metadata: authors: 0: author: Espitia Rueda,Alvaro Raul
1: author: Mattoo,Aaditya
2: author: Mimouni,Mondher
3: author: Pichot,Xavier
4: author: Rocha,Nadia
count: World
docna: 0: docna: How preferential is preferential trade ?
docty: Policy Research Working Paper
subtopic: International Trade and Trade Rules,Business Cycles and Stabilization Policies,Construction Industry,Common Carriers Industry,Food & Beverage Industry,Plastics & Rubber Industry,Pulp & Paper Industry,Textiles, Apparel & Leather Industry,General Manufacturing,Global Environment,Transport Services,Energy and Natural Resources,Coastal and Marine Resources
teratopic: Macroeconomics and Economic Growth,Industry,International Economics and Trade,Transport,Energy,Water Resources
abstracts: cdata!: World trade is increasingly ruled by
            preferential trade agreements (PTAs), but their precise
            nature remains relatively opaque. This paper assesses a
            central dimension of these agreements, the significance of
            tariff preferences, using a new data set on preferential and
            non-preferential or Most Favored Nation (MFN) applied
            tariffs, constructed by the International Trade Center and
            the World Bank. The data set covers 5,203 products, 199
            reporters, and 239 partners, representing approximately 97
            percent of world imports in 2016. There are three main
            findings. First, PTAs have significantly widened the scope
            of tariff-free trade. Whereas 42 percent of the total value
            of trade traded free under MFN rates in 2016, PTAs have
            fully liberalized an additional 28 percent of global trade.
            Second, the extent of preferential liberalization varies
            significantly across countries and sectors. Around 70
            percent of countries have reduced trade-weighted average
            preferential tariffs to less than 5 percent, but PTAs have
            not been able to eliminate the high levels of protection in
            some low-income countries and in agricultural products,
            textiles, and footwear. Third, while the average
            preferential margin for trade covered by PTAs is low because
            one-fifth of world trade under preferential agreements is
            already duty free, more than a quarter of world trade is
            subject to an average preference margin of 7.4 percent.
            Considering competition from preferential and
            non-preferential sources, however, only 5.2 percent of
            global exports benefited from a preferential advantage of
            over 5 percent and only 3.3 percent of global exports
            suffered from a preferential disadvantage higher than 5
            percent. Furthermore, data for a subsample of importers
            reveal that not all eligible imports take advantage of
            preferences, because of impediments such as restrictive
            rules of origin, and therefore actual preference margins are
            generally lower than potential margins.
repnme: repnme: How preferential is preferential trade ?
display_title: How preferential is preferential trade
listing_relative_url: /research/2018/05/29898343/preferential-preferential-trade
topicv3: Natural Resources m1326446 1979,Manufacturing Sectors m1326521 1281,Transport m1326661 135,Trade m1326924 698,Environment, Natural Resources and Blue
            Economy m1327391 566
publishtoextweb_dt: 2018-05-16T00:00:00Z
historic_topic: Macroeconomics and Economic Growth,Industry,International Economics and Trade,Transport,Energy,Water Resources
no_of_pages: 34
author_keys: 0: author_key: 1548121
1: author_key: 429183
model_extractions: WPS8446 Policy Research Working Paper 8446 How Preferential Is Preferential Trade?

_Alvaro Espitia Aaditya Mattoo Mondher Mimouni Xavier Pichot Nadia Rocha_ Development Economics Development Research Group & Macroeconomics, Trade and Investment Global Practice May 2018
Policy Research Working Paper 8446

# **Abstract**

World trade is increasingly ruled by preferential trade agreements (PTAs), but their precise nature remains relatively opaque. This paper assesses a central dimension of these agreements, the significance of tariff preferences, using a new data set on preferential and non-preferential or Most Favored Nation (MFN) applied tariffs, constructed by the International Trade Center and the World Bank. The data set covers 5,203 products, 199 reporters, and 239 partners, representing approximately 97 percent of world imports in 2016. There are three main findings. First, PTAs have significantly widened the scope of tariff-free trade. Whereas 42 percent of the total value of trade traded free under MFN rates in 2016, PTAs have fully liberalized an additional 28 percent of global trade. Second, the extent of preferential liberalization varies significantly across countries and sectors. Around 70 percent of countries have reduced trade-weighted average preferential tariffs to less than 5 percent, but PTAs have not been able to eliminate the high levels of protection in some low-income countries and in agricultural products, textiles, and footwear. Third, while the average preferential margin for trade covered by PTAs is low because one-fifth of world trade under preferential agreements is already duty free, more than a quarter of world trade is subject to an average preference margin of 7.4 percent. Considering competition from preferential and non-preferential sources, however, only 5.2 percent of global exports benefited from a preferential advantage of over 5 percent and only 3.3 percent of global exports suffered from a preferential disadvantage higher than 5 percent. Furthermore, data for a subsample of importers reveal that not all eligible imports take advantage of preferences, because of impediments such as restrictive rules of origin, and therefore actual preference margins are generally lower than potential margins.

