Preferential Trade Agreements: Session 5, Rules of Origin

Session Five:
Rules of Origin

WTO, Agreement on Rules of Origin

Gasiorek, Michael, “Multilateralizing Regionalism: Rules of Origin or Can Those PECS be Flexed” Unpublished, 2007

Coyle, John, “Rules of Origin as Instruments of Foreign Economic Policy: An Analysis of the Integrated Sourcing Initiative in the US Singapore Free Trade Agreement,” 29 Yale J. Int. Law 545 (2004)

OECD, Working Party of the Trade Committee, “The Relationship Between Regional Trade Agreements and the Multilateral Trading System:  Rules of Origin” (2002)

Comments

[Anthony Raphael V. Jacoba]

John Coyle considers Rules of Origin as powerful trade policy instruments. He further commented that, although Rules of Origin are often criticized as protectionist instruments, they have the potential to realize a variety of other ends. In particular, the analysis of the Integrated Sourcing Initiative (ISI) in the US-Singapore FTA was used as an example to show that by conferring benefits to third party, there is a possibility of circumventing the general rule in Article I of the GATT. Coyle raised a solution by including the Rules of Origin in the “other regulations of commerce” clause within the ambit of Article XXIV of the GATT to limit the effect of the Rules of Origin to the parties of an FTA.

Coyle raised an interesting point in so far as Rules of Origin clauses in FTAs affect third parties. This brought to mind the possibility of conferring positive benefits in Rules of Origin clauses which does not necessarily run counter to the principles established in the GATT. Before doing so however, prudence dictates a bit of a background discussion on Rules of Origin.

Rules of Origin are primarily concerned with the designation of a particular good as to where it originated. That being the case, there is no controversy if a good is made from raw to its finished state in just one state only. The problem begins when a manufactured good goes through different processes in different states. Hence, the provisions of Rules of Origin developed. Three classifications emerged in determining the origin of a particular good: 1) change of tariff classification; 2) ad valorem criterion or value added; and 3) specified manufacturing process. (See Agreement on Rules of Origin and OECD paper) Note, that Rules of Origin find importance only when there is an existing agreement between states providing for preferential treatment, such that, a third state would not be able to piggy-back ride on this preferential treatment by going through one of the parties in exporting its goods, which leads to trade deflection.

The change in tariff classification provides for a rule that when a good changes its tariff classification as provided under existing rules that would be the point of reckoning when a substantial transformation took place. If there is value added and the percentage of the value added is determined, then, provided that a particular percentage of value added was reached then it will be determined as the reckoning point of the substantial transformation, thus determining the origin of a good. If there is a specified manufacturing process identified as conferring origin, then it would be determinable where the good originated.

These classifications, although contextually different, provide for a means of determining whether a particular good originated in one country or another. These solve the problem of goods undergoing different stages of production in different countries. Note, however, that with the implementation of the ISI in the US-Singapore FTA, there exists a possibility of circumventing this classification, subject to a defined limitation.

Conferring benefits to third party, therefore, is not a prohibited topic in light of the US-Singapore FTA experience. Now, combining this stipulation pour aui trui, as known in domestic laws with the “Enabling clause” would provide for another benefit conferred to developing countries. Developing countries can ask for a modification of the different classifications mentioned above.

Developing countries like the Philippines should pursue, vigorously, this possibility by lobbying. If through the determination of last substantial transformation, and the same was found to happen from a third world country, then preference could be maintained in a particular FTA. This does not have bearing on the FTA between two states because one state would necessarily assert that its goods came from its state, hence, would ask for a preference. This would only allow leeway for both countries to outsource their production in countries where it is actually cheaper to produce those goods, hence, increasing efficiency. At the same, it would confer benefits on developing countries by providing for a medium within which its direct foreign investments could increase. Such a conferral of benefit does not deviate from the GATT, which, from the Enabling Clause, can be said to have a soft spot for developing countries.

The Rules of Origin then, as Coyle mentioned, can be a powerful trade policy instrument. Its scope, as can be seen from the ISI in the US-Singapore FTA has far reaching implications, such that it is possible for developing countries to once again be protected in so far as trade liberalization is concerned. This will encourage developing countries to participate and negotiate more fully in agreements that are one step closer towards multilateral trade liberalization. Obviously, the potential for Rules of Origin clauses in FTAs remains to be seen.

