U.S.-China Phase 1 Trade Deal: A Win for U.S. Farmers?

After a year of negotiation, the U.S. and China finally reached a phase 1 trade deal that is scheduled to be signed on January 15, 2020. As part of the trade deal, China has promised to purchase a significant amount of agricultural products from the U.S. According to U.S. Trade Representative Robert Lighthizer, China would purchase 40 billion to 50 billion dollars of agricultural products annually over the next two years under the deal.

There has been scepticism over whether China will be able to import such a large amount of U.S. farm products. On January 2, a China's buy list (expected) is released online. Here, I compare the amounts in the list with historical trade data to get a sense how "big" the Chinese purchase is. Since the trade deal has not been signed yet, it is unsure that if the list would be the final one to be used.

1. The (expected) China's buy list   
According to the list, China is expected to buy: Soybeans (34.0 million ton), Sorghum (5.0 million tons), DDGs (5 million tons), Corn (5.5 million tons), Wheat (4.5 million ton),  Ethanol (2.0 million tons), Cotton (2.5 million ton), Dairy products (2 million tons), Broilers (1.6 million tons), Beef ( $1.0 billion worth), Rice ($600 million worth).

2. Historical Trade Data   
Figure 1 shows annual U.S. exports (in quantities) of several agricultural products to China from 2010 to 2018. The horizontal dashed lines represent the amounts of agricultural products that China is expected to buy. The data show that the expected purchases for corn, cotton, dairy products, and wheat are higher than the observed exports to China in any year during 2010-2018. Notably, for corn, cotton, dairy products, and wheat, the expected purchases are almost four times as high as the historical exports. For DDGs, sorghum, and soybeans, the expected purchases are not much higher than the historical exports.

Though not shown in figure 1, the expected purchases for beef products and rice are also much higher than the historical exports. The U.S. exported 60 million dollars of beef to China in 2018, the highest level in the recent history. The U.S. rice exports to China has always been lower than 5 million dollars since 2010. If China purchases 600 million worth of rice, the rice farmers could really benefit. In fact, China has been a large rice importer. In 2018 alone, China imported 3 million tonnes of rice that worth 1.6 billion dollars, mainly from Thailand, Vietnam, and Pakistan.

3. Discussions
Historically, China has been stick to the self-sufficiency policy, under which agricultural imports (especially for staple foods including rice, wheat and maize) are minimized (Chen et al, 2019). However, China's policy makers have been more positive about importing since 2010s. Given the sheer size of Chinese population, China has the potential to be a larger buyer of agricultural products. For U.S. farmers, market access to China is very valuable.

The expected purchases from China of agricultural products might be surprisingly good, since they look much higher than the historical U.S. exports to China. Yet, the promises (if the list is truly used) made by China are not beyond the realm of possibility. Besides, increasing agricultural imports are in alignment with the China's agricultural policy of increasing agricultural imports to certain degree.

Expanding agricultural imports from the U.S. is at odds with China's intention to diversify the sources of agricultural imports. (Import diversification has been emphasized in China's government reports.) Yet, this is only a problem for corn. We can see from figure 1 corn exports to China dramatically declined in 2014. This is a year that China starts to import corn from Ukraine, which is part of the strategy of import diversification (Gale et al., 2015). Nevertheless, the bilateral U.S.-China trade deal as a policy shock will likely affect the global agricultural markets. More analyses are needed to understand the possible global impacts of the trade deal.

Brief on the Trade Dispute regarding Tariff Quota Administration between the U.S. and China

* This report has been published at AgManager by Department of Agricultural Economics of the Kansas State University. Please see the link to the published paper from here.

Suggested citation: 

Chen, B., "WTO Dispute Panel Report on China’s Administration of Grain Tariff-Rate Quotas". Kansas State University Department of Agricultural Economics Extension Publication. April 26, 2019.

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General background

In December 2016, the U.S. launched a dispute request against China at the World Trade Organization (WTO) over China's tariff quota administration for imports of maize, rice and wheat. Later in September 2017, the WTO established a panel to investigate this dispute, and the panel issues its final report today (April 19, 2019). This final report will become the ruling or recommendation within 60 days, unless a consensus rejects findings of this report (a rare case in the history).

What is tariff rate quota and tariff quota administration?

