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CALCULATING THE TARIFF EQUIVALENT TO THE CURRENT EU BANANA REGIME

Introduction

After many years of conflict in the WTO concerning the EU banana regime, the primary players in the EU, U.S., and Latin America reached an accord in 2001. The settlement, set out in separate understandings between the EU and the U.S., and the EU and Ecuador, provided for the introduction of tariff-only regime no later than 1 January 2006. In the interim, the EU would be allowed to maintain the quota system, with some minor adjustments, that had been ruled to be in violation of WTO agreements by WTO panels and the WTO Appellate Body.

There was nothing in the two Understandings that sets the rate of tariff to be

applied. There is, however, general agreement that the single tariff is to afford equivalent protection as the current system; that is, the necessary exercise is to calculate the tariff that would produce the same volume of banana imports from Latin America as the current regime. If the tariff is set too high, then banana imports from the Latin American will drop to levels below current volumes. The proper “tariffication” of the EU banana regime is a prerequisite to a lasting resolution of the U.S./EU banana dispute. It must, therefore, be calculated on the basis of WTO criteria.

As compared with some barriers where tariffication is relatively simple, the EU

transition system is a complex one with two components. The first, the TRQs, are quantitative restrictions and therefore are amenable to traditional tariffication exercises. The second is a simple tariff of €75/tonne, but the combination of the two could complicate the analysis.

The procedure here will be to isolate the effects of the quantitative restrictions, and

then to consider the additional effects of the tariff, to the extent that the two can be separated. The calculation of the tariff-equivalent to the quotas is an update of our previous work. We initially calculated a tariff-equivalent to the pre-single-market banana regime and published the results in the journal World Economy in 1995.1 This study was updated in 1999 to calculate the tariff-equivalent to the EU banana regime in place in the late 1990s.

The current paper will first discuss the procedure to be used to calculate the tariff-

equivalent to the quotas incorporated in the current regime. It will then calculate this tariff-equivalent using several data sources. This will be followed by a discussion of the proper treatment of the existing in-quota tariff. Finally, the range that would include the tariff deemed to provide the same level of protection as the current banana regime, including both quotas and a tariff, will be determined.

1 David G. Raboy, Teri L. Simpson and Bing Xu, “The Lome Convention and the EU Banana Regime,” The

World Economy, July, 1995, pp. 565-581.

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Background on the Tariffication Methodology

There are many procedures that could be used to calculate a tariff equivalent to a non-tariff barrier. For example, economists could use partial or general equilibrium models of importing-country economies to produce simulations of various tariff levels in order to determine the level that produces the same quantity of imports as a quota. Such an exercise requires precise estimates of various elasticitities, and other statistical parameters, but all properly constructed models should yield the same result. It is difficult, however, to produce statistical results that are sufficiently accurate for policy purposes. Slight changes in assumptions can radically change the results of competing models, and as some imprecision always exists in econometric models, reliance on them is not conducive to transparent negotiations.

Another problem with this approach is that necessary data may not exist. Typically

econometric analyses of the supply and demand for traded goods employ official trade data (i.e., border prices), but this might not be appropriate for the tariffication of a quota system. For example, in the case of the EU banana regime, import licenses reside with importers, who, therefore, have substantial market power over exporters. The quota rents will be captured after the point of importation, rather than be reflected in c.i.f. prices. Thus the appropriate data for modeling purposes will not be border prices, but rather the prices that reflect the quota rents – the price importers, who may be original license holders or who may have purchased licenses, charge to the next purchasers.

Unfortunately, there is no source of transparent or official data for prices further

down the distribution chain in the EU banana market. Models that employ official trade data, therefore, cannot accurately quantify the tariff that would capture the quota rents, and produce the same level of protection as the quota.

It is a similar lack of public information that renders ineffective another possible

tariffication technique. In some cases it might be possible to observe the level of quota rent by monitoring import license prices, and set the tariff-equivalent equal to some measure of this quota rent. Such a calculation would be possible if licenses were traded in a public auction. This is not the case with banana licenses, however, and there is no other transparent data source. Tariffication by this method would be a problem in most quota systems because auctions are rarely used to allocate TRQs.

It is for these reasons that negotiators in the Uruguay Round agreed on a tariffication

methodology that they viewed as transparent. Although this procedure does not exist, in the general case, in any WTO agreement, it is required under the Agriculture Agreement in specific incidences. Due to its history, general acceptance in the Uruguay Round, and explicit, albeit limited, presence in the current Agriculture Agreement, we believe that use of this procedure, known as the “price-gap” method and codified in the Attachment to Annex 5 of the Agreement on Agriculture, will make the job of negotiators charged with producing a tariff equivalent to the EU banana transition regime much easier.2 2 During the Uruguay Round, countries were required to convert agricultural non-tariff barriers to common

tariffs pursuant to a set of guidelines described in the Draft Final Act on Agriculture (“the Dunkel text”). The tariff equivalents that Contracting Parties produced, rather than the underlying tariffication methodology, were then incorporated into the WTO agreements. With respect to certain remaining non-