[Anna Theresa L. Licaros]

The attribution of a nationality to a product or service would have to be the height of personification, nationality being a traditionally human concept related to birth and blood. However, at the rate and volume by which products and services cross international borders, it is now necessary that a nationality be attributed to them in order to determine how they will be regarded and treated by the receiving nation. Moreover, with the continued product specialization that states engage in to maximize their competitive advantages, the idea of a product that is “wholly obtained” from one state is being redefined. Not only is value-addition done by different entities, it is now done in different states. Trade agreements between and among states have incorporated rules of origin to guide both its actions as well as the actions of those who wish to trade with it. It aims to reduce uncertainty and encourage a system of transparency and reliability. With rules of origin, an extra layer or process has been added and such translates to a transaction cost. However, rules of origin have also created an alternative trade route (in particular for third-party states not party to a preferential trade agreement), which translates to a reduction in transaction cost. It seems to confer gains with one hand but take away with the other. It is precisely its potential to do both which makes it necessary to regulate.
The readings distinguish between a preferential and a non-preferential rule of origin in that the goal of preferential rules of origin is to distinguish products that are entitled to preferential treatment from those which are not. These rules are usually found within preferential trade agreements. On the other hand, non-preferential rules are those governed by the WTO provisions and are used by a state to address anti-dumping measures, countervailing duties and the like. It is the preferential rules of origin which are used to implement a tariff policy and should not, per se, be the one to confer a preferential treatment. The WTO provisions champion transparency and reliability in the rules of origin to be adopted by member states. One of the papers also encourages states to give advanced rulings to guide prospective traders by giving them an idea as to how their products will be treated.
As earlier mentioned, the rules can both increase and decrease trading costs. The way the rules per se can add costs to traders is when time and effort are expended to apply the rule. Administrative costs swell as the complexity of the rules grow. When the application ultimately leads to the determination that a product must be subjected to a particular tariff, it is not actually the rules that added the cost. Rather, it is the tariff policy of the state. The rules simply utilize criterion set by the parties, which would probably be any of the three: content test, technical test or change in tariff classification test – or any permutation thereof. The first cost is a transaction cost, which can be addressed by efforts at harmonization. The second is a sort of fixed business cost that can be addressed by efforts at economic policy negotiation. It is also in the first cost sense that a rule may be regarded as an additional layer and thus a potential protectionist measure when crafted precisely to create the added layer. On the flip side, in the context of a third-party state who is not a party to the preferential or regional trade agreement, rules of origin can provide for it a window of opportunity to ride on the benefits conferred to member states. It can also be a “free pass” that would eliminate the need to go through an administrative determination of origin as in the case of the Singapore and USA Free Trade Agreement.
In understanding how to regulate and harmonize these rules of origin, it is important to understand how they are formulated and what are taken into consideration in their formulation. First, it is important to understand that these rules are much like any rule, law or regulation passed – they are not insulated from lobbying. While it is an agreement between two states, it is meant to be used by both public and private entities which operate within the industries covered. The rules could spell the difference between state policies and that which is done in practice in terms of improved access to markets. The lobbying efforts can be viewed as a good check on the government as well. As non-governmental interest groups push for their economic interests, they manage to focus the bargaining power of their states to prioritize economic development over other less relevant political interests that may cloud the latter’s judgment. Hence, in concluding trade agreements, the vigilance (and even more the participation) of the private sector serves to ensure that it is a concrete economic instrument. Considering how the rules can effectively flesh out economic policies, rules of origin must be adopted with care. As the OECD paper pointed out, they may become the very means by which protectionist interests can be “institutionalized.”
With the adoption of the WTO provisions on the rules of origin, the premise seems to be that harmonization of rules would facilitate the ultimate goal of trade liberalization by reducing transaction and administrative costs as well as reducing uncertainty. The same would manage to translate to increased profit and increased business dealings through reduced costs and facilitated access. However, the OECD paper proposes another view – that the consideration of an RTA participant is not the complexity of rules, but ultimately whether it will be able to derive trade benefits that would outweigh the hassle of sifting through these rules. It seems that having a sea of confusing rules is not a deterrent in itself, there just has to be something worth diving for. This kind of proposition is consistent with the idea that in entering into trade agreements of any sort, a participant subjects the agreement to a cost-benefit analysis and opts for dealings that would yield a benefit or an incentive. With the proposition of the OECD paper, it seems that to simply rely on the “complex system of rules” argument to streamline and harmonize would be a bit shallow. After all, there is no too “complicated” a system of rules of origin for a great deal of profit. This kind of perspective would be useful to consider in any effort to harmonize these rules of origin as it would give insight on what would motivate participants to cooperate as well as what might possibly make them ambivalent about harmonization.
Rules of origin are supposed to be neutral tools that implement the trade policy of a state. However, a state’s trade policy is never neutral. It always seeks to maximize benefits for itself and reduce its costs. The rules cease to be neutral in certain cases wherein their formulation is precisely to confound those who seek to use it, and to impede transactions. The WTO’s efforts in harmonizing rules of origin arguably do not directly address any preferential treatments conferred by a state’s trade policy precisely and rightly so. It correctly limits itself to making sure that what is supposed to be neutral stays neutral, and confines its battle against disallowed preferential treatment to its dispute settlement machinery under MFN violations. However, in cases where the tool becomes a trade barrier in itself, the WTO must find ways to compel states to restore the tool’s neutral use. For now, harmonization, standardization and transparency would have to do.

