Do relaxed rules of origin boost LDC exports?

by Matthias Bruckner*

At the last WTO Ministerial, held in Nairobi from 15-19 December 2015, WTO Members agreed on new guidelines for preferential rules of origin for LDCs. These guidelines (text available here) go beyond those contained in the 2013 Bali Ministerial Declaration. The guidelines allow that up to 75 per cent of value added of a product receiving preferential treatment could be imported from outside the LDC. When origin status of products is conferred based on change in tariff classification, a simple change of tariff heading or sub-heading should be sufficient for receiving preferential treatment. The guidelines also call to use ‘single transformation’ as criterion in cases rules of origin are determined based on production processes, for example assembling clothing from fabrics. In addition, the guidelines cover the cumulation of value added across LDCs or other beneficiaries of preferential schemes as well as the simplification of documentation requirements.

But will a relaxation of rules of origin really help LDCs to make better use of preferential market access opportunities? Based on a quick look at experiences since the EU relaxed their rules of origin in 2011, the answer should be positive at least for the clothing sector. But most benefits may go to the few LDCs that have already achieved a certain level of productive capacity.

In 2011, the EU introduced preferential rules of origin in its GSP scheme. In many sectors, up to 70 per cent of the value added of exports from LDCs can be produced abroad, while the share for non-LDCs is only 50 per cent. For the clothing sector, the EU rules of origin allow for single transformation for LDC exports (e.g., fabric to clothing), whereas exports from non-LDCs require double transformation (e.g., yarn to fabric to clothing). The 2011 rules of origin reform also simplified many conditions applicable to all beneficiaries.

Figure 1 shows the evolution of imports into the EU from 2000 to 2014, separated into textiles and clothing (benefitting from single transformation), other manufactures (often benefitting from the 70 per cent non-originating material clause) and primary products. We see a strong increase in LDC clothing and textiles exports to the EU since 2011, the year of the rules of origin reform.  Primary products also showed a significant increase over the time period. However, the main increase happened between 2005 and 2008, followed by a significant drop during the great recession and a subsequent rebound in 2011. The timing indicates that the increase in LDCs’ primary product exports is driven more by commodity price movements than by changes in market access conditions.

Source: Comtrade, accessed via WITS on 13/1/2016.

Figure 2 shows the evolution of market share of LDCs in the three product categories, as market shares are less affected by changes in commodity prices or fluctuations in global currency markets than exports in current US dollars. It confirms that the reform of rules of origin in 2011 coincides with an improvement in LDC export performance in textiles and clothing, but not in other products.

Source: Comtrade, accessed via WITS on 13/1/2016.

To see whether LDC exports to the EU benefited from rules of origin reform or sector specific developments, it is instructive to consider the evolution in market shares in other markets as well. Figure 3 shows the results for Canada, Japan, the United States and the EU. The figure shows that after the reform, the EU regained its position as the market where LDCs have the highest market share. The market share of LDCs in Canada increased remarkably after the 2003 tariff reform (which expanded coverage in the textiles and clothing sector together with a liberalization of rules of origin). On the other hand, the market share of LDCs remains rather flat in the United States, where only African LDCs benefit from preferential market access in the sector. Lately, LDCs gained market share in Japan, which also liberalized its rules of origin in 2011.

Source: Comtrade, accessed via WITS on 13/1/2016.

The increase in textile and clothing exports is distributed very unequally among LDCs. Figure 4 shows that the increase in exports to the EU is almost completely due to Bangladesh and Cambodia, who together represent 94 per cent of all LDC exports to the EU in this sector. These two countries also increasingly dominate the exports of LDCs in the textile and clothing markets of other countries, with a combined share of 97 per cent in Canada and 85 per cent in the United States. With 65 per cent it is a bit lower in Japan, where Myanmar also has a significant market share.

Source: Comtrade, accessed via WITS on 13/1/2016.

Overall, the data supports the view that relaxing rules of origin has the potential to boost LDC exports. But it will remain to be seen to which extent sectors besides textile and clothing can benefit. And while boosting LDC exports through preferential market access promises to reduce the gap between LDCs and other developing countries, it may also increase differences among the LDCs. Currently, only a few LDCs appear to have built sufficient productive capacity to be able to respond to improved market access.

*The content, findings, interpretations, and conclusions as expressed in this article reflect the views of its author and do not necessarily represent the views of the United Nations.