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The Methodology in General

According to the guidelines included in the Attachment to the Agriculture

Agreement’s Annex 5, the tariff equivalent to a non-tariff barrier covering a product shall be calculated using “the actual difference between internal and external prices in a transparent manner.” For the purposes of that calculation, “the internal price shall be a representative wholesale price ruling in the domestic market;” and external prices shall be, “where average c.i.f. unit values are not available or appropriate, either (i) appropriate average c.i.f. unit values of a near country; or (ii) estimated from average f.o.b. unit values of (an) appropriate major exporter(s) adjusted by adding an estimate of insurance, freight and other relevant costs to the importing country.” [emphasis added] Further the guidelines imply that the tariff equivalent should be calculated using data from a three-year time period. WTO practice is to generally use the most recent three-year period for which data is available, and there does not seem to be sound reasons to use some other period, with respect to the tariffication exercise that is the subject of this paper.

Internal Price

The Agriculture Agreement’s tariffication guidelines were written to reflect the

common case: the calculation of the tariff equivalent to a non-tariff barrier that protects a good produced domestically. With respect to the EU banana regime, the concept of “internal price” must be adjusted to account for the EU’s protection of bananas sourced both from territory that is and from territory that is not formally part of the EU. The appropriate internal price would therefore be the weighted average c.i.f. price of bananas “imported” into the EU from EU, DOM, Canary Island (and any other similar territories) and ACP sources, all of which are protected. The most reliable data source for such prices is the EU’s statistical agency, EUROSTAT. However, EUROSTAT data isolating EU banana imports from EU and DOM (and other territorial) sources for any period after 1996 is unavailable. Consequently, the internal price in this calculation is defined to be the weighted average c.i.f. price for ACP-sourced bananas only. This does not materially affect the

tariff barriers, however, the tariffication methodology, itself, was included in the WTO agreements, and its use was made obligatory.

Article 4(2) of the Agreement on Agriculture stated that, “[m]embers shall not maintain, resort to, or revert to any measures of the kind which have been required to be converted into ordinary customs duties, except as otherwise provided in Article 5 and Annex 5.” Although written generically, Annex 5 of the Agreement on Agriculture was targeted to a very narrow class of non-tariff barriers still in place in a limited number of countries at the end of the Round. In return for a minimum access commitment, the relevant countries were allowed to delay tariffication under the procedures described in Annex 5.

The Attachment to Annex 5 of the Agreement on Agriculture provided guidelines for tariffication of the remaining non-tariff barriers. Paragraph 6 of the Agreement’s Annex 5 established that the use of these guidelines was mandatory when the “special treatment” for the non-tariff barriers expired: “These duties shall be established on the basis of tariff equivalents to be calculated in accordance with the guidelines prescribed in the attachment hereto.” [emphasis added] Therefore, with respect to a specific class of non-tariff barriers, the tariffication methodology, itself, is part of WTO agreements.

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calculation of the internal price. If anything, the result is an overstatement of the internal price, and therefore the tariff-equivalent.3

As in the past, we used EUROSTAT data for entries into the EU 15 to determine the “internal” price. The most recent three-year period for which data is available is 2000-20002. This price was defined as the weighted-average price of traditional ACP bananas entered into the EU in each of the years 2000, 2001 and 2002. The prices were as follows:

The Internal Price Traditional ACP Price Per Tonne

2000 2001 2002

€624.20 €656.40 €614.90

The External Price The Agricultural Agreement tariffication guidelines establish a hierarchy, such that the external price is to be based on “appropriate average c.i.f. unit values of a near country” or “estimated from average f.o.b. unit values” of major exporters when actual c.i.f. values in the country performing the calculation “are not available or appropriate.” In this exercise we will consider several possible approaches. First, we will consider the prices in near markets. We will investigate the price basis of our 1999 study, Norway. Next, we will analyze the U.S. market using official data. Since the “customs value” recorded upon importation into the U.S. is based on port-of-origin f.o.b. prices, as opposed to most systems which use c.i.f. or c&f prices, obtaining U.S. data and then adjusting it to produce EU constructed c.i.f. prices is equivalent to using “average f.o.b. unit values of (an) appropriate major exporter(s) adjusted by adding an estimate of insurance, freight and other relevant costs to the importing country.” [Agreement on Agriculture, emphasis added.] In addition we will look at several EC 10 countries to see if they might be appropriate near markets. Finally, we will analyze EU c.i.f. prices to determine whether they have any use in a tariffication exercise. None of these prices should require additional alterations.4 3 Using EUROSTAT data, we have compared the prices of major EU and ACP suppliers during 1995 and

1996, the latest period for which EU supplier data was available. In this period, the weighted average price of EU/DOM bananas was lower (by about 4%) than that for ACP imports. Accordingly, limiting the internal-price calculation to ACP prices has the effect of most likely overstating the internal price, and therefore the tariff-equivalent. As such, it is a conservative approach. Anecdotal evidence suggests, if anything, that this relationship is even more pronounced today.