This paper is a product of the Development Research Group, Development Economics; and the Macroeconomics, Trade and Investment Global Practice. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/research. The authors may be contacted at aespitiarueda@worldbank.org, amattoo@ worldbank.org, mimouni@intracen.org, pichot@intracen.org, and nrocha@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# How Preferential Is Preferential Trade?

Alvaro Espitia*, Aaditya Mattoo*, Mondher Mimouni**, Xavier Pichot**, Nadia Rocha* _Keywords_ : regionalism, trade agreements, tariffs, MFN _JEL codes_ : F13, F14, F15

*World Bank and **International Trade Centre.  We have benefited from the helpful comments of Nuno Limao, Ileana Cristina Neagu, Alejandro Forero Rojas, Michele Ruta and participants in the workshop on Deep Trade Agreements at the World Bank. We are also grateful for financial support from the World Bank’s Multi‐Donor Trust Fund for Trade and Development and Strategic Research Program _._ The findings in this paper do not necessarily represent the views of the World Bank’s Board of Executive Directors or the governments they represent. Any errors or omissions are the authors’ responsibility.

1
# 1. Introduction

Countries around the world have increased their participation in preferential trade agreements (PTAs) especially in the last two decades **.** From the 1950s onwards, the number of active PTAs increased steadily to almost 50 in 1990. Thereafter, PTA activity accelerated noticeably, with the number of PTAs more than doubling over the next five years and more than quadrupling by 2010, to reach close to 280 PTAs presently in force (see Figure 1).

Figure 1: Trade agreements have proliferated over time <!-- Start of picture text --> 300<br>250<br>200<br>150<br>100<br>50<br>0<br>Number of agreements in force<br><!-- End of picture text --> Source: Authors’ calculations using World Bank PTA data set (2016) The existing literature suggests at least two reasons for the significant increase in the number of PTAs. First, the lack of progress in trade negotiations at the multilateral level has improved countries’ incentives to engage in bilateral or regional preferential negotiations.<sup>1</sup> Second, the fear of market share loss by being excluded from existing PTAs has pushed more countries to sign PTAs ‐ a “domino effect” of PTAs.<sup>2</sup> The extent of preferential trade across countries has been previously estimated. However, the analysis is usually limited to a subsample of countries, due to the limited availability of data on preferential tariffs. Grether and Olarreaga (1998) estimated the share of preferential trade flows for a sample of 53 countries, representing around 85 percent of world trade for respectively 1990 and 1995. They estimated that the share of preferential trade was around 40 percent in 1995. Fugazza and Nicita (2010) calculated a bilateral index of preferential access, using a data set based on HS6‐digit tariff lines and trade data ranging from 2000 to 2007 and covering 85 countries; they also tested the impact of preferences on bilateral trade. Figures included in their paper suggest that 40 percent of world trade was at zero MFN rates and 30 percent duty‐free

> 1 Capling and Low (2010) and Bhagwati (2008).

> 2 Baldwin and Jaimovich (2010).

2
under preferences. Carpenter and Lendle (2011) used detailed information on tariffs and imports at the HS6‐digit tariff line level for the 20 largest importers to estimate how much of world trade was preferential. They found that only 16 percent of world trade was eligible for preferences and that preferential margins are often small.

The findings of this paper are in line with the literature assessing the extent of preferential liberalization but add to it in scope and substance. We investigate the significance of tariff preferences using a new data set on preferential tariffs at the HS6‐digit product level, imposed by 197 importers on 239 partners and representing approximately 97 percent of world imports in 2016. Two main questions are addressed in the analysis: (i) What tariff structure has emerged from unilateral and multilateral non‐preferential liberalization? (ii) How have preferential tariffs changed the trade regime?

We find – in line with Fugazza and Nicita (2010) – that whereas 42 percent of the total value of trade traded free under MFN rates in 2016, PTAs have fully liberalized an additional 28 percent of global trade. In fact, only 5 percent of global imports are subject to positive tariffs under PTAs. Our findings also suggest that the extent of preferential liberalization varies significantly across countries and sectors. In terms of preferential margins, we find that while the average preferential margin in PTAs is low, more than a quarter of world trade is subject to an average preference margin of 7.4 percent.

