Give up tariff, not TRQ

Economist argues there’s more damage by ceding tariff rate quota levels in trade deals than just reducing tariff

Public commentary regarding the North American Free Trade Agreement negotiations is mainly on the auto industry, as is appropriate. But another of U.S. President Donald Trump’s whipping boys is U.S. market access to Canada’s supply managed dairy and poultry industries.

In the fourth round of the NAFTA discussions, the U.S. negotiators tabled a proposal to eliminate Canada’s supply management system for dairy, poultry, and eggs, which Canada’s Agriculture Minister Lawrence MacAulay responded by calling it a “non-starter.”

Canada’s recent track record in trade negotiations has been to offer increased access to dairy and poultry through a mechanism called Tariff Rate Quotas (TRQs), which denotes a minimum market access for imports before tariffs become applied. Changes in TRQs can affect imports without having an impact on tariff levels. However, questions can be raised about the wisdom of this approach.

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Why it matters: By raising TRQs on supply managed products, Canada allows more foreign competition for those goods in the Canadian marketplace. However, offering lower tariffs during trade agreement negotiations might be a better option.

To prevent imports from undermining them, Canada imposes tariffs of between 150-300 per cent on supply managed dairy and poultry products, which are allowed by the World Trade Organization (WTO). WTO also mandates a minimum market access using the TRQ mechanism. In Canada’s case, TRQs are essentially from five to eight per cent of domestic consumption.

Tariffs work in conjunction with TRQs: once the TRQ for a product is full; i.e. when the amount allowed in duty free is imported, the tariff applies against any further imports.

For example, Canada’s tariff on butter is slightly less than 300 per cent. So, assuming the TRQ is eight per cent of domestic consumption, as soon as that quantity is imported, any remaining imports are subject to the 300 per cent tariff. Imports are tariff free within the quota, but highly protected thereafter.

The strategic policy issue

In trade negotiations, the importing country can offer market access by reducing tariffs, increasing TRQ, or a combination of the two.

To date, Canada has been willing to increase TRQs for dairy and poultry in trade negotiations. In the Comprehensive Economic and Trade Agreement (CETA), Europe got 16,000 tonnes of TRQ for high quality cheeses and 1,700 for industrial cheese. In the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), Canada gave 3.25 per cent more TRQ for dairy and two per cent each for chicken, turkey and eggs. With other access already given up, this means Canada has given just under 10 per cent of Canadian consumption to other countries.

How should the government proceed on NAFTA? Current data suggest major reductions in Canadian tariffs would not give up much protection. Butter will illustrate. Canada’s milk prices are based on support prices for butter and skim milk powder. Canada’s current support price for butter is $8/kilogram. The intent of the tariff is to keep imports out by making their landed cost (their price plus transportation and tariff) higher than $8.

The U.S. Department of Agriculture’s average wholesale price of butter in late March 2018 was US$4.85 per kg. Given the weaker Canadian loonie (US $0.7680), this gives a U.S. price in Canadian funds of C$6.22. So, ignoring transportation costs, U.S. butter within its TRQ can be sold in Canada for a very healthy profit of $1.78 ($8.00 – $6.22).

But the 300 per cent tariff (again ignoring transportation costs) at $6.22 is $18.66. Adding the tariff to the cost of $6.22 gives a landed price of $24.88.

In other words, in the current situation of relatively low dairy prices in the U.S., Canada’s tariff is far higher than needed to protect the Canadian market. This is rather like using an artillery barrage to kill a fly when a flyswatter would suffice: in this example, the fly swatter would be a minimum $1.78 tariff.

Implications

Because the tariffs for supply managed products are so high, giving up a lot of tariff gives up only a little protection, whereas giving up a little TRQ gives up a lot of protection. Canadian tariffs are far higher than needed to protect the domestic market.

We should expect two arguments against negotiating tariffs rather than TRQs. The first is that exporting countries can do the same arithmetic and conclude that TRQs are much better for them because the drop in Canadian tariffs required to have real impact on market access is so large. But there’s nothing in the history of trade negotiation that says the exporting countries get to choose how importers provide more market access. Canada has no obligation to give up TRQs.

The second argument is one that members of the supply management industry have made for 30 years. It’s the “slippery slope” argument: i.e., if we give up any tariff at all, there will be no end to demands to give up even more in trade negotiations. While that’s clearly true, giving up more and more TRQ is not a slope. It’s falling off a cliff: we simply give increasing parts of the domestic market to foreign suppliers and take it away from domestic farmers. At least with lower tariffs the domestic industry would still have substantial protection, would be able to adjust to meet foreign imports, thereby having a chance to compete in its own country’s market.

There is clearly a choice.

Originally published in the Macdonald-Laurier Institute’s Inside Policy Magazine.

About the author

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Larry Martin is Principal at Agri-Food Management Excellence.

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