4 The Agriculture Agreement guidelines provide for an adjustment in internal or external prices where there is

evidence of quality-related price differences. In order for such an adjustment to be justified, a statistically significant coefficient must be estimated, using standard econometric techniques. For example, economists typically measure quality- or characteristic-related price differences through use of an “hedonic” pricing model. An hedonic model explains the price of a good as the sum of the individual contributions to value for each characteristic. The model is capable of separately estimating the amount by which a “characteristic” increases price. A characteristic may be something like color, or protein content, but it could also be something like product origin. We have used such models in the past (see; e.g., D. Raboy and T. Simpson, “A Methodology for Tariffication of Commodity Trade in the Presence of Quality Differences – The Case of Peanuts,” World Economy, March, 1992. The use of hedonic models is widespread. For a discussion of the

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Norway

In our initial study analyzing the collective effects of the 12 individual regimes that existed prior to 1993, we defined the external price to be the weighted average of German import prices from Latin American origins.5 Now, of course, the German market is no longer a free market, therefore German prices cannot be used to calculate the external price for tariffication purposes.

In order to determine the efficacy of a near market it still makes sense to compare the near market to the German one when the competitive market still existed. This is, of course, of somewhat limited value as the German free market is over a decade removed. There are “near countries” that could be appropriate proxies for an EU free-market. Open markets exist in Norway and Switzerland, countries that are economically and demographically similar to many EU Member States. Based on the analysis of our 1999 study, we conclude that Norway is the most useful near market.6

original uses of hedonic models see, Sherwin Rosen, “Hedonic Prices and Implicit Markets: Product Differentiation In Pure Competition,” Journal of Political Economy, 1974. This type of model, or an appropriate substitute, must be employed to justify any coefficient that is part of the tariffication calculation.

Because the internal price is defined to be a weighted average ACP price, it is the relationship between ACP and Latin American prices that will determine whether quality adjustments are necessary. The data for the analysis of the need for a quality coefficient should reflect internal and external prices in a market setting where goods from both sources compete directly. In the case of the EU banana regime, for example, ACP and Latin American fruit compete most directly in Spain and the UK. ACP and Latin American fruit also compete in France, but the Latin American market share is very small. DG Agriculture developed a data set which reports weekly wholesale prices for dollar-zone and ACP sources in each Member State from 1993 through 1998.

In our 1999 study an hedonic pricing model was used to test the DG Agriculture wholesale price data for statistically significant Latin American price premia in the UK, Spain and France. In each country, the systematic price difference between Latin American and ACP bananas is not statistically different from zero. The empirical research does not support the need for any quality-related price adjustments. This most likely reflects long-held tastes and market segmentation.

5 Prior to the Single European Market, Germany maintained a free market with respect to the import of

bananas, so German banana import prices provided precise information on external prices. Further, the market was large and fairly dynamic, with a substantial number of competitors, and a considerable quantity of new entrants in the 1980s and early 1990s, parallel to developments in the North American market.

6 The last two years of the German free market were 1991 and 1992. Our test procedure was to compare proposed near markets to Germany for these two years. There are three criteria that should apply to the comparisons: 1) how well did the prices in the candidate proxy market correlate with those in Germany; 2) how many individual adjustments must be made to the candidate market to account for demographic, size, transportation, or other differences; and 3) what magnitude of adjustment is needed to produce a price level in the proxy market equivalent to what was observed in Germany?

An obvious candidate for a near market is Norway. On the positive side, Norway is clearly a “near” market, with demographics similar to many EU Member States. Further, the Norway service is part of the same transportation configuration that services other Northern European ports, and therefore the issue of qualitatively different capital costs does not arise. The negatives are that Norway is a small market and that there are transport operating cost differences vis a vis a putative German free market.

A statistical comparison between the German and Norwegian markets during 1991 and 1992 was performed to gauge the suitability of Norway as a proxy market. The first point of interest is that the correlation

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We obtained data from the Central Bureau of Statistics of Norway for banana

imports by origin for the years 2000-2002. From this data we constructed a weighted-average Latin American price for Norwegian imports. Based on the analysis performed in our 1999 study, we discounted the Norwegian prices by 10%, to produce an equivalent EU free market price. These can be compared to traditional ACP prices to produce a tariff-equivalent.

Tariff-Equivalent Calculations (€/tonne) (Latin American Prices Constructed From Norwegian Prices)

2000 2001 2002 Average

Traditional ACP 624.20 656.40 614.90

Constructed Latin American

546.48 589.28 747.00

Tariff Equivalent 77.22 72.12 0 49.95

As can be seen, 2002 was an outlier year7 where the price constructed from

Nowegian prices is higher than the traditional ACP price. We haven’t determined the reason for the spike in the Norwegian market, but clearly the next EU banana regime will not produce subsidies for Latin American bananas. We have two choices here. The first, is to assume a zero tariff in 2002, and then take the simple average of the three years. This produces a tariff-equivalent of €49.95/tonne.

