Tariff Preferences and Developing Countries

PREFERENTIAL TARIFFS are of great importance to developing countries because of the impetus that they give to their exports, which in turn enable these countries to import badly needed equipment and machinery from the industrialized countries. While all developing countries and a good many industrialized countries believe in the necessity of preferential tariffs, some industrialized countries are concerned about the effects that such tariffs would have on their own domestic industry and also on trade among themselves. Is anxiety on this score justified?

The Widening Gap

In the first place, such anxiety as exists must be looked at in the context of the widening gap between the economic conditions of the developed countries and the developing countries. Not only are the rich getting richer, but they are also doing it at a proportionately much faster rate. The United Nations has told us ¹ that the per capita gross domestic product (GDP) of the developed market economies, i.e., the industrialized countries of the West and Australia and New Zealand, increased from $1,277 in 1955 to $1,509 in 1962. During the same period, the per capita GDP of the developing countries increased from $119 to $136. Even within this class of developing countries, those in Africa and the Far East have much lower incomes than others—$107 and $89, respectively. The Far East region, which includes, among others, Afghanistan, Burma, Ceylon, India, Indonesia, Nepal, Pakistan, Thailand, and Viet-Nam, but excludes Mainland China, has a population of almost one billion people. Its per capita GDP increased from $79 in 1955 to $89 in 1962. In the United States, by contrast, per capita GDP is now about $3,500 and is increasing at the rate of $235 a year. This means that the developing countries in Southeast Asia and the Far East, with one billion inhabitants, have a GDP which is only one fortieth of the GDP of the United States. Moreover, the increase in the goods and services available to the average U.S. citizen in a single year is more than twice as great as the total of goods and services available to the average person in Asia. It is difficult for people living in affluent societies to understand or to imagine what deprivation of the barest necessities of life, such as food, clothing, and housing, millions must suffer all their lives. Not only for humanitarian reasons but also because of enlightened self-interest, all developed countries would be wise to do their utmost to help the developing countries to have a slightly larger share of the cake. Economic aid is one way of doing this, and the postwar years have seen a new awakening of conscience and a new sharing of responsibility in this matter. Another, equally important, way is by expanding trade and, in particular, by increasing the exports of the developing countries.

Here again, the figures given by the United Nations are very revealing. During the period 1955-64, the exports of the developed market economies nearly doubled—increasing from $58 billion to $113.8 billion. Those of the centrally planned economies—i.e., the communist countries—also more than doubled. On the other hand, the increase in the exports of developing market economies during these 9 years was only 43.5 per cent—from $23.7 billion to $34 billion. Because of this comparatively smaller increase, the developing countries’ share of world exports, which was 26 per cent in 1955, fell to 20 per cent in 1964. Yet the developing countries were trying their utmost. Actually, the volume of their exports has been increasing, on an average, by about 5 per cent every year during the past 10 years. But the value of each unit of the exports from the developing countries has been going down, whereas the unit value of the exports of developed market countries has been increasing; that is to say, the terms of trade have been unfavorable to the developing countries.

Preferential Tariffs Would Help

Viewed in this context—the very low levels of income in developing countries, their falling percentage share in world exports, the continued worsening of their terms of trade—it is clear that we should give the highest priority to reversing these trends. The world should aim at giving a big boost to the exports from developing countries and at improving their terms of trade. One of the major instruments for achieving this objective would be the granting of preferential tariffs to developing countries—i.e., reducing or eliminating import duties on goods imported from these countries.

Preferential tariffs have been employed in the Commonwealth countries and also between the European Economic Community (EEC) and 19 African countries (see “Africa and the EEC,” in Finance and Development, Vol. Ill, No. 2, June 1966), and the possibilities that they offer for development have received a good deal of attention. The United Nations Conference on Trade and Development (UNCTAD), held in Geneva in 1964, unanimously recognized the urgent need for the diversification and expansion of exports of manufactures and semi-manufactures from developing countries, and all developing countries and many industrialized countries have agreed that preferential tariffs would be an effective way of achieving this. It is also generally recognized that the terms of trade of the less developed countries could not be improved significantly by any generalized reduction of tariffs because such a cut would give equal benefits to all exporters who enjoy most-favored-nation terms. Only tariffs that favor developing countries exclusively could make any significant contribution in this field.

