Two weeks ago, the IDB’s Integration and Trade Sector (INT) and the International Centre for Trade and Sustainable Development (ICTSD) hosted a Dialogue on inclusive Rules of Origin (RoO) as part of the RTA Exchange project. Rules of origin tell us where a product comes from and how that product should be treated in a particular market. The “rules” are the specific provisions that determine the national “origin” of a product, and whether that product is eligible for preferential treatment offered by a particular free trade agreement (FTA). These rules also spell out the procedures and documentary requirements that allow customs authorities to apply the rules and enable preferential treatment.
Rules of Origin give order to the increasingly fragmented and global trading system. However, the complexity and variety of RoOs that exist today also presents a challenge for firms that want to participate in production networks that span multiple countries, and therefore multiple trade agreements.
At the seminar we discussed the critical issues surrounding RoO regimes and how they can be made more inclusive at the regional and multilateral level, through simplification and harmonization. Below are the five most important aspects of RoO and inclusive trade that you should know.
Strict rules of origin can impact global value chains
Countries that participate in GVCs tend to source 15% more of their foreign value-added (inputs) from members of the same trade agreement, than they do from non-members. This is due in part to rules of origin since those rules determine whether a product is eligible for preferential treatment. While being a member of a trade agreement does not necessarily impede the development of supply chains with non-member countries, empirical evidence suggest that RoOs have significant implications in the way firms choose the location in which to set up production. This means that strict RoOs can negatively impact the development of value chains by discouraging the use of cheaper parts and materials from third countries.
Complex rules of origin can impede developing countries’ trade
Origin requirements generally vary across products within a given trade agreement and across agreements for a given product. This variability can lead to confusion and error when firms are deciding where to invest and export. Least developed countries (LDCs) in particular are affected by this complexity as it adds uncertainty to their decision making and affects their ability to fully benefit from enhanced market access granted through FTAs and unilateral preferences. There is therefore an argument for the simplification and harmonization of RoO and expansion of cumulation across trade agreement and through FTAs, and Generalized Scheme of Preference schemes for LDCs which would reduce the implicit costs faced by current and potential new participants in GVCs. This is especially important for LAC countries that have relatively low participation rates in international production networks.
Simplified rules of origin mean more inclusive trade
The large network of FTAs creates challenges for operating across multiple agreements with differing uncoordinated RoO. For example, when RoOs obligate a firm to source certain inputs within the FTA, but sourcing from outside the region would be cheaper, the firms’ costs increase and exports may fall. Thus for any given FTA a firm must balance the benefits of the tariff preferences against the added costs of compliance with the rules. Expanding the set of countries from which originating materials can be sourced – known as expanded cumulation – can reduce the costs of compliance. By expanding the set of countries from which “originating” materials can be cumulated, the chances of including the supplier that the firm would have chosen without the origin restrictions increases, or at least the sourcing options are broadened. This allows firms more latitude to choose suppliers that meet their needs and minimize costs while remaining eligible for tariff preferences in the RTA in question.
Mega-regionals have an important (positive) role to play
Mega-regional trade agreements like the proposed Trans-Pacific Partnership (TPP), the Regional Comprehensive Economic Partnership (RCEP), Continental Free Trade Area in Africa (CFTA), and “mini-mega-regionals” like the Pacific Alliance are expanding cumulation by bringing countries with multiple agreements under a new regime that establishes a single set of RoOs. By negotiating a new, single set of rules that are acceptable to the economic realities of the participating countries these agreements can better promote trade and the establishment of trade linkages. Most importantly, these regimes help reduce the costs and complexity of origin requirements, which in turn improves utilization rates of the negotiated preferences.
The multilateral and regional trading system can contribute to increasing coherence in RoO
Organizations like the World Trade Organization and World Customs Organization can help promote “best practices” for rules of origin. For example, defining RoOs on a positive standard (what conditions grant originating status), instead of listing circumstances that do not result in originating goods. At the regional level, countries should focus on trade facilitation measures to make RoO regimes more productive. For example, integrating preferential origin into electronic single windows – especially those that are interoperable among countries – can help trade flow more efficiently. Authorized Economic Operator systems could also incorporate preferential origin by adopting a “once and done” rule whereby frequent traders demonstrate origin once and are granted expedited treatment going forward.
The tangled global network of FTAs is ripe for reforms to the origin provisions that can make the “spaghetti bowl” work more rationally, and give developing countries more opportunities to grow through engagement with global markets. The forthcoming reports from the Dialogue will set out concrete recommendation for policy changes that can contribute to this goal.