INTERNATIONAL AGRICULTURE AND TRADE--NAFTA June 12, 1995 Approved by the World Agricultural Outlook Board ----------------------------------------------------------------------------- INTERNATIONAL AGRICULTURE AND TRADE Situation and Outlook is published four times a year by the Economic Research Service, U.S. Department of Agriculture, Washington, DC 20005-4788. WRS-95-2. Please note that this release contains only the text of INTERNATIONAL AGRICULTURE AND TRADE--tables and graphics are not included. Subcriptions to the printed version of this report are available from the ERS- NASS order desk. Call, toll-free, 1-800-999-6779 and ask for stock #WRS, $20/year. ERS-NASS accepts MasterCard and Visa. ----------------------------------------------------------------------------- Report Coordinators John Link Constanza Vald‚s Daniel Plunkett Contributors Christine Bolling Dick Brown W. Terry Disney Suchada Langley Daniel Plunkett James Stout Miriam Stuart Constanza Vald‚s International Agriculture and Trade Reports NAFTA Situation and Outlook Series Contents Summary What Is NAFTA? Conditions Right for North American Integration The Agricultural Provisions of NAFTA NAFTA Addresses Environmental Quality (box) Canada-U.S. Free Trade Agreement Subsumed under NAFTA Canada-Mexico Agreement Does Not Remove All Barriers Prospects for the Second Year of NAFTA The Peso Devaluation Will Dampen Demand for Imports (box) North American Trade Vital for the United States Evolution of Trading Patterns in North America Leading Up to NAFTA Cattle Trade With Mexico Shows Complementarity of Sectors (box) Cross-Border Investment Shows Integration of Economies Factors Affecting Future Development of Trade U.S. Farm Bill Debate Driven by Campaign To Reduce Deficit Canada Moving Toward Whole-Farm Insurance Policy Reform in Mexico Moves Away from Government Intervention Chile First in Line for Expansion of NAFTA Outlook for Agricultural Supply and Demand in 2005 United States: Most Sectors Growing Strongly Canada: Wheat and Canola Exports Continue To Rise Mexico: Higher Imports of Meats and Feed Ingredients List of Tables List of Figures Approved by the World Agricultural Outlook Board. Summary released May 23, 1995. Summaries and text of reports are available electronically through USDA's CID service. Call 202-720-9045. The U.S. Department of Agriculture (USDA) prohibits discrimination in its programs on the basis of race, color, national origin, sex, religion, age, disability, political beliefs, and marital or familial status. (Not all prohibited bases apply to all programs.) Persons with disabilities who require alternative means for communication of program information (braille, large print, audiotape, etc.) should contact the USDA Office of Communications at (202) 720-5881 (voice) or (202) 720-7808 (TDD). To file a complaint, write the Secretary of Agriculture, U.S. Department of Agriculture, Washington, DC 20250, or call (202) 720-7327 (voice) or (202) 720- 1127 (TDD). USDA is an equal opportunity employer. Acknowledgments The authors wish to thank William Coyle, Patrick O'Brien, Terry Crawford, Fred Surls, William Kost, Carol Whitton, Nancy Morgan, Mark Simone, and Shayle Shagam of the Economic Research Service; Carol Goodloe, Peter Burr, and others at the Foreign Agricultural Service; Gerald Bange, Jim Matthews, Ed Missiaen, James Nix, Jerry Rector, Russell Barlowe, Andrew Aaronson and others at the World Agricultural Outlook Board for their reviews; and Diane Decker, Joyce Bailey, and Vic Phillips for editorial, production, and design assistance. Summary Long-Term Trade Prospects Bright for NAFTA Partners, Despite Short-Term Uncertainties The North American Free Trade Agreement (NAFTA), which liberalizes trade among the United States, Canada, and Mexico, started its second year on January 1, 1995. The agricultural provisions of NAFTA call for the elimination of tariffs and non-tariff barriers among the members over 15 years, which should lead to increased trade in the future. All three NAFTA countries benefited from expanded trade in agricultural products during NAFTA's first year. The effects of the peso devaluation will reduce the U.S. agricultural trade surplus with Mexico in 1995, although the long-term prospects remain bright for all three NAFTA partners. Even prior to NAFTA, agricultural trade had been growing quickly among the United States, Canada, and Mexico, driven by income growth, producers' response to changes in government policies, and the search for more efficient means of supplying consumers. U.S. exports to North America have been growing faster than to the two other main buying regions, East Asia and Europe. In calendar 1994, U.S. exports to Canada and Mexico combined reached $10 billion (about 22 percent of total U.S. farm exports), while U.S, imports reached $8.1 billion (over 30 percent of all imports). Part of the reason was that all three NAFTA partners had strong economic growth, which translated into rising consumer demand. In calendar year 1995, U.S. exports to its NAFTA partners are expected to fall 9 percent to $9.1 billion due to decreased demand in Mexico. U.S. imports are expected to increase 7 percent to $8.7 billion in 1995, as the weaker peso makes imported products from Mexico relatively less expensive for U.S. consumers. While Mexico is currently in a recession, both the United States and Canada should experience relatively brisk economic growth in 1995 and beyond. The economic crisis in Mexico was caused by a growing current account deficit that eroded investor confidence in the Mexican government's ability to maintain the value of the peso in the pegged exchange rate system. The devaluation and subsequent floating of the peso, combined with the new Mexican austerity program, should lower Mexican imports and boost exports, reducing the U.S. trade surplus with Mexico. According to Mexican authorities, Mexican GDP is expected to contract 2 percent in 1995, but return to positive growth in 1996. NAFTA establishes the framework that will eventually result in free trade in agriculture and food products in North America. Therefore, the traditional role of border protection in supporting agriculture will decline, at least for the three NAFTA countries. As a result, all three NAFTA partners are changing their agricultural policies in an attempt to ensure the effectiveness of domestic support in a free-trading environment. How producers respond to the changing policies will be one of the primary determinants of future trade within NAFTA and between NAFTA and non-NAFTA countries. Mexico's PROCAMPO program, underway since 1993, is phasing out government support prices and providing direct payments to farmers. The peso devaluation has made support prices unnecessary for the time being because prices in pesos have risen above the support levels. While many of the changes in Mexico have an immediate effect (such as reducing consumer subsidies), others are being phased in (the producer support policies), or will take many years to show their effect (land reform). The future competitiveness of Mexican agriculture will depend to a large extent on new investment, technology adoption (both for inputs and techniques), and a reorganization of agricultural structures. In Canada, upcoming changes include elimination of the Western Grain Transportation Act (WGTA) freight subsidy for prairie grains and oilseeds on August 1, 1995. To compensate for the lost subsidy, the Canadian government will offer a one-time payment to prairie farmland owners, as well as expanded export credit guarantees to enable Canadian products to better compete on world markets. U.S. agricultural policy for the next 5 years will be largely determined by the 1995 farm bill currently being formulated. While the final shape of the legislation is not yet clear, there could be fundamental changes in the USDA crop and commodity programs. Reducing the Federal budget deficit is the most important force driving the 1995 farm bill debate. The reduction of border protection due to NAFTA reinforces the need to heighten the competitiveness of U.S. agriculture by encouraging innovation throughout the production and marketing chain in order to lower costs and respond to changing consumer demands. Negotiations with Chile on joining NAFTA will begin in mid-1995. Expanding NAFTA to include Chile will have only a small impact on total U.S. agricultural trade. With Chile as part of NAFTA, U.S. exports of wheat and corn are expected to increase. If phytosanitary regulations in Chile can be changed, exports of offseason cherries, nectarines, peaches, apricots, and grapes are also expected to increase. While Chile may join NAFTA in the near future, integrating other Latin American countries with NAFTA will be a more complex task. For example, the technical aspects of negotiating with a group of countries could lengthen the timeframe for integration. For the United States, agricultural production is expected to continue to grow through 2005, driven by strong export demand, moderate domestic income growth, and a slowly increasing population. For crops, productive capacity is projected to rise because of increases in resource and input use and gains in productivity. Most crop yields are projected to rise at or near their long- term trends. If the Conservation Reserve Program is extended, there will be only limited increases in land used for crop production. Despite recently announced reductions in Canadian agricultural support programs, prospects remain bullish for most of Canadian agriculture and for Canadian agricultural exports over the next 10 years. The Uruguay Round agreement reducing agricultural export subsidies should buoy world prices and allow Canadian grain producers to recoup more from the world market than they are being required to sacrifice in domestic support. Elimination of the WGTA subsidy for transportation of western Canadian crops should encourage planting of higher value products such as canola and encourage the development of livestock feedlots on the prairies. In Mexico the outlook is for an expansion of the agricultural sector over the next decade. Income growth will increase demand for livestock products, boosting Mexican imports of meats, feed grains, and oilseeds well above the levels of recent years. However, in the short term, growth in Mexico's import demand for these products will be weaker than expected before the devaluation. What Is NAFTA? The North American Free Trade Agreement (NAFTA) reduces trade barriers