Brazil’s WTO Case Against the U.S. Cotton Program
Released: 2011-11-22T00:00:00

Overview

This report provides a description and status report on Brazil's challenge to certain aspects of the U.S. cotton program under the rules of the World Trade Organization's (WTO's) dispute settlement process in case DS267. The "Brazil cotton case" had its WTO origins in 2002 and has since evolved into a sprawling legal enterprise that is still ongoing as of 2011.

Readers interested in the current status of the dispute—including details of the implementation of a memorandum of understanding between the United States and Brazil—should proceed directly to the report section entitled " Recent Action Related to the WTO Brazil Cotton Case ."

Report Phases

The Brazil cotton case has touched on many aspects of WTO legal procedure, including an initial WTO panel and appeal phase, a compliance dispute phase, and the ongoing retaliation phase. Because of the case's longevity and complicated legal twists and turns, this report seeks to keep the timeline clear and to footnote official reference documents. The report begins with a brief overview of the U.S. cotton sector and domestic support programs. It then provides a detailed history of the case in chronological phases, each representing a different (and somewhat independent) phase of the case. These phases are followed by a summary of the potential role of Congress with respect to the WTO case rulings and their implications for U.S. cotton programs.

1. Phase I : Pre-case background on the U.S. cotton sector and its global context. 2. Phase I I : Brazil's WTO dispute settlement case against U.S. cotton programs. a. Brazil's specific charges and the WTO panel's findings. b. WTO panel and Appellate Body (AB) recommendations. c. Implementation timeline for panel and AB recommendations. 3. Phase I I I : WTO compliance panel and AB review of U.S. compliance with dispute settlement panel's and AB's recommendations. 4. Phase I V : WTO arbitration of Brazil's request for retaliatory countermeasures. 5. Phase V : Retaliation or settlement. 6. Phase VI : Implementation of the MOU and Framework Agreement. 7. Phase V I I : Discussion of the potential policy implications of this WTO case for the U.S. cotton sector. 8. Role of Congress .

The report ends with a timetable of the WTO dispute settlement process ( Table 5 ), to facilitate the reader's understanding of and access to the multifaceted legal procedures involved in the case's slow progression. However, the main thrust of this report is to provide an economic and policy perspective on case developments. For more on the legal aspects of WTO dispute settlement cases in general, and the cotton case in particular, see CRS Report RL32014, WTO Dispute Settlement: Status of U.S. Compliance in Pending Cases , by [author name scrubbed].

Phase I: Background on the U.S. Cotton Sector

The cotton industry is a major component of the U.S. agricultural sector. From 1991 to 2010 U.S. cash receipts from cotton production averaged $4.3 billion per year, while export sales averaged nearly $3 billion. Cotton is grown across the southern tier of states stretching from Virginia down through the Carolinas and into Georgia, then westward through a belt of contiguous states to California. Texas is the largest cotton-producing state, accounting for an average of 26% of U.S. production since 1990. In 2002, when Brazil first originated its WTO dispute settlement case against U.S. cotton programs, 17 states reported cotton production valued at over $20 million.

The United States is the third-largest producer of cotton in the world, behind China and India, and the world's largest cotton exporter. In the 1990s, U.S. exports accounted for 25% of world trade in cotton. However, since 2000 the United States has accounted for an increasing share of world trade (averaging over 37%). U.S. exports as a share of domestic production have averaged over 70% since 2000, up from a 40% average during the early 1990s, due in large part to a decline in domestic mill use. (See Figure 1 .) The expanding U.S. prominence in global markets since 2000, coupled with large U.S. subsidy levels directed considerable international attention to U.S. cotton program outlays.

Domestic Program Support

Cotton is one of the principal U.S. program crops, along with wheat, rice, feed grains, soybeans, and peanuts. Traditionally, qualifying U.S. cotton producers were eligible for direct payments, counter-cyclical program (CCP) payments, marketing loan benefits, Step 2 payments, and other program benefits. Since 2000, U.S. farm subsidies for cotton production have averaged $3.4 billion per year, while the harvest-time value of production has averaged $4.3 billion ( Table 1 ).

Marketing loan program benefits and CCP payments are price-contingent in the sense that payments are determined by market prices falling below their respective price triggers (i.e., the loan rate and the adjusted target price). For upland cotton, the loan rate is set at $0.52 per pound and the target price is set at $0.71 per pound for calendar years 2010 through 2012 by the 2008 farm bill ( P.L. 110-246 ). The target price is adjusted by subtracting the direct payment for upland cotton of $0.0667 per pound for calculating any CCP payment.

If the price triggers are set too far above market prices, they act as an incentive to encourage greater production (and exports) than what the market would otherwise demand. This results in lower domestic and international prices than would exist in the absence of these programs. It is this "price effect" that was found by the WTO to cause adverse effects and serious prejudice in the international cotton market, as described below. Indeed, a comparison of relative support prices versus market prices for major U.S. program crops reveals that cotton producers receive payments under these programs far more routinely than do other crops. This would suggest that cotton support prices are set too high relative to general cotton market conditions, as well as to other crop prices.

Export Credit Guarantee Programs

In 2002, at the time that Brazil first initiated WTO case DS267, the United States operated three principal export credit guarantee programs to facilitate the export of U.S. agricultural products (including but not limited to cotton). These were the GSM-102 program (which extended credit for periods ranging from 90 days to three years), the GSM-103 program (which extended credit for periods of more than three years, but not more than 10 years), and the Supplier Credit Guarantee Program (SCGP). The GSM-103 and SCGP programs were part of Brazil's original case; however, they both were eliminated by congressional action in 2008, as described below.

The GSM-102 export credit guarantee program (hereafter referred to as the GSM-102 program) is authorized under the Agricultural Trade Act of 1978 (7 U.S.C. §5622), as amended. The program, backed by USDA's Commodity Credit Corporation (CCC), guarantees the repayment of credit made available to finance export sales of agricultural commodities on credit terms between 90 days and three years. Typically, 98% of principal and a portion of interest are covered by a guarantee. To obtain a guarantee, an exporter has to pay a fee (or "premium") calculated on the basis of guaranteed value, according to a schedule of rates applicable to different credit terms and repayment intervals. At the time that Brazil initiated DS267, the fee was capped by law at 1% of the guaranteed value.

Phase II: Brazil's WTO Dispute Settlement Case Against the U.S. Cotton Program

In 2002, Brazil—a major cotton export competitor—expressed its growing concerns about U.S. cotton subsidies by initiating a WTO dispute settlement case (DS267) against certain features of the U.S. cotton program. Once initiated, a dispute settlement case follows a sequence of events designed to produce resolution of the dispute within a 12-15 month time frame. However, the WTO dispute settlement (DS) process that reviewed Brazil's charges against the U.S. cotton program has extended well beyond the hypothetical 15-month time frame. In this particular case, the initial WTO panel review took 17 months from the establishment of the panel in March 2003 to its final ruling in September 2004.

Furthermore, substantial additional time has since been added to the dispute settlement process—first, for an Appellate Body review of the initial ruling on appeal, then for a WTO compliance panel to review a dispute over U.S. compliance with the initial panel's ruling, and finally for an arbitrator to review a disagreement between Brazil and the United States over Brazil's proposed retaliation amounts. See Table 5 for a timeline of the dispute settlement case and related events.

With respect to the initial dispute settlement case, it was broadly written and touched on almost every aspect of U.S. commodity programs, although the focus was on the six principal claims described below along with the WTO dispute settlement panel finding (of September 8, 2004) and Appellate Body (AB) ruling (of March 3, 2005).

Brazil's Six Principal Claims Against U.S. Cotton Programs

Claim 1: Peace Clause Violation

Brazil claimed that the United States was no longer exempt from WTO dispute proceedings under the so-called "peace clause" (Article 13) of the WTO's Agreement on Agriculture (AA) because U.S. domestic and export subsidies to its cotton sector were in excess of its 1992 benchmark level. Prior to its expiry in January of 2004, Article 13 exempted domestic support measures that complied with the AA's requirements from being challenged as illegal subsidies through dispute settlement proceedings, as long as the level of support for a commodity remained at or below the benchmark 1992 marketing year (MY) levels. Brazil argued that U.S. cotton subsidies were about $2 billion in MY1992 compared with over $4 billion in MY2001. Therefore, Brazil argued that the United States was no longer in compliance with the requisite conditions and could no longer seek protection under the WTO's peace clause rule.

In response, U.S. trade officials argued that WTO members agreed to the peace clause recognizing that agricultural subsidies could not be eliminated immediately and needed, under certain conditions, to be exempted from the Subsidies and Countervailing Measures (SCM) Agreement and GATT 1994 subsidies disciplines. As a result, U.S. officials argued that the words "exempt from actions" as used in Article 13 of the AA were of overarching importance and precluded not only the "taking of legal steps to ... obtain a remedy," as Brazil has argued, but also the "taking of legal steps to establish a claim." Furthermore, U.S. trade officials argued that the immunity granted by the peace clause was still important, since even if a country was no longer in compliance with the peace clause, it was incumbent on the complaining party to prove there had been injury. (See Table 5 , below.)