1. Tariff rate quota is a two-tiered trade tariff system: the first-tier tariff rate is applied to in-quota imports and the second-tier tariff is applied to out-of-quota imports. Currently, nearly 43 countries have a combined total of 1,425 tariff quotas for various agricultural commodities.
2. Tariff quota administration involves allocating the quotas among quota applicants, and it determines who has the quota and how many quotas can be used for importing at the in-quota tariff rate.

Key features of tariff rate quota policy in China

1. China implemented the policy in grain markets in 2001 when joining the WTO; 
2. The in-quota tariff rate for most grain products is 1%, and the out-of-quota tariff rate is 65%; 
3. The National Development and Reform Commission of China (NDRC, a government agency) administers the quota allocation and distribute quotas between two types of firms: State-trading Enterprises (STEs) and non-State-trading Enterprises (non-STEs). 
4. The majority shares of quotas, i.e., 90% for wheat, 60% for maize and 50% for rice, are reserved to STEs; 
5. Unused quotas of non-STEs shall be returned to NDRC and then reallocated to quota applicants. It is a matter of legal debate that whether the STEs shall return the unused quotas.

What is under dispute?

The U.S. claimed that “China’s administration of its TRQs for wheat, rice, and corn violates six obligations that China has committed: (1) administer TRQs on a transparent basis; (2) administer TRQs on a predictable basis; (3) administer TRQs on a fair basis; (4) use clearly specified administrative procedures; (5) use clearly specified requirements; (6) administer TRQs in a manner that would not inhibit the TRQ fillings.

The U.S. challenged China in six different aspects and provided evidence to support its claim from each aspect: (1) the basic eligibility criteria; (2) the allocation principles and the reallocation procedures; (3) public comment process; (4) the administration of STE and non-STE portions of TRQs; (5) public notice; and (6) the usage requirements. Table 1 at the end of the document summarizes the arguments of both the U.S. and China and the panel analysis in each aspect.

What is in the panel report?

The report by the WTO panel listed arguments of both the U.S. and China about the tariff quota administration. This report also provided the assessments of the WTO panel on the related disputed issues. As I learn from the report, the WTO panel has focused on two points. First, are the legal instruments concerning the TRQ administration issued by China consistent with China's legal obligations? Second, are the practices of the NDRC, the government agency administering the quotas, are in alignment with the legal instruments and with the China's legal obligations? The legal obligations are to administer TRQs on a transparent, predictable, and fair basis, to use clearly specified requirements, and to not inhibit the TRQ fillings.

What are the findings of the panel report?

The panel concluded that China’s administration of its grain TRQs are inconsistent with its legal obligations regarding tariff quota administration in all six aspects challenged by the U.S. except in the public notice aspect. In addition, the panel concluded that the way that China administers STE and non-STE portions and the usage requirements could inhibit the filling of TRQs. Based on the conclusion, the panel recommends the Dispute Settlement Body to request China to bring its TRQ administration measures into conformity with its legal obligations.

To what extent has the tariff quote administration reduced China’s imports?

The trade impacts of the tariff quota administration are not discussed in the panel report, but are extensively studied in my recent paper with Dr. Villoria and Dr. Xia. The paper is only available upon request since it is still under peer review. An outdated version of our paper is yet available online here.

Economic costs of African swine fever to China pork market - a rough estimate

African swine fever (ASF) “is a highly contagious haemorrhagic viral disease of domestic and wild pigs, which is responsible for serious economic and production losses”, according to World Organization for Animal Health. As reported by Reuters, "over the last three months, China has reported almost 50 outbreaks of the highly contagious disease in 13 provinces." Currently, the Chinese government is still working to prevent the further spread of the virus. For instance, China has culled 200,000 pigs following 41 African swine fever outbreaks in the country on October 19, according to Reuters, even though the number is very small relative to the total number of pigs raised in China (430 million).

The occurrence of ASF in China will induce a negative supply shock in China's pork market. Pork price is very likely to increase, especially when there is no negative shock in demand. The question is: to what extent that the pork price will increase? Besides, given the sheer market size, it is important to understand how the domestic producers and consumers would be impacted by the ASF. Here I attempt to answer these questions by using the Equilibrium Displacement Model (EDM).

