TI 2004-132/2 Tinbergen Institute Discussion Paper Preference Utilisation and Tariff Reduction in EU Imports from ACP Countries Miriam Manchin Faculty of Economics, Erasmus Universiteit Rotterdam, and Tinbergen Institute. Tinbergen Institute The Tinbergen Institute is the institute for economic research of the Erasmus Universiteit Rotterdam, Universiteit van Amsterdam, and Vrije Universiteit Amsterdam. Tinbergen Institute Amsterdam Roetersstraat 31 1018 WB Amsterdam The Netherlands Tel.: +31(0)20 551 3500 Fax: +31(0)20 551 3555 Tinbergen Institute Rotterdam Burg. Oudlaan 50 3062 PA Amsterdam The Netherlands Tel.: +31(0)10 408 8900 Fax: +31(0)10 408 9031 Please send questions and/or remarks of non- scientific nature to [email protected]. Most TI discussion papers can be downloaded at http://www.tinbergen.nl. Preference utilisation and tariff reduction in EU imports from ACP countries Miriam Manchin1 Tinbergen Institute, Rotterdam Contact addresses: [email protected] Abstract Despite the long relationship between the EU and the African, Caribbean and Pacific (ACP) countries aimed at encouraging their exports while stimulating growth and investment, the ACP states still face difficulties in integrating into the world economy. This paper examines the non-least developed ACP countries preferential trade with the EU. The objective is to explain the determinants of preferential exports of ACP countries towards the EU and to assess the impact of preferences on trade volumes. We also investigate the existence of a threshold in the offered duty reduction under which traders have no incentives to ask for preferences. 1 I am thankful for helpful comments from Paul Brenton, Joe Francois and Eric Strobl. I am also thankful to Micheal Henry for providing me with programs for the threshold estimations. 1 Section 1: Introduction Economic and trade co-operation play an integral part of the EU policy towards African, Caribbean and Pacific (ACP) countries, dating back as early as the treaty of Rome (1957). However, despite benefiting from one of the most generous trade preference scheme of the EU providing free access (subject to rules of origin) for 95% of their exports, it is a generally accepted view that the ACP countries have been unsuccessful in taking advantage of their preferential status and, indeed, performed poorly in comparison with other developing countries (McQueen, et al. (1997)). For instance, the share of world exports of ACP countries fell from 3.4 % in 1976 to 1.9 % in 2000 and their share in developing countries exports from 13.3 % in 1976 to 3.7 % in 2000. Their trade patterns with the EU has followed a similar evolution: the share of EU imports from the ACP in total EU imports has decreased, falling from 6.7% in 1976 to 3.11% in 2002, and the share of imports from the ACP in total imports from developing countries (excluding countries in transition) has fallen from 14.8 % in 1976 to 6% in 2000.2 Davenport, Hewitt and Koning (1995) also point out that, despite the number of Lomé beneficiaries increasing from 46 countries to 69 countries over the period 1975-92, the share of ACP non-oil-exports in EU imports declined from 6.1% to 2.9%, and compared to other developing countries with less preferential access to the European market, the deterioration in the ACP performance is even more pronounced. Successful experiences of the preference utilisation are restricted to certain sectors and countries (ECDPM (2001a). Due to these inefficiencies in delivering improved market access, changing geopolitical interests and other political factors, the EU relationship with the ACP came under growing pressure (ECDPM (2001b)), and as a result new Partnership Agreement was signed in Cotonou. Under the Cotonou Agreement current non-reciprocal trade preferences will be maintained temporarily up to 2008 and new reciprocal trade agreements will be negotiated and implemented gradually. The main objective of the economic and trade co-operation signed in Cotonou is to promote gradual integration of the ACP States into the world economy and support their sustainable development as well as enable the ACP States to manage their transition to the liberalised global economy (ECDPM (2001c)). In order to achieve these objectives, it is essential to understand the main determining factors of the utilisation of trade preferences. 2 Source: European Commission, http://europa.eu.int/comm/trade/issues/bilateral/regions/acp/index_en.htm. 2 Nevertheless, there is very little ex-post evidence on the effects of preferential schemes on the export performance of the beneficiaries. The empirical literature on preference schemes highlights several difficulties limiting the benefits available for the recipient countries. Some papers pointed out that administrative requirements and technical requirements (such as rules of origin) of preferential programs often impose considerable burden on traders, especially on lesser-developed countries, resulting in low utilisation rates of the preferences.3 Certain preference schemes, such as the GSP preferences of the US, are limited to some sectors, in which developing countries lack comparative advantage4 (only 53 per cent of dutiable imports from developing countries are eligible for preferences under the US's GSP5). When the preference schemes include export ceilings these are often binding.6 Özden and Reinhardt (2004) find that countries dropped from the US's GSP scheme subsequently adopt lower trade barriers than those remaining eligible. The authors conclude that full integration into the reciprocity-based world trade regime rather than continued GSP-style preferences would be more beneficial for developing countries. The current paper explicitly examines the non-least developed ACP countries’ preferential trade with the EU. Our objective is to explain the determinants of preferential exports of non-least developed ACP countries towards the EU and to assess the impact of preferences on trade volumes. The paper also investigates if there exists a threshold in the offered duty reduction under which traders have no incentive to ask for preferences since the costs of obtaining these exceeds their benefits. One should note, that while there are currently two preferential schemes available for these countries - the Generalised System of Preferences (GSP) and the Lomé preferences which were recently revised under the Cotonou Agreements -our empirical analysis mainly concentrates on the Cotonou preferences due to the limited utilisation of the GSP preferences by this group of countries, although we do compare the two schemes. The next section of the paper explains the historical evolution of the two preferential schemes. The third section looks at the importance of the preferences in terms of coverage, tariff reductions and utilisation rates. The paper then provides a quantitative assessment of the impact of preferences using Heckman sample selection and threshold estimation techniques. The final section of the paper concludes. 3 UNCTAD (1999, 2000), Brenton and Manchin (2003), Falvey and Reed (2002), Krishna and Krueger (1995), Cadot, et al. (2003). 4 Devault (1996). 3 Section 2: EU-ACP relations Lomé The first agreement between the European Economic Communities (EEC) and the ACP countries dates back to 1963 when the “Yaoundé Agreements” were signed which was in effect between 1963 and 1975. The objective of the agreement was to foster economic cooperation between the EU and ACP countries. The most important part of the resources was directed towards francophone Africa to build up infrastructure during the decolonization. After the United Kingdom joined the EEC, the Lomé I Agreement was singed and was in force between 1975 and 1980 including 46 ACP countries and the EEC Member States. At the same time, the ACP countries joined together to form the ACP with the completion of the Georgetown Agreement. The first Lomé Agreement introduced trade preferences for most ACP exports to the EEC. Special trade protocols were introduced for sugar, bananas, beef and veal. These trade preferences and protocols were extended for further periods under successive Lomé Conventions (Lomé II (1980-85), Lomé III (1985-90) and Lomé IV (1990-2000)). The banana protocol gives duty-free entry for specific quotas of bananas into the EU market. Under the sugar protocol, EC annually buys a fixed quantity of sugar from ACP producers at its internal sugar price. Among the major beneficiaries of this arrangement are Mauritius, Fiji, Guyana and Barbados. Under the beef and veal protocol, the EC refunds 90 per cent of tax normally paid on beef imports from several ACP countries. This has been especially beneficial to Southern African exporters (Panagariya (2002)). The scope of the Lomé Convention covers more than just trade preferences, incorporating even environmental and human rights considerations. After the expiration of the Lomé IV a new Partnership Agreement with the ACP states was signed in Cotonou in 2000. The agreement’s key objective is poverty reduction and bringing more stability in the region. According to a Press release of the EC: "Focusing on poverty reduction as its principal objective, to be achieved through political dialogue, development aid and closer economic and trade cooperation, this agreement will shape a significant part of the European Union's dealings with the rest of the world."7 The agreement is for a 20-year period. The trade relationship between EU and ACP partners is intended 5 The information here comes from UNCTAD (2001). 6 MacPhee and Rosenbaum (1989), Hoekman and Kostecki (2001). 