This is the first of a two part series which focuses on accessing inputs and capital goods at competitive prices.
Background
Access to imported inputs at world prices is found to be crucial for export expansion. However, in general, tariffs and other measures which protect domestic industries create disincentives to export. Firstly, tariffs raise the price of raw materials, intermediate and capital goods and thus reduce the profitability of export production. Secondly, nominal tariffs increase the relative return to production for the domestic market leading firms to shift production out of the export market and into the domestic market1. This problem, known as “anti-export bias”, occurs whenever the relative profitability of the home market as opposed to export sales is raised due to policy intervention. In the presence of protection against imports such a bias will be unavoidable, unless compensatory supply-side export promoting schemes are provided.
An ideal trade policy approach would suggest that the best way to reduce anti-export bias and to improve the environment for export growth is to reduce protection of the domestic market. This means reducing tariffs, reducing or eliminating tariff escalation, and avoiding the use of anti-dumping and quantitative restrictions (QRs). Although developing countries have made good progress in liberalising, such reforms are typically long and difficult. In addition, export subsidy measures which were previously used extensively by many countries to improve the competitiveness of local suppliers can no longer be employed. The following section however shows, there are a number of counter-balancing export promotion policies that can be used to reduce anti-export bias and make exports more competitive including specialised schemes; policies to develop local industries, and; regional sourcing.
Such export subsidy policies, have previously been used extensively by developed and developing countries (particularly as a means of industrialisation); however, in recent years WTO trading rules governing their use have been tightened. Specifically, a number of subsidy schemes would be judged to be trade distorting for all but some developing countries (with a per capita income below $1000); certain developing countries for specific designated schemes and all LDCs.
Many countries favour using specialized schemes since they are easier to administer than larger-scale national reforms. Such schemes include, utilising duty drawback and special import licenses for exporters, as well as specialized schemes, like bonded manufacturing and export processing zones. Developing and least developed countries can benefit utilising more favourable rules regarding subsidies to support local industry, such as: duty drawback, special economic zones (SEZs), condoning or not collecting government revenues otherwise due and export credits.
This briefing focuses on the specialised export promotion schemes of duty drawback and special economic zones, and how they can contribute best to accessing inputs and capital goods at competitive prices. Further schemes will be profiled in the following briefing.
Duty drawback schemes
Duty drawback schemes are often used as means to provide exporters of manufactured goods with imported inputs at world prices and thus increasing their profitability, while maintaining the protection for domestic industries that compete with imports. Duties are initially paid as goods are landed. Refunds are provided upon shipment of export goods, which include dutiable components. Such schemes are in place in most countries and constitute an important tool to promote exports. These schemes are particularly advantageous in countries where tariffs for intermediate products are high, since the duties paid will be refunded when the product, into which the imported input has been incorporated, is exported.
Legal compliance
WTO Members may establish duty drawback schemes provided that:
Customs duties have been paid on inputs used for the production of the finished product
The amount of drawback does not exceed the amount of duties levied on inputs consumed in the exported good, and;
There is a verification system to check the inputs used in the production of the exported goods as well as amounts of the inputs concerned.
Also included in drawback schemes is what is known as “substitution drawback systems”. This system allows for the refund or drawback of import charges on inputs which are consumed in the production process of another product and where the export of this latter product contains domestic inputs having the same quality and characteristics as those substituted for the imported inputs. The main requirement for substitution drawback systems to be authorized is that the home market inputs substituted for imported inputs in the production of a product for export must be equal in quantity to, and have the same quality and characteristics as, the imported inputs being substituted.
In developed countries
Duty drawback schemes are implemented in different ways by Member countries. Generally, in developed countries there are sophisticated means which normally allow for the establishment of clear linkages between the imported inputs for which exemption or remission of import charges is sought and the exported product. New technologies can often facilitate these procedures.
In developing countries
By contrast, in developing countries, has not fared very well for various reasons, including: administrative weaknesses in customs administration; poor statistical infrastructure; and the failure of the government to reimburse pre-paid duties because of financial difficulties. In particular, some developing countries consider having in place and implementing the procedures of developed countries would be “impracticable” and “places an onerous burden due to the prevalence of a large number of small and medium enterprises”. These countries consider that “[t]he administrative machinery required for such verification of inputs would be prohibitive in terms of costs”. In order to meet the criteria, some developing countries, such as India, have developed and apply what is known as standard input-output norms or similar averaging procedures (SION). However, still such verification systems have been frequently rejected for not being reasonable and effective in the context of countervailing investigations.
Developing countries ought to ensure that the verification systems are in full compliance with the provisions of the ASCM. For this, it may be advisable that such countries seek technical assistance from customs authorities of developed countries, or from compliant developing countries, in order to set up the appropriate verification systems.
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Box 1: Columbia - Incentive schemes used
Columbia’s government policy towards investment and export promotion has met with some recognition by business analysts. According to the Doing Business Report 2009, Colombia ranked in second place in Latin America in the ease of doing business. The Colombian government’s investment and export promotion strategy uses Duty Free Zones to promote the industrial processing of goods and services, primarily for export. Colombian legislation provides tax and procedural incentives to users of the free trade zones.
Further important features of the Colombian investment and export promotion measures include:
Special Import/Export Programs: enable producers to seek duty exemption on inputs in the production of exported goods.
