A real beginners’ guide to tariffs and the WTO

‘Can someone explain to me international tariffs and WTO law as if I were a six year old? Seriously. I don’t get it. At all. No frame of reference whatsoever. Any takers?’

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Photo by Bill Wegener on Unsplash CC0

By Peter Ungphakorn
POSTED JULY 28, 2018 | UPDATED JULY 28, 2018

All too often we assume people know what we’re talking about. A question someone asked recently on Twitter showed how wrong those assumptions can be.

One of the assumptions is that everyone knows what “tariffs” are. The BBC prefers “trade tariffs” in case we confuse them with energy rates or other prices.

Tariffs are part of the Brexit debate, and are central to Trump’s trade war. But the fact is, most of us never had to deal with this before.

So for the benefit of Dr Dominic Pimenta and six-year-olds everywhere, here goes.

What are tariffs?Back to top

JUMP TO
What are tariffs?
Why are there international rules on tariffs?
How were the rules on tariffs created?
What does this mean legally in the WTO?
1. They are ceilings
2. They are the same for imports from all countries
Follow-up questions

SEE ALSO
What is the WTO? And is it undemocratic?

When goods are imported into a country, the government charges a customs tax or duty, often also called a tariff. For example the EU charges 8% of the price per pair on some types of shoes.

So does the UK until it leaves, because all EU members have the same tariffs.

Here, the EU is a special case, a “customs union”. EU members (such as the UK) collect the tax, hand it over to the EU because it’s an important part of the EU budget (and a lot of that is spent in the member states), but they are allowed to keep about 20% to cover administrative costs even though the actual costs are much smaller.

Most countries don’t have that complication. Their governments just collect the tax, full stop.

The UK says that after it leaves the EU it will stick to the EU tariff rates in general, and has now officially confirmed that with the World Trade Organization (WTO).

Extract of the EU's WTO commitment on tariffs for some shoes
Click the image to see it full size
Why are there international rules on tariffs?Back to top

Once upon a time there were no disciplines on tariffs. Countries could set them at any rate, and raise or lower them at will.

Then came the depression when countries complained about imports unfairly hurting their producers and workers. So they raised tariffs against each other to protect their producers, first one, then another in retaliation. It was a trade war.

Sounds familiar? ’Fraid so.

Rather than protect jobs, the trade war just slowed down trade and worsened the depression everywhere. And that meant jobs were lost.

To cut a long story short, the Second World War followed, and afterwards world leaders decided they needed to do something about it.

One thing they did was to negotiate to get rid of the free-for-all in tariffs, and to reduce them gradually.

(They felt the whole international economy needed sorting out so they also set up the World Bank and the International Monetary Fund.)

How were the rules on tariffs created?Back to top

The negotiations produced agreements, in which each country agreed to set limits on its tariffs.

From 1947 until now more products were brought into these agreements, and the ceilings were gradually lowered. That’s how the EU’s tariff for those shoes has ended up at 8%

In other words, the EU’s 8% import duty on shoes was the result of negotiations with other countries in what is now the WTO. The others agreed in return to set lower tariffs on products the EU (and UK) wanted to sell to them.

Because it was the result of a negotiation, the 8% tariff on shoes is part of an agreement. All the negotiated rates are legally binding commitments in the WTO.

Each WTO member has lists of tariffs on thousands of products, and they are different for each country except those in groups like the EU.

What a world trade agreement looks like
Click the image to see it full size
What does this mean legally in the WTO?Back to top

To keep it simple, the tariff rates have two legal implications in the WTO.

1. They are ceilingsBack to top

The 8% tariff on shoes (and all other agreed tariff rates) is a legally “bound” ceiling. The EU can reduce it to, say 5% or scrap it completely without breaking its promise.

But to raise it to 20% would be breaking its promise, or violating the WTO commitment. Except …

… except it could go back to WTO members to renegotiate the ceiling in order to raise the tariff above the 8% ceiling.

It might have to give something in exchange such as a lower tariff on another product.

(There are rules about which WTO members would have the right to negotiate, but I won’t go into that here.)

2. They are the same for imports from all countriesBack to top

Secondly, the legal obligation is for that 8% tariff to apply to imports from all other WTO members, equally, without discrimination.

MFN
Most-favoured-nation (MFN) treatment is probably the most important WTO rule.It means not discriminating between one’s trading partners

Article 1 of the General Agreement on Tariffs and Trade (GATT), for trade in goods
Article 2 of the General Agreement on Trade in Services (GATS)
Article 4 of the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS)

But in each agreement the principle is handled slightly differently

Trade specialists talk about “MFN”. This stands for “most-favoured-nation” treatment and it’s so important that it’s the very first article of the WTO agreement on trade in goods.

The phrase sounds weird, but it means not discriminating between trading partners, treating them equally. Favour one, favour all.

There are exceptions.

You can have a free trade agreement (such as the EU-Japan deal, which recently took effect), or even the EU single market, which is a very sophisticated and far-reaching free trade agreement.

Or you can discriminate in favour of poorer countries by cutting tariffs on their products or allowing their imports to enter duty-free without doing the same for other countries.

The EU has numerous “preferences” schemes for developing countries allowing their products to be imported duty-free or at lower than normal duty. So does the UK so long as it’s an EU member — and it’s already announced it will continue with the preferences after leaving the EU.

There are other exceptions in special circumstances but those two are the basics.

Follow-up questionsBack to top

Q. When you say 8% on shoe imports, is that the agreed rate for all WTO members to import shoes at or just a ceiling for that one country on all WTO imports?

A. Each WTO member has its own tariffs. So this 8% is charged by the EU on shoes imported from all other WTO members (except under a free trade agreement, such as EU-Japan, or preferences on shoes from developing countries). The import duty rate in other countries will be different. The US’s import duties on shoes vary from duty-free to around 10% or higher. Japan charges 20%–30% duty on many shoe imports

Q. Can you explain a bit more about free trade agreements (FTAs)? That exempts you from WTO rules?

A. Not exactly. It’s about being exempt from the non-discrimination rule (MFN). WTO rules allow pairs or groups of countries to set up free trade agreements subject to certain conditions. When they trade among each other duty-free, they can still charge duties on imports from others.

So free trade agreements are within WTO rules provided the conditions are met. For example a free trade agreement has to cover all or most trade. You can’t have a free trade agreement in cars alone

Q. So essentially the UK already operates on WTO rules — the EU single market is like a big free trade agreement for us and acts like a single entity for making other FTAs? How does being an EU member now affect trade with WTO countries? Eg, the USA?

Correct. Even the single market is under WTO rules.

UK trade is currently

  • within the EU internal market (or single market)
  • on terms the EU has negotiated in the WTO — on tariffs that includes with the US
  • though free trade agreements (eg EU-Canada, EU-Japan)
  • through unilateral preferences for developing countries

I’m sticking to tariffs because the question asked for a simple explanation, but there are many other important issues such as product standards and food safety, which also come under WTO rules.

Note that until the referendum the UK was active and influential in EU trade policy.

Chart showing range of depths of free trade agreements and integration
The spectrum of free trade agreements and integration. Click the image to see it full size


Updates: None so far
Photocredits:
• School children: Bill Wegener on Unsplash, CC0
• Other images by the author 


Author: Peter Ungphakorn

I used to work on trade issues and am now retired. I am an occasional freelance journalist, focusing mainly on international trade rules, agreements and institutions, with periodic analyses for AgraEurope www.agra-net.com/agra/agra-europe. This blog is for trialling ideas on trade and any other subject, hence “β”. You can respond by using the contact form or tweeting @CoppetainPU — Copyright © Peter Ungphakorn except where stated