Nationally, according to the Census of Agriculture, there were 24,805 U.S. farms producing cotton in 2002. (1) Out of this total, nearly 60% (14,476farms) were classified as specialized cottonfarms (because half or more of their commodity sales were cotton), and this group produced 70%of that year's total cotton crop. In 2003, 12.1 million harvested acres produced an estimated 18.255million 480-pound bales of cotton lint (3.97 million metric tons), or 725 lbs. per acre. (2) If themarketing year farm price averages $0.638/lb., the farm value of the 2003 crop will be about $5.5billion. With calendar year 2003 estimated cash receipts for lint and seed at $5.5 billion, cotton will account for 5.1% of estimated total receipts from all U.S. crops ($106.7 billion) and 2.5% of totalcrop and livestock receipts ($212.4 billion). Other leading crops were corn (71.1 million acres, and$18.7 billion in receipts), soybeans (72.3 million acres, and $15.7 billion in receipts), wheat (52.8million acres, and $6.8 billion in receipts), and rice (3.0 million acres, and $1.1 billion in receipts). (3) The leading seven cotton-producing states accounted for 80% of total production in 2003: Texas, 24%; Georgia, 12%; Mississippi, 12%; California, 10%; Arkansas, 10%; North Carolina, 6%;and Louisiana, 6%. (4) Figure 1 illustrates the cotton-producing regions. Figure 2 shows annual U.S. cotton production since 1991, and the U.S. share of world production. Annual average U.S. production since 1991 is 16.8 million bales (weighing 480 poundsper bale), ranging from a low of 13.9 million bales to a high of 20.3 million bales. The U.S. shareof world production has averaged 20% since 1991, ranging from a low of 16% to a high of 23%. This recent history differs little from that of the past 30 years. Since 1971, the U.S. average shareof world production is 19% and the range has been from a low of 12% to a high of 23%. (5) The United States is the world's second largest cotton producer, behind China (see Figure 3 and Appendix Table 2 ). While some 80 countries are forecast to produce about 93 million balesof cotton in the 2003/04 marketing year, the leading seven countries account for about 75 millionbales, or 80% of world production. Among these leading producing nations, only the United States,Brazil, and Uzbekistan are net exporters. The others are net importers of cotton as well as leadingcotton producers. The United States dominates all other cotton exporting countries ( Figure 4 and AppendixTable 2 ). Expected U.S. exports of 13.8 million bales constitute 42% of total world exports inmarketing year 2003/04. The second largest single country exporter is Uzbekistan at 3.1 millionbales, holding 10% of the world share. The 13 countries of West and Central Africa (WCA), withan export volume of 4.621 million bales, account for 13% of the world total. Such major cottonproducers as China, India, and Pakistan also are importers of cotton to meet the needs of their yarn,fabric, and textile manufacturing industries. The United States is itself a large user of its own cotton. At 6.2 million bales, domestic use accounted for 32% of combined domestic and export use in the 2003/04cotton marketing year. However, domestic manufacturing of cotton fabric and yarnhas been declining rapidly while foreign manufacturing has increased. On the otherhand, for the past three years exports have risen rapidly and to record levels asmanufacturing has expanded overseas. In the 2003 marketing year, U.S. cottonexports are expected to reach 13.8 million bales, constituting 68% of total use. Figure 5 graphically portrays the market shift in deliveries from domestic to foreignusers. Observers may question whether cotton support and export promotion programsare contributing to the decline in U.S. cotton manufacturing. However, by design thedirect and counter-cyclical payments as well as the marketing loan provisions do notraise the market price for U.S. cotton or constrain production. To the contrary, thesubsidies support the income of producers and enable them to incur variable andfixed production costs when market prices are low. As shown in Figure 2 , U.S.cotton production did not drop in response to low market prices in 1999 through2002. In fact, average annual production increased after the price drop in 1999compared to production levels in the higher price years prior to 1999. The United States does have tariff barriers to discourage domestic manufacturers from importing lower-priced world cotton. These barriers areintended to protect U.S. cotton producers from foreign competition. At the sametime, Cotton User Marketing Certificates (also called Step 2 Payments), SpecialImport Quotas, and the Limited Global Import Quota are designed to benefit U.S.yarn and fabric manufacturers by partially offsetting domestic supply shortages orhigher U.S. cotton prices. The factors thought to be most important in the decline in U.S. textile and fabric manufacturing are increased import competition and the scheduled phase-out ofquotas on textiles and apparel in January 2005. Efforts to boost economic growth inpoorer regions of the world have contributed to the import competition. TheCaribbean Basin Economic Recovery Act (CBERA) (Title II of P.L. 98-67 ), theAndean Trade Preference Act ( P.L. 102-182 ), and the African Growth andOpportunity Act (Title I of P.L. 106-200 ), were initial measures to help those regions. The last two Congresses have expanded the benefits accorded in those measures. (See CRS Report RL31723 , Textile and Apparel Trade Issues , January 6, 2004.) U.S. farm-level cotton prices are determined by world supply and demand conditions, which are substantially influenced by U.S. cotton production and U.S.demand for cotton textiles. Supply, which is subject to farmers' planting andmanagement decisions as well as the vagaries of weather and pests, is variable,particularly at the individual farm level. Demand also is unstable since it is subjectto