Finding 1

The panel found (and was upheld by the AB in finding) that Brazil had successfully discharged its burden to show that U.S. domestic cotton support measures during MY1999-MY2002 (which averaged $3.28 billion) were in excess of WTO commitments (of $2.0 billion) during MY1992. (See Table 2 .) As a result, U.S. domestic cotton support measures lost the protection afforded by the "Peace Clause," which had shielded them from substantive challenges in the past. This occurred in part because, under Finding 2, Production Flexibility Contract and Direct Payment outlays were included with other commodity program outlays and evaluated against "peace clause" limits.

Claim 2: U.S. Direct Payments Do Not Qualify for Exemption from Reduction Commitments as Decoupled Income Support

Brazil claimed that two types of U.S. payments—production flexibility contract (PFC) payments made under the 1996 farm bill and direct payments (DP) made under the 2002 farm bill—failed to fully meet the conditions for decoupled income support in Annex 2 of the Agreement on Agriculture and should therefore be counted against the U.S. "Peace Clause" domestic support benchmark limit.

The United States considers both PFC and DP programs to be consistent with WTO language for exempt domestic support that has "no, or at most minimal, trade-distorting effects or effects on production." As a result, the United States notifies both the PFC and DP outlays as "green box" where they are not subject to any limits. Furthermore, the United States argued strongly against including such "minimally distorting, non-commodity specific" payments in evaluating whether the United States has met or exceeded its "peace clause" limits.

Finding 2

The panel found (and was upheld by the AB in finding) that U.S. payments made under the PFC and DP programs, because of the prohibition on planting fruits, vegetables, and wild rice on covered program acreage, do not qualify for the WTO's green box category of domestic spending. (The green box contains only non-distorting program payments and is not subject to any limit). Instead, they should be counted as domestic subsidies directly affecting cotton production (i.e., distorting) and be included with other commodity program outlays to evaluate whether the United States has met or exceeded its "peace clause" limits.

Claim 3: The Step 2 Program Functions as an Export Subsidy

Brazil argued that Step 2 payments made under the U.S. cotton program functioned as export subsidies and were inconsistent with U.S. WTO obligations regarding export subsidies as specified under the SCM Agreement.

Step 2 payments were part of special cotton marketing provisions authorized under U.S. farm program legislation to keep U.S. upland cotton competitive on the world market. Step 2 payments were made to exporters and domestic mill users to compensate them for their purchase of higher priced U.S. upland cotton. Under the 2002 farm act, the Step 2 payment rate for the 2002-2005 marketing years was calculated as the difference between the price of U.S. upland cotton, delivered c.i.f. (cost, insurance, freight) in Northern Europe, and the average of the five lowest prices of upland cotton delivered c.i.f. Northern Europe from any source.

The United States argued that Step 2 payments were part of its domestic support program since they were targeted to domestic cotton users as well as exporters. As a result, Step 2 payments were notified to the WTO as "amber" box (trade-distorting) domestic support payments and not as export subsidies. Consequently, U.S. trade officials contended that Step 2 payments were not subject to any limitations placed on export subsidies.

Finding 3

In its finding, the panel considered Step 2 program payments to eligible 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.

The DS panel finding was upheld by the AB.

Claim 4: U.S. Export Credit Guarantees Function as Export Subsidies

Brazil argued that the U.S. GSM-102 program operated as a prohibited export subsidy under item (j) of Annex I of the Agreement on Subsidies and Countervailing Measures (SCM) because the premium rates (i.e., fees) charged to GSM-102 program beneficiaries were inadequate to cover the long-term operating costs of the program, thus imparting an implicit subsidy benefit.

Item (j) of Annex I identifies a prohibited export subsidy as:

[t]he provision by governments (or special institutions controlled by governments) of export credit guarantee or insurance programs, of insurance or guarantee programs against increases in the cost of exported products or of exchange risk programs, at premium rates which are inadequate to cover the long term operating costs and losses of the programs.

Brazil claimed that the favorable terms (i.e., the interest rate and time period that countries have to pay back the financing) provided under U.S. export credit guarantee programs—GSM-102, GSM-103, and the Supplier Credit Guarantee Program (SCGP) —were effectively export subsidies inconsistent with the WTO's AA and SCM Agreements. Further, the subsidy effects of export credit guarantees applied not only to cotton, but to other eligible commodities.

U.S. trade officials argued that the U.S. export credit guarantee programs were consistent with WTO obligations. Furthermore, the United States asserted that Article 10.2 of the AA reflected the deferral of disciplines on export credit guarantee programs contemplated by WTO members to the next WTO multilateral negotiating round—the Doha Round.

Finding 4

The panel found (and was upheld by the AB in finding) that U.S. export credit guarantees effectively functioned as export subsidies because the financial benefits returned by these programs failed to cover their long-run operating cost as specified by item (j) of the SCM. Furthermore, the panel found that this applied, not just to cotton, but to all commodities that benefit from U.S. commodity support programs and receive export credit guarantees. As a result, export credit guarantees for any recipient commodity were subject to previously scheduled export subsidy commitments for that commodity. This referred to those U.S. export subsidies under the Export Enhancement Program (EEP) and the Dairy Export Incentive Program (DEIP). Under these criteria, export credit guarantees benefits extended to cotton and other "unscheduled" commodities (that are supported under U.S. agricultural programs) were found to be in violation of previous WTO commitments. With respect to "scheduled" commodities, export credit guarantees extended to U.S. rice exports were found to be in violation of previous EEP volume commitments. The panel found (and was upheld by the AB) that "unscheduled" commodities not supported under U.S. agricultural programs, as well as scheduled agricultural products that remain within WTO commitments are exempt from actions under this dispute settlement case.

Claim 5: U.S. Subsidies Have Caused "Serious Prejudice"

Brazil argued that domestic farm subsidies provided to U.S. cotton growers contributed to significant overproduction and resulted in a surge in U.S. cotton exports, particularly during the 1999-2002 marketing years, when unusually large outlays were made under provisions of the U.S. cotton program (see Table 1 and Figure 1 ). Brazil claimed that the resultant rise in U.S. exports led to three market conditions, each of which contributed to serious injury to Brazilian cotton exporters: (1) an increase in the U.S. share of the world upland cotton market; (2) a displacement of Brazilian upland cotton sales in third-country markets; and (3) a steep decline in world cotton prices (see Figure 2 and Figure 3 ).

In particular, Brazil claimed that injury to its economy due to low cotton prices, measured as the sum of individual negative impacts on income, foreign trade revenue, fiscal revenues, related services (transportation and ginning), and employment, exceeded $600 million in 2001 alone. Brazil asserted that injury under each of these three circumstances are in violation of the SCM Agreement. In addition, Brazil argued that these same programs would be harmful (i.e., threatened serious prejudice) in future years.

U.S. trade officials argued that the subsidies provided to U.S. cotton growers have been within the allowable WTO limits and are consistent with U.S. WTO obligations. Furthermore, they argued that the decline in U.S. domestic use (due to declining U.S. competitiveness in textile and apparel production), rather than government support program outlays, contributed to larger U.S. raw cotton exports. In addition, they contended that international market forces—including weakness in world demand for cotton due to competing, low-priced synthetic fibers, and weak world economic growth—have played a larger role in determining the generally weak price level during the period in question, rather than U.S. export levels.

In evaluating this particular claim, the DS panel separated U.S. cotton support programs into two groups: those that are directly contingent on market price levels (i.e., loan deficiency payments, marketing loss assistance payments, counter-cyclical payments, and Step 2 payments), and those that are not (i.e., PFC and Direct Payments, and the federal crop insurance program).

Finding 5

The panel found (and was upheld by the AB in finding) that U.S. domestic support measures that are directly contingent on market price levels caused serious prejudice in terms of market price suppression for the period 1999 to 2002. However, U.S. domestic support measures that are not contingent on market price levels were not included in this finding as the panel could not find enough of a connection between the direct payments program and cotton planting decisions to declare the direct payments program a serious factor in price suppression.

The panel also did not find in favor of Brazil's alleged serious prejudice in terms of an effect on international market share. Article 6.3 of the SCM lists several factors indicating serious prejudice; the panel only had to find one of the factors in violation to rule in Brazil's favor on the claim of serious prejudice during the 1999 to 2002 period.

With respect to Brazil's claim of a threat of serious prejudice going forward (2003 to 2007, the remaining life of the 2002 farm act), the panel stated in its final report that those "prohibited" subsidies that caused serious prejudice during the 1999-to-2002 period—namely, user marketing (Step 2) payments to exporters and domestic users; and export credit guarantees in respect of certain products under the GSM-102, GSM-103, and SCGP programs—must be withdrawn "without delay" pursuant to Article 4.7 of the SCM Agreement. According to the panel, required withdrawal of the prohibited subsidies, within the time frame set by the panel, would curtail the future threat posed by U.S. cotton support programs. As a result, the panel stated that "it is not necessary or appropriate to address Brazil's claims of threat of serious prejudice."

Claim 6: FSC-ETI Act of 2000 Acts as an Export Subsidy to Upland Cotton

Brazil claimed that the Foreign Sales Corporation Repeal and Extraterritorial Income Act of 2000 (ETI Act of 2000), by eliminating tax liabilities for U.S. upland cotton exporters who sell to foreign markets, constitutes an export subsidy and is inconsistent with U.S. export subsidy commitments for cotton.

