A Methodology for Tariffication of Commodity Trade In the Presence of Quality Differences-The Case...

A Methodology for Tariffication of Commodity Trade In the Presence of

Quality Differences - The Case of Peanuts

David G. Raboy and Teri Simpson

1 . INTRODUCTION

NE important objective of the Uruguay Round of General Agreement on Tariffs and Trade (GATT) negotiations is the reduction of non-tariff trade

barriers in order to foster market access. The suggested method is to convert non-tariff barriers into equivalent tariffs which could then be reduced according to a negotiated schedule.’ For agricultural products, the GATT tariffication procedure would involve choosing a base period and measuring the protected domestic and free-trade world prices of a relevant product. The difference between these prices would be the ‘price gap’ which defines the specific tariff and the percentage difference between them would be the ad valorem tariff that would replace the non-tariff barrier.

In the GATT guidelines to tariffication it is noted that ‘the initial tariff equivalent calculation for the principal product should be adjusted as necessary to take account of differences in quality or variety using an appropriate coefficient . . .12 Although quality or attribute-related price differentials are

DAVID G. RABOY AND TERI SIMPSON are from Patton, Boggs & Blow, Washington DC. They would like to acknowledge helpful comments on an earlier draft of the paper from an anonymous referee. ’ Non-tariff barriers within the scope of the negotiations include ‘quantitative import restrictions, variable import levies, minimum import prices, non-automatic licensing, non-tariff measures maintained through State trading enterprises, voluntary exporr restraints and similar schemes.’ The suggested method to reduce non-tariff barriers ‘involves the conversion of such measures into ad valorem or specific tariffs (i.e. tariffication).’ See Arthur Dunkel (June, 1991) ‘Options in the Agriculture Negotiations: Note by the Chairman,’ Negotiating Group on Agriculture-GAlT, June 24, 199 1 at p.6. *Arthur Dunkel (August, 1991) ‘Options in the Agriculture Negotiations: Note by the Chairman, Addenda,’ August 2, 1991, in Inside US. Trade, August 16, 1991.

27 1

272 DAVID G. RABOY AND TERI SIMPSON

normally associated with manufactured goods, they exist among commodities as well. If such price premiums are not accounted for in the tariffication process, then constructed tariffs may be overstated or understated to the extent that the difference in the domestic price and the world price of a good is explained by attribute differences rather than by non-tariff barriers.

It is beyond the purview of this paper to discuss the efficacy of tariffication in general. Certainly the concept is not without pitfalls as is discussed in the voluminous literature on the measurement of non-tariff barrier^.^ Nonetheless, a major initiative exists at the GATT which requires both tariffication and incorporation of quality adjustments during tariff equivalent calculations. The purpose of this paper is to describe a simple methodology for estimating tariff equivalents to non-tariff barriers that are not biased by attribute differences. This procedure is appropriate for a certain class of commodities under specific circumstances. For other commodities, a modification of the procedure may produce suitable results and for a final class of commodities, the procedure would be inappropriate. To illustrate the procedure the peanut import quota system that is associated with the domestic support program in the United States is analy~ed.~ An ad valorem tariff is constructed that affords the same level of protection as the current quota system and is not biased by systematic quality price premiums among peanuts from different c~untries.~

2. THE METHODOLOGY

The theoretical methodology can be described as a series of steps:

1 . Develop a testable hypothesis to esplain price diflerences under free trade.

Systematic attribute-related price differences can exist for commodities as well as for manufactured goods. The theoretical basis for a quality price premium is simiIar to that for price differences between trademarked and non-trademarked products. In many cases, to the purchasers of raw inputs, commodities are clas- sic ‘experience’ goods entailing substantial pre-purchase or pre-delivery

’See Deardorff and Stem (1984) and Baldwin (1988), among others, for a survey of this literature. ‘The basic elements of the current US Government price support program for peanuts are a national poundage quota and a two-tier, non-recourse government loan mechanism, backed by an import quota which results in a virtual ban on imports. Under the program, the US Government determines the level of the national poundage quota each year from an estimate of domestic demand, and assigns portions to individual growers guaranteeing each allotment holder a high minimum price for peanuts by providing a large non-recourse loan. ‘Additional’ peanuts - those not grown for domestic edible use - must be exported or crushed. For a more in depth description of the US peanut program see USITC (1991).

