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«Tariff Escalation and the Developing Countries: How Can Market Access Be Improved in the Doha Round of Trade Negotiations? Steve McCorriston and Ian ...»

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Tariff Escalation and the Developing Countries: How Can Market

Access Be Improved in the Doha Round of Trade Negotiations?

Steve McCorriston and Ian Sheldon

University of Exeter and Ohio State University respectively

All correspondence should be addressed to: Ian Sheldon, Department of Agricultural, Environmental and

Development Economics, The Ohio State University, 2120 Fyffe Road, Columbus, Ohio-43210. Voice-mail:

614-292-2194, e-mail: sheldon.1@osu.edu Selected Paper prepared for presentation at the American Agricultural Economics Association Annual Meeting, Denver, Colorado, August 1-4, 2004 Copyright 2004 by Steve McCorriston and Ian Sheldon. All rights reserved. Readers may make verbatim copies of this document for non-commercial purposes by any means, provided that this copyright notice appears on all such copies.

Tariff Escalation and the Developing Countries: How Can Market Access Be Improved in the Doha Round of Trade Negotiations?

Abstract This paper explores the issue of market access where some developing countries export highvalue processed goods and others export raw commodities. The results show that market access issues for goods entering at different stages of the marketing chain should take into consideration the potential existence of successively oligopolistic markets.

JEL Calssification: F12, F13, and O12 Keywords: Tariff escalation, market access, developing countries Introduction The current Doha Round of trade negotiations of the World Trade Organization (WTO) has been labeled the ‘development round’ a key aim of which is to increase developing countries’ access to developed country markets. A key area of these negotiations will relate to agriculture with the focus being increasing market access through reducing high levels of tariffs and promoting market access through the expansion of tariff rate quotas. Other aspects of negotiations on agriculture of interest to developing countries will include the subsidization of exports via explicit export subsidies and through less explicit incentives such as export credit guarantees and state trading enterprises. The focus of this paper is on market access via the reduction in tariffs.

In this context, tariffs that are applied by importing countries relate to both raw and processed commodities. Where tariffs on processed commodities are greater than those on related raw commodities, we have tariff escalation. Many commentators on the issue of market access for developing countries have highlighted the problem and extent of tariff escalation that many developing countries face. See, for example, UNCTAD (2002), Watkins (2003) and World Bank (2003). The obvious insight from trade theory would be that reducing the tariff on the raw commodity but leaving the tariff on the processed commodity unchanged would increase the level of effective protection which clearly discriminates against those countries that export processed goods. With policy advice to developing countries being that since there is higher value-added and hence greater potential returns from exporting processed goods developing countries should ‘up-grade’ their export profile and rely less on raw commodity exports, focusing on market access issues that relate to both raw and related processed commodities and corresponding tariff levels at upstream and downstream stages is clearly warranted.1 However, the issue of trade liberalization and market access should also account for market structure issues since market power may ameliorate (or indeed exacerbate) the impact of a change in a tariff. In this regard, many models that have been used to quantify the impact of trade reform in agriculture have largely ignored competition issues in the food sector and how they may impact on the trade liberalization outcomes. Yet, as we show below, industries downstream from agriculture are, in developed economies, typically highly concentrated.

Moreover, these industries are typically highly concentrated at both the processing and retail sectors, such that when we consider the structure of the food sector, the most appropriate characterization is one of ‘successive’ oligopoly. In this regard, the issue of tariff escalation and promoting market access should explicitly account for the successively oligopolistic industries in which the tariff applied at various upstream/downstream sectors is aiming to protect.

The objective of this paper is to explore tying some of these issues together. More explicitly, we consider the issue of market access to developed country markets where industry structure in the importing country is characterized by imperfect competition at both the retailing and processing stages, i.e., we have successive oligopoly. Developing countries export raw commodities and processed food products, though we assume below that these are different countries and where tariffs are applied on both goods, i.e., the issues of tariff escalation and effective protection form a key ingredient in this analysis. Setting the issue of market access, imperfect competition and tariff escalation in a formal framework leads to important insights.

The issue of tariff escalation and the distinction between processed and unprocessed goods is clearly not confined to agriculture. However, given the profile of agriculture in the Doha Round and since our data relates to agricultural and food markets, we stick with the agricultural trade context here.

First, in the context of a model of successive oligopoly, an equal reduction in tariffs on the processed product and raw commodity are not equivalent in guaranteeing increases in market access for raw agricultural and processed good exporters respectively. Second, the extent to which this is true depends on the nature of competition in the developed country markets. Third, to the extent that the processed exporter and the raw commodity exporter are different countries, tariff reductions that maintain the same level of effective protection are likely to be discriminatory in terms of market access considerations. This is in contrast to the general perception of trade policy that reducing tariffs by the same amount is necessary to avoid increasing the disincentives to processed good exporters. If the primary focus is on market access, which we argue below should be the appropriate focus of trade negotiations, varying the level of tariff reductions will be necessary to avoid discrimination between developing country exporters. This in turn has a political economy consideration: developing country negotiators should not focus solely on market access commitments offered by developed countries, but also be aware of what each developing country receives in terms of market access contingent on their export profile, if negotiated market access outcomes are to avoid being discriminatory.

The paper is organized as follows. In section 1, we summarize some recent concerns facing developing country exporters with respect to the issues of tariffs and tariff escalation. In section 2, we report some data relating to market structure of the food industry in developed countries, focusing primarily on the European Union (EU) and the United States that suggests a successively oligopolistic framework. A formal modeling approach is outlined in section 3 which is used to explore the issues of tariff concessions and market access when the importing country’s food industry structure is characterized by successive oligopoly. Key results that arise from this theoretical model are presented in section 4. In section 5, we summarize and conclude and consider some avenues for future research on this issue.

