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AoA Issues Series: Market Access: Tariffication and Tariff Reduction

John Wainio
USDA, Economic Research Service

Tariffication, the conversion of nontariff barriers (NTB) into equivalent bound tariffs, was one of the most important outcomes of the Uruguay Round Agreement on Agriculture (AoA).  Adoption of a tariffs-only approach for agriculture was a sweeping reform that went a long way toward subjecting agricultural trade to the same disciplines applied to other traded goods.  However, some of the potential benefits that tariffication holds for spurring efficient production and stimulating increases in consumption and trade of agricultural products will have to await the results of subsequent multilateral trade negotiations. This is because many countries fixed initial tariffs at levels significantly higher than required to provide import protection equivalent to the NTB's they replaced.  Nevertheless, the immediate benefits of tariffication are substantial, as bound tariffs, compared with NTB's, are far more transparent in their application, less intrusive into the market, and less of an impediment to changing competitive conditions.

Background

One of the cornerstones of the General Agreement on Tariffs and Trade (GATT) is the general rule against the use of quantitative restrictions on trade.  Tariffs are preferred by the GATT because they are inherently less trade distorting than nontariff barriers (NTB). Unlike NTB's, tariffs do not establish maximum ceilings on imports.  While NTB's tend to insulate markets, tariffs allow global price changes to be transmitted to the domestic market.  Tariffs are predictable and transparent to exporters, and they do not discriminate between suppliers nor exclude imports of lower-cost goods.  Despite these advantages, prior to the Uruguay Round, GATT members had never reached agreement on how to discipline the use of NTB's to protect domestic agricultural sectors from international competition.  Many NTB's were integral and essential elements of domestic agricultural policies in place in each country and could be disciplined only if accompanied by changes in domestic policies.

Results of the Uruguay Round Agreement on Agriculture (AoA)

The scope of reform in the AoA rules for agricultural trade was a remarkable achievement.  In the area of market access, countries agreed to convert all NTB's (including quantitative import restrictions, variable import levies, discretionary import licensing, nontariff measures maintained through state trading enterprises and voluntary export restraints) to tariff equivalents and to bind these and any other existing tariffs.  Countries were also prohibited from adopting new NTB's.  All tariffs were to be reduced from their base period rates (1986 for existing tariffs and 1986-88 for tariff equivalents) by a total of 36 percent, on a simple average basis, with a minimum cut of 15 percent for each tariff.

Countries also agreed to provide minimum levels of import opportunities for products that were subject to tariffication.  Where imports were less than 5 percent of domestic consumption in the base period, minimum import access opportunities equal to 3 percent of domestic consumption in the base period were established in the first year of the Agreement (1995), increasing to 5 percent by the end of the implementation period (2000).   Where imports exceeded 5 percent of domestic consumption in the base period, countries were required to maintain the access opportunity that existed in the base period.  To ensure that these access opportunities could be met, countries established two-tiered tariffs, called tariff-rate quotas (TRQ's), which included the minimum or current access level of imports on which the country agreed to impose a "low or minimal" bound tariff.  A higher bound tariff (the "tariff equivalent" calculated via the tariffication process) would apply to any imports in excess of the minimum or current access commitment.  (See Tariff-Rate Quota Administration).

The Processes of Tariffication and Tariff Reduction

Having successfully negotiated a set of new rules for agriculture, countries faced the details of putting these rules into effect.  In the case of tariffication, the GATT provided countries with a loose set of guidelines to follow in converting their NTB's into tariffs and in formulating tariff reduction schedules.   The proposed method for setting tariff equivalents in the AoA was based on a U.S. proposal that relied on calculating the gap between the internal (domestic) price and the external (international) price.  Although it had the advantage of simplicity, this method of calculating a tariff equivalent may not always accurately reflect the level of protection afforded by the nontariff barriers they replace.  When this is done as it was in the AoA, the process often results in significantly higher initial tariffs than more precise calculations might have produced and levels of protection that sometimes bear little resemblance to those provided by the NTB's being replaced.

