An Interplay between Internal and External Markets

Introduction

The multilateral regulatory framework of the World Trade Organization (WTO) sets substantive limits to the sovereign competence of the European Union (EU) to impose customs barriers to protect its internal market from products coming from outside the region. Although membership to the WTO is not an obligation, it is now extremely difficult to conceive the EU exiting the organization. By being a member of it, other countries or customs territories that are also members of that organization ¹ are also compelled to follow a set of rules in relation to the EU and its trade. Such rules relate to relevant aspects such as nondiscrimination, provision of freer market access, greater predictability for businesses, and fair competition. ²

As highlighted by the Trade Policy Review report on the EU prepared by the WTO’s Secretariat, in 2009, the EU accounts for some 17 percent of world merchandise trade. In addition, taken as a unit, the bloc is “the world’s largest trader in services, as well as the largest recipient and supplier of foreign direct investment (FDI), accounting for some 40 percent of global inward stock and over 50 percent of global outward stock,” being a net investor in the rest of the world. ³

Hence, being able to count on multilateral rules that provide a more stable and safer environment for EU’s exchange with the rest of the world is often considered as an extremely important matter to the EU trade policy. For that reason, as also noted in the Trade Policy Review report on the EU, “support for the multilateral trading system is at the core of the [EU’s] trade policy.” As a consequence, the EU has become “a major driving force behind the [current WTO] negotiations, having made numerous proposals in a wide range of areas.” ⁴ In this context, the limitations and commitments established within the multilateral framework of the WTO set boundaries that should not be crossed by the EU, as it agrees to share a set of common rules with other states within the international community at a multilateral level. ⁵

On the other hand, the process of economic integration undertaken by the EU in the past few decades has had an important component of fostering the trade within the region and stimulating its regional producers. Among other measures, these producers would benefit from an increase in the freedom of the internal market, combined with an advance of coordination toward a common external customs policy, in order to balance the competition stemming from external economic actors in line with the blocs’ productive and developmental objectives.

This article seeks to provide a brief analysis on an aspect of the formal interplay between internal and external markets through a case study on the EU dairy import tariffs and the way its broader multilateral regulation, provided by the WTO, can have effects on regional regulations and objectives by establishing limits to the margins of regulatory action that are found in the scope of the regional regulatory framework. We initially look at some of the relevant provisions of the EU’s regulatory framework related to tariff matters, as it is present in the framework of the Treaty on the Functioning of the European Union (TFEU), which relate to the EU’s current stage of economic integration. We briefly explore how those issues are dealt with in the broader framework of the WTO, at the multilateral level, and then analyze some aspects related to the levels of the EU’s Common Customs Tariff for the agricultural sector. ⁶ After that, we highlight some aspects about the socioeconomic importance of the dairy sector in the EU. Finally, we examine potential impacts that the new tariff commitments that are being discussed within the Doha Round of negotiations of the WTO can have over the EU’s capacity to protect its regional market and producers from the competition that comes from other parts of the globe.

Import Tariffs in the TFEU’s Regulatory Framework

The Treaty on the TFEU is one of the core pieces of legislation of the EU currently in effect. It sets relevant organizational and functional details of the regional integration bloc. ⁷ After the entry into force of the Lisbon Treaty, in December 2009, the newly established TFEU amended previously existing treaties, such as the Treaty on EU (also known as the Maastricht Treaty) and the Treaty Establishing the European Community, providing a consolidated regulatory framework concerning fundamental aspects related to the Union. Some of those aspects are of particular interest to this study, especially some of those related to the internal market, free movement of goods and the specification of the common customs area.

First of all, it is important to underscore that Article 28 of the TFEU, the first article under the title “Free Movement of Goods,” affirms that the EU “shall comprise a customs union which shall cover all trade in goods and which shall involve the prohibition between Member States of customs duties on imports and exports and of all charges having equivalent effect, and the adoption of a common customs tariff in their relations with third countries.” ⁸ From that, we can apprehend that a stimulus system was established in order to minimize barriers to the trade between Member States of the EU; thus, fostering such trade and the production done within the region. At the same time, the system that was set was based on the mandate for implementing a common, and therefore coordinated policy in terms of customs duties applied to goods coming from outside the Union. Thus, it established the mandate for setting common import tariffs. According to Article 31 of the TFEU, the competence to fix the levels of the Common Customs Tariff duties was assigned to the Union’s “Council,” which, on its turn, should decide after a proposal done by the “European Commission,” both of them bodies of the EU regional structure. ⁹

