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Implications of Qualitative
Restrictions in Internationa

Agricultural Trade

TEXAS AGRICULTURAL EXPERIMENT STATION/Neville P. Clarke, Director
The Texas A&M University System/College Station, Texas ~

B-1594

[Blank Page in Orwaai Bulletin] A

r4 ‘ 1*’

'5":

Implications of Qualitative
Restrictions In International
Agricultural Trade

E. Wesley F. Peterson
~ Assistant Professor

Guy Henry
Research Assistant

Mechel Paggi
Assistant Professor (formerly)*

Department of Agricultural Economics
Texas Agricultural Experiment Station
Texas A&M University

*Dr Paggi is currently an Agricultural Economist with the American Farm Bureau Federation in Chicago.

Table of Contents

Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 3
I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  . . . . . . . . . . . . .. 4

III. The Economic Impact of Quality Restrictions and Other Trade Barriers . . . . . . . . . . . . . . . . . . . . . . 5 ~
Import Tariffs
Import Quotas and Voluntary Export Restraints
Quality Restrictions

III. The EC Hormone Ban and the Market for Edible Offals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 
EC Policy and the Market for Edible Offals
Implications of the Hormone Ban for Edible Offals

IV. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 11
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 12

Appendix: The Impacts of Alternative Trade Barriers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .» . . l3

Import Tariffs

Import Quotas

Voluntary Export Restraints

Quality Regulations

Further Considerations on Trade Barriers

Executive Summary

The purpose 0f this report is to examine the effect of
qualitative restrictions on internationally traded goods.
The case of the European Community ban on the use
of hormones in livestock production illustrates the con-
sequences of these types of restrictions.

Quality restrictions include such measures as sanitary
regulations, product definitions, grades, and production
or processing standards. Normally, they are applied to
both domestic and imported products. Although they
are often motivated by legitimate health or safety con-
cerns, many of these measures can be seen as a kind of
trade barrier used to protect domestic producers from
foreign competition.

The economic effects of quality restrictions differ from
those of the conventional trade barriers: Import tariffs,
import quotas, and voluntary export restraints (VERs).

Tariffs lead to higher prices in the importing country,
increased production, lower consumption, and a reduc-
tion in imports. If a country is a major importer, the
tariff will lead to depressed world prices. Tariffs generate
government revenue. Ordinary tariffs contribute less to
world price instability than other forms of protection.
The variable levy is a type of tariff that has the same
destabilizing effects as quotas and VERs.

Import quotas restrict the quantity imported, causing
the price to rise in the country imposing the quota. The
static effects are the same as those for import tariffs
except for the disposition of the revenue, known as the
quota rent, generated by the quota. Tariff revenues be-
long to the government, while quota rents generally ac-
crue to private traders. VERs are the same as import
quotas but are administered by the exporting country.
The quota rents generated by a VER are retained in the
exporting country. Because both quotas and VERs pre-
vent world price variation from influencing producer
and consumer decisions, they are more destabilizing than
ordinary tariffs.

The economic elfects of quality restriction are more
complicated. In extreme cases, no producers in other
countries can comply with the regulation and the coun-

try implementing the quality restriction ceases to trade.
If this occurs, internal prices may increase greatly and
the world price may be depressed. In general, quality
restrictions likely will lead to higher domestic prices
although the benefit to producers may be offset by higher
production costs. Consumers will pay higher prices and
have fewer choices, although regulations may be needed
if the market fails to eliminate harmful products. The
volume of trade may be reduced, depending on how
many producers in other countries can comply with the
regulation. Quality restrictions do not generate quota
rents. If the primary motivation for a quality restriction
is to protect producers from foreign competition, the
economic effects are likely to be worse than those gen-
erated by more conventional trade barriers.

The economic effects of a specific quality regulation
are analyzed. The example studied is the European Com-
munity (EC) ban on the use of hormones in livestock
production. This regulation will also be applied to im-
ported livestock products and may have a significant
impact on the world market for edible offals, a product
extensively imported by the EC.

Econometric estimates of the economic relationships
indicate that the hormone ban could cause EC edible
offal prices to increase by as much as 45 percent. Con-
sumption is predicted to fall by 12 percent and the reduc-
tion in world demand due to the EC withdrawal from
the market could cause the world price of edible offals
to fall almost 35 percent. These estimates represent
upper limits and the actual effects of the hormone ban
are likely to be more moderate. Nevertheless, it appears
that the EC policy will have a significant impact on the
world market for edible olfals.

A critical issue in evaluating the impact of quality re-
strictions is the problem of distinguishing between reg-
ulations reflecting legitimate health and safety concerns
and those that are simply another way to eliminate
foreign competition. This is an important problem in
political economy and requires further research.

I. Introduction

The purpose 0f this report is to present an analysis of
the effect of qualitative restrictions 0n internationally
traded goods and to illustrate the consequences of these
measures with a specific example: The case of the Euro-
pean Community (EC) hormone ban and its implications
for trade in edible offals. Qualitative restrictions include
measures such as sanitary regulations, product defini-
tions, grades, and production or processing standards.
When a country establishes regulations of this nature, it
must also apply the regulations to imported goods. If it
does not, goods not meeting the standards would enter
the market and undermine the regulation. The necessity
of extending domestic quality regulations to imported
goods opens up the possibility of using these regulations
to protect domestic producers from foreign competition.
Although quality restrictions are often motivated by
legitimate health or safety concerns, many of these meas-
ures can be seen as barriers to trade.

A recent case from Germany illustrates the nature of
the problem. A law dating back to 1516 specifies the
ingredients legally permitted in beer. This law, the
Reinheitsgebot, stipulates that only yeast, malted barley,
hops, and water can be used to brew beer (Agra Europe,
March l3, 1987). Recent German legislation extended
the beer regulation to imported beer. In effect, the old
Reinheitsgebot was used to prevent beer imports from
other European countries where additives or other ingre-
dients such as rice or corn are used to brew beer. The
European Court of Justice ruled that this ban on imports
of foreign beers was a barrier to trade aimed at other
members of the EC. Because trade barriers between EC
members are generally not allowed, Germany has been
instructed to lift its ban on beer imports. The German
government had argued that a legitimate health concern
existed because Germans drink more beer than others
and could be harmed by heavy consumption of the addi-
tives used in beers from other countries. The Court did
not accept this argument, ruling that the law was actually
a trade barrier designed to protect German beer produc-
ers from foreign competition (Agra Europe, March 15,
1987).

Determining whether a quality regulation is a trade
barrier or a legitimate measure to protect public health
and safety is a complicated problem. Scientific evidence
that certain substances are harmful is not always conclu-
sive. Moreover, quality differences will be taken into
account, in many cases, through the normal functioning
of the market. On the other hand, some quality problems
are particularly difficult to detect and could be danger-
ous to human health if left unregulated. For example,
salmonella bacteria, a common health hazard arising
from unsanitary livestock slaughter and processing pro-
cedures, are not visible to the naked eye. However, in
many instances, it is unclear that quality regulations are
necessary to protect human health or safety. To the extent
that quality regulations applied to imported goods are
trade barriers, they will serve to protect domestic pro-
ducers and limit the choices available to consumers.

The use of quality restrictions as barriers to trade is
a particularly important issue as the world enters a new
round of trade negotiations. Agricultural subsidies will
be included in the new round of multilateral trade negoti-
ations (MTN) being conducted through the General Ag-
reement on Tariffs and Trade (GATT). Previous rounds
have made progress in establishing rules for international
trade and limiting conventional trade barriers such as
import tariffs and quotas. However, movements toward

freer trade often result in efforts to circumvent the new .-

rules. For example, elimination or reduction of industrial
tariffs was followed by a proliferation of “non-tariff” bar-
riers such as import quotas. As nations move to limit
import quotas, one can expect greater use of voluntary
export restraints or other means to protect domestic
producers. In this setting, quality regulations may be-
come particularly attractive as a barrier to trade that is
justifiable as a measure to ensure the quality and safety
of the goods allowed in internal markets.

