Rule of origin in international trade

Verification:...11 THE SIGNIFICANCE OF RULES OF ORIGIN IN INTERNATIONAL TRADE .... The harmonization of non-preferential and preferential ROO...17 THE RULES OF ORIGIN IN ASEAN FREE TRADE

TABLE OF CONTENTS

INTRODUCTION 4

LITERATURE REVIEW 5

INTRODUCTION TO RULES OF ORIGIN 7

1 Definition and classification 7

2 Roles of Rules of Origin in international trade 7

3 Origin criteria 8

a Wholly obtained criterion 8

b Substantial transformation criterion 8

4 Origin certification and verification 10

a Certification: 10

b Verification: 11

THE SIGNIFICANCE OF RULES OF ORIGIN IN INTERNATIONAL TRADE 12

1 Introduction 12

2 The significance of Rules of Origin 12

a ROO reduce costs of doing business in international trade 12

b Rule of Origin as trade policy instrument 13

c ROO expand foreign direct investments (FDI) and export processing zones (EPZs) 13 d ROO circumvent trade remedy measures 13

e Minor rule amendment requires a big operation change 14

3 Conclusion 14

THE HINDRANCE OF RULES OF ORIGIN IN INTERNATIONAL TRADE 15

1 Introduction 15

2 ROO as International Trade Hindrances 15

a ROO as protectionist apparatuses 15

b ROO rules of origin triggers trade diversion 16

c Trade – diverting ROO lead to a loss in welfare 17

d The harmonization of non-preferential and preferential ROO 17

THE RULES OF ORIGIN IN ASEAN FREE TRADE AGREEMENTS 19

1 Reforms in ASEAN FTA Rules of Origin: 19

2 Comparison of ROOs in ASEAN and ASEAN + 1 FTAs 21

CONCLUSION 23

REFERENCES 25

In the modern world, countries all over the world are becoming more and moreinterdependent With the establishments of many trade unions and associations,countries can now benefit from the trade agreements they participate in However,each country has a different level of advantages and duties As the origin of goodsplays an important role in determining this level, specific rules have been set toremedy the problems regarding the good’s origin These rules are called “Rules ofOrigin” Since its approval, Rules of Origin have been widely implemented in manyagreements and now are becoming topical than ever

Understanding the importance of Rules of Origin, in this study, we want tofocus on providing knowledge about these rules: what it is, how it is classified andhow to determine the origin of a product Moreover, like any kind of provision, Rules

of Origin still has merits and demerits In this study, we can have a thorough look atthese rules and then come up with a better solution for any problems Also, this studywill mention the implementation of Rules of Origin in ASEAN so that we can obtain adeeper insight into the provision and its real situation

Hopefully, our study can enrich your economic knowledge and provoke yourinterest in international trade and policy Thanks for your time and we wouldappreciate it if you could leave any comments or ideas

LITERATURE REVIEW

Studies on Rules of Origin have been undertaken by not only researchers withpolitical background but also economists, most of these concerned with measuringimpacts of Rules of Origin on trade flows Others have noticed that approaches totrade facilitation studies can be used to address certain administrative issues of ROO(Harris & Staples, 2009; Izam, 2003; James, 2006; Messerlin & Zarrouk, 2000)

Estevadeordal et al (2007) summarise two key aspects of the ROO that werethe subject of their research: restrictiveness and divergence While ‘restrictiveness’refers to the aspect of ROO that restrict trade under FTAs, ‘divergence’ denotes thedivergent ROO that differ across FTAs and products within an FTA.Though fewstudies embrace other issues concerning ROO, most studies have been devoted toassessing these two aspects

The complexity that results from the diversity of ROO has been examinedfrequently based on the estimated cost of complying with such rules (Anson et al.,2003; Anson et al, 2005; Carrère & De Melo, 2004; Estevadeordal et al., 2007) Anson

et al (2003,) suggest that the compliance costs of ROO largely negate preferentialaccess under FTAs, and that the compliance costs of ROO amount to 6% of aproduct’s export value, which is higher than the average preferential margin of 4%.Carrère and De Melo (2004) argue that, to compensate for the production andcompliance costs caused by the restrictiveness of ROO, about 10% of the preferencemargin would be needed for NAFTA Cadot, Carrère, De Melo and Portugal-Pérez(2005) estimate that the border price of Mexican apparel product has risen 12% tocompensate for the cost of complying with NAFTA’s ROO Cadot, Carrère, De Meloand Tumurchudur (2006) estimate the trade-weighted compliance costs atapproximately 8.0% for the PanEuropean Union (PANEURO) and 6.8% for NAFTA

