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TB0347

Roy Nelson

Brazil vs. the U.S. at the WTO: The U.S.-Brazil Cotton Subsidy Dispute

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In April 2010, after years of trying to get the U.S. to drop its illegal cotton subsidies, Roberto Azevedo, Brazil’s Ambassador to the WTO, knew that he had the U.S. trade negotiators where he wanted them. The U.S. had not responded in any significant way to Brazil’s previous threats of imposing retaliatory trade tariffs. But now, armed with the WTO’s approval to impose $829 million in retaliatory sanctions against the U.S.—including, significantly, authorization to revoke intellectual property rights (IPR) protection for certain U.S. products and services—Brazil had considerably more leverage.

This case had serious implications for the U.S. economy. If Brazil revoked patent protection for U.S. pharmaceutical products and copyright protection for U.S. music and films, then the losses to some of the most lucrative business sectors in the United States would be severe. Beyond that, however, other countries might choose to take similar action. Knowing how badly the U.S. negotiators wanted to avoid this outcome, Azevedo proposed a deal. On April 6, 2010, one day before Brazil was going to impose the sanctions, the U.S. trade negotiators agreed.

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The deal was that Brazil would hold off on retaliating until the U.S. enacted a new Farm Bill, to be completed by 2012 (later postponed until 2013). If the new U.S. legislation did not remove the illegal cotton subsidies, Brazil would still have the right to retaliate. In the meantime, the U.S. government would pay Brazilian cotton farmers $147.3 million per year. This amount had symbolic significance. Although it was not the total amount of retaliation the WTO had authorized Brazil to impose against the U.S., it was the specific amount of retaliation the WTO had allowed in response to two loan programs for U.S. cotton farmers which were especially blatant violations of WTO rules.1

No

While helpful, obtaining this annual $147.3 million payment for Brazilian cotton farmers was not Azevedo’s primary motivation in agreeing to the deal with the U.S. His main purpose was to use this payment to spark protest in the U.S. itself about the illegal cotton subsidies. Azevedo knew how embarrassing it would be for U.S. policymakers to make this annual payment to Brazil as they sought to renegotiate farm subsidies in the latest U.S. Farm Bill. In a time of austerity, U.S. politicians would have a difficult time justifying subsidies worth hundreds of millions of dollars even for U.S. cotton farmers. Paying subsidies to Brazilian cotton farmers, as well, would be sure to provoke outrage by key members of the U.S. Congress. Azevedo hoped that this might finally persuade U.S. policymakers to eliminate their illegal subsidies, which in turn would mean they could also eliminate the annual payment to Brazilian cotton farmers.2

Brazil’s Growing Assertiveness in the Global Economy

Do

Brazil’s growing importance in the world economy in the last two decades had been matched by its increasing assertiveness on global trade issues. A persistent theme in the last decade was Brazil’s challenge to U.S. agricultural subsidies. Under its former president, Luiz Inácio “Lula” da Silva (2003-10), Brazil refused to go along with negotiating for the Free Trade Area for the Americas (FTAA) when the U.S. refused to drop its agricultural subsidies. In the Doha Round of trade negotiations under the auspices of the WTO (2001-present), Brazil helped 1 2

Sewell Chan, “U.S. and Brazil Reach Agreement on Cotton Dispute.” New York Times, April 6, 2010, p. B2. Roberto Azevedo, Brazil’s Ambassador to the WTO. Author interview, Geneva, Switzerland, July 28, 2011.

Copyright © 2013 Thunderbird School of Global Management. All rights reserved. This case was prepared by Professor Roy C. Nelson, based in part on field research and interviews in Switzerland and Brazil, for the purpose of classroom discussion only, and not to indicate either effective or ineffective management.

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lead developing countries’ efforts to get industrialized nations to eliminate agricultural subsidies. Even though the Doha Round negotiations had stalled, Brazil’s leadership on this issue helped win support for this objective from other developing nations.