The working hypothesis underlying this study is that
nations will take whatever action they can to protect
their domestic markets at the same time they are
negotiating reductions in protection. In industrial na-
tions, the producer generally is protected, while less
developed countries tend to intervene on behalf of the
consumer. Thus, we predict that as progress is made in
reducing agricultural barriers in the GATT negotiations,
governments in industrial countries will begin to seek
out new methods to protect agricultural producers. One
method they are likely to discover fairly rapidly is the
use of quality regulations.

The experience of the EC supports these predictions.
One of the basic principles of a common market such
as the EC is that no trade barriers should exist between
the members of the community. This principle led to
the gradual elimination of tariffs and import quotas be-
tween the countries in the EC and the establishment of
a common external tariff applied to non-EC countries.
Eliminating agricultural trade barriers within the EC,
however, may result in shifts in the location of agricul-
tural production. These shifts occur as less efficient pro-
ducers in one region go out of business and more efficient
producers in other areas expand their operations. These
changes can be socially disruptive; therefore, it is not
surprising that a variety of unconventional protective
measures has surfaced within the EC. Rejuvenation of
the German beer law is one example. Others include
definitions of the ingredients allowed in French and Ita-
lian pasta; prevention of pork imports from Spain where
African swine fever has not been eradicated; Danish rules
on reusable packaging for beer, mineral water, and soft
drinks; and the entire agri-monetary system (Peterson,
1985; Harris, Swinbank, and Wilkerson; Agra Europe, Feb-
ruary 6, 1987). Some of the quality regulations in indi-
vidual EC countries effectively protect their producers
from competition from producers in other EC countries
even though protection violates a basic principle of a
common market.

Q

If the EC experience is an indication of a likely re-
sponse to agricultural trade liberalization, the use 0f qual-
ity regulations to restrict trade may increase. In this
context, it is important to understand the effects of this
type of trade barrier. In the first section of the report,
the effects of quality restrictions on prices, supply, de-
mand, trade, and producer and consumer welfare are
analyzed and contrasted with import tariffs, import

quotas, and voluntary export restraints. The second sec-
tion of the report is devoted to analyzing a specific case:
The EC ban on the use of hormones (growth promotants)
in livestock production and its probable effect on the
world edible offal market. Conclusions and suggestions
for further research are presented in the final section of
the report.

II. The Economic Impact of Quality Restrictions And Other Trade Barriers

A detailed discussion of the economic impact of tariffs,
import quotas, voluntary export restraints, and quality
restrictions is presented in the Appendix. The implica-
tions of these trade barriers are outlined in this section
of the report. Readers interested in the technical back-
ground and economic logic behind the propositions pre-
sented here may wish to refer to the Appendix.

The four trade barriers noted above must be studied
in terms of both the static and the dynamic effects. The
static effects of a trade barrier include the impacts on
domestic and world prices; the quantities produced, con-
sumed, and traded; and producer, consumer, and govern-
ment situations. The dynamic effects concern the way
in which trade barriers influence price stability through
time. Frequently, a trade barrier has the static effect of
increasing producer prices at the same time that it has
the dynamic effect of contributing to greater price insta-
bility in the world market. Static and dynamic effects
are outlined for each of the trade barriers discussed.

Import Tariffs

An import tariff is a tax applied to imported products
at the point of entry. Tariffs can be set as a fixed amount
(e.g., $10 per ton), a percentage of the pre-tariff price
(known as an ad valorem tariff), or as an amount that
varies with world market conditions. An example of the
latter is the variable levy used by the EC. The variable
levy is a tax or tariff set as the difference between the
world price and a predetermined internal price known
as the threshold price. Unlike per unit and ad valorem

 tariffs, the variable levy can change from day to day. All
‘ three types of tariffs have the same static effects, but the

dynamic impacts of the variable levy differ from those
of the other two.

The purpose of a tariff is to protect domestic producers
from the competition of cheaper imported goods. Tariffs
raise the price of a product in the domestic market. As
a result, producers receive and consumers pay a higher
price than they would if no tariff was imposed. Because
producers receive a higher price, they will normally pro-
duce more goods. Likewise, consumers generally pur-
chase fewer goods at the higher price. The result is that
the amount of goods the country imports is reduced. If
the country imposing a tariff is a major importer, the

reduction in its imports may represent a significant de-
crease in world demand. If this occurs, it is likely that
the world price will also be depressed.

In summary, the static effects of import tariffs are as
follows:

0 The price in the country levying a tariff increases.

0 At the higher price, producers in that country in-
crease their output while consumers reduce con-
sumption.

I The amount of goods the country imports declines.

I The fall in world demand leads to a reduction in
world trade and lower world prices.

These changes are to the advantage of producers in
the country imposing the tariff. They may also benefit
consumers in the rest of the world who are able to
purchase at a lower world price. Conversely, producers
in the rest of the world and consumers in the country
levying a tariff are hurt by the changes. As shown in the
Appendix, a tariff also leads to an efficiency loss for the
world as a whole. This efficiency loss may be partially
offset by government revenue generated by the tariff. In
some cases, it may be possible for a government to levy
an “optimum” tariff which leads to an increase in social
welfare for that country as compared to its situation
under free trade. Of course, this increase in social welfare
is at the expense of the country’s trading partners. For
the world as a whole, an import tariff, or any other kind
of trade barrier, necessarily reduces global welfare below
the level attained with free trade.

Per unit and ad valorem tariffs have a minimal impact
on price stability. Variations in world prices are transmit-
ted to markets protected by these measures. Consider
a $10 per unit tariff on a good with a world price of
$ 100. A shock to the world market leading to an increase
of the world price to $120, for example, is reflected in
the protected market in which prices rise from $ 110 to
$130. In addition, shocks within the protected market
are transmitted to the world market. For example, an
unusually good harvest leads to lower prices in the pro-
tected market. This, in turn, leads to increased consump-
tion, although the net result is likely to be some decrease
in imports. The decrease in imports results in a slight
reduction in world price. The main dynamic effect of an

ordinary tariff is that it leads to a lower volume of world
trade than in the free trade case. Markets in which the
volume of trade is low are sensitive to relatively small
changes. Thus, in the smaller world market, a fairly small
shock may cause significant price instability Within the
protected market, the greater degree of self-supply re-
duces the vulnerability of the market to shocks transmit-
ted from the world market.

The variable levy, on the other hand, often contributes
to much greater price instability. Because the variable
levy is adjusted to reflect world price changes, no vari-
ation in world prices is transmitted to the protected
market. If the EC threshold price is $140 per unit and
the world price is $100 per unit, the variable levy is
$40. If a shock on the world market causes the world
price to rise to $ 120, the variable levy is reduced to $20
per unit and the internal price in the EC remains at the
predetermined level. In addition, a shock within the EC
is entirely transmitted to the world market. Because the
internal price in the EC is fixed, an unusually good har-
vest does not lead to a price decline within the EC, and
consumption, therefore, does not change. With the same
level of demand and a larger supply, the effects of the
good harvest are entirely absorbed by a reduction in
imports. Thus, the variable levy insulates the EC from
any instability that may originate in the world market
and shifts any internally generated instability onto the
world market.

Import Quotas and Voluntary Export
Restraints

An import quota is a restriction on the quantity a
country imports. Import quotas can be designed to have
the same effect on prices as tariffs. Limiting imports
brings about a kind of shortage, causing the price in the
protected market to rise. At the higher price, production
increases while consumption falls and equilibrium is re-
established between the increased domestic supply, re-
duced domestic demand, and lower quantity of imports.
A tariff raises the price, leading to a decrease in the
quantity imported, while a quota limits the quantity im-
ported, leading to a rise in the price.

The static effects of an import quota are the same as
those of a tariff. The price in the protected market in-
creases, domestic production increases, and domestic
consumption decreases. Imports, of course, decline, and
if the country imposing the quota is a large country, the
world price will be depressed by the decrease in world
demand. There is one way, however, in which an import
quota differs from an import tariff. Recall that an import
tariff leads to government revenues equal to the per unit
value of the tariff multiplied by the number of units that
are still imported. In the case of a quota, an equivalent
revenue, referred to as a quota rent, is generated (Appen-
dix). The quota rent is equal to the difference between
the price in the protected market and the depressed
world price multiplied by the quantity of imports permit-
ted under the quota.

