Use of free trade agreements

Free trade agreements: How are companies using them?

As a follow-up to a study examining the utilization of free trade agreements ("Analyse zur Nutzung von Freihandelsabkommen") published by the State Secretariat for Economic Affairs (SECO) in August 2020, a further analysis was conducted in cooperation with the University of St. Gallen. The analysis examined the factors which influence whether companies avail themselves of the preferential tariffs granted under free trade agreements (FTAs) when importing goods into Switzerland.

This in-depth analysis confirms that smaller and larger companies use free trade agreements with equal frequency (savings rate of 88% and 87% on customs duties respectively). While companies with over 250 employees saved around CHF 728 million in customs duties in 2019 thanks to FTAs, the figure for SMEs was higher totaling CHF 1,134 million. Firms for which the number of employees is not known achieved a further CHF 221 million in customs duties savings. Across all companies, the savings rate (the proportion of potential customs duties savings that was actually achieved) is 84 percent.

Questions and Answers

1. Which firms engage in foreign trade and how does firm size influence the utilization of free trade agreements?

As part of the in-depth data analysis, the imports of over 180,000 companies from 2016 - 2019 were analyzed. Merging data on imports with data on firm characteristics allows the companies to be categorized according to the number of employees. Some 97,000 of the companies included in the dataset are microbusinesses (9 employees or less); around 25,000 small companies (10 - 49 employees); 7,000 medium-sized companies (50-249 employees) and roughly 2,600 large companies (over 250 employees). For some 50,000 companies, the size of the company cannot be discerned from the data.

The analysis shows that large companies with over 250 employees use FTAs with a similar frequency as SMEs. In terms of achieved customs duties savings, SMEs achieved more savings in 2019 (CHF 1,134 million) than large companies (CHF 728 million). In addition, there are further customs duties savings of CHF 211 million that were achieved by companies of an unknown size.

Figure 1 shows the achieved and non-achieved customs duties savings for different company sizes (measured by the number of employees). Although achieved customs duties savings reached some CHF 2,063 million, possible customs duties savings not achieved totaled CHF 372 million. Of these non-achieved customs duties savings, CHF 121 million are attributable to companies of unknown size while CHF 103 million is attributable to large companies and a further CHF 148 million to SMEs.

The distribution of customs duties savings by company size for individual FTA partner countries of Switzerland is presented in the FTA Monitor 2019.

2. What role does the size of potential customs duties savings play in the utilization of FTAs?

The analysis shows that the greater the difference between the regular MFN tariff and the preferential FTA tariff, the more FTAs are used. The MFN tariff is the basic tariff that Switzerland levies on imports from all countries. Within the framework of FTAs, lower tariff rates are agreed upon with the partner countries; these lower tariffs are referred to here as FTA tariff rates. The preference margin is defined as the difference between the MFN and the FTA tariff rates.

Notably, the average utilization rate is relatively high even at very low preference margins. At a preference margin of twenty percentage points, the average utilization rate is over 90%.

Based on 2019 data, Figure 2 shows the average FTA utilization rate for each preference margin between 0 and 100 percentage points.

A large part of non-achieved customs duties savings can be attributed to imports with low preferential margins. Cumulatively, about 75% of the non-achieved customs duties savings relate to imports with a preference margin of less than ten percentage points. This suggests that the utilization of FTAs is associated with costs. Firms only have an incentive to use an FTA if the potential customs duties savings outweigh these costs.

3. What are the costs associated with using FTAs?

The analysis provides further evidence that the utilization of FTAs is associated with costs. Included are both variable costs (which are incurred with each transaction) and fixed costs. Companies also have one-time costs spent to familiarize themselves with the formalities required to take advantage of FTAs. In addition, suitable suppliers may have to be found to fulfill the rules of origin. The analysis shows that firms, which have already used an FTA once, use it more frequently for future imports. This observation underlines the importance of such fixed costs in determining FTA utilization.

The analysis also confirms the assumption that compliance with rules of origin is associated with costs. The exact extent of these costs cannot yet be quantified. However, various analyses indicate that restrictive rules of origin significantly reduce the use of FTAs.

4. What further steps does SECO plan to take?

Based on the results of the study published in August 2020 and the in-depth data analysis, the State Secretariat for Economic Affairs will seek an exchange with business representatives in the first half of 2021. The aim is to identify the most significant obstacles they face in making use of FTAs. Based on this exchange and the findings to date, measures will be identified to simplify the utilization of free trade agreements.

Free trade agreements: Do companies benefit?

The State Secretariat for Economic Affairs (SECO) has commissioned a comprehensive data analysis. It shows the extent to which Swiss companies make use of Switzerland's free trade agreements to save customs duties.

The study "Analysis on the use of free trade agreements" by Stefan Legge and Piotr Lukaszuk of the University of St. Gallen was commissioned by SECO to obtain findings on the use of and tariff savings gained through all of Switzerland’s existing free trade agreements (FTAs). The study was commissioned by the Business Audit Committee of the National Council (GPK-N) to examine the effects of FTAs.