The alternative is to ignore 2002 altogether, and base the tariff-equivalent on only 2000 and 2001. This would produce a tariff-equivalent to the TRQ-portion of the EU

coefficient is quite high for German and Norwegian prices. For German and Norwegian c.i.f. prices, the correlation coefficient was 76%. This was much higher than the correlation between, say, U.S. and German prices during the same period.

Next, an “hedonic” pricing model was employed to test the magnitude and statistical significance of the “premium” in Norwegian prices, relative to those observed in Germany at the end of the free-market German era. The empirical analysis established that Norwegian c.i.f. prices were a highly statistically significant 10% higher than German c.i.f. prices during 1991 and 1992. This 10% premium reflects the difference in transport costs and any market dynamics variations. The adjustments required to transform the Norwegian prices into a reliable approximation of the German prices are few, and the magnitude of the required transformation is small.

During 1991 and 1992, Swiss c.i.f. prices for Latin American bananas also correlated well with German c.i.f. prices. Due primarily to geographic differences, however, Swiss prices were significantly higher than Norwegian (and German) prices. Because the magnitude of the adjustment that would be required to transform Swiss into German-equivalent prices was larger than that associated with Norway, we conclude that Norway constitutes the better near market.

7 An outlier is a value in a data sample that lies far outside the normal range for other values in the sample.

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transition regime of €74.92/tonne. Most likely the correct figure lies between these two calculations.

It should be noted that there may be a distortion in the “internal” price which leads

to an overestimate of the price gap. The ACP price, which is the actual EU price, is influenced both by the TRQ system and the €75/tonne tariff. The price gap between the ACP price and the constructed Norwegian price may reflect more protection than that afforded by the TRQ in isolation. As will be discussed later, if the simple tariff is added to the price gap to produce a tariff-equivalent to the current banana regime, it may result in double counting because the tariff is, at least partially, reflected in the price gap calculation.

The U.S. Market

The U.S. is not a “near” market, but as the largest free banana market in the world, it

may provide useful information in the current tariffication exercise. Even though U.S. prices did not correlate well with German prices in 1991 and 1992, much has changed and the U.S. market can provide the information necessary to perform the equivalent of an “f.o.b.-price-up” calculation. The basis for the analysis of the U.S. market is the excellent import data produced by the U.S. International Trade Commission (ITC).

As compared to most WTO Member countries, the basis for U.S. “customs value” is port-of-origin f.o.b. prices. The ITC’s primary interest, therefore, is to accurately record the f.o.b. prices of all goods, including bananas, that enter U.S. customs territory. We have been able to obtain f.o.b. prices for bananas shipped to the U.S. from Latin American origins that also export to the EU.

After determining customs value the ITC makes a statistical adjustment to the primary data source, f.o.b. prices, to construct c.i.f. prices. Whether these prices accurately reflect the shipping dynamics of vertically integrated banana companies is uncertain. Nonetheless, because the c.i.f. prices are derived directly form f.o.b. prices, we can, with adjustments, use them to produce constructed EU c.i.f. prices for tariffication purposes. In essence, this procedure has elements of both the technique using c.i.f. prices from near countries, and employing f.o.b. prices from exporting countries, with the proper cost adjustments.

The construction of an EU price from a U.S. one is not merely a matter of adding pro-rated costs to reflect greater distances between the ports of origin and delivery. In reality, the functioning of the supply mechanisms to the two markets is qualitatively different, although based on the same marketing principle. The differences between the two markets will be discussed here, after which a coefficient will be produced to convert U.S. c.i.f. prices to EU ones. It is crucial that all calculations be based on academic-grade peer reviewed information.

The starting point of the analysis is a discussion of the differing transportation systems used in servicing the respective markets. The modern banana business is based on service which requires predictable, periodic (i.e.; weekly) deliveries of fruit of good and invariable quality (the marketing principle). This is true of both the U.S. and the EU. Because of the substantially greater shipping distance from Latin America to Europe, relative

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to the United States, the transport configuration is qualitatively different. Three separate, major transportation cost differences exist: 1) the EU market entails substantially higher per-unit (box or tonne) capital costs; 2) transportation operating costs are higher; and 3) the European market requires atmosphere control during the transoceanic voyage, resulting in additional ship equipment.

Based on research of the banana industry, we published an article in the journal Public Finance Review which included a quantification of per unit costs for the North American banana market.8 This article provides the basis of a transportation-cost comparison of the EU and U.S. markets. The same techniques used to analyze the U.S. market can be, and are, applied to the EU market.

The first issue to be considered is that of capital costs. The primary shipping assets that are relevant are the “reefer” ships used to transport bananas. Depending on the configuration of transport, additional capital investments may be required, such as the purchase of containers and associated equipment.

An investment in shipping assets is no different than any other investment. The

asset must produce sufficient revenue to recover amounts related to the physical and financial depreciation of the asset, service debt, and provide the minimum return to equity holders (the hurdle rate of return) to keep equity capital flowing to the business enterprise. This required revenue is often described as the “cost of capital.”

