FTAs: Free but with few takers

Free Trade Agreements (FTAs) are negotiated by governments to provide preferential rates of duty for goods traded with other countries. These agreements can increase local business opportunities as well as reduce the cost of imported goods for local consumers. Lower costs afforded by FTAs allow businesses to develop or maintain their competitive position in the international market.

Recently, an increasing number of FTAs have been signed in the Asia Pacific region. This expansion in FTA activity was partly caused by the slow down of multilateral negotiations for tariff reduction at the World Trade Organization (WTO) because FTAs provide an alternative for countries to pursue a more expedient mode of trade liberalization. Today, over a hundred FTAs are in place in the Asia Pacific region.

FTAs are also being considered to keep trade barriers low in the midst of the current economic crisis. In the present economic climate, policymakers and local industries have begun to adopt inward looking policies to encourage people to buy locally, rather than from abroad. FTAs are also being used to sustain the gains from liberalization and limit the pressures of increasing protectionism.

Decreased trade from protectionism can incur substantial costs. The European Union (EU) estimates that present trade barriers in China cost European businesses 21 billion euro in lost trade opportunities every year. This comprises a quarter of the current EU exports to China, equivalent to the total Gross Domestic Product (GDP) of Bulgaria or the total imports of New Zealand. Increasing trade barriers would drive this opportunity cost even higher, thereby heightening threats of a deeper recession.

The use of FTAs makes for sound government policy and business sense. It could aid the global economy and provide strategic cost advantages to large and small enterprises. As FTAs have been in existence for decades, one may think that FTAs would already be on the brink of full utilization. FTAs have unlimited availability for qualifying goods, therefore businesses and consumers in Asia Pacific are already enjoying the benefits of lower raw materials costs and more affordable products.

However, FTA utilization has been low in Asia Pacific. In ASEAN alone, despite almost two decades of the ASEAN Free Trade Area (AFTA), intra-ASEAN trade remains only a quarter of total ASEAN trade. Meanwhile, countries designated by the World Trade Organization (WTO) as least developed nations have only been using 50 percent of the total product coverage under the US Generalized System of Preferences (GSP) program.

This statistic is mirrored at the level of individual companies. The Asian Development Bank (ADB) released last April a study on the utilization of FTAs by firms in Japan, Korea, the Philippines and Thailand. In a survey of 609 firms in the region, the ADB reported that only 139 or 22 percent are actually taking advantage of FTA preferences, the bulk of which are in the automotive industry. The ADB study also pointed out that despite limited FTA usage, at least 40 percent of the East Asia firms surveyed had plans to use FTAs in the future. It would appear therefore that many companies in Asia (or at least in the countries surveyed) are interested to use FTA preferences, but still require the proper guidance and initiation.

The relatively low use of FTAs can be attributed principally to a lack of awareness and information. For example, the ADB study noted that overall awareness of FTA provisions in both companies that are users and non-users of FTAs is generally low. In the Philippines, the survey showed that only 6.5 percent of FTA users are aware of the FTA provisions that affect business. Only 1.6 percent of Philippine non-FTA users, on the other hand, claimed to be aware of relevant FTA provisions. This demonstrates that even firms that are currently using FTAs are still struggling to fully understand the implications and opportunities available.

The perception of burdensome and costly administrative procedures for FTA applications is another reason for the low FTA use. FTA rules are indeed complex, particularly the Rules of Origin (ROO) used to determine whether or not a particular product qualifies for a preferential tariff rate. This process can be painstaking, and may involve the overlap of technical methodologies and eventually lead to trade disputes. Also, ROOs are fluid such that products that presently qualify for preferential tariffs may no longer qualify one year later. If a company does not closely monitor its ROO compliance, penalties may be assessed if Customs uncovers unauthorized claims of preferential tariffs. As such, FTAs are perceived as too risky and burdensome to pursue.

Nevertheless, these anxieties on the part of companies can be traced to a lack of information. Arguably, the more a company learns about the processes and requirements for FTA qualification, and the more experience it gains, the less costly FTA operations would be. The ADB study noted that the companies using FTAs in the countries surveyed have been in business longer than non-users. Philippine users of FTAs, for instance, are at least five years older than non-users.

Information and experience are the key factors in exploiting the vast range of opportunities afforded by FTAs. Far from any saturation point, FTAs remain a viable instrument for companies to manage their transaction costs and remain competitive in the midst of a challenging economic environment. It is never too late for either new or long established companies to take solid steps to read up on the rules and learn more about the advantages FTAs offer. Approaching a seasoned advisory firm with the knowledge and experience would likewise be encouraged, since any fees paid can be readily recouped and exceeded by the realization of duty savings along the supply chain.

(Raphael B. Madarang is a Manager for Business and Financial Advisory Services of Manabat Sanagustin & Co., CPAs, a member firm of KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative.

The views and opinions expressed herein are those of Raphael B. Madarang and do not necessarily represent the views and opinions of KPMG in the Philippines. For comments or inquiries, please email [email protected] or [email protected]).