The study shows that Swiss importers and consumers saved CHF 2.5 billion in customs duties in 2018 thanks to FTAs. The average usage rate for FTAs was 73%. For exports to FTA countries (for those that provided data), the preference utilisation rate in 2018 was 80%. This corresponds to a customs saving of CHF 1.8 billion.

Questions and answers

1. What is the objective of free trade agreements?

As a highly developed economy with a small domestic market, Switzerland is strongly integrated into international value chains and is dependent on foreign markets for both imports and exports. By concluding free trade agreements, Switzerland aims to ensure stable and easy access to foreign markets for the Swiss economy and to improve the framework conditions in economic relations with economically important partners. Currently, in addition to the Free Trade Agreement with the European Union and the EFTA Convention, Switzerland has a network of 30 free trade agreements with 40 partners worldwide.

2. How much use is made of free trade agreements?

The central element of FTAs is the reciprocal granting of tariff preferences - i.e. a complete or partial elimination of customs duties in favour of the respective contracting party. These preferential tariffs are lower than the regular import duties and companies can thus benefit from savings. Where companies can benefit from an FTA, the majority of them do so. This is shown by the calculations of the preference utilisation rate. This rate measures the share of imports actually imported under the FTA, measured against all the goods that could potentially have been imported more cheaply under the FTA (goods that were duty-free or otherwise duty-privileged owing to factors other than FTAs were not included in this calculation).

3. How high are the tariff savings of Switzerland's free trade agreements?

On the import side:

In Switzerland, more than a third of imports are already duty-free and the remaining duties are generally low. In 2018, Swiss companies and consumers benefitted from tariff savings of CHF 2.5 billion thanks to free trade agreements. This corresponds to a preference utilisation rate of free trade agreements of 73 percent.

On the export side:

For exports to the FTA countries that have provided data, the preference utilisation rate of FTAs in 2018 was 80 percent. This corresponds to tariff savings of CHF 1.8 billion thanks to free trade agreements. This has enabled Swiss companies to improve their competitiveness in foreign markets.

Figure 1 shows in green the tariff savings (customs duties) actually achieved as a result of Switzerland's free trade agreements.

4. How high are the additional possible tariff savings of Switzerland's free trade agreements?

On the import side:

Swiss companies and consumers could have benefited in 2018 from additional tariff savings thanks to free trade agreements amounting to a maximum of CHF 447 million.

On the export side:

In the case of exports, additional tariff savings of up to CHF 443 million could have been achieved in 2018 thanks to free trade agreements.

Figure 1 shows in red the potential additional tariff savings that are theoretically possible as a result of Switzerland's free trade agreements; these are non-realised tariff savings.

5. Where do Swiss companies save most thanks to free trade agreements?

On the import side:

Swiss companies achieved the greatest savings in the import of plastics, cheese and paper products.

On the export side:

Swiss companies have achieved the greatest savings in the watch sector (over 300 million Swiss francs). Major savings were also achieved in the area of machinery and precious metals.

By country of origin:

Swiss companies achieve the greatest savings in customs duties on imports from Germany. High savings are also achieved with imports from Italy, France, China and Austria. Nevertheless, there is considerable additional savings potential for imports from China and Germany. Die grössten Zolleinsparungen realisieren Schweizer Unternehmen bei Importen aus Deutschland. Ebenfalls hohe Einsparungen finden sich bei Einfuhren aus Italien, Frankreich, China und Österreich. Trotzdem zeigt sich ein beachtliches zusätzliches Sparpotenzial bei Importen aus China und Deutschland.

6. How can free trade agreements be used?

Companies can use free trade agreements if their products meet the preferential rules of origin of an FTA. This means that a product must have been manufactured to a significant extent in Switzerland in order to benefit from preferential duty exemption or duty reductions in Switzerland's FTA partner states. For example, if a company produces machines in Switzerland, it can only export them to China under the FTA with preferential tariff treatment if a sufficiently large part of the value-added has been created in Switzerland. Further information on preferential rules of origin: FCA Circular free trade agreements (origin) and FCA Free trade agreements, tariff preferences and origin of goods

7. Why is the use of FTAs sometimes modest?

The utilisation rate of FTAs varies greatly depending on trading partners, product groups, time, firm and delivery. This can have various reasons, e.g. :

the type of products that are traded and their preferential rules of origin: For certain products that are produced in highly fragmented international value chains, it is sometimes difficult for companies to achieve preferential origin.
administrative and financial burden: companies must document the production process and, if necessary, adapt it in order to achieve preferential origin. Companies can therefore decide not to use FTAs if the costs of these adjustments exceed the potential benefits.
other reasons not yet known

This study lays the foundation for a detailed analysis of the factors that can explain the variation in the use of FTAs across trading partners and product group. However, this analysis was not part of the commissioned study and will be carried out in a next step.

8. How can the utilisation rate be increased in the future?

Based on the results of the study, the State Secretariat for Economic Affairs will initiate further work to identify the factors that lead to incomplete use of free trade agreements. The aim is to identify measures to increase the use of free trade agreements, especially for products with high tariff saving potential.