among the United States, Mexico, and Canada. NAFTA took effect January 1, 1994. The economic and political conditions were right for North American integration because each of the NAFTA partners saw benefits from joining. Additional countries, such as Chile, may join NAFTA in the future. [John Link (202) 219- 0610] The North American Free Trade Agreement (NAFTA) is an agreement liberalizing trade among the United States, Mexico, and Canada. NAFTA encompasses the Canada-U.S. Free Trade Agreement (CFTA), effective January 1, 1989, and builds on the "Framework of Principles and Procedures for Consultations Regarding Trade and Investment Relations" between the United States and Mexico, initiated in 1987. The United States and Mexico began discussions on a free trade agreement in 1990. Canada joined the discussions in 1991. Negotiations were completed and the Presidents of all three countries signed the agreement in December 1992. The U.S. Congress approved the agreement in November 1993 and NAFTA was signed into law on December 8, 1993. NAFTA came into effect on January 1, 1994. NAFTA aims to eliminate tariffs and non-tariff barriers to trade between the members, facilitate cross-border investment, and expand cooperation in other areas such as environmental and labor protection. Under NAFTA, signatory countries maintain their own schedule of tariffs applicable towards third parties. Under the rules of origin provisions, products from outside the NAFTA region will be treated as a non-NAFTA product when moving between countries that are a party to NAFTA. NAFTA is consistent with the principles of the General Agreement on Tariffs and Trade (GATT)--now the World Trade Organization (WTO)--of which all three countries are members. GATT Article XXIV permits the establishment of free trade areas provided that duties and other restrictive regulations are eliminated on substantially all the trade between those countries. The agricultural provisions of the Uruguay Round will operate side-by-side with the NAFTA concessions. Additional countries may be added to NAFTA in the next few years. A number of Latin American countries have already expressed interest in joining and negotiations with Chile are set to begin. As the next likely member of NAFTA, Chile has demonstrated a history of free markets, monetary stability, a commitment not to use taxes on trade when undertaking fiscal reforms, liberalization of the movement of capital, and a democratic political system. Conditions Right for North American Integration NAFTA was the result of a series of economic and political factors, both within the Western Hemisphere and elsewhere in the world. Over the past couple of decades, agricultural trade has become more and more important to the agricultural and rural sectors of many countries of the world. In the late 1970's, Latin America experienced a series of internal and external shocks (the oil shocks, the debt situation) that led to a deep economic crisis in the region. To address that crisis, the region renewed its interest in open economies and trading blocks and preferential markets.1/ The Western Hemisphere is one of the world's largest regions, with a combined GDP of about $8 trillion in 1994 representing about one-third of global wealth and 740 million consumers, representing 14 percent of the world's population (the United States is by far the most prominent part of the Western Hemisphere with GDP of $6.7 trillion and 261 million people in 1994). Elsewhere in the world there was also movement towards establishing regional trading blocs. In 1985 the European Community announced a plan for its 12 countries to achieve a single market by the end of 1992. In 1986, negotiations began on the Uruguay Round of GATT, which would bring new economic sectors, including agriculture, into the multilateral trading system for the first time. 1/ The Latin American region has made numerous attempts since the late 1940's to develop trading blocs and preferential markets. See Western Hemisphere International Agriculture and Trade Report, Situation and Outook Series, RS-93- 2, July 1993. The NAFTA is the most recent step in U.S. involvement in hemispheric integration. The Caribbean Basin Initiative implemented in 1984 offers U.S. trade preferences for 24 Caribbean and Central American countries. The Enterprise for the Americas Initiative (EAI), announced by the United States in June 1990, is intended to encourage trade liberalization, reduce developing country debt, and increase foreign investment in developing countries. The EAI also envisions a hemisphere-wide free trade zone, such as the Free Trade Area of the Americas later proposed in December 1994 at the Summit of the Americas. The United States pursued NAFTA as a means of cementing its relationships with Mexico and Canada, ensuring economic stability in both countries, and locking in recent trade gains. Welfare gains usually result from merging economies with different comparative advantages. In many sectors, such as agriculture, the United States and Mexico are relatively complementary. Trade liberalization under NAFTA would reinforce the potential for sustained long-term economic growth in Mexico brought about by Mexico's reforms and the U.S.-led investment in Mexico of the 1980's. Typically, U.S. exports expand along with economic growth in foreign markets. Furthermore, economic growth in Mexico would lessen immigration pressures by providing more jobs at home in Mexico. The United States also had an interest in supporting its closest neighbors and friends in the region by granting them improved access to the U.S. market. After the debt crisis of the early 1980's, Mexico undertook significant reforms designed to move away from its long-held goal of import substitution and towards a competitive market economy. In joining the GATT in 1986, Mexico agreed to substantial liberalization of its trading regime, including tariff reductions and elimination of most licensing requirements for imports and exports. By committing to multilateral trade obligations in the GATT, the Mexican government aimed to guarantee that domestic political factors could not reverse its market reforms. In addition, Mexico unilaterally moved to open its economy in many areas. With economic growth becoming stronger in the following years, NAFTA represented a means of modernizing the Mexican economy through further liberalization of rules governing financial activities and investment, and through exposing its economy to competition from the United States and Canada. Through NAFTA, Mexican goods would have free access to the huge U.S. market and Mexico could capitalize on its geographic proximity and lower labor costs. For Canada, the free trade agreement with the United States was a way to lock in the trading relationship with the United States and improve access for Canadian products. Canada's Conservative government at the time had a pro- U.S., free-trading orientation and recognized that, as a small country, Canada needed to cooperate with the United States in order to grow. Canada is the largest U.S. trading partner, with bilateral trade reaching $241 billion in 1994. The free trade agreement also offered an institutionalized mechanism for resolving trade disputes, which are perhaps inevitable in a trading relationship of that magnitude. As far as participating in NAFTA, Canada saw an opportunity to gain access to the Mexican market of 90 million consumers on terms equivalent to those enjoyed by the United States. The Agricultural Provisions of NAFTA NAFTA will eliminate all tariff and non-tariff barriers to agricultural trade between the United States and Mexico over 15 years and increases cooperation on environmental issues. The Canada-U.S. Free Trade Agreement, signed in 1988, is now included under NAFTA, but trade restrictions on certain products remain difficult to liberalize. [Daniel Plunkett and Constanza Vald‚s (202) 219-0610] As in the Uruguay Round negotiations, agriculture remains a sensitive area for all three NAFTA countries. The United States, Canada, and Mexico all operate domestic agricultural policies to support prices and incomes. In many cases, trade restrictions have been used to maintain the effectiveness of those programs. Therefore, efforts to phase out border protection can provide new challenges to domestic agricultural policy. Agriculture is the only area where the NAFTA involves three bilateral agreements. NAFTA establishes two new agreements on cross-border trade in agricultural products; one between the United States and Mexico and the other between Canada and Mexico. In general, the rules of the CFTA will continue to apply to agricultural trade between the United States and Canada. Therefore, the concessions on agricultural trade with Mexico are the main changes from NAFTA affecting U.S. agriculture. The major issues addressed in NAFTA related to agriculture are non-tariff barriers, tariffs, safeguards for producers, rules of origin, and sanitary and phytosanitary regulations.2/ All tariffs, quotas, and licenses that are barriers to agricultural trade between the United States and Mexico will be eliminated over the 15-year implementation period (tables 1 and 2). Before NAFTA, licensing requirements affected about one-third of all U.S. farm exports to Mexico, most notably corn, wheat, poultry, nonfat dry milk, animal fats, and grapes. Under NAFTA, import licenses, which were granted at the discretion of the Mexican government, were eliminated as of January 1994, substantially improving the transparency of trade policy and thus fulfilling a major goal in the GATT/WTO. 2/ NAFTA also includes provisions relevant to agriculture for dispute settlement procedures, inventments, intellectual property protection, and transportation. Since tariffs on agricultural trade between the United States and Mexico will be phased out within 15 years, NAFTA members face lower tariffs than the "most- favored nation" tariff faced by most non-members. Non-tariff barriers such as quotas and licenses were generally converted to "tariff-rate quotas" (TRQ's). TRQ's allow a specific quantity to enter at a reduced tariff, usually zero. Imports above the quota face a higher tariff. This mechanism is similar to that used to ensure "minimum and current access" in the Uruguay Round, although under NAFTA the over-quota tariffs will be reduced to zero during the implementation period (eliminating the need for a TRQ). Mexico established NAFTA TRQ's for imports of U.S. corn, barley/malt, dry beans, milk