Monday, December 27, 2010

How developed countries can boost LDCs’ exports

Adapted from Katriin Elborgh-Woytek and Robert Gergory’s piece in the latest edition of IMF’s Finance & Development magazine.

There are steps the poorest economies themselves could take to boost exports—such as reducing the often prevailing antitrade bias in their trade, tax, customs, and exchange rate regimes; issuing more transparent trade and customs regulations; and taking steps to improve such key service sectors as communications and transportation (see World Bank, 2010).

But the poorest exporting economies would benefit considerably if emerging as well as advanced economies gave them better opportunities for trade, which would improve their growth and productivity prospects (see Elborgh-Woytek, Gregory, and McDonald, 2010). There are a number of steps better-off countries could take to boost poor economies’ export potential. Some of them are well known to policymakers—in particular, concluding the current World Trade Organization (WTO) trade-negotiation talks, known as the Doha Round. Wide-ranging multilateral trade liberalization could spur growth and foster secure and open global trading. Poorer countries would gain from successful Doha Round conclusion through better access to advanced and emerging export markets.

Although broad-based multilateral trade liberalization is the ultimate policy target, there are less-obvious intermediate avenues—such as the extension and improvement of duty-free and quota-free (DFQF) trade preferences both by advanced and emerging economies—that could add nearly $10 billion a year to the coffers of poorer economies. These preference systems are designed to offset for the poorest countries some of the high trade barriers in sectors such as light manufacturing and agriculture—areas in which LDCs are likely to export.

There are three main avenues for the more advanced and emerging economies to help integrate LDCs into the global economy:

  • Remove all tariffs and quotas on products from LDCs.
  • Make the rules that determine whether a product is deemed to originate from an LDC more flexible and consistent—including relaxing so-called cumulation rules, which govern the extent to which inputs from other countries affect compliance with rule-of-origin requirements for LDC exporters.
  • Tilt preference benefits more specifically toward poorer economies.

If all exports from developing countries were exempt from tariffs and quotas, LDC exports to both advanced and emerging markets would grow significantly—on the order of $10 billion a year, or about 2 percent of their combined GDP (Laborde, 2008; and Bouët and others, 2010). Broadening the coverage of preferences by major advanced markets could generate increased exports from LDCs of about $2.2 billion a year, or about 6 percent of net official development assistance from industrial countries to LDCs. The potential increase is even larger for exports to emerging markets—about $7 billion a year in additional exports (Bouët and others, 2010). Although the positive impact on LDCs would be sizable, the negative effect on advanced and emerging economies would be tiny because of the low level of LDC exports.

Second, if better-off economies were to make rules of origin more flexible, LDCs would benefit too. Rules of origin determine whether a good “originates” in a country that benefits from a preference system. The rules specify the minimum amount of economic activity that must be undertaken in the country benefiting from the preference and whether inputs from other countries count toward this minimum. Rules of origin differ widely across countries’ preference programs. They are frequently based on the amount of value added in the preference-eligible country or on the transformation a good undergoes in that country (measured by a change in tariff classification). These rules strongly influence where an LDC buys its inputs, which affects the overall economic consequences of a preference program.

To qualify for a preference program, LDC exporters must often limit input sourcing to suppliers in their own country or those from the country granting the preference—even if it would be cheaper to buy inputs elsewhere. This can be difficult for less-diversified LDCs, which depend on intermediate goods, processes, or patents from other countries. Rules of origin can also be a source of distortion, if exporters turn to less-efficient, more costly input sources to qualify for preferences. Moreover, the administrative burden of meeting complex rules of origin can be substantial, costing as much as 3 percent of export value (Hoekman and Özden, 2005). As a result, perhaps a quarter to a third of eligible imports do not gain preference, and some trade that might have benefited from better-designed preferences is likely never undertaken.

More liberal rules of origin allow producers to source inputs flexibly. Such rules implicitly acknowledge LDCs’ low capital intensity and lack of horizontal or vertical integration. Under China’s preference program, for example, origin (and thus preference benefits) can be conferred on a product based either on a minimum local value-added threshold or a change in tariff classification—implicit acknowledgment that the product is different and the LDC has added value. India’s low 30 percent value-added threshold gives potential LDC exporters flexibility in sourcing their inputs.

Moreover, better-off countries could make it even easier to stimulate trade among LDCs if their rules of origin specifically allowed preference-eligible countries to buy inputs from other preference-eligible countries. If these so-called cumulation provisions allowed inputs from two or more countries to be counted together, it would make it easier for the preference-eligible country to meet the minimum requirements under the rules of origin. In contrast, narrow or restrictive cumulation provisions rules do not allow the use of inputs from other countries, often fragmenting established cross-border production relationships. Cumulation provisions therefore determine how easily preference beneficiaries can trade among themselves, using intermediate goods or processes that originate in other countries.

Permitting wider cumulation would assuredly mean that LDCs could meet the rules of origin more easily and at lower cost and would also encourage south-south trade. Allowing the poorest countries to source inputs from all LDCs and other developing countries while remaining eligible for preferences would provide the added flexibility needed for effective use of preference programs.