The United States asserted throughout the proceedings that Brazil failed to make any specific case with respect to the ETI Act of 2000 and U.S. upland cotton exports.

Finding 6

The panel concurred with the United States (and was upheld by the AB) in stating that Brazil failed to present any new arguments or evidence concerning effects upon upland cotton, but instead simply repeated the arguments that the European Union made in its WTO dispute settlement case with the United States (DS108). As a result, the panel declined to further examine Brazil's claims on this particular issue.

Panel and Appellate Body Recommendations

The initial panel's final ruling was released publicly on September 8, 2004. The following month (October 18, 2004) the United States notified the WTO of its intent to appeal the panel's ruling. A WTO Appellate Body (AB) reviewed the legality of the case and issued its final report on March 3, 2005, upholding most of the initial panel's rulings. The policy recommendations that emerged from the panel and AB rulings are described below.

Prohibited Subsidies

The AB recommended that the United States withdraw those support programs identified as prohibited subsidies within six months of the date of adoption of the panel report by the Dispute Settlement Body (DSB) or by July 1, 2005 (whichever was earlier). Since the DSB adopted the AB and panel reports on March 21, 2005, the relevant deadline for withdrawal was July 1, 2005. The list of prohibited subsidies subject to withdrawal "without delay" included the following.

Prohibited Export Subsidies

Export credit guarantees under GSM-102, GSM-103, and SCGP that assist exports of upland cotton and other unscheduled agricultural products that are supported under government agricultural support programs. Export credit guarantees under GSM-102, GSM-103, and SCGP that assist exports of one scheduled agricultural product (rice), but in excess of the scheduled volume. Step 2 program payments to exporters of upland cotton.

Prohibited Import Substitution Subsidy

Step 2 payments to domestic users of upland cotton.

In contrast, unscheduled agricultural products not supported under government agricultural support programs and scheduled agricultural product exports that remain within their schedules were judged not to circumvent U.S. export commitments and therefore were not subject to trade remedy actions in this case.

Actionable Subsidies

The panel recommended that the United States take appropriate steps by September 21, 2005, to remove the adverse effects or to withdraw those U.S. subsidy measures singled out as price-contingent—marketing loan provisions, Step 2 payments, and CCP payments. These subsidies were identified as "actionable" subsidies that contributed adverse effects to the interests of Brazil during the marketing years 1999-2002.

It is noteworthy that the actionable subsidies remedy dealt with adverse effects that occurred during a historical time period and not future prejudice or injury. In support of this concept, the panel stated (in its original ruling on the "threat of serious prejudice" by actionable subsidies) that U.S. compliance with recommendations on prohibited subsidies—the Step 2 provisions and export credit guarantees—could so significantly transform the basket of measures in question that it was not necessary or appropriate to address Brazil's claims of threat of serious prejudice. This appeared to leave open the possibility that removal of the prohibited subsidies might resolve the dispute under the actionable subsidies recommendation.

Implementation of Panel/Appellate Body Recommendations25

Following is a discussion of how the implementation phase was to unfold in accordance with WTO rules and how the actual implementation has unfolded.

In accordance with WTO rules, the evolution of the implementation phase depends on how both parties choose to respond to the different sequences of events as they unfold. In addition to the potential time tracks described below, the implementation phase also provides opportunities for the disputing parties to mutually resolve the dispute. If the United States failed to comply, Brazil could (upon visible evidence of noncompliance) request negotiations with the United States to determine mutually acceptable compensation (e.g., tariff reductions in areas of particular interest). Furthermore, if Brazil did not want to press ahead full force with imposing sanctions, there would be considerable opportunity to delay compliance steps.

The time track for compliance with panel and AB recommendations could diverge depending on whether the United States chose to respond separately to the rulings on prohibited subsidies and actionable subsidies. This is because prohibited subsidies are given expedited treatment under SCM, Article 4.12, which states that, "except for time-periods specifically prescribed in [SCM, Article 4], time-periods applicable under the DSU for the conduct of such disputes shall be half the time prescribed therein."

Prohibited Subsidies Potential Time Track

As a result of their expedited treatment, the AB recommended that the United States remove the prohibited export subsidies by July 1, 2005. Within 15 days after the AB and panel reports were adopted by the DSB (done on March 21, 2005), the United States was expected to present an implementation plan to the DSB, although precedence suggests that such a plan could be as minimal as stating intentions to work with Congress to bring U.S. policies into compliance. This was indeed the case when, on April 20, the U.S. representative to the WTO announced that the United States intended to implement the recommendations and rulings of the DSB in a manner that respected U.S. WTO obligations. The representative noted, however, that determining acceptable options would take a reasonable period of time and requested that Brazil be willing to consult on the potential timetable.

If, 10 days after the designated period (July 1, 2005) expires, no satisfactory compensation is agreed to, the complaining side (Brazil) may ask the DSB for permission to impose limited trade sanctions against the United States. The trade sanctions are limited to a value equivalent to no more than the level of nullification or impairment of benefits. The DSB must grant this authorization within 15 days of expiry of the "reasonable" time period unless a consensus exists against the request.

If the United States objects to the amount proposed by Brazil, the level of suspension would be arbitrated (by the original 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.

Once armed with the authority to impose trade sanctions, Brazil could 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) requested and received authorization to impose retaliatory measures against the United States on May 7, 2003. However, the EC refrained from immediate action, stating that it would review U.S. actions for a period of time before proceeding. The EC eventually began imposing additional duties on U.S. products in March 2004.

Actionable Subsidies Potential Time Track

In contrast to the July 1, 2005, deadline, the removal of actionable subsidies was subject to a six-month period starting on the date of adoption of the AB and panel reports (March 21, 2005). As a result, the panel recommended that, upon adoption of its final report, the United States take appropriate steps to remove the adverse effects or to withdraw those subsidies identified as contributing to serious prejudice to the interests of Brazil—marketing loan provisions, Step 2 payments, and CCP payments—by September 21, 2005. Thus, in every other respect, the timetable for actionable subsidies would follow the same sequence of events listed above for prohibited subsidies, but subject to the full time allotment for each event as described in the preceding footnotes rather than the "halved" time periods.

U.S. Compliance Actions

A spokesperson for the Office of the U.S. Trade Representative (USTR) expressed disappointment in the AB ruling, but also said that USTR would study the AB report carefully and work closely with Congress and U.S. farmers on its next steps. However, U.S. officials said that they preferred to resolve the cotton case through trade negotiations in the WTO Doha Round rather than a separate settlement. The National Cotton Council (NCC) of America—the principal national organization representing the interests of U.S. producers, ginners, warehousers, merchants, cottonseed processors/dealers, cooperatives, and textile manufacturers—also expressed disappointment in the AB ruling, but stated that it would work with USTR and USDA to coordinate a response to the decision.

On July 1, 2005, USDA instituted a temporary fix for its export credit guarantee programs, whereby the Commodity Credit Corporation (CCC) would use a risk-based fee structure for the GSM-102 and SCGP programs. The new structure responded to a key finding by the WTO that the fees charged by the programs should be risk-based. The 1% cap on user fees for GSM-102, the primary export credit program, was cited by the DS panel as contributing to the subsidy component of the GSM program. Higher fees would ensure that the financial benefits returned by these programs would fully cover their long-run operating costs, and eliminate the subsidy component. USDA could not remove the cap administratively as it is required by statute (7 U.S.C. 5641). In addition, the CCC stopped accepting applications for payment guarantees under GSM-103.

On August 1, 2006, the Step 2 cotton program, which was authorized by the 2002 farm act ( P.L. 107-171 , §1207), was eliminated by a provision (§1103) in the Deficit Reduction Act of 2005 ( P.L. 109-171 ).

On June 18, 2008, the date of enactment of the 2008 farm bill ( P.L. 110-246 ), a provision (§3101(a)) in the Trade title (Title III) eliminated the GSM-103 and SCGP programs, and removed the 1% cap on fees that can be charged under the GSM-102 program. In addition, the same 2008 farm bill provision explicitly requires the Secretary of Agriculture, in carrying out the GSM-102 program, to "work with the industry to ensure, to the maximum extent practicable, that risk-based fees associated with the guarantees cover, but do not exceed, the operating costs and losses over the long-term."

However, the 2008 farm bill defined the "long-term" as a period of 10 or more years. While the WTO panel did not explicitly define its view of the "long-term," it clearly is less than 10 years and more likely is on the order of a period of two years—that is, a net loss in one year must be offset by a net gain in the following year.

At this point the Administration likely felt that sufficient program changes had been enacted to fully comply with the both the prohibited and actionable subsidies portions of the WTO ruling.

Phase III: WTO Compliance Panel Review and Ruling

This section describes Brazil's charges of noncompliance, the proposed retaliation, the beginning of WTO arbitration over the size and nature of the proposed retaliation, and a ruling by a WTO compliance panel reviewing whether the United States had fully complied with earlier recommendations.