all of the forces that shape consumer purchases, including competing fibers suchas wool and synthetics. Imbalances between supply and demand are reflected in pricechanges. Figure 6 shows average marketing year upland cotton prices andcalendar-year cash receipts received by U.S. farmers from the sale of all cotton lintand seed from 1991 through 2003. Over the 13-year period from 1991 through 2003 shown in the graph, farm prices averaged $0.57/lb. However, this time frame is particularly unstable, with theannual average farm price reaching a record high of $0.75 for marketing year 1995and then dropping to $0.30 for marketing year 2001. A drop this low had not beenseen since 1972, when it averaged $0.27. The price swing, which occurred duringthe 1990s, falling from record or near-record highs to lows nearly as extreme, was notunique to cotton. During this time period, other agricultural commodities showedsimilar price swings in response to short supplies and strong demand followed byincreased production but declining demand due to financial crises in large parts ofAsia, South America, and Russia. The various programs categorized in this report as price support and crop loss assistance directly support farm income, mostly as direct payments to farms and ascrop insurance indemnity payments above and beyond the premiums paid by farmers. In most cases the programs are designed to offset either low market prices or lowyields. Detailed explanations of the various farm subsidy programs and exportsubsidy programs, along with expenditure data are presented in the appendix of thisreport. Total cotton subsidy payments to farmers averaged $0.21/lb. ($0.17 for pricesupport and $0.04 for crop loss assistance) from crop year 1991 through 2003 (See Figure 7 ). The practical result of these farm subsidies is that they stabilize the revenue of cotton farmers. Figure 8 demonstrates this by adding subsidy payments per poundof production to the average price received for cotton. The average price received byfarmers was $0.57 for crop years 1991 through 2003. Therefore, the combinedannual average value of the market price and the farm subsidy was $0.78/lb., rangingfrom a low of $0.71 to a high of $0.86. The United States is not the only nation that subsidizes the production and marketing of cotton. However, data published by the International Cotton AdvisoryCommittee (ICAC) (6) indicate that it is one of thelargest. Subsidies per unit werelargest in Spain ($1.04/lb.) and Greece ($0.77/lb.), followed by the United States($0.31/lb) for the 2001/02 crop. Spain and Greece are comparatively small producers(107,000 metric tons and 435,000 metric tons respectively) compared to the UnitedStates (4,420,000 metric tons). In terms of total subsidy cost, the United States rankshighest at $3,001 million, followed by China at $1,196 million, Greece at $735million, and India at $500 million ( Table 1 ). (7) Table 1. World Direct Government Assistance to Cotton Production, by Country, 2001/02 Source: International Cotton Advisory Committee, Production and trade PoliciesAffecting the Cotton Industry, Washington, DC, September 2003. * Income and price support only. According to the ICAC report, some countries that provided assistance in 2001/02 did so on an emergency basis for that year only and do not maintain ongoingprice support or income support programs for cotton. Production costs usually are divided into categories of variable cash costs and fixed costs. (8) U.S. variable cash costs of cottonproduction have shown somemovement above and below their $0.50/lb. average over the past 13 years ( Figure9 ). Variable cash costs (such as seed, fertilizer, chemicals, fuel, and repairs) typicallyare selected for examination because they largely are under the control of the farmoperator and vary with the intensity of the production effort. Revenue must at leastcover variable cash costs or the farming enterprise cannot be sustained for very long. Fixed costs, which have averaged about $0.29/lb., include depreciation of equipmentand buildings ($0.15/lb), land ownership and rental costs ($0.08/lb), (9) taxes andinsurance ($0.03/lb.), and general farm overhead ($0.03/lb.) An allowance forunpaid family labor is excluded from this analysis. Since 1991, cash variable costs have averaged $0.50/lb. while season averagemarket prices have averaged $0.57. While, on average, variable cash costs weremore than covered by market prices, there was not enough to pay for the remainingfixed costs. In addition, for crop years 1999 through 2002, variable costs exceededmarket prices. However, subsidies are another source of revenue for cottonproducers, as well as producers of other major crops, that enable them to cover costswhen market prices are low (described in a later section). Cost of production comparisons among countries are made by the International Cotton Advisory Committee (ICAC) based on survey data supplied by participatingmember countries. While there are problems of data comparability betweencountries, the numbers do indicate that U.S. costs of production rank near the top (see Figure 10 ). (10) Also, U.S. costsmay be about double or more than costs in Brazil andsome of the African countries that compete with the United States in export markets. It is beyond the scope of this report to examine why there are differences inproduction costs between countries, but some of the explanations include differencesin yields, land costs, labor costs, fertilizer costs, and ginning costs. (11) Over the 13-year period 1991 through 2003, U.S. farm cotton revenues annuallyaveraged $0.78/lb. ($0.57 from the marketplace plus farm subsidy payments of$0.21). In comparison, annual variable cash costs of production averaged $0.50/lb.,and total economic costs averaged $0.78/lb. (See Figure 11 .) The substantialcontribution cotton subsidies play in helping cover production costs explains theirimportance to farmers. In the absence of support programs, the