Preferential tariffs will naturally benefit only manufactures and semimanufactures. As far as raw materials and primary commodities are concerned, there are, generally speaking, either very low import duties or none at all. Here the obstacles are domestic duties, such as the duty on tea imposed in some European countries, which tend to discourage consumption. There are also some instances of quota restrictions (e.g., on sugar).

The justification for according preference to exports of manufactures and semimanufactures from developing countries is that without it, the developing countries will never be able to compete on even terms with the industrialized countries. Industries in developing countries have to operate under several handicaps, particularly in the early stages of industrialization. They have to import costly machinery and equipment. They have to absorb the cost of training local labor as well as the high cost of foreign technicians who have to be employed at least for the first few years until local labor is trained. They often have to operate without basic facilities, such as well-developed communications and transport systems and adequate financial and marketing organizations. When local labor is trained in the technical sense of that term, it is still inexperienced and accordingly less productive. Lastly, even when these newly established industries finally become fully experienced and productive, they have to operate in a small market, which rules out the economies of large-scale production.

To overcome such disadvantages in the competitive world market, the developing countries require preferential tariffs at least for the first few years. This is only a logical extension to the world markets of the principle of protection which the industries in question already enjoy in their domestic markets through tariffs. In the course of time, these exports—increased because of preferential tariffs—will strengthen and diversify the economies of developing countries, which may, after a reasonable period (say ten years) be able to stand on their own and withstand competition without special protection.

Effects on Developed Countries

It is fundamental to the case for preferential tariffs that increases in exports of developing countries resulting from such tariffs (or indeed from any other causes) will ultimately redound to the benefit of the industrialized countries because of the almost insatiable demand of the developing countries for plant and machinery and equipment of all kinds. Their increased export earnings would be spent mostly in the industrialized countries, and the resulting expansion in world trade would be to the benefit of all. Further, to the extent that the developing countries are able to import machinery and equipment without aid, they should be encouraged to do so; this, in fact, is the policy of the major aid-giving countries. Apart from the direct benefit of increased foreign exchange earnings, the opening of new and larger markets for exports of manufactures would provide an additional stimulus to the domestic economy of the developing countries.

The rates at which industrialized countries impose tariffs on imports depend generally on the extent of processing already undergone by the imports. Thus, whereas imported raw materials bear very low duties or no duties at all, higher duties are levied on products manufactured from the same raw materials, the rate of duty depending on the extent of fabrication or manufacture in the exporting country. This progressive increase in tariff rates from raw materials through successive stages of manufacture to the finished product shows how seriously the present tariff structure of developed countries has, through design or otherwise, hampered new industries in the developing countries. These countries have not been able to derive the natural benefit from the raw materials which they produce.

Considering the iron ore and steel industry, we find that in 1963 developing countries exported more than $400 million worth of iron ore to various industrialized countries. During the same year, the total export of iron and steel manufactures from the developing countries to the industrialized countries was only $19.3 million. The reason for this state of affairs is that, generally speaking, there is no tariff on iron ore in most industrialized countries, but the effective rates of tariff on ingots and other primary forms of iron and steel are generally very high. In two industrialized countries, the tariff rates are 100 per cent, and in most others they are about 30 per cent. It is interesting that, against these very high duties on ingots, the effective tariffs on iron and steel shapes are only 7 per cent to 10 per cent. It would seem that the tariff rates are so designed as to have the greatest impact on only the primary forms of iron and steel, which can be exported by the more industrialized of the developing countries. The more sophisticated forms of iron and steel manufactures exported by the industrialized countries do not have to face these high tariffs.