Import quotas are normally implemented by providing
private import firms with licenses to import a certain
quantity. The government first must decide the total
amount of imports that will be allowed. This total quan-
tity is then divided among the import firms, each of
which is licensed to import a specific amount. These
importers are able to buy the product at the depressed
world price and sell it at the higher price in the protected
market. The profits from the transactions of all the im-
porters are the quota rents. If the quota is set to raise
prices by the same amount as a given tariff, the quota
rent will be equal in value to the government revenue
generated by the tariff. The difference is that in the case
described above, the quota rent belongs to the private
traders granted the right to import, while in the case of
a tariff, the revenue accrues to the government.

Of course, an import quota can beimplemented in
other ways. For example, the government could capture
the quota rents by selling or auctioning the licenses to
import. The government could also tax the quota rents,
allowing the importers to keep some portion of this
revenue. Many possible arrangements can be imagined.
The important point is that import quotas generate quota
rents, which may very well be captured in whole or in
part by private traders. This is in contrast to the tariff
which generates revenues that belong unequivocally to
the government, the only authority with the power to
levy "taxes.

Voluntary export restraints (VERs) are agreements be-
tween an importing country and one or more exporting
countries. The exporting country “voluntarily” agrees to
limit the amount shipped to the importing country. The
agreement to limit exports is usually obtained through
the implicit or explicit threat of more severe measures
such as tariffs or quotas. AVER has the same static effects
as an import quota, including the generation of quota
rents. The reason for this is that VERs effectively limit
the amount that an importing country is able to purchase.
VERs differ from import quotas with respect to the dispo-
sition of the quota rents. In the case of an import quota,
the rents are retained in the importing country by private
traders, the government, or some mixture of private and
government interests. In the case of a VER, however, the
quota rents belong to government or private interests
in the exporting country. This is because the exporting
country is the one regulating the flow of the product. If
the government of the exporting country grants export
licenses to private traders, these individuals will be able
to buy the product at the depressed world price and
sell it to importers at the higher price in the protected
market. Thus, the only differences between a VER and
an import quota are how the trade barrier is administered
and who receives the quota rents.

The dynamic effects of import quotas and VERs are
the same as those occasioned by the variable levy. Quotas
and VERs regulate the quantities imported. The variable
levy also determines the quantity imported because in-
ternal prices are not allowed to vary. In all three cases,

a sudden decrease in world price will not lead t0 greater
imports because the quantities are fixed or world price
changes are not transmitted to the protected market.
Likewise, any instability within the protected market is
fully transferred to the world market. Thus, in compari-
son with ordinary import tariffs-variable levies, import
quotas, and VERs tend to reduce price variations within
the protected market and increase price instability in
the world market.

Quality Restrictions

The effects of quality restrictions are somewhat more
complex than those of the trade barriers described
above. Much depends on whether exporting countries
can comply with the regulation. If producers in some
or all exporting countries can comply easily with the
regulation, it may have very little impact on trade. On
the other hand, producers unable to comply with a qual-
ity restriction will find themselves completely excluded
from the protected market. If some producers can com-
ply while others cannot, quality restrictions may be dis-
criminatory. Trade may be entirely eliminated between
certain regions at the same time that it continues un-
abated between other regions. In the extreme, the coun-
try introducing a quality restriction may cease to import
altogether if no producers in other countries are able
to comply with the restriction. ~

Quality restrictions usually lead to higher internal
prices. In the extreme case in which a country ceases
to import, internal prices may increase dramatically be-
cause they are determined entirely by domestic supply
and demand (Appendix). Countries that do not engage
in foreign trade are in a situation referred to as autarky.
Ifall countries were to impose unique and exclusive quality
requirements, all trade would cease. In this state of gen-
eral autarky, global welfare would decline dramatically.

In more realistic cases, quality restrictions are likely
to lead to somewhat higher internal prices, a reduction
in the choices available to consumers, and a reduction
in imports. These effects are similar to those of import
quotas, and the extent to which the quality restriction
reduces the volume of trade determines the degree to
which these consequences are realized. One difierence
between quality restrictions and other types of trade

’ barriers is that they do not generate revenue or quota

rent. It is not possible to buy a lower priced product
that does not meet the quality standard and sell it for
the higher price in the market in which the standard is
applied. p

Another way quality regulations differ from the con-
ventional trade barriers is that they are often motivated
by honest health, safety, or quality concerns. If this is
the case, consumers may be willing to pay the higher
price in order to obtain products that meet the higher
standards. Of course, there are many cases in which the
market is able to account for quality variation without
a government regulation. Discounts for high moisture
content in grain is an example of price adjustments based

on quality criteria. However, if the market fails to take
quality differences into consideration, consumers may
be better off with a government regulation that causes
prices to increase and limits the range of products avail-
able. This would be the case if the regulation protects
consumers from unsafe or harmful products.

The dynamic effects of quality restrictions depend on
the specific situation. If a quality restriction adopted in
one country causes that country to stop importing alto-
gether, there may be increased instability within the
country. Although world market instability cannot be
transmitted to the internal market of the autarkic coun-
try, any shocks within that country must be absorbed by
this internal market. In other words, an autarkic country
cannot shift any of its internal instability to the world
market. If quality restrictions reduce the number of coun-
tries participating in world trade, the world market will
be smaller and more vulnerable to destabilizing shocks.
Thus, quality restrictions may lead to increased instabil-
ity in both the internal and world markets. These effects
will be mitigated if the regulation interferes only slightly
with international trade flows.

In summary, quality restrictions are likely to have the
following effects:

0 They will lead to higher prices in the country imple-
menting the regulation and may depress the world
price.

0 Domestic producers will receive a higher price but
their costs of production are likely to increase as
well since they must comply with the regulation.

0 Domestic consumers must pay higher prices and
the choices available to them are reduced.

0 Producers who exported to the country implement-
ing a quality restriction will find themselves exclud-
ed entirely from that country’s market if they cannot
comply. Quality restrictions may, therefore, be selec-
tive and discriminatory.

0 In some cases, quality restrictions can lead to greater
instability in both the domestic and world markets.

If the objective is to protect domestic producers from
foreign competition, quality regulations are the least de-
sirable way to achieve this goal. For the country imposing
quality restrictions, no quota rents are generated, the
choices available to consumers are reduced, the higher
prices received by producers may be offset by higher
costs of production, and the regulation may exacerbate
domestic instability. For other countries, these regula-
tions may be discriminatory and have the potential for
dramatically reducing the volume of trade. The result
will be increased instability in the world market and
larger efficiency losses (Appendix). The adverse eco-
nomic effects of quality restrictions may be acceptable
if the true motivation is to correct a market failure that
would threaten the health and safety of individuals or
livestock, or harm the environment. On the other hand,
better methods of protecting domestic producers from
foreign competition can be implemented.

III. The EC Hormone Ban and the Market for Edible Offals

On December 51, 1985, the EC adopted a directive
prohibiting the use of hormonal growth promotants in
livestock production (European Community, Dec. 31,
1985). This directive includes provision to block imports
of livestock products from animals to which the barmed
hormonal substances have been administered. The U.S.
has challenged the EC ban before GATT ofiicials arguing
that the EC legislation is, in reality, a trade barrier (Inside
U.S. Trade, May 29, 1987). Meat producers in the U.S.
and Australia claim that there is little scientific evidence
of adverse effects from consuming meat from hormone-
treated animals (Agra Europe, January 17, 1986; De-
cember 5, 1986). Within the EC itself, the United King-
dom and Denmark are opposed to the hormone ban and
have taken steps to block its implementation (Agra
Europe, May 8, 1987). European consumer groups, how-
ever, are pressing for implementation of the ban as sched-
uled (Agra Europe, December 5, 1986). The ban was to
have gone into effect on January 1, 1988, but its im-
plementation was delayed for one year in response to
foreign opposition (Agra Europe, November 20, 1987).