powder, poultry meat, fresh potatoes, fresh and fertilized eggs, and animal fats and oils. The United States established NAFTA TRQ's for imports from Mexico for the so-called "quota commodities," i.e. sugar and sugar-containing products, dairy products, and peanuts, and cotton. The U.S. also established special safeguard TRQ's for seasonal imports of tomatoes, onions and shallots, eggplants, chili peppers, squash, and watermelons. NAFTA does not affect U.S. export programs, such as the Export Enhancement Program, the Dairy Export Incentive Program, or the GSM program of export credits. GSM is particularly important for exports to Mexico. As with CFTA, NAFTA establishes a dispute settlement mechanism involving representative panels to rule on cases that involve the interpretation or application of the agreement. START BOX NAFTA Addresses Environmental Quality The North American Free Agreement (NAFTA) is the first substantial trade agreement to address seriously the connections between environmental quality and economic development. For agriculture, the environmental provisions mainly affect trade, but could also affect investment. The NAFTA text addresses three specific environment-related concerns. First, the NAFTA parties renounce the relaxation of environmental, health, and safety measures for the purpose of attracting investment that could create "pollution havens." Second, the sanitary/phytosanitary (SPS) and standards-related provisions seek to ensure that regulations related to human, animal, and plant health and safety are applied to imports under the principles of transparency, equivalency, and consistency, and are not used as disguised barriers to trade. Imported foods will still be required to meet the standards set by U.S. regulatory agencies. The SPS text also recognizes the concept of regionalization, whereby risk assessment criteria should be placed on the degree of risk for an area within a region rather than a whole country being risk-free or not risk-free. The third environmental concern addressed in NAFTA involves protecting national measures taken under international environmental treaties against challenges that they are inconsistent with the trade- liberalizing rules of NAFTA. The NAFTA parties also reached a side agreement, the North American Agreement on Environmental Cooperation, which specifically commits the parties to effective enforcement of their own environmental laws and to monitoring the environmental effects of NAFTA. New institutions were created, such as the Commission on Environmental Cooperation, the Border Environmental Cooperation Commission, and a North American Development Bank, all of which will play a role in some transboundary environmental issues. END BOX Canada-U.S. Free Trade Agreement Subsumed Under NAFTA The Canada-U.S. Free Trade Agreement (CFTA), signed on January 2, 1988, went into effect on January 1, 1989. The CFTA has as its goal the elimination of all tariffs on agricultural products within 10 years, but restrictions on certain products remain difficult to liberalize (table 3). The agreement commits the United States and Canada to work toward improving market access by removing trade barriers, including harmonizing technical regulations and standards. CFTA sets up binational dispute settlement panels to rule on cases involving countervailing and antidumping duties. The United States and Canada also agreed to forbid export subsidies in bilateral trade. Prior to the CFTA, Canadian tariff rates on agricultural imports from the United States averaged 9.9 percent compared with the U.S. average of 3.3 percent on imports from Canada (table 4). Tariffs on most agricultural products will be eliminated by January 1, 1998. Some tariffs were eliminated immediately or as of January 1, 1993. A 10-year phaseout applied to the most sensitive commodities (table 3). No new tariffs or tariff increases are allowed on either country's products during the implementation period. The CFTA offers special protection for fruit and vegetable trade for 20 years, although the provisions are not the same as the NAFTA special safeguard tariff- rate quotas (TRQ's) between the United States and Mexico. One major dispute involves Canada's argument that its Uruguay Round commitments are consistent with its obligations under NAFTA. Under the CFTA, Canada agreed to increase global import quotas for poultry, poultry products, and eggs to reflect actual shipments during the 5 years prior to the agreement. As part of the Uruguay Round, Canada agreed to establish a minimum access TRQ with extremely high over-quota tariffs, which, in the U.S. view, violates the CFTA (now NAFTA) prohibition on new tariffs or tariff increases. On February 2, 1995, U.S. Trade Representative Kantor requested consultations with Canada as the first step toward establishing a NAFTA dispute settlement panel to resolve the matter. Canada-Mexico Agreement Does Not Remove All Barriers The NAFTA agreement on agriculture between Canada and Mexico eliminates tariffs and non-tariff barriers in 15 years for most products. Many tariffs were eliminated immediately as of January 1, 1994, or will be phased out within 5, 10, or 15 years. Unlike the U.S.-Mexico agreement, the Canada-Mexico one does not commit to complete elimination of tariffs. For example, for sugar, poultry, eggs, and dairy products, Canada and Mexico only agreed to accord each other the same access enjoyed by other GATT/WTO partners. Mexico established TRQ's for slaughter swine, pork and ham, animal fats, fresh potatoes, dried potatoes, frozen potatoes, dry beans, barley and malt, and corn. Canada granted immediate duty-free access for most fruits and some vegetables. For the most sensitive fruit and vegetable categories, Canada established tariff- rate quotas. Bilateral agricultural trade between Canada and Mexico is relatively small, only about 5 percent of the value of U.S.-Mexico trade before NAFTA. Canada ships mostly wheat, canola, and dairy products to Mexico and imports mostly fruit and vegetables (cucumbers, peppers, melons, and frozen strawberries), as well as cotton, coffee, and beer. Canada competes with the United States in exporting milling-quality wheat to Mexico. Canadian canola competes for market share in Mexico with U.S. soybeans and with oilseeds from other suppliers. Prospects for the Second Year of NAFTA 3/ After rising 25 percent in the first year of NAFTA, U.S. agricultural exports to Mexico are expected to decline in calendar 1995 due to the effects of the peso devaluation. Higher U.S. imports from Mexico will eliminate the trade surplus of recent years. The peso devaluation, and the Mexican government's austerity program announced in response, have led to a recession in Mexico in 1995, decreasing import demand for many products. A weakening Canadian dollar in 1994 helped U.S. imports from Canada increase more rapidly than exports to Canada, but prospects for 1995 appear bright. [Daniel Plunkett and Constanza Vald‚s (202) 219-0610] U.S. agricultural trade with Mexico and Canada is expected to fall 1.7 percent to $17.8 billion in calendar year 1995, as expanded trade with Canada is offset by sharply lower U.S. exports to Mexico. Due to the peso devaluation and Mexican austerity measures announced in early 1995, the agricultural trade surplus that the United States has enjoyed with Mexico for the last few years is expected to be eliminated. U.S. exports and imports in 1995 are both expected to be near $3.2 billion. Key uncertainties will be: a) the value of the peso against the dollar throughout 1995; and b) to what degree economic recession and higher import prices will lead Mexican consumers to reduce or shift consumption patterns. 3/ For a detailed review of U.S. trade with Mexico and Canada during 1994 and the outlook for 1995, see NAFTA YEAR ONE, a report by the NAFTA economic Monitoring Taskforce, April 1995, ERS/USDA. The first year of NAFTA saw a rapid expansion of agricultural trade between the United States and Mexico (table 5). For calendar year 1994, U.S. agricultural exports to Mexico reached a record $4.5 billion, 25 percent over the previous year. Mexico accounted for 9.9 percent of total U.S. agricultural exports. About three-quarters of U.S. exports to Mexico consist of feedstuffs and animal products. The surge in agricultural exports to Mexico can be attributed to the removal of trade barriers, strong economic growth in Mexico, and the overvalued peso, which made the price of U.S. commodities more attractive to Mexican consumers. U.S. agricultural imports from Mexico totaled $2.9 billion in 1994, up 5 percent from a year earlier. Mexico supplied 10.6 percent of total U.S. agricultural imports in 1994. U.S. imports from Mexico are primarily vegetables, fruits, and cattle, as well as "non-competitive" products not produced in the United States or produced in only limited amounts (for example, coffee, cocoa, and bananas). Processed food imports from Mexico were up 14 percent in 1994 to $1.3 billion, mostly fish, processed fruits and vegetables, and beverages. The outlook for U.S.