But perhaps the most striking example of this new assertiveness was Brazil’s WTO trade dispute with the U.S. over U.S. cotton subsidies. Although the WTO ruled decisively in Brazil’s favor in this dispute twice, once in 2004 (winning on appeal before a WTO appeals panel in 2005) and again in 2007 (winning on appeal again before another WTO appeals panel in 2008), the U.S. had been slow to modify its policies. After the Brazilian government began to make effective use of a combination of retaliatory threats and an appeal to U.S. media and public opinion, Brazil’s prospects for success seemed more favorable.

Resolving Global Trade Disputes: From the GATT to the WTO

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To understand this dispute fully, it is important to have some background on the World Trade Organization (WTO) and efforts after World War II to establish rules for international trade in the global economy. The WTO, established on January 1, 1995, was designed to serve as a forum for global trade issues and to resolve disputes among its members, which by August 2013 numbered 159 countries. Before the WTO existed, however, a much weaker organizational structure and mechanism for resolving disputes had been in place, from 1948-1994. This was part of the General Agreement on Tariffs and Trade (GATT). After World War II, attempts to form a powerful International Trade Organization (ITO) failed. Governments were still too reluctant to give up sovereignty, the legal control they had over their countries and their national economies, to a powerful international trade organization. As a result, in 1947 many governments formed just an agreement, the General Agreement on Tariffs and Trade (GATT), which established certain rules that all contracting parties to the agreement would follow. Although the GATT was supposedly only an agreement, not an organization, it did have an organizational structure and a headquarters based in Geneva, Switzerland, with a small staff (mainly statisticians) overseeing compliance with the agreement. Somewhat confusingly, both the agreement and the organizational structure overseeing it were referred to as “the GATT.”

No

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The GATT had a mechanism for resolving disputes among contracting parties to the agreement. If a country brought a dispute to the GATT for resolution, the GATT would establish a panel of experts on the given issue relevant to the trade dispute, such as automobiles, textiles, etc. If the panel found that provisions of the GATT had been violated, it would issue a ruling, authorizing the country that won the dispute (let’s call it “Country A”) to impose retaliatory sanctions against the other country (let’s call it “Country B”) until Country B agreed to stop the unfair trade practice. These retaliatory sanctions imposed by Country A normally took the form of trade tariffs (taxes on imports) that Country A would be authorized to impose on a select group of products that Country A imported from Country B.3 The amount of the sanctions would be based on the amount of damages the panel calculated that Country A had suffered as a result of Country B’s unfair trade practice. The objective was to make these increased tariffs so painful for Country B—or, at least, for influential exporters in Country B, able to exert influence over their government—that Country B would stop violating the rules to make the tariffs stop.4

Do

The problem with the GATT’s approach to dispute settlement was that before the panel ruling to authorize retaliatory sanctions could be implemented, 100% consensus among the contracting parties to the GATT was required. This meant that even the country that was going to be punished for breaking the rules, and was going to face the retaliatory sanctions, had to agree that it should be punished! Since that never happened, the GATT dispute settlement mechanism was almost completely useless. At best, then, the GATT was ineffective at resolvThe authorized retaliatory sanctions normally took the form of trade tariffs because this type of sanction was easy for GATT statisticians to measure and monitor, to ensure that the country imposing the sanctions was in compliance with the authorized amount of sanctions. 4 The tariffs did not need to be imposed on the exact same industry that was affected in the dispute. So, for example, Country A, winning a dispute about restricted access to Country B’s automobile market, could impose retaliatory tariffs on imports of other products, such as wine, sweaters, candy, etc., from Country B. Influential exporters of these products in Country B would then persuade their government to drop the tariffs on automobiles, since this was hurting their ability to export their own products to Country A. 3

2 TB0347 This document is authorized for use only by RATNA PALURI at HE OTHER until September 2014. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860.

