6:21 AM Dec 6, 1995

EAST EUROPE CAUTIONED ON EU-OPT DEPENDENCE

Geneva 7 Dec (Chakravarthi Raghavan) -- The intensification of trade, since the collapse of central planning, between east Europeans and the European Union has been accompanied by a significant growth in outward processing trade (OPT), but dependence on OPT may not be an "optimal long-term strategy" for the east Europeans, according to the UN's Economic Commission for Europe (ECE).

The ECE's latest economic bulletin (Vol. 47 of 1995) has devoted a chapter to analyze the OPT trade in textiles and clothing sector between the EU and the associated states of eastern Europe (Bulgaria, Czech Republic, Hungary, Poland, Romania and Slovakia) and reaches the conclusion that while such trade has short-run advantages for the east Europeans, it would have long-run disadvantages and the countries would do well to undertake restructuring policies to encourage modernization and stimulation of direct exports.

Under an OPT, manufacturers or even trade in the EU, shift part of their manufacturing activities to a foreign country. Raw materials and production components are exported abroad where they are further processed in labour-intensive stages, and the final products are re-imported, with the customs duties paid only on the value-added abroad.

Originally intended to avoid levying charges on domestic value added, OPT has become an important instrument of trade policy in the EU (and the US too) in textiles and clothing industry, as also footwear and other such sectors. It is sometimes seen as a substitute for foreign direct investment (FDI).

The rules of origin accompanying such transactions provide the tariff preference on the reimported product only if produced from components of a specific origin.

The OPT transactions are largely concentrated in sectors generally characterized as labour-intensive -- textiles and clothing, footwear, some categories of machinery and mechanical appliances, other industrial goods, vehicles, processed food and leather products.

The share of OPT in total exports of the six east European countries to the EU reached 18.% in 1994, with textiles and clothing accounting for more than 75% of total OPT exports to the EU.

At the same time, the share of eastern Europe in EU's total OPT imports from outside the EU was 37&, and for textiles and clothing 60%.

The exports of each of the six east Europeans to the EU is highly concentrated on textiles and clothing as well as metal products. East Europeans' textiles and clothing exports is characterised by a dominating share of garments -- generally about 80% of exports in this sector, and over 90% for Poland and Romania. Textiles and clothing exports also remain an important source of export earnings for the east Europeans.

The expansion of the EU's OPT operations to east Europe, the ECE notes, has been influenced by a number of factors including the situation of the EU's textiles and clothing industry, the EU's legal framework and other internal factors of EU and east Europe.

The adjustment process in textiles and clothing inside the EU, while socially and economically difficult, has been reinforced by the Uruguay Round Agreement on Textiles and Clothing which has set deadlines for removal of quantitative restrictions on suppliers to the EU, and implies a continuing increase in international competitive pressures on the textiles and clothing sector.

In this situation, the OPT has become an avenue for improving the competitiveness of EU's clothing industry and has gained much importance recently in east Europe countries which have begun market reforms. Their lower labour costs, relatively skilled workforces and geographical proximity have stimulated the process of delocalization of textiles and clothing production from EU to east Europe.

The EU's own legal framework of trade relations with east Europe has encouraged EU producers to move labour-intensive processes eastward.

In 1991, the individual quotas for products undergoing EU economic OPT in eastern Europe were included in their bilateral textile agreements under the MFA, making the OPT system more transparent, and at the same the east European OPT quotas -- within which reimports of certain textiles and clothing categories got zero tariff benefits -- were increased significantly.

In 1994, east European partners have been granted zero-duty access to the EU market for all 39 textiles and clothing categories covered by the EU's new OPT regulation, thus gaining preferential status in comparison with other OPT exporters to the EU. At the same time, the general trade regime in textiles and clothing allows MFA-type quota restrictions on direct exports of a considerably larger number of products than for OPT exports from eastern Europe. The direct exports subject to quotas also face customs tariffs.

The formal bias towards OPT in the EU should end in 1997-1999 when customs duties and quantitative restrictions on east European textiles and clothing exports to the EU are scheduled to be eliminated.

[The Indian ambassador to the WTO, Mr. S.Narayanan, recently told European Parliamentarians at a public hearing in Brussels, that the EU plans to remove quotas on these items from countries with whom the EU has preferential trading arrangements, would "adversely affect textiles and clothing exports from other developing countries"]

The OPT currently protects indirectly the EU's textiles and clothing industry, the ECE notes. It forces OPT operators to use fabrics of Community origin to benefit from the system and encourages not only Community operators, but east European producers to move towards OPT transactions to get the duty-free treatment for the final products re-imported into the EU.

Internal factors such as the structural adjustment problems confronting the east European textiles and clothing industries in the face of market reforms, has also favoured the OPT.

The EU's 1995 regulations on OPT creates the possibility of east European increased participation in preferential outward processing, but under strict rules designed to protect EU employment. Since these are more restrictive for the EU OPT operators, the ECE suggests that some of them might turn to southern EU member countries, rather than locations outside.

If this happened the east European countries could suffer.

When MFA quotas are eventually abolished under the Uruguay Round agreement, the EC's specific OPT system of quantitative restrictions would also disappear for suppliers which are WTO members. Trading partners with free trade agreements with EU will thus enjoy free access to the EU market for OPT in textiles and clothing.

If the EU were to maintain its policy of helping domestic textiles and clothing industry adapt to competition from abroad, the remaining WTO exporters may be granted preferential tariff quotas in OPT which, unlike the current quota system, would be of a non-discriminatory character. But because of adjustment problems in the EU, there would be pressures to maintain present system of prior authorization for OPT tariff quotas.

Even with the end of quotas in 1998-1999 (ahead of general end in 2005) on OPT and direct textiles and clothing exports of the east Europeans, the east European producers would still be subject to prior authorization of the OPT regime even after 1999.

The low-labour costs in east Europe which has stimulated the OPT could probably be maintained over the short and medium-term, but over the longer-run the lower wages are bound to rise upward to west European levels.

When Portugal joined the EU in 1986, and during the transition period to membership, Portugal attracted a lot of OPT. When the low labour costs attraction weakened or disappeared, the EU's OPT operations shifted to North Africa, Turkey and Yugoslavia, and later to east Europe.

Growing labour costs in east Europe may thus lead to the EU's OPT operators shifting to lower low-labour cost countries, among whom constituents of the former Soviet Union are beginning to play an important role.

"Given these considerations, as well as the likely future expansion of human and physical capital," the ECE says, "it is unlikely that a significant dependence on OPT will be maintained for very long, or, indeed, that it could be an optimal long-term strategy despite its many short-run advantages."