Foreign Relations of the United States, 1981–1988, Volume XXXVIII, International Economic Development; International Debt; Foreign Assistance

317. Memorandum From the Under Secretary of State for Economic Affairs (Wallis) to Secretary of State Shultz¹

Washington, September 7, 1984

SUBJECT

• Next Round on the International Coffee Agreement

As we prepare for the meetings in just over a week of the Council of the International Coffee Organization,² we have a revived and aggravated problem of what to do about the anti-market character of that organization. The global quota increase that we successfully pressed for last year, in line with your decision, was not big enough; the price of coffee has risen artificially this year from around $1.25 a pound to the range of $1.40 to $1.55, while inventories continue to pile up in the producing countries. That directly threatens the long-term viability of the agreement. Moreover, the consequent spread between the prices of coffee sold to member countries and that sold to non-members has opened to about 60 cents a pound, violating the agreement. Furthermore, membership in what is becoming a market-rigging cartel is contrary to general Administration policy. The ICA is supposed simply to smooth adjustments to market trends.

Under these circumstances, we should be working to prevent a buildup of costs and problems like those in United States and EC farm programs, with a possible eventual collapse of the agreement. To that end, we should try more forcefully than before to shape its operation in the direction of a genuine stabilization agreement. To move in that direction will take firmness and persistence, despite your encouragement in this direction last year, because of opposition in the State Department, in other agencies, and in other governments.

A move in the right direction will mean that the global quota would have to be enlarged enough to allow the price of coffee to settle back down around its free market price of about $1.20 ± .07. Because some people in the government want to funnel money into Central America by all possible means, this proposal will raise passionate objections and has already led to misrepresentation of the facts. Central America gets very little out of the restrictive practices of the Coffee Agreement. Even if a quota increase were to lower total coffee export earnings, at most about 12 percent of the change would fall on friendly Central American countries (and they might still gain revenues, if Brazil continues to fall short of its quota). Furthermore, a quota increase will not necessarily lower total coffee export earnings; if it does lower them, the loss will be considerably smaller than the estimates coming out of EB. A number of attempts to estimate the elasticity of demand for coffee have produced numbers that scatter around –1 to –2 for the first-year effect, and around –.3 to –.7 for the longer term effect. (The short-run effect is more elastic because of inventory changes, which we cannot separate from actual consumption. The estimates do not have high confidence.) If these numbers are correct, the earnings of coffee exporters would remain the same or increase in the first year of a quota increase, and then would eventually slip down to an earnings reduction around half the numbers EB gets (they assumed a fixed quantity of exports, ignoring the increases that would accompany lower prices). The billion dollars or so that the present price costs coffee consumers (in lost real income, not in expenditures, because of the demand elasticity) translates into a much smaller figure of net gain to coffee producers. Some of it is tied up in inventory accumulation, and some lost in carrying costs of inventory. It goes to friendly and unfriendly countries alike, allocated in a way that has no relation to our foreign policy objectives.

A large quota increase, moving to something like a free coffee market in the mid-range of prices, would eliminate the gap between member coffee and non-member coffee, and would on the average end the buildup of inventories. The bureaus and some other government agencies want to err on the side of too small a quota increase, when there is uncertainty, whereas the right way to go is to err on the side of making it too large. That error would not threaten the safety-net operation of the agreement at exceptionally low prices and would not impair coffee exporter revenues compared to a free market situation.

With all that in mind I think that the United States delegate to the Coffee Council should make a somewhat firmer statement about the long-term viability of the agreement than he did last year. (Then he said that the price discount for non-agreement coffee “threatens the smooth functioning of the agreement as well as the continued participation of existing members . . .”) We should step it up a notch so that they notice. Reflecting last year’s underestimate of the quota increase needed to prevent a price run-up, we should get a quota increase of at least two million bags above present levels. (USTR and the bureaus here want to settle for 58.2 million bags, an increase of two million over the quota that was in effect at the beginning of this coffee year, but a reduction of one million below the present level.)

We should press also for a more consumer-oriented, economic approach to setting export quotas for individual countries, rather than letting the dominant producer countries use the process for their own purposes, as they do now. This point, however, is one that in the negotiating process we might trade for a sufficient increase in the global quota; economically the global quota is what matters.

To support this position and to follow it up, we should engage in immediate and continuing persuasion of the producer countries that what we propose is in their own long-run best interests. We should emphasize that more elaborate attempts at market rigging (limits on production, controls on sales to non-member countries, etc.) are not the right way to go and the United States will not participate in them. We also need to do some persuading in the United States government, especially if failure to make progress on reshaping its operation forces us to think in terms of withdrawing from the agreement sometime later.

You may want to look over the memo that EB and the bureaus prepared,³ although it is too long, technical, and contentious to be worth much of your time. If you agree with my general approach, I will have to move quickly to press our position with other agencies (relying primarily, as before, on Martin Bailey to work with EB on follow-through) to get a timely resolution of interagency differences. It will, of course, be especially important in this case that they know that you have been briefed on the issue and are behind what I am doing.

RECOMMENDATION:

That you authorize me to work with other agencies to develop a United States position along the lines outlined above.⁴

Allen Wallis⁵

1. Source: Department of State, Files of the Under Secretary of State for Economic Affairs, W. Allen Wallis, Chrons; Memo to the Secretary/Staff and Departmental/Other Agencies; Memos to the Files; White House Correspondence, 1987–1987, Lot 89D378: Chron File August 22, 1984–October 30, 1984. Confidential.
2. The 42nd session of the International Coffee Council took place September 17–30 in London.
3. A copy of this proposed memorandum, dated August 31, attached but not printed, is also in the Reagan Library, George Shultz Papers, Official Memoranda (09/12/1984); NLR–775–49–72–2–7.
4. Shultz did not indicate approval or disapproval of the recommendation.
5. Wallis initialed “AW” above his typed signature. Attachment A, “The Demand Function and the Market Price of Coffee,” is also attached but not printed.