Peanut production exists throughout the world although most of the world’s production is used for oil and meal. Although many countries produce peanuts, only a few actively participate in trade. China, Argentina and the United States are the principal exporters of peanuts, accounting for 62 per cent of peanut exports during the period 1986-88 (USITC 1990). For tariffication purposes, the potential exporters to the US market are China and Argentina.

TARIFFICATION OF COMMODITY TRADE 273

uncertainties. Commodities from some sources will command a Klein-Leffler price premium over similar commodities from other sources.6

2 . Identib a Comparable Free Market.

Once a testable hypothesis has been established for systematic price premiums, a free-market that is otherwise comparable to the protected market at issue must be identified to allow an empirical test of the price premium hypothesis. The market must be comparable to the protected market in terms of the factors that produce any putative attribute price premium, including similar cultures, levels of economic wellbeing and similar usage of the commodity.

The lack of comparable markets for many commodities produces the most serious limitation on the procedure suggested in this paper. Commodities that are appropriate for the procedure, as well as those that are not, are discussed at the end of the paper.

3. Estimate systematic empirical price differences in the comparable free market.

Hedonic price models are prevalent in the international trade literature.’ These models estimate the price of a good as a function of the qualities or attributes associated with that good. As such, hedonic price models are particularly well suited to estimate price differences resulting from the attributes identified in step 1 among commodities from different sources.*

6See Klein and Leffler (1981). The authors describe the basis for a quality price premium as follows: The price ‘premium’ is a payment for high quality in the face of purchase quality-determination costs. The relevant consumer choice is between demanding minimum quality output at a perfectly competitive (costless information) price or paying a competitive price ‘premium’ which is both necessary and sufficient, for higher quality output. The literature on trademarks stresses the role of trademarks in minimising consumer search costs and providing quality assurance - services for which a price premium is paid. See Landes and Posner (1987), where the authors note that ‘[fjirms with strong trademarks . , . will command higher prices for their brands not because of market power but because the search costs associated with their brand are lower.’ There are several dimensions to price premiums in commodity trade, where source may be equivalent to brand name. The major reasons for quality premiums are differential quality (size, lack of disease, taste, longevity, ripening properties, etc.), differential quality assurance (a function of product quality variability), delivery reliability (a function of predictable sourcing based on stable weather, geographical diversity, labour stability and political stability) and transportation service (affecting the previous three dimensions). ’ For the origins and uses of hedonic price models see Giliches (l971), Rosen (1974), Hogarty (1 974), and Feenstra ( 1986). * Hedonic models can be used to separate attribute related price premiums for exports among countries or suppliers within countries. One of the authors has analysed the North American banana trade and noted that although there are distinct price premiums associated with different product services among banana companies, there are no separate price differentials associated with country source, at least with respect to Latin America. A quality adjustment in a tariff-equivalent calculation is only appropriate if there are systematic quality differences among countries. Therefore, the relevant hedonic model would summarise attributes in a country specific binary variable rather than a model including company specific attributes.


4, Subtract quality premiums.from gross commodity price differentials in the domestic country to produce the homogenous product equivalent price gap and ad valorem tar@

A concern with the procedure in this context is that there may be multiple quality premiums among competing goods in the comparable market. This raises the question of determining a singie tariff rate for all exporters to the protected market if quality-related price differences relative to the domestic good vary across exporters.

In fact, the issue of different tariff rates for different exporters only arises if quality differences are nor accounted for. In the presence of quality differences, there will be different prices for goods from various sources in the same market at equilibrium. Absent the quality adjustment, the only recourse to construct a single tariff rate under the price-gap method is to compare the protected domestic price to some weighted average of external prices. By definition some exporters will be disadvantaged and others benefitted to the extent that the single tariff deviates from that which would pertain under bilateral calculations of tariff rates.