In pricing a box of bananas, the annual cost of capital of shipping assets must be

allocated across the annual sales volume. The larger the volume associated with a given ship, the lower will be the per box cost of capital expense. Assume that a given ship can carry about 250,000 boxes of bananas. The round trip from Colombia or the East Coast of Central America to the East Coast of the United States is about 14 days (7 for transport to U.S. Gulf ports and back). For the same ship (from the same origin) to deliver in Northern Europe, however, requires a round-trip of about 28 days. Thus, if the ship were to service the U.S. market, it could generate at least twice the annual sales volume that the same ship could produce by servicing the EU. In other words, for the EU service, the same capital costs must be recovered over half the volume of the U.S. service, necessitating a higher per box price for European deliveries.

Currently, banana companies provide consistent, weekly deliveries to both Europe

and the United States. The average (across origins and destination ports) number of ships (known as a rotation) required for a weekly discharge in a U.S. port is 1.5 ships. A weekly discharge, averaged over Latin American origins and EU destination ports, involves a rotation of 4.5 ships. Ship capital costs for European deliveries are, therefore, 3 times the level for U.S. deliveries. To the extent that shipments are containerized, a technology gaining in prevalence in the EU, container capital costs would also be three times those associated with U.S. deliveries.

8 David G. Raboy and Steven N. Wiggins, “Intangible Capital, Hedonic Pricing, and International Transfer

Prices,” Public Finance Review, July 1997, pp. 347-364.

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Solely based on ship capital cost differences, ship operating cost differences, and atmosphere control requirements, European c.i.f. prices would have had to have been about 40% higher than average U.S. c.i.f. prices in order to produce a normal, competitive rate of return. For fully containerized shipments, European c.i.f. prices would have had to have been 60% higher than average U.S. c.i.f. prices just to account for tangible capital costs.9 In addition to these capital costs, however, there are special capital costs associated with the R&D, special scheduling and other intangible assets associated with the unique banana container system.10 These costs are subject to the same “rotation” issue as other ship capital costs. We have quantified these in an article published in the Journal of Industrial Economics.11 When these costs are accounted for, fully containerized shipments would have to be priced over 70% higher for EU deliveries than for U.S. deliveries.

These percentage differences understate the true difference between U.S. and EU

c.i.f. prices, under free-market conditions. There are additional factors that would be differentially reflected in U.S. and EU c.i.f. prices. For instance, some companies harvest fruit earlier for EU deliveries than for U.S. deliveries, in order to influence ripening schedules at the ultimate destination. This process affects yield and therefore adds cost. The substantially greater sunk costs associated with establishing a European service would indicate relatively greater risk, and therefore risk premia would be associated with the European market.12 9 This is based on the Raboy/Wiggins paper. During the study period, the per-box ship-related capital costs

for deliveries to North America were $.90/box or about $50/tonne. (See Raboy and Wiggins at 357, Table 2.) The ship-related capital costs for European deliveries were, therefore, about $150/tonne. As a result, EU c.i.f. prices would have to be $100/tonne higher than U.S. c.i.f. prices, just to recover ship capital costs.

For fully containerized shipments, capital costs associated with the acquisition of a ship-load of containers for U.S. deliveries were about $.80/box of bananas, or $44/tonne. Since rotation differences would also result in container capital costs for EU service 3 times those associated with U.S. service, EU c.i.f. prices for containerized shipments would be $88/tonne higher than U.S. c.i.f. prices.

Ship operating costs associated with European deliveries are also higher than for U.S. deliveries, due to additional fuel costs, crew time and other variable factors. Ship operating costs in the early 1990s were $.65 per box or about $36/tonne for U.S. deliveries. (Raboy and Wiggins at 357, Table 2.) The additional ship operating costs that must be reflected in EU c.i.f. prices were calculated to be about $37/tonne.

In addition, shipments to Europe require the injection of nitrogen into the reefer ships’ holds, or directly into containers, so as to retard the ripening process. This requires special equipment which increases capital costs by $3 to $4/tonne. The additional costs can be added to the North American market costs, and then a ratio calculated, which when applied to U.S. prices would produce a representative constructed EU price.

10 Containerization in the banana trade bears no relation to normal container transport. Banana containers are

specially designed in terms of size and weight, and are equipped to control temperature and atmosphere precisely.

11 Steven N. Wiggins and David G. Raboy, “Price Premia to Name Brands: An Empirical Analysis,” Journal of Industrial Economics, December, 1996, pp. 377-387.

12 The risk premia would be evident in relatively higher debt service costs for EU-bound ships as well as in equity hurdle rates reflecting systematically greater project risk. The capital costs employed in this paper assumed equal debt and equity rates for assets employed in the EU and U.S. markets, and therefore underestimated the capital-cost differential.

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We have considered all of the cost differentials mentioned and the percentage of EU

shipments that are containerized. A conservative statement would be that free-market EU c.i.f. prices would have to be 50% higher than U.S. c.i.f. prices, in order to reflect competitive market economics.