It should be emphasized that, as established by the TFEU, not only import tariffs but also quantitative restrictions on imports and all measures having equivalent effect are prohibited in trade between Member States. ¹⁰ Exceptions to this general rule can normally be applied in very particular cases, such as when justified on grounds of “public morality, public policy or public security; the protection of health and life of humans, animals or plants; the protection of national treasures possessing artistic, historic or archaeological value; or the protection of industrial and commercial property.” ¹¹ However, even in such cases, such restrictions must not “constitute a means of arbitrary discrimination or a disguised restriction on trade between Member States.” ¹²

The features of having (i) an institutionalized regional/internal market, as a general rule, free from import tariffs and free from quantitative restrictions to trade between Member States, combined with (ii) the coordination and definition of a common external tariff over imports from outside of the region, are traits that are typical of integration blocs that have reached the level of a “customs union” or a more advanced stage. According to M. D. Varella, ¹³ public international law recognizes five different levels of regional economic integration: preferential trade zone, free trade area, customs union, common market, and economic-monetary union. Each of those levels, normally, encompasses the features of the less advanced stages, added by one or a few steps further into the economic integration process. Taking into account its current stage, the EU is often classified as the closest example of the fifth stage mentioned, the economic-monetary union, for it presents, in addition to free movement of goods, services, and production, substantive advances in terms of integration of economic and monetary policies among Member States, as well as of the establishing of a common currency.

The Regulation of Regional Economic Integration Processes at the Multilateral Level

Looking through the prism of the multilateral regulation of international trade and, in particular, of the national and regional margins in terms of trade policies, one may observe that regional integration processes are, at the same time, an exception to global integration and a tool to enable it. As Varella explains,

On the one hand, [a regional integration process] is an exception to global integration because it creates benefits to some States, different from those set in the multilateral agreement. One of the basic principles of global economic integration, such as the example of the World Trade Organization, is the principle of most favored nation, on account of which any customs benefit granted by one State to another, shall automatically be extended to all the other members of the WTO. The regional integration systems are, therefore, exceptions to the principle of the most favored nation, because already from the simplest form of integration there are customs duties applied to the States that are part in the regional integration which are different from those set to the other States. On the other hand, it is a tool for global integration, for it enables that the States gradually give space for international competition. By opening their markets bits by bits, they can strengthen their local and regional industries, seeking to establish synergies, for then accepting a definitive reduction of barriers and the competition with other industries from the entire world. ¹⁴

The General Agreement on Tariffs and Trade (GATT), which is currently one of the agreements contained in the regulatory framework managed by the WTO, recognizes and stimulates two modalities of regional integration: the customs union and the free trade area. Other integration areas less comprehensive than those types are considered as provisional agreements, aimed at forming a customs union or a free trade area. Article XXIV of the GATT establishes parameters related to the formation and existence of areas of integration, in terms of trade policies, within the multilateral trading system. For the present analysis, it is important to highlight that in order to be recognized, and thus accepted by the multilateral system, all regional integration treaties must be notified to the WTO and follow parameters outlined in its normative framework. In case of failure to abide by the conditions set by the WTO, the States that are members of the WTO that are taking part in an integration region may be indicted through the Dispute Settlement Mechanism of the WTO for noncompliance with basic principles of the multilateral system. This could lead to an authorization by the WTO for other Member States to retaliate economically against the members of that integration region that were not formally recognized.

In the eyes of the WTO, the EU is currently formally recognized as a regional integration zone comprising “a single customs union with a single trade policy and tariff.” ¹⁵ Hence, in practical terms, and in spite of the fact that the twenty-eight member States of the EU are also members of the WTO in their own right, the “European Commission—the EU’s executive arm—speaks for all EU member States at almost all WTO meetings.” ¹⁶ This also means that the EU, in its Common Customs Tariff, has to abide by the commitments and limits resulting from the agreements established by means of the successive rounds of multilateral negotiations, which formally aim at promoting a progressive deepening of trade liberalization.

The Common Agricultural Tariffs of the EU within the Context of the WTO

From the very beginning, agricultural tariffs have been a sensitive issue for the EU in the GATT and the WTO, ¹⁷ and the current situation does not seem to be much different. The recently established TFEU reinforces the perspective that the EU’s policies shall aim at fostering an internal market that, among other things, provides for a “rational development of agricultural production and the optimum utilization of the factors of production, in particular labor” and which ensures “a fair standard of living for the agricultural community, in particular by increasing the individual earnings of persons engaged in agriculture.” ¹⁸ At the same time, as will be seen, the current round of multilateral negotiations of the WTO, the Doha Round, ¹⁹ puts on the EU substantive pressure for cuts to its Common Customs Tariff for some of its most relevant/sensitive products, which could force an opening of the EU internal market to the competition of foreign producer at an extent that could negatively affect agricultural production and employment inside its integration area. As can be seen from Figure 1, the EU maintains substantially high tariff peaks for relevant agricultural products, especially some of those that fall into the category of staple foods ²⁰ and that are relevant in terms of rural employment in the region.