The proper procedure is to first estimate individual quality premiums between each exporter’s good and the ‘domestic’ good in the comparable market. Then a weighted-average quality premium would be constructed where the weights are each exporter’s expected share of sales to the protected market. This average quality premium is then subtracted from the domestic price to produce the quality adjusted domestic price. This quality adjusted price is then compared to a weighted average of external prices where the weights are the same as in the quality adjustment. The single tariff rate is identical to the tariffs resulting from bilateral, quality-adjusted tariff calculations which are, themselves, equal for all exporters?

Thus, where multiple quality-related price differences exist, quality adjustment becomes essential. The only alternative to constructing quality-adjusted tariffs occurs when product differentiation is sufficient to define quality differences as separate goods in the tariff schedule, but this is unlikely in the case of commodity trade where quality differences are not related to systematically separable physical attributes.

!’To illustrate the necessity of quality adjustments in the presence of multiple premiums consider the following: Country A sells a good at $100 per unit in the protected domestic market. In a comparable free market Country A sells for $75, Country B sells for $70 (a 6.67 per cent discount relative to A) and Country C sells for $65 (a 13.33 per cent discount relative to A). B will account for 30 per cent of the exports to A. Without a quality adjustment, the tariff equivalent would be the percentage difference between A’s price and a weighted average of the prices of B and C ($66.50) or 50.38 per cent. B is disadvantaged because a bilateral calculation between A and B would set the tariff rate at 42.86 per cent. C is benefitted because the bilateral calculation would set the rate at 53.85 per cent. In a bilateral, quality-adjusted calculation between A and B, A’s domestic price would be reduced by 6.67 per cent and compared to B’s price of $70, for a tariff rate of 33.33 per cent. Similarly, in a bilateral calculation between A and C, A’s price would be reduced by 13.33 per cent and compared to C’s price of $65, for a tariff rate of 33.33 per cent. Alternatively, if A’s price were reduced by a weighted average of the discounts of C and B (resulting in $88.67), and compared to a weighted average of the prices of B and C, the result would also be a 33.33 per cent tariff.


3. A HYPOTHESIS FOR A QUALITY PREMIUM IN PEANUT TRADE

A recent United States International Trade Commission publication (USITC, 1991) has noted that ‘[wlorld trade in edible peanuts is affected by perceptions of quality, reliability of delivery, the supply source, and the characteristics of the peanuts.’ As with many commodities, peanuts are purchased sight unseen. In the United States the great majority of peanuts are sold on a forward contract rather than on a spot basis.I0 Thus, peanuts are experience goods to the purchaser.

In the United States, peanuts are primarily consumed in peanut butter, in confectioneries, or as salted peanuts. For each of these uses, there is a basis for Klein-Leffler price premiums among peanuts from different sources. The ingredients of the premium include, but are not limited to, relative quality, relative quality variability, delivery reliability and transportation service.”

4. A COMPARABLE MARKET: THE EUROPEAN COMMUNITY

The European Community (EC) is the major destination for the world’s peanut exports and is the largest peanut consuming region that does not produce peanuts. The three principal suppliers to the EC are the United States, China and Argentina. The EC is the largest outlet for US peanut exports, accounting for 69 per cent of the total for crop years 1987/88 through 1989/90 (USITC 199 1).

Peanuts are freely traded in the EC with prices quoted c.i.f. for the port of Rotterdam. There is sufficient trade volume in Rotterdam for a meaningful empirical exercise. Transportation costs for the three sources are roughly equivalent, and the direction of any bias is known.I2