1. The model

The EDM model is a partial equilibrium model that has been widely used to evaluate the impacts of demand or supply shocks. For those who are interested in the model, I prepare a one-page handout that offers a brief graphical explanation (from Dr. Nathan Hendricks). Briefly speaking, the model derives for price changes following the demand or supply changes based on demand and supply elasticities. Then, the derived price changes are combined with the elasticities to calculate the changes in consumer and producer welfare. Here I use a closed-economy EDM model since pork imports only account for 4% of domestic consumption, according to the USDA PSD database. 

To run the model, I collect estimates of elasticities from the agricultural economics literature. The price elasticity of demand for pork is -0.67 (Chen et al., 2015). The price elasticity of supply for pork is 0.128 (Zhuang and Abbott, 2005). Besides, I also collect consumption and price data from the USDA report. In 2017, The domestic consumption of pork is estimated to be 55 million tonnes, and the average pork price is 25 RMB per kg (roughly 3.6 USD per kg). The model is then calibrated to the China's pork market in 2017.  

2. Simulation results

(1) Price changes

The figure below shows the simulated percentage changes in pork price in China given some hypothetical decreases in pork supply. We see that the pork price is likely to increase by 7% if the pork supply decreases by 5%. If the pork supply decreases by 10%, the pork price in China will increase by 12%. The pork price is a bit sensitive to the supply shock mainly because the demand elasticity is low (or pork consumers are insensitive to the price changes). If demand in elastic, price change will be small. 

(2) Welfare changes

My simulation shows that pork producers will be largely negatively affected. If the pork supply reduces by 5%, the pork producers will loss 63 billion dollars; meanwhile, the pork consumers will loss about 12 billion dollars. This number, divided by the Chinese population which is 14 billion, is 86 cents (or 6 RMB). In total, the social welfare will decline by 75 billion dollars given a 5% supply shock. The change in social welfare is dominated by the change in producer surplus. Besides, the social welfare loss will be higher if the supply shock is larger. For instance, the social welfare will decline by 150 billion dollars if the supply shock is -10%. 

3. Conclusion

Here I present a simple welfare analysis of the African swine fever in China's pork market based on the Equilibrium Displacement Model. Imports are not accounted due to its relative small size. However, pork imports will likely grow in China following the negative supply shock, offsetting some of the negative welfare impacts. Nevertheless, I find that Chinese pork producers could be largely impacted by the ASF, with possible 63 billion losses in their welfare in a hypothetical scenario with 5% negative supply shock.

This analysis faces several caveats. First, I do not consider the elasticity uncertainty. Results are potentially sensitive to the elasticity inputs. Second, I solve this model using linear approximation method, and the approximation might perform badly when the supply shocks are large. Third, the analysis ignores the supply chain effect. The shock transmission might be escalated or lessened depending on the market structure. Lastly, no policy response is considered. 

The U.S. might be the only loser in the soybean fight with China

China imposed 25% tariffs in the last week on U.S. soybeans as a retaliation to U.S. tariffs on Chinese products that worth 34 billion dollars. Theoretically, both consumers in China and producers in the U.S. would be hurt in this fight. It is an empirical question that which side would loss more in terms of welfare. And this is the probably the question that matters the most.

1. The economics
To see this, I draw a simple demand-supply diagram below (figure 1) that demonstrates the welfare distribution with the tariffs imposed. In figure 1a, ED denotes the excess demand curve (of China), and ES denotes the excess supply curve (of US). The interaction of the two curves defines the equilibrium. In figure 1a, the equilibrium price is p0. When tariff is imposed, the domestic price in China increases to p2, and the world price (or US price) declines to p1. The price gap between p2 and p1 is the tariff rate. At the new equilibrium, Chinese consumers loss the area of A in terms of consumer surplus; and the US producers loss the area of B in terms of producer surplus.

Which area is larger, A or B? Figure 1a shows a case that A is larger than B. However, it might not be the case. Shown in figure 1b, when the excess demand curve is more elastic, the A could be smaller than B. We can definitely calculate them once the excess demand and excess supply curves are estimated. Yet, we can still take a good guess before doing these. Notice that in figure 1a, the new world price p1 is closer to p0, the initial equilibrium price. This is the case that A is larger than B. In figure 1b, p1 is further away from p0; this is the case that A is smaller than B. Simply speaking, the US producer might loss relatively more if the world price drops significantly.

