31 March 2020
Julia Magntorn Garrett is a Research Officer in Economics at the University of Sussex and Fellow of the UK Trade Policy Observatory.
On Wednesday 18 March, the UKTPO published a Briefing Paper in response to the UK Government’s consultation on the UK’s future applied Most Favoured Nation tariff.
In lieu of a public launch event, which had to be cancelled due to coronavirus, this blog outlines some excellent feedback we have already received and aims to open up the issue for further discussion.
To recap, the Government has outlined three broad proposals in the tariff consultation:
In the Briefing Paper, we provided some analysis of the implications of these changes, and listed eight recommendations we believe the Government should consider when developing the UK’s tariff schedule. A summary of these recommendations is at the end of this blog.
One issue discussed in the Briefing Paper concerned the potentially detrimental impact that the tariff proposals could have on developing countries, particularly the removal of tariffs on products with no UK production. Currently, many of these goods are imported from developing countries on preferential terms. Removing tariffs on such goods, as well as the proposals with regard to tariff simplification and intermediate goods, would erode those preferences, which could be damaging for these countries. We recommended that before tariffs are eliminated on such goods, the Government should evaluate the potential impact that this might have on developing countries.
Sheila Page from the Overseas Development Institute rightly pointed out that the way to deal with the effects of potential preference erosion on developing countries is not necessarily to preserve the tariffs, but to offer assistance to help the affected countries adjust to the changing circumstances. Sheila further stated that: “It is better to say that tariffs are an instrument of policy; they are not a policy, and other instruments (notably ODA [Official Development Assistance]) are more suitable for implementing development policy.”
Seeing tariffs as an instrument of (trade) policy as opposed to a policy in themselves, is exactly the right approach. Presented in this way it becomes much clearer that policymakers need first to be clear about the policy itself, and then ask the question as to what changes in the instrument, if any, are appropriate. In turn, while other instruments are certainly more suitable for development policy, this is also not an argument for suggesting that the proposals would have a negligible impact on developing countries. It is an argument for having a coherent policy.
Many agricultural goods face specific duties, which levy a fixed charge per unit of a good. The Government is considering moving away from such tariffs to so-called ad-valorem tariffs, which are expressed as a percentage of the value of a good. The consultation document states that “Moving towards simplification of these more complex tariffs would make it easier for importers of agricultural goods to know what tariff they are being charged.”
In the Briefing Paper we discuss the difficulty of determining ad-valorem equivalents (i.e. percentage rates) for specific duties, since these will depend on the unit price of a good, which, of course, varies over time. It will therefore be a considerable challenge for the Government to determine the appropriate percentage duties to set if the aim is to maintain a rate of protection equivalent to that which these industries currently enjoy.
David Roberts, former Deputy Director General of DG Agriculture at the European Commission, echoed our concerns over the difficulties of estimating ad-valorem equivalents (AVEs). He agreed that there is no way of identifying an AVE based on current data that will produce a percentage tariff in the future which will be equivalent to the protection given by a specific tariff. In addition, however, he made the important point that a specific tariff could be seen to be the most appropriate way of giving producers a fixed level of protection, since such tariffs do not fluctuate when world prices fluctuate, and converting such tariffs to percentage terms may therefore not constitute a simplification for importers.
David said “[T]he “simplification” is for researchers and negotiators. For importers and customs authorities fixed tariffs are very much simpler because they do not have to reach agreement on the import price of a consignment in order to establish the amount of tariff to be paid.”
Once again this echoes the principle that tariffs are instruments and not policies in their own right. If the aim of policy is to provide given sectors with certainty around fixed levels of protection (e.g. agricultural sectors, which see considerable price fluctuations) then specific tariffs may well be more appropriate.
Any changes to applied tariffs can have complex consequences and often involves difficult trade-offs. Whether or not these are desirable requires consideration of the broader policy contexts – precisely to understand these trade-offs better. This was a key message in our Briefing Paper, and the comments we have received reinforce that view. It is important for the Government to analyse the impact of such changes on different groups, how the changes integrate into policy objectives, and also to evaluate what the most appropriate policy instruments are to help those affected to adjust.
The comments that we have received have provided important insights into some of the complexities of this issue. We encourage those interested to use the comment section to give any further comments, so that we can have a useful, albeit virtual, exchange of ideas and an online discussion.
Recommendation 1: In the near future, maintain as much as possible the existing structure of applied tariffs.
Recommendation 2: Reducing firms’ imported input costs in order to increase their competitiveness is potentially a sensible strategy, but is not without its downsides.
Recommendation 3: Decisions regarding the structure of applied tariffs should be made bearing in mind the possible regional consequences of any changes.
Recommendation 4: The analysis of the impact of tariff changes on prices and households should be undertaken at a detailed level.
Recommendation 5: Before eliminating tariffs on goods not produced within the UK, the impact on developing countries should be evaluated.
