1. “Normalizing Trade Relations with Cuba: GATT-compliant Options for the Allocation of the U.S. Sugar Tariff-rate Quota”

Presented By: Devry S. Boughner International Trade Analyst Office of Industries Agricultural and Forest Products Division United States International Trade Commission Presentation based on a paper by Devry S. Boughner and Jonathan R. Coleman, “Normalizing Trade Relations with Cuba: GATT-compliant Options for the Allocation of the U.S. Sugar Tariff-rate Quota,” The Estey Centre Journal of International Law and Trade Policy, Vol. 3, No. 1, 2002, http://128.233.58.173/estey/index.htm. [Introduce myself and Jonathan.] [Introduce title and explain based on a recently published paper in the Estey Journal of International Law and Trade Policy. Both countries are members of the WTO, and if sanctions were removed, Cuba would likely want access to the U.S. sugar market. Cuba is not currently part of the U.S. allocation scheme, so what rights does have and what obligations does the United States have? Would the U.S. be required to provide access to Cuba? If so, how much? What criteria would be used to determine Cuba’s allocation? What tariffs would apply to Cuba, MFN or preferential tariffs? Other complications--expropriated properties (sugar mills and refineries) with claims to land. Very complicated legal issues that need to be resolved [law and economics] Economic point of view in a legalistic framework. [Lawyer joke] [Introduce myself and Jonathan.] [Introduce title and explain based on a recently published paper in the Estey Journal of International Law and Trade Policy. Both countries are members of the WTO, and if sanctions were removed, Cuba would likely want access to the U.S. sugar market. Cuba is not currently part of the U.S. allocation scheme, so what rights does have and what obligations does the United States have? Would the U.S. be required to provide access to Cuba? If so, how much? What criteria would be used to determine Cuba’s allocation? What tariffs would apply to Cuba, MFN or preferential tariffs? Other complications--expropriated properties (sugar mills and refineries) with claims to land. Very complicated legal issues that need to be resolved [law and economics] Economic point of view in a legalistic framework. [Lawyer joke]

2. The structure of my presentation is as follows: I will provide brief background on the historical trade relations between the United States and Cuba with respect to sugar, which is something that I am sure I do not need to explain in detail to this group. In fact, most of you could probably provide me a lesson or two on that issue. Then, I will spend a few moments on the legal considerations involved in normalizing trade relations with Cuba. Mostly, I will discuss the considerations in the international context. That is, the considerations as they apply to the General Agreement on Tariffs and Trade. Then, I will briefly cover the six allocation options that we have selected as GATT-compliant options. The options for allocation are impacted by the timing for normalizing trade relations with Cuba, and so I will spend a few minutes on this issue. Finally, in conclusion, I will provide the policy implications for each of the selected options. The structure of my presentation is as follows: I will provide brief background on the historical trade relations between the United States and Cuba with respect to sugar, which is something that I am sure I do not need to explain in detail to this group. In fact, most of you could probably provide me a lesson or two on that issue. Then, I will spend a few moments on the legal considerations involved in normalizing trade relations with Cuba. Mostly, I will discuss the considerations in the international context. That is, the considerations as they apply to the General Agreement on Tariffs and Trade. Then, I will briefly cover the six allocation options that we have selected as GATT-compliant options. The options for allocation are impacted by the timing for normalizing trade relations with Cuba, and so I will spend a few minutes on this issue. Finally, in conclusion, I will provide the policy implications for each of the selected options.

3. Until the suspension of imports in July 1960 following the expropriation of property owned by U.S. nationals in Cuba, the U.S.-Cuba relationship with respect to sugar had become highly interdependent. Cuba provided the United States with a proximate, stable source of raw sugar, such that by the late 1950s Cuban sugar accounted for about 35 percent of annual U.S. domestic consumption. Meanwhile, the United States served as Cuba’s primary export market for raw sugar, receiving more than one-half of Cuba’s annual exports and providing a guaranteed and profitable market. The United States favored Cuban sugar by allocating 72 percent of the total U.S. import quota to Cuba and granting it a tariff rate 20 percent below that faced by other countries. Until the suspension of imports in July 1960 following the expropriation of property owned by U.S. nationals in Cuba, the U.S.-Cuba relationship with respect to sugar had become highly interdependent. Cuba provided the United States with a proximate, stable source of raw sugar, such that by the late 1950s Cuban sugar accounted for about 35 percent of annual U.S. domestic consumption. Meanwhile, the United States served as Cuba’s primary export market for raw sugar, receiving more than one-half of Cuba’s annual exports and providing a guaranteed and profitable market. The United States favored Cuban sugar by allocating 72 percent of the total U.S. import quota to Cuba and granting it a tariff rate 20 percent below that faced by other countries.

