How can small businesses benefit from mega-regional trade deals?

Since the WTO’s Doha Round stalled, the world has been awash with mega-regional preferential trade negotiations. These agreements will improve market access by lowering tariffs to firms in participating states. But not all firms will gain equal benefits because the improved access, while largely tariff-free, will not be cost-free. In other words, the administrative burden of demonstrating compliance with cumbersome rules of origin will be disproportionately heavy for small and medium-sized enterprises (SMEs) that make smaller shipments. We discuss how this can be remedied, thereby boosting SME utilisation of these agreements.

As background, because of fixed costs of demonstrating compliance with rules of origin, utilisation of preferences shrinks as the size of shipments and tariff levels decline. For example, utilisation of EU preferences is consistently above 50% only for shipments facing tariffs over 15% or with face value over USD 100,000.

These costs also limit the potential of electronic commerce to enable smaller firms to “go global.” Small businesses using online platforms and payment solutions reach, on average, 20 to 40 markets. These trade patterns are characterised by many small shipments to many customers in many different markets with the allocation across destinations almost random.

The ability to – randomly – serve many customers in a large number of different markets increases the chances of firms surviving past their first year and increases the likelihood of exporter-destination relationships surviving past four years.

Moreover, data on Turkish sellers using the eBay Marketplace suggests a phenomenon of “learning by exporting,” on behalf of small businesses trading using technology tools. The exports of these sellers expanded significantly over the period 2007 to 2013 but the number of product categories they sold decreased after 2009. As firms gained experience, they grew their sales through higher sales per product category, rather than by expanding product categories. As they learned what products worked best for them, they specialised into selling those few items, thereby increasing their productivity.

To date, free trade agreements have not had a strong impact on this type of trade, instead focusing on supporting traditional trade. However, when a country joins a single market like the EU, the positive impact on e-commerce surpasses that of traditional trade. Notably, joining a single market does not require companies to comply with rules of origin, but does give them immediate access to markets and customers.

These findings suggest that current trade agreements provide little support to small businesses in traditional or e-commerce business modes. This apparent bias against SMEs has a number of non-obvious consequences.

First, by limiting the participation of smaller firms in trade, preferential agreements favour larger firms even in domestic markets. This can result in the following scenario:

• Upstart SME competitors may not attain economies of scale from access to export markets; and
• Larger exporters meanwhile expand the scale of their shipments, lowering unit costs for domestic sales.
• This diminishes internal competitive dynamics that drive industrial renewal within economies.

Second, it also weakens the productivity-enhancing effect of free trade agreements. Modern firm-level trade literature shows that firms that enter into trade:

• Benefit as exporters from knowledge spillovers or “learning by exporting;”
• Are induced to make efficiency enhancing investments or “learning to export;” and
• Benefit as importers from access to higher quality production inputs available in global markets.
• Importantly, these learning effects are also seen in firms utilising e-commerce, and not only when there is extensive direct interaction with foreign customers that the mainstream “learning by exporting” literature suggests are key.

Is there is a remedy? One approach that might help is to reformulate the de minimis rule for waiver of origin certificate requirements. Currently the more or less standard de minimis provision exempts shipments with a face value of US$1000 or less. This is on the order of magnitude that consumers can bring in from abroad on vacation and is clearly below commercial scale.

The de minimis rule should be recast in terms of face value of duty paid. Consider the implications of setting the face value of duty payable at €1000 (US$1,250):

• For a tariff rate of five percent, a €1000 duty payable waiver implies a waiver of origin certificates for shipments of €20,000, or the recommended increase in de minimis levels.
• For a tariff rate of 20 percent, the €1000 duty payable waiver reduces the scale of shipment that enter without origin certification to €5000, approximating the EU’s 2017 amendment to its generalised system of preferences (GSP) regime.
• For a tariff rate of one percent, however, the wavier increases the size of shipment not requiring origin certification to €100,000.

A waiver based on the amount of duty payable thus constitutes a sliding scale for the size of shipments. This technical “tweak” has several useful features. First, by targeting the size of the fixed costs of compliance with rules of origin, the modification also targets SMEs. Second, it automatically takes into account the risk of cheating, in other words, the waiver threshold rises for shipments facing lower tariffs where there is a lower incentive to cheat and falls for shipments facing higher tariffs where there is greater incentive to cheat.

For customs departments, it should be feasible to apply. Customs officers need only look at the face value of duty payable, rather than the face value of the shipment, to see whether a certificate of origin is required or not.

The next major steps in re-framing global trade rules will most likely be taken by the mega-regional trade agreements. If these agreements are to live up to their stated aims of supporting SME participation in trade, including through the increasingly important e-commerce mode, the approach to formulating the de minimisprovisions for origin certification needs to be revisited. The proposal discussed in this post would increase SME participation in trade, expand sharply the utilisation of e-commerce to conduct preferential trade, and generally work to provide a fairer competitive framework for domestic competition.

This article is published in collaboration with ICTSD. Publication does not imply endorsement of views by the World Economic Forum.

To keep up with the Agenda subscribe to our weekly newsletter.

Author: Dan Ciuriak is Director and Principal, Ciuriak Consulting Inc. Hanne Melin is Director Global Public Policy and Head of eBay Inc. Public Policy Lab for Europe, Middle East and Africa.

Image: A seagull flies over the dock of C.C shipyard Co.Ltd. REUTERS/Kim Kyung-Hoon