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ing disputes. As a result, the GATT’s main function was not to resolve trade disputes, but rather (a) to provide a set of rules that countries could at least publically proclaim that they adhered to, thus giving all signatories to the agreement some incentive for following those rules; and (b) to provide a global forum for discussing trade issues, and for negotiating to reduce trade barriers (in a set of “rounds” or trade negotiations that occurred in various cities around the world).

In the Uruguay Round (1986-94), the final round of trade negotiations to occur under the auspices of the GATT structure, the contracting parties to the GATT decided to create a more powerful organizational structure with a better mechanism for resolving trade disputes. Thus, on January 1, 1995, the World Trade Organization (WTO) officially came into existence.

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The WTO is officially an organization, with countries that are members of an organization, rather than just contracting parties to an agreement. The WTO continues to oversee the original GATT agreement (revised in 1994), as well as many other agreements—over 20 in all. These newer agreements range beyond just the GATT agreement dealing with trade in products, and now also include agreements such as the General Agreement on Trade in Services (GATS), the Agreement on Agriculture, the Subsidies and Countervailing Measures (SCM) agreement, and the Trade Related Intellectual Property Rights (TRIPS) agreement.

As with the former procedure, if a member country brings a dispute before the WTO, it selects a panel of experts, normally three (or, if both parties to the dispute agree, five) individuals. Once both parties to the dispute are satisfied with the composition of the panel, the panel can begin its investigation of the issues, a process that can take up to six months. The panel then makes a ruling on the dispute. As under the old GATT structure, if the panel rules in favor of the country bringing the dispute (Country A), the panel will decide on the amount of retaliatory sanctions Country A can impose on the other country (Country B). This amount is based on the amount of damages Country A has suffered as a result of Country B’s unfair trade practice. As in the old GATT procedure, the sanctions are normally in the form of retaliatory tariffs.

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While all of these aspects are very similar to the way dispute settlement worked under the old GATT structure, a major difference is that once the WTO panel makes a ruling on behalf of Country A, Country B will have only one chance to appeal to an Appellate Body composed of legal experts. Once an appeals panel composed of three members of the Appellate Body decides whether the initial panel’s ruling should be upheld or overturned, in full or in part, then that ruling—known as the Appellate Body’s ruling—is the final decision. The only way the Appellate Body’s ruling can be overturned is by reverse consensus. Reverse consensus requires every single member of the WTO to vote to overturn the Appellate Body’s ruling, including the country that won the dispute. Since that never happens, the WTO’s dispute settlement mechanism is much more powerful, and panel rulings carry much more weight, than was the case for the GATT’s old dispute settlement process.

No

Although the entire process is supposed to take no longer than nine months to a year for the initial panel’s decision and three months for the Appeals Panel, in practice—as the U.S.-Brazil Cotton Subsidy case demonstrates—disputes sometimes take much longer to be resolved.

Subsidies: Prohibited and Actionable

Do

Understanding the U.S.-Brazil Cotton Subsidy dispute also requires some explanation of subsidies. Subsidies are the financial assistance that a government provides to an industry or to a specific company. Subsidies can take many forms, such as a government’s direct payments of cash to a company or industry, tax incentives, forgiving of government loans, loans at reduced interest rates, etc. The WTO’s Subsidies and Countervailing Measures (SCM) agreement defines certain kinds of subsidies that are prohibited for WTO members to use, and those that are actionable. Prohibited subsidies clearly have a distorting effect on global trade, and are of two kinds: (1) those contingent on export performance (export subsidies), and (2) those contingent on the use of domestic content. Contingent in this context means that the government requires a company or industry to meet a certain target amount of exports or domestic content in order to receive the financial benefit. In the case of prohibited export subsidies, a company must agree to export a certain percentage of whatever it produces to receive a financial benefit from TB0347 3 This document is authorized for use only by RATNA PALURI at HE OTHER until September 2014. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860.

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the government. In the case of subsidies contingent on domestic content, a company must agree to use a certain percentage of domestically produced raw materials, component parts, etc., in order to receive the government’s financial benefit.