The fundamental objective of ROO is often identified as the checking of riders who ‘seek to enjoy the benefits of the FTA without paying the costs associatedwith FTA membership’ (Boadu & Wise, 1991) For this reason, researchers oftensuggest that the origin certification and verification procedures under the ROO bemade integral to the administration of ROO Izam (2003), Brenton and Imagawa

free-(2005) and Estevadeordal et al (2007) conclude that the procedures for exporters orproducers to obtain the certificate often require expensive accounting and inventorysystems The administrative burden in this procedure, they warn, may result ininadequate administrative cooperation, faults, and fraud in the certification of originprocess Manchin and Pelkmans-Balaoing (2007b, p 14) indicate that the costs anddelays in obtaining certification and in proving conformity with their originrequirements depend largely on the stringency of the verification procedures Harrisand Staples (2009, p 7) suggest that the primary dilemma in this regard is ‘balancingthe rights and obligations of the producer and the importer’ While the producer hassufficient knowledge of the origin of their product, the importer is responsible for thepayment of tariffs Therefore, if the producer, either by fraud or by negligence,provides faulty origin details about their product, the importer is liable for non-paidtariffs and penalties Boadu and Wise (1991), Cantin and Lowenfeld (1993) and Harrisand Staples (2009) emphasise the fact that the administration of ROO often results inconsiderable uncertainty for companies, and this can occur under circumstances inwhich ‘procedures are unclear, customs officials lack capacity, or legal provisions areincomplete’ (Harris & Staples, 2009).

In summary, studies have found the restrictiveness, complexity (or divergence),compliance costs, and uncertainty arising from the administration of ROO to befactors that influence the full use of FTAs However, in this report, we are going tohave a brief look over the landscape of Rules of Origin and specific case of ASEAN isgiven at the end of the report

Abbreviation:

ROO: Rule of origin

RTA: Regional Trade Agreement

FTA: Free Trade Agreement

CU: customer union

AD: Anti-dumping

CV: Countervailing

ICC: International Chamber of Commerce

WTO: World Trade OrganizationMFN: Most Favoured NationPsROO: Product-specific Rules of OriginGSP: Generalized System of PreferencesCTC: Change in Tariff ClassificationVC: Value Content

INTRODUCTION TO RULES OF ORIGIN

1 Definition and classification

Rules of Origin (ROOs) are specific provisions that are established in theagreement to determine the origin of goods (Medalla, Balboa, 2009, p.2)

Rules of Origin are usually used in cross - border trade, especially free tradeagreements (FTA) There are two types of Rules of Origin: preferential rules of originand non-preferential rules of origin

- Preferential rules of origin are used to determine whether the good qualifies for the

preferential tariff offered under the agreement They are a set of criteria that the goodneeds to comply with in order to be considered originating in the territory of the tradeagreement The goods are checked against these criteria to establish whether they can

be considered originating in a country when exported to an FTA partner

- Non-preferential rules of origin apply to goods traded between countries not linked

by any preferential trade agreement (in the absence of any preferential agreement orwhen the goods are not covered by an existing FTA) It does not lead to a reduction intariffs but is used for a number of other purposes such as quotas, anti-dumping andcountervailing duties It is also used for trade statistics and for the purpose oflabelling

2 Roles of Rules of Origin in international trade

- Rules of Origin allow the application of trade measures to the right subject-matters For example, when country A wants to impose an import tariff for apples from

country B There may be 3 cases: (1) The apples are from country B, which means country A can apply the measure properly; (2) The apples are from country C and just transit through country B, which means country A cannot impose the tariff on these apples; (3) The apples are from country B but transit through country C, which means country A should impose the tariff To differentiate between these cases, Rules of Origin are inevitable in order to assure the right implementation

- Rules of origin are also used in trade statistics which is very important for countries

to keep track of their trade balance

- In FTAs, Rules of Origin are used to differentiate between goods originating incontracting parties and those originating in third countries Such differentiation serves

two purposes: (1) it allows the importing party to determine whether a product iseligible for preferential treatment under the FTA at hand; (2) it avoids the scenariowhere exports from third countries enter the FTA via the member with the lowestexternal tariff (i.e., trade deflection).