Arbitration Requested, Then Suspended, Over Brazil's Proposed Retaliation Amounts

As the reform deadlines under the two different subsidy types expired, Brazil first requested (July 4, 2005) authorization from the WTO to impose $3 billion in countermeasures against the prohibited U.S. subsidies. According to WTO rules, trade sanctions are limited to a value not to exceed the level of lost benefits. The $3 billion value corresponded to (1) Step 2 payments made in the then-most-recently-concluded marketing year (2004/2005) and (2) the total of exporter applications received under the three export credit guarantee programs, for all unscheduled commodities and for rice, for the then-most-recent fiscal year (2004). This amount was later pared back to $1.155 billion in annual retaliation to counter the prohibited subsidies based on Brazil's methodology applied to FY2006 data. The United States objected to the amount of Brazil's proposed sanctions and requested WTO arbitration. However, on August 18, 2005, the United States and Brazil reached a procedural agreement temporarily suspending arbitration proceedings concerning the prohibited subsidies.

Then, as the September 21, 2005, deadline to address the actionable subsidy ruling expired, Brazil charged that the United States had neither taken nor announced any specific initiative for the price-contingent programs deemed to cause adverse effects to Brazil's trade interest. Brazil then requested authorization from the WTO to impose countermeasures valued at $1.037 billion as retaliation against the actionable programs. According to WTO rules, trade retaliation should take place within the sector where the violation occurred. In this case, retaliation would be restricted to punitive tariffs on U.S. goods entering Brazil. However, Brazil argued that limiting retaliation to the goods sector alone would have a more deleterious effect on the Brazilian economy (via higher input costs) and Brazilian consumers (via higher inflation) than on U.S. exporters due to the asymmetries between the two economies. Instead, Brazil proposed to suspend tariff concessions as well as obligations under the WTO Agreement on Trade-Related Intellectual Property Rights (TRIPS) and the General Agreement on Trade in Services (GATS) in the amount of $1.307 billion until the United States withdrew the four domestic subsidies (counter-cyclical payments, market loss assistance payments, market loan program benefits, and Step 2 payments) or removed their adverse effects. This type of "cross-retaliation" has been permitted twice previously in WTO dispute settlement cases, so it is not without precedent. However, its impact is potentially very far-ranging and could include the protection of copyrights, trademarks, industrial designs, patents, and undisclosed information, as well as withdrawal of concessions in services related to communication, construction, distribution, finance, tourism, and transport.

Once again, the United States objected to both the amount and nature of Brazil's proposed request and asked for WTO arbitration over the level of the proposed sanctions (October 18, 2005). Again, the United States and Brazil reached a procedural agreement (December 7, 2005), thereby temporarily suspending further retaliation proceedings on the actionable subsidies.

The suspensions were likely intended to permit policy reform to occur in a less confrontational forum under either the then-ongoing congressional debate on an extension or revision of U.S. farm legislation (as current farm law was set to expire in 2007) or the ongoing Doha negotiations.

Brazil Requests WTO Compliance Panel

Initially Brazil showed a willingness to permit the U.S. legislative process—motivated by the 2007 expiration of U.S. farm programs and the prospects of a successful Doha Round of trade negotiations —to bring U.S. farm programs into compliance with the WTO ruling, even if this process extended well beyond the deadlines established under the WTO dispute settlement ruling. However, Brazil argued that U.S. program changes were insufficient and, on August 21, 2006, requested the establishment of a WTO compliance panel to review whether the United States had fully complied with panel and AB rulings.

Brazil identified below-market premium rates (i.e., user fees) charged to GSM-102 program beneficiaries as the primary reason that the revised GSM-102 program operated at a net loss and was still out of compliance with WTO rules. The WTO Compliance Panel (upheld on appeal) concurred with Brazil, after an examination of new evidence on GSM-102 operations for the 2006-2008 period showing that it continued to operate at a net loss. See Table 3 for the most recent estimates of credit subsidies under CCC export credit guarantee programs.

The GSM-102 premium rates were identified as below-market rates, in part, because they failed to fully account for the risk of non-payment or default for individual countries. There is no widely accepted international standard for determining country risk and assigning "market" premium rates. In its determination, the Compliance Panel used a list of "minimum premium rates" as reported in the Organization for Economic Cooperation and Development (OECD) Arrangement on Officially Supported Export Credits. A comparison with premium rates charged under the GSM-102 program found the GSM-102 rates to be significantly below the OECD measures, suggesting that they were under-valued.

In addition, Brazil charged that U.S. farm programs continued to provide significant (and injurious) support to U.S. cotton producers ( Table 1 and Table 4 ).

WTO Compliance Panel Rules Against the United States

Following Brazil's request, the WTO's Dispute Settlement Body (DSB) agreed to establish a compliance panel to review U.S. farm program changes at the September 28, 2006, DSB meeting.

On July 27, 2007, the compliance panel released a confidential interim ruling to the two countries that the United States had not fully complied with the March 2005 WTO ruling against certain U.S. cotton support programs. On October 15, 2007, the compliance panel's final report was released confidentially to the U.S. and Brazilian governments and, two months later on December 18, 2007, it was released publicly. The panel's final ruling confirmed the earlier interim ruling against the United States.

In February 2008, the United States appealed the compliance panel's ruling. On June 2, 2008, a WTO Appellate Body (AB) publicly released its final report upholding the compliance panel's ruling that the United States had not fully complied with the March 2005 WTO ruling. The AB report was adopted by the WTO's Dispute Settlement Body on June 25, 2008.

Phase IV: WTO Arbitration of Brazil's Proposed Countermeasures

Brazil Requests Resumption of Arbitration

On August 25, 2008, Brazil requested a resumption of the arbitration proceedings to review its proposed retaliatory countermeasures. On October 1, 2008, Brazil and the United States agreed on the arbitration panelists, who then were to produce a ruling within 60 days. However, the arbitration review continued past the normally allotted 60 days and into 2009. During that period, both parties made written submissions to the WTO arbitrator stating their positions with respect to retaliation in this case.

Brazil Alters Its Countermeasure Request

At a March 3, 2009, Dispute Settlement Body meeting, Brazil revised its total retaliation request to $2.5 billion, down from an earlier $3 billion request. Brazil's proposed sanctions total comprised both prohibited and actionable subsidy countermeasure components.

Under the prohibited subsidies arbitration case, Brazil was seeking two countermeasures:

1. a one-time countermeasure in relation to the Step 2 program of $350 million based on U.S. government payments made under the Step 2 program in marketing year 2005 (this corresponds roughly to the period that elapsed between the expiration of the prohibited subsidy compliance period on July 1, 2005, and the effective repeal of the Step 2 program by the U.S. Congress on August 1, 2006); and 2. annual countermeasures proportionate to the entire annual amount of GSM 102 export credit guarantees issued to all countries for export transactions involving unscheduled products—rice, pork, and poultry—valued at $1.155 billion during FY2006 (initially Brazil valued this countermeasure at $1.294 million) and composed of three parts: a. an interest rate subsidy component amounting to $234.7 million; b. the additional export sales obtained by the United States as a result of these discounts, including sales to creditworthy foreign obligors, referred to as marginal additionality and valued at $62.3 million; and c. the additional export sales to noncreditworthy foreign obligors, referred to as full additionality and valued at $855 million.

Under the actionable subsidies arbitration case, Brazil again asked for:

3. annual countermeasures valued at $1.037 billion until the United States withdrew the relevant subsidies or removed their adverse effects (based on marketing year 2005 data, Brazil calculated the amount of adverse effects on the rest of the world at $3.335 billion, although it only requested countermeasures of $1.037 billion).

Under the combined prohibited and actionable subsidy cases, Brazil asked for:

4. the right to engage in cross-retaliation (i.e., countermeasures in sectors outside of the trade in goods, most notably in the area of U.S. copyrights and patents, as well as services), stating that retaliation in goods would not be practicable or effective due to limited trade in goods between Brazil and the United States.

The United States argued that it had removed the prohibited subsidy component of its export credit program via provision 3101(a) of the 2008 farm bill ( P.L. 110-246 ). Furthermore, the United States argued that it had operated its remaining GSM-102 export credit program at "no net cost" to the government since 2005. The United States asked the arbitrators to dismiss all claims related to prohibited subsidies since they currently operated at "no net cost" to the government. Furthermore, the United States argued that Brazil's prohibited-subsidy countermeasure request continued to include a program that no longer exists (i.e., Step 2). Finally, with respect to Brazil's actionable-subsidy countermeasure request, the United States pointed out that Brazil included a calculation for the entire global adverse effect, not just those adverse effects relevant to Brazil. According to U.S. calculations, the total effects of U.S. counter-cyclical payments and marketing loan payments on Brazil during the 2005-2007 period averaged $30.4 million per year.

Arbitration Panel Ruling

On August 31, 2009, the arbitrator ruled on Brazil's arbitration requests in two separate reports. The first report (WT/DS267/ARB/1) ruled on Brazil's retaliation requests regarding the prohibited subsidies—the Step 2 cotton program and the GSM 102 program (under certain conditions)—based on Article 4.11 of the SCM Agreement. The second report (WT/DS267/ARB/2) ruled on Brazil's retaliation requests regarding the actionable subsidies—market loss assistance payments, marketing loan benefits, counter-cyclical payments (CCP), and Step 2 payments—based on Article 7.9 of the SCM Agreement. The arbitrator's decisions are final and are not subject to appeal.

