By Peter Ungphakorn
POSTED SEPTEMBER 9, 2018 | UPDATED SEPTEMBER 10, 2018
In trade policy, life can quickly become pretty complicated. The first beginners guide was on tariffs, and it was relatively simple. Move on to “tariff quotas” and we enter a complex, controversial and sometimes murky world.
But it’s useful to understand them because they feature in current debates about Brexit and Donald Trump’s trade policies. So let’s keep this as simple as possible.
• UK, EU, WTO, Brexit primer — WTO membership (2017)
• What’s really happening on tariff quotas and Britain’s WTO commitments? (2018)
• Comments on the EU’s (and UK’s) proposed modified tariff quotas (2018)
• Archived: UK, EU, WTO, Brexit primer — 2. Tariff quotas (2017)
• The limits of ‘possibility’: Splitting the lamb-mutton quota for the UK (2017)
• The Hilton beef quota: a taste of what post-Brexit UK faces in the WTO (2016)
We are familiar with quotas. They are simply limits on numbers or amounts. Until recently, Britain had a quota on how many foreign doctors and nurses would be granted visas to work in the UK: 20,700 per year. (This limit was removed in June 2018 in order to tackle health staff shortages.)
Sticking with trade in goods (and ignoring services), quotas are limits on the quantities imported or exported (the technical term is “quantitative restrictions” or QRs, which includes outright prohibitions).
By and large, the world’s trading nations have agreed in the World Trade Organization (WTO) to scrap import quotas. Export quotas are discouraged (although some countries use them legitimately to control exports that face tariff quotas in the importing country — we’ll see why in a moment).
Below is an imaginary quota on importing some types of live sheep. It could have been a number of animals, say 5,000. But instead, this quota is 196 tonnes (ie, the number of sheep is converted to an equivalent amount in tonnes by some formula.)
This hypothetical country allows 196 tonnes (equivalent) to be imported. Beyond that, imports are banned completely. (The imports will be charged whatever the normal import duty — or tariff — is.)
The full name is “tariff-rate quotas” (TRQs), and they apply to imports of goods. Within the quota, the tariff rate is zero (duty-free) or low. Outside the quota the tariff rate is much higher. Importing outside a tariff quota is not impossible, but the tariff rate could be so high that it’s unprofitable.
In other words the quota is a limit on the quantity eligible for lower duty.
Below is an actual tariff quota. The EU allows some types of live sheep to be imported at a 10% duty rate, up to a limit of the equivalent of 196 tonnes (yes, the previous example was based on a real figure*). Outside the quota, the duty is €805 per tonne. That would add €805 per tonne to the import price. The exporter could lower the price in order to try to sell the sheep, but often that would still be unprofitable either for the importer or the exporter.
Tariff quotas are used on a wide range of products. Most are agricultural: cereals, meat, fruit and vegetables, and dairy products are the most common. Sugar is not far behind. Not all are food: the US has tariff quotas on cotton. And not all are agricultural. The EU has around 100 tariff quotas: most are agricultural but they also include on fish (not “agricultural” in the WTO), glass beads and imitation precious stones, ferrosilicon, newsprint, and other products.
So far so simple (hopefully). Now it starts to get complicated.
Essentially they are a compromise. On one side, they protect domestic producers from having to face competition from large quantities of imports. On the other, they allow exporters some access to the market. They also allow consumers and other producers in the importing country to get hold of some imports.
The US cotton tariff quota protects US cotton growers while allowing textiles manufactures to import some cheaper cotton.
The compromise would have come from international trade negotiations, leading to a balance between the interests of importing and exporting countries.
Inside a country it would also have come from the government balancing the interests of different groups of producers (those who compete with the imports, and those who use the imports as raw materials or components) and consumers. How that balance is struck depends on the country’s political processes, including lobbying and interests represented in parliaments.
In the US, cotton growers are a powerful lobby. From Canada eastward to Japan and in many countries in between, it’s dairy producers. In the EU, farmers groups lobby on a wide range of products. In Japan, it’s rice farmers. Sugar is protected in most producing countries, often with tariff quotas. And so on.