Actionable subsidies are government financial benefits to companies or industries that harm the ability of companies in other countries to do business. For example, if a country provides financial benefits to its own companies to the extent that companies in other countries lose market share, then that would be an unfair actionable subsidy. However, it can be very difficult to prove that the reason its business has been harmed is because of subsidies imposed by the government in another country. In the case of the U.S.-Brazil Cotton Subsidy Dispute, the Brazilian government accused the United States of using both kinds of subsidies.

The Origins of the Dispute: U.S. Cotton Subsidies

Direct Payments

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Brazil initiated the WTO dispute with the U.S. over cotton subsidies, Dispute Settlement (DS) 267, in 2002. Brazil’s main charges were that U.S. subsidies in this sector were not compliant with WTO agreements, including aspects of the WTO Agreement on Agriculture and the WTO’s Subsidies and Countervailing Measures (SCM) agreement. Specifically, Brazil argued that the following subsidies, among others, were not consistent with the WTO’s rules.5

The WTO panel ruled that these payments, given to producers of cotton based on their historical production levels, would artificially increase cotton production, harming Brazilian cotton producers.

Step-2 Payments

The WTO panel found that these payments, designed to keep relatively expensive U.S. upland cotton competitive with cotton from other countries, served not only as prohibited export subsidies (contingent on exports), but also as prohibited domestic subsidies (contingent on the use of domestic content).

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Export Credit Guarantees

No

The U.S. Department of Agriculture (USDA) works with the U.S. Commodity Credit Corporation to provide loan guarantees to promote exports. This means that U.S. banks can provide credit to importers in foreign countries on terms that would not exist if market forces dictated the terms. Although there are fees to pay for this insurance, the government subsidy means that these fees are well below market rates. In fact, they are insufficient to cover the costs of the program, as a private insurance scheme would; that is why the WTO ruled that these export credit guarantees were prohibited export subsidies.

Countercylical Programs

These programs pay farmers whenever actual cotton prices fall below a target price (determined by historical prices). The WTO ruled that by reducing risk to farmers, this tended to distort production levels, giving U.S. producers an unfair advantage in global markets.

Slow U.S. Response Leads to Brazil’s Threat: Cross-Retaliation

Do

After the WTO panel’s 2004 ruling in favor of Brazil, and an Appellate Body ruling in favor of Brazil in 2005, the U.S. did make some modifications in its cotton subsidies. For example, it eliminated some Export Credit Guarantees that provided lengthy terms for repayment. The U.S. Department of Agriculture (USDA) did keep one Export Credit Guarantee, GSM-102, which continues to exist today, and it did increase the premiums charged for the GSM-102 export guarantee, but still not sufficiently to cover the risks.6 Nevertheless, the U.S. government kept essentially all of the other subsidies. Randy Schnepf, “Brazil’s WTO Case Against the U.S. Cotton Program.” Congressional Research Service, June 21, 2011; and William Ridley and Stephen Davadoss, “Analysis of the Brazil-USA Cotton Dispute.” Journal of International Trade Law and Policy, Vol. 11, No. 2, 2012, pp. 148-162. 6 Schnepf, 2011: 16. 4 TB0347 5

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When it became clear in late 2005 that the U.S. would not make further changes, Brazil received approval from the WTO to retaliate. Brazil argued that imposing tariffs on imports of goods from the U.S. would be detrimental for Brazilian consumers and would have a minimal impact on the U.S. economy. Therefore, it requested that it be authorized to suspend parts of the TRIPs agreement as part of its retaliation against the United States.