With respect to the four main countermeasure requests, the arbitrator issued four key findings, discussed below.

First Finding

Brazil was not entitled to its request of a one-time $350 million retaliation award to compensate for previous Step 2 injury. In rejecting Brazil's request on this point the arbitrator stated that countermeasures are an exceptional temporary remedy, available only where compliance has not been achieved, and aimed at inducing such compliance, and that in fact the United States had fully (albeit belatedly) complied with the panel's recommendation to eliminate the Step 2 program.

Second Finding

With respect to Brazil's request for $1.155 billion in countermeasures related to the "prohibited" subsidies, the arbitrator found that Brazil was only entitled to retaliate for the effects of these subsidies on Brazilian products and not for their full effect on the rest of the world (ROW). The arbitrator used Brazil's share of world exports of those products receiving GSM 102 credit guarantees (estimated to be 11.7% in 2006) to apportion Brazil's share of the subsidy effect from the entire global market effect. With this revision to Brazil's formula, the arbitrator estimated the countermeasure at $147.4 million in FY2006—comprising an interest rate effect of $25.27 million, marginal additionality of $41.3 million, and full additionality of $80.8 million. Furthermore, the arbitrator ruled that the retaliatory amount accorded Brazil would vary each year (via formula) based on the total of exporter applications received by the U.S. government under the GSM 102 program for the most recently concluded fiscal year. The formula would consider an interest rate subsidy component and the trade displacement additionality (both full and marginal) of the subsidy component of GSM 102.

Third Finding

The arbitrator found that the amount of countermeasures specific to Brazil and commensurate with the degree and nature of adverse effects resulting from the actionable subsidies was fixed at an annual amount of $147.3 million. This figure was obtained, first, by a recalculation of the total adverse effects on the ROW resulting from the actionable subsidies, to an amount of $2.905 billion in the 2005 marketing year. The adverse effect was calculated as a price effect whereby it was determined that the world price of cotton would have been 9.38 cents per pound higher in the absence of U.S. marketing loan benefits and CCP payments, and that the lower world price resulted in both lost income effects in the ROW of $2.384 billion and reduced production effects of $521.5 billion, for a total of $2.905 billion. However, the WTO arbitrator determined that Brazil should be entitled to retaliation on only a specific portion of the $2.905 billion. The share apportioned to Brazil was based on Brazil's share of cotton production in the ROW in marketing year 2005, which equaled 5.1% or $147.3 million. Furthermore, the panel fixed Brazil's maximum annual retaliation with respect to the "actionable" U.S. subsidies at this same $147.3 million (in other words, this amount will not vary from year to year).

Thus, the overall annual permissible retaliation amount for 2006 was $294.7 million (= $147.4 million + $147.3 million). Furthermore, this amount varies annually, since it consists of both a fixed retaliatory amount in response to "actionable" U.S. subsidies, and a variable retaliatory amount in response to "prohibited" U.S. subsidies.

Fourth Finding

Finally, Brazil had requested the right to engage in cross-retaliation, that is, retaliatory countermeasures in sectors outside of the trade in goods, most notably in the area of intellectual property (IP) rights such as copyrights and patents. A key determinant in ruling on this request was Brazil's contention that there is insufficient trade in consumer goods with the United States to permit compensatory retaliatory action, and that a substantial portion of those imports were of critical importance to Brazil's economy such that punitive sanctions on them would harm Brazil's economy. However, the panel felt that a certain percentage of Brazil's imports of consumer goods originating from the United States should be eligible for countermeasures without causing harm to Brazil's economy because there was available to Brazil a sufficient amount of alternate sources of imports or of sufficiently close substitutes in consumption so as to avoid economic harm. As a result, the panel ruled that Brazil would be entitled to cross-retaliation, if (and only if) the overall retaliation amount (combining both the variable and fixed components) to which it would otherwise be entitled exceeds a variable annual threshold (described below). If the threshold is surpassed, then Brazil would be entitled to suspend certain obligations under the TRIPS Agreement and/or the GATS in the amount in excess of the threshold.

Threshold for Permitting Cross-Retaliation Countermeasures

For purposes of determining eligibility to apply cross-retaliation, the panel established an initial threshold amount of $409.7 million that could be subject to countermeasures without harming Brazil's economy based on the volume and composition of Brazil's imports of consumer goods in the year 2007. The amount of $409.7 million represents the sum of the value of those consumer goods imported by Brazil where the U.S. share is less than 20%, excluding books and automotive parts which are considered essential to Brazil's economy.

The threshold amount may vary from year to year according to the following formula:

T t+1 = T t * (1 + g t+1 ) where T 2007 = $409.7 million

where

T t+1 = threshold value in year t+1

T t = threshold value in year t

g t+1 = percentage change in the value of Brazil's total imports from the United States between years t and t+1.

Brazil's Reaction

Following the arbitration panel's ruling, Brazil claimed that applying the panel's countermeasure determination formulas to preliminary 2009 data would allow for $800 million in total retaliation, including both the fixed $147.3 million of actionable subsidy countermeasures and $650 million of prohibited subsidy countermeasures. The $650 million figure resulted from expanded use of GSM 102 credit guarantees by the United States during FY2009—rising from $1.36 billion in FY2006 to $5.5 million in FY2009. According to Brazil, using 2009 data to calculate the threshold for cross-retaliation would produce an amount of $460 million. If confirmed, these data would suggest that Brazil would be authorized to engage in cross-retaliation equal to $340 million (i.e., the difference between $800 million and $460 million) by suspending commitments it made under the WTO concerning the protection of intellectual property and services.

U.S. Reaction

USTR spokeswoman Carol Guthrie issued the following statement:

While we remain disappointed with the outcome of this dispute, we are pleased that the Arbitrators awarded Brazil far below the amount of countermeasures it asked for. In its first requests for countermeasures in the Cotton dispute, Brazil asked for more than $4 billion in annual countermeasures. During the arbitration proceedings, Brazil argued for more than $2 billion annually. Further, we are grateful that the Arbitrators denied Brazil's request for unlimited ability to suspend concessions on intellectual property or services. And we are pleased that the Arbitrators denied Brazil's request for an additional one-time $350 million in countermeasures in connection with the repealed Step 2 payment program for cotton.

At this time, we do not know when or if Brazil will move to obtain final authorization to suspend concessions or when or if Brazil would act on any such authorization.

The Administration will be actively consulting within the U.S. Government and with stakeholders on how to move forward.

U.S. industry groups, led by the National Cotton Council (NCC), argued that substantial changes had been made to the GSM 102 programs since the initial WTO dispute settlement panel issued its ruling in 2005 and that, as a consequence of those changes, the GSM 102 program now operates in a fully WTO-compliant manner. Similarly, the NCC argued that changes under the 2008 farm bill ( P.L. 110-246 ) to the marketing loan and CCP programs had made them more WTO-compliant. Finally, the NCC complained that the WTO arbitration ruling was based almost entirely on 2005 data, when U.S. cotton support programs were at their peak and the U.S. share of the world cotton market was near 40%, compared with about 12% today.

As a result of these changed circumstances, the NCC and other U.S. farm groups publicly stated that USTR should seek the establishment of a new WTO compliance panel in order to prove that U.S. cotton subsidy programs and export credit programs no longer violate WTO rules. However, in accordance with WTO rules, even if the United States were to initiate such a new compliance panel, Brazil would be able to proceed with its WTO-authorized retaliation.

Phase V: Retaliation or Settlement?

Following the WTO arbitrator's August 31, 2009, ruling, Brazil now had the approval to initiate sanctions against the United States. The arbitrator's decisions were final and not subject to appeal, and Brazil had complete freedom to decide which products would be subject to retaliatory hikes in import tariffs and which IP and services rights could be targeted by supplementary countermeasures. However, before Brazil could proceed with any retaliation, it first had to request the WTO Dispute Settlement Body (DSB) to authorize its retaliation request in an amount, and with respect to types of trade, consistent with these decisions. Following the circulation of the arbitrator's decisions on August 31, 2009, Brazil accordingly submitted requests to the DSB to authorize the suspension of concessions or other obligations. Such approval is decided under reverse consensus, such that WTO members would have to decide by consensus (including Brazil voting against itself) to not allow Brazil to proceed.

On November 19, 2009, the DSB agreed to grant Brazil authorization to impose countermeasures consistent with the arbitrator's decisions. WTO dispute settlement rules did not require that Brazil pursue its retaliation request or, if it did so, that it request authorization to retaliate by a given date. Other possible options included the negotiation of a settlement of the case before Brazil were to impose retaliatory measures or, as suggested by some, a request by the United States for a ruling by a new compliance panel that the objectionable elements of the prohibited subsidy have been eliminated.

Brazil Targets Goods and Services for Countermeasures

On December 21, 2009, Brazil announced that it was authorized by the WTO to impose trade retaliation against up to $829.3 million in U.S. goods in 2010 (based on 2008 U.S. trade data). The countermeasure included a fixed annual amount of $147.3 million, reflecting the adverse effects from U.S. price-contingent subsidies (i.e., marketing loan benefits and counter-cyclical payments), and the balance of $682 million related to the volume of U.S. export credit guarantees (found to operate as a prohibited export subsidy), which may vary annually. The WTO also established a threshold value (related to the value of Brazil's consumer goods imports from the United States) for determining the extent of permissible cross-retaliatory countermeasures. The threshold varies annually based on changes in Brazil's total imports from the United States, but is currently estimated at $561 million, yielding a remaining value of $268.3 million ($829.3 million - $561 million) in eligible cross-retaliatory countermeasures.