7 Press release IP/00/640 Brussels, 21 June 2000, The European Community and its Member States sign a new Partnership Agreement with the African, Caribbean and Pacific states in Cotonou, Benin 4 to change gradually. During 2000-07, which is regarded as the preparatory period, the current regime with its preferences and the protocols on sugar, banana, and beef and veal are to be maintained in some modified form. In parallel, countries other than the least developed countries are to negotiate economic cooperation agreements under which current one-way trade preferences by the EU will be replaced by reciprocal preferences more or less as in the case of the Mediterranean partners. The new arrangements are to enter into force latest by January 1, 2008, with transition to a full FTA spread over at least 12 years. GSP preferences While being beneficiaries of the Cotonou Agreements, ACP countries are eligible also for GSP preferences. In 1968, UNCTAD recommended the creation of a ‘Generalised System of Preferences’ (GSP) under which industrialised countries would grant autonomous trade preferences to all developing countries and the waiver to allow such preferences was granted in 1971 by the GATT. The GSP preference scheme provides nonreciprocal preferences with lower tariffs or completely duty-free access for imports from 178 developing countries and territories into the EU market. GSP preferences are not part of contractual agreements with the recipient countries.8 The general arrangements cover roughly 7000 products, of which 3250 are classified as non-sensitive and 3750 are classified as sensitive products. The tariff preferences offered by the general arrangements differ according to the sensitivity of the products concerned: non-sensitive products enjoy duty free access to the EU market, while sensitive products benefit from a tariff reduction. These arrangements provide, as a rule, for a reduction of MFN ad valorem duties by a flat rate of 3,5 percentage points. An important exception to this rule of a flat rate reduction is granted to the textiles and clothing sectors which enjoy a percentage reduction of 20%. For specific duties a percentage reduction of 30% is the general rule. Where duties include ad valorem and specific duties, only the ad valorem duties are reduced. A special arrangement under the Everything but Arms (EBA) initiative, which is incorporated into the GSP preference scheme, is provided for least developed countries (LDCs). The EBA scheme provides duty-free access for all products covered and originating in the beneficiary country, with 8 A new GSP regulation, the third of the 10-year cycle, (Council Regulation (EC) No 2501/2001 as last amended by C Council Regulation No 2211/2003) implements the current scheme from 1 January 2002 to 31 December 2005. New guidelines for the next 10-year cycle 2006-2015 are currently being prepared. 5 the exception of imports of fresh bananas, rice, and sugar.9 This scheme is more generous in terms of duty reduction than the Cotonou scheme; however in some other aspects, such as cumulation rules, it is less generous. Section 3: Importance of preferences for ACP countries In order to examine the relationship between trade and preferential treatment we use information of EU member states' imports eligible for preferences under the Cotonou agreement for the period 2001 from non-least developed ACP countries at the 8-digit level. This raw trade data was obtained from Eurostat and includes both total imports from ACP countries and imports requesting preferential treatment. Using information on tariffs and preferential quota applicable on each 8-digit product for the year 2001 we then identified those products which were eligible for preferences and calculated the ad-valorem tariff rates. Figure 1 shows the developments of EU imports from non-least developed ACP countries during the last decade.10 While the value of the imports had been increasing during the period, the share of imports from these countries in total EU imports had been decreasing. Table 1 demonstrates which export schemes were used by the different countries.11 It is apparent from the table that GSP preferences were requested only by a few countries (mainly by South Africa, Swaziland, and Namibia) and only to a limited extent. The share of exports that requested GSP preferences in total exports for the country group was around 6%. Instead ACP countries tended to use Cotonou preferences rather than GSP preferences; the utilisation rate (share of exports that requested preferences in total exports) of Cotonou preferences was close to 50%. However, there are important differences between countries in the utilisation rate. While certain countries, such as Senegal, Seychelles, Dominica, Cameroon etc, have high utilisation rates, several countries utilise the Cotonou preferences only limitedly. 9 For a detailed discussion on the impact of EU preferences for LDCs under Everything But Arms see Brenton (2003). 10 Nauru, Niue and the Cook Islands were not included in the analysis due to data limitations. 11 The columns of the table show the share of exports which requested Cotonou or GSP preferences. The preferential access actually granted might be less than these figures, thus the table could overstate the actual utilisation of the preferential schemes. 