See USITC (1991). The USITC notes, for example, that between 65 and 80 per cent of the ‘quota’ peanuts sold in Georgia and the Virginia-North Carolina region were on a contract basis. “The most important aspect of quality is freedom from disease - most noticeably aflatoxin. US peanuts, with a higher perceived probability of acceptable disease levels, should command a premium in a competitive market. Peanuts from the US and Argentina are shipped to market in containerised vessels. Chinese peanuts usually are not, resulting in perceived differences in on-board transportation service that indicate a greater probability for damage en route for Chinese peanuts than for US peanuts. There are considerable differences in delivery reliability among peanut source countries. Because of the perception of greater delivery reliability for US peanuts, these peanuts should command a price premium in a free market such as the EC. For discussions of peanut quality differences and the existence of price premiums see USDA (1989), USDA (1991), USITC (1991), and ‘The Nuttiest Peanut Butter’ Consitmer Reports, September, 1990 at p. 591. l 2 To the extent that there are differences in transportation costs for peanuts sold in the EC, the calculated quality premium is understated. The price of transportation to the EC from the US and Argentina is similar, with Argentine shipping costs slightly higher. Transportation costs for Chinese peanuts shipped to the EC are higher than those for US peanuts. Since the Rotterdam prices used in the empirical exercise are c.i.f., the price difference between US and Chinese (and Argentine) peanuts includes the relatively higher Chinese (and Argentine) shipping costs and therefore the price difference is less than if such costs were accounted for.


The EC demographics, culture and economic structure are sufficiently close to those of the United States to afford comparability. Beyond the effect of transportation costs, there are other reasons that Europe would produce a lower bound on the quality premium that would be expected in the United States under free trade. European producers have substantial experience in purchasing Chinese and Argentine peanuts. Thus, they do not incur the search costs that less knowledgeable US purchasers would be forced to assume, reinforcing the view that the EC is a conservative choice for a comparable market.I3 Also, it should be noted that since US peanuts sold domestically do not entail ocean voyages, the relative delivery reliability benefit of US peanuts would be greatly enhanced compared to that component in the EC.

5. THE EMPIRICAL MODEL

A simple hedonic price model is used to estimate quality premiums among peanut exports from the three major sources. The price of peanuts is expressed as a function of an ‘attribute’ variable and trend ~ariab1es.I~ It is expected that the prices of all peanuts will move together as a function of general supply and demand conditions but that the relative values of the various peanuts will vary by the quality premium. Thus time trends, both monthly and annual, must be accounted for as must any periods of exogenous supply shock.

The ‘quality’ component - which includes all the quality dimensions previously discussed - is summarised in a binary variable for each country that takes the value 1 if the peanuts are from the country in question and 0 otherwise. Following Griliches (1!?71), the semilogarithmic functional form is used so that the coefficients measure the percentage change in price due to a unit change in an independent variable.

”There are other unknowns that US purchasers will have to contend with such as pesticide use in China and Argentina and resulting regulatory risk. These search costs have already been internalised in the EC. j 4 As noted in Griliches ( 1 97 I): These qualities do not necessarily have to be numerical. Given a sufficient number of observations, we can use variables which take the value one if the item possesses the particular quality and zero if it does not and derive the average contribution of this ‘quality’ to the price of the item. Griliches also points out that an attribute does not have to be desired for its own sake but can be ‘well correlated with some more basic dimension which may be more difficult to measure.’ In addition, Griliches suggests the use of ‘additional “time” or “dummy” variables, taking the value one in their reference period and the value zero in all other periods.’ This allows the estimation of the average price change holding quality constant.


The model to be estimated is as follows:

c- 1 T- 1

Where c = aconstant; Dcountr y

= the country dummy variable where there are C countries in all;

D yedl = a dummy variable for each year;

Dsplke = a dummy variable for the period in the 1986/87 marketing year when there was an unusual price spike for several months;I5

TZME = a monthly time trend variable; and E = a randomly distributed error term.

The regression is run by designating a base country and a base year and omitting the associated dummy variables. c is the mean value of the dependent variable in the base year in the base country. The resulting a, are the percentage price differences (quality premium) between country i and the base country. It is the u, that are of primary interest in this investigation. If statistically significant ai exist, then they can be used to produce quality adjusted domestic prices in the tariff equivalent analysis.

a. Data

USITC Publication 2276 provides monthly data for the calendar years 1986 through 1988 for the Rotterdam prices of US, Argentine, and Chinese peanuts.I6 This data is used to estimate equation (1 ). Figure 1 depicts the price movements.

