trade policy brief
Local content requirements
February 2019
ocal content requirements (LCRs) are part of a broader set of ‘localisation’ policies that L favour domestic industry over foreign competition and have become more prevalent since the economic crisis of 2008. CRs decrease trade in intermediate goods, which lowers competitiveness, increases domestic L production cost and prices, and hurts jobs across the economy.previous one, as the growth in demand for many commodities slows down. orizontal policies offer an alternative to LCRs and have less negative economy-wide effects H including on output, exporting industries and jobs.
What’s the issue? Local content requirements (LCRs) are part of a broader set of ‘localisation’ policies that favour domestic industry over foreign competition, requiring companies and the government to use domestically-produced goods or services as inputs. While the application of localisation barriers has been around for many years, they have seen a resurgence especially since the economic crisis of 2008. Policy makers often to use LCRs as a fiscally neutral way to promote domestic industry and employment, or to help spur domestic innovation. While the short-term impact of these measures makes them politically attractive, their long-term attractiveness hinges on the hope that the protected industry will become a self-sustaining source of growth and jobs. In reality, LCRs create unrealistic market conditions that make the targeted industries uncompetitive and less innovative over time. In addition, the inefficiencies associated with LCRs have economy-wide spill over effects that can prove long lasting and extremely difficult to undo over time. LCRs tend to act as drain on the rest of the economy, increasing prices, reducing diversification, and competition. The OECD has studied LCRs across different sectors where they tend to be prevalent, including energy, green technology, raw materials, and the automobile industry. Using the METRO trade model, the OECD quantified the economy-wide effects of several LCRs, which showed that
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(despite their intended outcomes), LCRs in fact increased production costs for domestic producers, leading to lower exports and increased imports in non-targeted sectors. This point is illustrated in the diagram below. It shows the change in source of supply in response to an LCR in communication. In the face of increasing domestic costs, domestic firms switched from domestic to foreign suppliers. Even the small subset of LCR policies modelled (8% of all LCR policies in effect in 2015) quantitatively had a net impact that would decrease global trade by USD 23 billion and result in a USD 5 billion loss in global income. In almost all cases where LCRs were implemented, exports in final goods decreased by up to 5%. The measures also hurt jobs in non-LCR-targeted sectors, whereby unskilled jobs disappear at three times the rate as skilled ones. The work also reveals negative economy-wide impacts for countries imposing LCRs. The key negative effect is a decrease in trade in intermediate goods, which is particularly alarming in the context of global value chains (GVCs). When producers in LCR targeted sectors adjust their production and input sourcing due to LCRs, these sectors undergo a concentration of domestic economic activity. Such concentration, in turn, undermines opportunities for growth and innovation that come from a diverse economy. Sectors without LCRs lose international competitiveness because they face higher prices on some domestically produced inputs.
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Local content requirements
Change in source location of inputs in other sectors resulting from an LCR in the communications sector Domestic supply
Foreign supply
Agriculture Coal, oil and gas Other minerals Other food Textiles Other transport Manufacturing equipment Motor vehicles Electrical equipment Other manufacturing Electricity Construction Other transport Water transport Insurance Trade Other business services Recreational services Other services -0.4
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The economy-wide effects of LCRs ultimately result in higher domestic production costs and domestic prices of final goods. Consequently, countries lose competitiveness, export less and, ironically, import more of the final goods consumers demand. In the long-term, the isolation from competition and technologically advanced inputs can also remove the incentives for sectors to innovate and develop.
What should policy makers do? Well-designed horizontal policies targeted at specific policy objectives such as industrial development, technological development, or job creation, can address these objectives in the short- and long-term with fewer potential trade and market distortions. Instead of specific sectors and industries, policies should target the business and regulatory environment, trade and investment barriers, innovation policy, and infrastructure development. More targeted and sector specific policies must be implemented with caution to avoid introducing additional distortions and unintended spill-over effects in other sectors. As a first step, governments should address information barriers and rent-seeking behaviour. Such measures include strong public accountability and transparency requirements. A key aspect of strong, independent institutions is a shift in focus from ‘picking winners’ to strategically working with the private sector to develop policy interventions.
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Further reading • Stone, S., J. Messent and D. Flaig (2015), “Emerging Policy Issues: Localisation Barriers to Trade”, OECD Trade Policy Papers, No. 180, OECD Publishing, Paris, https://doi. org/10.1787/5js1m6v5qd5j-en. • Korinek, J. and I. Ramdoo (2017), “Local content policies in mineral-exporting countries”, OECD Trade Policy Papers, No. 209, OECD Publishing, Paris, https://doi.org/10.1787/4b9b2617-en. • OECD/ISOC/UNESCO (2013), “The Relationship between Local Content, Internet Development and Access Prices”, OECD Digital Economy Papers, No. 217, OECD Publishing, Paris, https://doi. org/10.1787/5k4c1rq2bqvk-en. • OECD (2015), “Local-content requirements in the solar- and wind-energy global value chains”, in Overcoming Barriers to International Investment in Clean Energy, OECD Publishing, Paris, https://doi. org/10.1787/9789264227064-6-en.
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