These results are based on potentially applied tariffs. In practice, preferential duties are not granted automatically to all eligible products. An assessment of the scope of preference utilization for the sub‐sample of EU imports from its trading partners suggests that more than 80 percent of preferences granted by the EU were fully utilized in 2016 – which is consistent with the findings for Australia, Canada, EU and US in Keck and Lendle (2012). However, the rate of utilization of preferences varies across countries and products. Key factors explaining low utilization rates include rules of origin as well as the related administrative burden and lack of knowledge of import and export processes.

The paper is organized as follows. Section 2 introduces the new data set on tariffs and preference margins that has recently been constructed by the International Trade Center (ITC) and the World Bank. Section 3 describes the multilateral trade regime and the scope for further liberalization. Section 4 discusses how preferential tariffs have changed the trade regime. Section 5 concludes.

2. A new database on preference margins and preferential trade This analysis is based on a new data set on tariffs and preference margins that has recently been constructed by the ITC and the World Bank. The data set includes information on most favored nation (MFN) and preferential tariffs imposed at the HS6 digit product level in 2016 and has been constructed by merging different sources of data. The ITC is the main source of information on ad valorem equivalents at the HS 6‐digit level for both MFN applied tariffs and preferential tariffs 3
by country pair. Imports in 2016 come from UN Comtrade<sup>3</sup> and information on PTAs in force during the same year comes from the new World Bank data set on the of content PTAs (Hofmann et at, 2017).<sup>4</sup> ITC database description The ITC Market Access Map database includes customs duties at the national tariff line code (NTLC) for 201 reporters and faced by 239 partners under MFN, non‐MFN and preferential regimes and tariff rate quotas. The database is continuously updated with tariff data that ITC collects directly from national authorities such as customs offices, ministries and other governmental institutions. When the national sources cannot provide ITC with the preferential rates under a preferential trade agreement that is known to be in force, then ITC obtains the missing information from the tariff phase‐out schedules of the agreement to complement.

The ITC database contains pre‐calculated ad valorem equivalents (AVE) for non‐ad valorem duties and tariff rate quotas (TRQ) (Table 1).

Table 1: Non‐ad‐valorem tariffs and ad‐valorem equivalent composition

|NAV tariff category|Example|Final AVE composition|
|---|---|---|
|**_Specific tariff_**<br>**_Compound tariff_**|$2 per kg<br>10% plus $2 per kg|AVE of the specific tariff<br>Ad valorem component added to (or subtracted from) the AVE of the<br>specific component|
|**_Mixed tariff_**<br>**_Tariff rate quota_**|30% or € 2 per kg, whichever<br>is highest<br>5% for imports within quota<br>and 20% for out of quota<br>imports|AVE of the specific component subject to the conditional choice<br>expressed in the tariff<br>AVE depends on the real volume of imports in the year of reference. The<br>marginal level of protection of a TRQ consists of the average of the inside<br>and outside tariff rates if the import volume is less than or equal to 80%<br>of the contingent, or the outside tariff if beyond|
|**_Technical tariff_**|9% on dairy spreads with a fat<br>content between 39% and<br>60%|Not calculated due to a lack of information on technical product<br>specifications|

Source: ITC Market Access Map methodology ‐ User guide AVEs express non‐ad valorem tariffs in percentage terms as follows: Where SP is the monetary value of duty per unit of imports; UV is the import unit value that is calculated as the ratio between the value of imports (V) and the quantity of imports (Q); XR is the currency exchange rate when appropriate. The accuracy of the AVEs depends on the UV estimates, which are sensitive to variations in the data. ITC’s strategy to select the most accurate UV estimates is schematized in Appendix figure A1 and the entire calculation process is detailed in the World Tariff Profiles 2006.<sup>5</sup>

> 3 TRAINS and COMTRADE information is taken from the World Integrated Solution (WITS).

> 4 The data set is available at <u>http://data.worldbank.org/data‐catalog/deep‐trade‐agreements.</u>

> 5 See World Tariff Profiles 2006, pages 186 ‐197.

4
Notice that not all non‐ad valorem tariffs can be converted into an ad valorem equivalent rate. This is the case for technical duties imposed on some products (see Table 2). Nonetheless, such duties represent only 1.7 percent of the country‐pair‐product observations in the database.