data suggest asizeable proportion of cotton would not be profitable. The 1994 WTO Agriculture Agreement developed in the Uruguay Roundbrought all agricultural products listed in the agreement under more effectivemultilateral rules and commitments, including "tariff bindings." It prohibitssubsidies that exceed negotiated limits for specific products, and it specifiesgraduated reductions in domestic support. However, this Agreement was seen onlyas a beginning for reductions in protection and trade-distorting support. Article 20of the Agriculture Agreement committed members to start negotiations on continuingthe reform effort. This commitment was fulfilled when the United States and other WTO members began a new round of multilateral trade negotiations, called the Doha DevelopmentAgenda (DDA.), in November 2001. The objectives for agricultural tradeliberalization are to substantially improve market access for agricultural products,reduce and phase out export subsidies, and substantially reduce trade-distorting(production inducing) domestic support. One step in the negotiations was to agreeon a "framework" for the agriculture negotiations at a ministerial meeting in Cancunin September 2003. Just prior to the Cancun meeting the United States and the EU reached agreement on a proposed framework for the agriculture negotiations. This provokeda group of 21 developing countries (that included, among others, Argentina, Brazil,China, and India) to make a counterproposal (called the G-21 framework) that calledfor deeper cuts in developed country domestic support, the elimination of exportsubsidies, and preservation of special and differential treatment for their ownsubsidies and tariffs. This standoff reflected the continuing differences betweendeveloped and developing countries, and U.S. support for cotton was viewed assymbolic of the differences between the two groups. Developed (U.S. and EU) anddeveloping (G-21) nations' differences over cotton contributed to the failure to reachagreement on a framework for the agriculture negotiations. Four African cotton-exporting countries -- Benin, Burkina Faso, Chad, and Mali -- proposed an end to global trade-distorting subsidies for cotton within threeyears with transitional compensation to be paid to producers. The United States, inresponse, proposed a global sectoral initiative for cotton and textiles that would haveaddressed subsidies for cotton and textiles, tariffs on fibers, textiles and clothing,nontariff and other barriers in the fiber sector. A compromise on cotton the cottonissue could not be reached at the September 2003 Cancun ministerial conference andnegotiations broke down. (See CRS Report RS21715, The African Cotton Initiativeand WTO Agricultural Negotiations .) Earlier, in December 2002, Brazil initiated a dispute settlement case (DS267) at the WTO against the U.S. cotton program. Brazil charges that U.S. cotton subsidyoutlays have exceeded U.S. commitments to the WTO, which causes overproductionand higher exports that cause serious injury to the Brazilian cotton sector. U.S. tradeofficials argue that the subsidies provided to U.S. cotton growers have been withinthe allowable WTO limits and are consistent with U.S. WTO obligations. Consultations between the two countries failed to resolve the dispute and a DisputeSettlement Panel was formed on March 18, 2003, to review the charges. (See CRS Report RS21715, U.S.-Brazil WTO Cotton Subsidy Dispute .) Brazil also argues that the "Step 2" provisions of the U.S. cotton program, as well as the favorable terms provided under U.S. export credit programs and theMarket Access Program (MAP), function as export subsidies and are inconsistentwith U.S.-WTO obligations regarding export subsidies. The United States considersStep 2 payments as part of its domestic support program since they are targeted todomestic cotton users as well as exporters and reports the payments as "amber" box(trade-distorting) domestic support payments. U.S. trade officials also contend thatboth the U.S. export credit (GSM) programs and MAP are consistent with WTOobligations. Key to Brazil's case is the argument that the United States is no longer exempt from WTO dispute proceedings under the so-called "peace clause" (Article 13) of theWTO's Agreement on Agriculture. Article 13 exempts domestic support measuresfrom being challenged as illegal subsidies as long as the level of support remains ator below the benchmark 1992 marketing year (MY) levels. Brazil argues that U.S.cotton subsidies were about $2 billion in MY1992 compared with over $4 billion inMY2001. Therefore, Brazil argues that the United States is no longer in compliancewith the requisite conditions and can no longer seek protection under the WTO'speace clause rule. The Dispute Settlement Panel released its confidential interim report to Brazil and the United States on April 26, 2004. News reports suggest at least a partialfinding against the United States. The panel's final report was released confidentiallyto the disputing parties on June 18, 2004, but the ruling is not expected to be madepublic until late August. If the ruling is unfavorable, as expected, the United Stateslikely will appeal, which would extend the process until mid- to late November 2004. Resolution of the WTO case in Brazil's favor could result in a WTO decisionconcerning implementation of U.S. cotton program provisions. Noncompliance withsuch a decision on the part of the United States could result in compensation toBrazil, or possible limited trade sanctions against U.S. cotton or other exports. U.S. agricultural subsidies and import barriers in general and for cotton in particular have become a complicating factor in negotiating a Free Trade Area of theAmericas that would encompass 34 countries. Brazil and the United States co-chairthe Trade Negotiating Committee, which is responsible for directing nine negotiatinggroups, one of which is agriculture. Differences between Brazil and the