On March 10, 2010, Brazil released a final list of goods of U.S. origin valued at $561 million that would be subject to import tariffs within 30 days unless a last-minute agreement was reached. The following week (March 15), Brazil released a preliminary list of U.S. patents and intellectual property rights it could restrict, barring a joint settlement. The new measures—which were open to public comment for a period of 20 days and subject to public hearings—included the temporary suspension of U.S. patents on pharmaceuticals, chemicals, and biotechnology, and the restriction of copyrights in the music and audiovisual industry.

Negotiations Seek Mutual Settlement

The United States and Brazil continued to seek a last-minute negotiated settlement to avoid the retaliatory measures. Brazil said that it would only apply sanctions if the United States refused to eliminate its cotton subsidies. The United States reiterated its intention to comply with the DSB's recommendations and rulings and therefore did not believe that it would be necessary for Brazil to exercise that authorization. The United States added that suspending concessions or obligations could present economic and other challenges for both Brazil and the United States.

Brazil indicated that it could accept a U.S. pledge to send a reform bill to Congress to alter the offending cotton program provisions, if Brazil were compensated for damages until the bill's approval. Some Brazilian leaders proposed compensation through U.S. investments into cotton research, as well as more U.S. imports of Brazilian beef, orange juice, and ethanol. In contrast, some speculated that the United States could take offense at Brazil's retaliatory action and suspend the more than $2.5 billion in trade privileges that it offers Brazil under its Generalized System of Preferences (GSP).

Several U.S. trade associations—including the Brazil-U.S. Business Council, the National Association of Manufacturers, the U.S. Chamber of Commerce, the Council of the Americas, and the American Chamber of Commerce in Brazil, and others—voiced strong concerns that the U.S. government take every measure possible to avoid Brazil's imposition of trade retaliation.

Steven Bipes, executive director of the Brazil-U.S. Business Council, argued that settlement of the dispute would likely have to occur in two stages:

the first stage would involve administrative action by the U.S. government on any number of several pending trade issues with Brazil as a gesture of good faith; the second stage would have to occur in the context of the 2012 farm bill, where Congress could make further substantive changes to U.S. cotton subsidies or to the GSM 102 export credit guarantee program.

Brazil and United States Sign Memorandum of Understanding

On April 1, 2010, Deputy U.S. Trade Representative (USTR) Miriam Sapiro and USDA Under Secretary for Farm and Foreign Agricultural Services Jim Miller met with Ambassador Antonio Patriota, Secretary General of Brazil's Ministry of External Relations, to discuss possible resolution of the dispute. On April 5, 2010, the United States floated a proposal to Brazil on a negotiated settlement. After reviewing the proposal, Brazil's Foreign Trade Council (CAMEX) approved a resolution that postponed until an initial deadline of April 22 the implementation of WTO-approved countermeasures by Brazil against U.S. imports. Key features of the U.S. proposal and the ongoing negotiations included the following:

The United States will establish a fund in the amount of $147.3 million per year to provide technical assistance and capacity-building for Brazil's cotton sector. Under terms of a memorandum of understanding (MOU) signed by Brazil and the United States, the fund will continue until the passage of the next U.S. farm bill or a mutually agreed solution to the dispute, whichever is sooner. Also, the fund will be subject to transparency and auditing requirements, as well as a list of allowable uses specified in the MOU. The United States agreed to make some near-term modifications to the operation of the GSM-102 Export Credit Guarantee Program, and to engage with the government of Brazil in technical discussions regarding further operation of the program. On April 6, 2010, USDA announced that it was cancelling unutilized balances from the GSM-102 program for FY2010, and that these balances would be re-announced under a new guarantee fee rate schedule announced on April 19, 2010. The United States also agreed to publish a proposed rule by April 16, 2010, to recognize the state of Santa Catarina as free of foot-and-mouth disease (FMD), rinderpest, classical swine fever, African swine fever, and swine vesicular disease, based on World Organization for Animal Health guidelines, and to complete a risk evaluation that is currently underway and identify appropriate risk mitigation measures to determine whether fresh beef can be imported from Brazil while preventing the introduction of FMD into the United States.

USDA would finance the annual "cotton" fund of $147.3 million using Commodity Credit Corporation (CCC) funds under the auspices of the CCC Charter Act (15 U.S.C. 714). The CCC Charter Act contains language that allows USDA to use CCC funds to "export or cause to be exported ... agricultural commodities."

In light of the conclusion of the MOU with Brazil (April 20), publication of the proposed rule on meat imports from Santa Catarina (April 16), and the above changes to the GSM-102 program, Brazil extended the ongoing negotiations for resolving the path forward by 60 days, to a second deadline in June 2010. Brazil said that it was still pursuing the full U.S. compliance with the WTO dispute settlement ruling, particularly as concerns U.S. cotton-specific farm program subsidies. However, any changes to farm programs would likely have to be made in the context of the 2012 farm bill.

Although the proposal succeeded in avoiding, at least temporarily, the imposition of harmful trade countermeasures including the suspension of copyright and patent protection, the U.S. proposal was met with both praise and criticism. Proponents of U.S. farm programs (and their incumbent support payments) were generally in favor of the ongoing negotiations and the U.S. proposal. In contrast, opponents and critics of U.S. farm programs were generally critical of the U.S. negotiating offer. In particular, the establishment of the $147.3 million annual fund to support Brazil's cotton sector was described as "subsidy payments to Brazil's cotton farmers needed to permit the continuation of subsidy payments to U.S. cotton farmers."

Brazil and United States Reach Framework Agreement

On June 17, 2010, U.S. and Brazilian trade negotiators concluded the Framework for a Mutually Agreed Solution to the Cotton Dispute in the WTO (WT/DS267) for moving forward in the dispute settlement case. The framework agreement—which lays out a number of "steps and discussions"—represents a path forward toward the ultimate goal of reaching a negotiated solution to the dispute, while avoiding WTO-sanctioned trade retaliation by Brazil against U.S. goods and services. The framework agreement was formally accepted by Brazil's Foreign Trade Council of Ministers (CAMEX) on June 17, 2010. As a result, Brazil has suspended trade retaliation pending U.S. compliance with the framework agreement measures.

Changes to Trade-Distorting Domestic Cotton Support Programs

The framework agreement includes quarterly discussions on potential limits to trade-distorting U.S. cotton subsidies (recognizing that actual changes to cotton-specific subsidies require legislation by Congress and are not likely to happen outside of the 2012 farm bill debate). Specifically, the agreement identifies parameters for a future annual limit on U.S. domestic support for upland cotton such that "[t]he level of the limit would be significantly lower than the average annual level of trade-distorting domestic support provided for upland cotton in the period MY 1999-2005." Based on fiscal year data from Table 1 , annual upland cotton subsidies for the FY1999-FY2005 period averaged $3.568 billion.

Changes to the GSM-102 Program

In addition, the framework agreement provides semi-annual operation reviews to evaluate two sets of guided changes to the GSM-102 agricultural export credit guarantee program. First, the weighted-average length for a GSM-102 contract will be lowered to 16 months by the end of 2012, down from the current average of about 20.5 months. Second, a set of benchmarks is established for implementing changes to GSM-102 contract premiums (i.e., the rates charged for each dollar of credit guarantee) contingent on performance. The current $5.5 billion in annual GSM-102 export credit guarantee value remains intact; however, the annual value is broken into two six-month tranches of $2.7 billion. Every six months an operational review (held each October and April) will determine how GSM-102 usage (i.e., the value of uncancelled guarantee value) for the preceding six-month period compares with the eligible $2.7 billion:

if usage is greater than $1.3 billion, premiums increase by at least 11% of the simple average fee rate; if usage is not greater than $1.3 billion, then during the following six-month period, if usage exceeds $1.5 billion, premiums increase by at least 15% of the simple average fee rate; and if usage is below $0.8 billion, premiums could be decreased by an amount equal to half of the most recent premium increase.

The GSM-102 semi-annual operational reviews will coincide with the relevant quarterly cotton program discussions. Both parties to the dispute have said that a final mutually agreed solution would not be possible until after the 2012 farm bill, when the nature of any changes to U.S. domestic cotton subsidies has been made clear.

Phase VI: Implementation of the MOU and Framework Agreement

The United States has taken several steps to comply with the three major points identified under the April 2010 Memorandum of Understanding (MOU) and the June 2010 Framework Agreement.

Payments to the Brazilian Cotton Institute

The United States has agreed to pay $147.3 million annually into a Brazilian fund (known as the Brazilian Cotton Institute) for technical assistance and capacity building for Brazil's cotton sector.

In June 2010, the United States began making payments to the Brazilian Cotton Institute (BCI) with an initial tranche of $34.3 million, to be followed by successive monthly payments of $12.275 million going forward. The BCI's board of directors consists of three private-sector representatives (including a representative from the Brazilian Association of Cotton Producers (ABRAPA) and two state-level cotton sector representatives) and three government representatives (one each from the ministries of foreign affairs, agriculture, and the ministry of development, industry, and foreign trade). Harold Cunha, a former president of ABRAPA, was designated as the BCI's first executive director.