Although the WTO encouraged countries to impose countermeasures in the same sector that was affected by a dispute, WTO rules did allow for this sort of cross-retaliation if the other country seemed unlikely to respond to standard retaliatory measures.7 In fact, the WTO had already approved this approach for two other disputes involving other countries: Ecuador’s dispute on banana imports to the EU, and Antigua and Barbuda’s dispute with the U.S. over restrictions on internet gambling.8

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Although initially Brazil sought over $1 billion worth of retaliatory sanctions, it did not implement any retaliatory measures at the time, but was willing to wait for the U.S. to make modifications to the next Farm Bill of 2008. By 2007, however, it again seemed clear that the U.S. was not going to make significant modifications, and, at Brazil’s request, a WTO compliance panel ruled again (later upheld by an appeals panel in 2008) that Brazil was authorized to retaliate, including with revocation of IPR for specific U.S. products.

By 2009, after U.S. appeals, a WTO arbitration panel reduced Brazil’s authorized amount of retaliation from over $2 billion to a fixed amount of $147.3 million per year to respond to U.S. actionable subsidies, and a variable (and much larger) amount to respond to U.S. prohibited subsidies.9 In August 2009, Brazil announced that it would impose a total of $829 million in retaliatory sanctions.10 The IPR part of this retaliation would involve a range of actions, including revocation of patents on specific pharmaceutical products, and temporary suspension of copyright protection for the music and film industries.11

Effect: The U.S.-Brazil Agreement—and Future Compliance? In response to the threat of cross-retaliation, in April 2010 U.S. trade officials were ready to negotiate. Therefore, Roberto Azevedo, Brazil’s Ambassador to the WTO, proposed a deal. If the U.S. would pay $147.3 million per year to Brazilian cotton farmers, then the Brazilian government would not impose the cross-retaliation measures. 12

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On April 6, 2010—one day before Brazil was going to begin implementing its retaliation—the U.S. trade negotiators agreed to this deal, and more. Specifically, they agreed to pay the $147.3 million per year to provide technical assistance to Brazilian farmers. To manage the funds, the Instituto Brasileiro de Algodão (the IBA, or Brazilian Cotton Institute) was established. In addition, the U.S. government agreed to increase the fees for the GSM-102 program, and to begin the process of reopening the U.S. market to exports of beef from Brazil.13

No

Azevedo emphasized in an interview (2011) that the purpose of the $147.3 million was primarily to embarrass members of the U.S. Congress during discussion on the U.S. Farm Bill, set to be enacted into law in 2012 (later extended into 2013). The idea was that members of the U.S. Congress would be embarrassed if they had to explain that the reason they were paying $147.3 million per year to Brazilian cotton farmers—in effect, subsidizing Brazilian cotton farmers—was that they had refused to cut subsidies for U.S. farmers.14,15 Frederick M. Abbott, “Cross-Retaliation in TRIPs: Options for Developing Countries.” International Centre for Trade and Sustainable Development, Issue Paper No. 8, April 2009. 8 Ibid. 9 Schnepf, 2011: 21. 10 Schnepf, 2011: 24. 11 “Brazil Details Retaliation on U.S. Copyright, Patents.” Reuters, March 15, 2010. 12 Azevedo, 2011. 13 “U.S., Brazil Agree on Memorandum of Understanding as Part of Path Forward Toward Resolution of Cotton Dispute.” USTR Press Release, April 21, 2010. 14 Azevedo, 2011. 15 One Brazilian business executive stated in an interview that once the annual payment to the IBA started, a Brazilian cotton farmer told her that as a result of the money he received from IBA, he had just bought a helicopter, a gift of President Barack Obama (Source: Anonymous Brazilian Business Executive. Author interview, São Paulo, Brazil, August 20, 2011). Whether valid or not, stories like this would be sure to infuriate U.S. politicians.

Do

7

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At least in terms of shaping opinion of the U.S. media and political leaders, the approach seems to be working. As Time magazine noted: What could be more outrageous than the hefty subsidies the U.S. government lavishes on rich American cotton farmers?....How about the hefty subsidies the U.S. government is about to start lavishing on rich Brazilian cotton farmers?16

Congressman (now Senator) Jeff Flake of Arizona and others gave speeches on the floor of the House of Representatives denouncing not only the Brazilian subsidies but the U.S. subsidies that were ultimately their reason for existence. Most important, the U.S. government began making major changes in its subsidies program. Step-2 subsidies had already been eliminated in 2006. In the negotiations over the 2012 Farm Bill (eventually extended to continue into 2013), direct payments and countercyclical programs were also proposed to be eliminated completely.

