Could the banana dispute between the European Union and the US get worse? Yes, if the EU goes ahead with its idea of implementing a high tariff-only policy.

The World Trade Organisation has ruled seven times that the EU's highly distortive banana regime is illegal. In addition, the US has applied various trade sanctions because Brussels has not complied with the WTO's repeated rulings. So the EU now faces pressure from two separate quarters to conform to WTO rules.

The current system relies on quotas, licences and preferential access for Lome ACP (African, Caribbean, Pacific) and EU producers. Quota restrictions raise EU consumer prices. The stated objective of the policy is for high consumer prices to provide benefits for preferred suppliers from ACP countries and EU regions - a form of aid. In reality, it is a ridiculously inefficient form of aid, because it costs consumers $13 (€12) to transfer each dollar of aid to producing countries.

Most of the high consumer price does not reach the intended beneficiaries: it is siphoned off as extra profits by trading companies with licences to import and market bananas within the EU.

Licences are allocated in ways that discriminate against some marketing companies, particularly US-based groups, in favour of EU-based ones. The US complaint against the policy hinges on this discrimination.

But the policy also discriminates against the banana exports of efficient Latin American producers. Reduced access costs them dearly, particularly as some Latin American producers are poorer than the ACP countries the EU regime is meant to support.

One of the reform options the EU is considering is a discriminatory tariff-only policy. If it were set at €275 a tonne - the level some people are hinting at - and applied to Latin American imports but not ACP imports, it is likely to greatly reduce EU imports of Latin American bananas.

This is bound to create frictions and add to the costs of the policy. A tariff of €275 a tonne on Latin American bananas would equate to an ad valorem rate of 110 per cent in the country of origin. That would restrict Latin American competitiveness relative to ACP producers with potential to expand and who are not required to pay the tariff.

More worrying still, the high tariff would be associated with elimination of quota restrictions on ACP bananas that currently constrain ACP preferred access. Together, these changes would open up big opportunities for efficient African ACP producers to expand production and steal EU market share from Latin American suppliers.

My estimates suggest the African expansion would halve Latin American exports to the EU. Given that the EU currently imports about 40 per cent of all bananas traded globally, such a development would wreak havoc among Latin American suppliers. Not only would they lose large amounts of EU sales, world prices for all their other sales would decline substantially as they redirected unsold EU sales to other markets.

The high-tariff solution makes no economic or political sense. The EU stands to gain nothing. The marketing companies the EU is so desperately trying to protect with the policy would lose their privileged position, which presumably represents a big political cost to the EU.

Most of the existing losers from the current policy would continue to lose or see their losses escalate. Latin American producers and their marketers could see their business halved.

EU consumers would still pay well above the world price for bananas. And African suppliers would emerge as a new group of highly aid-dependent producers, with all the attendant long-term problems and costs that arise from subsidised agriculture and preferential access. Furthermore, as African producers expand to exploit their new windfall preferences, EU tariff revenue would decline.

A high tariff-only option is no answer to the banana trade dispute. One solution, however, stands out as the obvious option. It involves a transition, over a defined number of years, to a low-tariff arrangement to raise funds to directly provide compensatory aid to ACP countries. This is a highly efficient way to deliver aid: it could be targeted at competitive industries within ACP countries, it would cost consumers little, and it would not fall foul of WTO rules.

Brent Borrell is chief market economist with Australia's Centre for International Economics - (Financial Times Service)