Democratic Reforms and Trade: Evidence from the European Union's Generalized System of Preferences for Myanmar.

• Author: Tanaka, Kiyoyasu

1. Introduction

   Democratization and economic globalization have concurrently occurred in the developing world for past decades (Milner and Kubota 2005; Mukherjee 2016). The relationship between democracy and trade has received considerable attention in the literature. One argument is that democratic institutions tend to reduce trade barriers and thus increase trade flows (e.g., Mansfield, Milner, and Rosendorff 2000; Galiani and Torrens 2014; Zissimos 2017). An alternative argument is that democratic countries have higher institutional quality in the rule of law, property rights, and contract enforcement, which contributes to product-quality improvement and trade promotion (e.g., Anderson and Marcouiller 2002; Berkowitz, Moenius, and Pistor 2006; Levchenko 2007; Yu 2010). A positive association between a democracy index and trade flows is taken as evidence of the important role that democratic institutions play in trade patterns (e.g., Morrow, Siverson, and Tabares 1998; Decker and Lim 2007). However, previous studies do not conclusively identify specific mechanisms through which democratization processes affect trade in the developing world. To the best of our knowledge, there is little concrete evidence for the question of how a developing country implements democratic reforms and what effects institutional changes have on trade.

   In this paper, we analyse the linkage between democratic reforms and trade growth by examining the European Union's (EU) Generalized System of Preferences (GSP) for Myanmar. The EU has granted beneficiary developing countries preferential import tariffs on some or all of their exports to the EU market under the GSP programme since 1971. The Union suspended trade preferences for Myanmar in 1997 following allegations of systematic violation of core international conventions on forced labour by the military regime at the time. In 2011, the newly established "democratic" government in Myanmar implemented a series of democratic reforms to improve political, social, and labour environments. Polity5 data by Marshall, Gurr, and Jaggers (2017) show a remarkable improvement in the political liberalization index during a subsequent period. (1) Consequently, the EU decided to re-instate preferential access for Myanmar under the Everything But Arms (EBA) regime in 2013, which allows Myanmar to benefit from duty-free and quota-free access to the EU market for all products except arms and ammunitions. Figure 1 shows that imports in twenty-eight EU member countries from Myanmar started to come under the duty-free access regime in 2013 (Eurostat). (2) The value of duty-free imports increased sharply after 2012, as the total value of imports increased from [euro]0.13 billion in 2012 to [euro]2.02 billion in 2018. A casual observation indicates that the democratic reforms in Myanmar led to a remarkable trade growth after the GSP re-instatement.

   To assess how democratic reforms promote trade, we discuss the political background of the EU's GSP re-instatement for Myanmar from a qualitative perspective. The EU's withdrawal process started after the International Confederation of Free Trade Unions and the European Trade Union Confederation filed a joint complaint on 7 June 1995 to the European Commission (EC) on the use of forced labour in Myanmar. After the EC obtained evidence of the country's serious and systematic violation of the EU GSP stipulation with respect to the International Labour Organization's (ILO) Convention No. 29 concerning Forced or Compulsory Labour, the Union temporarily withdrew preferential tariffs for industrial and agricultural products originating from Myanmar on 24 March 1997. (3)

   After a twenty-three-year-long military rule, President Thein Sein established a "democratic" government on 30 March 2011 and implemented a series of democratic reforms. He expressed his willingness to cooperate with the National League for Democracy (NLD), the largest opposition party, and made efforts to restore Myanmar's strained relations with Western countries. Acknowledging the progress made by the Myanmar government, the European Parliament and the Council of the EU decided to repeal the temporary withdrawal of trade preferences for Myanmar on 19 July 2013. Thus, democratic reforms led to a dramatic reduction in trade barriers to the EU market.