The same story could be repeated in respect of wood, leather, wool, rubber, cocoa, and cotton manufactures. For almost all of these, the developing countries are the major suppliers of the raw material, on which the import duties are nil or very close to it—but the manufactured products have to face duties of from 30 per cent to 136 per cent. Cocoa powder and cocoa butter form an extreme example because they are subject to an effective duty of 136 per cent in the EEC, whereas the duty on raw cocoa beans is only 5 per cent! How can we expect the cocoa exporting countries to establish the reasonably simple and easy process of making cocoa powder and butter under such circumstances? Similarly, there are high tariffs on cotton manufactures, which inhibit their export to industrialized countries. Textile exports also suffer from quota restrictions.

Arguments Against

In a field as extensive and complex as that of international development, every far-reaching proposal becomes the subject of argument, and preferential tariffs are no exception. The arguments generally advanced against them are as follows:

• (i) Such a system of tariffs would violate the most-favored-nation principle, which has brought orderliness to world trade and has contributed to its expansion. This principle is fundamental to the General Agreement on Tariffs and Trade (GATT) as it has existed since 1948.

• (ii) After the Kennedy Round of discussions, the average level of tariffs will be so low that a preference undercutting that level would not confer any significant tariff advantage.

• (iii) There are practical difficulties in devising and operating a scheme which would be equitable to all developing countries while not disrupting the developed countries’ industries. Such a scheme would be very complicated and not easy to operate.

• (iv) The tariffs would help only the more advanced of the developing countries.

• (v) The tariffs might lead to the setting up of inefficient industries in developing countries and thus lead to a misallocation and waste of resources.

The first objection—violation of the most-favored-nation principle—belongs to the realm of theory rather than that of current politics. Apart from the Commonwealth preferential system which has been operating for 30 years, there is the Yaoundé Convention under which certain agricultural products of 19 Associated African States enter the EEC free of duty. In fact this most-favored-nation principle has been breached in substance, if not in letter, by the formation of the EEC itself. As regards GATT, the objection is only technical. GATT contemplates the grant of waivers for such preferences. Instead of there being individual waivers for each developing country, there should be one general waiver for all the developing countries. Australia has obtained such a waiver from GATT and has introduced preferences up to 7½ per cent for the import of certain manufactures from all developing countries—thus giving an enlightened lead to other industrialized countries. As a result of this measure, not only certain manufactures but the entire range of handicrafts from developing countries have been given duty-free entry to Australia.

The second argument is that the general lowering of barriers to trade is more important for increasing world trade and that it would, in the long run, be of more advantage to the developing countries than preferential tariff reductions; such a general lowering is the object of the Kennedy Round. A general expansion of world trade is, of course, very much to be desired, but the Kennedy Round of discussions has come up against various difficulties and at the time of writing there is great uncertainty about its outcome. We cannot say now to what extent these negotiations will include those export items in which the developing countries are particularly interested. The Kennedy Round envisages that negotiating countries could stipulate that for specified commodities the reduced tariffs would not be applicable. Such lists of excepted commodities are known as “exception lists.” If the commodities which are normally exported by the developing countries are included in such “exception lists” of one developed country or another, the tariff reductions negotiated during the Kennedy Round would not apply to those commodities. In effect, the position in respect of these commodities would be the same as before the Kennedy Round. If this happened, the preferences would still be very important for the developing countries. And even if the Kennedy Round were fully successful and there were no exception lists affecting exports from developing countries, the question of preferential tariffs would still be pertinent, as long as the tariffs were not reduced to zero as a result of the negotiations.

Coming to the last three objections, it is fair to say that the developing countries generally, and many of the developed countries as well, recognize that any scheme that is adopted must be simple and easy to operate. The developing countries understand that there have to be adequate safeguards to see that the industries in the developed countries are not disrupted. UNCTAD had constituted a “Special Committee on Preferences” consisting of representatives of industrialized countries, developing countries, and countries with centrally planned economies. The scheme submitted by the developing countries to this Special Committee fully satisfies this and other criteria. The scheme is quite simple in that the preferences would be of general application to all developing countries without discrimination. It envisages no import duties on products of cottage industries or handmade goods, semimanufactured goods which are subject to further industrial processing, goods processed or manufactured primarily from products or materials originating in developing countries, and goods on which the most-favored-nation duty is 10 per cent or less. In respect of all other manufactures and semimanufactures, the scheme proposes that import duties should be at least halved.

