Commentary Type

What Is GSP and Why Does It Matter for US Trade?

Chad P. Bown (PIIE)


Throughout his presidential campaign, President Trump took aim at the North American Free Trade Agreement (NAFTA), the Trans-Pacific Partnership (TPP), and other US trade agreements. One year into his administration, America is officially out of the TPP, and Trump is renegotiating NAFTA. Yet another trade deal—the US Generalized System of Preferences (GSP)—is also now on life support.

Better known as GSP, the program is supposed to encourage economic development by offering poor countries a patchwork framework to export tariff-free into the US market. It expired on December 31, 2017. The GSP is far from perfect, and the program could stand a rethink. But ending it abruptly would also cause harm, including to US interests.

So what exactly is the GSP and what do you need to know?

1. The US GSP program isn't particularly big

Relatively few US imports benefit from the GSP. In 2016, the GSP covered only $19 billion, or less than 3 percent, of US imports that could face a tariff.

The US program dates to the Trade Act of 1974. Under the GSP, the US government selects a group of poor countries and a set of products, and it offers these countries lower-than-normal tariffs than it applies to imports from all other World Trade Organization (WTO) countries.

Imports from China and some developing countries are ineligible for GSP benefits. But top exporters under the program include India and Brazil, major emerging economies that the Trump administration has accused of problematic trade policies. Nonetheless, 90 percent of Indian/Brazilian exports to America face normal US tariffs and would remain unaffected by changes to the GSP program.

2. GSP is not generous, partly by design

Many factors limit the trade coming in under the GSP. For nearly half of all the goods America imports, the normal tariffs are zero—there isn't a lower tariff to offer.

The other half of products is where the GSP program's limits kick in. Because the US government unilaterally determines where to give zero tariffs under the GSP, exclusion of certain products and countries can be subject to domestic politics. Trade economist Emanuel Ornelas reports only about half of eligible products end up part of the program.

Left out are goods that many poor countries would be keen to export, such as agriculture and relatively lower-skilled manufacturers like clothing. From a development perspective, GSP tariffs of zero would provide big benefits for poor country exporters; many of these goods face relatively high normal US tariffs.

But they are kept out of the GSP because of strong American domestic political pressure. Instead, noncontroversial products—like gold necklaces—end up topping the program's import list.

Access to the zero tariff under the GSP also has costs. In addition to paperwork, foreign companies must use enough locally sourced inputs—even if of dubious quality—to comply with "rules of origin" requirements. IMF economist Shushanik Hakobyan has found that poor countries frequently don't bother to utilize the GSP because compliance costs are too large.

3. Political economists have long been skeptical of GSP's benefits

Another major concern with the GSP is its uncertainty. The US program has always been temporary and sometimes suffers periods of nonrenewal. But even when operational, products and country eligibility are always at the discretion of the US government. Furthermore, a country can export only a limited amount of any product under the GSP. The cap was $180 million in 2017, and no more than 50 percent of a product can derive from a single country.

These combined "unknowns" tend to limit the economic development benefits of any "trade-instead-of-aid" program. And research indicates companies invest too little for export when uncertain of the future tariff they face.

But there is a second, systemic worry about all the one-way tariff preference programs that countries like the United States began to offer in the 1970s. Richer countries kept products with high trade barriers—like clothing, footwear and agriculture—ineligible for the GSP. And the "one-way" part of the GSP meant poor countries got away with refusing to offer to reduce their own trade barriers in return.

The result was a stalemate. And because of this, Arvind Subramanian and Shang-Jin Wei find poor countries were not able to expand exports for decades. Most also didn't begin lowering their own import tariffs until the 1990s. A further legacy is that trade liberalization by countries like India and Brazil remains highly incomplete, lending some legitimacy to the Trump administration's misgivings.

4. Ending GSP could nevertheless prove locally disruptive

Because GSP coverage is small, even immediate termination is unlikely to impact the overall US economy. Nevertheless, it would hurt poor countries as well as some US interests.

Two sets of empirical studies illustrate the supply chain linkages. Emily Blanchard and Xenia Matschke find the United States applies lower tariffs toward imports from subsidiaries of US multinational companies under the GSP. And in a cross-country examination of GSP-type programs, Blanchard, Robert Johnson and I document countries like the United States as offering lower tariffs to imports that contain high levels of US content arising through global value chains.

But the implication is that eliminating the GSP and raising US tariffs on poor country exports would reach back through supply chains to harm Americans. Anytime President Trump cuts off sales by foreigners to America, those foreigners will no longer buy the parts and components currently supplied by US companies and workers.

Will the GSP be revived? Or will Trump kill it off for good?

Earlier administrations—including under President Barack Obama—also allowed the GSP to expire. Yet in each case, the program eventually was renewed. After an initial period of silence, the Trump administration has most recently stated it "supports congressional action to renew the GSP program and is working with Congress toward this end."

This time could be different. Trump's trade policy to date—evidenced by his NAFTA renegotiations and threats to WTO judicial independence—reflects his clear skepticism of prior US deals.

A considered overhaul of the GSP is in order, as is the need to reengage major emerging economies like India and Brazil to take on additional responsibility in the WTO system.

But is the Trump administration really committed? The worry is that failing to revive the GSP is just another way to raise tariffs and add one more brick to an increasingly higher and broader protectionist wall.

Chad P. Bown is a senior fellow at the Peterson Institute for International Economics and former lead economist at the World Bank. With Soumaya Keynes of the Economist, he hosts Trade Talks, a weekly podcast on the economics of international trade policy. Listen to their Trade Talks episode on GSP. Follow him on Twitter @ChadBown.

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