-Mexico trade in crops shows a negative impact from the peso devaluation, which makes imported U.S. products more expensive for Mexican consumers. Because of the peso devaluation, domestic Mexican corn is less expensive than imported corn in some areas. However, CONASUPO (the Mexican procurement agency for corn) has been subsidizing the price of corn for feed to the local feed industry. Despite a slowdown in U.S. corn exports during the first few months of 1995 (in part due to credit difficulties), U.S. corn exports could still reach the 2.575 million tons accorded under NAFTA. The Mexican government has allocated zero-duty access for 3 million tons of U.S. corn for 1995. Mexican sorghum imports in 1995 are likely to be lower than the 3.3 million tons imported in 1994 as higher sorghum prices in Mexico generated by the devaluation provide stronger incentives for sorghum planting and production. Mexican wheat area and production are expected to be down in 1995, although the impact was lessened because the peso devaluation occurred after most of the fall planting was completed. Over the next year or two, higher Mexican wheat prices could expand Mexican wheat area and further limit import growth, dependent on the government's ability to pay the flour millers. U.S. oilseed exports could fall slightly in 1995 due primarily to strong buying during the last quarter of 1994 and reduced consumption of vegetable oil and meat products in 1995. However, favorable crushing margins and continued demand for poultry meats are expected to keep soybean imports from falling dramatically. U.S. fruit and vegetable exports to Mexico are expected to be negatively affected by the peso devaluation, while Mexican products will be more favorably priced in U.S. markets. As for meats, higher prices and lower incomes in Mexico are expected to reduce demand for livestock and livestock products. There will be a large reduction in U.S. exports of cattle to Mexico, although the percentage decline for beef could be less if consumers shift towards buying lower-value meats (which favors importing beef cuts over live cattle for slaughter). Even with declining prices for feeder cattle in the United States, U.S. imports of feeder cattle from Mexico will likely increase as the lower peso makes the United States an attractive market. There could be some liquidation of hog inventories in Mexico as higher prices and lower incomes reduce demand. Therefore, U.S. pork exports, despite continued low U.S. pork prices, will likely face larger supplies of domestic Mexican product and will probably decline dramatically. U.S. poultry exports to Mexico could decline almost 50 percent if the Mexican government limits imports to the level of the TRQ (which was not the case in 1994), although mechanically deboned chicken and turkey meats used for sausages are less likely to be affected. U.S. dairy exports in 1995 will depend on Dairy Export Incentive allocations and credit to offset the impact of the peso devaluation. U.S. exports of "other dairy products" (i.e. not butter or nonfat dry milk) have increased, being sold through commercial channels without a subsidy. The outlook for U.S. trade with Canada is more optimistic, as economic growth is expected to remain relatively strong in 1995. U.S. agricultural exports to Canada for calendar 1995 are forecast at $5.9 billion, up 7 percent from 1994. U.S. imports from Canada are expected to be up nearly 6 percent at $5.5 billion. In calendar year 1994, U.S. exports to Canada grew 4.4 percent to $5.5 billion (table 6). Canada's economy grew 4.5 percent, but the 6-percent depreciation of the Canadian dollar in 1994 helps explain why the rate of growth in U.S. exports was much slower than during the first few years after implementation of the Canada-U.S. Free Trade Agreement. The main commodities whose export value increased in 1994 were orange juice, potatoes, live cattle, beef, pork, and hides and skins. The subcategory of processed food, mostly meats, processed fruits and vegetables, and grain mill products, rose 11 percent in 1994 to $3.9 billion. Fruits and vegetables and their products are the largest and fastest growing category of U.S. exports, accounting for one-third of U.S. farm sales to Canada. U.S. imports from Canada grew 13 percent in 1994, reaching $5.2 billion. Over half of Canada's agricultural exports go to the United States. U.S. imports of Canadian barley, wheat, rapeseed, and canola oil increased sharply in 1994. The United States took fewer live cattle from Canada, but made small increases in imports of other animal product categories. The subcategory of processed foods grew 11 percent to $4.3 billion, with fish, meats, and beverages the main elements. After rising 36 percent in 1994, U.S. wheat imports from Canada will be governed until September 11, 1995, by the 1-year Memorandum of Understanding imposing tariff-rate quotas on Canadian wheat exports (table 4). A Joint Commission on Grains will submit its preliminary report to the two governments by June 12, 1995, with the final report to be submitted by September 11. Elimination of the Western Grain Transportation Act subsidy on August 1, 1995, will be a major change in Canada's export policy because farmers will now have to pay 100 percent of transportation costs rather than the approximately 50 percent that they have paid in the past. Canadian barley exports (mainly of malting quality) to the United States will probably fall to around 1.3 million tons in 1995 due to the rebound in U.S. corn production in 1994 and tight supplies in Canada. U.S. imports of beef from Canada could increase further in 1995, depending upon marketing decisions made by IBP Inc., which recently purchased the second largest Canadian slaughter plant. Increased imports of feeder cattle from Canada can be expected. U.S. pork exports to Canada will likely increase again in 1995 as production declines in eastern Canada, while U.S. pork imports from Canada (which serve the U.S. west coast population centers) are unlikely to increase due to low U.S. prices. U.S. poultry exports to Canada will be limited by Canada's TRQ's, although premade poultry dinners are not covered and have increased in recent years. Due to Canada's relatively small tariff-rate quotas for 1995, U.S. dairy product exports are not expected to increase. Bilateral agricultural trade between Mexico and Canada will probably follow a similar pattern to that anticipated for U.S.-Mexico trade, with higher Mexican exports to Canada and lower Canadian exports to Mexico. Bilateral agricultural trade between Mexico and Canada grew to $410 million in 1994, with Canadian exports up 43 percent to $248 million and imports into Canada up 25 percent to $163 million. Canada's main exports to Mexico in 1994 were canola ($113 million), wheat ($94 million), and less importantly, pork, condensed milk, and peas. Canada's main imports from Mexico in 1994 were vegetables such as tomatoes ($12 million), mushrooms, peppers, squash, and cucumbers, and noncompetitive products such as coffee ($30 million), bananas, and mangoes. START BOX The Peso Devaluation Will Dampen Demand for Imports The economic crisis in Mexico starting in late 1994--and the austerity package instituted by the government in response--have caused a recession in Mexico in 1995 and a much weaker peso. The primary impact on U.S. agricultural trade will be a short-term erosion of some trade gains realized from NAFTA. In 1994, the Mexican economy rebounded from the recession of the previous 2 years as increased investment and government spending reactivated aggregate demand. Real GDP grew 3.1 percent and inflation fell to a relatively low 7 percent. The boost to trade provided by NAFTA fed back into the economy in the form of greater production, higher foreign and domestic investment, and higher real wages. However, Mexico had a large current account deficit--largely due to the trade deficit with the United States, as imports from the United States grew faster than exports to the United States. The Mexican government, which was pegging the exchange rate, did not adjust the value of the peso downward quickly enough to reflect the market fundamentals, instead using its international reserves to maintain its overvalued currency. With $20.3 billion in Tesobonos (Mexican Treasury bonds) held by foreign investors coming due, investor confidence sank, leading to the crisis. On December 21, 1994, the Mexican government devalued the peso 15 percent and eventually allowed the peso to float freely against the dollar. The peso would eventually fall to about 7 pesos per dollar in mid-March 1995, a 51-percent depreciation overall. In an effort to stabilize the peso, a $52-billion package of short-term credit was organized, with contributions by the U.S. Government, the International Monetary Fund, the Bank for International Settlements, the World Bank, the Inter-American Development Bank, Canada, and several Latin American countries. In response to the currency crisis, the Mexican government on March 9, 1995, announced a stabilization program called A Revised Agreement of Unity to Overcome the Economic Emergency. The goals of this economic and financial program are to reduce the current account deficit, restrain inflation and limit the adverse effects of the crisis on output and employment. To achieve these goals, the program is centered on a policy of wage, price, and credit restraint supported by a tighter fiscal policy. By May, the peso had strengthened to about 6 pesos per dollar (figure 1). For 1995, the economic plan is expected to lead to a 2.7-percent contraction in GDP and a budget surplus of 4.4 percent of GDP. Inflation is forecast at 40 to 50 percent, aggravated by the failure to reach a new PACTO (an agreement between government, business, and labor negotiated periodically since 1987 to limit price and wage increases). A significant reduction in real wages is expected, lowering demand. Official Mexican government estimates indicate that nearly half a million people have lost their jobs since the peso crisis began in December 1994, with unemployment potentially rising to over 1 million people as tighter monetary policy (higher interest rates and scarcer credit) will induce additional business failures. However, the Mexican government has committed to letting the exchange rate float freely. Mexico's trade deficit is expected to decrease substantially, possibly swinging into surplus for 1995. A modest recovery from the recession is expected in 1996, as financial conditions stabilize, with the long-term growth path somewhat lower than previously expected. The significant program of economic reforms undertaken by Mexico in the past several years has resulted in a more flexible economy, which may help facilitate the adjustment to the devaluation. The slowdown in economic growth in Mexico, and the weaker peso, is expected to reduce U.S. exports and increase U.S. imports of both agricultural and non- agricultural products. DRI/McGraw-Hill estimates that total U.S. exports to Mexico will be $9 billion lower in 1995 than a year earlier and $3 billion lower in 1996, leading to 350,000 fewer U.S. jobs by early 1997. U.S. agricultural exports to Mexico and imports from Mexico are both expected to be worth $3.2 billion in calendar 1995. The impact of the peso devaluation on Mexican agriculture differs among commodities. Higher domestic prices in Mexico are expected to encourage expansion of feed grain production at the expense of imports. The higher feed costs, plus tighter credit supplies, are expected to outweigh higher domestic livestock prices, increasing herd liquidation, especially for hogs. In the short-term, this will increase meat supplies and reduce imports. On the demand side, the devaluation will lead to an increase in consumption of corn as a food staple and a temporary reduction in consumption of beef, pork, and poultry. As more competitive export prices for Mexican goods offset rising credit and input costs, acreage in export-oriented crops, including horticultural products and cotton, will likely expand. END BOX North American Trade Vital to the United States Trade within North America was rising steadily prior to NAFTA as Canada and Mexico grew in importance as both suppliers and export markets. Trade in cattle and beef between the United States and Mexico shows the complementarity of their respective sectors. Increasing cross-border investment helps bind the NAFTA countries more closely together. [Christine Bolling, W. Terry Disney, and Daniel Plunkett (202) 219-0610] In the years prior to NAFTA, trade between the future NAFTA partners was already growing strongly, providing further reason to liberalize barriers and establish dispute settlement procedures. Canada and Mexico are considered large foreign markets with excellent growth prospects for U.S. agricultural exports, both raw materials (processed or unprocessed)4/ and consumer-ready (processed or unprocessed). Based on 1991-93 data, Canadians bought $179 worth of U.S. agricultural products per person per year, while Mexicans bought $39 annually. 