Based on this analysis we have constructed EU c.i.f. prices from U.S. ones (in turn

based on Latin American f.o.b. prices) for the years 2000-2002. The first step was to construct a weighted-average U.S. price where the weights represented country-of-origin shares in the EU market. These dollar prices were converted to euros at the average exchange rate for each year, and then were grossed up by 50% to reflect the free-market cost differentials. The following table provides the result and compares the constructed EU Latin American prices to traditional ACP prices to produce a tariff equivalent to the EU quotas.

Tariff-Equivalent Calculations (€/tonne) (Latin American Prices Constructed From U.S. Prices)

2000 2001 2002 Average

Traditional ACP 624.20 656.40 614.90

Constructed Latin American

542.54 598.11 549.38

Tariff Equivalent 81.66 58.29 65.25 68.40

The cost assumption used in this calculation was conservative. Therefore a tariff-

equivalent to the transition quotas of €68.40 should be considered an upper bound. It should also be noted that the caveat to the Norwegian analysis applies here as well. The ACP prices used are actual EU prices and may, therefore, reflect both the influences of the TRQs and the simple tariff. As such, the calculated tariff equivalent may overstate the effects of the TRQs in isolation. Because there is no 2002 “outlier” problem with the data from the U.S. market, we believe that this data is the most appropriate for tariffication purposes.

Central and Eastern European Markets Some have suggested that prices from EC 10 countries in Central or Eastern Europe

could be used to measure external prices in a tariffication exercise. In order to test this proposition we gathered data from six of the larger EC 10 banana importing countries, including (by order of quantity of banana imports) Poland, Czech Republic, Hungary, Slovakia, Lithuania, and Slovenia. Data, by origin, for banana imports into these countries are available from EUROSTAT.

During the study period, excess capacity and over-production existed in the banana

industry, resulting from plantings made in the past that produced a supply of bananas greater

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than the demand for them at fully remunerative prices. There is a substantial gestation period associated with production investments on banana plantations. Decisions to increase production, as were made in the early 1990s, have ramifications for years to come. Central and Eastern Europe were the places where excess supply was sold. The bananas were sold at less than fully remunerative prices, but pricing that does not produce a profit in an over-supply period is perfectly rational, as long as variable costs are covered. In the case of bananas sold in Central and Eastern Europe, this was particularly true. Bananas are harvested (cut) on plantations at pre-determined times relating to ripening schedules. It is more efficient not to disturb the cutting schedules and to load ships to capacity, rather than sending half-empty ships across the Atlantic. Therefore, it made sense, during the study period, for companies to sell bananas at less than fully remunerative prices in Central and Eastern Europe, because banana companies were economically better off than if they had simply destroyed the bananas. It must be recognized that these prices were less than full market prices.

A look at the EUROSAT data immediately confirms this proposition. Take, for

example, the official data for banana imports into Hungary, which is the third largest importer of Latin American bananas of the six countries studied. In 2000 the weighted average price for Latin American bananas imported into Hungary was €166.33, only 42% of the price for Poland, the largest banana importer, and 40% of the Czech price (the Czech Republic is the second largest banana importer of the six countries).

In 2001 the Hungarian import price was 39% and 37% of the Polish and Czech

prices, respectively. The Hungarian prices were substantially lower than prices in the other five countries in 2002, as well.

The official Hungarian import prices were only 45% of actual U.S. c.i.f. prices for

bananas imported into the United States for both 2000 and 2001. And most bizarre is the comparison of f.o.b. prices for bananas exported to the U.S. with Hungarian import prices. In 2000 f.o.b. prices for bananas exported to the U.S. were €115/tonne more than Hungarian import prices! In 2001 this figure rose to €133.

How would an analyst treat the Hungarian prices in a tariffication analysis? One

can’t simply ignore prices for the third largest banana importer in the region. And yet the prices don’t make economic sense.

Even if Hungary is ignored, there is evidence that these EC 10 prices are not fully

remunerative competitive prices. In 2000 the weighted average Latin American import price for the remaining five importers in the sample was €387.16/tonne, only €25.48 more than the c.i.f. price for bananas entered into the U.S., weighted by the origin shares of EU imports. For the largest banana importer of the six, Poland, the difference was only €21.56. The difference between Lithuania’s import price and the U.S. c.i.f. price was only €1.02. These numbers are hardly sufficient to compensate for the substantial cost differences that exist between shipments to the U.S. and shipments to the EU. If Hungary is added back to the sample, the weighted-average import price in these six countries in 2000, was €2.67 less than the U.S. c.i.f. price.

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There is additional evidence that EC 10 banana prices are below market prices. It turns out that all import prices were low, not just those from the Latin American. Substantial amounts of African ACP bananas are imported into two of the six countries studied -- Czech Republic and Hungary. Cameroon and Cote d’Ivoire are both substantial suppliers.

In 2000 African ACP bananas were imported into the Czech Republic in amounts

greater than those from either Guatemala or Honduras, neither of which were insubstantial suppliers. The Czech import price for bananas from African ACP countries was €150.66/tonne lower than the price of African ACP imports into the EU in the same year.