4. The imposition of sanctions affected both the U.S. and Cuban sugar industries. With the loss of Cuban sugar, U.S. refiners were forced to seek alternative suppliers. This was done by reallocating the share of import quota previously held by Cuba to other sugar-producing nations that were more than willing to supply the lucrative U.S. market. The economic rents that had previously been captured by Cuba were thus transferred to other countries such as the Philippines and Dominican Republic. Cuba did not fare as well as the United States, at least initially, losing an estimated $120 million annually in economic rents from its preferential access and forcing alternative markets to be found. Over time, Cuba increasingly turned to the Soviet Union who agreed to take most if its sugar mainly bartered for oil at extremely favorable terms of trade. The imposition of sanctions affected both the U.S. and Cuban sugar industries. With the loss of Cuban sugar, U.S. refiners were forced to seek alternative suppliers. This was done by reallocating the share of import quota previously held by Cuba to other sugar-producing nations that were more than willing to supply the lucrative U.S. market. The economic rents that had previously been captured by Cuba were thus transferred to other countries such as the Philippines and Dominican Republic. Cuba did not fare as well as the United States, at least initially, losing an estimated $120 million annually in economic rents from its preferential access and forcing alternative markets to be found. Over time, Cuba increasingly turned to the Soviet Union who agreed to take most if its sugar mainly bartered for oil at extremely favorable terms of trade.

5. Since the imposition of sanctions, there have been drastic changes in both countries’ sugar industries. Real tension exists--U.S. oversupplied and sensitive to imports and Cuba searching for preferential markets for sugar. Since the imposition of sanctions, there have been drastic changes in both countries’ sugar industries. Real tension exists--U.S. oversupplied and sensitive to imports and Cuba searching for preferential markets for sugar.

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7. Within the constraints of the U.S. commitments, we have identified six allocation options that appear to be GATT-compliant options. Within the constraints of the U.S. commitments, we have identified six allocation options that appear to be GATT-compliant options.

8. Using a FCFS basis is coined “globalizing the TRQ,” which essentially refers to opening the quota to exports of sugar from any country in the world. Under the FCFS scheme, the low in-quota tariff rate would be applied to imports arriving at U.S. ports at the beginning of the quota period that claim entry thereunder and would continue in force until the TRQ were filled. Imports arriving beyond the quota level would face the higher over-quota tariff rate. Under the FCFS method of allocation, no over-quota imports would be allowed until the TRQ were completely filled. Currently, countries not holding quota can export unlimited quantities at the over-quota rate, regardless of whether or not the TRQ fills. Under the FCFS system the United States would not be required to grant Cuba a specific share of the TRQ, but instead Cuba would have to compete with other sugar exporting countries for a share of the U.S. imports. FCFS option has often been deemed the option closest mirroring unrestricted trade, as countries must “compete” for access; however, given that the rents still provide incentives for inefficient producers to export sugar to the United States, competition is distorted. The FCFS method encourages exporters to be the first in line at the border on the opening day of the TRQ season in order to capture the economic rents associated with being the first to enter their sugar into the United States (a practice referred to as “a run for the border”). Another downside to the FCFS method is that often exporters may not know whether they will face the in-quota or the over-quota tariff until the product actually arrives at the border, or even after arrival when shipments hit different ports at the same time, possibly causing efficient exporters to divert their sugar to guaranteed markets other than the United States. Using a FCFS basis is coined “globalizing the TRQ,” which essentially refers to opening the quota to exports of sugar from any country in the world. Under the FCFS scheme, the low in-quota tariff rate would be applied to imports arriving at U.S. ports at the beginning of the quota period that claim entry thereunder and would continue in force until the TRQ were filled. Imports arriving beyond the quota level would face the higher over-quota tariff rate. Under the FCFS method of allocation, no over-quota imports would be allowed until the TRQ were completely filled. Currently, countries not holding quota can export unlimited quantities at the over-quota rate, regardless of whether or not the TRQ fills. Under the FCFS system the United States would not be required to grant Cuba a specific share of the TRQ, but instead Cuba would have to compete with other sugar exporting countries for a share of the U.S. imports. FCFS option has often been deemed the option closest mirroring unrestricted trade, as countries must “compete” for access; however, given that the rents still provide incentives for inefficient producers to export sugar to the United States, competition is distorted. The FCFS method encourages exporters to be the first in line at the border on the opening day of the TRQ season in order to capture the economic rents associated with being the first to enter their sugar into the United States (a practice referred to as “a run for the border”). Another downside to the FCFS method is that often exporters may not know whether they will face the in-quota or the over-quota tariff until the product actually arrives at the border, or even after arrival when shipments hit different ports at the same time, possibly causing efficient exporters to divert their sugar to guaranteed markets other than the United States.