4/ Canadian imports of unprocessed raw material agricultural products (grains, oilseeds) from the United States were worth about $265 million in 1992 and are considered to have only moderate growth potential. U.S. exports to its North American neighbors have been growing more quickly than to the other two main buying regions, East Asia and the EU (figure 2). The three regions accounted for nearly 70 percent of U.S. exports in recent years. During 1990-92, the United States provided 63 percent (by value) of the agricultural imports of its NAFTA partners, more than double the U.S. share in the East Asian markets and far higher than the 4-percent U.S. share in the EU. The share of U.S. agricultural exports going to Canada increased from 4.8 percent in 1980-82 to 11.2 percent in 1990-92, as the EU became a less important destination for U.S. products. Mexico took 7.7 percent of U.S. exports in 1990-92, up from 4.9 percent in 1980-82. On the import side, exports from Canada and Mexico to the United States make North America the largest and fastest-growing region supplying the U.S. market (figure 3). North America, the EU, and Latin America (excluding Mexico) supply over 70 percent of U.S. imports. Trade liberalization offers the NAFTA partners increased incentive to trade among themselves. In 1993, about 36 percent of total trade by the NAFTA partners was intraregional. As has happened within the European Union and East Asia, NAFTA intraregional trade can be expected to increase as a share of NAFTA total trade (figure 4). Evolution of Trading Patterns in North America Leading Up to NAFTA United States. In the period leading up to NAFTA, the importance of Canada and Mexico as suppliers to the U.S. market greatly increased. In 1980-82, only 14 percent of U.S. imports came from Canada and Mexico combined, but by 1990-92 the share had risen to 26 percent. The share of U.S. agricultural imports coming from Canada more than doubled from 7.3 percent in 1980-82 to 15 percent in 1990-92, while Mexico's share grew by more than half from 6.7 percent to 10.7 percent (figure 4). Animals and animal products and fruits and vegetables account for over half the value of U.S. imports coming from its NAFTA partners. The U.S. import market for animals and products from all suppliers increased from $3.7 billion in 1980-82 to $5.6 billion in 1990-92 with the share of the NAFTA partners increasing substantially at the expense of Oceania and South America (figure 5). The accompanying box explains the factors related to U.S.- Mexico trade in cattle and beef. As for Canada, the United States imports both cattle and beef from feedlots in western Canada to supply U.S. urban populations on the west coast, such as Los Angeles. From 1980-82 to 1990-92, Canada's share of U.S. meat imports increased by more than half to 22 percent. START BOX Cattle Trade with Mexico Shows Complementarity of Sectors A good example of how comparative advantage works in trade can be seen in the complementarity of the cattle and beef industries in Mexico and the United States. The production process has been divided into its component parts, with trade between the two countries reflecting how producers search for lower costs, even across national boundaries. Trade has increased steadily, although growth in U.S. cattle exports to Mexico has been dampened as Mexico has begun to import substantial quantities of beef in recent years (figure 6). The increasing specialization of production has fueled U.S.-Mexican trade in cattle and beef, which seeks to capitalize on the differing factor allocations between the two countries. The U.S. beef industry ships breeding animals to Mexico, as Mexican producers upgrade their herds. Mexican producers are able to rear the calves profitably in the northern states of Chihuahua, Durango, and Sonora due to abundant rangeland (making for lower fixed costs) and warmer, wetter weather during the summer and fall months that provides ample forage (lowering variable feed costs). However, Mexican producers using grain feeding practices face a higher cost structure than in the United States. Therefore, Mexico ships over a million head of feeder cattle per year to the United States, providing about 6 percent of the U.S. feeder cattle supply. Mexico has progressively liberalized its export policy for feeder cattle, replacing an export quota with an export tax in 1988 and then phasing it out in 1992. The U.S. cattle operations importing feeder cattle prefer to focus on adding value through the fattening process as the efficient U.S. crop sector provides an advantage to U.S. feeders through lower-cost feed. By operating intensive feedlots for high-energy ration finishing located near the main corn- and soybean-producing areas, U.S. producers take advantage of economies of scale and location. Typically, U.S. imports of feeder calves from Mexico from one year to the next are dependent on U.S. feeder cattle prices and the price of feed, particularly corn. In the final step in the cross-border trade, the U.S. ships either beef or cattle to be slaughtered to Mexico, where the marketing system makes the final product available to consumers. END BOX From 1980-82, the value of U.S. imports of fruits and vegetables increased 2.5 times to $3.4 billion in 1990-92, with the share from Mexico and Canada combined remaining near 40 percent (figure 5). Fruits and vegetables are increasingly seen as part of a healthy diet. With U.S. incomes growing, albeit relatively slowly, consumers have diversified their diets and sought higher- value products. Moreover, consumers now expect to be able to purchase certain fruits and vegetables and other items throughout the course of the year. Due to improved transportation and marketing systems, there tends to be less seasonal variation in the availability of fruits and vegetables than in the past. All of these trends point to greater imports. Most U.S. imports of fruits and vegetables from Mexico are based on seasonal limitations in the United States and lower-cost Mexican labor. During the winter and spring, Mexico competes directly with Florida in providing U.S. consumers with many fresh vegetables, including cucumbers, eggplant, peppers, and squash. Fresh tomatoes are an important component of U.S. imports, worth about $300 million annually. U.S. fresh tomato imports, nearly all of which come from Mexico, have accounted for 20 to 22 percent of total domestic U.S. consumption for about the last 20 years. The U.S. import total for fresh tomatoes in a given year typically varies according to relative prices and weather. Other import categories from Mexico showing significant growth in the last 15 years have been cauliflower, broccoli, and onions. The value of Mexican fruit and vegetable imports to the United States more than doubled from 1980-82 to 1990-92, although Mexico's market share fell from 38 percent to 34 percent in that period (figure 5). Canada gained some market share through increased sales of potatoes and prepared vegetables. Among other suppliers, Chile doubled its share of U.S. fruit imports (mostly fresh grapes) to 24 percent. Canada. Since the early 1980's, Canada's imports from its NAFTA partners have grown by about two-thirds, about the same pace as imports from the rest of the world. Imports from the United States accounted for 55.8 percent of Canada's total imports in 1990-92, with Mexico's share at 1.6 percent (figure 7). Figure 7 also shows the relative market shares of the United States and Mexico for fruits and nuts, vegetables, and meats--categories that combined for about 46 percent of Canada's agricultural imports from its NAFTA partners in 1990-92 and are some of the fastest-growing categories of trade. According to U.N. trade data, Canadian meat imports (mainly beef and poultry) nearly tripled from 1980-82 to about $788 million in 1990-92, with the U.S. share growing substantially (figure 7). Generally, the U.S. supplies grain-fed beef, fresh or frozen chicken, and prepared poultry to eastern Canada, where the bulk of the population is located. Canada also buys beef from Australia, although it tends to be of frozen processing quality. Canada's colder climate limits the growing season for many horticultural products and greenhouse production can be prohibitively expensive. Furthermore, many fruits and nuts cannot be grown in Canada. Therefore, Canadian horticultural imports have been a function of income trends, changing diets, and a reduction in border protection. From 1980-82 to 1990-92, Canadian imports of fruit and nuts grew by more than three-fourths to almost $1.7 million, although the U.S. share fell. Canada's main imports from the United States are fresh grapes, citrus, fruit juice, berries, peanuts, and almonds. Canadian vegetable imports increased about 85 percent in value over the period, with the U.S. share reaching nearly 80 percent. Imports of fresh lettuce, peppers, and fresh tomatoes account for most of the growth in Canadian vegetable imports from the United States. Mexico. Prior to NAFTA, Mexico's imports from both its NAFTA partners grew in value, although Mexico diversified its sources away from the United States. From 1980-82 to 1990-92, the U.S. share of Mexico's agricultural imports declined from 69 percent to 59 percent, while increasing about 36 percent in value, according to U.N. trade data. Canada's share of the