3 Origin criteria

As Rules of Origin plays an important role in determining the accuracy of tradepolicies, it focuses on the criteria that differentiates between products from differentcountries

There are 2 approaches to determine the country origin of goods: whollyobtained (or produced) criterion and substantial transformation criterion

a Wholly obtained criterion

Wholly obtained or produced goods are defined as natural products in a country

or products made from entirely domestic inputs in a country They are mineralsextracted from the soil, animals born and raised in the country and their products,plants harvested in a single country These goods are more easily identified and haveclear HS nomenclature and coding

b Substantial transformation criterion

For non - wholly obtained goods, there are 3 common ways to determine thecountry origin of goods: the value-added measure (VA), the tariff heading criterion(CTH), and the specified processes (SP) test These methods can be used singly or incombination based on specific cases

Rules Content Merits Demerits Value - added A good is considered - Simple and precise - Costly and

measure (VA) substantially transformed when - Suitable for sophisticated due to

the value added of a good addressing certain differences inincreases up to a specified level goods which have calculation methods,expressed by ad valorem been further refined fluctuation in

percentage The value added or value-added values…

requirement of domestic content

heading substantially transformed when predictable suitable for origin

different from all non-originating requirements are

with

Specified A good is considered - Technical and - Modifications

processes (SP) substantially transformed when objective needed to keep up

There are other tests used for different products Some FTAs use the so-called

“hybrid tests” One type of this test requires a combination of two (or more) criteria;the other type provides a choice among two (or more) criteria There is no standardsand countries can choose the appropriate approach based on different partners

Apart from the core origin criteria, there are also general rules to determine theeconomic nationality of products Examples of these are De Minimis and cumulationprinciple De Minimis principle is a provision that allows a small amount of non-originating materials to be used in the production of the good without affecting itsoriginating status The provision acts as the relaxation of the rules of origin The otherprinciple - cumulation is a provision which allows to consider goods obtained in aswell as processing taking place in one FTA member country as originating in another

4 Origin certification and verification

Certification and verification are also important when applying rules of origin.Although a product can fulfill all the criteria, they may not be entitled to preferencesunless they comply with procedural requirements These requirements can differbetween trade agreements but are clearly declared, so participating countries mustfollow in order to gain the benefits Certificate of origin is one of the most importantrequirements for a consignment Many agreements provide a value threshold underwhich the country origin of the goods cannot be certified

- Another important step is to obtain the suppliers’ declarations as a pROOf

- Once the exporter has verified that the good meets the relevant rule of origin, acertificate of origin needs to be provided If self - certification is permitted, the traderonly needs to fill out the information relating to the consignment on a prescribed form(if any), and declare that the goods listed therein fulfill origin criteria and otherrequirements

- However, if self-certification is not allowed, a trader must apply for a pROOf oforigin issued by a certifying authority, which is normally the chamber of commerce or

an agency of the ministry of trade or commerce To obtain such document, theexporter or the producer will submit various documents relating to the production ormanufacturing of the goods The competent authority will examine the documents,and pay visits to an applicant's premise to verify if necessary, and certify if the goodsare compliant with the origin criteria set out in the trade agreement at hand

b Verification:

- When the consignment arrives at the port of entry in the importing country, thepROOf of origin will be submitted to the customs authority To facilitate trade,sometimes a physical submission is not required - the importer or its representativemay simply submit the document number and/or an electronic copy thereof Thecustoms' acceptance of the pROOf of origin will decide whether or not theconsignment is entitled to preferential treatment

- In case there arise some doubts, the customs authority may resort to severalmeasures, e.g examining the original pROOf or origin or verifying the information onthe document and the goods actually imported The customs may require the trader toprovide more information, or even contact the issuing authority in the exportingcountry for further clarification

THE SIGNIFICANCE OF RULES OF ORIGIN IN INTERNATIONAL

TRADE 1 Introduction

The basic role of Rules of Origin is the determination of the economicnationality as opposed to the geographical nationality of a given good There areseveral mandatory legal or administrative requirements to observe when goods aretraded on the international market This is necessary for the implementation of varioustrade policy instruments such as imposing import duties, allocating quotas or for thecollection of trade statistics The determination of the country of origin is the last step

in the customs clearance procedures, the first steps being the classification of thegoods and the determination of the value of the goods The classification and valuationare important per se for the customs clearance, but these are also the basic tools for thedetermination of the country of origin of goods in the sense that the rules of origin areproduct specific rules linked to specific HS codes, and that in order to assess if valueadded rules are fulfilled, the composition of the customs value is needed