Table 2: Examples of technical duties

|**Importing**<br>**country**|**National Product**<br>**Code**|**Product description**|**Custom duty as**<br>**reported**|
|---|---|---|---|
|**_Yemen_**|22043000|Wine of fresh grapes, including fortified wines;<br>grape must other than that of heading 20.09;<br>othergrape must.|**Prohibited**|
|**_Russian_**<br>**_Federation_**|8703329093|Motor cars and other motor vehicles principally<br>designed for the transport of persons (other<br>than those of heading 8702), including station<br>wagons and racing cars; Other vehicles, with<br>compression‐ignite.|**2.2 euro per cm**<sup>**3**</sup>**of**<br>**engine volume**|
|**_New Zealand_**|95081000|Roundabouts, swings shooting galleries and<br>other fairground amusements; travelling circuses<br>and travellingmenageries;travellingtheatres|**The rates applicable to**<br>**the separate**<br>**components**|
|**_United States_**|91091010|Alarm clock movements, complete and<br>assembled, electrically operated, with<br>optoelectronic displayonly|**3.9% on the movement**<br>**+ 5.3% on the battery**|

Source: ITC Market Access Map To make the tariffs comparable across countries and sectors, AVEs are aggregated from the NTLC to HS6 by calculating the simple average of all underlying NTLC rates. If there is more than one preferential tariff under a given NTLC for a partner country, then the ‘minimum’ rate is selected. The most favored nation (MFN) tariff or the general tariff is used if no tariff preference is applicable.

The resulting aggregated database includes information on the ad valorem equivalent at the 6‐ digit HS product level for both the maximum applied rate (MFN rates) and preferential tariffs for a total 199 reporters and 239 partners. Among the 199 reporters, 141 countries have data for 2016, 7 for 2017, 20 for 2015 and 13 for 2014. For the remaining 18 countries, most recent information is available between 2006 and 2013 (see Figure 2).<sup>6</sup> In terms of products, information is reported on all 5,203 HS6 level products (HS 2012 nomenclature).

> 6 Out of these 18 countries, only Panama and Trinidad and Tobago have signed agreements entering into force after the date for which tariff information is available (see Appendix Table A. 2).

5
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fallen from levels between 12.5 and 15 percent in 1995 to lower than 10 percent during 2015 (see Figure 3).

Figure 3: Applied MFN rates have steadily declined over time <!-- Start of picture text --> 15.0<br> 12.5<br> 10.0<br> 7.5<br> 5.0<br>1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015<br>Simple Average Trade Weighed<br>MFN tariff (%)<br><!-- End of picture text -->

# Source: WITS

Note: To avoid sample selection bias, tariffs have been calculated for a balanced sub‐sample of countries and missing data have been interpolated. The sub‐sample includes 27 countries with applied MFN rates in at least 15 years between 1995 and 2015 (see Appendix Table A. 3). The data used in the figure are simple averages and trade weighed of MFN rates for all products.

Of the total value of imports, 42 percent trades free under MFN rates. Another 45 percent is subject to MFN rates below 10 percent, and only one‐tenth to MFN rates above 10 percent. In terms of products, 24 percent of tariff lines are subject to zero MFN rates, 23 percent to MFN rates over 15 percent and one‐quarter to rates between 5 and 10 percent (see Figure 4).

Figure 4:Almost two‐thirds of imports by value are subject to MFN rates of less than 5 percent <!-- Start of picture text --> 42.3%<br>35.9%<br>24.2% 24.2% 23.2%<br>20.9%<br>12.7%<br>5.8%<br>4.3% 3.9%<br>2.5%<br>0.1%<br>MFN = 0 MFN < 5% MFN [5%,10%] MFN (10%,15%] MFN > 15% Missing<br>MFN range<br>Global Imports Tariff Lines<br><!-- End of picture text --> Source: Authors’ calculation using ITC/World Bank database On average, agricultural imports are subject to higher MFN rates than manufacturing and natural resources. Whereas more than half the imports of natural resources and around 42 percent of 7
manufacturing goods are subject to zero‐MFN rates, less than a quarter of agricultural imports benefit from duty free treatment. At the same time, nearly 40 percent of agricultural imports are subject to MFN rates over 10 percent (see Figure 5), compared to less than one‐tenth of manufacturing imports.

Figure 5: MFN rates vary significantly across the three economic sectors (value of imports) <!-- Start of picture text --> 60%<br>50%<br>40%<br>30%<br>20%<br>10%<br>0%<br>MFN = 0 MFN < 5% MFN [5%,10%] MFN (10%,15%] MFN > 15% Missing<br>Agriculture Natural Resources Manufacturing<br>Share of 2015 sector imports<br><!-- End of picture text --> Source: Authors’ calculation using ITC/World Bank database Also, a higher share of tariff lines is subject to higher MFN rates in agriculture, compared to manufacturing and natural resources (see Figure 6). Nearly two‐fifths of agricultural tariff lines and about one‐fifth of manufacturing tariff lines are subject to MFN rates over 15 percent.

Figure 6: MFN rates vary significantly across the three economic sectors (tariff lines) <!-- Start of picture text --> 45%<br>40%<br>35%<br>30%<br>25%<br>20%<br>15%<br>10%<br>5%<br>0%<br>MFN = 0 MFN < 5% MFN [5%,10%] MFN (10%,15%] MFN > 15% Missing<br>Agriculture Natural Resources Manufacturing<br>Share of 2015 sector tariff lines<br><!-- End of picture text --> Source: Authors’ calculation using ITC/World Bank database 8
# 4. How have preferential agreements changed trade regimes?