Mexican market remained stable at about 2.2 percent. Mexico, on the other hand, began to diversity its source of supply, lowering the share of imports originating within North America from 71 to 61 percent in that period. Figure 8 shows the three main import categories for Mexico, which account for over 90 percent of total farm imports from the United States and Canada. The value of Mexican grain and flour imports remained about the same in 1980-82 and 1990-92, although Canada captured a small share away from the United States, primarily in wheat. Mexican imports of oilseeds and meals (mainly soybeans) were up about one-fourth in value over that period, with the U.S. share falling slightly but remaining above 75 percent. Mexican imports of animals and products more than tripled in value from 1980-82 to 1990-92, with the United States capturing an even greater share. Canada's share of Mexico's animal and products imports fell, particularly for dairy products, due to subsidized exports from the EU (the United States was able to increase its dairy product sales--and hold its share--with introduction of the Dairy Export Incentive Program). However, Canada has begun to ship pork and breeding cattle to Mexico. Cross-Border Investment Shows Integration of Economies In addition to trade, a further sign of the integration of the North American economies in the agriculture and food sector is cross-border investment. U.S. investment in the food and agribusiness industries of Canada and Mexico reached nearly $6 billion in 1993. After remaining stable at about $2 billion through the late 1980's, U.S. investment in Canada's food industry has grown, reaching $3.6 billion in 1993. It is estimated that Canadian affiliates of U.S. companies had over $8 billion in assets, $9 billion in sales, and employed about 50,000 people. U.S. investment in food manufacturing is principally in grain milling and beverages. U.S. companies such as Cargill have invested in Canada for decades. Canadian investment in the United States has grown from less than $100 million in the early 1980's to probably more than $1 billion in recent years. In figures from 1992, U.S. affiliates of Canadian companies had assets of about $10 billion, sales of about $5 billion, and employed more than 25,000 people. U.S. affiliates of Canadian textile companies also had textile sales of $1.5 billion in 1992, while Canadian-owned food stores had $3.9 billion in sales in the United States in that year. The Bronfman family (which owns Seagram's) is the largest Canadian investor in the U.S. food industry, with wineries in California's Napa Valley, canola processing in Idaho, and Tropicana orange juice in Florida. McCane's is a large Canadian vegetable processor with U.S. affiliates. IMASCO owns Hardee's fast food restaurants in the United States. Hiram Walker also has large investments in the United States, but it is now owned by a British company. The Bronfman family has also invested in other industries, including chemicals and communications. Canada is the largest single-country owner of land in the United States. Nearly 80 percent of that land is forestland located in the Northeastern States. Canadian investment in U.S. land was 3.3 million acres in 1993, down about 20 percent since 1982. U.S. investment in Mexico's food industry grew from $618 million in 1989 to $2.3 billion in 1993 as the Mexican government changed its investment laws considerably to accommodate foreign investment. Up until 1988, Mexican laws limited foreign participation to 49 percent of the capital of new Mexican enterprises. The new rules eliminated the discretionary authority of government officials and the limitations on foreign ownership. Many U.S. food manufacturing companies such as Campbell Soup, General Mills, Ralston Purina, and PepsiCo have invested in Mexico for decades. Companies such as Tyson Foods and Sara Lee have invested more recently. In 1992, Mexican affiliates of U.S. food processing companies had sales of $5.1 billion, assets valued at $4 billion, and employed 79,400 persons. U.S. capital flows to the Mexican food industry remained high in 1994. The devaluation of the Mexican peso will probably slow U.S. investment in 1995, although companies that export food products to the United States may gain from the devaluation. Mexico's investment in the U.S. food industry is very small and regional, measuring only $79 million in 1993, but that figure does not include the purchase of Dole fresh fruits by a Mexican businessman. In 1993, Mexican and U.S./Mexican interests owned 428,000 acres in the United States, up from 244,000 acres in 1982. Most of the land is pastureland in the southwestern United States. U.S. affiliates of Mexican companies had 1992 sales of $2.6 billion, and employed about 5,000 people. As recently as 1985, U.S. affiliates of Mexican companies had sales of less than $100 million and employed less than 1,000 people. Factors Affecting Future Development of Trade NAFTA will liberalize trade over the next 15 years, but domestic policy changes in all 3 NAFTA countries will also affect future trading patterns. The U.S. farm bill debate will revolve around proposals to reduce costs. Canada is emphasizing whole-farm insurance, rather than crop-specific and production- distorting subsidies. Mexico will proceed with the PROCAMPO program, while land reform could lead to important structural changes. Chile may join NAFTA in the near future, leading to increased trade. [Suchada Langley, Daniel Plunkett, James Stout, Miriam Stuart, and Constanza Vald‚s (202) 219-0610] NAFTA establishes the framework that will eventually result in free trade in most agriculture and food products within North America. Therefore, the traditional role of border protection in supporting agriculture will be diminished, at least for the three NAFTA partners. As a result, all three NAFTA partners are changing their agricultural policies in an attempt to reduce the cost of providing domestic support in a free-trading environment. How producers respond to the changing policies will be one of the primary determinants of trade within NAFTA and between NAFTA and non-NAFTA countries. U.S. Farm Bill Debate Driven by Campaign To Reduce Deficit U.S. agricultural policy for the next 5 years will be largely determined by the 1995 farm bill currently being formulated. The Administration announced its proposal on May 10, 1995, although action in Congress is continuing. One of the main impacts on the 1995 farm bill will probably be the drive to reduce the Federal budget deficit. U.S. spending on price and income support through the Commodity Credit Corporation will be an estimated $10.6 billion in fiscal 1995, but the potential budgetary exposure in any given year could be much greater because of the variable impact of weather on production and prices. Proposals to reduce costs include complete elimination of programs, capping expenditures, reducing payment acres, and reducing target prices. The current debate is focusing on the appropriate role of government in an agricultural sector characterized by increasing efficiency, concentration of production, division of labor, high-tech coordination, and specialization. The reduction of border protection due to NAFTA reinforces the need to heighten the competitiveness of U.S. agriculture by encouraging innovation throughout the production and marketing chain in order to lower costs and respond to changing consumer demands. One of the main goals of policy makers is to increase the market orientation of U.S. agriculture, perhaps by increasing the share of acreage on which program participants have more flexibility in their production decisions. Reform could even affect some of the most highly-protected commodities (sugar, peanuts, tobacco, and dairy). Environmental and conservation requirements, nutrition programs, and food safety regulations are all under review. The fate of the Conservation Reserve Program (CRP), which has 36.4 million acres enrolled at a budget cost of $1.8 billion in 1995, will have a large impact on the U.S. exportable surplus. A variety of options are being discussed to enable farmers to reduce or manage risk associated with variability in yield, price, and income. Some of the proposals being discussed include: expansion of the pilot futures and options program; implementation of a revenue assurance program similar to one proposed by the Iowa Farm Bill Study Team; and introduction of a farmer individual retirement account based on the Canadian Net Income Stabilization Account program. Canada Moving Toward Whole-Farm Insurance Since the CFTA implementation, Canada has enacted new farm programs that change how producers receive support. Beginning in 1991, a new set of programs was introduced under the Farm Income Protection Act. These consisted of commodity- specific crop insurance programs, revenue insurance programs (insurance against low prices), and a Gross Revenue Insurance Program (GRIP), as well as an entirely new whole-farm savings plan, the Net Income Stabilization Account (NISA). The GRIP program, designed to eventually replace the separate crop and revenue insurance programs, expands traditional crop insurance by adding protection against variability in revenue as well as crop yield. Premium costs are shared among the federal government, provincial governments, and participating producers. Payouts occur when the insured target revenue falls below the market revenue for the crop. The NISA allows the farmers to set aside money in individual savings accounts and draw on this money during low income periods. Both the federal and provincial governments also contribute to the account. Producers can make withdrawals from their accounts when their net farm income falls below the average of the previous 5 years or when their current net income falls below Can$10,000. Canada is currently reevaluating its support programs to agriculture. The emphasis is on reducing budgetary costs while providing whole-farm insurance, as with the NISA program, rather than crop-specific and production-distorting subsidies. The government has already announced that rail subsidies under the Western Grain Transportation Act (WGTA), which have existed in one form or another for over 100 years, will be eliminated as of August 1, 1995. Other items in the new Canadian budget include a C$254-million reduction in agricultural support programs from the current C$854 million, and a 30-percent reduction in direct payments to dairy farmers for milk for processing