These price anomalies cannot be dismissed on the belief that African ACP bananas

are not marketed in sufficient quantities to establish equilibrium prices. In 2001 African ACP imports into the Czech Republic were 60% of imports from Costa Rica, a major supplier. In that year, the EU import price for African ACP bananas was €143.10/tonne higher than the Czech price. In 2002 the EU price was €101.92 higher than the Czech price.

Clearly the market dynamics that affected Latin American exports to the EC 10 also

applied to African ACP exports, which were priced substantially below exports destined for the EU. Indeed, the relative prices of African ACP and Latin American bananas were roughly the same in the Czech Republic as in the EU. In 2000 the ratio of African to Latin American prices in the EU was 74%, while it was 73% in the Czech Republic. In 2001 the African ACP/Latin American price ratios in the EU and Czech Republic were 83% and 78% respectively. And in 2002 the ratios were 86% and 83%.

It is also instructive to look at Hungary, the largest importer of African ACP

bananas. In 2000 imports from African ACP origins constituted 12% of Hungary’s total banana imports. In 2001 African ACP banana imports were 16% of the total, and in 2002 the figure was 11%.

The problems with Hungarian data have already been discussed. Whereas the

absolute prices seem alarmingly low, there is no reason to dismiss the ratios of prices from different origins. In Hungary, during the study period, the import prices of bananas from the Latin American and African ACP origins were roughly at parity. In 2000 the African prices were 96% of those from the Latin American. For 2001, the African ACP import prices were higher than (109% of) Latin American prices. In 2002 African prices were 98% of Latin American prices.

African ACP bananas are exported to the EC 10 insubstantial quantities, and the

ratios of prices in the EC 10 are very similar to those in the EU. If EC 10 prices for Latin American bananas were to be used in a tariffication analysis, serious questions would be raised with respect to the proper “internal” price, as obviously competitive African ACP bananas are sold in the EC 10 at prices substantially below EU prices for the same bananas.

The logical conclusion is that both Latin American and African ACP bananas were

sold in the EC 10 at sub-market prices in the 2000 – 2002 period, and for the same reason -- oversupply. Due the ubiquity of less-than-market prices in the EC 10 from all sources

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during the study period, we conclude that such prices should not be used in a calculation of the tariff equivalent to the EU’s transitional banana regime.

It should be noted that recently EC 10 prices have been firming up. Indeed, this is

already evident in the 2002 data. We have compared data from the EC 10 countries, after eliminating Hungary, to the prices constructed from data in the U.S. market (the external price). In 2001 the EC 10 banana import price was only about 70% of the proper external price. By 2002, however, this ratio had risen to 90%. The Czech import price for 2002 was 96% of the external price.

This trend has apparently continued into the present. Were accession into the EU to

occur, say, four or five years in the future, and if the tariff-equivalent were calculated about the same time, the EC 10 prices might be the best representatives of the external price. In the most recent data period, however, we cannot use the EC 10 prices.

EU C.I.F. Prices Normally in the presence of a quota border prices will be distorted and, as such, are

not appropriate for use in a tariffication exercise. For several reasons, however, EU c.i.f. prices may approximate free-market prices. We are not suggesting that these prices should be used formally in the tariff-equivalent calculation. They may be useful, however, as a sense check on the constructed prices already cited. In addition, they may assist in an analysis of the proper treatment of the €75/tonne tariff when measuring the total effects of the current regime.

Under the current quota system licenses to import reside with individuals on the EU

side of the customs frontier. The total number of licenses (the demand) is substantially less than the tonnage that could be supplied from Latin America. It is a buyer’s market. As a general principle, then, it should be expected that quota rents would be captured after entry of bananas for free circulation, and not be reflected in c.i.f. prices. There would be no reason for license holders to give quota rent to exporters. In the general case, when the rights to a binding quota are distributed to importers with many options for supply, c.i.f. prices should be the same as those that prevail in a competitive market place.

This analysis would certainly hold for the approximately 20% of EU Latin American

banana imports where the buyer and seller are unrelated. Even though a vertically integrated transnational company could theoretically manipulate prices between related parties, in reality the scope for this is minimal. With EU member state tax laws conforming to the OECD Transfer Pricing Guidelines, transnational companies must price bananas at the border in a way that mimics an arm’s length transaction. Since the construction of cost-based transfer prices for bananas is a relatively straightforward matter, the possibility of price manipulation is small.

Anecdotal evidence indeed suggests that transnational-company prices to all

destinations utilize the same f.o.b. port-of-origin price as a starting point. Constructed cost-based transfer prices should, therefore, approximate those that would prevail in a competitive market.

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The following table compares the prices constructed from U.S. and Norwegian data to actual EU border prices from 2000-2002.

Price Comparison (€/tonne)

2000 2001 2002

Actual-EU 542.20 583.80 612.90

Constructed from Norwegian 546.48 589.28 747.00

Constructed from U.S. 542.54 598.11 549.38

For 2000 and 2001 the prices from all three sources match with a high degree of

precision. The 2002 actual-EU price displays a price increase, although not of the same magnitude as the Norwegian-based price.

