Why MSMEs Rarely Capture the Full Upside of FTAs — And What Actually Changes That
By Swarnakshi Luhach, Ishita Jain
Free trade agreements are frequently presented as instruments that level the playing field for smaller firms. By reducing tariffs and formal barriers, they are expected to enable MSMEs to participate more directly in international trade, diversify markets, and integrate into global value chains. Yet the evidence from actual trade agreements tells a more nuanced story.
Empirical data on the utilisation of preferential trade arrangements show that formal eligibility does not automatically translate into realised trade benefits. In the context of EU free trade agreements, preference utilisation — defined as the share of eligible trade that actually claims preferential tariff treatment — has averaged around 67%, indicating that a significant volume of potentially tariff-advantaged trade continues to be conducted under standard Most-Favoured-Nation (MFN) terms.
This gap between eligibility and utilisation suggests the existence of structural constraints that disproportionately affect smaller exporters. The EU–India Free Trade Agreement expands legal access across goods and services, but the determining factors for whether MSMEs convert that access into actual participation are rooted in administrative, regulatory, and risk allocation frictions — not in tariff schedules alone.
Comparative Advantage Is Not the Same as Commercial Competitiveness
Standard economic theory frames international trade through comparative advantage. India’s MSMEs often possess labour-efficient production and specialised capabilities. However, in highly regulated markets such as the EU, these theoretical advantages are frequently neutralised by compliance and procedural requirements. Research on EU SMEs highlights that the complexity and cost of complying with rules of origin, documentation, and customs procedures are high fixed costs, deterring smaller firms from utilising trade preferences even when tariff margins exist.
Empirical analysis of EU FTAs shows that even where preferential tariffs are available, many firms do not claim them. Across the European Union’s FTA network, the average preference utilisation rate — the share of trade that utilises tariff preferences when eligible — was approximately 67% in 2021, indicating that one in three eligible shipments still clears under MFN terms instead of preferential treatment.
As a result, many firms remain formally eligible to benefit from FTAs while remaining practically excluded from direct participation.
Preference Utilisation Patterns Reveal Execution Gaps
Preference utilisation patterns provide a measurable indicator of structural constraints. A study by the Federation of German Industries (BDI) on EU FTAs found that despite preferential tariffs being available, large shares of eligible trade remain untapped. In one analysis, more than half of surveyed firms acknowledged that they did not utilise FTAs fully, and 87% of industry participants estimated that firms in their sector do not take full advantage of available trade preferences.
Across existing EU free trade agreements, only about 67% of eligible trade claimed preferential tariffs in 2021, demonstrating that structural barriers hinder full use of tariff reductions.
Utilisation rates also vary significantly across member states and industries, with documented cases showing differences of more than 15 percentage points between countries and sectors. This variation suggests that eligibility does not translate uniformly into utilisation, reinforcing the view that structural and procedural factors limit participation.
This phenomenon occurs even in advanced economies with significant institutional capacity, demonstrating that utilisation barriers are not limited to exporters in developing countries.
Capital Structure and Risk Allocation Shape MSME Engagement
Participation in EU-facing trade is also a function of balance sheet resilience. Export contracts in developed markets often involve extended payment cycles, stringent quality requirements, and penalties for non-compliance. These risk exposures are typically borne by the supplier under standard contract terms.
For MSMEs with limited capital and working capital constraints, these conditions dampen incentives to enter export markets directly. Instead, smaller firms commonly participate indirectly — for example, as suppliers to larger firms or through distribution networks that manage compliance and regulatory risk. While this promotes integration into global value chains, it often limits MSMEs’ ability to capture value directly.
Rules of Origin as a Silent Constraint on Preference Uptake
Rules of origin determine whether a product is eligible for preferential treatment under an FTA. The administrative complexity of these rules — sometimes codified in extensive annexes — disproportionately affects smaller producers with limited compliance capacity. Trade research literature emphasises that rules of origin and related compliance costs are a significant determinant of utilization, as firms may opt not to claim preferential tariffs if the administrative and evidentiary burden outweighs the potential duty savings.
These constraints are particularly acute for products with intricate supply chains or for firms operating without sophisticated compliance infrastructure.
What Actually Enables MSME Participation
Where MSMEs successfully leverage trade agreements, enabling conditions are typically present alongside tariff preferences. These include:
Aggregation mechanisms that spread compliance costs across multiple firms.
Digitalised customs and single window systems that reduce documentation uncertainty.
Trade finance and export support instruments that provide working capital and mitigate risk.
Standardised compliance procedures that reduce the administrative burden on individual exporters.
Complementary institutional and market mechanisms matter as much as, if not more than, the trade agreement provisions themselves.
Long-standing analysis by UNCTAD suggests that low utilisation rates are often symptomatic of the inability of firms — particularly smaller exporters — to navigate multiple rules of origin frameworks and certification systems, which add compliance costs that may exceed tariff advantages.
Redefining Success Under the EU–India FTA
Expectations around MSME participation under the EU–India FTA must therefore be calibrated carefully. For most MSMEs, success will not manifest as rapid, direct market penetration. Rather, plausible trajectories involve:
Incremental upgrading of internal compliance systems;
Specialisation within compliant sub-segments of value chains;
Integration via intermediaries that manage regulatory risk collectively.
The value of the trade agreement will ultimately be judged not by the number of firms technically eligible to benefit, but by the number able to participate sustainably — operationally and financially — without eroding their economic viability.
Author(s)
Swarnakshi Luhach, Principal
Ishita Jain, Strategic Partner
