Rules of Origin in the World Trading System

 

Antoni Estevadeordal

Kati Suominen

Integration, Trade and Hemispheric Issues Division

Integration and Regional Programs Department

Inter-American Development Bank

PREPARED FOR THE SEMINAR ON

REGIONAL TRADE AGREEMENTS & THE WTO

WORLD TRADE ORGANIZATION

NOVEMBER 2003

Facilitating or hindering trade: the role of rules of origin in RTAs

I. Rules of Origin: Key Issues

II. (a) Product-Specific Rules of OriginII. (b) Regime-Wide Rules of Origin

III. (a) Measuring Restrictiveness of Product-Specific RoOIII. (b) Constructing a Facilitation Index of Regime-Wide

RoO

IV. Empirical Analysis to Evaluate the Impact of RoO

V. Policy Conclusions: Is Harmonization the Key to Mitigating RoO’s Negative Effects?

Rules of Origin: Key Issues

• Two types of RoO: non-preferential and preferential• The justification for preferential RoO is to ensure

that non-members do not obtain access to regional preferences (avoid trade deflection)

• However, RoO can be a powerful trade policy instrument:– RoO’s effects in the S/R different than in the L/R– RoO can fully insulate an industry from the consequences

of an FTA– RoO can protect intermediate good producers by

favoring intra-PTA supply links– RoO can be used to attract investment in strategic sectors– Very limited theoretical and empirical work

• Details matter a lot!

Objectives of RoO

Rules of Origin and WTO

• Non-Preferential Rules of Origin are being harmonized under Uruguay Round Agreements

• Preferential Rules of Origin would be a key element of discussion under Doha mandates on Regional Agreements (Rules Negotiations):

“We also agree to negotiations aimed at clarifying and improving disciplines and procedures under the existing WTO provisions applying to regional trade agreements. The negotiations shall take into account the developmental aspects of regional trade agreements.”

Product-Specific RoO

• Wholly obtained or producedWhere only one country enters into consideration in attributing origin

• Substantial transformationWhere two or more countries have taken part in the production process

– Change in Tariff Classification (CTC)Requires the product to change its HS tariff heading, chapter, heading, sub-heading, or item in the originating country

– Import Content Rule (MC) or Regional Value Content (RVC)Requires a MIN % of local value added in the originating country (or a MAX % of value originating in non-member countries)

– Technical Requirement (TECH)Prescribes that the product must undergo specific manufacturing

processing operations in the originating country

Types of Product-Specific RoO

Source: World Trade Organization (2002).

Frequency of Various Product-Specific RoO Criteria

• The product-specific RoO of the EU’s PANEURO system cover more than 65 PTAs, both across Europe and in EU’s recent extra-regional PTAs with Mexico, Chile, and South Africa

• PANEURO model mainly combines CTC (usually CH) with RVC and/or TECH

Product-specific RoO in Europe

Four RoO families can be identified:

1. LAIA, Andean Community, Caricom -across-the-board CH or VC

2. NAFTA, Mexico’s FTAs, Can-Chi, US-Chi, Chi-Cacm-high degree of variation in RoO across products-different types of CTC in combinations with VC

and/or TECH

3. Mercosur and its FTAs with Chile and Bolivia -mainly CH; also CH and VC or TECH

4. CACM-falls between NAFTA and Mercosur models:

mainly CTC but also combinations

Product Specific RoO in the Americas

• RoO are based on an across-the-board VC criterion (usually RVC of 25-50 percent)

• Alternative, across-the-board RoO usually involves a change in heading or change in subheading

• More complex RoO regimes emerging: - SADC - Japan-Singapore FTA- US-Singapore FTA- Chile-Korea FTA- Some moves to renegotiate RoO in Africa

Product-specific RoO in Asia and RoW

• Harmonization work carried out since July 1995 by the WTO and the World Customs Cooperation Council

• The most common RoO is change in heading; however, also important amounts of sectoral selectivity

• Some 90 (mainly political rather than techncical) issues affecting about 20% of tariff lines have yet to be resolved

• Main sticking points: - RoO in machinery: CTC- or RVC-based?- Disagreements over related trade policy issues (SPS,

EEZ, trademarks, geographic indications, etc.)- Disagreements over role of RoO in anti-dumping