Permanent Customs Users: a program that allows business providers to obtain duty drawbacks if their operations exceed US$6 million during the previous year.
Temporary Imports for Re-Exporting Unaltered Products: allows importers to import products duty-free provided that they are re-exported in the same state as they were when imported into the country.
Highly Exporting Users: offers a number of tax incentives to companies that export at least 30% of total sales.
Special Customs Zones: offers tax benefits to companies that set up operations in designated areas.
Sales Tax (VAT) Exemption: to industrial machinery that is imported into Columbia.
In summary, the Colombia’s investment and export incentive strategy focuses on tax breaks and customs facilitation measures. Colombia is also among the countries that have established Duty Free Zones where measures are intended to facilitate and provide incentives to export oriented businesses. |
Special economic zones
For many countries, providing trade liberalization on a national scale is not possible in both the short and medium term. Instead, they commonly favour an intermediary step and choose liberalization of trade and investment in geographically delineated economic areas, such as export processing zones, special industrial zones, free trade zones or export promotion zones. As will be seen shortly, governments using, or considering using SEZs must abide by WTO rules, particularly those regarding subsidies, as well as give careful consideration to their economic feasibility.
The common feature of these schemes is that they all offer a range of benefits to the companies making use of them.
These benefits vary from country to country and even within the same country, from one free zone to another. While each country defines its own objectives for such schemes, they quite often involve the following:
- Increase exports;
- Attract foreign capital, achieve accrued capital;
- Introduce new technology, especially in the industrial field;
- Provide employment opportunities, generate a substantial skill surge.
Free zones, and similar schemes, have therefore become popular tools to promote exports, especially in developing countries. This is particularly the case for countries in which import tariffs are, or have been, high. Companies operating under these schemes have traditionally been exempt from paying customs duties on imports of raw materials, and often intermediate inputs and capital goods, used for the production of exported goods. Zones can be publicly or privately owned or managed and can be “high-end” or “low-end,” depending on the quality of the management, facilities, and services they provide firms. They tend to promote the establishment of related industries to form clusters and, as they grow, they tend to attract new companies operating in the specific field in which the free zone specializes.
Policies for success
Governments ought to be fully aware of the costs and benefits of the incentives they allow for in SEZs. Incentives should be in-line with WTO rules and timelines; or else host countries may face retaliatory actions by importing countries. In particular, several types of incentives (subsidies) that are typically part of SEZ policy are subject to disciplines under the WTO, most notably through provisions in the SCM Agreement and therefore need to be complied with.
Government should further provide efficient, streamlined, and prompt services for setting up and running export processing zones (approval of investment applications, customs and other supervisory institutions). Privately owned and managed zones should be encouraged. If zones are public, considerable autonomy should be granted. Zone firms exporting from one member of a trade arrangement should be aware of potentially complex rules of origin and restrictions. Zones in countries that are members of preferential trade arrangements (regional or bilateral) may be more attractive to firms targeting these markets, because such a membership enlarges potential market size and eases entry barriers. Exports from these zones may, however, face complex rules of origin regulations and restrictions. Finally, is it important to develop special customs rules and regulations drawing upon WCO and WTO provisions, and fast-track implementation of automated customs systems, with proper inventory controls and audit systems, within the special economic zones.
Owing to the distortions created, it is important to make clear that SEZs are a less than optimal strategy and should not be favoured over overall improvements to the business environment and economy wide strategies. However, SEZs, can be useful in countries at earlier stages of development, since they are usually easier to administer than full-scale national liberalisation reform.
Further still, SEZs can logically serve as a bridge to trade liberalization on a national basis. They reduce anti-export bias of high tariffs by permitting an exporting company to access inputs at global prices, and therefore may aid the creation of an export industry and improve a country’s trade balance.
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Box 2: Costa Rica and Senegal’s experiences with Economic Processing Zones
Costa Rica established its first EPZs in the early 1980s in the port cities of Puntarenas and Limón - both of which were economically depressed areas. To attract foreign investment, the authorities designed a system of fiscal incentives for interested firms to locate in these zones. However, mainly due to their locations, these initial attempts were unsuccessful in attracting large investment and saw only a few firms and jobs created. The majority of companies invested in operations in private zones, which were subsequently formed in the central region of the country. These areas had better infrastructure facilities, access to specialized services, and abundant skilled workers that made the location more attractive. EPZ investors preferred better supporting conditions than incentives. Since 1990, that export-oriented activity in Costa Rica has increased rapidly under the EPZ and Regime of Temporary Admission (RTA) regimes. Between 1991 and 1996 employment increased annually by more than 7 percent and net EPZ and RTA exports increased annually by more than 14 percent. In 2005, 8 percent of Costa Rica’s total export volume and 53 percent of total value originated in EPZs. This value-added production is driven by Intel Corporation, which is the largest exporter. EPZs in 2005 were employing around 39,000 people, 5,000 more than in 2001.
Senegal established an EPZ near the port of Dakar in 1974 but the project failed and was aborted in 1999. At the time of closure, the Dakar EPZ had hosted only 14 active enterprises with a total of 940 employees. Principal reasons of failure included excessive bureaucracy (custom procedures, long delays in acquiring permits etc.), unfortunate location (12 km from the Dakar port), an obligation for companies to hire more than 150 people, and rigid and constraining labour regulations. |