The agricultural tariff quotas in the WTO have a particular history. They are the result of the 1986–94 Uruguay Round negotiations, which reformed international trade rules and created the WTO.
In the talks, countries agreed to scrap import bans and straight quotas, and to replace them with tariffs having a similar effect. (This conversion to tariffs was called “tariffication” — the full complexity is in Annex 3 of this non-binding document from the talks.)
How did tariffication work? If banning imports meant the domestic price was six times the world price, the equivalent tariff would be 500% — the 500% tariff would, in principle result in a price that’s six times the world price. That was approximately the situation for rice imports into Japan.
Importing with a 500% duty rate is clearly impossible (or almost impossible). So the negotiators compromised by opening up tariff quotas that would allow some imports. The unofficial target was 5% of domestic consumption, but that was never officially agreed.
The result was tariff quotas that were often considerably manipulated. (This could have been called “cheating” but because the target was not agreed it was just called “dirty tariffication” — the 5% target is in paragraph 5 of the same non-binding document.)
And now, I’m afraid, it gets really complicated.
Or, does the tariff quota have to be used up completely before imports are charged the higher duty? The short answer is “no”. Some imports can face the higher duty even if the lower-duty quota is not filled.
QUOTA ALLOCATION METHODS
WTO members identified all these methods in their notifications to the organisation (compiled in Secretariat document TN/AG/S/26/Rev.1)
- Applied tariffs: unlimited imports at the in-quota tariff rate or below
- Auctioning: importers bid for shares or licences
- First-come, first-served: physical imports charged in-quota tariffs until the quota is filled
- Historical importers: based past imports of the product
- Licences on demand: allocated in relation to quantities demanded, often before the period specified for the quota — first-come, first-served or allocations trimmed proportionately if demand exceeds the quota
- Mixed allocation methods: combinations of the above, none dominant
- Non-Specified: no method notified
- Other: methods not clearly within any of these categories
- Producer groups or associations: if they import or control the country’s imports
- Imports by state trading entities: if they import or control the country’s imports
It depends on how the importing country manages the tariff quota. Normally this means issuing import licences, and the way they are issued has an impact.
If the licences are issued automatically as shipments head for the importing port, and if they are issued first-come-first-served, then the quota would be filled before the higher tariff kicks in.
But there are many other criteria that countries use for issuing import licences. One is for this year’s licence to be based on the company’s previous years’ imports (“historical importers”). Another requires importers to pay for the licence by bidding — a controversial method that some argue that in practice raises the in-quota tariff, violating the country’s WTO commitment (explained here).
Among the questions countries ask each other most often in the WTO’s Agriculture Committee is why imports under their tariff quotas do not reach the limit (the quotas are “unfilled”).
The answer is usually because of supply and demand — domestic demand for the imports is too weak or the prices on imports are too high. A number of countries claim that the real reason is often the way import licences are allocated. They have tried to negotiate tighter disciplines, but as part of a wider agriculture negotiation which is largely stalled.
Some are, some aren’t. Tariff quotas often specify which countries can supply the product. Sometimes the quota is defined by which country can supply, meaning there can be several quotas, one for each supplier. Sometimes a single quota is subdivided to show how much goes to each country, how much goes to other unspecified countries and how much is available for all countries (the dreaded “erga omnes”, abbreviated as “EO” — personally I prefer to think of “EO” as “everyone”).
The US recently announced how its 1.1 million-tonne WTO sugar tariff quota will be shared out among 40 countries in financial year 2019.
On the face of it, this is about protectionism versus access to markets (or to imports). But there’s more to it.
In the 1980s and 90s, Thailand exported millions of tonnes of tapioca pellets to the EU through a tariff quota. (Tapioca is called manioc in the EU; elsewhere it’s also called cassava.) The tapioca fed pigs in Europe because it was cheaper than barley and other feed ingredients, whose imports faced high tariffs.
Thailand was also allowed to control its exports to match the EU’s import quota, under a voluntary export restraint (VER) agreement, and this transferred control of the quota rent to Thailand. (VERs were largely outlawed when the WTO came into being in 1995, but they have reappeared in response to Trump’s threats against imports.)