Recommendation 6: We strongly support the idea of encouraging trade in environmental goods, but suggest that any such policy should not be based on the existing lists. Instead the government should produce a list based on scientific evidence.
Recommendation 7: The Government should develop a broader approach to environment-friendly or climate-friendly trade policy. It should consider both tariffs and non-tariff barriers to imports and exports, and should be closely integrated with the Government’s domestic environmental policies.
Recommendation 8: The Government should consult widely, not just on tariffs, but also on non-tariff measures and trade-related regulations, and the coherence of these policies with domestic policy objectives.
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Thank you for this update to your original briefing paper on the UK Global Tariff. I want to take issue with the comment of David Roberts who suggests that simplification of agricultural tariffs is “only for researchers and negotiators”. This overlooks an important public good aspect of percentage or ad valorem tariffs compared to specific tariffs, namely, that they help to dampen world market price volatility to the benefit of consumers and producers in other countries who are often less able to bear the risk of fluctuating prices.
When world market prices go up, this is a sign of increasing scarcity at global level. Rising prices signal to consumers that they should hold off on consumption and shift to now-cheaper alternatives until producers have the chance to respond by increasing production again. The implication of a specific tariff is that the UK (and the EU) are lowering the tariff paid (in comparison to an ad valorem tariff) on imported goods and thus supporting consumption at home even when there is a global scarcity. This has the effect of pushing global prices even higher (as consumption must still be cut). Consumers in poorer countries are thus doubly disadvantaged while the specific tariff means that UK (and EU) consumers do not contribute to the global belt-tightening to the extent that they should. This is particularly objectionable when the commodities concerned have a dual use as food and animal feed. In that case poorer consumers go hungrier than they otherwise would while livestock production in the UK (and the EU) continues without responding as it should to be global shortage that pushed world market prices higher in the first place. While this sounds as though I am asking the UK government to put the interests of third country nationals ahead of their own, we should remember that introducing a general prohibition on the use of specific or compound tariffs into WTO rules would also benefit UK citizens by leading to a more robust and resilient world market for food. By introducing this change, the UK can give itself a leading role in trying to persuade other countries (not least the EU) to follow suit.
For this reason, I applaud the UK government’s willingness to consider simplification of agricultural tariffs while recognising that it is a political decision involving trade-offs between groups inside and outside the country and over time.
Picking up on Alan’s final political point, there are good domestic reasons for preferring ad valorem tariffs too. If the trend in prices is upwards then a specific tariff favours consumers. If the trend is downward, then it favours producers. As prices vary, an ad valorem tariff is neutral between consumer and producer interests.
At an economy-wide level, distortions in the allocation of resources across sectors depend on the variation in tariff rates rather than the level. Uniform ad valorem tariffs would minimise these distortions, to the benefit of UK citizens. Insofar as they are seen to be “fair” they could hopefully constrain sector by sector lobbying for special treatment.
With some pratical experience of international trade in food, I must agree with David Roberts with respect to the higher administrative simplicity in implementing fixed tariffs relative to ad valorem tariffs.
I wonder that Prof. Matthews sees ad valorem tariffs as helping to “dampen world market price volatility”. Mathematically, an ad valorem tariff increases domestic price volatility since a given percentage applied to a high import price will lead to a higher levied tariff than when applied to a lower import price. I can see that he suggests such domestic amplification of world price movements should boost the response of consumption to price changes but, in developed countries where less than 15% of disposable income is used for food, we know that demand price elasticity is tiny.
Furthermore, Prof. Matthews states that world market prices going up “is a sign of increasing scarcity”. Of course, a supply and demand imbalance will explain international commodity price variations, but that is not the only possible cause of such variations. For example, exchange rates play a major role. For a given commodity, exchange rate induced price variations say nothing about the underlying relative physical productivities.
I applaud administrative simplifications, be they public or private, but I have learnt that the pursuit of low-cost processes can lead to poor outcomes.
@Patrick
I accept that traders may perceive specific (fixed) tariff rates to be easier to manage, although I would point out that many of the agricultural tariffs that the UK will inherit are actually compound tariffs. They contain both a specific and an ad valorem component. I find it hard to believe that moving just to an ad valorem tariff alone would not be a simplification also for traders. Traders also manage other percentage changes (such as import VAT) without apparent difficulty.
Nor would I underestimate the demand response to changes in relative prices (and bear in mind there will also be a supply response). While overall elasticity of demand for food at the farm gate level is indeed low, what is important here are the substitution possibilities as measured by elasticities of substitution. Food processing and the food chain in general is highly price-sensitive to small changes in relative prices.
Introducing price variability due to exchange rate changes is an important point. But even here I would argue ad valorem tariffs make more sense from the point of view of an importing country. If sterling depreciates relative to other countries and this leads to a rise in import prices, this sends a signal that import consumption should be reduced and exports encouraged. If tariffs are fixed rather than ad valorem , this favours the continuation of imports and interferes with the responses that the economy requires.
Thanks to @uk_tpo for facilitating this very useful exchange.