There are three countries and 36 months of data, allowing for 108 observations in the regression. This provides sufficient degrees of freedom to employ the necessary dummy variables.

b. Results

Regressions were run using each country as the base case and 1986 as the base year.” In each case, highly reliable results were achieved. R2 was over 68

l 5 See USITC (1991). US production was 10 per cent less in 1986/87 than in the prior crop year. IbThe USITC has suggested using the period 1986 through 1988 as the base period for tariffication and so that period is used in this analysis. Other time periods display the same types of quality premiums (e.g. annual data from 1983 to 1991). I 7 Choice of a base year does not influence the quality premium coefficients.


per cent.’* The coefficients on all trend and year dummy variables were highly statistically significant, as was the price spike dummy variable.

FIGURE 1 Peanut h c e s in Europe for Major Exporters

Monthly Prices -Rotterdam c.i.f.

1986 I987 I988

--C US + Argentina -rC- China

Source: Us ITC Publication 2276

When the US is used as the base case the quality coefficients for China and Argentina are both highly statistically significant. Table 1 provides the results. Argentine peanuts display prices that are systematically 28.12 per cent less than US prices over the sample. Similarly, Chinese peanuts sell at 27.91 per cent less than US peanuts.Ig Thus the systematic price premium for US peanuts over Chinese and Argentine peanuts is 28 per cent. This is the number that should be used in any turifficution analysis.

IxR2 could have been even higher if a greater attempt to purge seasonal influences had been made. Because of the observation of very high stability of the country coefficients under a wide range of trend specifications, further efforts in the ‘seasonal’ area were not necessary. ly When Argentina is used as the base case, the US/Argentina premium is identical to that reported above, However, there is no systematic statistically significant price differential between Chinese and Argentine peanuts. (The coefficient on China is only 0.2 per cent and it is highly statistically insignificant.) Identical results are observed with China as the base case.


TABLE 1 Statistical Results from Regression Equation

Standard Variable Coefficient Error T-Statistic

C 6.649 0.0497 133.8 139 D4rgea,m* -0.2813 0.0358 -7.8528

-0.2791 0.0358 -7.7924 DChlnn

Dl987

D,%* -0.4199 0.0635 -6.6159

DSplkc 0.2433 0.0371 6.4044 Time 0.0 156 0.0042 3.6721

-0.3001 0.1 107 -2.7099

RZ = 0.6833 Log Likelihood = 53.85

Adjusted R2 = 0.6645 F Stat. = 36.32 S. E. of Regression = 0.152

6. CALCULATING THE TARIFF EQUIVALENT OF THE US PEANUT PROGRAM

To illustrate the tariffication procedure, this section calculates the tariff that would afford the same level of protection as the US peanut program. The formula for the ad valorem tariff is, of course:

where z = the tariff equivalent; P"S = the constructed US price; and

= the constructed world price.

Both P,, and Pw should be expressed on an 'in-shell' basis, P,,, is equal to the US peanut program support price in a given year (which is stated on an in-shell basis) less the estimated quality premium (28 per cent). Rotterdam prices are quoted on a shelled basis. Thus in-shell equivalent prices must be constructed for Argentine and Chinese peanuts. This is done using a procedure described in USITC (1990). P , is a weighted average of the constructed in-shell prices for Argentine and Chinese peanuts. Table 2 provides the tariff calculation.

p W

TABLE 2 Tariff Equivalent to US Peanut Program

Specific Year Pw Pus Tariff Ad valorem

fclkg) (clkgl (prica gap} Tariff

1986f87 33.62 48.2 14.58 43% 1987/88 29.36 48.2 19.84 70% 1988/89 31.92 48.82 16.90 53%

AVERAGE 17.1 1 55%


7. LIMITATIONS TO THE PROCEDURE

The procedure described in this paper works well for a tariff equivalent to the US peanut quota because of good data and a truly comparable market in the EC. Comparable markets may not exist, however, for many other commodities that are currently subject to non-tariff barriers. For instance, the procedure would not be appropriate for dairy products, or hides and skins, where protection exists worldwide and a comparable free market does not exist (FAO, 1988). Nor could the procedure be applied to cereals where the US presence is so large in external markets that distortions caused by domestic programs are translated to those markets (Knudsen and Nash, 1990).

