Local Content Requirements: Backdoor Protectionism Spreading Under the Radar

July 22, 2016 10:00 AM

Local content requirements (LCRs), or more broadly “localization rules,” have become a popular protectionist tool to favor domestic industries over foreign competitors. Classic LCRs span from the requirement to purchase a certain percentage of domestic goods—e.g., the United States’ notorious “Buy America” [PDF] statutes—or to produce locally, to requirements that services use only local infrastructure, to conditions on doing business like technology transfer to local companies.

Empirical analyses have shown that LCRs can come at high cost through distorting trade flows, increasing the costs of domestic production, and transferring higher prices to consumers (see Hufbauer et al. 2013 for an overview). But that hasn’t stemmed their momentum. Faced with increasing protectionism abroad, companies like General Electric have been adjusting their production decisions to reflect a new localization strategy.1 Like many nontariff measures, LCRs are motivated foremost by the need to create jobs in the local economy and often by the “infant industry” argument that less established local producers require state interventions to survive in the marketplace. In this post, we survey a few recent, prominent examples.

  • Retail: India has long maintained local sourcing requirements as a condition on foreign investment or procurement. Single-brand retail stores must currently source at least 30 percent of the value of their goods from Indian firms—though exceptions can be made for products with “state of the art” or “cutting edge” technology where local sourcing isn’t feasible. Apple is under pressure to comply with these requirements despite calls to exempt the company under a permitted waiver.  
  • E-commerce: The Office of the US Trade Representative (USTR) maintains a long list of complaints regarding LCRs and/or data localization policies affecting e-commerce, internet services, and telecommunications. China, Russia, and Indonesia in particular are among countries that have LCRs in these sectors. For example, Russia has mandated that the data collected electronically by companies be processed and stored locally, while Indonesia requires “public service” providers to maintain local data centers.
  • Film, radio, and television: LCRs are routinely used to protect audiovisual services in the name of safeguarding cultural diversity—see Bernier (2012) for some well-documented examples. In the European Union, Netflix and Amazon are under pressure to comply with proposed requirements that video streaming services allocate at least 20 percent of their catalogues to European content. In China, the US film industry has long had to adapt to mandatory quotas on the number of foreign films released, profit-sharing agreements, and requirements to sell rights to domestic companies. Regulations requiring the broadcast of a minimum of domestic-produced songs have been in place in France for decades and inspired a similar law in Slovakia.

As trade in digital services continues to grow, regulators will need to understand how its features differ from goods trade, the regulation of which typically involved tariffs and quantitative limits on the volume of imports. One aspect of consumption online is that switching and search costs may be lower, allowing users to circumvent the seemingly mandated consumption of home-made songs, shows, and related products. Subscribers to a streaming service, such as Netflix, in France can choose to view only foreign movies, even if their menu is narrower compared with a case without an imposed quota. The bundle available to subscribers does not comprise purely domestic or foreign-made movies (this would be the case with or without mandatory content quotas), and users can avoid the movies they do not wish to view.

But even if the impact of music and movie quotas turns out to be negligible in some cases, their overall effect is less than benign. First, monitoring and enforcement of such quotas is a poor use of state resources. Second, the motivation for LCRs is rarely scrutinized, often leading to a wrong impression that they are harmless—compliance costs to businesses are rarely considered, their discriminatory outcomes are seldom challenged, and exceptions are sometimes necessary when no local producer can meet essential needs. Third, production efficiency decreases when businesses need to make noneconomic considerations in their purchases of inputs. Trade liberalization and lower nontariff barriers have long been linked to greater productivity. Fourth, there is a slippery slope risk: LCRs open the door for excessive regulation of software, for example, if a regulatory body decides it does not approve users’ streaming of content that goes contrary to the LCR intent.

Just how widespread are LCRs? The Peterson Institute (Hufbauer et al. 2013) conducted one of the first early surveys on the global practice of LCRs and found more than 100 cases, across sectors including health care, renewable energy, autos, oil and gas, that could have affected $90 billion of international trade. A more recent study by the Organization for Economic Cooperation and Development (Stone, Messent and Flaig 2015) documented 146 LCR measures across 39 countries. Their quantitative estimate of select LCRs found that 80 percent of reduced trade was in intermediates, with serious implications for disrupting global value chains. The latest report from the Global Trade Alert (Evenett and Fritz 2016) identified more than 340 localization measures implemented since November 2008, with nonprocurement measures concentrated in electrical machinery and equipment and vehicles. Other studies document the characteristics of forced localization in renewable energy (Kuntze and Moerenhout 2013), information and communications technology (Ezell, Atkinson, and Wein 2013 and Bauer et al. 2014), and the extractive industries (Tordo et al. 2013).

What are countries doing about it? While a number of World Trade Organization (WTO) agreements discipline LCRs, the rules are neither comprehensive nor effectively enforced. Cimino-Isaacs, Hufbauer, and Schott (2014) propose a new code to fill gaps in the WTO rulebook. Several countries have pursued cases at the WTO challenging the use of LCRs, like the prominent US case against Indian solar policies. APEC countries elevated localization onto their agenda, seeking to “identify alternatives to localization policies and develop best practices.” The Trans-Pacific Partnership trade deal gives some special attention to LCRs, prohibiting data localization in its e-commerce chapter (Branstetter 2016), and the United States is seeking similar provisions in the plurilateral Trade in Services Agreement. These efforts could constrain the use of LCRs but only for select groups of countries. At the recent G-20 meeting of trade ministers in Shanghai, officials agreed to “improve global trade governance…[to] help address the global trade slowdown” but they did not explicitly refer to concrete steps to discourage localization barriers. In the near term, the use of LCRs seems likely to continue unabated.

Note

1. CEO Jeff Immelt recently stated, “in the face of a protectionist global environment, we can no longer rely on governments to drive expansion; we must plan to navigate the world on our own. We will localize. In the future, sustainable growth will require a local capability within a global footprint.

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