreement would be reached by the end of 2005 and individual countries would be working on the final details of specific commitments by the spring of 2006. By then the U.S. will also be well along in discussions toward a 2007 farm bill. A reasonable approach would be to roll the discussions with Brazil into the larger work on a WTO agreement with actual changes of U.S. law being part of the next farm bill.

Changes in some cotton programs may be relatively minimal. Loan deficiency payments and marketing loan gains under the commodity loan program (part of the price-contingent subsidies in the report) are already reported to the WTO in the Amber Box as potentially trade distorting and are subject to the overall limit of $19.1 billion for all U.S. programs in the Amber Box. As long as the total of cotton price-contingent payments and other commodity payments do not exceed the total limit for the Amber Box there is no need for changes in the underlying programs. President Bushs proposed 2006 budget would limit the amount of commodities allowed to be placed in the loan program and would reduce farm program costs. The current negotiations may result in a lower Amber Box payment cap.

Last summers framework agreement would allow counter cyclical program payments to be moved to the Blue Box of permitted subsidies. Given the cotton decision, opponents of this change may make a concerted effort to reject the Blue Box designation for these payments.

The most significant changes may come in direct payments under the 2002 farm bill. The U.S. considers these payments to be decoupled and classified them as Green Box, non-trade distorting. The original panel disagreed with that classification and the Appellate Body concurred with that decision. That decision turned on the fact that, while producers could plant any program crop they wanted, they could not produce fruits and vegetables. Fruit and vegetable restrictions have been part of farm bills since1990.

The fruit and vegetable restrictions protect crops that have a relatively small demand base. A small increase in acres for a particular fruit or vegetable by shifting acres from farm program crops could have a drastic impact on prices and incomes for fruit and vegetable producers. Farm program crops total about 250 million acres while total fruit and vegetable acres are about 9 million. Regardless of the farm program rules, few acres would have shifted away from cotton or any other farm program crops.

This situation could be changed by removing the fruit and vegetable planting restriction. Fruit and vegetable producers would likely be opposed to removing the planting restrictions without some type of farm program considerations in return. Last year Congress passed the Specialty Crop Competitiveness Act that authorizes $54 million per year for the next five years to improve the competitiveness of fresh produce crops. Policy analysts have expected that fruit and vegetable producers will receive increased funding in the 2007 farm bill.

Creative minds will find a way to comply with this latest ruling. Analysts in the EU are also closely studying the ruling. Over the last two years the EU has made modifications in its direct payment programs to make them compatible with the expected outcome of the WTO negotiations. Despite all of the disagreement between the U.S. and the EU on trade issues, they may be on the same side on the issue of direct payments to producers.

Trade negotiators have to keep in mind that the issue is whether or not certain payments are trade distorting, not the level of payments themselves. The U.S., EU and Japan will continue to make transfer payments to some producers for a host of political and public policy reasons. As long as the payments do not distort imports or exports they are not issues for the WTO. That point is beginning to be lost in the debate. Unless a significant amount of land is idled in the U.S. because of changes in farm program payments, which few people are arguing at this point, the impact of this decision on world commodity markets and producers in other countries is likely to be small.