Who will benefit from GSP graduation?

15 July 2011

The European Commission’s proposal for a new Generalised System of Preferences (GSP) includes more stringent provisions on graduation (whereby countries’ eligibility for the GSP is removed) than does the current system [1]. It argues that this will free up space in the European market for poorer states that find it difficult to compete head on with richer and highly competitive developing countries.
But will it help poor states’ exports? And what will be the net effect on poverty reduction: are the producing communities in the states that may gain exports poorer than those in the graduate countries and will the relative economy-wide poverty reduction effects be greater? ODI is undertaking research to answer both questions. Full answers should be available by September, but early results suggest that gains by poor countries will be relatively limited because they do not export to the EU many of the goods on which there will be graduation. This does not necessarily mean that the exercise will have no benefits – it is often the case that very poor countries are able to make gains only at the margins because of the structural factors that make them very poor. But it does suggest that focusing the gains from the GSP more strongly on the poorest is unlikely to stand as the primary justification for the new graduation.

The new graduation proposals

Current beneficiaries of the GSP will lose their eligibility either entirely or for some exports if they are: dependent territories of an EU state, beneficiaries of another EU trade regime that is equivalent to or better than the GSP, too rich, or too competitive for certain products. The first two criteria are uncontroversial in themselves, and represent a tidying-up exercise that will remove confusion[2]; it is the others that have attracted attention.
Income graduation, under which a country will become ineligible for the GSP, will apply if it “has been classified by the World Bank as a high-income or an upper-middle income country [UMIC] during three consecutive years immediately preceding the update of the list of beneficiary countries” (Article 4.1.a). Other countries will be caught by product graduation: they will lose preferences on any product groups in which their share of EU imports from GSP beneficiaries exceeds 17.5 percent (or 14.5 percent in the case of textiles and clothing). The first three criteria for graduation reinforce the fourth: the current regime already includes product graduation if imports from a country exceed 15 percent (12.5 percent for textiles and clothing), but this share concerns imports from 176 states whereas the proposal is for the calculation to be made in relation to imports from about 80 states.
The exact figures will not be known until shortly before the new regime comes into force (which is expected to be 2014) because the Commission will make its calculations on the latest data available at that time. But ODI has identified which countries and goods would be subject to product graduation if the calculations were done today [3].

The potential effects of graduation

Income or product graduation will increase the tax payable on imports from the graduates in all cases where there is a higher tariff under the best alternative regime available to them (almost always the EU’s basic most–favoured nation (MFN) regime to which all WTO members are entitled). This will not always be the case. The MFN tariff on almost all of the products on which Iraq would be graduated, for example, is zero as is also the case for 98 percent of Nigeria’s graduated exports. Even in the cases of China and India (which would experience the greatest absolute product graduation), 42 percent of affected exports (for China) and 36 percent (for India) face zero MFN tariffs.
In such cases graduation will have no effect, but in all others it will increase the tax payable on some or all imports from the graduates. This could have one or more of four possible effects.
1. Margin trimming: may have no effect on the volume of imports from the graduated state (which remains competitive even when paying MFN tariffs).
2. European protection: may result in a fall in EU imports as domestic suppliers become more competitive with imports from the graduated state.
3. Increased rich country exports: may result in a decline in imports from the graduated state and an equivalent increase in imports from rich states that trade with the EU on MFN or free trade agreement (FTA) terms.
4. Increased poor country exports: may result in a decline in imports from the graduated state and an equivalent increase in imports from other GSP beneficiaries.
Only in the last of these is there any possibility of offsetting development gains: in case 1 money is simply taken out of the supply chain and transferred to the European budget; in cases 2 and 3, any fall in imports from the graduates is offset by increased supply from countries that are not poor. The first task in identifying the potential development gains from the new regime is to assess on a product by product basis which of these four outcomes is the most likely.

Which countries and which products?