UnitedStates typify an underlying challenge. The United States has a relatively low averagetariff compared to Brazil and so is pushing for broad tariff reduction. Brazil andother Latin American countries are pressing the case that the United States shouldrelax use of its trade remedy laws, curtail domestic subsidies for farmers, and lowerpeak tariffs related to quotas. For many Latin American countries, agricultural tradeis at the forefront of concerns, given the importance that it plays in their economies. However, the United States does not want to address its agriculture policies in aregional FTAA, preferring that this be part of the global Doha Round negotiations. (See CRS Report RL30935 , Agricultural Trade in the Free Trade Area of theAmericas .) In each of the challenges described here, cotton is the focus for policies that apply to grains and oilseeds as well. Thus, if the United States is forced to makechanges to cotton programs, such changes can be expected to support programs thataffect much of U.S. crop production. International Cotton Advisory Committee, Production and Trade Policies Affecting the Cotton Industry , Washington, DC, July 2002. International Cotton Advisory Committee, Survey of the Cost of Production of Raw Cotton , Washington, DC, September 2001. USDA, Economic Research Service, Cotton and Wool Situation and Outlook Yearbook , U.S. Department of Agriculture, Washington, DC, November 2003. USDA, Farm Service Agency, Commodity Credit Corporation Commodity Estimates Book, FY 2005 President's Budget , Washington, D.C., February 2004. USDA, Farm Service Agency, Fact Sheet, Upland Cotton, Summary of 2002 Commodity Loan and Payment Program , January 2003. USDA, Farm Service Agency, History of Budgetary Expenditures of the Commodity Credit Corporation , Washington, DC, Book 3, April 9, 2001, and Book 4, January30, 2004. Wescott, Pual C., and Leslie A. Meyer, U.S. Supply Response Under the 2002 Farm Act , USDA, Economic Research Service, Agricultural Outlook Forum 2003,February 21, 2003. To stabilize and support farm incomes, in the face of highly variable prices caused by fluctuating world supply and demand conditions, major crops produced inthe United States, including cotton, have been subsidized since the 1930s. Mostrecently, the 2002 farm bill ( P.L. 107-171 ) authorized a price support framework thatprovides three unique subsidy mechanisms for upland cotton and other coveredcommodities (including wheat, corn, sorghum, barley, oats, rice, soybeans and otheroilseeds, and peanuts). By design, none of the three support mechanisms raises themarket price of cotton. However, they do raise the effective price received byfarmers and so are called "price support" programs. The three support mechanismsavailable to producers include (1) marketing assistance loans, (2) direct payments,and (3) counter-cyclical payments. Marketing Assistance Loan Program. Upland cotton producers are eligible for the minimumnational average price of $0.52/lb. under the market assistance loan program on allthey produce. ELS cotton producers are eligible for the minimum national averageprice of $0.7977/lb. under the marketing assistance loan program, but are not eligiblefor other support payments. Farmers with harvested cotton can use the stored commodity as collateral for a nonrecourse marketing assistance loan from the U.S. Department of Agriculture'sCommodity Credit Corporation (CCC). The farmer has the choice of repaying theloan in full (plus interest) in order to recover clear title, which is commonly donewhen market prices are higher than the loan rate. Alternatively, when market pricesare lower than the loan rate, the farmer can repay the loan at the adjusted world price(AWP) (12) , retain ownership of the cotton and sellit in the marketplace (mostadvantageously when prices rise above the loan rate). The difference between the loan rate and the AWP is known as a marketing loan gain. This gain is considered a direct payment from the CCC and is reportable assuch for income tax purposes. This marketing loan gain is limited to $75,000 perperson per year (but the rules allow a doubling of the limit for a spouse or formultiple farms). By design, repayment of loans at the AWP is intended to avoidacquisition of cotton by the CCC due to forfeiture of collateral in settlement of thenonrecourse loans. Forfeiture of cotton to CCC is another alternative available to thefarmer borrower. Still another way farmers can repay nonrecourse marketing assistance loans is to purchase cotton commodity certificates from the CCC at the adjusted world priceand use the certificates to repay the loans, the only use that is allowed for thecertificates. Gains achieved in this way (though identical to gains achieved byrepaying loans at the AWP) are not subject to the per person annual payment limit. Farmers otherwise eligible to put cotton under loan can agree to forgo the loan option and instead receive loan deficiency payments (LDPs) when market prices fallbelow the loan rate. The LDP payment rate is the difference between the AWP andthe loan rate (financially equivalent to the marketing loan gain). The loan deficiencypayment option has several administrative and financial advantages for farmers overactual nonrecourse loans, which encourages its use. However, LDPs are treated justlike marketing loan gains in terms of contributing toward the per person annualpayment limits. Marketing assistance loans reduce revenue risk associated with price variability and are considered production distorting in a WTO-sense because benefits are linkeddirectly to production. Direct Payments Program. The direct payments program pays upland cotton farmers $0.0667/lb. on 85% ofhistorical cotton production (ELS cotton is not eligible). These direct payments arenot linked to either current production or prices. In fact, farms may but need notproduce cotton to receive the direct payments. They are allowed to grow cotton orany other major