Trade Note May 16, 2005 The Value of Trade Preferences for Africa Improving the ability of the least which they raise actual returns in developed countries (LDCs) to developing countries. participate fully in world markets can be a powerful way of stimulating The arguments underlying trade preferences growth and poverty reduction. To are that the small scale of industry and the The promote this end, industrial countries low level of development in developing World Bank offer developing countries preferential countries lead to high costs, which reduce Group access to their markets through lower their ability to compete in global markets, www.worldbank.org duties. In this note we discuss the and to lack of diversification, which magnitude of the preferences granted increases risks. Developing countries, by the EU, Japan and the US to sub- especially least developed countries, face Saharan African countries and show much higher trade-related costs than other that only a small number of countries countries in getting their products into actually receive substantial international markets. Some of these costs preferences. may reflect institutional problems within the countries themselves, such as inefficient International The Role of Trade Preferences practices or corruption, which require a Tariffs introduce a wedge between the domestic policy response. They also reflect Trade world price of a product and the price weak transport infrastructure in many Department in the domestic market. This price countries and firms' lack of access to premium normally accrues to the standard trade facilitating measures such as importing country government as insurance and trade finance. tariff revenue. With preferences these rents may go to the developing Trade preferences may provide the premium country beneficiary raising returns to over the normal rate of return that is the activity concerned and, depending required to encourage investment in these on the nature of competition in economies. The increase in trade due to ByPaulBrentonand domestic product and factor markets, preferences leads to more output and, if Takako Ikezuki stimulate expansion of the activity, there are scale economies, to lower costs, with implications for wages and which stimulate further trade. It is employment. important, however, that the sectors that These notes summarize receive preferences and investment are those recent research on global However, if there is little effective in which the country has a comparative trade issues. They reflect solely the views of the competition among buyers/importers advantage in the long term and that author, and do not in the developed country then the investment not be based on a false necessarily reflect the views suppliers/exporters in the developing comparative advantage due to the margin of of the World Bank Group or its Executive Directors. country may be unable to acquire preference. much of the price premium. Ozden and Olareaga (2005) find that only Tariff preferences can, however, lead to Trade Note 21 one third of the available rents for several adverse effects. Negotiations under African exports of clothing to the US the Doha Round have shown that under AGOA actually accrue to the preferences can be used to bolster external exporters. In addition, as will be support for highly protectionist policies in discussed below, the costs of industrial countries and to weaken proposals satisfying the rules governing that would substantially reduce such levels preferences reduces the extent to of protection. Preferences can also create a TRADE NOTE May 16, 2005 degree of dependence that constrains countries under AGOA and the GSP flexibility and diversification and results in amounted to 1.3 per cent of the value of high-cost production of preferred products exports to the US. Japanese preferences to (Topp 2001). The beneficiaries of trade sub-Saharan African exporters amounted to preferences are not always the poorest 0.1 per cent of the value of exports. The constituents in developing countries. When next columns of the table show that the rents do accrue to the developing country, value of preferences to non-LDCs is higher they tend to accrue to the owners of the than that for LDCs in the EU schemes, most intensively used factors. With while this situation is reversed for the US agricultural preferences the main and Japanese schemes. beneficiaries are typically the owners of land. Preferences will typically only have a These benefits are highly concentrated upon strong impact on poverty if the landowners a small number of beneficiaries. (Table 1) are poor. So, even when preferences create Under the EU schemes, 60 per cent of the substantial transfers for producers in benefits accrue to 5 countries. For the US, developing countries, they may not the top 5 beneficiaries account for almost stimulate the long-term growth of exports or three-quarters of the value of preferences, reduce poverty, and it can lead to a less while for Japan nearly 90 per cent of the diversified export base. preferences go to the top 5 countries. For the LDCs, the top 10 beneficiaries account for The Value of Preferences Offered by the 100 per cent of the benefits under the US EU, Japan and US and Japanese schemes and more than 90 per Table 1 summarizes our calculated value of cent of the benefits offered by the EU EU, US and Japanese preferences for sub- schemes. Thus, the value of preferences for Saharan African countries in 2002. We the remaining 37 countries (although they allow for the fact that both the EU and the are not the same countries in each case) is US have schemes that offer enhanced very small. preferences beyond those of the standard Generalised System of Preferences (GSP). Preferences are also concentrated upon a The US has introduced the African Growth small number of sectors, especially for the and Opportunity Act (AGOA) while the EU LDCs. In the EU schemes these are mainly has the Cotonou Agreement and Everything agricultural products (sugar, fruits and But Arms (EBA) for the least developed processed meat and fish). US preferences countries, actually special provision in the are dominated by clothing (knitted and not EU's GSP scheme. The value of preferences knitted) and mineral fuels. Fish, Iron and is derived from the value of exports which steel and nickel dominate Japanese actually request preferences multiplied by preferences. Almost one third of the value the preference margin and is the implicit of EU preferences is derived from sugar, the transfer of tariff revenue due to the market for which is highly distorted. These preference scheme, all of which we assume preferences, which will be affected by the goes to developing country. This is domestic reform of this sector in the EU, presented in the tables as a share of the total should be distinguished from general trade value of exports to each market. preferences that arise only from a tariff preference in otherwise non-distorted The table shows that the overall value of EU sectors. preferences to sub-Saharan African countries under the Cotonou Agreement and Table 2 classifies the individual countries in under the EBA/GSP amounted to just 4 per Africa according to the combined magnitude cent of the value of those countries exports of non-oil preferences in the EU, Japan and to the EU in 2002. The value of US US expressed as a proportion of total non-oil preferences for sub-Saharan African exports. For only 5 countries do preferences 2 TRADE NOTE May 16, 2005 Table1: Summary of the Impact of Trade Preferences for Sub-Saharan Africa (2002) Sub-Saharan Africa (total) LDCs Non-LDCs EU US Japan EU US Japan EU US Japan Value of preferences/ total exports (%) 4.0 1.3 0.1 2.3 2.1 0.4 5.1 1.1 0.1 Share of top 5 beneficiaries in total value of preferences requested (%) 59.9 73.9 88.9 73.8 98.8 95.8 76.9 92.9 98.7 Share of top 10 beneficiaries in total value of preferences requested (%) 80.1 95.4 97.7 91.2 100.0 100.0 97.5 99.3 100.0 Share of top sectora in total value of preferences (%) 31.3 31.9 41.0 37.1 51.5 70.9 34.5 33.4 31.9 Share of top 3 sectorsa in total value of preferences requested (%) 56.5 79.6 63.6 68.5 91.3 92.2 65.2 71.3 56.8 adefined at the 2 digit level of the harmonised system Table 2: Classification of Sub-Saharan African Countries by Magnitude of the Value of Combined (non-oil) Preferences in the EU, Japan and US Relative to Total (non- oil) Exports (2002) Angola, Burundi, CAR, Chad, Congo, Countries for whom the value of Congo Dem, Djibouti, Eq. Guinea, Gabon, preferences is less than 1% of the value of Guinea, Liberia, Mali, Níger, Nigeria, their total exports Rwanda, S.Tome et Princ., Somalia, South Africa Benin, Botswana, Burkina Faso, Cameroon, Countries for whom the value of Cape Verde, Comoros, Eritrea, Etiopía, preferences is between 1% and 5% of the Ghana, Ivory Coast, Mauritania, Sierra value of their total exports Leone, Sudan, Tanzania, Togo, Uganda, Zambia Countries for whom the value of preferences is greater than 5% and less Gambia, Guinea Biss., Kenya, Madagascar, than 10% of the value of their total Mozambique, Namibia, Senegal, Zimbabwe exports Countries for whom the value of preferences is greater than 10% of the Lesotho, Malawi, Mauritius, Seychelles, value of their total exports Swaziland 3 TRADE NOTE May 16, 2005 amount to more than 10 per cent of the the incentives to invest in the developing value of total exports. For 35 of the countries to take advantage of preferences. countries, -- 73 percent of the total number Fourth, exporters in developing countries of sub-Saharan countries -- preferences are often hampered in their ability to take amount to less than 5 per cent of the value advantage of preferences by the rules of of exports. For 18 countries preferences are origin. There are two elements of the costs negligible, amounting to less than 1 per cent of these rules (i) the additional costs that are of exports. incurred in sourcing inputs and designing production structures to ensure So, for most countries in Africa, the compatibility with the requirements preferences that are requested in the EU, stipulated by the rules of origin (ii) the US and Japan amount to a very small costs, in terms of documentation, proportion of the value of exports. As such maintenance of complex accounting systems the impact of preferences on these countries and the expenses incurred in obtaining the is likely to be very muted. Only a small relevant certificate, in proving conformity number of countries receive substantial with the rules (see Trade Note 4). transfers under current preference schemes. These are driven mainly by preferences for Here we have concentrated on the nature of sugar in the EU and for clothing in the US. the preferential schemes which limit their impact. But there are important issues Why Do Trade Preferences Fall Short of relating to the beneficiaries capacity to Their Potential? satisfy other requirements for market access, Trade preferences have not transformed the such as, mandatory standards and quality export and growth performance of most demands of consumers and broader developing country beneficiaries, although constraints relating to transportation, energy performance may have been worse without and so on, all of which constrain the supply them and a few countries may have response to preferences, and trade benefited substantially. Trade preferences opportunities in general, in developing have not enabled beneficiaries as a group to countries. increase their market shares in the main preference-granting markets. Why? Conclusions In principle, trade preferences can assist First, many products produced in development if they provide temporary developing countries are subject to zero margins of preference to