Economics - Headway

Standard 12. - International trade, exchange rates, and international institutions affect individuals, organizations, and governments throughout the world.

Benchmark - 9.2.5.12.1 - Apply the principles of absolute and comparartive advantage to explain the increase in world production due to specialization and trade; identilfy the groups that benefit and lose with the free-trade treaties, trading blocs and trade barriers.

 

                       

Lesson Overview

This reading-based activity is a combination guided discussion and paper-and-pencil exercise examining the impact of trade barriers on various participant groups in the sugar market. U.S. sugar policy creates a tale of 2 markets and offers a clear illustration of who benefits from and who bears the costs of market restrictions.  In the process of analyzing and comparing those markets, students rediscover three important economic constants:

• Voluntary trade creates wealth;

• Incentives always matter; and

• Economic change creates winners and losers.

Is This a Sweet Deal ?

Every year U. S. consumers pay from $500 million to $3 billion extra for sugar and products containing sugar because the U.S. government imposes import quotas and provides subsidies for sugar beet and sugar cane farmers.  True, even at $3 billion, this works out to only around $10/consumer, but what about the other side of the fence? Sugar trade policies allow approximately 10,000 growers to each reap anywhere from $40,000 to $250,000 annually, with a relatively few larger growers receiving the greatest benefits.  How did cane and beet farmers get this sweet deal?

A look at the history of the American sugar industry reveals that government involvement in the sugar market is anything but new.  In 1789, the First Congress of the United States imposed a tariff on foreign sugar.  Its simple purpose – to raise revenue – proved to be a sweet deal for a government that had no income tax with which to pay its expenses. Although the purposes varied and the legislation became more complex, the federal government’s sweet tooth was in evidence throughout the next century.  Between 1789 and 1930, Congress enacted a total of 30 pieces of sugar tariff legislation.

In the 1930s the focus of sugar policy changed from raising revenue to protecting sugar growers from foreign competition, and the 1934 Jones-Costigan Act initiated the use of quotas to control the supply of sugar in the U.S. market.  Under that legislation, the Department of Agriculture determined the demand for sugar; that is, it made an educated guess about how much sugar people and businesses would buy.  The next step was to choose who would supply the sugar to meet this estimated demand. The USDA allocated just over 99% of the supply quota to:

1. U.S. suppliers of beet and cane sugar, and

2. Cane sugar suppliers from Cuba and the U.S. dependencies of Hawaii, Puerto Rico, the Virgin Islands, and the Philippines.

Once the domestic supply was allotted, the quota for imported sugar was determined by subtracting the amount produced by groups 1 and 2 from the total estimated demand.  Thus, foreign producers were allowed to supply less than 1% of the sugar that American consumers wanted.

While the legislation obviously had an impact on foreign producers of sugar who hoped to sell in the U.S., the quotas also affected the income-earning ability of American sugar producers. Because the Jones-Costigan Act was designed to stabilize the domestic sugar industry, the quota system could impose limits on individual growers.  Anticipating the possibility that some American producers would not be allowed to grow as much sugar as they wanted to or as they had in the past, Jones-Costigan provided for a tax on sugar processing.  The tax was, of course, ultimately paid for by consumers in the form of higher prices on sugar and products using sugar.  Tax revenues were used to compensate those beet and cane growers who had to reduce production.

In the late 1940s, the U.S. started using sugar quotas as a foreign policy tool.  For example, Cuba received preferential treatment in the assignment of 1948 quotas because Cuban cane growers had increased output during WWII and supplied the U.S. with low-priced sugar.  Ironically, in 1960 the sugar quota was once again used as a foreign policy tool in Cuba, but this time all sugar imports were banned to protest the communist takeover of Cuba’s government.

Beginning in 1970, world consumption of sugar increased significantly and resulted in record high world sugar prices. Because of these high prices, the U.S. government removed the quotas on raw sugar and the Agriculture Department stopped allocating sugar quotas for domestic areas.  Only a small tariff remained on imported sugar.

Predictably, the high world price called out increased production by both domestic and foreign producers and the price declined sharply. In response to this decline the U.S. government increased the tariff on imports and instituted subsidies for domestic growers through a loan guarantee program.  Growers are allowed to obtain government financing at a below-market rate and commit raw sugar as collateral. If the market price does not reach the level of the loan rate the producer simply gives the collateral sugar to the government to repay the loan.  Definitely a sweet deal for sugar farmers.