OPEN IN VIEWER

Figure 1.

Agricultural import tariff structure of the European Union: Distribution following the classification of the international Harmonized System (HS). Source: Institute for International Trade Negotiations (ICONE), according to the Food and Agriculture Organization of the United Nations. Food and Agriculture Organization of the United Nations, “Tariff Reduction Formulae: The Importance of Tariff Profiles,” in FAO Trade Policy Briefs on Issues Related to the WTO Negotiations on Agriculture, No. 2 (Rome, Italy: Food and Agriculture Organization of the United Nations, 2005). Note: Non ad valorem tariffs have been converted to their ad valorem equivalents.

As analyzed by French researcher Jacques Berthelot, the EU has 141 agricultural tariff lines (i.e., product items in its tariff structure), which correspond to up to 8 percent of its agricultural tariff lines, especially those considered most sensitive, for which it applies import tariffs higher than 100 percent, with some even exceeding 250 percent. ²¹ From these figures, one can observe that a tariff profile with high peaks for products that are sensitive to the EU in terms of food and rural livelihood security is an important element in the external trade aspect of the agricultural policy of the bloc.

The current Doha Round of multilateral negotiations of the GATT–WTO system, in its market access pillar within the agricultural negotiation, has set a mandate requiring that, upon the conclusion of the Round, all member countries and regional formally recognized integration areas reduce their current levels of import tariffs. Taking into account that the tariff structures of the different WTO members are substantially different, negotiations relating to the new commitments in terms of tariff reductions are based on the definition of a generic formula of cuts. Such a formula establishes differentiated cuts depending on the current tariff levels that the Member concerned is currently allowed to apply for protecting its internal market. As part of the special and differential treatment granted to developing country members, the formula that has been being discussed sets different specific levels of cuts and thresholds for developing countries as compared to those corresponding to developed countries. Since, we are here analyzing the formula concerned through the lenses of a regional integration bloc, that is, in the category of developed members of the WTO, we shall focus on the respective parameters of the formula related to this category.

The general formula for tariff cuts—as sketched in the “Revised Draft Modalities for Agriculture” put forward in 2008 (a key document that systematized the state of the art of the advances in the agricultural negotiation within the Doha Round of the WTO) sets out a tiered approach. ²² By means of this approach, each developed member of the WTO shall identify its particular import tariffs structure in relation to the different corresponding tiers established by the formula and then apply the corresponding cuts respective to each tier. To better understand this, let us look at the tiered formula as it has been described in the text of the “Revised Draft Modalities for Agriculture”:

A Brief Case Study: The EU Dairy Tariffs and Implications of the Potential Multilateral Commitments

According to G. Ernst, the dairy sector figures as the most important rural activity in the EU. The production of milk accounts for about 20 percent of the total final agricultural value produced in the region. It is found in 17 percent of the total number of rural estates, representing about 27 percent of the total area destined to agriculture in the bloc. ²⁷ The relevance of the dairy sector to the EU goes much beyond a merely economic aspect. As underscored by the European Commission:

The dairy sector is of great importance to the European Union (EU) in a variety of ways. Its most striking feature is that milk is produced in every single EU Member State without exception. Dairy is the most prominent sector in many regions of the EU, often regions of particular value for their landscape and environment (for example, mountainous areas). Dairy farming has helped to shape those landscapes. Dairying therefore has an importance that goes far beyond simple statistics. Dairy farming gives many rural areas their distinctive character, and a thriving milk sector is important for the economy and employment. ²⁸

As presented in Figure 1, the dairy sector is among those that are most protected by the EU in terms of trying to secure the supply of the internal market mostly by producers in the region. On one hand, the EU has an average import tariff of 87 percent for dairy products (coming from outside the region), which is substantial considering that it almost doubles the price of entrance of a foreign dairy product into the bloc’s territory. ²⁹ On the other hand, if we look beyond the average numbers, we will observe that some dairy products—usually the most sensitive and the most tradable—for which the EU import tariffs are significantly above 100 percent, with levels reaching close to 200 percent in ad valorem equivalents. ³⁰ This is mostly explained by the multifunctional relevance that the sector presents for the region, as indicated previously.

Taking this scenario, if the EU were to fit its average dairy tariff into the tiered formula being negotiated in the Doha Round of the WTO, we would observe that such a tariff, currently of 87 percent, would have to be reduced by 70 percent, for it would be placed in the tier of tariffs that are currently above 75 percent. Hence, the average tariff would have to fall to around 26 percent.