Lack of progress in multilateral negotiations, among other reasons, has spurred tariff reductions through bilateral and regional preferential trade agreements.

Patterns of preferential liberalization In 2016, preferential trade agreements fully liberalized an additional 28 percent of global trade. This brings to 70 percent the share of global imports taking place duty free between countries in 2016. Only 5.5 percent of global imports are subject to positive tariffs under PTAs, of which one‐ fifth receive no preferences at all (see Figure 7). The overall trade‐weighted average tariff has been reduced from 5.0 to 2.7 percent.

Figure 7: More than half of the value of global trade took place under an agreement in 2015 <!-- Start of picture text --> Share of global imports<br>No Agreement Agreement<br>45% 55%<br>2.0% 21.3% 21.3% 21.0% 28.4% Missing<br>Missing MFN rate > 0 zero‐MFN rate zero‐MFN rate Preferential (Prf) tariff = 0 0.5%<br>2.3%<br>Zero tariif rates 3.2% 0 < Prf = MFN<br>70% 0 < Prf < MFN rate rate<br><!-- End of picture text --> Source: Authors’ calculation using ITC/World Bank database The extent of preferential liberalization varies across countries, but more than two‐thirds of countries have reduced trade‐weighted average tariffs to less than 5 percent. Multilateral liberalization efforts have been driven mainly by high‐income countries. This is reflected in their low preferential trade‐weighted applied MFN rates (mainly below 5 percent, see Figure 8). However, preferential liberalization has been widely spread across nations, with developing countries such as Rwanda, Burundi and Uganda reducing their average preferential trade‐ weighted rates by 40 percent.<sup>9</sup>

> 9 See Appendix **Error! Reference source not found.** .

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Source: Authors’ calculation using ITC/World Bank database Tariffs have been reduced across sectors but are still high for agricultural products. Agricultural sectors such as foodstuffs, animal and animal products, and vegetables (MFN trade‐weighted average over 15 percent) have seen tariff rates cut by half, but remain relatively high (see Figure 10). On average tariff reductions across sectors range between 32 and 62 percent on average.

Figure 10: Tariffs have been reduced across sectors but are still high for agricultural products Source: Authors’ calculation using ITC/World Bank database There is room left for further liberalization, especially in lower income countries. Low‐income and lower‐middle‐income countries still have trade‐weighted preferential tariff levels over 5 percent on average (see Figure 11.a). When preferential tariffs are split by level of development of importing and exporting countries, trade‐weighted preferential tariffs imposed by South countries on the North and on the South are respectively more than 2.7 times and 2 times higher than those imposed by the North (see Figure 11.b).

11
Figure 11: There is room for further liberalization <!-- Start of picture text --> a. Especially in lower income countries... b. ...in their trade with both developing and developed<br>nations<br>10.7<br>9.5<br>8.0 7.6<br>7.6<br>5.0 5.3 4.8 5.1 5.0<br>4.0<br>3.4 3.6<br>2.4<br>1.9<br>1.4<br>Low income Lower middle Upper middle High income South-South South-North North-South North-North<br>income income<br>MFN Preferential Tariff MFN Preferential Tariff<br>Average Preferential Trade Weighed (%) Average Preferential Trade Weighed (%)<br><!-- End of picture text --> Source: Authors’ calculation using ITC/World Bank database What did preferences do to tariff peaks?

The analysis below focuses on “sensitive products,” defined as the subset of tariff lines that are subject to MFN rates above 15 percent.

Although preferential liberalization has targeted highly protected sectors, there remain pockets of protection in agricultural products, textiles and footwear. Preferential tariff lines with MFN rates over 15% are mostly concentrated in apparel and agroindustry goods. Around half of those tariff lines have been fully liberalized through preferential trade agreements (see Figure 12). While total liberalization efforts in these industries has been mostly granted by developed nations, developing nations are still reluctant to grant liberalization in multilaterally sensitive products (see Appendix Table A. 4 and Table A. 5). This trend is maintained when tariff rates are weighted by partner’s share of global trade at the product level,<sup>10</sup> to control for the fact that lower tariffs can be granted on non‐traded goods or to non‐trading partners (see Appendix Figure A 3).

> 10 We use the following formula to calculate the trade‐weighted tariff lines: wT�� �T�� ∗∑SX� �� WHERE T�� IS the total number of tariff lines of product k from country i. ( T�� �∑t� ��� ) and SX�� is the share of country j of global exports of product k ( SX�� � ∑∑�∑�� � � ������ ~~)~~ .