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Nevertheless, in place of these older subsidies, new ones emerged out of negotiations. Much of the money saved on the other subsidies would be put into an expansion of the crop insurance subsidy. The Senate proposal called for a program called Agricultural Risk Coverage (ARC), which would limit losses farmers would experience from lower prices for agricultural products. The program would pay farmers if their revenues fell below 90% of their average revenue over the last five years. A program specifically for cotton producers, called the “Stacked Income Protection Plan” (STAX), would do the same thing for cotton.17 A serious flaw in these proposals was that with current high prices, significant subsidy payments would be likely in the future.

By 2013, Azevedo and the Brazilian government stood ready to take action again. As Azevedo stated in a January 2012 letter to Colin Peterson, the ranking member on the House of Representatives Committee on Agriculture, the STAX proposal would distort trade even more severely than the older subsidies, and would also cost the U.S. taxpayers billions more than before.18 Yet, as he noted in an interview, if the current Farm Bill did not put U.S. policies into compliance, then Brazil would have to evaluate again whether retaliation was warranted.19

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Conclusion

No

Based on past trends and current developments, persuading the U.S. government to reduce cotton subsidies was not an easy task. Nevertheless, Brazil’s combination of retaliatory threats—all within the rules-based framework of the WTO—and appeal to U.S. media and public opinion, appeared to have had at least some success in reducing U.S. cotton subsidies. Moreover, Azevedo’s willingness to stand up to the U.S. within the system, using the WTO’s rules and U.S. opinion themselves to achieve his desired outcome, won the respect of other WTO members. Observers attributed his ability to challenge the U.S. and win, without creating a serious conflict, as a large part of the reason why so many WTO members supported him to become the next Director General of the WTO, a position he assumed on September 1, 2013.20 Given Azevedo’s—and, increasingly, Brazil’s—assertive approach to trade issues, U.S. policymakers need to consider whether maintaining cotton subsidies, even in a significantly altered form, is worth the prospect of facing the potential loss of IPR protection for U.S. companies in Brazil.

Michael Grunwald, “Why the U.S. is Also Giving Brazilians Farm Subsidies.” Time, April 9, 2010. Emily Goff, “Shallow Loss: The 2012 Farm Bill’s New Subsidy Program,” The Heritage Foundation, Issue Brief #3662. (), accessed May 4, 2013; and Goodwin, Barry. 2013. “More Subsidies for Prosperous Farmers.” The American: The Online Magazine of the American Enterprise Institute, May 1, 2013. (), accessed May 4, 2013. 18 Roberto Azevedo, “Letter to the Honorable Colin Peterson,” Ranking Member, House Committee on Agriculture. January 2012. 19 Azevedo, 2011. 20 John Lyons, “World News: New Chief has Credibility with Developing Nations.” Wall Street Journal, May 8, 2013, p. A.11. 16

Do

17

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Table 1. WTO Dispute Settlement Process

These approximate periods for each stage of a dispute settlement procedure are target figures—the agreement is flexible. In addition, the countries can settle their dispute themselves at any stage. Totals are also approximate. Consultations, mediation, etc.

45 days

Panel set up and panelists appointed

6 months

Final panel report to parties

3 weeks

Final panel report to WTO members

60 days

Dispute Settlement Body adopts report (if no appeal)

Total = 1 year

(without appeal)

60-90 days

Appeals report

30 days

Dispute Settlement Body adopts appeals report

Total = 1y 3m

(with appeal)

Do

No

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Source: www.wto.org.

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60 days

TB0347 7 This document is authorized for use only by RATNA PALURI at HE OTHER until September 2014. Copying or posting is an infringement of copyright. [email protected] or 617.783.7860.