10. The United States could allocate a country-specific quota to Cuba by reducing the quota allocated to current quota holders such that the overall level of the TRQ remained unchanged, but the relative shares of current quota holders were reduced to accommodate Cuba’s entry. Therefore, the size of the pie would not change, but the size of the individual slices would. The U.S. would add Cuba to the list of recipients and then perform the prorating of shares (taking a formula approach) as it did during the URAA. The United States should justify the choice of the newly selected historical base period under which it was able to calculate Cuba’s portion. In this case, choice of the base period presents some very real problems, and makes it impossible for the U.S. to make any formula driven allocations. Cuba has not exported to the U.S. in 40 years, so choosing a ‘representative base period’ based upon historical exports to the United States is virtually impossible unless a period pre-1960 is selected. The pre-1960 base period is not a viable option because at that time Cuba dominated the U.S. import market owing to its quota share; thus, an allocation based upon this period would mean that Cuba would receive practically all of the TRQ, at the expense of current quota holders. Meanwhile the current base period of 1975-81 is also not a viable option because Cuba was restricted from exporting to the United States during that period. There exists no historical base period for U.S. imports of sugar that would represent actual imports from Cuba and other countries if trade were normalized with Cuba. The United States may wish to seek alternative factors for redistribution of the TRQ, as opposed to using an arbitrary and unrepresentative base period. Because of sanctions, the United States could therefore argue that ‘special factors’ have affected trade in the product (citing Article XIII, paragraph 2(d)). In doing so, the United States might justify adding Cuba to the mix and then computing what Cuba’s exports would likely be, given the removal of the sanctions. That is, the United States could use production and consumption figures in Cuba to determine Cuba’s potential level of exports. From there, a reasonable amount could be allocated to Cuba, accounting for Cuba’s export commitments to other markets. The United States could allocate a country-specific quota to Cuba by reducing the quota allocated to current quota holders such that the overall level of the TRQ remained unchanged, but the relative shares of current quota holders were reduced to accommodate Cuba’s entry. Therefore, the size of the pie would not change, but the size of the individual slices would. The U.S. would add Cuba to the list of recipients and then perform the prorating of shares (taking a formula approach) as it did during the URAA. The United States should justify the choice of the newly selected historical base period under which it was able to calculate Cuba’s portion. In this case, choice of the base period presents some very real problems, and makes it impossible for the U.S. to make any formula driven allocations. Cuba has not exported to the U.S. in 40 years, so choosing a ‘representative base period’ based upon historical exports to the United States is virtually impossible unless a period pre-1960 is selected. The pre-1960 base period is not a viable option because at that time Cuba dominated the U.S. import market owing to its quota share; thus, an allocation based upon this period would mean that Cuba would receive practically all of the TRQ, at the expense of current quota holders. Meanwhile the current base period of 1975-81 is also not a viable option because Cuba was restricted from exporting to the United States during that period. There exists no historical base period for U.S. imports of sugar that would represent actual imports from Cuba and other countries if trade were normalized with Cuba. The United States may wish to seek alternative factors for redistribution of the TRQ, as opposed to using an arbitrary and unrepresentative base period. Because of sanctions, the United States could therefore argue that ‘special factors’ have affected trade in the product (citing Article XIII, paragraph 2(d)). In doing so, the United States might justify adding Cuba to the mix and then computing what Cuba’s exports would likely be, given the removal of the sanctions. That is, the United States could use production and consumption figures in Cuba to determine Cuba’s potential level of exports. From there, a reasonable amount could be allocated to Cuba, accounting for Cuba’s export commitments to other markets.