The purpose of this section of the report is to analyze
the economic consequences of the EC hormone ban. No
attempt will be made to judge the legitimacy of the
competing claims concerning the harmful health effects
of livestock growth promotants. The analysis will focus
on the economic consequences of the ban for a particular
market. The specific case chosen for study is the market
for edible ofials. This example was chosen because edible
offals are an important U.S. export to the EC.

EC Policy and the Market for Edible Ofials

Hormones are used extensively as growth promotants
in livestock production. They lead to improved feed con-
version and faster, more uniform growth rates, thus re-
ducing the costs of production. Growth promotants are
usually administered through implants or injections. The
EC has offered some concessions in the conflict over
the hormone ban, including limited hormone use ad-
ministered though injections. U.S. livestock producers
have rejected this offer because the most common treat-
ment method in the United States is to use ear implants
(Inside U.S. Trade, May 29, 1987). This issue concerns
residues that may remain in the meat depending on the
method of administering the hormones and the timing
of the treatment. In 1981, the EC adopted legislation
prohibiting the use of certain kinds of hormones follow-
ing discovery of the hormone DES (a known carcinogen)
in Italian baby food (European Community, November
6, 1981). This was followed by the 1985 ban on all sexual
hormones.

Agricultural policy in the EC includes a great many
measures to protect internal markets. Tariffs, variable
levies, export subsidies, and various input subsidies and
production aids are used to protect livestock product
producers. In recent years, EC livestock production has
generally been greater than consumption, and the EC
has become an important exporter of milk products,

beef, and veal. Prior to 1968 and the implementation of
the Common Agricultural Policy (CAP), Western Europe
was the largest beef deficit area in the world (Simpson
and Farris). Currently, the EC is self-sufficient in pork
and poultry but imports substantial quantities of sheep-
meat, high-quality beef, and edible offals. Because the
support prices for most livestock products are above the
world price, any exports must be subsidized. The hor-
mone ban may lead to higher production costs and, ulti-
mately, higher internal prices in the EC. The effect of
such a change would be to increase the size of the export
subsidies needed to continue exporting the surplus.
Thus, a potential consequence of the ban may be to
worsen the already tight agricultural budget. This effect
would be lessened if the EC is able to promote its meat
exports as hormone-free and charge a premium on
foreign markets.

Edible offals include livers, brains, kidneys, sweet-
breads, tripe, and tongues from cattle and hogs. They
are by-products of less value than the meat for which
the animals are primarily produced. Because edible offals
are by-products, supply is largely determined by the
number of animals slaughtered for meat. Thus, the supply
of edible offals can generally be calculated as a fixed
proportion of total meat supplies. Consumption of edible
offals in the EC is relatively high. This is particularly true
in France and Ireland where per capita consumption is
about twice the average for countries belonging to the
Organization for Economic Cooperation and Develop-
ment (OECD, 1984). Because of the high consumption
rate and the fact that the amount of edible offals per
animal slaughtered is fixed, the EC must import signifi-
cant quantities. More than half the edible offals con-
sumed in France are imported, and they constitute 15
percent of the meat consumed annually in France (Ross).

The EC imports about 200,000 metric tons of edible
offals each year and the U.S. is a major source of these
imports. In 1986, U.S. exports to the EC amounted to
90,000 metric tons of edible offals worth some $107
million (U.S. Meat Export Federation, April 14, 1987).
Other suppliers to the EC include Argentina, Brazil, Aus-
tralia, and New Zealand. For most livestock products,
the EC applies extensive trade barriers. For edible offals,
however, the only measure used is a tariff of 7 percent
for livers and 4 percent for other edible offals (Agra
Europe, Ltd., 1986). The hormone ban is an additional
trade barrier that may have a significant impact on the
edible offal market.

Implications of the Hormone Ban
for Edible Ojfals

A model of the world market for edible offals is illus-
trated in Figure 1. The world is divided into three regions:
exporting countries, the EC, and non-EC importing coun-
tries. Because offals are by-products of meat production,
marketed supplies depend more on conditions in meat
markets than on edible offal prices. The supply schedules
for all regions are therefore shown as perfectly inelastic.

P
P Es P P
S
o, “
SX Sec
PEC
PW PW PW PW A B
PW ' P’
PW \ W DR DEC
ED,
o ED“ Q o o
w? QB; Q2’ ‘Q. w? 5v". Q01. 50..
Panel a Panel b Panel c Panel d
Exporting World Other European
Countries Market Importing Community
Countries

Figure 1. World Market for Edible Oflals.

Excess supply and demand schedules are derived as the
difference between supply and demand in the three re-
gions. The excess demand schedules for the two import-
ing regions are added horizontally in the world trade
quadrant to give EDT. The intersection of ES and EDT
determines the initial world price, PW.

For the purpose of this analysis, it is assumed that all
exporting countries use hormones and that it would be
very costly to change this practice. Thus, when the EC
hormone ban goes into effect, the EC will cease import-
ing edible offals. Trade will continue among the other
importing countries and exporting countries. The situa-
tion is assumed to be similar to the first quality restriction
case described in the Appendix. In fact, this is an extreme
case and the estimated effects should be seen as upper
limits. With these assumptions, the EC will be in autarky
after implementing the hormone ban. The price in the
EC will rise from PW to PEG. Producer surplus increases
by area ‘K’ while consumer surplus falls by area “A + B.”

; (See Appendix for definitions of producer and consumer
' surplus.) Area “B” represents the net loss to the EC of

the hormone ban. In the world market, removal of the
EC excess demand leaves the excess demand schedule
labeled EDR. This is the excess demand from non-EC
countries. A new equilibrium is established at a lower
world price, PW, ‘and a smaller quantity traded, Q}. The
fall in world price is dampened somewhat because other
importing nations may increase purchases at the lower
price. For the exporting countries, a smaller quantity is
exported at a lower price.

The relationships described above were estimated
econometrically using annual data from 1972 to 1984.
The data include the quantities produced, consumed,
and imported in nine EC countries (Greece, Spain, and
Portugal are excluded). In addition, data on the supply
of edible offals to the world market and an estimate of
world price obtained by dividing the dollar value of
world trade by the quantities traded are used (U.S. Meat
Export Federation, April 18, 1986). The EC price was
obtained by using real exchange rates to translate the
world price into an EC price and adjusting this price to
reflect the tariff. Other variables used include world and
EC income (OECD, 1986). The quantity variables were
obtained from Foreign Agriculture Service (USDA) or
Food and Agriculture Organization (FAO) publications.

To measure the effects of the hormone ban in the EC,
it is necessary to estimate a demand equation. The as-
sumption of perfectly inelastic supply was tested and
not rejected (Peterson, Paggi, and Henry). The system
is assumed to be recursive with predetermined supplies.
These assumptions mean that the logical specification
of the demand relationship is with price as the dependent
variable. This specification allows direct estimation of
the price flexibility of demand. A price flexibility meas-
ures the percentage change in a price for a given percen-
tage change in quantity. For this analysis, knowledge of
the price flexibility allows estimation of the change in
EC prices when imports are eliminated and the quantity
supplied and consumed is determined entirely by EC
production.

The estimated price-dependent demand relationship
is shown below in Equation 1. (Throughout the report,
the figures shown in parentheses are standard errors.)

1. ECUPR = 5595.46 - 814.72 CONS + 0.067 RLY
(1805.25) (548.10) (0.039)
R2 = .55 first order rho = .539
Where:

ECUPR = EC price of edible oflals in European
Currency Units per metric ton (ECU/MT)

CONS = per capita consumption of edible offals (kg)

RLY = real per capita Gross Domestic Product
(GDP) in ECU

This equation has been corrected for first order auto
correlation. Although the adjusted R2 is fairly low, the
coefficients of the explanatory variables are significantly
different from zero and of the expected sign. The price
flexibility derived from this equation is —3.2l. Alterna-
tive specifications generally gave flexibility estimates be-
tween -2.80 and —3.60.