   A unique feature of the EU's GSP re-instatement allows us to examine the causal impact of duty-free access on Myanmar's exports. Specifically, Myanmar's exports to the EU were previously subject to the Most-Favoured Nation (MFN) tariff rates in the EU market, implying that the tariff cuts due to the GSP re-instatement corresponded to the MFN tariff rates in the EU market. Because the MFN tariff rates had previously been determined in multilateral trade negotiations, these tariff cuts were arguably exogenous to export industries in Myanmar during the study period. In this respect, we argue that Myanmar experienced plausibly exogenous tariff cuts in the EU market from 2013. Using trade data for the period 2010-18, we find that larger tariff cuts significantly increased Myanmar's exports to the EU. For instance, a 5 percentage-point reduction in tariff rates would increase the nation's exports to the EU by 73.3 per cent. Among export products, we find a prominent growth in the volume of garment exports to the EU. However, we do not find any significant increase in the variety and quality of garment exports, suggesting that democratic reforms did not instantaneously induce quality improvements in key export products in Myanmar.

   We offer qualitative explanations for the garment export growth. First, garment firms in Myanmar started to export to Asian markets such as Japan and South Korea in 2003 after the US imposed an import ban on made-in-Myanmar products. These garment firms learned superior sewing skills and quality control methods to serve the Japanese market, suggesting that the export growth after the GSP re-instatement could be partly due to previous improvements in productivity and production capability that garment firms acquired through past export experiences (Atkin, Khandelwal, and Osman 2017). Second, when Myanmar lost access to the American market, EU buyers became reluctant to source from Myanmar because they feared a possible consumer boycott and loss of their reputation. The EU's GSP re-instatement signalled a green light to the EU buyers to resume sourcing from Myanmar. Additionally, the Myanmar government improved the business environment for garment production through policy reforms, including the unification of multiple exchange rates, trade liberalization and infrastructure development. These developments are consistent with the prior argument that democratization can lead to institutional improvements and trade liberalization. Taken together, all these factors could also help explain the remarkable export growth in Myanmar's garment industry after democratic reforms induced the re-instatement of the EU's GSP.

   To the best of our knowledge, this paper presents new evidence on the role of GSP programmes in linking democracy and trade. Morrow, Siverson, and Tabares (1998) argue that the ability of governments is limited in a democratic system to protect arbitrarily domestic firms against foreign competition, while political stability facilitates trading relations. Milner and Kubota (2005) highlight that a democratic system reduces an incentive for governments to use trade barriers in gaining political support, thereby promoting trade liberalization in democratic developing countries. Additionally, prior studies such as Anderson and Marcouiller (2002), Berkowitz, Moenius, and Pistor. (2006), Levchenko (2007), and Yu (2010) highlight that the quality of institutions such as intellectual property rights, contract enforcement, and the rule of law is higher in democratic exporting countries. These institutional differences influence product quality, trust in exporters, and trade costs, thereby increasing trade flows. We contribute to the literature by showing that democratic reforms in a developing country can increase trade flows through preferential market access to high-income markets.

   Another branch of related literature examines the effects of GSP programmes on trade (Ornelas 2016). Herz and Wagner (2011) find that such programmes promote exports in developing economies in the short run, but generate a negative impact in the long run. By contrast, Gil-Pareja, Llorca-Vivero, and Martinez-Serrano (2014) provide robust evidence that GSP initiatives have a significantly positive impact on exports in developing economies. Sharma, Boys, and Grant (2019) show a positive effect of GSP only on agricultural exports in low-income countries. These results imply that the effects of GSP on aggregate trade flows are heterogeneous across programmes and beneficiary countries. Meanwhile, prior work on specific GSP schemes finds a positive impact on exports, but the estimated effects are also heterogeneous across beneficiaries and sectors (Frazer and Van Biesebroeck 2010; Cipollina, Debucquet, and Salvatici 2017; Ito and Aoyagi 2019). Additionally, Cuyvers and Zhou (2011) and Gnutzmann and Gnutzmann-Mkrtchyan (2022) examine the effect of the EU's GSP withdrawal on trade and find mixed evidence of trade effects in the case of Belarus and Myanmar. (4) Our paper provides the first formal assessment of the effects of GSP re-instatement on trade and adopts a unique approach to identifying the causal impact of the GSP re-instatement.

   The rest of this paper is organized as follows. The following section provides the background of the EU's decision to re-instate GSP for Myanmar. The third section presents our empirical framework to estimate the impact of the GSP re-instatement on Myanmar's exports, followed by data sources. The fourth section then shows the estimation results for exports and examines alternative factors for EU-bound garment exports...