11. A further GATT-legal option would be simply to increase the total quota amount of the TRQ and allocate the extra quantity to Cuba; however, the amount allocated to Cuba should mirror the share of total imports Cuba would likely capture given the absence of the quantitative restriction. Thus, the United States would need to justify the allocation, but could rely on the ‘special factor’ clause found in Article XIII. The overall size of the TRQ would increase and the prorated levels would be altered. That is, adding Cuba to the allocation list would require the readjustment of allocation shares for each country, as in the previous option. The overall percentage of the TRQ granted to other countries would be lowered; however the size of the pie would be larger, so the absolute levels would not change for current quota holders. A further GATT-legal option would be simply to increase the total quota amount of the TRQ and allocate the extra quantity to Cuba; however, the amount allocated to Cuba should mirror the share of total imports Cuba would likely capture given the absence of the quantitative restriction. Thus, the United States would need to justify the allocation, but could rely on the ‘special factor’ clause found in Article XIII. The overall size of the TRQ would increase and the prorated levels would be altered. That is, adding Cuba to the allocation list would require the readjustment of allocation shares for each country, as in the previous option. The overall percentage of the TRQ granted to other countries would be lowered; however the size of the pie would be larger, so the absolute levels would not change for current quota holders.

12. If the tariff rate were set equal to the tariff equivalent created by the import quota, exports of sugar to the United States would equal the current level under the TRQ. In fact, because the TRQ does not always fill, imports would increase slightly to the actual level of the current TRQ. Any further liberalization could therefore occur under the auspices of a tariff reduction. Replacing the TRQ with a tariff would not conflict with U.S. commitments for tariff reductions made during the Uruguay Round because the tariff equivalent created by the import quota is lower than the bound over-quota tariff rate found in the United States’ Schedule of Concessions. Tariffication would remove the need to allocate shares of U.S. sugar imports to any country, and inefficient rent allocation would cease to exist since rents that were once captured by foreign exporters would be converted to tariff revenues for the U.S. Treasury. The level of imports of sugar under tariffication would be negatively correlated with the world price of sugar. The lower the world price, the lower the tariff, and thus the higher are the level of exports of sugar to the United States. The higher the world price, the higher the tariff, and subsequently, the lower are the level of exports of sugar to the United States. If complete tariffication is perceived to leave the U.S. sugar market vulnerable to world price swings, then a “range of safety” could be instituted. A safeguard tariff could be implemented so that if the world price falls below a certain level, the additional tariff would be triggered. As with the FCFS method, the United States would be in full compliance with GATT if the country tariffied the sugar TRQ; however, political backlash from domestic producers as well as from current quota holders would certainly result. Cuba is a high-cost producer. Costs of production are well above the world average. If the quota were removed and replaced with a tariff, then all preferences to inefficient, high-cost producers would be erased. Therefore, competition would prevail and the most efficient, low-cost producers would have the comparative advantage. In the short run, Cuba would most likely not be competitive in the world market.If the tariff rate were set equal to the tariff equivalent created by the import quota, exports of sugar to the United States would equal the current level under the TRQ. In fact, because the TRQ does not always fill, imports would increase slightly to the actual level of the current TRQ. Any further liberalization could therefore occur under the auspices of a tariff reduction. Replacing the TRQ with a tariff would not conflict with U.S. commitments for tariff reductions made during the Uruguay Round because the tariff equivalent created by the import quota is lower than the bound over-quota tariff rate found in the United States’ Schedule of Concessions. Tariffication would remove the need to allocate shares of U.S. sugar imports to any country, and inefficient rent allocation would cease to exist since rents that were once captured by foreign exporters would be converted to tariff revenues for the U.S. Treasury. The level of imports of sugar under tariffication would be negatively correlated with the world price of sugar. The lower the world price, the lower the tariff, and thus the higher are the level of exports of sugar to the United States. The higher the world price, the higher the tariff, and subsequently, the lower are the level of exports of sugar to the United States. If complete tariffication is perceived to leave the U.S. sugar market vulnerable to world price swings, then a “range of safety” could be instituted. A safeguard tariff could be implemented so that if the world price falls below a certain level, the additional tariff would be triggered. As with the FCFS method, the United States would be in full compliance with GATT if the country tariffied the sugar TRQ; however, political backlash from domestic producers as well as from current quota holders would certainly result. Cuba is a high-cost producer. Costs of production are well above the world average. If the quota were removed and replaced with a tariff, then all preferences to inefficient, high-cost producers would be erased. Therefore, competition would prevail and the most efficient, low-cost producers would have the comparative advantage. In the short run, Cuba would most likely not be competitive in the world market.

