Order Code RS22187
July 11, 2005
CRS Report for Congress
Received through the CRS Web
U.S. Agricultural Policy Response
to WTO Cotton Decision
Randy Schnepf
Specialist in Agricultural Policy
Resources, Science, and Industry Division
Summary
On March 3, 2005, a World Trade Organization (WTO) Dispute Appeals Panel
ruled against the United States in a dispute settlement case (DS267) brought by Brazil
against certain aspects of the U.S. cotton program.1 The United States was given a July
1, 2005, deadline to bring certain cotton programs into compliance with WTO rules. On
July 5, 2005, U.S. Secretary of Agriculture Mike Johanns announced that the
Administration was sending proposed statutory changes to Congress to comply with the
WTO case including elimination of the Step 2 cotton program, removal of a 1% cap on
fees charged under the GSM-102 export credit guarantee program, and termination of
the GSM-103 export credit guarantee program. In light of USDA’s proposed changes,
and with the expectation that they will be fully implemented in an expeditious manner,
Brazil has temporarily suspended its pursuit of WTO-sanctioned retaliatory trade
measures against U.S. agricultural products. The U.S. National Cotton Council (NCC)
has announced its opposition to the removal of the Step 2 cotton program.
Modifications to or the elimination of the programs as suggested by USDA, ultimately
will be decided by Congress. This report will be updated as events warrant.
Background
In late 2002, Brazil initiated a WTO dispute settlement case against specific
provisions of the U.S. cotton program. On September 8, 2004, a WTO dispute settlement
panel released its ruling on the case, finding against the United States on several key
issues. On March 3, 2005, the WTO panel’s ruling was upheld on appeal. On March 21,
2005, the panel reports were adopted by the WTO membership, initiating a sequence of
events, under WTO dispute settlement rules, whereby the United States is expected to
bring its policies into line with the panel’s recommendations or negotiate a mutually
acceptable settlement with Brazil. U.S. failure to comply could result in WTO-sanctioned
trade retaliation by Brazil against certain U.S. agricultural exports.
1 For a detailed discussion of the U.S.-Brazil WTO dispute settlement case see CRS Report
RL32571, U.S.-Brazil Cotton Subsidy Dispute.
Congressional Research Service ˜ The Library of Congress

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The U.S. response to the WTO cotton ruling is being watched closely by developing
countries, particularly by a consortium of four African cotton-producing countries which
has submitted its own proposal to the WTO calling for a global agreement to end all
production-related support for cotton growers of all WTO-member countries.2 In
addition, other WTO members are likely to evaluate the U.S. response as an indicator of
whether the United States is prepared to make substantial cuts in market-distorting
agricultural subsidies as part of the Doha Round of WTO trade negotiations.3
WTO Panel’s Recommendation
In its final report, the WTO panel recommended that the United States withdraw
those support programs identified as “prohibited” subsidies by July 1, 2005, and bring
into compliance those programs identified as “actionable” subsidies with no deadline
given. Each of these subsidy types — prohibited and actionable — involve a different
type of response and a different timetable for implementing that response. Under the
WTO’s Agreement on Agriculture, prohibited subsidies are treated with greater urgency
than actionable subsidies — in particular, they are given a shorter time frame for
compliance.4
Prohibited Subsidies. Prohibited export subsidies refer to unscheduled export
subsidies (i.e., subsidies applied to commodities not listed on a country’s WTO schedule
or made in excess of the value listed on the schedule).5 Prohibited import substitution
subsidies refer to subsidies paid to domestic users to encourage the use of domestic
products over imported products.
Step 2 User Payments. Step 2 payments are part of special cotton marketing
provisions authorized under U.S. farm program legislation to keep U.S. upland cotton
competitive on the world market.6 Step 2 payments are made to exporters and domestic
mill users to compensate them for their purchase of U.S. upland cotton which tends to be
priced higher than the world market price. In its finding, the panel considered Step 2
program payments to exporters separately from payments to domestic users. Payments
to exporters were found to be “contingent upon export performance” and therefore
qualified as prohibited export subsidies in violation of WTO commitments. Payments to
domestic users were found to be “contingent on the use of domestic over imported goods”
and therefore qualified as prohibited import substitution subsidies.