The guidelines for tariffication allowed governments considerable latitude in their interpretation; consequently, governments tended to interpret them in ways that benefited their domestic interests.  They were able to set their initial tariffs at very high levels while minimizing the amount by which these tariffs were to be reduced. This process effectively postponed the time when countries would face any real international competition—particularly in those politically sensitive commodities for which they did not have a competitive advantage.  The high tariff levels were achieved in the following ways:

• Selecting a high base period. The 1986-88 base period tied tariffication to a time when protection was at its highest.  By the time the Uruguay Round had concluded, many countries had already undertaken domestic agricultural policy reforms that included sharp reductions in price supports.  Thus the choice of the base period guaranteed that base tariffs would overstate the existing protection at the time of tariffication.
• Overestimating the domestic price and/or underestimating the international price. Countries often inflated the gap between the two prices, thereby increasing the tariff-equivalent calculation.  This practice, referred to as "dirty tariffication," was particularly common for politically sensitive commodities.  It allowed governments to set some base tariffs for these commodities at levels that provided greater protection than had existed in 1986-88.
• Minimizing the effect of reductions.  The requirement for reductions of 36 percent, on a simple average basis, had limited significance.  The tariffs most critical for protection of domestic agriculture generally are only a subset of the total.  By making rather large cuts in tariffs for commodities that do not compete with domestic production, or large percentage cuts in tariffs that already were very low, the 36-percent average reduction could be achieved with minimal cuts in politically sensitive tariffs. In many cases, the higher cuts would be for commodities the countries were not producing at all or not producing on a competitive basis.   Figure 1 illustrates how this strategy of tariff reduction in the grain sector led to a pattern whereby the higher the initial tariff, the smaller the percentage reduction.
• Making superfluous reductions.  Some countries reduced the above-quota tariffs for commodities subjected to TRQ's by the minimum amount of 15 percent.  By also reducing the within-quota tariffs for these commodities by large enough amounts, they could achieve the required 36 percent cut in tariffs, on a simple average basis.  However, reductions in the within-quota tariff, while they have an effect on quota rents, contribute nothing to trade liberalization, since the within-quota tariff was supposed to be set at a rate sufficiently low for profitable trade to take place at the quota level.

The overall result was that tariffication and tariff reduction were carried out in a manner that minimized the reductions in import protection in the agricultural sector (and, in some cases, may have actually increased protection). Base tariffs on some commodities were set at such high levels that, even by the end of the implementation period, imports above the minimum access levels are unlikely to occur.

While it may seem that the level of protection was not significantly reduced by the AoA, the greater transparency associated with a tariffs-only regime was itself a significant achievement.  Tariffication eliminated the use of the most trade-distorting protectionist policies used around the world.  Since the level of protection provided by NTB's was often opaque and hard to measure, tariffication resulted in more transparent world markets. With further reductions in tariffs, tariffication should lead to more trade over time.  Because the level of protection provided by tariffs is so highly visible, this visibility should help make tariffs more susceptible to reduction in future negotiations.

Issues for New Negotiations

As the United States undertakes new agricultural trade negotiations, it is essential to clearly recognize the issues that remain to be addressed.  The level of protection afforded by tariffs around the world is high, if uneven.  Agricultural tariffs in industrialized countries now average about 45 percent, slightly higher than the average (trade-weighted) most-favored-nation  tariff rates on industrial goods that existed at the end of World War II and significantly higher than the average level for industrial tariffs today (an estimated 4 percent).  Moreover, agricultural markets continue to be plagued by high levels of tariff dispersion (widely varying tariff levels across commodities and countries) and tariff escalation (higher tariffs on processed goods than on the raw materials).  These problems are not new to the agricultural sector, but tariffication has made them more visible. One of the main challenges facing negotiators in the new agricultural negotiations is how to sufficiently reduce tariffs to provide significant new trade opportunities.