During the early 1980s this loan program was expanded to include estimated interest and shipping costs, and the USDA designated a “Market Stabilization Price” (MSP).  When the world price of sugar continued to fall, the U.S. re-imposed the sugar quota in 1982.  The quota worked as expected, reducing the amount of sugar available to purchase and thus pushing the price higher.  Since that time the U.S. has continued to use quotas to regulate the volume of raw sugar imports so that domestic sugar prices don’t fall below the MSP.  If the volume of sugar on the domestic market increases – say, because of an extraordinarily good crop year – the import quota is reduced.  If domestic production is very low for some reason, then the import quota may be expanded.  (Wouldn’t the local pizza delivery love it if the government closed his competitors whenever an increasing supply of pizzas threatened to make the pizza price drop!)

During the 1980s the U. S. continued to use the sugar quota as a foreign policy tool with South Africa, Nicaragua, and Haiti.  Also of significance was that U.S. food processors, faced with the relatively high price of sugar, dramatically increased use of high fructose corn syrup, a close substitute for refined sugar.  This led to a decline in the domestic demand for refined sugar, but rather than domestic growers adjusting their output, the global quota amount was reduced to keep the sugar price from falling.

In 1989, in response to Australia’s challenge under GATT (the General Agreement on Tariffs and Trade), the U.S. changed to a “tariff-rate quota.”  Under the TRQ system a quota-holding country can export up to the quota amount at a tariff rate of 0.625 ¢/lb.  The same country may export additional sugar to the U. S., but the tariff rate jumps to 16.72¢/lb.

The North American Free Trade Agreement (NAFTA) also addressed the sugar trade.  One result of the NAFTA process of reducing and eliminating trade barriers is that Mexico’s sugar production increased dramatically from the 3.8 million tons of sugar in 1994 to almost 5.5 million tons in 1998.  In addition, Mexico’s imports of U.S. high fructose corn syrup, a good substitute for sugar, increased from 52,000 metric tons in 1995 to over 207,000 tons in 1998.

The farm bill of 1996 removed all controls on domestic production and reduced the tariff rate-quota on imported sugar to 15.36¢/lb, but kept in place the practice of taking sugar at guaranteed prices in payment of government loans to sugar farmers.  This practice, of course, reduces or eliminates incentives for growers to cut back on production.

Trends that have developed in the past few years include a decrease in the number of domestic sugar producers, but an increase in the average number of acres farmed by each producer. Fiscal year 2000 domestic production of sugar is estimated at a record 9 million metric tons, a surplus of almost 2 million tons in U.S. production.  Some growers blame the surplus on the rapid development of alternative sweeteners and on the flexibility of U.S. farmers who switch among grain, oilseed, cotton, rice, and sugar depending on the market prices of the different crops.  Regardless of the validity of those claims, it is certainly the case that government sugar subsidies increase the incentives for farmers to make the switch to sugar when the prices of other crops fall.

World sugar production in 1999 was a record 132 million metric tons.  2001 world sugar production is forecast to be down by about 6 percent, with Brazil, one of the world’s largest sugar producers, expected to decline by about 26%, and the European Union, the leading producer of beet sugar, expected to drop 13%.

World prices have, for the most part, declined since 1998, with the average world price being around 6¢/lb.  The U.S. domestic price for the same period is approximately 17.5¢/lb.

With the significant emphasis on reducing trade barriers during the last decade of the 20^th century, why have quotas and subsidies been retained in the sugar industry, and why haven’t consumers raised a fuss over the extra millions of dollars they spend each year for sugar and sugar-related products?

 

Questions:

1.  When did the united States first impose a tariff on foreign sugar?

2.  What was the shift of focus on sugar duringthe 1930's?

3.  Who ultimately paid for the tax on sugar processing in the Jones-Costigan Act?

4.  How did the 1960 sugar quota affect Cuba?

5.  Describe the reasons behind the price flucuations during the 1970's.

6.  What was the result of eliminating trade barriers with Mexico during NAFTA?

7.  Answer the question posed by the author in the last sentence of the reading.

8.  Who wins by having barriers to free trade (sugar)?  Who loses?