2 The significance of Rules of Origin

Rules of Origin have become one of the major trade issues among tradingnations and trading communities worldwide While reasons for this could be closelylinked to each other, the following factors are pointed out

a ROO reduce costs of doing business in international trade

Thanks to the series of General Agreement on Tariffs and Trade (GATT)multilateral trade negotiations, “trade liberalization” measures (i.e., reduction orelimination of customs duties) have been implemented, and according to WTO, theaverage tariff rate is 4% Generally speaking, tariffs are not regarded as major barriers

to trade although high-tariff items and tariff escalation still exist for certain sensitiveproducts Instead, business and trading communities—in particular, small and mediumenterprises (SMEs) - pay greater attention to “trade facilitation” measures, such asestablishment or harmonization of customs procedures In fact, an Asia PacificEconomic Cooperation (APEC) study shows that trade facilitation efforts will producemore fruits than trade liberalization Customs procedures cover not only export/importclearance procedures, but also certification of Rules of Origin requirements Excessive

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and burdensome government documentation requirements would undermine thebenefits from trade liberalization measures.

b Rule of Origin as trade policy instrument

Rules of Origin are supposed to be technical and neutral rules to determine thecountry of origin of goods However, Rules of Origin are frequently used as a tradepolicy instrument in some importing countries in the form of preferential tradeagreements and arrangements, such as GSP and FTAs.4 In order to protect nationalinterest, Rules of Origin tend to differ from one FTA to another, reflecting differenttrade patterns and structures on a bilateral basis Thus, for example, jurisdictions such

as the United States and the European Communities have used Rules of Origin as thelegal justification for imposing antidumping duties on third country exports(sometimes retroactively) following findings that merchandise produced in such thirdcountries had not acquired third country origin but continued to have the origin of thecountry with respect to which antidumping duties were imposed As such conclusionswere drawn without any investigation whether third country exports were dumped andthereby caused injury, the use of Rules of Origin was effectively extrapolated toconstruct an independent shortcut for imposing antidumping duties on exports from athird country, although the international legal basis for doing so is ambiguous, to saythe least

c ROO expand foreign direct investments (FDI) and export processing zones

(EPZs)

Exports are regarded as an engine for economic growth Many developingcountries offer tax incentives to EPZs to attract FDI Rapid growth of FDI indeveloping countries creates a production base for exports to enjoy preferential tarifftreatment under GSP and FTAs In order to benefit from such treatment, goodsproduced at EPZs must meet the requirements for Rules of Origin

d ROO circumvent trade remedy measures

Some companies tend to circumvent trade remedy measures (e.g., anti-dumpingand countervailing duties) by simply transferring their factories to third countries that arenot subject to these trade remedy measures, or to the importing country that has imposedsuch measures and is supplying essential parts and components Since trade

remedy measures are taken against specific exporting countries, Rules of Origin play akey role in determining the country of origin of the goods in question Determination

by the importing authorities is vital for such companies to waive payment ofadditional customs duties Measure-imposing countries may wish to create specialorigin rules to avoid such circumvention practices, which could lead to another tradepolicy instrument (Darlan Marti, n.d.)

e Minor rule amendment requires a big operation change

Authorities often issue technical amendments of Rules of Origin Even if suchamendments are minor, it could require considerable modification of presentproduction operations There are instances where the combination of use of domesticand imported materials should be changed to meet the new origin rules

to either import the product at a cost or prevent you from importing and selling it

The rules of origin have become increasingly more important given the globalvalue chains where materials and labour from different countries are used in theproduction or manufacture of an end product This becomes even more evident whentrying to navigate the free trade arrangements that your product may benefit from aseach of the free trade arrangements have different rules of origin and the rules oforigin are not the same for all products The rules of origin could for example requirethat you are only allowed to use a certain percentage of materials that do not originatefrom the country where you may want the product to originate from The rules couldalso specify the type of processing that needs to be applied to non-originatingmaterials in order that an end product may be deemed to originate from the countrywhere you would like the product to come from Such processing could require thatthe material you use must be classified under a different tariff heading than the tariffheading of the end product or prohibit the use of materials from certain tariff headings

Failure to adhere hereto could result in unforeseen costs in the forms of duties,storage cost, re-shipment cost and penalties (Rian Geldenhuys, 2019)