2 For more information, see CRS Report RS21712, The African Cotton Initiative and WTO
Agriculture Negotiations.
3 “U.S. Proposes to Abolish Cotton Subsidy Scheme,” Financial Times, July 5, 2005.
4 For disputes involving prohibited subsidies, the prescribed time is halved (WTO, Agreement
on Subsidies and Countervailing Measures, Article 4.12).
5 For more information, see CRS Report RL32916, Agriculture in the WTO: Policy Commitments
Made Under the Agreement on Agriculture.
6 For more information on Step 2 payments, see CRS Report RL32442, Cotton Production and
Support in the United States.

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Export Credit Guarantees.7 USDA’s export credit guarantee programs (GSM-
102 and GSM 103) underwrite credit extended by private U.S. banks to approved foreign
banks for purchases of U.S. food and agricultural products by foreign buyers. GSM-102
covers credit terms up to three years, while GSM-103 covers longer credit terms up to 10
years. The Supplier Credit Guarantee Program (SCGP) insures short-term, open account
financing designed to make it easier for exporters to sell U.S. food products overseas.
The WTO panel found that the GSM-102, GSM-103, and SCGP export credit
programs effectively functioned as export subsidies because the financial benefits
returned to the government by these programs failed to cover their long-run operating
cost. Furthermore, the panel found that this applies, not just to cotton, but to all recipient
commodities that benefit from U.S. commodity support programs. As a result, the WTO
panel ruled that export credit guarantees for any such recipient commodity are limited by
previously scheduled WTO export subsidy commitments. If a commodity that benefits
from program payments is unscheduled (i.e., not listed on a country’s WTO schedule)
then, according to the WTO panel, it is not eligible for U.S. export credit guarantees so
long as the credit guarantees continue to function as an implicit export subsidy. With
respect to the WTO case, the panel ruled that the subsidized export of scheduled
agricultural products that remain within their export subsidy schedules do not circumvent
U.S. export commitments and are not subject to trade remedy actions.
Actionable Subsidies. The panel also issued recommendations concerning
“actionable” subsidies identified as contributing to serious prejudice to the interests of
Brazil during the marketing years 1999-2002. Specifically, this involved those U.S.
subsidy measures — marketing loan provisions, Step 2 payments, and Counter Cyclical
Payments — singled out as price-contingent (i.e., dependent on changes in current market
prices). The panel recommended that, upon adoption of its final report, the United States
take appropriate steps to remove the adverse effects or to withdraw the subsidies.
However, it is noteworthy that the actionable subsidies remedy dealt with serious
prejudice and injury that occurred during a historical time period (1999-2002) and not
current or future prejudice or injury. In support of this concept, the panel stated that U.S.
compliance with recommendations on prohibited subsidies — i.e., the Step 2 provisions
and export credit guarantees — could so significantly transform the basket of policy
measures currently in question that it is not necessary or appropriate to address Brazil’s
claims of threat of serious prejudice.8 Thus, it appears that removal of the prohibited
subsidies may by sufficient to resolve the actionable subsidies recommendation.
U.S. Response
With respect to implementing changes to the “prohibited subsidies,” the
Administration is limited to how much response can be accomplished through altering the
program’s operation and how much response requires new legislation. The Step 2 cotton
7 For information on these programs, see CRS Report IB98006, Agricultural Export and Food
Aid Programs; or USDA, Foreign Agricultural Service, “Export Credit Guarantee Programs,” at
[http://www.fas.usda.gov/excredits/default.htm].
8 Report of the Panel, “United States — Subsidies on Upland Cotton,” WTO, WT/DS267/R, para.
7.1503, p. 354.

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program was authorized by the 2002 farm act (P.L. 107-171; Sect. 1207) and would
necessitate new legislation to remove or alter its implementation. The Administration has
more discretion over the implementation of the export credit guarantee program, since it
may choose simply not to operate the program or to provide credit only for WTO
scheduled commodities. However, if the Administration intends to use export credit
guarantees for the current list of supported commodities in otherwise unrestricted
amounts, then some statutory changes will be needed to eliminate the alleged “subsidy”
component of export credit guarantees. This is because user fees for GSM-102, the
primary export credit program, are capped at 1% of the value of the export product.
