International Harmonization of Standards: A catalyst for developed countries and a barrier for developing countries?

Keyword: 
Trade
Topic: 
Globalization - Trade

On February 7, 1904, a blaze erupted in Baltimore and fire fighters from neighboring Washington DC came to help extinguish the flames only to discover their hoses would not fit Baltimore’s fire hydrants. This is a classic example of how disruptive the heterogeneity of product standards can be for the normal functioning of societies. The following year, national standards for fire hoses were adopted. Harmonization of product standards is crucial to ensure a smooth dynamism in economic activity, and it is equally important when it comes to international trade. Nowadays, when regional economies become integrated through trade, the differences of product standards across countries or economic regions have far-reaching implications. As it turns out, this is especially true for exporting firms from the developing world (Chen et al. 2006 and Czubala et al. 2007).

Despite the growing evidence of the negative impact of market-specific standards, there is little understanding of the gains of harmonization at the micro level. In recent research (Reyes 2011a), I shed light on this issue by documenting the response of U.S. manufacturing firms to international harmonization of European standards in the electronics sector. I break down the gains of harmonization into the margins of international trade to conclude that this policy fosters competition in the European market (the pro-competitive effect).

In subsequent research (Reyes 2011b), I use aggregate country data to unveil the ambivalent effect of international harmonization of European standards in exports from developed countries versus exports from developing countries. While harmonization tends to increase exports from the developed world, it has an ambivalent impact on exports from the developing world. I propose an explanation to this puzzle based on the pro-competitive effect of international harmonization of standards.

Harmonization and the extensive margin of trade
Prior to export to a new market, a firm must research the foreign environment and adapt its product to ensure that it complies with the prevailing standards in the market. The firm-heterogeneity literature models this as a fixed cost to export (Melitz 2003). When standards differ across market destinations and/or when there are differences in the stringency of the regulatory framework in each country, exporting to new markets gets more complicated because there are market-specific fixed costs to export that increase depending on the toughness of the regulatory regime in each country. Arguably, the most productive firms should be able to bear different fixed costs and to export to a large breath of markets than other less productive firms. Thus, productivity provide a natural hierarchy of firms, with less productive firms serving less stringent markets whereas more productive firms being able to export also to most stringent market. Harmonization of standards unifies these fixed costs to export and equates stringency levels across market destinations. This enables new firms to enter the most stringent markets. New entrants are mainly drawn from the most productive set of firms exporting to less stringent markets.

I find support to these hypotheses in the data. After controlling for changes in traditional trade costs and firm’s characteristics, I find a positive and statistically significant association between EU harmonization of standards to international norms and the probability that a non-exporting firm to the EU becomes exporter to the EU. The probability of becoming an EU exporter is greater for high productive firms and in industries with greater harmonization. Furthermore, U.S. firms that were already exporters serving only developing markets have a higher probability of begin exporting to the EU than brand-new exporting firms.

The pro-competitive effect of international harmonization
As international harmonization triggers U.S. firms to enter into the European market, competition becomes tougher and export shares of market participants is reduced. I called this “the pro-competitive effect of international harmonization of standards”. I find support for this hypothesis in my sample of U.S. manufacturing firms by finding the impact of harmonization at the intensive margin of trade is negative: The change in the value of U.S. goods that are already exported to the EU within surviving trade relationships throughout the time span is negatively correlated with harmonization. Overall, I find that the extensive margin effect outweighs the intensive margin effect: American exports to the EU increase in response to European international harmonization of standards.

Is this positive impact on export flows the same across other EU trading partners?
In Reyes (2011b), using country level data, I show that the impact of harmonization varies across exporting partners. While harmonization tends to increase exports from the developed world, it has an ambivalent impact on exports from the developing world. Breaking up the EU total import value into imports from developed countries and imports from developing countries, it is easy to see that harmonization (a decrease along the Y-axis in figures 1 and 2) is more strongly correlated with increments in total import value in the former group than in the latter group. Once usual gravity variables are controlled for, the negative correlation for developing countries vanishes while the correlation for developed countries survives. This divergent impact of harmonization across rich countries and developing countries is in line with the two-tier system of market access developed by Baldwin (2000).

I propose an explanation to this puzzle based on the pro-competitive effect of international harmonization. Since the intensive margin effect negatively impacts profits of all market participants, the key feature that must determine the overall impact in export value, at the country level, is the unobserved ability of new firms to start exporting to the EU in response to harmonization –the extensive margin of trade. Empirical evidence suggests that, in average, the extensive margin effect outweighs the intensive margin effect for developed countries whereas the reverse is true for developing countries.

Policy implications
This research provides support for the WTO agreement on technical barriers to trade as a way to champion the use of international standards whenever possible and sectoral efforts to foster international harmonization, for example, by building on the Information Technology Agreement for electronic products. It also unveils the importance for firms in the developing world to find ways to improve competitiveness and take advantage of further reductions in barriers to international trade. 

Disclaimer: Any opinion and conclusion expressed here are those of the author and do not necessarily represent the views of the World Bank, its Board of Directors or the countries they represent.

References

Baldwin, Richard, 2000."Regulatory Protectionism, Developing Nations and a Two-Tier World Trade System," CEPR Discussion Papers 2574, C.E.P.R. Discussion Papers.

Chen, M. X., T. Otsuki and John Wilson. 2006. “Do Standards Matter for Export Success?” Policy Research Working Paper No. 3809, The World Bank.

Czubala, Witold, Ben Shepherd and John Wilson. 2009. “Help or Hidrance? The Impact of Harmonized Standards on African Exports”, Journal of African Economies doi:10.1093/jae/ejp003

Melitz, Mark, 2003, “The impact of trade on intra-industry reallocations and aggregate industry productivity”, Econometrica 71 (2003), pp. 1695–1725.

Reyes, José-Daniel. 2011a. “International Harmonization of Product Standards and Firm Heterogeneity in International Trade”, Policy Research Working Paper No. 5677, The World Bank.

Reyes, José-Daniel. 2011b. “The Pro-Competitive Effect of International Harmonization of Product Standards”, mimeo, The World Bank.
 

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