By limiting the quantity available in the EC, the hor-
mone ban will lead to an increase in price (to PEC in
Figure 1) and changes in producer and consumer
surplus. To measure these effects, it is necessary to know
the price flexibility, EC production of edible offals, EC
imports of edible offals, and the initial price. Subtracting
imports from total consumption gives the change in
quantity in the EC. The percentage change in quantity
multiplied by the flexibility gives the percentage change
in EC price. This allows an estimate of PEC to be made
and also makes it possible to estimate areas ‘i4’ and “B”
in Figure 1 with some simple geometry. To provide a
range in the estimates, flexibilities of —-2.80, —3.2l,
-3.60 were used. The average values of the other vari-
ables for the period 1980-1984 were used in the compu-
tations. The results are shown in Table I.

Elimination of imports in the EC would lead to a de-
cline in consumption of about 12 percent and an increase
in market prices of some 34 percent to 45 percent. At
the higher price, producer surplus increases by between
720 million ECU and 925 million ECU. The ECU (Euro-
pean Currency Unit) is a basket of EC currencies that is
usually fairly close to the U.S. dollar in value. The analysis
has been conducted in real terms, that is, after monetary
values are corrected for inflation. The maximum gain
for EC edible offal producers is, thus, less than one billion
real (1980) ECU. The fall in consumer surplus is larger
than the increase in producer surplus, leading to a net
loss for the EC. However, this efficiency loss is fairly
small compared to the magnitude of producer gains.

Real world price depends on both excess supply and
excess demand. A two-equation excess supply and excess
demand model was estimated but the results could not
be used for this analysis (Peterson, Paggi, and Henry).
The two-equation model did, however, provide useful
information in choosing the variables included in Equa-
tion 2. World per capita poultry consumption and the

1O

time trend are supply shifters while income (real GDP)
is a demand shifter. These variables, along with the vol-
ume of world edible offal trade, explain much of the
variation in real world offal price.

Table 1. Welfare Effects of Hormone Ban in EC
(in millions of 1980 ECU)

Flexibility
Measure -2.80 —3.21 —3.60
Change in producer surplus (P) 719.7 825.0 925.3
Change in consumer surplus (C) -769.6 —882.3 —989.6
Net welfare change in EC (P+C) —49.9 —57.3 -64.3

A constant elasticity, price dependent equation was
estimated for the world market.

2. Log RWP= —42.525 + 1.289 log VT + 4.061 log WGDP

(19.36) (0.755) (2.525)
—2.227 log T + 1.870 log PCP
(0.616) (1.177)
R2 = .81 first order rho = 0.588
Where:
RWP = real world price ($/MT)
T = time trend
VT = world edible offal trade (MT)
PCP = world per capita poultry consumption (kg)

WGDP = real GDP of OECD countries ($)
log = natural logarithms

Equation 2 can be used to obtain an estimate of the
decrease in real world price resulting from EC with-
drawal from the world market. The average volume of
world trade during 1980- 1984 was about 700,000 metric
tons, of which 200,000 were imported by the EC. Setting
the quantity variable (VT) at 500,000 using 1980-1984
average values for the other variables, and solving Equa-
tion 2, provides an estimate of the decrease in world
price. The results indicate that the real world price would
decrease almost 55 percent after the hormone ban hold-
ing all else constant. In combination with the lower quan-
tity traded, the total value of world edible offal trade
could shrink from a 1980-1984 average, in nominal dol-
lars, of more than $1 billion to $504 million.

It should be emphasized that these results are upper-
limit estimates. Changes in imports by non-EC importing
countries have not been taken into account. These im-
ports can be expected to increase, dampening the impact
of the EC ban. In addition, these results are based on
the assumption that the EC ceases all imports. If some
countries are able to comply with the EC regulation with
no cost involved, or if some exporting countries do not
use hormones, the decrease in EC imports may be less
pronounced and the impact on world prices less severe.
Also, negotiations on the implementation method of the

hormone ban may result in its dilution, thereby diminish-
ing the impact of the EC regulation. Nevertheless, the
results show that removal of the large part of world
demand presently accounted for by the EC would lead

to a fairly large decrease in the world price of edible
offals. If the price is depressed sufficiently, many produc-
ers may find that exporting edible offals is no longer
profitable.

IV. Conclusion

The example described in the previous section illus-
trates the way in which quality restrictions can affect
world and internal markets. The results of the analysis
indicate that the hormone ban will lead to an increase
in EC edible offal prices of some 34 percent to 45 per-
cent, while the world price could fall by as much as 35
percent. Within the EC, the net welfare loss is relatively
small compared to the increase in producer surplus. The
actual effects of the hormone ban would probably be
much less severe because some producers may be able
to comply with the regulation so that EC imports would
not stop altogether. Also, if other importing nations re-
spond to the lower world price by increasing their pur-
chases of edible offals, the impact of the ban would be
mitigated.

Despite these qualifications, it appears that the EC
hormone ban may substantially disrupt the world market

\ for edible offals. In this situation, an interesting question

concerns the response of producers in exporting coun-
tires. The U.S. beef industry estimates that compliance
with the ban would result in the loss of about $314
million of domestic production, almost three times the
value of U.S. beef and veal exports to the EC (U.S. Meat
Export Federation, April 14, 1987). On the other hand,
some producers may find that they can increase their
returns by producing hormone-free beef and edible offals
to take advantage of the higher prices in the EC. Whether
this kind of response is possible depends in part on the
certification and inspection procedures that the EC re-
quires. It is not inconceivable for the EC to set up certifi-
cation requirements that are so cumbersome that any
potential for specializaion to take advantage of the EC
price would be eliminated.

For the EC, an essential question concerns the impli-
cations of the ban for beef exports. Higher prices in the
EC may increase budget problems because export sub-
sidies may have to be increased. On the other hand, it
is possible that a premium for hormone-free beef could
be charged, offsetting, at least partially, the need for in-
creased subsidies. It also should be noted that no com-

T pletely effective method has been developed for detect-

ing hormones in meat. In fact, a thriving black market
trade exists for hormones that have been illegal for many
years in countries such as Germany and The Netherlands.
These circumstances may preclude charging a premium

x for hormone-free beef and raise interesting questions

concerning how the EC will enforce the ban, both inter-
nally and with respect to imported meat. Another issue
concerns the likelihood that other countries will adopt

11

similar legislation. If Japan established a hormone ban,
it could have a dramatic impact on world trade in beef.
U.S. consumer groups may also elect to follow the exam-
ple of their European counterparts in eliminating the
use of hormones in livestock production. The extent to
which countries adopt regulations of this nature and the
way in which the regulations are implemented will have
important consequences for world trade.

Because food and agricultural markets are highly in-
terdependent today, quality restrictions adopted in one
region are likely to affect producers and consumers in
other regions. The reason for this widespread effect is
that domestic measures must also be applied to imports
if the good is traded. In many, perhaps most, cases the
motivation for establishing quality regulations is the be-
lief that the market will fail to account for health or
safety hazards, or other quality components believed to
be important. However, many situations occur in which
the quality regulation is perceived by at least some of
the market participants as a trade barrier. If elimina-
tion of conventional agricultural trade barriers leads to
great reliance on quality restrictions to protect domestic
producers, there may be a proliferation of regulations
that have little to do with legitimate health and safety
concerns.

This type of outcome may be worse than the current
situation. The conventional trade barriers presently in
use may be less disruptive than quality restrictions de-
signed as an alternative protectionist device. For the
importing country, a tariff or import quota has the advan-
tage of generating government revenue or quota rents
that may offset the efficiency losses to some extent. This
is not the case with quality restrictions. For the world
as a whole, the efficiency losses may be greater with
quality restrictions because they eliminate trade be-
tween countries with different regulatory regimes al-
together. In general, using quality regulations to protect
domestic producers from foreign competition is the least
desirable way to accomplish protectionist objectives.

This points back to the problem of distinguishing be-
tween quality restrictions that are based on legitimate
concerns from those that are simply methods to elimi-
nate foreign competition. To make such a determina-
tion requires more than scientific evidence. The eco-
nomic, political, legal, social, and cultural aspects of the
issue may be as important as any laboratory evidence
presented. The political economy of quality restrictions
in international trade is an important area for further
research.

References

Agra Europe. various issues. Newsletter on the European Community. London.