enable industries to MFN duties in industrial countries, and adjust and compete more effectively in therefore no trade preference can be given. global markets. Multilateral trade Second, products with high duties are liberalization contributes to this outcome by typically excluded from preferences or the ensuring that preferences have a short "half- preference margin is very small. For a small life" and that inefficient, high-cost number of products, however, preference industries with entrenched lobbies do not margins are substantial, though usually constrain flexibility and adjustment. within strict quantitative limits and only for Multilateral liberalization is also important certain countries. Some countries that have for limiting the long-term trade diverting been granted preferential access for sugar impact of preferences on other countries and tobacco, for example, have received (typically these will be other developing large transfers due to preferences. countries). Third, many of the schemes are surrounded In practice, only a small number of by uncertainty concerning their duration and countries receive large transfers as a result the discretion that the donors have to of preferences in OECD markets. The exclude countries and products. This limits values of preferences are largest in the EU 4 TRADE NOTE May 16, 2005 market, driven by a narrow range of stifling diversification and multilateral trade products and the very high EU price for liberalization. Trade preferences are not a sugar. In very few countries, such as panacea for success but rather should be Mauritius, preferences appear to have seen as just one part of a strategy for contributed to a relatively strong economic export-led growth. performance and economic diversification (Subrmanian 2003). In some other countries, In this context, it is crucial that the preferences have led to large transfers, but developed countries do not treat preferences domestic industries have experienced rising as a substitute for direct development costs and declining output and have assistance. Such assistance is crucial to accumulated large debts.1 Nonetheless, the progress in alleviating key internal barriers majority of beneficiaries of U.S., EU, and which constrain supply responses in Japanese preferences have experienced developing countries. Preferences cannot little or no impact. Preferences have done achieve this task. It is also crucial that little to stimulate the export of a broader allocations of development assistance are range of products. not distorted by preferences. While there is a need to address the difficiulties that a Preference schemes would be enhanced by small number of countries may face from · Extending coverage to all products and preference erosion, such needs must not be making schemes permanent (as in the met by redirecting assistance away from the EBA). large number of very low income countries · Liberalizing the rules of origin and that do not benefit from preferences. At the simplifying the process of certifying same time, developing countries must not compliance. If all schemes had the same view preferences as an alternative to simple and easy to apply rules a domestic reforms that are vital to improve producer in a least developed country investment conditions, to promote effective could make production and investment competition and to facilitate integration into decisions on the basis of equal and the global economy. predictable access to all industrial markets. The impact of preferences on developing countries would be facilitated by · Improving the domestic investment environment. · Addressing the internal barriers that raise the costs of trade for developing countries--inadequate and high-price 1 transport services, reflecting lack of For example, Mitchell (2005) concludes that infrastructure and lack of effective despite substantial preferences most Caribbean competition in many countries, sugar producers are not competitive and will need to close or restructure. inadequate and unreliable energy supply, inefficient customs practices, and lack of trade-supporting financial and telecommunications services. The challenge is to find preference schemes that compliment the domestic reforms that developing countries must undertake to improve the returns to exports without 5 TRADE NOTE May 16, 2005 References Mitchell, D (2005) `Sugar in the Caribbean: Adjusting to Eroding Preferences', Policy Research Working Paper, World Bank, forthcoming Ozden, C and M. Olarreaga (2005) `AGOA and Apparel: Who Captures the Tariff Rent in the Presence of Preferential Market Access?' World Economy, 28, 63-77 Topp, V (2001) `Trade Preferences: Are they Helpful in Advancing Economic Development in Poor Countries?' ABARE Further Reading Brenton, P and T. Ikezuki (2005) `The Impact of Agricultural Trade Preferences, with Particular Attention to the Least Developed Countries', A. Aksoy and J. Beghin (eds) Global Agricultural Trade and Developing Countries, World Bank, Washington D.C. Hoekman, B and C. Ozden (2005) `Trade Preferences and Differential Treatment of Developing Countries: A Selective Survey', Policy Research Working Paper 3566, World Bank. Stevens, C and J. Kennan (2005) `Making Trade Preferences More Effective', Trade Note, IDS, http://www.ids.ac.uk/IDS/global/pdfs/CSJKTradePreferences.pdf This Trade Note was written by Paul Brenton, Senior Economist, and Takako Ikezuki, Junior Professional Associate Economist, of the International Trade Department, The World Bank. Comments from Elke Kreuzwieser and Faezeh Foroutan on the paper underlying this note are gratefully acknowledged. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author and do not necessarily reflect the views of the Board of Executive Directors of the World Bank or the governments they represent. This Trade Note can be downloaded at http://www.worldbank.org/trade. 6