The BCI's board of directors—who will be responsible for deciding on the uses of funds—are limited by a negotiated list of "acceptable uses" that includes activities such as pest and disease control, purchase and use of capital equipment, and generic promotion of cotton uses. The money is prohibited from being used as a direct subsidy for Brazil cotton production.

Semi-Annual Operational Review of the GSM-102 Program

The United States has agreed to meet with Brazilian officials on a semi-annual basis to review the operation of the U.S. GSM-102 program (both funding levels and average length of tenor) relative to a series of benchmarks.

On October 20, 2010, U.S. and Brazilian government officials met in their first "operational review" of the GMS-102 program, as called for under the framework agreement. The principal purpose of the review was to evaluate U.S. use of GSM-102 credit guarantees during the six-month period April through September of 2010 against the $1.3 billion threshold (described above). According to public USDA figures, USDA received $1.39 billion in GSM-102 applications during the six-month period. However, the officials jointly agreed that the actual usage of GSM-102 had come very close to the $1.3 billion threshold but had not exceeded it. Apparently cancellations reduced the actual usage level substantially from the initial application level. As a result, no fee increase under the U.S. operation of the program was triggered.

The two sides also discussed the average length of loan tenors made under the GSM-102 program. Under the framework agreement, the United States is obligated to try to lower the weighted-average tenor to 16 months by the end of 2012. It was jointly concluded that the weighted-average tenor exceeded the target of 16 months. In response, the United States committed to make further changes to the program before the next operational review. U.S. officials suggested that a possible method to lower the weighted average loan tenor would be to raise fees for use of credit guarantees with longer tenors as an incentive for use of shorter tenors. As a result, in February 2011 USDA initiated fee hikes.

The second operational review of GSM-102 usage took place in April 2011 and covered the October 2010 through March 2011 period. GSM-102 usage for the six-month period was about $1.54 billion, thus exceeding the larger $1.5 billion threshold. As a result, the United States was obligated to increase fees associated with the program by an average of 15%. The fee hikes are also intended to help draw down the average length of tenor for GSM-102 transactions. For transactions involving an annual payment of principal, USDA increased fees for transactions using longer loan tenors by a greater amount than for transactions using shorter loan tenors.

Quarterly Discussions of U.S. Farm Programs

The United States has agreed to meet with Brazilian officials on a quarterly basis to exchange information on U.S. domestic cotton support with a goal of bringing annual spending on trade-distorting upland cotton programs under a cap equal to the annual average provided during the 1999 through 2005 marketing years.

During the October 20 meetings, it was deemed too early relative to the 2012 farm bill to discuss any substantive program changes. However, Brazilian officials expressed their interest in eventually meeting with members of the House and Senate Agricultural Committees to discuss their concerns.

APHIS Rule Changing Animal Disease Status of Brazilian State of Santa Catarina

Under the April MOU, the United States agreed to expedite publication of a rule governing modification to the animal disease status of the Brazilian State of Santa Catarina.

On November 16, 2010, USDA's Animal and Plant Health Inspection Service (APHIS) published its final rule amending the regulations in the U.S. Code (9 CFR part 94) governing the importation into the United States of certain animals and animal products by modifying the disease status for the Brazilian State of Santa Catarina with respect to certain ruminant and swine diseases—FMD, rinderpest, swine vesicular disease, classical swine fever, and African swine fever. These changes will make it easier for animal products such as pork and live swine from Santa Catarina to enter the United States.

At the second review of GSM-102 held in April 2011 (mentioned earlier), Brazil also inquired as to why the United States had not yet released a proposed rule concerning the increased imports of meat products from 14 additional Brazilian states by declaring those states free of foot-and-mouth disease, after having announced that it would do so by January 31, 2011. The U.S. officials did not give a precise timetable for when the rule would come out.

Recent Action Related to the WTO Brazil Cotton Case

Congressional Action

Although the House and Senate Agriculture Committees agreed that the issue of bringing U.S. cotton programs into compliance with the WTO ruling should be addressed in the context of the next farm bill (expected in 2012), several other Members of Congress have been outspoken critics of the terms imposed on the United States in the MOU negotiated with Brazil to temporarily avoid trade retaliation. Since February 2011, several bills or amendments have been introduced that would alter or prevent U.S. compliance with the MOU, especially as regards the annual payment of $147.3 million to the Brazilian Cotton Institute (BCI).

On February 18, 2011, Representative Kind introduced an amendment to the Full-Year Continuing Appropriations Act, 2011 ( H.Amdt. 108 to H.R. 1 ). The Kind amendment read:

None of the funds made available by this Act may be used to provide payments (or to pay the salaries and expenses of personnel to provide payments) to the Brazil Cotton Institute.

If passed, the Kind amendment would have brought the United States into noncompliance with the terms of the MOU. However, the amendment failed in a floor vote of 183-246.

On May 31, 2011, during the House Appropriations Committee's full committee markup of the FY2012 Agriculture appropriations bill ( H.R. 2112 ), two amendments were adopted and subsequently removed on the floor that again dealt with funds originally targeted for paying the $147.3 million annual fee to the BCI. One provision (§743, as reported), offered by Representative DeLauro, would have prohibited any payments to the BCI in FY2012. (In a separate provision offered by Representative DeLauro and also subsequently removed on the floor, the $147.3 million in BCI payments were instead added to the Women, Infants, and Children public nutrition program for FY2012.) A second provision (§741, as reported), offered by Representative Flake, would have reduced outlays to U.S. upland cotton producers under the direct payment program of the 2008 farm bill (§1103; P.L. 110-246 ) by $147.3 million to offset the BCI payments. However, during the bill's floor debate on June 15, 2011, House Agriculture Committee Chairman Lucas raised a point of order against these provisions, which was sustained, thus removing them from the bill.

The next day, on June 16, 2011, during the House floor debate, two new amendments were introduced to H.R. 2112 that dealt explicitly with the WTO Brazil cotton case. Representative Kind introduced an amendment ( H.Amdt. 454 to H.R. 2112 ) identical to his February amendment to H.R. 1 to prohibit use of funds for payments to the BCI. This time, however, the amendment passed by a vote of 223-197. A second amendment ( H.Amdt. 472 to H.R. 2112 ) introduced by Representative Flake would have prohibited any funds from being used to provide payments under the price-contingent cotton programs—marketing loan benefits, counter-cyclical payments, or cotton storage program—identified by the WTO dispute settlement panel as being the primary source of U.S. cotton program market distortions. However, this second amendment was strongly opposed by several Members from cotton-producing regions, and the amendment failed by voice vote.

On June 16, 2011, H.R. 2112 was passed by the U.S. House of Representatives, inclusive of the Kind amendment, by a vote of 217-203. The Senate version of H.R. 2112 , which passed on November 11, 2011, did not contain a similar amendment banning the use of funds for payment to the BCI. The final conference report, passed by both chambers on November 17, 2012, and signed into law on November 18, 2011, also did not contain the Kind amendment.

Congress is expected to address the next farm bill in 2012. As mentioned earlier, Chairman Lucas has stated that any changes to the U.S. cotton program should occur as part of larger farm program changes within the next farm bill debate.

Industry Action

On August 26, 2011, the National Cotton Council (NCC) issued a statement recommending an adjustment to the current U.S. cotton program as part of the 2012 farm bill negotiations. In particular, the NCC recommends that changes to the U.S. cotton program should include replacing the direct payments, the counter-cyclical payments, and the Average Crop Revenue Election (ACRE) programs with an affordable revenue-based crop insurance program created by making "modest enhancements" to existing crop insurance products, complemented by adjustments to the upland cotton marketing loan program.

The NCC proposes using a modified Group Risk Income Protection (GRIP) type of insurance program (where losses are determined at the county level rather than the farm level) to protect farms against shallow revenue losses. However, unlike crop insurance, which uses a projected price based on pre-planting time prices for harvest-time futures contracts, the NCC proposal would also include a "fixed reference" price to act as a floor price guarantee for the projected price. With respect to its marketing loan adjustments, the NCC proposes using a two-year moving average of USDA's calculated Adjusted World Price (AWP) for the most recently completed marketing years to serve as the marketing loan provided it stays within a tight price-band of 47 to 52 cents per pound. If the moving average AWP moves below 47 cents/lb., then the proposed marketing loan for upland cotton would be 47 cents/lb. The current marketing loan rate for upland cotton is set at 52 cents/lb.

Under the terms of the MOU between the United States and Brazil, Brazil retains substantial privileges in determining whether any proposed changes to the U.S. cotton program (including the NCC's proposed changes) would bring U.S. cotton programs into compliance with WTO commitments. A key measure will likely be the extent to which the proposed changes bring the U.S. cotton programs into line with market conditions—a key criteria cited by the WTO dispute settlement panel.

Phase VII: Potential Policy Implications of WTO Panel Ruling

The arbitration ruling in favor of Brazil's requested cross-retaliation countermeasure could raise the stakes in this particular dispute by potentially expanding retaliation into TRIPS and the General Agreement on Trade in Services. 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 that 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.

