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TTIP: Does it Benefit the Mittelstand?


By Kristin Johannimloh and Pierre Francois

On June 24, 2015, after weeks of intensive discussions, the United States Congress gave President Barack Obama the authority to conclude the 12 country Trans-Pacific Partnership (TPP), and move forward with the Transatlantic Trade and Investment Partnership (“TTIP”).

TTIP is meant to reduce regulatory barriers and improve the exchange of goods and services between the United States of America (US) and the European Union (EU), mainly by harmonizing standards, simplifying customs clearance and eliminating tariffs.

While negotiations are ongoing, the goal is to have a signed agreement before the election of a new US president in 2016. Germany, in particular, stands to benefit from TTIP as the largest European exporter of goods to the US and fifth overall after Mexico, Canada, China and Japan.

However, public opinion in both Germany and, more generally, Europe, has turned against TTIP, with only large public companies appearing to still support the agreement. Is TTIP only relevant and beneficial to large companies?

TTIP – Designed only for large companies?

The Mittelstand refers to small and medium-sized enterprises (SMEs)[1] 95% of which are family-owned businesses. It is the backbone of the German economy, representing 99% of German companies, more than half of the country’s economic output, and employing 63% of its work force. Exports by the German Mittelstand represented approximately EUR 199bn in 2012, which makes it a significant contributor to German exports overall.

Mittelstand’ s Looking to Increase Exports

A study performed by KfW in late 2012 found out that 64% of Mittelstand companies are looking to increase their exports in 2015. Many of these companies are presently focused on Western European export markets. While these markets are expected to remain important to SMEs, the significance of North America and the high-growth markets of Asia (especially China) – both as export targets and as regions for foreign direct investment – are expected to increase over the medium term.[2]

Export Challenges to be tackled by TTIP

Existing challenges include non-tariff barriers, administrative burden when developing an export business, lack of a free trade deal between the EU and US, as well as high safety requirements in international trade of goods.

These items, which apply to export businesses of all sizes, are tackled by TTIP. Should TTIP be implemented, Mittelstand companies willing to increase exports to the US would be able to do so under a simpler, more favorable regulatory framework. This would entail a reduction in both customs and non-tariff barriers as well as simplified administrative and arbitration procedures to protect investment (investor-state dispute settlement), which should result in lower costs to companies operating in both the EU and the US.

Easing the Establishment of a US Presence 

Although not as favored as exports, the development of on-site production capabilities in the US is an alternate solution available to Mittelstand companies. It can take the form of the establishment of a foreign subsidiary, a branch or a sales office.

Major hurdles to investing abroad include high capital expenditure, the identification and employment of skilled local management, dealing with different legal jurisdictions in different states, exchange rate fluctuations, and increased legal exposure. These all come at a higher cost than merely exporting, and may make a direct investment in the US unviable for Mittelstand companies, who often do not have the financial and human resources required.

TTIP would alleviate many of these burdens and increase direct investment by lowering barriers to entry and putting in place a more favorable regulatory framework, thereby facilitating the establishment of a US presence.

TTIP Benefits to the Mittelstand Vary Case by Case

Despite the apparent benefits from TTIP, a recent study by Commerzbank found that only 15% of the Mittelstand believe that the trade agreement will have a positive impact on their business.[3] Damon V. Pike, President of The Pike Law Firm and internationally recognized trade law expert, illustrates the areas which may be of concern.

Elimination of tariffs

Tariffs between the EU and the US are relatively low by global standards – the average level of import tariffs for manufactured products is only 1.7 % in the US and 2.3 % in the EU. To claim duty-free entry under TTIP, companies will have to implement a compliance and recordkeeping process to ensure that the specific rules of origin for each and every product are met. Pike notes that this additional cost to companies may outweigh the benefits from the elimination of customs duties.

As a result, each Mittelstand company will need to determine whether the benefits from the elimination of tariffs outweigh the additional costs. This is likely to be the case for companies exporting products subject to higher customs duties (such as textiles, footwear, chemicals).  Similarly, products sold in large volumes or with high profit margins would likely be able to absorb the additional fixed cost of the administrative burden.

Customer Relationship and Pricing Issues

TTIP could also create customer relationship and pricing issues between Mittelstand exporters and their U.S. customers. Pike explains that, under the North American Free Trade Agreement (NAFTA), the importing jurisdiction was able to conduct audits of the exporter in a foreign country. For example, U.S. Customs was able to audit a Canadian or Mexican exporter. This naturally led to problems as most companies are not keen on foreign governments auditing their procedures, books, and records. Thus, under all U.S. Free Trade Agreements subsequent to NAFTA, the importer is now the party audited – but the audit is based on information and records supplied by the exporter/seller.  As a result, many importers will be demanding meticulously detailed supporting documentation from the exporter to claim duty-free entry under TTIP prior to even accepting the order.  Mittelstand companies must therefore be prepared to be fully compliant much earlier in the process – or give up margin to the importer/customer if duty-free status cannot be supported at the beginning of the order process/during the pricing negotiations.

Non-tariff barriers, compliance requirements and manufacturing processes

Any potential positive or negative effect of TTIP on the manufacturing sector will also greatly depend on the degree to which non-tariff trade barriers are adjusted or eliminated. Pike comments that, where common quality and safety standards are achieved and testing processes are harmonized, exports will likely increase as they grant companies direct access to a broader market for those products that could not previously be exported.

However, this comes at a cost. For example, differing labeling or packaging, or increased requirements to identify a product as environmentally-friendly, may make it necessary for companies to change their processes to comply with differing standards, leading to additional marginal costs. Industries currently subject to differing regulations in the US and the EU would likely be the most affected.

Companies will therefore need to keep abreast of amended or harmonized standards and regulations, as well as differing EU and US standards where no common ground exists, and assess the impact these may have on their manufacturing process on a product by product basis.  Although the cost of performing such an analysis and understanding regulations in depth may be a deterrent to Mittelstand companies, due to their size they often have fewer product lines to analyze.  Also, as Pike points out, some industries with more stringent specifications and processes are already aligned, including the high-tech, automated industrial machinery companies, a segment in which the Mittelstand is particularly strong.

Investor State Dispute Settlement

One of the main areas of concern in TTIP for the US and EU is the Investor State Dispute Settlement mechanism, which provides arbitration procedures to protect investment.  This area remains unresolved as various governments of the individual EU member countries are concerned that it undermines their sovereignty and legal systems. This debate goes beyond considerations specific to the Mittelstand as it equally impacts large companies and governments.

Beneficial to the German Mittelstand, Beneficial to Germany?

The German Mittelstand is well placed to benefit in a number of ways from TTIP, but this will require each company to perform their own analysis to determine the scale of the associated benefits and costs, as these are dependent on their industry, products and processes. Where benefits outweigh costs, TTIP will give Mittelstand companies access to an increased client base, potential for growth and resilience to competition in the global economy, thereby further expanding the success of Mittelstand companies beyond Germany’s borders.

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[1] The German definition of SMEs is up to 500 employees and up to €50m annual turnover

[2] https://www.kfw.de/Download-Center/Konzernthemen/Research/Research-englisch/PDF-Dateien-Paper-and-Proceedings/Internationalisation-in-Germanys-SME-sector.pdf

[3] //www.spiegel.de/wirtschaft/unternehmen/ttip-mittelstand-setzt-kaum-hoffnung-in-freihandelsabkommen-a-968383.html, (05/06/2015). TNS Infratest questioned 4025 companies with minimum annual sales of 2.5M Euro.

 


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