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Renew AGOA, but Address its Limitations

by and Lawrence Edwards | November 22nd, 2013 | 05:22 pm
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The centerpiece of US trade relations with sub-Saharan Africa is the African Growth and Opportunity Act (AGOA). First implemented in 2000, AGOA grants duty-free, quota-free access to the US market to qualifying countries. The program, which has been renewed several times, expires in 2015. In the past, extensions have been granted at the last minute, but this time the United States Trade Representative, Michael Froman, has pledged to renew AGOA in a timely manner. In our view AGOA should be renewed, but its weaknesses need to be addressed.

US officials view AGOA as a success, so the administration’s position is not surprising. On May 12, 2010, for example, at a ceremony on Capitol Hill on the tenth anniversary of AGOA, Froman’s predecessor, Ron Kirk, credited it with “a substantial increase in two-way U.S.-Africa trade since 2000, with African countries now exporting to the United States a more diverse range of value-added products.” He said the program demonstrated the “link between trade and economic development.”

Trade preferences like those granted in AGOA can stimulate trade, but they have limits as tools for development. Poor countries with preferential access to developed-economy markets supposedly learn to upgrade their product sophistication, diversify into other products and markets, and ultimately compete without preferential treatment. But the AGOA experience actually shows that more trade does not necessarily lead to this type of development. Indeed, the record shows that trade preferences are not a substitute for development assistance through such bilateral programs as the US-sponsored Millennium Challenge Corporation. In renewing AGOA, the United States should better integrate it with its broader aid programs.

Trade preference programs by the United States and other countries, such as the European Union’s program of everything but arms (EBA) for least developed countries, give the false impression that developed-country markets are open to manufactured exports from the poorest economies. But some of the preference programs are a sham. Many require more local production than these poor countries are capable of. The AGOA program is different. It contains an unusual and generous waiver for wearing apparel granted to lesser developed beneficiary countries (LDBCs), allowing them to use third-country fabrics or yarn and still export clothing under the AGOA preferences. All that was needed was an inspection by US officials that certified that real production was taking place.

The results have been impressive. In 2004, three years after Lesotho, one of Africa’s poorest land-locked nations, became eligible for AGOA preferences, its clothing exports to the United States tripled, reaching $460 million and employing more than 50,000 workers. Exports from Kenya, Madagascar, Malawi, Swaziland, and other African countries also increased dramatically. The rule clearly matters. Almost all AGOA apparel exports enter the United States under the lesser developed country provision.

Despite this impressive growth in export volumes, AGOA’s performance demonstrates that beneficiary countries still do not have viable industries that could survive without the preferences. Nor have they diversified into new products and markets or added greater domestic value. In recent years, exports from several AGOA countries have declined. As we show in more detail in our working paper, (Edwards and Lawrence 2013), factories in Lesotho continue to concentrate on a narrow range of low unit value garments, such as knitted tee-shirts, slacks, blouses, and blue jeans. Their slice of the production chain is narrow and not expanding. Most apparel manufacturing in Lesotho remains CMT (cut-make-trim). The firms, almost entirely foreign owned, typically provide assembly, packaging, and shipping services and depend on their Asian headquarters to generate orders, design the clothes, and provide the fabric. Productivity and worker skills remain low. Most of the value is thus added in other countries.

Why this disappointment? In our paper we argue that the preferences embodied in AGOA and the fact that fabric is provided by third countries have distorted production decisions. The implicit subsidy of the trade preference is greatest for products with low value addition and thus at the margin, resulting in an effective high tax on adding additional value. For example, the 17 percent preference margin granted by AGOA through most-favored nation (MFN) tariff relief on clothing is equivalent to a 34 percent effective subsidy for products where value addition makes up 50 percent of total costs, but 85 percent for products where value addition is only 20 percent of total costs.

This allows AGOA producers to offset cost disadvantages of lower productivity of their workers and greater distance from suppliers and markets and explains why the initial responses to AGOA were so powerful. But AGOA preferences have two adverse effects. First, the incentives are most powerful in lower quality products with less value addition, discouraging skills development and other forms of quality upgrading. Second, the system encourages use of more expensive imported fabrics, inhibiting the incorporation of the cheaper fabrics more likely to be produced in less developed countries.

The experience of AGOA demonstrates that policies designed to promote more trade do not automatically lead to more economic development. Trade preferences have major advantages. First, they can offer powerful inducements to beneficiary exporters that are financed through foregone tariff revenues by developed countries rather than taxpayers in developing countries. Second, they provide a form of infant industry protection in export rather than domestic markets. And third, since they are externally imposed they do not give incentives for domestic producers to seek favors and rents from their governments.

But trade preferences are not a panacea and certainly not a substitute for other development policies. The special third country fabric provision rule distorts decisions on value-addition and fabric use, undercutting the benefits that would be expected from these preferences. Preferences are thus an opportunity but not a substitute for more comprehensive industrial strategies to improve private and government capabilities in poor countries. Trade preferences may be helpful but are unlikely to be sufficient.