12
Figure 12: Although preferential liberalization has targeted highly protected sectors (MFN tariffs greater than 15%), agricultural products, textiles and footwear remain pockets of protection <!-- Start of picture text --> 8%<br>7%<br>6%<br>5%<br>4%<br>3%<br>2%<br>1%<br>0%<br>MFN range<br>Total liberalization Partial Liberalization No Liberalization<br>Share of sector tariff lines<br><!-- End of picture text --> Source: Authors’ calculation using ITC/World Bank database How big is the preferential advantage?

The most common way to measure the advantage given by preferential access is through preference margins. Preference margins are traditionally calculated as the difference between the MFN applied rate and the preferential tariff.<sup>11</sup> While the average preferential margin in PTAs is low, more than a quarter of world trade is subject to an average preference margin of 7.4 percent. The average preferential margin is low, because one‐fifth of world trade under preferential agreements is already duty free and a further 2 percent of world trade is not at all liberalized. However, significant margins are applied to the trade that is liberalized under PTAs: the average preference is 7.4 percent for the 28 percent of world trade that is completely liberalized, and 6.4 percent for the remaining 3 percent that is partially liberalized (see Table 3).<sup>12</sup>

> 11 Traditional preference margin = T�,���� �T�,�� , where ��,���� is the MFN rate applied by country k on product i and � ��,� is the preferential rate applied to country j.

> 12 The preferential margin is significantly larger if MFN bound rates instead of applied rates are used as a point of reference. The average preferences are on average 17.4 percent for the 28 percent of world trade that is completely liberalized, and 13.6 percent for the 3 percent that is partially liberalized (see Table 3). 13
Table 3: More than a quarter of world trade is subject to an average preference margin of 7.4 percent

||**Type of regime**|**Share of global**<br>**imports(%)**|**Avg. Bound**<br>**MFN rate**|**Avg. Applied**<br>**MFN rate**|**Avg. Applied**<br>**Preferential Rate**|
|---|---|---|---|---|---|
|**Trade not**|MFN rate > 0|21|27.9|9.9||
|**covered by an**<br>**Agreement**|Zero‐MFN rate|21|10.5|0.0||
|**Trade covered**|Zero‐MFN rate|21|13.4|0.0|0.0|
|**by an**<br>**At**|Total Liberalization|28|24.8|7.4|0.0|
|**greemen**|Partial Liberalization|3|27.7|14.1|7.7|
||No Liberalization|2|34.5|15.1|15.1|

Source: Authors’ calculation using ITC/World Bank database How are preference margins distributed? Of the 31 percent of global trade subject to positive preference margins, 16 percent is subject to preferences below 5 percent, 10.2 percent is subject to preferences between 5 and 10 percent and 5 percent is subject to preference margins over 10 percent (see Figure 13).

Figure 13: Distribution of preference margins <!-- Start of picture text --> 15.7%<br>10.2%<br>5.0%<br>PFM less 5% PFM between 5% and 10% PFM over 10%<br>Total Liberalization Partial Liberalization<br><!-- End of picture text --> Source: Authors’ calculation using ITC/World Bank database Preferential margins vary significantly across economic sectors. Preferential liberalization efforts have been significant for sectors such as agroindustry and apparel, where initial trade‐weighted MFN rates were above 10 percent. Over 45 percent of animal and animal products, foodstuffs, and textiles preferential trade was subject to preferential margins over 10 percent (62, 47 and 46 percent, respectively). On the other hand, sectors such as machinery/electrical, transportation and raw hides, skins, leather where initial MFN rates were moderate (between 5 and 10 percent) were mainly subject to preferential margins under 5 percent (see Appendix Table A. 6).

Given the proliferation of PTAs, the advantage conferred by a preferential tariff to a given exporter does not depend only on the difference between the MFN tariff and preferential rate, but also on tariffs faced by competing suppliers from other countries in the same market. Low et al. (2009) introduced the concept of competition‐adjusted preference margins to account for 14
this. Competition‐adjusted preference margins are calculated as the percentage‐point difference between the weighted average tariff rate applied to the rest of the world and the preferential rate applied to the beneficiary country, where weights are represented by trade shares in the preference‐granting market.<sup>13</sup> Unlike a traditional preference margin, the competition‐adjusted preference margin can assume positive as well as negative values. A negative value indicates that, in a specific market, a certain country faces worse market conditions than its trade competitors.

In terms of competition‐adjusted preference margins, relatively small shares of world trade receive a significant preferential advantage or suffer a significant preferential disadvantage. Specifically, only 5.2 percent of global trade benefited from a preferential advantage over 5 percent and only 3.3 percent of global trade suffered from a preferential disadvantage higher than 5 percent (see Figure 14).