6 The significant difference between requesting GSP and Cotonou preferences may reflect that for most of the products exported by the ACP countries the Cotonou scheme offers better access. One important difference between the two schemes is in the rules of origin. Rules of origin define the conditions that a product must satisfy to be originating from the exporting country which asked for the preferential access. The main justification for rules of origin is to prevent trade deflection, whereby products from non-participating countries destined to the free trade area partner are redirected through the other free trade partners to avoid the payment of customs duties. When products are produced in a single stage then the origin of the products should be relatively easy to establish. For all other cases the rules of origin define the methods by which it can be determined that the product has been sufficiently processed in the free trade partner to qualify for preferential access. The specification of rules of origin has become especially important in recent years as technological progress and globalisation have led to the increasing fragmentation of the production process into different stages or tasks which are undertaken in different locations. There are different methods used to determine whether preferential access can be granted. The simplest way of defining origin is probably change of tariff heading, alternatively there can be rules relating to the amount of domestic value-added or to specific technical requirements that the product may satisfy. The basic rule used in the EU’s bilateral trade agreements is that of the change in tariff heading at the 4-digit level of the Harmonised System of tariff classification. However, in a very large number of cases this basic rule is replaced by specific requirements. These other requirements can be a minimum percentage of local value added in the originating country, or a technical requirement that requires that the product undergoes specific manufacturing operations in the country. Several empirical studies found that the level of restrictiveness of the rules of origin depends on the method used for defining origin and it influences the utilisation of preferences (Augier et al. (2005), Estevadeordal and Suominen (2005)). Carrère and de Melo (2004) find that compliance costs are the least for a change of tariff classification, followed by regional value content and by technical requirements. One notable difference between the Cotonou and the GSP preference scheme’s rules of origin is in the cumulation rules. When cumulation is allowed materials used from other countries during the production can be regarded as originating materials. Different levels of cumulation are used in free trade agreements. The most advanced form of cumulation is full cumulation allowing for any processing (even if it does not confer origin) carried out in any participating country to be carried 7 on to another partner country and counted as if it were undertaken in the country of final processing. A stricter form of cumulation is diagonal cumulation which allows qualifying materials from any participating country to be used in the processing in another participating country and counted as if it were done in the country of final processing. The difference between diagonal and full cumulation is that under the diagonal cumulation the input used from another participating country has to be qualifying, in other words it has to meet the rules of origin requirements. Finally the bilateral cumulation allows cumulation only between the two partner countries, and does not allow regional cumulation. While the Cotonou Agreement allows full cumulation12, the GSP scheme allows diagonal cumulation within only four regions (ASEAN, CACM, the Andean Community and SAARC). Since non of the non-least developed ACP countries are members of these regional groups, diagonal cumulation is not available under the GSP scheme for these countries. Another difference is in the minimum processing or tolerance rules between the two preferential schemes. While under the GSP scheme non-originating inputs can be used given that their value does not exceed 10 per cent of the ex-works price of the product, under Cotonou, non-originating materials up to a total value of 15 per cent of the ex-works prices can be used (Brenton (2003)). The first column of Table 2 shows the total exports of countries to the EU. The second column of the table shows the share of exports where the applicable MFN tariff rate was zero. Around 64% of the exports from these countries entered into the EU with zero MFN tariffs, although there are important differences between countries. This implies that for several countries the trade preferences provided by the EU offered only limited benefits. The third column of the table shows the share of exports excluded from the preferences, which was around 4% of exports in 2001. There were again substantial differences between countries; while, for example, 92% of Fiji’s exports were excluded from preferences, in the case of Botswana no exports were excluded from the preferences. The final column presents the share of exports eligible for preferences, which for the country group as a whole was around 31%. Although the preferential scheme seems to be significant for several countries, some countries trade mainly in products where the MFN tariffs were already reduced to zero limiting the impact of Cotonou preferences on these countries’ trade. 12 There is no additional requirement on the value-added in the final stage relative to the inputs used with the exception of South Africa, for which the value-added has to exceed the value of materials from South Africa. 8