2.3 Could Preferences Be Harmful?
The discussion above suggests that many factors influence how valuable preferences are, and may explain why traders either do not request preferential treatment or perhaps do not export at all. In other words, it is far from certain that a given preference will have positive effects on trade. In fact, it has also been suggested that preferences are not just ineffective, but may even have overall negative effects. This subsection will discuss some of these arguments.
An obvious potential negative effect is trade diversion. In some sense, a major point of preferences is to divert trade away from developed countries to assist in the development of low- and middle-income countries. As long as the beneficiary countries are not too successful, this is generally not seen as very controversial. However, given the EU’s (and some other industrialized countries’) multilayered and extremely complex system of preferences, it is not just well-off countries that may be negatively affected, but indeed also other developing countries if they are offered less generous market access. Countries only having access to the general arrangements of the EU GSP might, for example, plausibly argue that their export prospects are hurt by preferences offered to ACP or Mediterranean countries.
Further, as noted by e.g. Grossman and Sykes (2005), since preferences generally do not cover all dutiable products, there is a risk that they could distort investment decisions in favour of sectors eligible for preferences, and away from sectors where there are prospects for long-term growth. This danger is underlined by the fact that preferential access changes over time, because of changed rules about preferential margins or product coverage, graduation of products or countries, changed rules of origin or, for that matter, because the MFN tariffs change as a result of multilateral trade negotiations. Hence, if investors expect an advantageous preferential access for a product, and the market access conditions then change, the result could be a serious misallocation of resources.
Another potential negative effect of trade preferences, pointed out by Özden and Reinhardt (2005), is that they may slow down the developing countries’ own trade liberalization. While import-competing sectors may have an incentive to lobby for trade barriers, this political pressure is often thought to be counteracted by the export sectors who can be expected to lobby for trade liberalization at home in order to achieve better market access in their export markets. However, with preferences, market access in developed countries is already settled, which reduces the incentive that the export sectors have for lobbying for trade liberalization at home. Hence, the political balance shifts in favour of the import-competing sectors, which could result in slower progress toward the dismantling of trade barriers. Özden and Reinhardt (2005) offer empirical evidence in favour of this hypothesis. Looking at beneficiaries of the US GSP from 1976 to 2000 – and considering the potential endogeneity problems – they find that countries that are dropped from the GSP scheme adopt more liberal trade policies than countries that remain eligible.
In addition to obstructing developing countries’ own tariff liberalization, trade preferences may also hinder multilateral trade negotiation by developed countries. The argument, discussed in e.g. Limão and Olarreaga (2006), is that developing countries that have preferential access to developed countries markets’ will oppose multilateral trade liberalization because this would lead to an erosion of preferences.8 Arguing from a slightly different perspective, but reaching a similar conclusion, Hart and Dymond (2003) suggest that since the non-reciprocity of trade preferences means that developing countries do not have to, in a sense, “pay” for new export opportunities, they will have difficulties in persuading developed countries to open up their markets for products of particular export interest, such as tropical agricultural products, and standard-technology, labour-intensive consumer products.