13. Discussion has circulated over including Cuba in current preferential trading arrangements such as the Caribbean Basin Economic Recovery Act, negotiating a separate bilateral agreement, or including Cuba in an existing free trade agreement (FTA) such as NAFTA. In order to grant Cuba a portion of the sugar TRQ under an existing trade agreement or a special bilateral agreement, the agreement must include ‘substantially all trade,’ not just trade in sugar. An importing country that applies a quantitative restriction cannot simply strike a side agreement on one product with a WTO-member without offering the same ‘privileges’ to the other members as well, or without obtaining a waiver from such members. The GATT requires that the elimination of trade barriers occur for ‘substantially all trade’ so as to guarantee that import sensitive sectors are not excluded. One way in which Cuba could receive access to the U.S. sugar market is through the allocation of its own TRQ; however in order for the allocation to comply with the GATT, the TRQ must be included in a current FTA such as the NAFTA or the FTAA, or in a full-fledged bilateral FTA with the United States (e.g., U.S.-Cuba FTA) such as the FTA the United States currently has with Israel, FTAs recently negotiated with Jordan and Singapore, and the FTA currently under negotiation with Chile. Allocating a separate TRQ to Cuba would increase the overall level of imports for sugar, which would most likely be unpopular with the U.S. producers. Under this scenario, total access to the U.S. market would include the TRQ under the WTO, and the TRQ with Mexico under NAFTA, as well as the TRQ with Cuba under a separate FTA. It should be noted that Cuba, while receiving access under the FTA, would still receive access under the WTO TRQ as well, as it is a member country. Discussion has circulated over including Cuba in current preferential trading arrangements such as the Caribbean Basin Economic Recovery Act, negotiating a separate bilateral agreement, or including Cuba in an existing free trade agreement (FTA) such as NAFTA. In order to grant Cuba a portion of the sugar TRQ under an existing trade agreement or a special bilateral agreement, the agreement must include ‘substantially all trade,’ not just trade in sugar. An importing country that applies a quantitative restriction cannot simply strike a side agreement on one product with a WTO-member without offering the same ‘privileges’ to the other members as well, or without obtaining a waiver from such members. The GATT requires that the elimination of trade barriers occur for ‘substantially all trade’ so as to guarantee that import sensitive sectors are not excluded. One way in which Cuba could receive access to the U.S. sugar market is through the allocation of its own TRQ; however in order for the allocation to comply with the GATT, the TRQ must be included in a current FTA such as the NAFTA or the FTAA, or in a full-fledged bilateral FTA with the United States (e.g., U.S.-Cuba FTA) such as the FTA the United States currently has with Israel, FTAs recently negotiated with Jordan and Singapore, and the FTA currently under negotiation with Chile. Allocating a separate TRQ to Cuba would increase the overall level of imports for sugar, which would most likely be unpopular with the U.S. producers. Under this scenario, total access to the U.S. market would include the TRQ under the WTO, and the TRQ with Mexico under NAFTA, as well as the TRQ with Cuba under a separate FTA. It should be noted that Cuba, while receiving access under the FTA, would still receive access under the WTO TRQ as well, as it is a member country.