or industrial milk. The trend toward lower Canadian support will probably lead to lower exportable surpluses of agricultural commodities, although the impact on the United States is unclear at this point. Policy Reform in Mexico Moves Away from Government Intervention Among the NAFTA countries, the most profound changes affecting the agriculture sector have been in Mexico. While many of the changes have an immediate effect (such as reducing consumer subsidies), others are being phased in (the producer support policies), or will take many years to see the effect (land reform). The open borders with the United States and Canada will increasingly force Mexican agriculture to be competitive without government intervention. Therefore, the future competitiveness of Mexican agriculture will depend to a large extent on new investment, technology adoption (both for inputs and techniques), and a reorganization of agricultural structures. The path for producer support for the next decade was laid out in the PROCAMPO (Programa de Apoyos Directos al Campo) program implemented in October 1993, which will phase out price supports for corn, beans, wheat, sorghum, rice, and soybeans over a 15-year period. Subsistence producers of these crops, in addition to those planting cotton, safflower, and barley, receive direct payments per hectare on the basis of their historical area cropped. As planned, the PROCAMPO payments to eligible producers will be increased to 440 pesos per ton in 1995, compared to 350 pesos per ton the year before. The peso devaluation has led to lowering government support. The official PROCAMPO producer prices, set in pesos, have fallen below the price of imported products (converted into pesos at the rates prevailing after the devaluation), rendering government price support unnecessary for the time being. The government took advantage of the opportunity to announce in early April 1995 that it would no longer provide price support for corn and beans, a policy that had been in place for more than three decades. As part of the March 1995 stabilization plan, the government announced price increases for electricity (20 percent initially) and fuel (35 percent initially), with monthly increases of 0.8 percent for both through the rest of 1995. Because of the devaluation, prices of farm inputs have already increased significantly, although the impact of higher international prices has not yet passed through to all sectors. Mexico has already significantly liberalized non-commodity-specific producer support. For example, irrigation facilities have been privatized and the contribution of users to the recovery of operational costs has been increased (from 16 percent in 1988 to 74 percent in 1994). Fertilizer subsidies have fallen 78 percent since 1987. The agricultural credit subsidy has been virtually eliminated; the gap between market interest rates and agricultural rates dropped from 23 percent in 1986 to less than 1 percent in 1993 (only low- income producers are now eligible). Further changes could come in production input subsidies such as crop insurance and improved seeds. The effect of these changes is that producers will increasingly react to market signals, and the price of their products will more accurately reflect their production costs. On the consumer side, the Mexican government has in recent years reduced the subsidies to food processors that in the past offset the high prices they faced for raw agricultural products and allowed them to sell their output at low consumer prices. While price controls remain in effect for almost all basic foods (including corn products, wheat products, rice, beans, vegetable fats and oils, fresh and canned milk, butter, eggs, poultry, and pork), the government has allowed some price increases. As a result of the peso devaluation and despite the Emergency Price Freeze, SECOFI (the Ministry of Trade) authorized price increases for milk, sugar, wheat flour, tortillas, and bread. Even with trade liberalization, it is likely that the Mexican government will continue to be involved in ensuring that food is readily available to the whole population, particularly through providing low-cost food to low-income, largely urban consumers. It is possible that the government could continue the recent trend of selling off publicly owned processing plants and retail outlets. Reform of the most basic resource itself--land--could ultimately lead to significant structural changes in Mexican agriculture. The land reform implemented in 1992 modifies Article 27 of the Constitution and the Agrarian Reform Laws to allow residents of ejidos, communal land, to receive title to their land. Ejido farmers can now rent or sell their land, ending the government distribution of land to smallholders that had been in place since the rural reform in 1917. An increasing number of small private farmers and ejidatarios are expected to rent or sell their land to other farmers interested in consolidating holdings in order to take advantage of economies of scale in the use of agricultural inputs. The land tenure reform increases incentives for private investment in rural land and should enable a greater number of farms to achieve a size suitable for contracting with agro-industry. The reform should increase the rate of technology adoption, encourage greater agricultural productivity, and promote more efficient commercial production for export. The land tenure reform has already resulted in increased joint ventures between U.S. and Mexican agro-industrial firms. Chile First in Line for Expansion of NAFTA At the Summit of the Americas on December 12, 1994, the United States and 33 other countries agreed to begin constructing "The Free Trade Area of the Americas" (FTAA), in which barriers to trade and investment will be progressively eliminated. The goal is to conclude the FTAA negotiations by 2005. There are two main paths that will lead to Western Hemisphere integration. The path could proceed through other countries joining NAFTA. The NAFTA partners have agreed to begin negotiations with Chile as a first step in this direction. On the other hand, some South American countries, especially Brazil, hope to start by consolidating MERCOSUR 5/ and the other regional trade arrangements, and then bring the various regional agreements together. 5/ MERCOSUR, the Spanish acronym for Mercado del Sur (Common Market of the South), comprises Argentina, Brazil, Paraguay, and Uruguay. It was formed under the Treaty of Asuncion in March 1991. Negotiations for Chile 6/ to join NAFTA will start in mid-1995. The major economic benefits to the United States with Chile's accession to NAFTA would be increased trade, and increased opportunities for U.S. foreign investment in Chile. 6/ Chile is a small country of 13.8 million people with GDP less than 1 percent that of the United States. Agriculture represents just under 10 percent of Chile's GDP, with agriculture, forestry, and fishery products accounting for nearly 40 percent of Chile's exports. About 16 percent of Chile's agricultural imports come from the United States, and almost 35 percent of its agricultural exports go to the United States, although Chile is trying to diversity its export markets. Chile is a small but rapidly growing market for U.S. products. While the overall trade balance favors the United States, the United States has a net deficit in agricultural trade with Chile. U.S. imports totaled $543 million in 1994, about 70 percent horticultural products. Off-season table grapes account for about half the value of U.S. imports. Chile is also the primary supplier of fresh plums, peaches, pears, and kiwi. U.S. exports to Chile were only $98 million in 1994, with coarse grains and wheat among the most important products. With Chile as part of NAFTA, certain U.S. exports (wheat, corn, and offseason cherries, nectarines, peaches, apricots, and grapes) could be expected to register small increases. Some of the main issues in negotiations could be: eliminating Chile's price bands (which function like a variable levy) for imports of wheat, flour, vegetable oils, and sugar; and addressing Chile's strict phytosanitary restrictions, which have effectively closed off Chile to imports of fresh fruits and vegetables. While Chile may join NAFTA in the near future, integrating MERCOSUR with NAFTA will be a much more complex task because MERCOSUR comprises more countries, a far greater population, and more diverse agriculture. Under the Ouro Preto Protocol signed in December 1994, MERCOSUR members agreed not to negotiate free trade treaties on an individual basis. It is unlikely that MERCOSUR will be included within NAFTA within the next 3 to 5 years. Outlook for Agricultural Supply and Demand in 2005 The agricultural sectors of the 3 NAFTA members are expected to expand over the next decade, driven by productivity increases and demand by consumers both at home and abroad. Long-term growth in income for the NAFTA countries, including Mexico, should boost consumption of meats, leading to higher use of feed ingredients. U.S. agricultural exports are projected to grow at a brisk pace. [Daniel Plunkett, James Stout, and Constanza Vald‚s (202) 219-0610] BEGIN BOX About the Projections One way to show the outlook for agriculture for the NAFTA countries is to compare long-term projections with recent year averages. Historical data for 1992-94 and scenario projections to the year 2005 for production, consumption, and trade for major commodities in each of the NAFTA countries are shown in table 7. The projections, which show the percentage change from the 1992-94 average to 2005, rely on specific assumptions about world market developments, domestic macroeconomic conditions, and changes in policies. Results for the United States are those reported in the most recent USDA baseline publication. 7/ The results for Mexico, which include adjustments for the effects of the devaluation of the peso, and for Canada, which include elimination of the WGTA transportation subsidy, were developed by ERS for the purposes of this scenario. They are NOT approved by the interagency commodity and estimates committee and are not part of the USDA baseline. 