Tricks of the trade

Preferential treatment should be used by less developed countries as an instrument of industrial and export growth

By Hussain H. Zaidi

Special and differential (S&D) treatment for developing and the least developed countries (LDCs) is an important characteristic of the multilateral trading system. There are different views on whether the S&D treatment is beneficial or harmful for these countries.

The two major forms of S&D treatment are provisions for preferential tariffs on imports from developing countries and LDCs to the markets of developed countries; and exception or relaxation granted to these countries from implementing their obligations under various WTO agreements.

The principal way by which developed countries unilaterally impose lower tariffs on imports from developing countries and LDCs than on products from other developed countries is represented by the Generalized System of Preferences (GSP).

The legal basis of the GSP is the "Decision on Differential and More Favourable Treatment, Reciprocity and Fuller Participation of Developing Countries". Adopted in 1979 for an indefinite period, it is also called the General Enabling Clause and forms part of the WTO Agreement. The idea behind the GSP is that preferential treatment will help less developed countries integrate in global economy, which can serve as an instrument of development.

Every developed economy has its own GSP scheme with different product coverage, preferential tariffs and criteria for benefiting from the same. For instance, under the GSP scheme of the USA, all eligible products from developing countries enter the country's market duty free. On the other hand, under the GSP scheme of the European Union (EU), eligible products enter the markets of beneficiary countries at either zero duty or a lower duty than MFN duty -- 20 percent reduction from MFN tariffs in case of textile and clothing products and 3.5 percentage points reduction from all other eligible products. All eligible exports from LDCs enter the EU duty free under an arrangement called, "Everything But Arms" (EBA).

Let's now turn to the second aspect of S&D treatment -- the exception or relaxation granted to developing countries from meeting their obligations under various WTO provisions. Some instances are:

Under the WTO normally members cannot raise their bound rates of duty or impose quantitative restrictions on imports from other members. Developing countries, including LDCs, however can adopt such restrictive measures, subject to approval of other members, to promote the development of new industries or an existing industry. The purpose of this exception is to ensure that trade liberalization does not have adverse effects on economic development of developing countries.

WTO allows both developed and developing countries to restrict imports in the face of balance of payment problems. However, developed countries have more stringent criteria to follow than developing countries while adopting such restrictive measures. For developed countries there are two criteria. One, when the threat of a serious decline in their monetary reserves is imminent; two, when the level of reserves is very low. Developing countries can adopt such measures when they think there is threat of a serious decline in their monetary reserves, even though the same may not be imminent; or if monetary reserves are too low to cover expected foreign exchange payments.

The Agreement on Subsidies and countervailing measures prohibits members from using export subsidies--subsidies which are contingent upon export performance. However, LDCs and developing countries whose per capita income does not exceed $1,000 are exempted from this prohibition.

In the Agreement on Trade in Services, developing countries are allowed to open fewer sectors or to liberalise fewer types of transactions.

In the application of sanitary or phytosanitary measures, as provided in the Agreement on Sanitary and Phytosanitary Measures, members have to consider the special needs of developing countries, particularly LDCs.

The S&D provisions have been criticised for several reasons. One: these provisions conflict with the principle of non-discrimination, which forms the centerpiece of the WTO system. Two, preferential tariff treatment given to exports of developing countries in the shape of GSP is not really non-reciprocal. In return, the developing countries have to comply with the standards and conditions, at times arbitrary, imposed by the donors and the failure to do this may result in suspension of the benefits. For instance, in 1996, the USA suspended preferential benefits to Pakistan under its GSP scheme for "failure" to comply with the donor country's labour standards. Pakistan was re-admitted to the GSP scheme only after its support to anti-terrorism campaign of the US government in 2001.

Three, benefits given under the GSP are not binding, and the same can be withdrawn on grounds that are not always strong. For instance, very recently, the EU has suspended GSP treatment to Sri Lanka for alleged human right violations by Colombo. This raises the question of the link between trade preferences and human rights.

Four, donor rather than beneficiary country's interest determines the products to be extended preferential treatment under the GSP. For instance, the GSP schemes of the USA and Russia do not include textile and apparel products, partly because this sector is considered very sensitive for their domestic industry and partly because developing countries by and large have a competitive advantage in it. Similarly, several agricultural products are excluded from the GSP schemes of the EU and Japan for more or less similar reasons.

Five, non-reciprocal preferential treatment has not yielded much real benefits to developing countries. Rather it has had only a marginal effect on their export and general economic performance. There has been a strong tendency among developing countries to focus on products benefiting from GSP schemes to the neglect of industrial and agricultural diversification.

Six, unilateral preferences make it difficult for developing countries to shed off protectionism and liberalise their trade and economy. Finally, the exception or relaxation granted to developing countries from meeting their obligations obstructs rather than helps their integration into the multilateral trading system.

The above criticism of the S&D treatment is too a large extent valid. However, the problem is not with the notion of unilateral preferences or S&D treatment per se but with the way the unilateral preferences are being applied. A broader product coverage, for instance, inclusion of textile and clothing in US GSP, and absence of strict conditionalties accompanying unilateral preferences, such as labour and human rights standards, will go a long way in enhancing their usefulness. Moreover, preferential treatment should be used by less developed countries as an instrument of industrial and export growth. It should not become an obstacle to economic diversification.

It is, however, not true that non-reciprocal preferences yield only marginal benefits to recipient countries. For instance, Pakistan's export of textile products increased by $ 1 billion in three years (2002-2004) after it had been given duty free access to the EU market under the drug arrangement of the GSP scheme.

Preferential treatment does make exports of developing countries and LDCs more price-competitive and thus encourages them to pursue export led growth strategy. No doubt, the pursuit of such a strategy is also in the interest of developed countries, because this makes developing countries discard the import substitution strategy and increase their imports, which are largely supplied by developed countries. But this give-and-take situation is what international economic relations are all about.

There is, however, a strong tendency among developing countries to focus on products benefiting from GSP schemes to the neglect of the remaining products. This is a capital mistake. Preferential treatment should be an instrument of industrial and export growth. It should not become an obstacle to economic diversification.

All said and done, since less developed countries lag far behind developed countries in terms of financial, institutional, technological and human resources, they need special treatment in order to successfully integrate themselves into the multilateral trading system. However, it should also be borne in mind that S&D treatment by itself cannot make the exports of less developed countries competitive, though such treatment can serve as an instrument of export competitiveness.