Agra Europe Ltd. 1986. CAP Monitor, Agra Europe Ltd. Tumbridge Wells,
Kent, U.K.

Allen, Roy, Claudia Dodge, and Andrew Schmitz. 1985. Voluntary Export
Restraints as Protection Policy: The U.S. Beef Case. Amer. J. Agr. Econ.
65(2): 291-296.

Blyth, Nicola. 1984. The EEC Sheepmeat Market and Voluntary Export Restraint
Agreements. Australian J. of Agr. Econ. 28(1):33-43.

Byers, Floyd M. 1986. Department of Animal Science, Texas A&M University.
Personal Communication. College Station, Tx.

Caves, R. E. and R. W. Jones. 1977. World Trade and Payments. Little, Brown
and Co., Boston.

European Community. Official Journal of the European Community, various
issues, 1972-1986. Office of Official Publications of the EC, Luxembourg.
FAO, FAO Trade Yearbook. various issues. FAO Statistics Series, Food and

Agricultural Organization. Rome.

Galbraith, H. 1981. Hormone Levels in Humans, Animals and Plants. The
Scottish Farmer. 19(9) Edinburgh.

Harris, Simon, Alan Swinbank, and Guy Wilkinson. 1983. The Food and Farm
Policies of the European Community. John Wiley and Sons, New York.

Inside Washington Publishers. May 29, 1987. Inside U.S. Trade. Newsletter
on International Trade. Washington, D.C.

Kreinin, Mordechai. 1979. International Econonrics, A Policy Approach.
Harcourt Brace Jovanovich, Inc., New York.

12

OECD. 1984. Meat Balances in OECD Countries. Organization for Economic
Cooperation and Development. Paris.

OECD. 1986. National Accounts, Main Aggregate, 1960-1984. Organization
for Economic Cooperation and Development. Paris.‘

Peterson, E. Wesley F. 1985. Agricultural Policy in the European Community.
MP-1578, TAES, Texas A&M University, College Station, Tx.

Peterson, E. Wesley F., Mechel Paggi, and Guy Henry. 1987. Quality Restrictions
as Barriers to Trade: The Case of European Community Regulations on
the Use of Hormones. Unpublished manuscript, Texas A&M University,
College Station, Tx.

Ross, Leslie. April 1986. U.S. Variety Meats — Tops on French Tables, Foreign
Agriculture. Foreign Agriculture Service, USDA, Washington, D.C.

Simpson, James R. and Donald E. Farris. 1982. The Worlds Beef Business.
Iowa State University Press, Ames, Iowa.

Tomek, William G. and Kenneth L. Robinson. 1981. Agricultural Product
Prices. Cornell University Press, Ithaca.

U.S. Department of Agriculture, Foreign Agriculture Service. various issues, 1975-
1985. Foreign Agricultural Circular: livestock and Meat. Washington, D.C.

U.S. Meat Export Federation. April 18, 1986. Personal Communication.
U.S. Meat Export Federation. April 14, 1987. Personal Communication.

Wonnacott, Paul and Ronald Wonnacott. 1982. Economics. second edition,
McGraw Hill Book Co., New York.



fi  

APPENDIX

The Impacts of Alternative Trade Barriers

Trade barriers affect prices; quantities supplied, de-
manded, and traded; government budgets; and the well-

\ being of producers and consumers. The way in which

./

these variables are affected depends on the nature of the
trade barrier. The purpose of this appendix is to detail
the impacts of four common types of trade barriers:
Import tariffs, import quotas, voluntary export restraints,
and quality restrictions. Each type of barrier is analyzed
using graphs and the concepts of consumer and producer
surplus. Producer surplus is defined as the area above
the supply curve and below the prevailing price. Con-
sumer surplus is defined as the area below the demand
curve and above the prevailing price. These concepts
are illustrated in Figure A1.

In Panel a. of FigureA1, consumers are able to purchase
the product at the world price (PW). Consumer surplus
is represented by the hashed area labeled ‘A?’ If price
was at P2, there would be some consumers still willing
to buy the product. These consumers benefit from being
able to purchase the good at the lower PW. Consumer
surplus measures the total benefits to consumers of being
able to purchase at PW rather than at higher prices. The
small hashed area “B” is producer surplus. It measures
the benefit to producers of being able to sell at PW rather
than at lower prices. In Panel b. of Figure A1, the World
price has changed from PW to PW. This increase in the
world price leads to a reduction in consumer surplus.
Because consumers now must purchase at PW instead of
PW, total consumer surplus has declined by the area
“A+B+c+1).” Producers, on the other hand, benefit from
the higher price. In terms of producer surplus, they have

a. Total Producer and
Consumer Surplus

Figure A1. Producer and Consumer Surplus.

15

gained area “A.” Producer and consumer surplus are use-
ful concepts for evaluating the impact of trade policies
on the well-being of producers and consumers, and are
used in the following discussion.

Import Tarifis

The first type of trade barrier to be examined is the
import tariff. In Figure A2, a three-quadrant graph of a
world market is used to show the equilibrium prices
and quantities in the absence of trade barriers. The differ-
ence in supply and demand in the importing region is
used to derive an excess demand schedule (ED). This
excess demand schedule, shown in the world trade quad-
rant, indicates the quantities imported at different world
prices. The excess supply schedule (ES) for exporting
countries is derived in the same manner. The equilibrium
world price is established at PW where excess supply
equals excess demand. Note that QT = QDM — QSM =
QSX "' QDX-

If an import tariff is applied to the product being traded
in Figure A2, it will raise the price in the market of the
importing countries. This is shown in Figure A 3. A tariff
is a tax on imported goods. Tariffs can be levied on an
ad valorem, per unit, or variable basis. The effect of the
tariff is to raise the price in the importing countries from
PW to PT. At the higher price, consumers in the importing
countries purchase less, and producers in the importing
countries increase supplies to the market. Consequently,
the importing countries import less of the product. In
effect, the excess demand schedule shifts from EDO to
EDl, causing world price to fall to PW. The fall in world

P

    

F!

C

I
“on

>-_-__.i--n_-

l

|

I I

l l

Qé 5s’ 5

b. Changes in Producer
and Consumer Surplus

price occurs because the situation represented in Figure
A3 is that of a major importing country. A tariff applied
in a small importing country may have an imperceptible
effect on world price if the country purchases very small
amounts in relation to the volume of World trade.

In the case of a large importing country, the reduction
in demand for imports will depress the world price.
Importers in these countries now purchase the product
on the world market at PQV, pay a tax equal to the differ-
ence between PT and PQV, and sell the product on the
market of the importing countries at PT. This change
means that consumer surplus in the importing countries
is reduced by area “A+B+c+iz.” Producers gain area ‘W’

P S P

which is transferred from consumers. The small triangles
“B” and “E” represent efficiency losses due to the distor-
tion introduced by the tariff. Area “c+o” is the govern-
ment revenue from the tariff. The overall effect for the
importing countries can be determinled by adding the

i

gains and losses. The loss in consumer surplusii

(A+B+c+E) can be subtracted from the producer gains
(A) and government revenue (c+1)). The net effect is

area “D-B-E.” If area “D” is bigger than areas “n+5,”

there is a net gain for the importing countries.

In the exporting countries, consumers benefit from

the depressed world price, but there is a loss in producer

surplus. In Figure A 3, consumers in the exporting coun-

P

D

I I

I
I I
| I D

l I

 

Q ' ‘ Q

QSM QDM
Importing Countries

 

World Trade Quadrant

QDX QSX
Exporting Countries

Figure A2. Equilibrium World Price and Quantity Trade in the Absence 0f Barriers t0 Trade.

P P
iP S D
ES s
PT A B C E P N
PW P’ w L ‘g1 o l:
PW D \ M
\ ED /
D o ED‘ o o / o
f x ' \ ' 0 0' Q on QD’ QRsTTQs
QSM QSM QDM Q M T T X X X X

Importing Countries

Figure A 3. The Effects of Trade Barriers.