The scheme provides that a developed country granting preferential treatment could, after justifying it before an appropriate international body (viz., a committee designated by UNCTAD for this purpose), exclude a manufactured or semimanufactured product from the preferential treatment. The exceptions would, of course, have to be justified on grounds of overriding national economic interest, and the number of excluded items would have to be limited as much as possible. Further, any developed country joining the scheme could seek the intervention of the same body when imports under preferential arrangements were causing a serious dislocation in its domestic market. In such circumstances, the preferences could be suspended so as to facilitate adjustment. Preferential tariff quotas could also be arranged during the suspension.

Advantages of the Plan Submitted to UNCTAD

One clear merit of this scheme put forward by the developing countries is that the preferential treatment is to be limited to 10 years from the time the country begins to benefit from it. After this initial 10 years, the preferences could be extended for a further 5 years if the appropriate international body considered this necessary. This limitation would ensure that no inefficient industries were set up as a result of these preferential tariffs. Further, since the period would be calculated from the date on which a particular developing country benefited from the scheme, the more advanced of the developing countries, which were already exporters, would lose their preferences after 10 years or so. In this way, the interests of the less advanced among the developing countries would be protected.

One important feature of the scheme is that the preferential tariffs would be extended by the developed countries to all manufactures and semimanufactures imported from all developing countries without discrimination. This would not call for any reciprocal concessions from the developing countries.

It will be seen that the scheme meets the various objections set out above. While it is put forward by the developing countries, quite a few developed countries also consider that the best method of implementing the preferences on the basis of nonreciprocity from developing countries is through such an internationally negotiated scheme of general preferences.

Other Plans

Australia is not the only developed country to play a leading role in the granting of tariff preferences. Other industrialized countries have also proposed similar schemes and of these, the Brasseur Plan put forward by Belgium deserves special mention. Briefly, this scheme provides that each developing country should negotiate with each developed country the commodities to which preferential tariffs would be given. The extent as well as the duration of preference would be discussed. The negotiations, which would be bilateral, would take account of the probability of protected industries becoming competitive, the risk of disruption of the import market, and the level, duration, and rate of decrease of the preferences. One important feature common to all three, plans—that of the developing countries, the Australian Plan, and the Brasseur Plan—is that no reciprocity is sought by the party granting the preference.

The developing countries could also establish preferential tariffs for imports from one another, by means of either a customs union or a free trade area. The Central American Common Market and the Latin American Free Trade Association already exist, and more such common markets are in the making (see “Currency Unions—Pro and Con,” in Finance and Development, Vol. III, No. 2). Such preferences would be highly beneficial to the growth of trade among developing countries and might well have a multiplier effect. The growth in exports might improve the producer’s competitive position in the markets of the industrialized countries. Dr. Raul Prebisch, Secretary-General of UNCTAD, has welcomed this suggestion, and he thinks that it has a good chance of achieving this result.

Summing Up

During the last 10 years, the gap between the developed and the developing countries has been getting wider and wider. The flow of economic aid helps to redress this somewhat, but the volume of aid required and the effort involved are so large that aid by itself cannot solve the problem. An equally potent remedy is to help the developing countries to increase their exports by the introduction, among other things, of a system of tariff preferences under a broad international agreement. An analysis of the arguments advanced against preferential tariffs shows that there are no insuperable obstacles to such a course. If preferential tariffs are uniform and made available to all developing countries without distinction, this would go a long way in the orderly development of their exports and international trade. Such preferences may be operative initially for a period of 10 years but could be extended for a further period of 5 years. By providing exceptions, where justified on grounds of overriding national economic interests, the scheme can ensure that the domestic markets of the industrialized countries are not seriously dislocated. The developing countries themselves could start the ball rolling by giving tariff preferences to one another.

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