Product-specific NON-PREFERENTIAL RoO

Distribution of CTC Criteria by Agreement

Type and Height of RVC Criteria

Selected PTAs

RoO Combi-nations

Selected PTAs

Requirement PANEURO NAFTA AFTA ECOWAS SADC GULF CC Non-prefNC 0.39 0.54NC+ECTC 2.39NC+TECH 1.39 0.72NC+ECTC+TECH 0.00NC+VC 11.46 100 100 11.48NC+ECTC+VC 1.57NC+VC+TECH 0.08 0.34NC+WHOLLY OBTAINED CHAPTER 7.62 9.39NC+WHOLLY OBTAINED HEADING 0.70SUBTOTAL 25.60 0.54 100.00 0.00 0.00 100.00 21.93CI 3.64CI+ECTC 0.02 0.12CI+TECH 1.39 0.08CI+ECTC+TECHCI+VCCI+ECTC+VC 0.02CI+VC+TECHSUBTOTAL 0.00 0.04 0.00 0.00 1.39 0.00 3.84CS 0.20 1.29 100 1.16 13.53CS+ECTC 0.00 2.52 0.64CS+TECH 1.90 0.04CS+ECTC+TECH 0.00 0.40CS+VC 0.27CS+ECTC+VC 0.00 0.10CS+VC+TECH 0.00CS+ECTC+VC+TECH 0.00SUBTOTAL 2.37 4.35 0.00 100.00 1.16 0.00 14.17CH 32.99 17.09 68.65 40.13CH+ECTC 4.60 19.18 3.35 11.64CH+TECH 0.00 0.02 0.36CH+ECTC+TECH 6.66 0.14 6.52CH+VC 13.01 3.54 0.13CH+ECTC+VC 0.37 0.58CH+VC+TECH 0.00 0.10CH+ECTC+VC+TECH 0.02 0.03SUBTOTAL 57.65 40.65 0.00 0.00 78.65 0.00 52.13CC 2.16 30.95 0.68 7.86CC+ECTC 1.02 17.71 0.1CC+TECH 0.04 0.02CC+ECTC+TECH 11.02 5.76 18.09CC+VC 0.00CC+ECTC+VC 0.00CC+VC+TECH 0.00CC+ECTC+VC+TECH 0.00SUBTOTAL 14.24 54.44 0.00 0.00 18.77 0.00 7.96TOTAL 100 100 100 100 100 100 100

Regime-Wide RoO

• Provisions adding leniency to RoO:– De minimis

– Roll-up or absorption principle

– Cumulation

– Self-certification

• Provisions that may make RoO more restrictive:– Lists of operations insufficient to confer origin

– No-drawback rule

– Complex certification methods

– Inefficient or non-transparent verification by customs

Types of Regime-Wide RoO

Source: World Trade Organization (2002).

Frequency of General RoO Provisions

Regime-Wide RoO

Selected PTAs

Certifi-cation Method

Selected PTAs

PTA Certification methodPANEURO Two-step private and public; limited self-certificationPE Two-step private and public; limited self-certificationEU-South Africa Two-step private and public; limited self-certificationEU-Mexico Two-step private and public; limited self-certificationEU-Chile Two-step private and public; limited self-certificationNAFTA Self-certificationG3 Two-step private and publicUS-Chile Self-certificationMexico-CR Self-certificationMexico-Bolivia Self-certification (two-step private and public during first 4 years)Canada-Chile Self-certification CACM-Chile Self-certificationCACM Self-certificationMercosur Public (or delegated to a private entity)Mercosur-Chile Public (or delegated to a private entity)Mercosur-Bolivia Public (or delegated to a private entity)CAN Public (or delegated to a private entity)CARICOM Public (or delegated to a private entity)CARICOM-DR Public (or delegated to a private entity)LAIA Two-step private and publicANZCERTA Public (or delegated to a private entity)SAFTA Public (or delegated to a private entity)SPARTECA Not mentionedAFTA Public (or delegated to a private entity)BANGKOK Public (or delegated to a private entity)Japan-Singapore Public (or delegated to a private entity)Chile-Korea Self-certificationCOMESA Two-step private and publicECOWAS Public (or delegated to a private entity)SADC Two-step private and publicUS-Jordan Self-certification

Measuring the Restrictiveness of Product-Specific RoO

• Restrictiveness measured by Estevadeordal’s (2000) index ranging from 1 (least restrictive) to 7 (most restrictive)

• Construction of index:

- Degree of CTC: CC more restrictive than CH, CH more restrictive than CS, etc.