[Gerard Joseph M. Jumamil]

"Rich countries will have to reject not just protectionism, but populism, too. They will have to speak honestly to their people about the changing economies of the 21st century, and about global interdependence, and the fact prosperity elsewhere means prosperity and jobs at home." – Dr. Supachai Panitchpakdi, Secretary-General of the United Nations Conference on Trade and Development (UNCTAD)

Some scholarly writings and articles support the claim that rules of origin in preferential trade agreements should achieve a particular level of harmonization. According to this proposition, harmonization allows for a considerable degree of predictability, thereby facilitating international trade in general. More importantly, proponents of a harmonized system for rules of origin submit that synchronization prevents discrimination as it alleviates the effects of the “spaghetti bowl” of criss-crossing agreements restricting the ability of enterprises to source intermediate goods from the most efficient and economical source.

However, this blanket proposition seems to be ill advised if participating states are to achieve a context-based integration. The realities of the here-and-now speak of differing economic and socio-political contexts, and preferential trade agreements have been the appropriate answer to the seemingly impossible demands of a one-size-fits-all multilateral regime. In effect, full harmonization, in the sense of commonality in structure and provisions, would seem to be counter-productive to the gradual process of achieving an equitable global economy. An imposition of a harmonized system on a multilateral level would presently tend to further promote discrimination precisely because of the inherent inequality of states.

The very development of rules of origin, as embodied in preferential trade agreements, recognizes the need to accommodate, rather than negate, the existing economic disparities of contracting states. In the expansion of rules of origin, specific areas have emerged to address legitimate differences in state interests and distinctive issues involving particular international relations.

One such area is the emergence of the de minimis/tolerance rule. This rule permits a specified maximum percentage of non-originating materials to be used without affecting origin. It involves materials that would otherwise not be permissible under the specific production process test or the change in classification test, but does not influence the utilization of the value-content rule. Furthermore, an absorption or roll-up principle has surfaced, wherein materials that have acquired origin by satisfying particular processing requirements retain this origin when utilized as input in a subsequent process of transformation. Finally, sector-specific rules have been crafted and implemented to deal with vulnerable industries. These industries include textile and clothing, automobiles, and agriculture.

Nonetheless, it would seem rather hasty and improvident to claim that there should be a total absence of harmonization. Due regard must be accorded fundamental principles if a stable and equitable international economic order is to be achieved. Thus, a framework that integrates common principles must guide any set of rules of origin embodied in preferential trade agreements. This framework should provide for the basic principles that serve as minimum standards in framing and implementing rules of origin to carry out the objectives of any preferential trade agreement.

There are two key principles that must guide the formulation and administration of rules of origin. First, rules of origin should facilitate, rather than inhibit, international trade. Second, rules of origin must abide with the minimum requirements of due process, both substantive and procedural.

Furthermore, certain principles recognized in the Agreement on Rules of Origin may provide guidance and direction in the establishment and employment of rules of origin. The first principle is that of neutrality, embodied in Articles 2(b) and 2(c). Under this principle, rules of origin must not be utilized as devices to pursue trade policy, create restrictive, distorting, or disruptive trade effects, or be based on conditions unrelated to manufacturing, such as environmental or other conditions. Next, rules of origin must abide by the principle of transparency, as identified in Articles 2(a), 2(f), 2(g), 2(h), and 5. The principle of transparency requires a clear definition of the requirements conferring origin, a specification of tariff headings/subheadings covered by a specific rule, an explanation of method for calculation of ad valorem percentages, the identification of relevant manufacturing/processing operations, the utilization of a positive standard, prompt publication of all relevant laws, regulations, judicial decisions, an advance notice of new rules or proposed substantial modifications of existing ones, and provisions for pre-assessments of origin of goods upon request from interested enterprises. Finally, rules of origin must be predictable, as embodied in Articles 2(c) and 2(f). In this regard, rules of origin must not only be applied consistently, uniformly, and impartially, but should also provide recourse to judicial, arbitral, or administrative review of determinations of origin.

In the final analysis, the objective is to strengthen preferential trade agreements in order to establish an equitable regime of multilateralism. Rules of origin that incorporate and uphold the recognized fundamental principles effectively enhance the continuing process of development of states in a globalized community.