14. Effects on Cuba’s access to the U.S. market could hinge on whether sanctions are removed before or after some critical upcoming policy events. All events could signal the end of the U.S. sugar program. The upcoming WTO negotiations for agriculture could have implications for Cuba’s access. In the international forum, sugar is a commodity under great scrutiny. The United States and EU sugar programs have often been at the center of heated discussions regarding trade liberalization. In the next round of negotiations, the United States faces possible increases in the sugar TRQ levels and reductions in over-quota tariffs. These reforms could have implications for the Cuban sugar industry, depending upon whether sanctions are still intact. If removal of sanctions occurs before the completion of the next round of negotiations, then Cuba would be an active member in negotiating the changes in the allocation of the larger U.S. sugar TRQ (if the TRQ remains in place and if the TRQ level is increased as a result of the WTO negotiations), meaning that it would gain access to the U.S. sugar TRQ. The TRQ may implode and become irrelevant with the passage of an FTAA that includes liberalization features for sugar. At that point, all sugar exported to the United States would operate in the realm of competition, resulting in the most efficient (or subsidized) exporters serving the U.S. market. A great deal depends upon Mexico and whether sanctions against Cuba are removed pre- or post- common market with Mexico. When the United States moves to a common market for sugar with Mexico, the current TRQ regime will be under tremendous pressure and may very well collapse. Mexico has the ability to ship large quantities of sugar to the United States, but has been limited by the TRQ structure negotiated under NAFTA. Once the structure is removed for Mexico, the United States will more than likely see increased imports of sugar from Mexico, which may drive the U.S. price below the support level (i.e., the loan rate). Domestic U.S. producers may then forfeit their sugar to the government, and in this case, the Mexican sugar will simply substitute for domestically produced sugar. Thus, the creation of the common market may result in the complete reworking of the U.S. domestic and trade sugar policy. Effects on Cuba’s access to the U.S. market could hinge on whether sanctions are removed before or after some critical upcoming policy events. All events could signal the end of the U.S. sugar program. The upcoming WTO negotiations for agriculture could have implications for Cuba’s access. In the international forum, sugar is a commodity under great scrutiny. The United States and EU sugar programs have often been at the center of heated discussions regarding trade liberalization. In the next round of negotiations, the United States faces possible increases in the sugar TRQ levels and reductions in over-quota tariffs. These reforms could have implications for the Cuban sugar industry, depending upon whether sanctions are still intact. If removal of sanctions occurs before the completion of the next round of negotiations, then Cuba would be an active member in negotiating the changes in the allocation of the larger U.S. sugar TRQ (if the TRQ remains in place and if the TRQ level is increased as a result of the WTO negotiations), meaning that it would gain access to the U.S. sugar TRQ. The TRQ may implode and become irrelevant with the passage of an FTAA that includes liberalization features for sugar. At that point, all sugar exported to the United States would operate in the realm of competition, resulting in the most efficient (or subsidized) exporters serving the U.S. market. A great deal depends upon Mexico and whether sanctions against Cuba are removed pre- or post- common market with Mexico. When the United States moves to a common market for sugar with Mexico, the current TRQ regime will be under tremendous pressure and may very well collapse. Mexico has the ability to ship large quantities of sugar to the United States, but has been limited by the TRQ structure negotiated under NAFTA. Once the structure is removed for Mexico, the United States will more than likely see increased imports of sugar from Mexico, which may drive the U.S. price below the support level (i.e., the loan rate). Domestic U.S. producers may then forfeit their sugar to the government, and in this case, the Mexican sugar will simply substitute for domestically produced sugar. Thus, the creation of the common market may result in the complete reworking of the U.S. domestic and trade sugar policy.

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16. That concludes my presentation. If you have any questions, I would be pleased to answer them now. That concludes my presentation. If you have any questions, I would be pleased to answer them now.

17. So just to show you that I am capable of wearing both hats, let me just say that this is not an official ITC study. The opinions expressed here are those solely of the authors and not the ITC or any of its Commissioners. I am definitely no lawyer, but I do need to mention that this paper is not a U.S. International Trade Commission paper. We have decided to publish this work outside of the agency and so you must know that this in no way reflects the opinions of the Commission or of any of its Commissioners. This paper is not part of the official government study that was conducted for Congress. So just to show you that I am capable of wearing both hats, let me just say that this is not an official ITC study. The opinions expressed here are those solely of the authors and not the ITC or any of its Commissioners. I am definitely no lawyer, but I do need to mention that this paper is not a U.S. International Trade Commission paper. We have decided to publish this work outside of the agency and so you must know that this in no way reflects the opinions of the Commission or of any of its Commissioners. This paper is not part of the official government study that was conducted for Congress.