grain or oilseed (but not fruits and vegetables). The United Statesconsiders direct payments to be non trade-distorting under WTO rules, althoughsome dispute this classification. This decoupling of the support payments from production requirements and market prices was first adopted in the 1996 farm bill. The payments were calledproduction flexibility contract (PFC) payments, or simply "contract payments." Renamed "direct payments" in the 2002 farm bill, they were extended another sixyears through crop year 2007. Direct payments are subject to an annual per personlimit of $40,000, which can be doubled under the spouse or three-entity rules. While direct payments are decoupled from both production and market prices, they are tied to acreage and so are capitalized into land values. This wealth effectmay have some effects on production and investment decisions. Counter-Cyclical Program. The counter-cyclical program was adopted in the 2002 farm bill and makes paymentsbased on 85% of historical production (to the same farmers receiving directpayments). The payment rate is counter-cyclical to the market price. It goes up asthe season average market price for upland cotton declines below the target price of$0.7240/lb. The difference (with adjustment) between the lower season averagemarket price and the higher target price is the counter-cyclical payment rate. Thispayment rate is constrained on the lower end by the loan rate ($0.52) plus the directpayment rate ($0.0667), and so cannot exceed $0.1373/lb. Alternatively, if theseason average price is above $0.6573, no counter-cyclical payments are made. Again, farmers need not produce cotton to receive the counter-cyclical payments. While benefits are not linked to farmers' production decisions, they arelinked to market prices. The linkage to market prices may be seen by some farmersas reducing market revenue risks, and so may influence some production decisions. Together, direct payments and counter-cyclical payments are called the direct andcounter-cyclical payments program (DCP). Counter-cyclical payments are similar, but not identical to target price deficiency payments that were made from 1973 through 1995. The difference is that target pricedeficiency payments were made on each farmer's actual production of cotton eachyear whereas farmers now need not produce cotton to receive cotton counter-cyclicalpayments. Counter-cyclical payments are subject to an annual per person paymentlimit of $65,000, which can be doubled under the spouse or three-entity rules. Market Loss Payments. On an ad hoc basis, Congress directed that market loss payments be made to commodityprogram participants for the 1998, 1999, 2000, and 2001 crops. These paymentswere a reaction to sharply lower market prices that, in the absence of target pricepayments, meant substantially lower farm revenue. This experience played a criticalrole in the decision to create the counter-cyclical payments program in the 2002 farmbill. Most observers would say that the inclusion of counter-cyclical payments in the2002 farm bill institutionalized market loss payments. With counter-cyclicalpayments in place, it is not expected that market loss payments will be applied tocotton or the other "covered commodities" through crop year 2007, the life of thecurrent farm bill. CCC Expenditures for Price Support. Generally, a pound of cotton produced on program baseacreage is eligible for the loan program price of $0.52, plus a fixed direct paymentof $0.05667 (85% of $0.0667), plus a counter-cyclical payment of $0.1167 (85% of$0.1373 ($0.724-($0.52+$0.667)). This totals $0.6934/lb. (about 89% of the totaleconomic costs of production). How much these three support mechanisms cost thegovernment depends upon how low market prices go. However, no matter how highprices go, the government is obligated each year to make the fixed direct payments. Cotton produced outside of the program base is guaranteed only the market assistanceloan rate of $0.52/lb. (13) The history of cotton price support payments is shown in Figure 12 . For crop years 1991 through 2003, price support program payments averaged $1.441 billionannually. When total price support payments are divided by production, the subsidies average $0.17/lb. from crop years 1991 through 2003, ranging from a low of zero in1995 to a high of $0.38 in 2001 (see Figure 13 ). This $0.17/lb. average annualsubsidy amounts to 34% of the $0.50/lb. average variable cash costs of productionover that time period. Alternatively, this $0.17/lb. subsidy level was enough to covernearly 60% of the $0.29/lb. fixed and non-cash costs of production, including theaverage $0.08/lb. land cost. One reason for supply instability is low crop yield caused by natural disaster conditions (such as drought, flood, pests, and disease). Cotton producers can obtainsubsidized crop insurance to protect against these losses. In addition, Congress hasauthorized crop disaster payments nearly every year since 1982 to provide extraassistance for growers suffering substantial crop losses. Disaster payments wereavailable to qualifying growers who participated in the federally supported cropinsurance program as well as growers who chose to forego insurance. Crop Insurance. Multi-peril crop insurance is available to cotton producers (as well as most other crop producers) toprotect against losses of crop yield from natural hazards. Nearly every cause of yieldloss is covered (i.e., weather, pests, fire, but not producer negligence), hence thedesignation multi-peril. While the insurance is sold to farmers largely throughprivate agencies, the USDA's Risk Management Agency (RMA) pays in excess of50% of the premiums. Additionally, the RMA pays the private agencies nearly 24%of total premiums toward their administrative costs, plus RMA's own administrativecosts, which have averaged 4% of total premiums. By design, the crop insurance program is supposed to be actuarially sound. In other words, over