Figure 14: Most countries benefited from a competition‐adjusted margin between ‐2 and 2 percent <!-- Start of picture text --> 70% 70%<br>60% 60%<br>50% 50%<br>40% 40%<br>30% 30%<br>20% 20%<br>10% 10%<br>0% 0%<br>Competition Adjusted Margin Competition Adjusted Margin<br>Share of Tariff lines<br>Share of global imports<br><‐15 ‐14 ‐12 ‐10 ‐8 ‐6 ‐4 ‐2 0 2 4 6 8 10 12 14 >15 <‐15 ‐14 ‐12 ‐10 ‐8 ‐6 ‐4 ‐2 0 2 4 6 8 10 12 14 >15<br><!-- End of picture text --> Source: Authors’ calculation using ITC/World Bank database Lower income countries, tend to benefit the most from preferential access, with competition‐ adjusted margins over 3 percent. About 84 percent of competition‐adjusted preference margins are concentrated within the range of ‐2 percent and +2 percent (see Figure 15), 15 percent of countries benefit from competition‐adjusted margins of over 2 percent. Some countries such as

> 13 � � **Competition‐adjusted preference margin for product i granted to partner j by country k** = ������,� ���,� ���,� . Where ��,�� � ∑��∑����,���,����,� is the export‐weighted (X in the formula denotes exports of v into k) average tariff imposed by country k on all other exporting countries v (excluding country j) in respect of product i. The preferential rate � applied to country j is ��,� .

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Nepal, Lesotho and Afghanistan, receive positive preferential margins of 8.9, 9.2 and 10.5 percent, respectively, whereas a few countries, like Cuba, American Samoa and the Maldives, pay 4 percentage higher tariffs on their exports than the competition‐adjusted levels.<sup>14</sup>

> 14 A similar result is obtained when import demand elasticities are also used as weights to aggregate preferential margins across products (see Figure A 4), to account for the fact that imports of some goods can be more responsive to changes in prices than others (see Nicita and Hoekman, 2008).

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Figure 15: Lower income countries, tend to benefit the most in terms of competitive‐adjusted margins <!-- Start of picture text --> 12<br>10<br>8<br>6<br>4<br>2<br>0<br>‐2<br>‐4<br>‐6<br>Low Lower‐middle Upper‐middle High<br>AFG<br>LSO<br>NPL<br>HTI<br>GRL<br>MUS<br>SWZ<br>BTN<br>HND FJI<br>SEN SLV<br>BEN BGD LCA KHM JOR SYR BLR GMB<br>BRB GTM GRD TGO KEN MWI NIC<br>VCT TCAFROMHLCHNBLZJPNLKAMNGURYPRYINDGINSOMNCLGUMABWBRAPYFHKGMNPTJKSRBRUSOASPLWNZLTONBHSMACIRNSMRGABNGAANDNRUBMUSAUQATNORLBYDJIVENVGBTKMKWTUKRSTPCYMIRQCOGSSDPAKCUWSXMGUYAGOECUPNGTCDFINAZEKAZKORCHESWEAUSTUVDZAGNQGBRARGTUNUSASLEMNEDEUAREESTRWAAUTZAFITABDICIVISRLUXFRASLBMLTDNKLVAGHABWACOMHRVBRNLBRTTOPANLTUMRTOMNATGMYSSURUZBBELHUNPOLDMAERISVNYEMVNMBGRJAMTURCZENLDIRLSVKNERGRCMLICMRROUCAFZMBTHACANFSMESPCRIPHLCYPCOLPRTMKDSGPKGZALBIDNISLKNAPERETHWSMVUTEGYBFANAMBHRZWEMOZCHLLAOSYCMARBOLLBNUGACPVDOMPSEMDAGEO MEX ARM BIH TZA MDG MMR<br>GIB<br>KIR<br>PRK<br>Competition‐adjusted preference margin (received by country, %) MDV<br>ASM<br>CUB<br><!-- End of picture text --> Source: Authors’ calculation using ITC/World Bank database 17
# 5. From preferences in principle to preferences in practice

So far, the analysis has been based on the preferential tariff rates that would in principle be levied on imports. However, not all imported products from preference‐receiving sources are automatically eligible for preferential duties. If, for instance, a specific product does not comply with the origin rules specified in an agreement between two countries, its imports will be subject to the higher MFN duty. Preference utilization rates are defined at the HS‐6 level as the share of total imports in a specific category that enter a country under preferences divided by the total imports from that source in the relevant category.<sup>15</sup> In this section, we illustrate the extent of preference utilization focusing on the European Union’s preferential trade.<sup>16</sup> More than 80 percent of preferences granted by the EU were fully utilized in 2016. More than 70 percent of exports from least developed countries to the European Union are eligible for preferences. In 2016, the rate of utilization of the duty free preferential advantage provided by the “Everything But Arms” arrangement<sup>17</sup> was equal to 94 percent. The share of exports from developing and developed countries which are eligible for preferences through non‐reciprocal (GSP and GSP+) as well as reciprocal agreements with the EU is much lower and equal to 18 and 16 percent, respectively. The rate of utilization of such preference is still high at above 80 percent (see Figure 16).