For the new graduation criteria to affect the distribution of GSP benefits all of the following must apply:
1. a country must face new graduation for a ‘significant’ export (which we have taken as any item accounting for 1 percent or more of its exports in the product group for which it is graduated);
2. the resulting tax change relative to the EU’s treatment of competitors must be sufficiently large to support a plausible case that the graduate will not respond simply by margin trimming so that its exports might decline; we have taken the view that this criterion is unlikely to be fulfilled on goods where the MFN is less than 5 percent;
3. any potential beneficiary states of such a decline must already be exporting the products concerned to the EU on a sufficiently large scale to support a plausible case that they might be able to increase sales solely as a result of the change in tax treatment relative to the graduate; we have taken this as applying to any supplier of 5 percent or more of EU imports of the product.
The eight graduates under the new product graduation criteria are China (which will be graduated out wholly or partially from 79 of the 87 HS chapters in which there are GSP preferences), India (15 chapters), Indonesia (6), Ukraine (5), Vietnam (3), and Iraq, Thailand, and Nigeria (2 apiece). The proportion of the value of the items on which they will be graduated that faces an MFN tariff of over 5 percent varies from a high of 76 percent for Vietnam and 45 percent for India to zero or less than 1 percent for Iraq, Nigeria and Ukraine.
In addition 17 states are excluded from the GSP solely because they are UMICs (i.e. not also because they have an FTA with the EU) [4]. The share of their key products (accounting for 1 percent or more of their total exports) facing a 5 percent + MFN tariff is low in most cases, but there are some exceptions. Cuba, for example, will face 5 percent + MFN tariffs on 36 percent of its key exports currently covered by the GSP whilst for Argentina the share will be 12 percent and for Gabon 9 percent.

Who might gain?

Which suppliers might benefit from a fall in the graduates’ exports? Further work is needed to identify which states are competing directly with the graduates, but one thing is already clear: the list contains few poor and very few least developed states. Most of the countries that also supply the EU market for the 5 percent plus MFN items on which new graduation will occur fall into one of two groups: industrialised states and countries that are also being graduated but on other goods. India, for example, will face new graduation on 29 items [5]. The USA accounts for 5 percent or more of EU imports for 19 of these, Switzerland for 16 – and China (which is not being graduated on any of them) for 20. Of the 22 states that supply 5 percent or more of EU imports for any of these products only one, Bangladesh, is least developed (and it is an important supplier for just two of the products), and very few are poor.
One reason is that almost three-quarters of the goods on which there will be significant new graduation are agricultural or fisheries products, with organic chemicals accounting for most of the remainder. Clearly, a determining factor in which countries gain import share will be whether they can grow or fish the items on which there is graduation. If their natural resources in these areas are non-existent, no amount of aid for trade or tariff preferences will conjure up new exports. But if some poor states can produce some of the goods, graduation might help. The rest of the ODI research is focusing on this minority of cases.

Authors: Christopher Stevens is Senior Research Associate with the Overseas Development Institute (ODI), Jane Kennan is Research Officer with ODI.

1 COM(2011) 241/5 2011/0117 (COD) Proposal for a Regulation of the European Parliament and of the Council applying a scheme of generalised tariff preferences.

2 There has often been controversy for example over whether the GSP is actually used – with critics overlooking the fact that only countries without better access under another regime need to use the GSP.

3 In the case of income graduation, we have assumed that four countries which are currently rated as UMICs by the World Bank but have not yet been on the list for three years will remain on the list and, hence, will be graduated in 2014.

4 The difference between the figure cited by the Commission and this figure of 17 is that there are some small Pacific states which are not are not included in the World Bank lists because they are too small but are also not listed in the EU proposal as being eligible for the GSP. These have a high share of 5 percent + MFN tariffs in their export basket but very low absolute values.

5 Which account for 1 percent or more of its exports in the section subject to graduation and face an MFN tariff of 5 percent or more.

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