Trade Quadrant

Exporting Countries

vb

‘I

tries gain area “L+M” while producers lose area
“L+M+N+o+1>.” Thus, there is a net loss to the exporting
countries equal to area “N+o+1>.” Area “o” is transferred
from the exporting countries to the importing countries
where it appears as area “D.” For the world as a whole,
there are four small triangles—B, E, N, and P-which
represent the efficiency loss due to the imposition of
the tariff.

In summary, the introduction of an import tariff raises
prices in the importing countries and depresses the
world price received by exporters. The tariff benefits
producers in importing countries and consumers in ex-
porting countries. Producers in exporting countries and
consumers in importing countries are hurt by the tariff
and there is an efficiency loss for the world as a whole.
Finally, the government in the importing country obtains
revenue from the tariff.

Import Quotas

An import quota limits the quantity allowed on the
market. The effect of a quota is also a price increase, but
the direction of causality is reversed compared to import
tariffs. The tariff raises price, leading to a decrease in the
quantity imported. A quota limits the quantity imported,
leading to an increase in price. A quota can be designed
to have the same effect on prices as a tariff. In Figure

\A3, an import quota set equal to the difference between

QDTQ and QSTQ will cause the market price to rise to PT
A quota of this nature would effect producer and con-
sumer surpluses, quantities traded, and prices the same
as the tariff described above.

An import quota differs from a tariff in one way Recall
that area “c+1)” in Figure A3 represents government
revenue from the tariff. A quota will result in the same
potential revenue, generally referred to as a quota rent.
Normally, an import quota is implemented by granting
import licenses to private individuals. These individuals
have the right to import a certain quantity, and the sum
of all individual import rights is equal to the total amount
allowed by the quota. An individual granted a license to
import a certain quantity can purchase that amount at
the depressed world price PVQ, and sell it at PT in the
importing country. Under these circumstances, the quota
rents, which are equal in value to the tariff revenue,
belong to the private individuals who have the license
to import.

There are other ways of implementing an import quota
as well. The government could sell or auction the licenses
to import, for example. In this case, private importers

\would purchase the} right to import from the government
and the government would be able to capture the quota
rent. Another way to set up an import quota would be
to establish a state monopoly on imports of the good in
question. A state agency established as the only legal

._ importer could buy the entire quota on the world market
at PQV, sell it in the country at PT, and retain the quota
rent as government revenue. It would also be possible
for the quota rent to be shared in some fashion between

15

the government and private traders. For example, import
licenses could be sold at a price that would only recover
some portion of the quota rent, rather than the entire
amount.

In summary, an import quota leads to the following
changes:

0 Prices in the importing country increase.

0 World prices and prices in exporting countries
decrease.

0 Producer surplus in, the importing country and con-
sumer surplus in the exporting country increase.

0 Consumer surplus in the importing country and pro-
ducer surplus in the exporting country decrease.

0 There is a net efficiency loss for the world as a whole.

These effects are the same as those occasioned by an
import tariff. The main difference between import quotas
and import tariffs concerns the disposition of area “c+1)”
in FigureAj. In the case of a tariff, this area is government
revenue. In the case of a quota, it is a quota rent which
may be shared in any one of a number of ways between
the government and private traders.

Voluntary Export Restraints

Voluntary export restraints (VERs) are similar to im-
port quotas in that they regulate the quantity placed on
the market. VERs are agreements negotiated between an
importing country and one or more exporting countries.
The exporting countries agree to limit their exports to
some predetermined quantity. This type of restriction
has the same effects in the importing and exporting coun-
tries as an import quota. The difference, again, concerns
who will receive the quota rents represented by area
“c+1)” in Figure A3. Because the exporting countries
“voluntarily” agree to limit exports, it is up to them to
grant export licenses to control the amount exported.
The result is that the quota rents in Figure A 3 are trans-
ferred to the exporting country As with import quotas,
the government of the exporting country can simply
grant the right to export to private individuals, or it can
sell or auction the right, allocate it to a state monopoly,
or tax it.

Thus, in the case of a VER, quota rents are retained in
one form or another in the exporting country This is
presumably one of the main reasons exporting countries
agree to these arrangements. The usual sequence of
events is that economic conditions in an importing coun-
try generate political pressures to protect domestic pro-
ducers. The government then suggests that it will have
to introduce quotas or tariffs unless the countries supply-
ing the home market “voluntarily” agree to reduce their
exports. From the point of view of the exporting country,
a voluntary agreement is preferable to quotas or tariffs
because the quota rent generated by a VER is retained
in the exporting country.

An illustration of the value of these quota rents is
provided by Wonnacott and Wonnacott. In Hong Kong,

private exporters have been granted the right to sell
certain quantities of textiles in the United States. The
quota rent associated with this right is substantial and a
market has developed in which these export quotas are
traded. An individual who owns an export quota can sell
or lease it to someone who actually produces and exports
the good. “Some Hong Kong exporters with large quotas
found that it was more profitable to sell the quota rights
than to produce the goods. So they closed down their
factories and lived off the proceeds from the sale of their
quotas” (Wonnacott and Wonnacott, p. 656).

Quality Regulations

Quality regulations differ from the trade barriers de-
scribed above in several respects. First, they do not neces-
sarily have the same effect on imports from all sources.
Producers in some countries may be able to continue
exporting to a country implementing a qualitative restric-
tion if there are similar regulations in their country, or
if they can easily comply with the regulation of the im-
porting country. On the other hand, producers who are
unable to comply with a regulation will effectively be
excluded from the market——their exports will fall to
zero. Thus, quality regulations on internationally traded
goods may be discriminatory, eliminating all trade be-
tween certain regions, while allowing trade to continue
as if no barrier between other regions existed.

Quality regulations generally lead to higher internal
prices because domestic producers must also comply
with the regulation. Although producers will receive
higher prices, they are also likely to experience higher
costs of production as a result of complying with the
regulation. Imports by the country implementing a qual-
ity regulation may decline if few suppliers are able to
comply. In the extreme, imports will be entirely elimi-
nated if no producers in the exporting countries are able

P
P

to comply with the regulation. This extreme situation is
depicted in Figure A4. Assume that no producers in the
exporting countries are in compliance with a regulation
implemented in the importing countries and that they

are unable to alter their practices to comply with the ,

rule, at least in the short-term. Under these circum
stances, all trade of the product will cease and the two
markets will be in the situation referred to as autarky.
Prices will be determined entirely by domestic supply
and demand. For the importing countries, this is shown
as an increase from PW to PA in Figure A4. Producer sur-
plus increases by area “A,” consumer surplus decreas-
es by area “A+B,” and society experiences a net loss of
area “B.”

In the exporting countries, price falls from PW to PN.
Consumer surplus increases by area “c,” producer
surplus decreases by area “c+1),” and society experi-
ences a net loss of area “D.” For the world as a whole,
areas “B” and “D” represent the efficiency losses due to
the elimination of trade. The global efficiency loss repre-
sents the maximum loss to the world economy. If some
producers can comply with the regulation, or if only
some of the importing countries adopt the restriction,
some trade would continue and the impact on prices
and quantities would be less severe.

Consider a world made up of four regions or countries,
two of which are net exporters of the product, while
the other two are net importers. Excess supply (ES)
schedules can be derived for the two exporting countries
and excess demand (ED) can be derived for the import-
ing countries. These schedules can be added horizontally
to determine the aggregate ES and ED schedules. The
procedure is illustrated in Figure A5. The individual ex-
cess supply and excess demand curves are aggregated
to form the kinked schedules ESHZ and ED3+4. The
intersection of these schedules determines a world price

P

ES

Q

ED

 

Importing Countries

Figure A4. The Ef/‘ects 0f Eliminating Trade.

Trade Quadrant

16

Exporting Countries

u

ii

W

FigureAS. Equilibrium in a Four-Region 7radeM0del.

and the quantities traded by each region, assuming no
trade barriers are in effect.

As in Figure A4, quality restrictions that lead to a
cessation 0f all trade would result in autarky, in which
supply and demand in each region would determine
prices and quantities. In the more complex situation
shown in Figure A5, there would be four prices corre-
sponding to the four intersections of supply and demand
schedules in the four regions.