time total premiums (producer plus government premiumcontributions) are supposed to cover total indemnities. In practice, however, the ratioof cotton losses to premiums from 1991 through 2003 has averaged 1.3 to 1, and onlyin two years did premiums exceed indemnities. The net losses (indemnities overpremiums) fall upon the federal government because it reinsures the privatelymarketed policies. Critics of the crop insurance program argue that the highpremium subsidy and the lack of actuarial soundness imply that the program ismerely another tool for transferring government funds to cotton farmers. Substantial revisions were made to the crop insurance program by Congress in 1994 ( P.L. 103-354 , Title I, Federal Crop Insurance Reform Act of 1994) thateffectively mandated the participation of farm subsidy program recipients in cropyear 1995. While the mandatory provisions were eliminated the subsequent year,increased federal insurance subsidies enacted in 2000 ( P.L. 106-224 , AgriculturalRisk Protection Act of 2000) encouraged participation to rise above 90% of plantedcotton acres. From 1991 through 2003, the federal cost of crop insurance annually has covered an average 10.9 million planted cotton acres. The net federal cost ofpremium subsidies and the excess of indemnities over premiums averaged $219million per year (see Figure 14 ). These expenditures can be considered subsidies indirect support of farm income. Indirectly benefitting farmers were the reimbursementof private insurance agency administrative costs and federal administrative costs thattogether averaged an estimated $74 million per year. Counting only the $219 million annual average premium and indemnity subsidies, the average subsidy rate per pound of actual cotton production was $0.026over the 1991 through 2003 time period. When the 1995 through 2003 post-reformperiod is examined alone, the subsidy rate is higher, at $0.032/lb. Crop Disaster Payments. Congress, on an ad hoc basis, has mandated disaster payments above and beyondinsurance indemnities and also to producers who chose to not buy insurance. Overthe nine years from 1995 through 2003, when an average of 90% of planted cottonacreage was insured, annual disaster payments ranged from zero (in 6 of the years)to $444 million. The average was $100 million per year (see Figure 14 ), equaling$0.01/lb. of production over that time period. The farm income support programs are supplemented with additional tools to maintain sales of U.S. upland cotton when domestic prices are not low enough to becompetitive in international markets. Three competitiveness programs unofficiallyare called Step 1 , Step 2 , and Step 3 . Step 1 allows for additional reductionsin themarketing assistance loan repayment rate when world market prices are higher thanthe loan rate. Step 2 pays domestic mills and exporters that purchase U.S. cottonwhen domestic prices are higher than world cotton prices. And Step 3 permitsspecial (increased) import quotas when domestic prices are higher than world cottonprices so that domestic mills have adequate supplies. Also, a separate limited globalimport quota for upland cotton (which was adopted prior to the Step 1, Step 2, andStep 3 provisions) remains in effect. Step 1 Loan Repayment Rate Reduction. The Step 1 adjustment provision was initially adoptedby the USDA under its administrative authority on October 3, 1989. Congress putthe Step 1 provision into statute in the 1990 farm bill ( P.L. 101-624 , Sec. 501). Boththe 1996 and 2002 farm bills retained the Step 1 authority, but with technicalchanges. However, the USDA has not taken action under Step 1 since 1992. Marketing loan gains and loan deficiency payments are calculated as the difference between the loan rate and the adjusted world price (AWP). Only when theAWP is below the loan rate do farmers receive a subsidy payment. A provision ofthe law allows the USDA to lower the AWP when the price of U.S. upland cottonsold in Northern Europe (USNE) is higher than the price of competing cotton. Thisauthority to reduce the AWP is unique to cotton and creates the opportunity forincreased marketing loan program subsidies, even when the price of upland cottonis higher than the loan rate. A Step 1 downward adjustment to the Adjusted World Price (AWP) may be made when the five-day average of the U.S. Northern European price (USNE)exceeds the Northern European price (NE), and the AWP is less than 115% of theloan level. In this circumstance, the USDA may lower the AWP up to the differencebetween the USNE price and the NE price. In other words, when the AWP is lessthan $0.598 (115% of $0.52), it can be adjusted downward by the difference betweenthe higher USNE price and the lower NE price. The practical result of a Step 1adjustment is to enable loan deficiency payments when US prices are higher than theloan price of $0.52, and to increase the loan deficiency payment rate by increasingthe spread between the AWP and the loan price. Step 2 Payments to Domestic Mill Users and Exporters. Step 2, first enacted in the 1990 farm bill and officiallyknown as Upland Cotton User Marketing Certificates, provides subsidy payments todomestic users and exporters of U.S.-produced cotton when its price is higher thanforeign-produced competing cotton. By offsetting the price difference with directpayments, Step 2 encourages U.S. yarn and fabric mills and exporters to purchaseU.S. cotton. In other words, the subsidy payment to buyers makes higher-priced U.S.cotton competitive in the marketplace with lower-priced foreign cotton. Currently,Step 2 requires that through July 31, 2008, payments in either cash or marketingcertificates be made to domestic users and exporters for documented purchases ofU.S.