Trade experts have expressed concern that the panel findings could extend beyond cotton to other major field crops, particularly as concerns the potential limits on export credit guarantees. Some trade and market analysts, as well as legislators, have expressed concern that a broad finding against U.S. farm program provisions under the actionable subsidies ruling could necessitate legislative changes to the U.S. farm bill to bring existing program operations into compliance.

Bringing GSM-102 into WTO Compliance

Brazil argued that the fees charged to users of GSM failed to cover the U.S. government's costs (whether a default on the credit or late or partial payment) associated with running the program. This charge was confirmed by the original WTO panel (based on U.S. historical data of GSM-102 program operations) and upheld on appeal. Thus, a key to bringing the GSM-102 program into compliance would be setting premium rates high enough to cover long-run program operating costs. By the WTO Compliance Panel's own measure, this could be achieved by adopting the minimum premium rates as reported in the OECD Arrangement on Officially Supported Export Credits . Further, the rates could be subject to a proviso that, should the GSM-102 program operate at a loss during any given year, then the fees would be adjusted higher by some amount to offset the loss in the subsequent year.

A review of the estimated credit subsidies on CCC export credit guarantees since 2001 suggests that an annual average of $302 million could be saved by adjusting fees upward to more fully cover operating costs. The program net losses have varied annually with changes in the rates of participation and default.

Bringing Price-Contingent Programs into WTO Compliance

The obvious adjustment needed to bring price-contingent cotton programs into compliance involves lowering the support prices (i.e., the loan rate and the target price) until they are more in line with market prices. Depending on the degree to which cotton price triggers are adjusted downward relative to market prices, the average payment rate will decline. By setting trigger prices at a moving average of market prices, payments could approach zero.

CCC outlays to cotton producers under the price-contingent market loan provisions (including loan deficiency payments, marketing loan gains, and certificate exchange gains) and the CCP program have, on average, accounted for about 42% of all CCC payments under these programs since 2003 ( Table 4 ). During that period, cotton producers received an annual average of over $1.8 billion. During the 2007-2009 period, cotton receipts surged to a 66% share of total CCC outlays as high world commodity prices raised prices for most other major U.S. program crops above their program price triggers. In 2010, cotton prices have also moved above their program trigger levels.

Direct Payments Classification

Concerns have also been expressed regarding the reclassification of PFC and direct payments away from non-trade-distorting green box support. However, the panel finding that U.S. direct payments do not qualify for WTO exemptions from reduction commitments as fully decoupled income support (i.e., they are not green box compliant) appears to have no further consequences within the context of this case and does not involve any compliance measures. This is because direct payments were deemed "non-price contingent" and were evaluated strictly in terms of the Peace Clause violation.

The panel did not specifically reclassify U.S. PFC and DP payments as "amber box," nor did the panel recommend that the United States should notify such future payments as "amber box." This is a subtle but critical distinction because of the enormity of PFC and DP payments. During FY1996 to FY2008, PFC and DP payments averaged $5.2 billion per year and accounted for 34% of total U.S. farm program outlays. Shifting this amount to amber box could have important implications for future dispute settlement cases, as well as for the United States' ability to meet its WTO amber box commitments.

U.S. cotton industry and government officials are concerned that the specific finding on the apparent failure of U.S. "decoupled" payments to meet WTO green box criteria leaves such programs open to future charges, and that third countries may feel emboldened by knowing how a WTO panel is likely to rule on such matters. The European Union (EU) is also likely to be concerned about this finding since the EU's agricultural program (following agricultural policy reforms of June 2003) relies heavily on "decoupled" payments similar to the those of the U.S. program. These concerns appear to have merit, as both Canada and Brazil initiated a WTO dispute settlement proceeding against the United States charging that the United States has indeed incorrectly notified PFC and DP payments as green box and that their inclusion in the U.S. amber box results in the United States exceeding its WTO-agreed AMS spending limit on several occasions in recent years ( Figure 4 ).

Other Cotton-Related Trade Issues

Besides Brazil's WTO-initiated dispute settlement case (DS267), U.S. cotton subsidies are being challenged at the WTO on two additional fronts.

First, the Doha Development Agenda negotiating round has substantial reductions in trade-distorting domestic program support as one of its principal modalities. If realized, a new round of domestic spending limitations could potentially represent a "real" ceiling on U.S. commodity spending and could result in lower program outlays. Second, a consortium of four African cotton-producing countries—Benin, Burkina Faso, Chad, and Mali—has submitted a WTO proposal calling for a global agreement to end all production-related support for cotton growers of all WTO-member cotton producing nations. In acknowledgment of the concerns of African cotton-producing countries, the United States—while not agreeing with the African proposal—worked with the African countries on a formulation in the initial agriculture framework (of July 31, 2004) of the WTO's ongoing Doha Round. Although no specific cotton program concessions were mentioned in the framework, the United States committed "to achieve ambitious results expeditiously" under the framework. Further, it is notable that cotton is the only commodity singled out for special mention in the framework.

Role of Congress

Monitoring Trade Agreements and Negotiations

Given the importance of cotton in the U.S. agricultural economy and the potential for WTO-imposed limitations on U.S. cotton program operations, Congress likely will be closely monitoring developments in the WTO cotton case and the Doha Round of trade negotiations. Both the Senate and House Agriculture Committees regularly hold hearings on agricultural trade negotiations. In addition to congressional hearings, Congress will likely be engaged in consultations with the Administration on the bilateral trade negotiations as well as the Doha Round of WTO trade negotiations. Such consultations will be a major vehicle for Members to express their views on this dispute and on the negotiating issues it raises.

When confronted with a negative WTO dispute settlement ruling, a country has essentially five options to choose from: eliminate the subsidy; reduce the subsidy to diminish its adverse effect; revise the program function to reduce the linkage between the subsidy and the adverse effect (referred to as decoupling); pay a mutually acceptable compensatory payment to offset the adverse effects of the subsidy; or suffer the consequences of trade retaliation.

Bringing Domestic Farm Programs into Compliance

Ultimately, Congress is responsible for passing farm program legislation that complies with U.S. commitments in international trade agreements. The United States would appear to have already complied with several of the AB's recommendation concerning "prohibited subsidies" through changes in the 2008 farm bill ( P.L. 110-246 ; §3101(a)) by eliminating the Step 2, GSM-103, and SCGP programs, and by removing the fee cap on GSM-102 credit guarantees (i.e., by eliminating the "subsidy" component of export credit guarantees). In addition, by the same 2008 farm bill provision Congress requires that the Secretary of Agriculture, in carrying out the GSM-102 program, "work with the industry to ensure, to the maximum extent practicable, that risk-based fees associated with the guarantees cover, but do not exceed, the operating costs and losses over the long-term." However, a more explicit definition of "long-term" such as a two-year period would perhaps provide a stronger signal to the Secretary of Agriculture in regard to operating the GSM-102 program with no net losses.

Also, some questions remain as to what extent the 2008 farm bill has addressed the adverse effects charge related to price-contingent subsidies. Instead of eliminating or reducing program triggers, the 2008 farm bill appears to offer higher levels of price and income support that potentially could aggravate the perception (if not the reality) of adverse effects in the marketplace. Several of the proposed changes are specifically relevant to the Brazil cotton case, but also germane to the broader issue of program vulnerability to WTO challenge. For example, the enacted 2008 farm bill:

extends the counter-cyclical payments (CCP) program and current marketing loan provisions (§§1104 and 1201 of P.L. 110-246 ); raises both target prices and loan rates for several commodities, while only lowering (marginally) the target price for upland cotton (§§1104 and 1202); offers producers the choice (subject to a 30% reduction in marketing loan rates and in lieu of 100% of CCP and 20% of direct payments) of a revenue-based support option under the Average Crop Revenue Election program (ACRE, §1105) with potentially higher per-acre revenue guarantees for several crops than under the previous 2002 farm bill; and creates a new cotton-user payment of 4 cents per pound (§1207). This payment appears similar to the WTO-illegal Step 2 payment except that cotton from all origins (not just domestic sources) is eligible for the payment. Since the United States imports very little cotton, most payments would still likely go to domestically sourced cotton. As a result, this subtle technical loophole might ultimately be subject to a WTO challenge, but would not be part of the current WTO cotton case.

Finally, the 2008 farm bill does not address the issue surrounding the disqualification of direct payments from the WTO's green box exclusion as decoupled payments due to the planting restriction on fruits, vegetables, and wild rice on program base acres. Instead, direct payments are extended with no change to the current planting restriction, except for a small pilot program on 75,000 acres in seven states (§1107). This retention of the status quo has important WTO implications for the AMS case being brought against the United States by both Canada and Brazil. The U.S. aggregate measure of support (AMS) has exceeded, on at least two occasions, its total WTO limit if direct payments are included in the AMS calculation ( Figure 4 ).

Additional uncertainty arises from the ongoing Doha Round of trade negotiations, where a successful conclusion could potentially mitigate or end Brazil's interest in continuing its case against the U.S. farm programs. Both agriculture committees (House and Senate) of the 112 th Congress will likely continue to monitor developments in the WTO cotton case and the Doha negotiations, as well as the aftermath of the compliance panel's final ruling.