• Having successfully negotiated a modest reduction in tariff rates, WTO members are now well positioned to negotiate further reductions in tariffs.  A large across-the-board linear cut in agricultural tariffs is one way to begin the process of liberalizing trade in agricultural products.  The appeal of an across-the-board linear cut is that it results in automatic reciprocity, one of the objectives of the multilateral trade talks.  Theoretically, if all countries cut all tariffs by a fixed percentage, then each gives and receives the same concession on total exports and imports. However, a cut from 30 to 15 percent is likely to be more significant than a cut from 300 to 150 percent.  Thus, the disadvantage of a linear cut is that it may not be large enough to make a difference in markets subject to extremely high megatariffs.  Use of other tariff-cutting formulas, which impose deeper cuts for higher initial tariffs, are likely to be discussed as a means of getting megatariffs down to levels where trade can take place at the tariff-inclusive price.
• A second for the agricultural negotiations is understanding the tradeoffs between further reductions in tariffs and expansion of TRQ's. If greater liberalization can be achieved through modest expansions in quotas rather than by large cuts in tariffs, then countries may want to concentrate on negotiating an increase in quotas.  If quotas are to be expanded, however, the extent to which the administration of TRQ's results in quotas being under filled will have to be addressed.  TRQ administration has been one of the most contentious issues resulting from implementation of the AoA.  (See Tariff-Rate Quota Administration)
• Extreme disparities in tariffs exist both within and across commodity markets.  Based on the tariff reduction schedules submitted to the WTO, it would appear that tariff dispersion has increased in many markets, which may have led trade to become more, rather than less, distorted.  A tariff-cutting formula that reduces higher tariffs by greater amounts than lower ones would help to reduce this dispersion.
• Closely related to the dispersion of tariffs within commodity markets is the problem of tariff escalation within countries.  Tariff escalation refers to the situation where tariffs are zero or low on primary (unprocessed) products, then increase, or escalate, as the product undergoes additional processing.  Tariff escalation can result in a significant bias against trade of the processed product.  An effort is likely in the agricultural negotiations to ensure that disproportionately large cuts for inputs versus finished products do not lead to higher effective protection for finished products.
• While a gap between (lower) applied and (higher) bound tariffs  should generally be considered a positive element insofar as it expands trade, it may generate other problems.  Some countries use high bound tariffs as an umbrella under which to vary their applied tariffs to insulate their domestic market from fluctuations in world prices.  In this case, even though the applied tariffs are lower, they are frequently raised, and the resulting uncertainty can have a dampening effect on the level of additional trade created.  More importantly, a country's failure to stabilize its tariffs eliminates much of the advantage that bound tariffs have over NTB's and this failure can contribute to greater instability in world prices.   Recent data for wheat tariffs in selected countries (figure 2) gives an indication of the extent to which applied tariffs around the world are significantly below the bound rates.  When the bound and applied tariffs are equal, the tariff will be on the diagonal of the chart.  In the case of the wheat market, the gap between the two tariffs tends to increase the larger the country's bound tariff.  The larger the gap, the longer it will take to eliminate it, and thus the longer it will take to realize any significant new trade opportunities in that market.



• During the final stages of the Uruguay Round negotiations, some member countries explored the possibility of a zero-for-zero agreement in the oilseed sector.  This approach sought complete elimination of tariffs on oilseeds and oilseed products as well as elimination of export subsidies and differential export taxes and rebates.  Although agreement was not attained, this concept could again be pursued in the next negotiating round.  Complete removal of tariffs in some commodity sectors but not others would tend to increase tariff dispersion across markets and could lead to trade diversion, with the lower cost (duty-free) commodities replacing competing products subject to high tariffs.  Over time, however, this may exert pressure to liberalize trade in competing products as well.  The zero-for-zero approach has already resulted in the elimination of tariffs on such items as pharmaceutical products, steel, furniture, toys, beer, distilled spirits, and paper and construction, medical, and agricultural equipment in many countries.

Other Papers in This AoA Issues Series:

• Agriculture in the Uruguay Round
• Export Subsidies
• Domestic Support Policies
• Green Box Policies and the Environment
• Tariff-Rate Quota Administration