-upland cotton when the USNE price of upland cotton exceeds the NE price fora consecutive four-week period. Step 2 payments are not made if the AWP exceeds134% of the loan rate, or $0.697/lb. Similar user payments were adopted for ELScotton in 1999 and are authorized through July 31, 2008. Figure 15 shows yearly(August 1-July 31) payments (but the expenditures are for all cotton, not necessarilycotton produced in that crop year). From August 1, 1991 through May 31, 2004, Step2 payments have averaged $0.026/lb. of cotton produced in the United States. Step 3 Special Import Quotas. The United States maintains a tariff rate quota on imported upland cotton of 173.09million pounds (equivalently, 360.6 thousand bales or 86.545 thousand metric tons). The duty is nominal below the quota quantity, ranging from zero to $0.05/lb. Abovethe quota quantity trigger, the duty increases to a prohibitively high $0.1424/lb.($0.314/kg). In periods of short domestic supply (due possibly to weather-relatedproduction shortages) and strong world demand, U.S. mills might have insufficientsupplies. So-called Step 3 special import quotas allow for increased imports exemptfrom the high duty. Step 3 requires that a "special import quota" be opened if, for a consecutive four-week period, the USNE price, adjusted for Step 2 payments in effect theprevious week, exceeds the NE price. Another trigger for opening a Step 3 quota isa decline in the U.S. stocks-to-use ratio to below 16%. The size of the quota is equalto one week's domestic mill consumption. Importers have 90 days to make thepurchases and 180 days to bring the cotton into the country. Quota periods canoverlap. Total Step 3 imports in any crop year are limited to five weeks of domesticmill use. In practice, annual U.S. imports of cotton are much less than the 173 million pound tariff-rate quota. The USDA estimates that cotton imports will total about 19million pounds (40 thousand bales) in the 2003/04 marketing year. Limited Global Import Quota. A "limited global import quota" for upland cotton equal to 21 days of domestic millconsumption is allowed (at below tariff rate duty levels) when spot market pricesshow sustained strength for a three-year period. This allows domestic mills accessto lower-priced foreign cotton, helping them to compete with foreign mills. Limitedglobal import quotas cannot overlap with one another. Nor can a limited globalquota be established if a Step 3 "special import quota" is in place. The precisecondition for a limited import quota is an average spot market price for a month inexcess of 130% of the average spot market price for the preceding 36 months. Cotton, as well as other agricultural commodities, benefits from several export assistance programs. Federal export credit guarantees are available to eligible foreignbuyers who want to purchase commodities with borrowed funds. Additionally, theUSDA administers two promotion programs that operate on a cost-share basis withthe private sector. The Foreign Market Development (FMD) Cooperator Program(also widely known as the Cooperator program) focuses on generic commoditypromotion and the Market Access Program (MAP) focuses on value-addedagricultural products. FMD and MAP are exempt from Uruguay Round Agreementsubsidy reduction commitments. Export Credit Guarantees. The USDA's General Sales Manager (GSM) in the Foreign Agricultural Service (FAS)administers three credit guarantee programs for commercial financing of U.S. exportsof food and agricultural products. With funds from the CCC, the governmentunderwrites credit extended by the private lenders to finance exporter sales to eligibleforeign importers. The guarantees are intended to encourage sales in countries wherecredit is necessary, but where financing may not be available. The credit guaranteeprograms replaced more costly direct loan programs. USDA views its credit guarantee programs as commercial programs, not as export subsidies. The programs are supposed to support and encourage commerciallyviable transactions. Sales are made by private exporters to foreign buyers at pricesand other terms, such as interest rates, negotiated by the two parties. However, thiscountry has been working within the Organization for Economic Cooperation andDevelopment (OECD) to achieve internationally agreed disciplines on the use ofexport credits. Terms and conditions for export credit programs are now beingnegotiated in the WTO. GSM-102 guarantees repayment of short-term bank loans (up to three years), and GSM-103 guarantees repayment of intermediate-term bank loans (up to 10years). For a fee, the guarantees cover 98% of principle and a portion of the interest. Eligible countries are those that USDA determines can service the debt backed byguarantees (the "creditworthiness" test). Cotton-related exporter applications forFY2003 totaled $334.8 million, all under GSM-102. The Supplier Credit Guarantee Program (SCGP) guarantees short-term credit (not to exceed 180 days) extended by U.S. exporters directly to their foreigncustomers. Cotton-related exporter applications for FY2003 totaled $11.73 million. If a foreign borrower defaults on a guaranteed loan, the U.S. financial institution files a claim with the CCC for reimbursement, and the CCC assumes the debt. If acountry subsequently falls in arrears to the CCC, typically its debts are rescheduled. Under WTO rules, use of credit guarantees for foreign aid, foreign policy, or debtrescheduling purposes is prohibited. Foreign Market Development Program. The Foreign Market Development Cooperator Program(7 U.S.C. ï¿½ 5722) began in 1955 (under authority of P.L. 83-480, 7 U.S.C. ï¿½ 1701)with the purpose of expanding bulk commodity export opportunities over the longterm by partially financing industry-sponsored consumer promotions, technicalassistance, trade servicing, and market research. The 2002 farm bill reauthorized theFMD through FY2007. Funding is from discretionary appropriations of no more than$34.5 million annually. Typically, nonprofit industry organizations submit proposalsfor marketing activities to the USDA. Approved projects normally are reimbursedafter completion on a cost share basis of 45% federal and 55% private