Higher fees are needed to ensure that the financial benefits returned by these programs
fully cover their long-run operating costs; thereby eliminating their subsidy component.
On June 30, 2005, USDA announced that beginning July 1, the Commodity Credit
Corporation (CCC) would use a risk-based fee structure for the GSM-102 and SCGP
programs. As a result, fee rates are now based on the country risk that CCC is
undertaking, as well as the repayment term and frequency under the guarantee. The new
structure responds to a key finding by the WTO that the fees charged by the programs
should be risk based. In addition, the CCC stopped accepting applications for payment
guarantees under GSM-103. Any remaining country and regional allocations for GSM-
103 coverage under FY2005 program announcements was reallocated to the existing
GSM-102 program for that country or region.
On July 5, 2005, U.S. Secretary of Agriculture, Mike Johanns, announced that the
Administration was sending three proposed statutory changes to Congress to comply with
the WTO case: 1) elimination of the Step 2 program; 2) removal of the 1% cap on fees
that can be charged under the GSM-102 export credit program; and 3) termination of the
GSM-103 program.9 According to Secretary Johanns the proposed changes were worked
out in collaboration with U.S. industry groups. Furthermore, Secretary Johanns said that
repealing the Step 2 program would remove both the prohibited export subsidies and
import substitution subsidies that the WTO cited and address issues related to suppression
of cotton prices in world markets; eliminating the 1% fee cap would make the Export
Credit Guarantee Program more risk-based; and terminating the GSM-103 program
(which extends credit for up to 10 years) would reinforce the recent U.S. decision to stop
using longer-term export credit guarantees.
Brazil’s Response
What is Permissible? In accordance with WTO dispute settlement rules, upon
visible evidence of U.S. noncompliance by the July 1, 2005 deadline, Brazil could request
negotiations with the United States to determine mutually acceptable compensation (e.g.,
tariff reductions in areas of particular interest). If, 10 days after the designated period
expires, no satisfactory compensation is agreed to, Brazil may ask the WTO for
permission to impose limited trade sanctions against the United States. The trade
sanctions are limited to a value equivalent not to exceed the level of lost benefits. The
DSB must grant this authorization within 15 days of the expiry of the “reasonable” time
period unless there is a consensus against the request. If the United States objects to the
amount proposed by Brazil, the level of suspension would be arbitrated (by the original
9 USDA press release No. 0242.05, July 5, 2005.

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panel if available). Arbitration shall be completed within 30 days after the date of expiry
of the designated period (July 1, 2005). No trade sanctions are to be imposed during the
arbitration period.
What will Brazil Do? According to Brazil news media sources, on July 4, 2005,
Brazil sent an official request to the WTO seeking authorization to retaliate against U.S.
cotton subsidies. Brazil claims that the preliminary steps of June 30 concerning U.S.
export credit program modification were insufficient to comply with the WTO panel
recommendation.10 News reports suggested that Brazil was seeking authority for trade
retaliation valued at $2.905 billion. However, on July 5, 2005, a spokesperson for the
U.S. Trade Representative (USTR) announced that the United States and Brazil had
reached a procedural agreement suspending further retaliation proceedings in the WTO
cotton dispute.11 Brazilian news media stated that Brazil will defer its right for sanctions
until year’s end, under the condition that the White House convince Congress to change
the programs in question. “We have the intention and the desire that the United States
fulfill the WTO decisions, but we reserve our right to retaliate in case we have to use it,”
said Brazilian Foreign Minister Celso Amorim. A Brazilian government spokesman said
that the retaliation could be applied to imported U.S. goods, but could also be placed on
services and intellectual property.12
Once armed with the authority to impose trade sanctions, Brazil may still choose to
wait. A precedent for this occurred under the WTO Dispute Settlement case (DS108)
involving the U.S. Foreign Sales Corporation statute. Under DS108, the European
Communities (EC) received authorization to impose retaliatory measures against the
United States on May 7, 2003.13 However, the EC did not begin imposing additional
duties on U.S. products until March 2004.