1. Access by Developing Countries to Developed Country Markets In this section we consider some of the issues involved when developing country exporters are faced with the problem of market access in the context of a vertically related market. We consider two issues: first, the levels of tariffs and the problem of tariff peaks facing developing country exporters; and, second, the problem of tariff escalation.

(i) Tariffs and Tariff Peaks The traditional focus of trade models is on explicit trade barriers such as tariffs and quantitative restraints. Following the Uruguay Round of GATT, there was a process of tariffication whereby a range of non-tariff barriers including quantitative restraints were converted into tariff equivalents. A recent survey by USDA (2001) indicates that, on average, world tariffs in the food and agricultural sector stand at 62 percent for bound, most favored nation (MFN) rates.

However, average food and agricultural tariffs for WTO members by region vary from 25 percent for North America and 30 percent for the EU to 113 percent for South Asia. This compares with average developed country MFN tariffs of 5 percent across all sectors (Hoekman, Ng, and Olarreaga, 2002). It should also be noted that tariff levels in developing countries are also high, in many cases higher than those in developed countries, such that developing country access to other developing countries, may actually be more restricted than to developed countries.

While the level of average tariffs is in some way informative, it should be noted that products in this sector are often characterized by tariff peaks in the developed countries, i.e., where the tariffs on some imported products far exceed the average level. For example, as reported by Hoekman, Ng and Olarreaga (op. cit.), the United States, the EU, Japan and Canada have respectively 48, 290, 178, and 85 tariff peaks for food and agricultural products, with the maximum tariff rates being on butter (Canada, 340 percent), edible bovine offal (EU, 250 percent), raw cane sugar (Japan, 170 percent) and peanuts in the shell (US, 120 percent). As noted by Hoekman, Ng and Olarreaga, many of these tariff peak products are of interest to developing country exporters such that market access may be more limited than what the average tariff rates imply.

However, an additional aspect of market access relates to preferential treatment. Many developed countries also provide limited preferential access for food and agricultural products under both the Generalized System of Preferences (GSP), and reciprocal trade agreements such as NAFTA. For example, the EU has a myriad of preferential access agreements that cover a large number of developing countries with some developing countries being more favored than others. In Table 1, average MFN tariffs by Harmonized System 2-digit food and agricultural products are listed for the EU and the United States, along with margins for less developed country (LDC) preferences. Across all products, the average MFN tariff on food and agricultural products is 38.3 percent in the EU, and 30 percent in the United States, with developing countries getting preferences that imply on average they pay duty up to 50 percent of the MFN tariff. However, there are some clear tariff peaks in the EU for products such as meat and edible offal (02), cereals (10), and oil seeds (12) where preferential access for the developing countries is small, and likewise in the United States for oil seeds.

The tariff data suggest that developing country access to developed country markets for food and agricultural products could be improved through trade liberalization, particularly in the case of products that exhibit tariff peaks in developed countries and limited preferential access beyond MFN tariffs. This, however, is not the only consideration.

(ii) Tariff Escalation For developing countries attempting to diversify and up-grade their exports from raw agricultural commodities to processed food products, one of the most often-mentioned difficulties is that of tariff-escalation. Tariff escalation occurs when tariffs on imports of processed goods are higher than the tariffs on the corresponding raw commodity. This issue has been well-known from the work of Balassa (1965) and Corden (1971). UNCTAD (2002) has recently cited this issue as one of the main problems facing developing country exporters in diversifying their export profile.

The recent evidence on the extent of tariff escalation is rather mixed. For many agricultural commodities supported by government intervention in the developed countries, the tariff on the raw commodity is often exceptionally high. For example, USDA (op. cit.) report higher levels of tariffs on grain compared to grain products in several developed countries including the United States and the EU. Nevertheless, tariff escalation is still perceived to be a major issue facing developing country exporters. In Table 2 we report the highest post-Uruguay Round tariff escalation estimates for a series of commodities for the US, Japan and the EU. The estimates show high levels of tariff escalation across all three countries. The table also highlights that the level of tariff escalation has decreased following the Uruguay Round with some of the commodity groups facing the highest levels of tariff escalation also being the ones exhibiting the highest levels of reduction.

UNCTAD (2002) also reports high levels of tariff escalation for products exported solely from developing countries. For example, for coffee, tea and spices, the level of tariff escalation in Japan and the EU rose from averages of 0.11 per cent and 1.63 per cent for raw material imports in these two countries respectively to 8 per cent and 20 per cent in the case of the final product. Taken together, and in spite of the decline in tariff escalation following the Uruguay Round, tariff escalation remains a problem for developing countries diversifying their exports and attaining market access for the processed good.

2. Market Structure in the Food Sector in Developed Economies As noted in the introduction, the food industry is typically highly concentrated in developed countries at both the retail and processing stages. At the processing stage in the EU concentration ratios are high. For example, the average 3 firm concentration ratios for each of the following EU countries are respectively: Ireland, 89 per cent; Finland, 79 per cent; Denmark, 69 per cent; Italy, 67 per cent; France, 63 per cent; and the UK, 55 per cent with the EU average being 68 per cent.2 Data for the United States show similarly high levels of concentration across food manufacturing. At the retail level, markets are also highly concentrated in many EU countries.

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