The Economic Impact of Local Content Requirements
On the 25th of January 2018, ECIPE published a Case study of heavy vehicles on the economic impact of local content requirements.
The use of local content requirements (LCRs) has been growing for a long time. Used by developed as well as developing countries, they aim to promote the use of local inputs and serve the purpose of fostering domestic industries. Argentina, Brazil, China, India, Indonesia, Russia, Saudi Arabia and the USA are very frequent users of LCRs. India is by far the most prominent user, followed by Brazil. While LCRs might have perceived benefits related to specific policy goals in the short term, the damaging impacts of LCRs evolve over time and outweigh short term benefits. This study estimates the economic impact of LCRs in a selected sub-sector of motor vehicles, where they are frequently used, i.e. the heavy duty vehicles subsector.
ECIPE collected LCRs which affect the selected subsector in a database, classifying them by three different dimensions: their different types, their scope, and their level of impact. This database is used as a basis for the assessment of the economic costs of these LCRs for BRICS countries. Overall, 72 different LCRs have been identified. Most LCRs were found in Brazil and Russia, which each apply 20 measures, followed by India with 15 and China with 13 measures. Finally, in South Africa there are only 4 measures in place which affect the heavy vehicles sector. The analysis finds that most LCRs are related to government procurement, financial support and business operations, as well as to export measures. In addition, we find that the LCRs that are related to financial support and business operations have generally a high impact. For the purposes of this study, the cost of the collected LCRs has been estimated by translating their negative effects into ad valorem equivalents (AVEs). Brazil and Russia apply the most distortive LCRs for heavy vehicles with an estimated increase of their import price of 15.6 and 11.1 percent in both countries respectively. China and South Africa both show low AVEs of 4.5 and 3.3 percent respectively, and India’s LCRs are least distortive with an estimate of 2.2 percent.
Estimating the impacts of the collected LCRs on the economy in the BRICS countries shows that their impact is at least threefold. First, the LCRs have a negative impact on trade in heavy vehicles in the BRICS countries. The identified LCRs are estimated to restrict imports of heavy vehicles by -21% and -12% in Brazil and Russia, while for the other BRICS countries imports of heavy vehicles are reduced between -9.3% and -3.7%. Although to a much lesser extent, the identified LCRs also reduce BRICS countries’ exports of heavy vehicles. Second, LCRs significantly increase the prices for imported heavy vehicles leading to higher prices for firms as well as consumers. The prices firms have to pay for intermediate goods in the heavy vehicles sector are estimated to increase up to 2.9% and 4.8% in Russia and Brazil. Consumer prices for heavy vehicles are estimated to rise between 0.2% and 5.4%. Third, our estimations show that LCRs increase industry output in the targeted sector, but only at the expense of other closely related industries which decrease their industry production.
For example, while industry output in the heavy vehicles sector increases between 0.2% in China and 10.37% in Russia, the domestic production of other transport equipment and other machinery in Russia and Brazil decreases by -0.16% to -0.37%. While it is only natural that industry output that is subject to protection by LCRs increases, the analysis shows that this effect is outweighed by the detrimental side effects. LCRs raise the price of the product it protects and of the product which requires protected inputs, in this case heavy vehicles. As a result, this raises expenditures for every buyer in the economy, which has a depressing effect on sales and output also in other industries. Final consumers as well as firms have to reallocate resources from other areas in order to pay for more expensive vehicles and vehicle parts. Over time LCRs can therefore lead to lower competition, less innovation, and less product variety in the domestic market, which reinforces the negative effects of LCRs.
The analysis illustrates the detrimental impact of LCRs, highlighting again the need for policymakers to address the growth of LCRs and their significance in modern protectionism more thoroughly. A first multilateral option is an increased use of complaints through the WTOs Dispute Settlement Body (DSB) in order to eliminate them and to have specific LCRs declared incompliant with WTO rules. This would also establish necessary additional jurisprudence covering a wider set of LCRs. A second multilateral option is the start of negotiations in the WTO. The topic of LCRs should indeed be high on the new working agenda in order to clarify current rules on LCRs and to obtain stronger negative rules against their use. If negotiations among the entire WTO membership do not progress, a “coalition of the willing” of member countries could engage in negotiations with the aim of clarifying rules and making them stronger. These negotiations should be supported by a larger body of economic analysis on the full range of existing LCRs. In addition, negotiations on bilateral free trade agreements (FTAs) should lay a stronger focus on LCRs. Current EU negotiations on FTAs offer a good ground for such efforts and LCRs should be front and centre in EU FTA negotiations planned in the future.
In: Growth & Competitiveness, SMEs, Trade