Various controversial and allegedly corrupt schemes were devised by the Thai government to allocate shares of the exports among various companies.
In one method, companies could export in proportion of the stocks they held. This led to a race to stock tapioca, drove up warehouse rental and produced official figures for total stocks that exceeded total warehouse capacity. The quota rent went to warehouse owners, and perhaps officials who checked the stocks.
Thailand also exported its poorest quality tapioca to the EU at a high price, inflated by the quota and the captive market created by import barriers on alternative feed ingredients. It exported its best quality tapioca cheaply to South Korea. South Korean importers got a share of the quota rent both through the lower price and the better quality.
That battle is over. Tapioca is now traded mainly as starch for use in food processing. But it is a vivid example of how quotas create a battle ground for economic, political, and sometimes corrupt interests.
Quotas (including tariff quotas) create a free gift for someone. They are themselves valuable.
Part of the controversy is about the fight for that additional value, which economists call “quota rent”.
Quotas restrict the supply of a product. Buyers compete for shares of the restricted supply and bid up its price. That higher price produces quota rent for the amount supplied, as a free gift.
The fact that governments are able to open bidding for import licences shows companies are willing to pay extra in order to get their hands on products that have become more scarce as a result of a quota or tariff quota.
Who gets this free gift? It depends.
If the government allocates import licences by bidding, then some or all of the quota rent goes to the government.
Some economists argue that this is the most useful way of dealing with quota rent. It should not be seen as an extra tariff, they and some governments argue. Otherwise the free gift just goes to the private sector.
Sometimes companies receive import licences and sell them on to other companies for a profit. That profit comes from the quota rent.
Sometimes it’s the exporting county that controls the quota rent by controlling the quota (see box).
The bottom line: whoever controls the quota also controls who gets the quota rent.
Tariff quotas have emerged as part of the UK’s need to re-establish itself as a WTO member independent of the EU. In particular, the UK has to separate its own tariff quotas from those of the EU’s. London and Brussels have agreed on a method which would be a straight post-Brexit split of the present pre-Brexit tariff quotas of the EU–28.
Some other WTO members are unhappy with the method and have promised tough negotiations to produce something different.
This is discussed here.
Every year, WTO members have to notify what’s been happening with their agricultural tariff quotas. A useful tool for searching for these notifications is here — look for “Search documents online” and “Notifications on tariff and other quotas under Article 18.2 (MA:1, MA:2)”
Some importing countries have information on their websites. The EU’s is here, but searching the EU’s databases is complicated because of the need to look up tariff code numbers first rather than key words. So good luck! (If anyone knows a simpler source, please let me know.)
* The EU’s actual commitment in the WTO is 5,676 tonnes, but that is for the 25 EU members before Bulgaria, Romania and Croatia joined. The EU’s commitment for the EU–28 has not yet been cleared by WTO members but it is applying the 196 tonnes specified for “other countries” in its commitment.
Updates: September 10, 2018 — added box on quota allocation methods (thanks to Derrick Wilkinson for remining me about the WTO Secretariat paper); tweaked the list of products with tariff quotas, based on another Secretariat paper, TN/AG/S/5
• Public domain or CC0: customs barrier (YvonneH | Pixabay), hake (Freshwater and Marine Image Bank), wheat (Pixabay), newsprint (Samuel J Hood | Australian National Maritime Museum), glass beads (cocoparisienne | Pixabay), rice (strecosa | Pixabay)
• Ferro-silicon (FocalPoint | Wikimedia commons CC BY-SA 4.0)
• Raw sugar (Giridhar Appaji Nag Y | Wikimedia commons CC BY 2.0)
• Cotton (S Aziz123 | Wikimedia commons CC BY-SA 4.0)
• Sheep in front of a cattle grid — looking over the Duddon estuary, Cumbria (SKITTZITILBY | Wikimedia commons CC BY 2.0)
• Cheeses (Chris Buecheler | Wikimedia commons CC BY 2.0)