> 15 Note that the denominator of the utilization rate excludes all trade under zero MFN rates, and all trade in products under non‐zero MFN rates for which no tariff preference is available.

> 16 Data on utilization rates come from Eurostat.

> 17 The EBA agreement allows LDC‐originating products to enter the EU market duty‐free for all products except arms and ammunition.

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Figure 16: EU imports by tariff regime and country group (in million USD) <!-- Start of picture text --> Exports under zero-MFN Eligible exports that used preferences<br>Eligible exports that did not use preferences Exports non-eligible for preferences<br>Developed* 391,025 90,528 22,779 174,751<br>Developing 592,627 174,042 33,333 298,071<br>LDC 11,760 26,913 1,607 5<br>0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%<br>Source: Authors’ calculation using statistics from Eurostat, 2016.<br>Note: (*) Excluding EU countries<br><!-- End of picture text --> Preference utilization rates vary widely across countries. Countries such as Bangladesh represent more than 60 percent of preferential trade from LDC countries to the EU and have rates of utilization above 90 percent (see Figure 17). In contrast, countries such as Chad and Guinea‐ Bissau rarely use preferences provided through the EU’s EBA. Developing countries such as Sri Lanka used GSP preferences for only 55% of their eligible exports. A key explanation of the low utilization rates is restrictive rules of origin as well as the related administrative burden. In fact, 11 percent of Sri Lankan firms, interviewed in an ITC survey<sup>18</sup> on non‐tariff measures in 2011, considered rules of origin a recurrent problem.

> 18 <u>Sri Lanka: Company perspectives – An ITC series on non‐tariff measures, 13 Dec. 2011.</u>

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# 6. Conclusion

MFN Tariffs have progressively fallen since the establishment of the General Agreement on Tariffs and Trade (GATT) in 1948. Unilateral liberalization and eight rounds of multilateral trade negotiations have significantly reduced tariffs applied by WTO members over time from levels between 12.5 and 15 percent in 1995 to lower than 10 percent during 2015. Also, countries around the world have increased their participation in PTAs, especially in the last two decades. From the 1990s onwards, the number of PTAs has almost quadrupled, from around 50 to close to 280 PTAs presently in force. Lack of progress in multilateral negotiations in recent years, among other reasons, has spurred tariff reductions through bilateral and regional preferential trade agreements.

Three main findings emerge from this paper on the significance of tariff preferences in a context of decreasing MFN applied tariffs and PTA proliferation. First, preferential trade agreements (PTAs), which now cover more than half of world trade, have significantly widened the scope of tariff‐free trade. Whereas 42 percent of the total value of trade traded free under MFN rates in 2016, PTAs have fully liberalized an additional 28 percent of global trade. In fact, only 5 percent of global imports are subject to positive tariffs under PTAs.

Second, the extent of preferential liberalization varies across countries and sectors. Around 70 percent of countries participating in PTAs have reduced trade‐weighted average preferential tariffs to less than 5 percent, but there remain pockets of protection. Several lower income countries still have trade‐weighted average tariffs above 5 percent. And even PTAs have not been able to eliminate the high levels of protection for agricultural products, textiles and footwear.

Third, while the average preferential margin in PTAs is low, because one‐fifth of world trade under preferential agreements is already duty free and another 2 percent has not been liberalized at all, more than a quarter of world trade is subject to an average preference margin of 7.4 percent. Once we consider competition from both preferential and non‐preferential sources, however, only 5.2 percent of global exports benefited from a preferential advantage of over 5 percent and only 3.3 percent of global exports suffered from a preferential disadvantage higher than 5 percent.

These findings are based on potentially applied tariffs. In practice, preferential duties are not granted automatically to all potentially eligible products. An assessment of the scope of preference utilization for the sub‐sample of EU imports from its trading partners suggests that the rate of utilization of preferences varies across countries and products. Key factors explaining low utilization rates include rules of origin as well as the related administrative burden and lack of knowledge of import and export processes.

The stylized facts on the patterns and extent of preferential liberalization presented in this paper provide the basis for a future research agenda on the implications and determinants of 22
preferential tariffs. The relatively small extent of preference margins also suggests motives for PTAs beyond purely preferential tariffs.

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