7/ The USDA baseline projections were published in Long-Term Agricultural Baseline Projections, 1995-2005, Interagency Agricultural Projections Committee, USDA World Agricultural Outlook Board, Staff Report WAOB 95-1, Feb. 1995. END BOX United States: Most Sectors Growing Strongly For the United States, agricultural production is expected to continue to grow through 2005, driven by strong export demand, moderate domestic income growth, and a slowly increasing population. For crops, productive capacity is projected to rise because of increases in resource and input use and gains in productivity. For most crops, yields are projected to rise at or near their long-term trends. If the Conservation Reserve Program is extended, there will be only limited increases in land used for crop production. Domestic demand for crops is projected to grow slightly faster than population as expanding meat production boosts the use of feed grains and soybean products. For exports, the implementation of the recently completed Uruguay Round of the General Agreement on Tariffs and Trade will reduce trade barriers and raise global trade, with growth in U.S. exports of coarse grains (primarily corn) particularly strong. U.S. coarse grain exports can be expected to grow by about half, based on strong import demand for corn in China. U.S. fresh vegetable production will probably expand by about one-fourth by 2005 due to increasing domestic and export demand. Production of vegetables for processing will grow, but at a slower pace. Imports of both fresh and processed vegetables will probably also increase substantially, although U.S. trade will remain more or less in balance. As for fruits, citrus production will likely increase faster than noncitrus fruit, with both imports and exports growing rapidly, particularly for fresh fruit. Record U.S. meat production is projected to continue, reflecting moderate gains in nominal feed prices, small increases in other production costs, and ample forage supplies. Overall demand should increase for all meats, but growth in poultry will be much faster than for beef or pork, for which per capita demand is in fact expected to decline. Export growth for meats is expected to be robust as income growth in developing countries spurs demand and reduced subsidized exports from the European Union open the way for other suppliers. By 2005, U.S. exports of poultry and pork should more than double from the 1992-94 average, with growth in beef exports nearly as strong. Canada: Wheat and Canola Exports Continue To Rise Despite recently announced reductions in Canadian agricultural support programs, prospects remain bullish for most of Canadian agriculture and for Canadian agricultural exports over the next 10 years. Reductions in export subsidies due to the Uruguay Round should buoy world prices, outweighing what Canadian grain producers are being required to sacrifice in domestic support. This scenario includes elimination of the WGTA subsidy for transportation of western Canadian crops (specifically wheat, barley, oats, and canola), which should encourage planting of higher value products such as canola and boost the development of livestock feedlots on the prairies. Eliminating the subsidy should raise domestic Canadian use, lowering the exportable surplus slightly, although proximity could make the U.S. market more attractive. Wheat, Canadian rapeseed (canola), and barley will continue to provide the bulk of Canada's agricultural export earnings, with lesser contributions from meats and meat products, oats, soybeans, flaxseed, corn, and specialty crops (peas, lentils, etc.). Wheat production in Canada by 2005 could reach 30 million metric tons, with exports projected at 23 million metric tons, compared with the 1992-94 average of about 19 million tons. Due to crop-rotation constraints, production of Canadian rapeseed (canola) is not projected to expand much, reaching 6.3 million metric tons in 2005. Ongoing investments in Canadian crushing facilities should guarantee that an increasing share of Canadian exports, projected at 4.8 million tons in seed equivalent for 2005, will be in the form of oil and meal products rather than as canola seed. Production of horticultural products in Canada will not likely expand from existing levels, and future increases in demand will be filled by imports from current and future NAFTA trading partners. Beef and veal trade, the bulk of which is with the United States, should continue to grow and continue to remain relatively balanced, with the United States primarily exporting to the population centers in eastern Canada, while Canada's exports originate from its western agricultural regions. Canada's supply management system for dairy, poultry, and eggs will continue to expand production in lockstep with population growth and demand as long as the current policy regime survives. The current system, which guarantees producer returns at the expense of the consumer, is coming under increasing pressure from both the United States and within Canada from food processors and consumers, but is assumed to continue in this scenario. Mexico: Higher Imports of Meats and Feed Ingredients ERS analysis of the agricultural trade prospects for Mexico incorporates the potential effects of the peso devaluation and the government's austerity program. The Mexican outlook is characterized by an ongoing expansion of the Mexican agricultural sector over the next decade. Income growth will increase demand for livestock products, boosting Mexican imports of meats, feed grains, and oilseeds well above the levels in recent years. However, growth in Mexico's import demand for crops, oilseeds, and livestock products, particularly in the short term, is weaker than could have been expected in a pre-devaluation analysis. The analysis is based on a partial equilibrium model that incorporates linkages between livestock product output and feed demand, as well as an explicit specification of assumptions on the adjustment level of the exchange rate and other macroeconomic variables and the nature and extent of domestic price reform in Mexico. After the 1995 recession, Mexican GDP is expected to gradually recover, averaging over 5.5 percent annual growth from 2001 to 2005. After the initial adjustment in the peso/dollar exchange rate currently in progress, the real exchange rate is forecast to depreciate gradually at a rate equal to the inflation differential between Mexico and the United States. The projections shown may vary depending on how the Mexican economy responds to the stabilization program and on the future path of Mexican agricultural policy. For example, projections of income growth play a large role in determining consumption, particularly for meats. If Mexican income levels do not rebound as far as assumed in this analysis, Mexico's meat imports will be lower. For wheat, devaluation leads to higher domestic wheat prices, which, combined with gains in irrigated area, will increase wheat production faster than consumption, lowering import demand. The revised projection is for annual imports of 1.1 million tons in 2005, about 400,000 tons less than could have been expected without the devaluation. Wheat production is projected to grow at a 4.6-percent annual rate and reach 5.9 million tons by 2005. Despite consistent growth in consumption of bread and wheat products over the past 4 years, the devaluation will lead to higher consumer prices, reduced subsidies, lower real incomes, and slower annual growth in demand. Elimination of the official support price for corn leads to a continuing decline in area planted to corn. Strong yield growth results in production higher than current levels, but lower than in a pre-devaluation forecast. Demand is projected to grow at a 1.8-percent annual rate. Domestic use will include 15 million tons used for food and 6 million tons used for animal feed. Import demand for corn is now projected to reach 5.0 million tons in 2005, although imports were originally expected to be 17 percent higher before the devaluation. Under this scenario, projected imports reflect a 5.1-percent annual increase during 1995-2005, with import volumes exceeding the NAFTA minimum access quota. Given the higher transmission elasticity of international to domestic prices for the case of sorghum (due to the zero tariff under NAFTA), devaluation leads to high domestic sorghum prices in Mexico. Production shows a modest recovery as area planted to sorghum increases 2.2 percent annually. Sorghum production in 2005 is now estimated to reach 5.5 million tons, 5.6 percent higher than the earlier projection. Domestic use grows to 9.4 million tons for 2005, 11 percent lower than the pre-devaluation projection due to the high prices. Because the devaluation is expected to increase the use of corn in feed rations, sorghum import demand is about 4 million tons in 2005, 27 percent lower than the pre-devaluation projection. Beef consumption has been expanding on both a total and per capita basis over the past 2 to 3 years, but due to reduced income gains with the devaluation, the rate of expansion is expected to slow. Beef consumption in 2005 is expected to grow to 2.8 million tons, 1.2 percent lower than without the devaluation. Beef imports continue to expand, reaching 236,000 tons in 2005. For pork, weaker consumer demand and large increases in feed costs lead to slower growth in production. Consumption of pork is projected to reach 1.1 million tons in 2005. Annual import demand is now projected at 129,000 tons in 2005, 29 percent higher than the earlier projection as higher Mexican feed costs expose the relative inefficiency of the production structure. Large increases in feed costs lead to a slower growth pattern for Mexican broiler production to 2005, reversing the trend of the past few years. Annual growth in production is 5.4 percent for 1995-2005. Consumption in 2005 is expected to grow to 2 million tons. List of Tables 1. Changes in U.S. trade policy towards Mexican agricultural products due to NAFTA 2. Changes in Mexico's trade policy towards U.S. agricultural products due to NAFTA 3. Agricultural provisions of the CFTA (subsumed under NAFTA) 4. Changes to U.S. and Canadian tariffs due to CFTA/NAFTA 5. U.S. agricultural trade with Mexico, 1993 and 1994 6. U.S. agricultural trade with Canada, 1993 and 1994 7. Long-term projections for agricultural supply and demand List of Figures 1. Peso/dollar Exchange Rate and Mexico's International Reserves 2. Main U.S. Export Destinations 3. U.S. Imports from Main Suppliers 4. Share of Intra-Regional Trade 5. Canadian and Mexican Market Share of U.S. Imports 6. U.S. Cattle and Beef Trade with Mexico 7. U.S. and Mexican Market Share of Canadian Imports 8. U.S. and Canadian Market Share of Mexican Imports Long-Run Scenario Based on Specific Set of Assumptions END-END-END