2. The data
The Global Information Early Warning System of FAO (link) records the US international soybean price at weekly basis. I find that on July 13th, the US soybean price at the Gulf has declined by around 15%, relative to the price (around 400 dollars per tonne) in May. What does it mean to China? China pays 400 dollars per tonne in May. After the tariff is imposed, China pays around 420 dollars per tonne (after accounting for the tariff). Hence, the price that China pays increase by 5% (=420/400-1) only after 25% of import tariff is imposed!

3. Conclusion
China is a big soybean importer. This means that China's demand has a large influence on the world price. The terms-of-trade effect could offset most of the price effect of the tariff shock. In this case, what is happening now is that US producers sell their soybean at lower prices, while consumers in China might not even feel any big difference.

Why Pork?

On April 1st, China announced to retaliate on US pork industry. In my previous post, I analyzed the ag trade between the U.S. and China (see here). One message from that post is that China imports quite a bit of agricultural commodities from the U.S.. The analysis leaves me with one more question: why does China choose pork to retaliate on? What is special about pork? Here are two possible reasons.

(1) Pork exports matter to Iowa (or maybe the voters of Iowa)! 
In a talk (here) and a presentation (here), Dr. Glynn Tonsor analyzed the structure of US pork exports. One of his argument is that China's share on US pork exports has been declining in recent years. Therefore, China's retaliation on pork would not have high impacts on US pork exports overall. This is true. However, this does not sound right from China's perspective. Why would China act on this if it has limited impacts on the U.S. agriculture?

So, I dig into the US export data and find something interesting. In the figure below, I plot the value of pork exports by states. The data are from the ERS of USDA (see link here). The dataset is not perfect in terms of capturing the state exports, but the ERS has tried hard to get them. The figure clearly shows that Iowa is the major state that exports pork. Due to the data limitation, I do not know how much of the Iowa pork were shipped to China. However, it is for sure that the Iowa farmers are at stake. Why Iowa? This might be related to the current political environment in the U.S.. This is beyond the scope of my knowledge. The readers could dig more into this.

(2) US pork has lost market shares in China.
Note that the pork tariff would potentially increase domestic prices and hurt the consumers in China. However, the data show that China's reliance on US for pork has been dramatically declined in recent years.

In the figure below, I show the total import value of China for pork (in bars) and the US shares (in lines) during 2009-2016. The figure shows something important. During 2011-2015, China's total pork imports were rather steady (around 2 billion dollars). However, the US share dramatically declined from 58% to 18%. The lost shares have been filled by some EU countries, including Germany (a large pork producer in the region), Spain and Denmark (these are not shown in the graph). I am not sure about the reasons behind the change in import structure. Is it the price effect? or policy effect? This needs further investigation. However, this pattern implies that the EU countries can quickly substitute the US as pork suppliers to China. In a nutshell, the low import share from the US and the existence of EU as alternative suppliers make China resilient to the tariff shocks. 

Agricultural Trade between the U.S. and China.

On April 1st, China's Ministry of Finance announced to impose steep tariffs on a list of US products (see the Chinese version of announcement here). China claims that the action is to respond to the tariffs that were recently imposed on imports of steel and aluminum in the U.S.. 

Several agricultural commodities are included in the list. For instance, 25% tariffs are imposed on "pork and its products". China is a large importer of the U.S. agricultural products. Hence, it is not surprising that China would target at the U.S. agricultural products for retaliation. But, what agricultural commodities can be affected? and how large the impacts could be?

In the figure below, I plot the total export values of U.S. agricultural commodities and the shares that China takes. These are averaged values during 2014-2016. The data are sourced from the US Department of Agriculture. I select commodities that China took more than 10% of the export shares ( in addition to pork).   

The figure shows that China's share on soybean is the largest, amounting to 60%. Meanwhile, the U.S. export value is around 22 billion dollars, which is pretty high. This suggests high possible impacts of soybean tariffs by China on the U.S.. A study by Dr. Tyner and Dr. Taheripour found that "if China imposed 30% tariff, its imports of U.S. soybeans could drop by 71%. Meanwhile, total U.S. soybean exports could fall by 40%" (see link here).

China also takes high export shares in distillers grains (41%), hides (51%) and coarse grains (85%). The coarse grain is mainly sorghum. However, the total U.S. export values of these three commodities are less than 5 billion dollars.

China's share on forest products is 27% and the total U.S. export value is around 9 billion dollars. The forest products mainly include various kinds of limber, such as red oak and white oak and so on. Hence, tariffs on these products would also have prominent impacts on the U.S. agricultural economy.