In Figure A6, the world trade quadrant from Figure

\A5 is reproduced in order to further analyze the implica-
tions of quality restrictions. In the absence of trade bar-
riers, world price is PW and quantity QT is exchanged.
Consider the three following situations:

1. Region 4 implements a quality restriction with which
it is impossible for anyone in Regions 1 or 2 to comply
Region 3 does not have any quality restrictions.

2. Regions 3 and 4 both implement a quality restriction
with which Region 1 is unable to comply but with
which Region 2 can comply.

3. Region 4 implements a quality restriction with which
Region 2 can comply. Region 1 is unable to comply
with the regulation, which is not enforced in Region 3.

Other combinations could be imagined, but these are

the most useful cases for tracing the implications of qual-

ity restrictions. Each will be examined respectively.
In the first case, the regulation exists only in Region

4. Region 3 does not apply the regulation and the two

exporting regions cannot comply with it. The result is

that Region 4 will drop out of the market and move to

a state of autarky, while trade among the three remaining

regions will continue. The equilibrium will occur where

“ES,” = ED3 in Figure A6. World price declines from

PW to PA, while the‘ quantity traded falls from QT to QA.

Consumers (producers) in Region 3 stand to gain (lose)

from this change while producers (consumers) in Reg-

ions 1 and 2 stand to lose (gain) from it. In Region 4,

(the changes in producer and consumer surpluses are the
‘(same as those illustrated in Figure A4 since the region
essentially enters a state of autarky.

In the second case, Region 2 is able to comply with

l7

P P P
p P S S
E82
E81
S ES
1+2
Ix /S \ / PW
\ ED3+4 /
\ E03 D
o D D
o o ED‘ o Q o
QT
Region 1 Region 2 Trade Quadrant Region 3 Region 4

a regulation implemented in both importing regions but
Region 1 cannot. In this scenario, trade can continue
among regions 2, 3, and 4, but Region 1 is excluded
from the world market. Equilibrium is now established

where the Region 2 excess supply schedule (E82) inter-

sects the total excess demand (ED3+4). Because total
demand has not changed and one of the suppliers to the
world market is excluded, world price rises to PB. The

quantity traded is less than the case in which no regula-

tions are in place (QT). In this situation, producers in
regions 2, 3, and 4 benefit while consumers in those

regions must pay a higher price. The changes in con-

sumer and producer surplus in Region 1 are the same
as those shown in Figure A4 for an exporting country
forced into autarky.

The third case is somewhat more complicated. Region

P

World Trade Quadrant
Figure A6. The Effects of Quality Regulations.

4 implements a regulation with which Region 2 can
comply. The regulation is not applied in Region 3 and
producers in Region 1 are unable to comply with the
regulation in Region 4. It is certain that trade between
Regions 1 and 4 will be eliminated. Region 4 will trade
with Region 2 while Region 5 can purchase from either
of the exporting regions. To keep the graph from becom-
ing unduly complicated, no attempt is made to illustrate
this case in Figure A6. The most likely outcome is that
Region 4 will purchase an amount determined by BS2
and ED4 from Region 2 at a price determined by the
intersection of these schedules. The rest of world de-
mand will be satisfied primarily by Region 1, but depend-
ing on the location of ED3, Region 3 may also purchase
from Region 2. The implications of this situation for
the change in prices and quantities are somewhat
ambiguous.

In general, the impacts of quality regulations are more
complicated than those of more conventional trade bar-
riers. Frequently, this type of barrier is applied selectively.
Countries already complying with the regulation or able
to comply without cost can continue trading with the
regulating country. Countries unable to comply are com-
pletely excluded from the market in question. The quan-
tity of imports by an importing country implementing
a quality restriction may not change significantly if many
countries already have a similar regulation. In this situa-
tion, however, it is likely that the source of these imports
will be altered. On the other hand, some regulations may
move an importing country to an autarkic position, and
if this country is large, the impact on world prices and
trade could be substantial. An example of this situation
is discussed in Part III of the report.

Because quality restrictions essentially “prevent” cer-
tain exchanges, they do not generate quota rents. It is
not possible to purchase lower cost products not in
compliance with a regulation on the world market and
sell them for a higher price in a regulated market. This
is an important difference from the more conventional
barriers. It is possible, however, to question the rele-
vance of the standard measures of producer and con-
sumer welfare. After all, the loss in consumer surplus
resulting from higher prices in a regulated market may
be offset by the gain in consumer well-being brought
about by the assuranceof safer or better quality products.
The issue is whether the restriction is truly needed to
overcome some type of market failure, or whether it is
simply a way to protect domestic producers from foreign
competition.

Further Considerations on Trade Barriers

Up to this point, the discussion of the different barriers
to trade has been conducted in terms of the static effects
on prices and quantities. There is an important dynamic
component, however, which must also be considered.
The different trade restrictions have different impacts
on the evolution of prices through time. If the internal
market of an importing country is perfectly isolated from

18

the world market, variations in world prices are not
transmitted to that country’s market. In addition, instabil-
ity within countries with perfectly isolated domestic mar-
kets is shifted to the world market rather than absorbed
internally. ‘



An example of policies with these kinds of effects is“

the variable levy of the EC. The variable levy is a variable
import tariff set as the difference between the world
price and a predetermined EC import price. Because the
levy can change from day to day, imported agricultural
products covered by this policy can never enter the EC
at a price less than the EC import price, known as the
threshold price (Peterson 1985). Thus, if the world price
increases or decreases, the variable levy is adjusted so
that the price within the EC is not affected by the world
price change. On the other hand, a shock within the EC
can be shifted to the world market, thereby increasing
world price instability. Suppose the weather in the EC
has been particularly good and the corn harvest is much
larger than normal. Because internal prices cannot fall
below the threshold price, EC corn consumption will
not change. The only effect of the supply shock will be
to reduce EC imports which will tend to depress the
world price. Thus, a policy such as the EC variable levy
reduces instability internally by shifting the burden of
adjustment to the world market.

In terms of price stability, the least disruptive trade
barrier is an ordinary tariff (Blyth). An ad valorem tariff,
for example, allows fluctuations in world price to be
transmitted to the internal market. Also, variation in
domestic output is not prevented from causing a decline
in internal prices. The impact of an internal supply shock
is at least partially absorbed by the market in the import-
ing country where the shock occurred. Import quotas
and VERs lead to greater world price instability because,
as with the variable levy, quantities imported are limited
to a predetermined amount (Blyth). In general, trade
barriers tend to increase instability on world markets by
shifting the burden of adjustment out of the internal
market. On the other hand, variability originating in the
world market is more likely to disrupt domestic markets
if free trade exists than if countries employ trade barriers.

The way in which quality restrictions affect the
dynamics of prices and markets depends on the specific
situation. If the restrictions eliminate trade in a given
commodity, any shocks must be absorbed entirely by
the internal markets. Although an autarkic country is
unaffected by world market variation, it is unable to shift
a portion of the adjustment burden due to internally

$3

generated shocks to the world market. The result may‘

be increased internal instability. To the extent that quality
restrictions lead some countries to cease participating
in world trade, the world market will be thinner and
more vulnerable to destabilizing shocks. Often, trade
barriers stabilize internal markets and destabilize world
markets. Quality restrictions may have the disadvantage
of contributing to greater instability in both domestic
and world markets.

.'_ ~
w‘

In summary, quality restrictions used as barriers to
trade have several disadvantages compared to more con-
ventional barriers. From the regulating country’s point
of view, they reduce the choices available to consumers,
generate no quota rents, and may contribute to increased
domestic instability. For the rest of the world, quality
restrictions frequently are a discriminatory barrier affect-
ing some, but not necessarily all, exporting countries. If
they are highly restrictive, the result may be greater
instability in World markets and larger efficiency losses
than with more conventional trade barriers. In other
words, quality restrictions may be the least desirable
way to protect producers. If the motivation for imple-
menting a quality restriction is to protect consumers,
the environment, or livestock from harmful substances,
these disadvantages are likely to be of little concern.
However, if the primary motivation for implementing a
quality restriction is to protect producers from foreign
competition, better methods are available to accomplish
that objective, at least from the economic perspective.

19

a

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1.8M—2/88