Trade preferences can play only a limited role in LDCs

Updated: Mar 23 2005, 05:30am hrs
Improving the ability of the least developed countries (LDCs) to participate more in world markets can be a powerful way of stimulating growth and poverty reduction. To promote this end, industrial countries offer LDCs preferential access to their markets through lower duties in schemes such as the Generalised System of Preferences (GSP), the EUs Everything but Arms (EBA) scheme and the African Growth and Opportunity Act (AGOA) of the US.

In practice, however, the majority of developing countries receive little or no benefits from preferences. The argument for trade preferences is that the small scale of industry and the low level of development in LDCs lead to high costs, which reduce their ability to compete in global markets, and to lack of diversification, which increases risks. Trade preferences can provide a premium over the normal rate of return that may encourage investment in these economies. It is important, however, that the sectors that receive investment are those in which the country has a comparative advantage in the long-term and that investment not be based on a false comparative advantage due to the margin of preference.

Tariff preferences can, however, lead to several adverse effects. Preferences can be used to bolster external support for highly protectionist policies in industrial countries and to weaken proposals that would substantially reduce such levels of protection. Preferences can also create a degree of dependence that constrains flexibility and diversification and results in high-cost production of preferred products.

The beneficiaries of trade preferences are not always the poor. With agricultural preferences, for example, the main beneficiaries are typically the owners of land. Preferences will only have a strong impact on poverty if the landowners are poor.

For most countries in Africa, the preferences that are requested in Canada, the EU, US and Japan amount to a very small proportion of the value of exports. As such, the impact of preferences on these countries is likely to be very muted. Only a small number of countries receive substantial transfers under current preference schemes. These are driven mainly by preferences for sugar in the EU and for clothing in the US.

Why have preferences had such a small impact on the majority of beneficiaries First, many products produced in developing countries are subject to zero (MFN) duties in industrial countries and, therefore, no trade preference can be given. Second, products with high duties are typically excluded from preferences, or the preference margin is very small. For a small number of products, however, preference margins are substantial, though usually within strict quantitative limits and only for certain countries.

Third, many of the schemes are surrounded by uncertainty concerning their duration and the discretion that the donors have to exclude countries and products. This limits the incentives to invest in the developing countries to take advantage of preferences. Fourth, exporters in developing countries are often hampered in their ability to take advantage of preferences by the rules of origin.

In principle, trade preferences can assist development if they provide temporary margins of preference to enable industries to adjust and compete more effectively in global markets. However, for the majority of LDCs, preferences have had very little or no impact. This reflects in part the design of these preference schemes, but is also the result of severe constraints on supply in LDCs.

Preference schemes would be enhanced by (a) extending coverage to all products and making schemes permanent (as in the EBA) and (b) liberalising the rules of origin. The impact of preferences on developing countries would be facilitated by (a) addressing the internal barriers that raise the costs of trade for developing countries and (b) improving the domestic investment environment. The challenge is to find preference schemes that complement the domestic reforms that developing countries must undertake to improve the returns to exports without stifling diversification and multilateral trade liberalisation. Trade preferences are not a panacea for success, but should be seen as just one part of a strategy for export-led growth.

In this context, it is crucial that the developed countries do not treat preferences as a substitute for direct development assistance. Such assistance is crucial in alleviating key internal barriers which constrain supply responses in LDCs. Preferences cannot achieve this task. It is also crucial that allocations of development assistance are not distorted by preferences. While there is a need to address the difficulties that a small number of countries may face from preference erosion, such needs must not be met by redirecting assistance away from the large number of very low income countries that benefit little from preferences. At the same time, developing countries must not view preferences as an alternative to domestic reforms that are vital to improve investment conditions, to promote effective competition and to facilitate integration into the global economy.

The writer is with the poverty reduction and economic management department, international trade department, The World Bank