Trade preferences for the LDCs: Opportunities not panaceas

10 March 2016

The US should implement a DFQF program for all LDCs that covers as close to 100 percent of products as possible, and more than the minimum 97 percent it promised at the Sixth Ministerial Conference in Hong Kong. All preference programmes for LDCs should make rules of origin simple to use and flexible in meeting the needs of LDCs, including by incorporating cumulation zones that extend beyond narrow regional groupings to as much of the developing world as possible. Aid for trade initiatives should experiment with models that pay for development outcomes, rather than measuring results by the number of inputs delivered.

One of the main aims of trade is to enable consumers to choose from a wider variety of goods at lower prices and firms to grow and create more jobs by becoming more productive and accessing larger markets. However, these opportunities are often elusive for the least developed countries (LDCs). In 2000, the share of LDCs in world exports was under 1 percent, one-third of what it had been in 1970. In 2014, the LDC share of global exports had recovered modestly, to 1.2 percent.

There are many reasons for these patterns, but rich-country policies that discriminate against exports from poor countries play a key role. To promote LDC trade, WTO members agreed in Hong Kong in 2005 to provide duty-free and quota-free (DFQF) market access to those countries. Substantial progress has been made since then, but key gaps remain.

And it is even more important to address these gaps now that the global community has shifted to a new sustainable development agenda for the next 15 years. There is more attention to the need for economic growth and job creation as the foundation for sustainable development and poverty alleviation, and trade can help. After briefly reviewing where things stand and where the major gaps are, this article makes three recommendations for filling them.

The current status of DFQF market access for LDCs

Over the course of the 2000s, advanced economiesbegan to commit at the UN, as part of the Millennium Development Goals, and at the WTO ministerial in Hong Kong, to provide DFQF market access for LDCs. In 2000-01, the EU introduced the Everything But Arms (EBA) program for LDCs and the US implemented the African Growth and Opportunity Act (AGOA).

While average tariffs in high income countries are in the low single digits, the tariff peaks that remain are generally in sectors where poor countries have a comparative advantage: agricultural and food products, textiles and apparel, footwear, and other light manufactures. This is what makes trade preferences still of value.

Where the programmes have comprehensive product coverage and reasonable rules of origin, LDC exports benefiting from these high preference margins responded. Imports of clothing from Bangladesh and Cambodia increased immediately after Canada implemented its DFQF program in 2003, when Japan did so in 2007, and when South Korea expanded access for LDCs in 2010.

Even under its most generous programmes, US market access is not quota-free. There are still tariff-rate quotas for sensitive agricultural products, most notably sugar and confectionery, and there are caps on the volume of clothing that Haiti or AGOA beneficiaries can export to the US market without having to meet a costly rule of origin that would require the use of US fabrics. Moreover, unlike other advanced economies, the US has yet to provide meaningful preferential access for Asian LDCs.

A pragmatic proposal to improve US market access for LDCs

US trade preferences for LDCs cover only about 80 percent of tariff lines and the program excludes key labour-intensive products, including footwear, textiles, and apparel. The AGOA offers much better access, providing duty-free (but not quota-free) market access for 98 percent of tariff lines for less developed beneficiaries, not all of whom are LDCs.

For the Asian LDCs that are outside of regional arrangements, including Afghanistan, Bangladesh, Cambodia, Nepal, and Yemen, less than one percent of their exports to the US entered under preferences in 2012. Opposition to the proposal from the textile and sugar industries in the US is echoed by African apparel exporters that are concerned about erosion of their preferences under the AGOA. However, detailed analysis of US trade data suggests that excluding just a few dozen tariff lines (at the 10-digit level) would shield most AGOA and Haitian clothing exports, while DFQF treatment on the other apparel tariff lines would lower barriers for half or more of Bangladeshi and Cambodian exports.

US preference programmes, including the AGOA, also exclude sensitive agricultural products that are restricted under tariff-rate quotas (TRQs). Sub-Saharan African countries produce and export many of these products to other markets including the EU, yet they have little, if any, access in the US market. Expanding benefits for agricultural exporters would thus expand the number of African countries that benefit from AGOA preferences beyond the handful of apparel exporters that do so currently.

Current TRQ allocations, however, are based on historical trade patterns from several decades ago when US-Africa trade was minimal. For example, Malawi and Mozambique have small quotas to export sugar to the US market, but Zambia has none at all. Western African cocoa exporters have no specific quota access at all for chocolate or other confectionery that contains quota-restricted sugar or dairy products.