Potential Effects to U.S. Agriculture of Proposed Changes
Eliminating the Step 2 Program. According to the USDA’s chief economist,
Keith Collins, ending the Step 2 program would have some impact on U.S. cotton
markets.14 The Step 2 program has channeled nearly $3 billion to the U.S. cotton industry
since 1996.15 Collins said that the removal of Step 2 would result in slightly lower
domestic prices — by two to three cents per pound — and higher export prices for U.S.
10 This story appeared in several Brazilian news sources as reported by the U.S. Embassy,
Brasilia, Public Affairs Press Summary for July 5, 2005.
11 USTR, News Release 2005-38; July 5, 2005.
12 Brazilian newspapers O Estado de S. Paulo- B6; Valor Econômico- A1, A4; Folha de S. Paulo-
B9; O Globo- 22; and Jornal do Brasil-A19 as reported by the U.S. Embassy, Brasilia, Public
Affairs Press Summary for July 6, 2005.
13 For more information, see CRS Report RL32014, WTO Dispute Settlement: Status of U.S.
Compliance in Pending Cases, by Jeanne Grimmett.
14 “More Cotton Program Changes,” Washington Trade Daily, Vol.14, pp. 131 and 132, July 5-
6, 2005.
15 USDA, Farm Service Agency, Table 35-CCC, Net Outlays by Commodity & Function;
available at [http://www.fsa.usda.gov/dam/bud/bud1.htm].

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cotton. But he also anticipated that declines in producer prices would be likely to trigger
an increase in counter-cyclical payments (CCP) to U.S. cotton farmers that would offset
losses from lower prices.16 Hence, some of the budgetary savings from eliminating Step
2 would be negated by the required additional outlays for commodity price support.
The National Cotton Council (NCC) announced its opposition to the immediate
elimination of cotton’s Step 2 program as proposed by USDA.17 The NCC is an industry
group representing cotton producers, ginners, warehousers, merchants, cottonseed
processors/dealers, cooperatives and textile manufacturers. NCC chairman Woods
Eastland expressed concern that the program not be changed in the middle of the
marketing year when it could have disruptive effects on cotton producers and users alike.
Eastland expressed the NCC’s interest in working with Congress in effecting a “fair and
appropriate” response to the WTO case. However, in previous testimony to Congress the
NCC leadership has expressed a consistent interest in participating in the WTO’s rules-
based international trading system and in maintaining an effective U.S. cotton program
that complies with WTO rules.18
Changing GSM-102 and Terminating GSM-103. Export credit guarantees
underwrite, on average, about 6-8% of U.S. agricultural exports.19 Removal of export
credit guarantees on cotton would, in general, reinforce the results discussed for the
removal of Step 2 although by a likely smaller margin, since the share of U.S. cotton
exports supported with export credit guarantees is fairly small. In FY2004, about 11%
of U.S. cotton exports were facilitated with export credit guarantees — FY2004 U.S.
cotton exports were valued at $4,511 million of which $480 million were facilitated with
GSM-102 export credit guarantees and another $8 million relied on SCGP guarantees.
Role of Congress
Ultimately Congress is responsible for passing farm program legislation that
complies with U.S. commitments in international trade agreements. However, Congress
is not bound to necessarily accept the modifications to or the elimination of the cotton
programs as suggested by USDA. Senate Agriculture Committee Chairman Saxby
Chambliss has said that he would review the administration’s proposal and work with
industry and the Administration to identify the appropriate legislative solution for
complying with the WTO ruling.20
16 For more information on the CCP, see CRS Report RS21779, Farm Commodity Programs:
Direct Payments, Counter-Cyclical Payments, and Marketing Loans by Jim Monke.
17 NCC news release, “NCC Opposes Administration’s Step 2 Cotton Program Proposal,” July
6, 2005; available at [http://www.cotton.org/news/releases/2005/step2proposal.cfm].
18 Statement of Woody Anderson, then-chairman, National Cotton Council, before the U.S.
Congress, House Committee on Agriculture, May 19, 2004; available at [http://
agriculture.house.gov/hearings/108/10829.pdf].
19 For more information, see CRS Report RL32278 Trends in U.S. Agricultural Export Credit
Guarantee Programs and P.L. 480, Title I, FY1992-2002 by Carol Canada.
20 “USDA Calls for Repeal of Cotton Subsidy to Achieve WTO Compliance,” Inside U.S. Trade,
July 8, 2005.

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