sector. Cooperators receiving federal funds under FMD in FY2002 for cotton-relatedactivities were the Cotton Council International ($2,312,188) and the NationalCottonseed Products Association ($90,635). Market Access Program. The Market Access Program (MAP) was originally created in 1978 as the MarketPromotion Program ( P.L. 95-501 , 7 U.S.C. ï¿½ 5623). The name was changed in the1996 farm bill, and the 2002 farm bill authorized annual appropriations of up to $100million in FY2002 and gradually increasing to $200 million for FY2006 and FY2007. It is intended to help develop foreign markets for value-added agricultural productsand operates as a cost-share program like the FMD Program. The types of activitiesthat are undertaken through MAP are advertising and other consumer promotions,market research, technical assistance, and trade servicing. About 60% of MAP fundstypically support generic promotion (i.e., non-brand name commodities or products),and about 40% support brand-name promotion (i.e., a specific company product). The federal contribution for generic promotion is up to 90% and for brandedpromotion up to 50%. The FY2003 allocation for the Cotton Council Internationalis $8,406,098. Appendix Table 2. Major Cotton Producing,Exporting, and Importing Countries, and Share of the World Market, Crop Year2003/04 Source : Primary data are from USDA, FAS, Cotton: World Markets and Trade, June 2004. * WCA, West and Central African country production including Benin (685), Burkina Faso (965), Cameroon (500), CentralAfrican Republic (30), Chad (225), Cote d'Ivoire (400), Ghana(25), Guinea (40), Mali (1,200), Niger (5), Nigeria (415),Senegal (100), Togo (325). Appendix Table 3. U.S. Cotton Area, Production, and SeasonAverage Price Receivedby Farmers, Crop Years 1991-2003 Source : USDA, NASS, Crop Production, April 2004; ERS, Cotton and Wool Situation Outlook Yearbook, November 2003; World Board, World AgriculturalSupply and Demand Estimates, May 2004. Appendix Table 4. Cost of U.S. Cotton Production, Crop Years1991-2003 Est. Source : Basic data for per acre costs from USDA, ERS, Cost of Cotton Production. Costs per pound are calculated by the author based on actualproduction. Rounding the data creates apparent discrepancies that are notpresent in the underlying numbers. *The opportunity costs for unpaid family labor are excluded from economiccosts. Appendix Table 5. Federal Expenditures for Cotton PriceSupport and Crop Loss Assistance, CropYears 1991-2003 Source : Primary data from USDA, Farm Service Agency, Fact Sheet Upland Cotton: History of BudgetaryExpenditures, Commodity Estimates Book. USDA, Risk Management Agency, Summary of Business Data by Yearand Crop. *Includes target price deficiency payments in 1991-95 and counter-cyclical payments in 2002 and 2003. Appendix Table 6. Cotton Price Support Payments and CropLoss Assistance Per Pound, Crop Years1991-2003 Source: Calculated by author using basic data from the USDA, Farm Service Agency, Fact Sheet Upland Cotton:History of Budgetary Expenditures, Commodity Estimates Book. USDA, Risk Management Agency, Summary ofBusiness Data by Year and Crop. *Includes deficiency payments in 1991-95 and counter-cyclical payments in 2002 and 2003.

Summary: While cotton, along with other major crops, has been subsidized by the U.S. federal government since the 1930s, cotton subsidies are now in the focus of an international spotlight. The nature andextent of these subsidies have become a roadblock in negotiating multilateral and bilateral tradeagreements. Sharp criticism came from the West and Central African countries during various DohaRound meetings. Also, efforts to create a Free Trade Area of the Americas (FAA) foundered at leastpartially over U.S. cotton subsidies. Now, Congress is watching to see if the United States will berequired by the World Trade Organization (WTO) to revise its cotton subsidies in response to adispute lodged by Brazil. One reason the international spotlight is on U.S. cotton subsidies, in contrast to other subsidizing nations, is the sheer size of U.S. cotton production and exports. The United States is thesecond-largest producer of cotton in the world, and the largest exporter. Therefore, U.S. cottonsubsidies have global repercussions. Domestically, what happens to cotton subsidies is importantto a broad group of interests because grains, oilseeds, and peanuts receive similar support. U.S. cotton production and export subsidies provide comprehensive support for producers. Farmers with a history of cotton production are eligible for direct and counter-cyclical payments. On their actual production, farmers may utilize the marketing loans and loan deficiency payments. Protection against low yields is available through subsidized crop insurance, and in some yearsCongress has approved additional disaster payments. When U.S. market prices rise, and there is arisk that competitors might capture more of the world export market and even deliver to U.S. yarnand fabric mills, so-called Step 2 user payments are made to U.S. exporters and mills if theypurchase U.S. cotton. From 1991 through 2003 farm subsidies for cotton production have cost $1.76 billion per year, on average. This is the annual equivalent of $0.21/lb. of U.S. production. While the United Statesis not alone in subsidizing cotton, this level of support is nearly the highest in the world, accordingto the International Cotton Advisory Committee. When the $0.21/lb. average crop year farm subsidy is added to the $0.57/lb. average market price, it has given producers an average revenue of $0.78/lb. from 1991 through 2003. This levelof revenue is more than enough to cover average variable cash costs of $0.50/lb., and just enoughto cover average total economic costs of $0.78/lb. According to the International Cotton AdvisoryCommittee, variable cash costs of some of the competing cotton exporting nations are about halfthose of the United States. This report will not be updated.