Even using the exception to the regular tiered formula that was previously mentioned, which would allow the EU to deviate by up to two thirds from the normal tariff cut, the outcome would not necessarily be very comfortable. First of all, because the EU would have to “pay” for it, (most probably) by granting a duty free access to a certain volume of foreign dairy products that is substantial enough to compensate for the deviation from the regular tariff cut. This means that, for a certain share of the EU’s internal market, the foreign competitors would face a similar entrance condition, in term of customs tariffs, as the producers located inside bloc. In other words, in relative terms, the preference that was previously set only to the producers of the region would end up partly mitigated.

In addition to the necessity of compensating the other Members of the WTO with quotas for freer access to its internal market, the EU would encounter some relevant limitations in terms of deviating too much from the regular tariff cut. If we consider that some of the individual dairy tariffs that compose that 87 percent average reaches up to about 200 percent (in the case of some dairy products/subproducts), we will see that even a cut that is two-thirds smaller than the regular cut would not necessarily turn out to be as effective in maintaining the current protection to the European producers inside their own common market. For, as already mentioned, one of the rules under negotiation in the Doha Round of the WTO is that which could establish a tariff cap of 100 percent.

Therefore, even if the EU were to apply a tariff cut that was two thirds smaller than the regular 70 percent cut ³¹ —applicable to the tier of higher tariffs—over a dairy product, the tariff of which is currently around 200 percent, this tariff would first drop to 153 percent, but, then, afterward, it would have to be further reduced down to 100 percent, the maximum level that would be allowed at the end of the implementation of the commitments of the Doha Round.

Hence, in cases such as this, the regional bloc faces a dilemma. It has to take a position on whether (a) to agree that the necessity imposed by the advance of external (multilateral) commitments promotes substantial alterations in the relative conditions of competition of its internal producers (in relation to the producers of other countries from outside the region) or (b) to work toward negotiating greater margins of flexibility—within the agreement that is under negotiation—which would provide more “policy space” for the region to protect, through its common external tariffs policy, its internal sectors that it considers relevant, thereby avoiding mitigation of the preferences that were primarily conceded to the internal producers and traders.

In this latter solution, there is usually a negotiating price to be paid in return, either by means of the reduction of the ambitions of the EU when demanding deeper commitments from the other Members of the international trading system or by offering deeper openings of its internal market in other sectors or areas that are not considered to be so sensitive.

Conclusion

This article has presented an analysis of an aspect of the interplay between internal and external markets and respective regulatory frameworks. From what has been discussed, we can observe that, on one hand, undertaking a negotiation, and trying to consolidate new and more precise commitments of other Members in the multilateral arena, may generate benefits to a regional bloc such as the EU in terms of its trade with the world, providing more predictability and safety. On the other hand, at the same time, it suggests that the margins of the regional bloc to regulate and preserve its own internal market, especially access to it, are not absolute. As an active Member of the WTO, the EU has to comply with the limits that are established within such multilateral organization’s treaties. In the case of import tariffs, there are limitations established concerning the maximum levels of customs duties that can be applied by Members. In addition, by means of subsequent rounds of negotiations, those levels are usually subject to demands for progressive reduction.

As we highlighted in the analysis of the dairy sector, which is similar to what happens in other sectors of the EU such as bovine and pork meat and processed cereal grains, among others, we may observe that the bloc has opted to establish the duties of its Common Customs Tariffs at a substantially high level. This has been done as part of a regional integration and developmental policy in order to provide the producers of the region with a relative degree of competitiveness that is different (more beneficial) than the one that has been set for producers and traders outside the region. Internally, the regional producers benefit from the free movement of goods, which enables them to sell between countries of the bloc without having to pay import tariffs.

However, whenever a formal external commitment—such as from a treaty resulting from negotiations within the WTO—requires the regional bloc to lower its external customs tariffs, in practical terms it alters the balance of competitiveness between regional producers and external producers who seek to sell their goods in the bloc’s internal market. On the side of the regional producers, there was already no import tariff to be paid, and after the new tariff commitment, the import tariff remains the same (at zero). On the side of the external producers that intend to export to the EU, there was initially a high tariff to be paid to have access to the region’s internal market. With the tariff reduction commitment, the level of the tariff to be paid to get access to the internal market of the bloc becomes lower. Hence, in relative terms, a process of preference erosion occurs. If, on one hand, this may foster global integration, on the other it may affect particular regional objectives, such as those set out by the EU in its TFEU about the agricultural sector and its multiple functions to be preserved.

Therefore, what this analysis highlights is an important interplay between the rules concerning the functioning of regional/internal markets and the broader regulations established within the multilateral trading system, which is now strongly centered under the jurisdiction of the WTO. Taking this into account, policies aimed at further deepening integration processes—both those looking up from a regional perspective and the ones looking down from the prism of a broader process of global integration—will have to understand the different objectives that play a role in the distinct arenas that intersect. This is currently a necessity for enabling the identification of viable paths for promoting effective advances in terms of integration between nations without damaging important local and regional concerns.