Actual EU prices give us additional confidence in the constructed prices from the

U.S. and Norway. In addition, they suggest that using the U.S.-based price for 2002 would be highly conservative, as the actual-EU price rose in that year while the U.S.-based price fell. If EU c.i.f. prices were proven to be actual market prices, it would say something about the analysis of the simple tariff in the context of a total tariffication of the current regime. The difference between the internal and external prices, in this case, would by definition include the effects of both the TRQs and the simple tariff.

The In-Quota Tariff

The combination of a tariff and a quota could cause complications in analysis as the

effects of each may be difficult to isolate. Also at issue are concerns regarding the incidence of a tariff in different market structures.

In a hypothetical perfectly competitive market where imports and domestic goods

are complete substitutes, the incidence of a tariff is obvious. There will be a price gap between the c.i.f. import price and the competing domestic price exactly equal to the tariff. In the hypothetical world price adjustments for both imports and domestic goods will occur until a new equilibrium is reached.

What happens in this hypothetical world when a restrictive quota is added to the

tariff? The new, larger, price-gap will reflect the influences of both the tariff and the quota. To calculate the price gap directly, and add the resulting tariff-equivalent to the existing tariff, would result in double counting.

Markets rarely conform to the hypothetical perfectly competitive model. In some

markets prices of imports may remain rigid even in the face of a tariff should companies decide that it is in their best long-term interests. Thus incidence issues are relevant in other than perfect markets.

With respect to prices constructed from import prices in markets with no tariffs,

such as Norway and the U.S., it seems safe to say that the tariff-equivalents based on such prices reflect only quantitative restrictions, at least with respect to the external price. The

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“internal” price, which derives from actual prices subject to the influences of both TRQs and tariffs, might however bias the tariffication results.

The most conservative assumption is that the calculated tariff-equivalents only

measure the protection afforded by the quotas and that the in-quota tariff should be added to the tariff-equivalent to produce the total level of protection produced by the current regime. This would almost certainly overstate the true tariff equivalent to the current regime because the internal price reflects at least part of the protection produced by the simple tariff. The least conservative estimate would assume that the calculated price gap includes the total influence of the combined tariff/TRQ structure. This would understate the true tariff equivalent because the external prices used in the calculation are derived from markets where there is no tariff.

We believe that the answer lies somewhere between the two polar extremes. Where

exactly it lies is very difficult to determine analytically. Accordingly, in the conclusion section we will state a solid value for the price gap which may include some tariff influence, and add to it portions of the simple tariff which reflect the range of different assumptions previously discussed.

Conclusion

In this paper we have attempted to calculate the tariff equivalent to the EU banana

regime, which includes both TRQs and a tariff. The methodology employed was the “price gap” method,13 which is well established in WTO procedures. The internal price was defined to be the weighted average traditional ACP banana import price in the EU. Several alternatives were examined to produce the external price, and data from two markets, Norway and the U.S., were ultimately used in the price gap calculation.

When the external price was defined to be adjusted Norwegian import prices for

Latin American bananas, the resulting price gap was between €50 and €7514. When adjusted U.S. prices were used, the price gap was €68. We believe the use of U.S. data is preferable because there is no issue as to an outlier year, as there was with Norway. Therefore, for tariffication purposes we will use the figure of €68/tonne. It should be noted that this figure is very close to the one derived from Norwegian data after ignoring the outlier year, 2002.

Due to the use of actual EU ACP banana prices, the price gap most likely does not

simply measure TRQ effects, but includes some tariff effects. Lacking an empirical way to decide the magnitude of the effect, we will add portions of the simple tariff to the price gap to produce the range of plausible possibilities that measure the tariff equivalent to the total current regime.

Three possibilities will be presented. The first could be explained as follows. The

simple tariff has equal effects on the external and internal prices and/or companies do not 13 As previously stated, the price gap method is codified in the WTO Agriculture Agreement and was the basis

for tariffication in the Dunkel Text. 14 The reason for the range was the presence of an outlier year, 2002, where the external price was higher than

the internal price.

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fully adjust prices to reflect the tariff. Since the internal prices already reflect tariff influences but the external price do not, 50% of the tariff is added to the price gap to produce the tariff equivalent. The second assumption is that 75% of the tariff should be added. The limiting assumption, which places an upper bound on the tariff equivalent is that there are no tariff effects in the price gap, and therefore 100% of the tariff should be added to the price gap to produce the tariff equivalent to the transitional banana regime. The results are as follows:

Tariff Equivalent

(€/tonne)

Price Gap % of Tariff Added Tariff Equivalent

68 50% 106

68 75% 124

68 100% 143

The tariff equivalent is supposed to be designed to produce the same volumes of

Latin American banana imports as the current regime. If the tariff in a tariff-only regime is set higher than this range, the volumes of Latin American banana imports will be less than current levels..

David G. Raboy, Ph.D. Chief Economic Consultant Patton Boggs LLP Washington, DC USA 15 January 2004