The procedure would also be inappropriate for commodities where trade is regulated by international association agreements or cartel situations. For instance, until recently, coffee trade was managed by an international coffee agreement.2"

It should be noted, however, that these distortions are not peculiar to the quality premium analysis, but raise problems for tariffication in general. If a comparable market does not exist to test for quality premiums, the chances are there is no market to construct a world price either and tariffication would be impossible, with or without quality adjustments.*'

Thus, existence of a comparable market is a sine p a non for tariffication in general. In most cases, if a sufficiently free external market exists to construct a world price, then a subsequent quality-price-premium analysis is possible and, indeed, necessary. Other commodities that might lend themselves include cotton (USITC, 1990), bananas and other tropical fruits.22

REFERENCES

Baldwin, R. E. (1989), 'Measuring Nontariff Trade Policies,' NBER Working Paper No. 2978

Deardorff, A. V. and R. M. Stem (1984), 'Methods of Measurement of Nontariff Barriers,' (May).

Institute of Public Policy Studies Discussion Paper No. 203 (University of Michigan, June).

"ORecently, however, the coffee agreement collapsed and there may be sufficient data to test quality price premiums in the last couple of years, although not for the base period considered in this paper. With perceived quality advantages for Brazilian and Colombian coffee over coffee from other sources, an hedonic examination of coffee would be interesting. *' The one exception is where there is a substantial external market but the domestic country does not participate in that market. In this case tariffication is possible, but no comparable market would exist to measure quality differentials. 22 There are various qualities of cotton and although producer countries employ various non-tariff barriers, free trade exists in the second tier of consuming countries that are dependent on imports (world prices quoted by Liverpool Cotton Service). Although banana trade in bananas and other tropical products is protected in most of the EC, free trade exists in Germany where Latin American and other exporters compete.

TARIFFICATION OF COMMODITY TRADE 28 1

Food and Agricultural Organization (1988), Agricultural Policies, Protectionism and Trade: Selected Working Papers. 1985-1987, FA0 Economic and Social Development Paper 75.

Griliches, Z. (1971), ‘Hedonic Price Indexes for Automobiles: An Econometric Analysis of Quality Change’, in Zvi Griliches, ed. Price Indexes and Quality Change (Harvard University PresslCamhridge).

Hogarty, T. (1 975), ‘Price-Quality Relations for Automobiles: A New Approach’, Applied Economics.

Feenstra, R, C. (1986). ‘Gains From Trade in Differentiated Products: Japanese Compact Trucks’, NBER Working Paper No. 1978 (July).

Klein, B. and K. B. Leffler (1981), ‘The Role of Market Forces in Assuring Contractual Performance’, Journal of Political Economy.

Knudsen, 0. and J. Nash (1990), ‘Redefining Government’s Role in Agriculture in the Nineties’, The World Bank (August).

Landes, W. M. and R. A. Posner (1987), ‘Trademark Law: An Economic Perspective’, Journal of Law and Economics.

Rosen, S. (1974): ‘Hedonic Prices and Implicit Markets: Product Differentiation in Pure Competition’, Journal of Political Economy.

US Department of Agriculture (1989), Peanuts: Background for 1990 Farm Legislation (November).

United States International Trade Commission ( 1990), Estimated TariffEquivalents of U S . Quotas on Agricultural Imports and Analysis of Competitive Conditions in U S . and Foreign Markets for Sugar, Meat, Peanuts, Cotton, and Dairy Products, USITC Publication 2276 (Washington, DC, April).

United States International Trade Commission (1 991), Peanuts, USITC Publication 2369 (Washington DC, March).

United States Department of Agriculture (1991), Economic Implications ofthe Uruguay Round for U.S. Agriculture (May).

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