The pro-trade and pro-development approach would be to exempt LDC beneficiaries (and most would be African) from the TRQ restrictions, but that is not politically feasible. For TRQ products where there is unused and unallocated quota, the Obama Administration could reserve a portion specifically for AGOA countries (or LDCs) with minimal, if any, objection from current quota-holders. For example, the “other” category under the chocolate TRQ is only about half filled in most years, leaving about 8,000 metric tonnesthat could be reserved for Africa to encourage job creation in downstream processing of cocoa.

Making rules of origin less burdensome

Preferential trade arrangements include rules of origin to protect against the possibility of trade deflection—whereby goods are simply transhipped through beneficiary countries in order to qualify for preferential market access. These rules require that any imported inputs used in the production of the good receiving preferences must be “substantially transformed” in the beneficiary country. The problem is that preference-giving countries define “substantially transformed” in a range of ways with varying degrees of transparency and complexity.

When included, the general rule for apparel in most US trade agreements and preference programmes requires that the inputs must undergo “triple transformation”: clothing items must be produced from local fabric in the beneficiary country, or in the US using either local or US yarn, and then be cut and assembled in the beneficiary country. In the case of AGOA, however, the US has a single transformation rule for apparel exports from eligible beneficiaries. Researchers have estimated that the shift to a single transformation rule of origin for apparel under the AGOA led to a four-fold increase in exports for the top seven beneficiaries under that program.

The ministerial declaration on rules of origin for LDCs that was adopted in Nairobi last December offers useful principles for reducing the restrictive impact of these rules. It remains to be seen whether preference-giving countries will embrace it in practice or not. Mutual recognition of one another’s rules across the rich countries might be one alternative. In that case, preference givers would agree that an import that qualifies for preferential treatment in one market would be accepted as eligible in any other.

An even easier alternative is “extended cumulation,” which the Nairobi declaration encourages. With cumulation, preference beneficiaries are allowed to source inputs from a defined group of countries, the “cumulation zone,” and still have the final product be considered eligible for preferential treatment. In the case of apparel, extended cumulation is equivalent to the single transformation rule under the AGOA. If adopted with respect to countries in Africa, extended cumulation should be designed so as not to discourage regional integration in Sub-Saharan Africa and to encourage South-South trade liberalisation more broadly.

Preferences are not a panacea

The poorest countries face an array of other barriers besides market access that preference programmes cannot directly address. Exporters in countries without paved roads, or where red tape and inefficient customs hold up trade for days or weeks, will find it difficult to take advantage of preference programmes. Preference-giving countries should create mechanisms for dialogue and cooperation with LDC beneficiaries to address these other obstacles.

Targeted capacity-building assistance for LDCs should also be better coordinated with preference programmes. Building adequate physical infrastructure in countries without it will take years and billions of dollars, but in many cases trade costs can be significantly lowered with far more modest investments in trade facilitation activities.

In delivering aid for trade, donors should also consider using more results-based mechanisms to help reinforce reform efforts in recipient countries. Another idea for stimulating private investment in developing countries involves donors helping to underwrite "service guarantees" for businesses that would be available to both local and foreign investors covering areas such as customs clearance, licensing, and power supply in export processing zones. By providing some assurance that reforms will be sustainable, these proposals would help draw private investors to Africa and reassure donors that their aid dollars are being used effectively.

A slow evolution towards progress

The Tenth WTO Ministerial Conference which took place in Nairobi at the end of 2015 delivered some modest outcomes, including decisions on agriculture, cotton, and issues related to LDCs. A commitment from the US to move on improved market access for all LDCs was not on the list.

The signing of the Trans-Pacific Partnership in February will leave Asian LDCs at a competitive disadvantage in the US market, which US policymakers could mitigate by improving access for those very poor countries. If the LDC Group at the WTO could unite behind a compromise that expands preferences for Asian LDCs on all but a small number of apparel lines that are important to AGOA exporters, it would be difficult for US negotiators to continue to ignore the issue.

In light of measures in the Ministerial Decision to facilitate the global integration of LDCs, China and India should announce further improvements in product coverage under their DFQF initiatives and Brazil should, finally, begin to implement the program it announced years ago.

Trade preferences may be of less value than in the past, but they remain an important tool to address continued discrimination against LDC exports.

This article is an adaptation of a longer paper “Trade Preferences for the Least Developed Countries: Opportunities Not Panaceas,” October 2015, E15 Initiative.

Author: Kimberly Ann Elliott, Senior Fellow, Center for Global Development.

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