- Exceptions to CTC, RVC and TECH add to restrictiveness

Measuring and Comparing Restrictiveness of RoO Regimes

Restrictiveness

of RoO

Selected PTAs

Agreement

RoO

Inde

x

8

7

6

5

4

3

2

1

0

Sectoral Restrictiveness of RoO by HS Sections, Selected FTAs

SADC1. Live Animals 7 6 5.3 5.9 7 6.22. Vegetable Products 6.6 6 4 5.6 6.6 6.63. Fats and Oils 4.7 6 4 3 7 44. Food, Bev. and Tobacco 5 4.7 4.4 3.7 5.4 4.65. Mineral Products 3.5 6 3.5 5.3 4 4.86. Chemicals 3.9 5.3 3.8 2.6 4 2.57. Plastics 4.9 4.8 4.9 3.2 4.7 48. Leather Goods 3.3 5.6 3.5 3.7 3.8 3.49. Wood Products 2.9 4 2.9 3.2 4.8 3.310. Pulp and Paper 4.4 4.8 4.6 4.1 4.3 3.911. Textile and Apparel 6.1 6.9 6.1 4.5 6.1 3.412. Footwear 2.8 4.9 4.1 3.5 2.6 3.713. Stone and Glass 3.7 4.9 3.7 4.2 3.7 3.514. Jewelry 3.7 5.3 3.7 4 3.7 3.415. Base Metals 4.2 4.6 4.2 3.8 3.9 3.416. Machinery and Electrical Equipment 4.8 3.2 4 4.3 4.1 3.617. Transportation Equipment 4.7 4.8 4.2 3.4 3.8 3.818. Optics 5 4 4.4 4 3.9 3.519. Arms and Ammunition 4 4.7 4 4 3.1 420. Works of Art, Misc. 4.1 5.1 4.1 3.6 4 3.3

Average 4.5 5.1 4.2 4 4.5 3.9

Chile-CACM

Non-Pref. Av.HS Section PANEURO NAFTA

EFTA-MEX

Profiles of Sectoral Restrictiveness of EU, NAFTA, and SADC RoO by HS Sections

Section

21

20

19

18

17

16

15

14

13

12

11

10

9

8

7

6

5

4

3

2

1

Ro

O I

nd

ex

8

7

6

5

4

3

2

1

0

PANEURO

NAFTA

SADC

• Sectoral restrictiveness is very similar across the main regimes

• Non-preferential RoO echo the PANEURO and NAFTA models

• Highest restrictiveness values in sectors with relatively high tariffs especially in EU and the US:– Agriculture

– Textiles and apparel

– Transportation equipment

• Trade-weighted restrictiveness of RoO deviates little from unweighted restrictiveness

Comparing the Restrictiveness of RoO Regimes

Constructing a Facilitation Indexof Regime-Wide RoO Provisions

• Comprised of mechanisms that add flexibility to the application of the product-specific RoO

• Based on a scheme that considers five components: – De minimis– Diagonal cumulation – Full cumulation – Drawback– Self-certification

Regime-Wide RoO: A Facilitation Index

Facilitation Index for Selected PTAs

0

1

2

3

4

5

Agreement

Fac

il In

dex

RoO Innovations

• Further, it is important to consider innovative ad hoc features in some regimes that can alleviate the impact of stringent RoO:

- differential application of RoO due to differences in the partners’ development levels (esp. drawback)

- phase-in of the level of value content RoO (esp. footwear, vehicles)

- permanent sectoral deviations from standard RoO (esp. from the PANEURO model in EU-Mexico and EU-Chile FTAs)

- TPLs where RoO revoked on a certain amount of imports (esp. NAFTA-based regimes)

- flexibility in the calculation of RVC (esp. when partner lacks domestic processing, as in Singapore’s FTAs):

Stage1             Stage 2                  Stage 3

Singapore Foreign Country Singapore Exported

Conventional RoO Stage 3 = Local Content

Recognition of OP Stage 1 + Stage 3 = Local Content

Measuring the Impact of RoO

• Important growing pool of theoretical evidence: restrictive RoO distort trade, investment, and production patterns

• Increasing number of empirical studies assessing the economic impacts of preferential RoO on:

– Firms’ administrative costs

– Degree of utilization of RTAs (or GSP) conferred trade preferences

– Trade patterns in final and intermediate goods

Summary of Empirical Evidence

• RoO are used “legitimately” as instruments to curb trade deflection

– Estevadeordal (2000): Sectoral restrictiveness of NAFTA RoO positively and significantly related to MFN tariff differentials between US and Mexico

– Sanguinetti (2003): Sectoral restrictiveness of MERCOSUR RoO positively and significantly related to MFN tariff differentials between Argentina and Brazil

• However, RoO are also used for political economy purposes– The restrictiveness of RoO in NAFTA(Estevadeordal 2000), Mercosur

(Sanguinetti 2003), and EU (Suominen 2004) appears to be driven by the same political economy variables as drive tariffs

Summary of Empirical Evidence: RoO and Trade deflection

Summary of Empirical Evidence: Firms’ Administrative Costs

• Koskinen (1983): Administrative costs of certifying origin in EC-EFTA FTA 1.4 – 5.7 % of value export transactions

• Herin (1986): Administrative costs of certifying origin in EFTA 3 – 5 % of value export transactions

• Holmes and Shephard (1983): Average export transaction EFTA to the EC requires 35 documents and 360 copies

• Today, official certification of RoO for a single shipment costs $7 in Chile, $6-$20 in Brazil, but free in general in EU countries

• Cadot et al. (2004): NAFTA’s non-RoO related administrative costs approximate 2% of the value of Mexican exports to the US

A Summary of Empirical Evidence: Utilization of Trade Preferences

• Estevadeordal and Miller (2002): Canada’s utilization rates of preferences to US market declined in sectors where NAFTA RoO became more stringent than CUFTA RoO

• Cadot et al. (2002, 2004): the mere 64% utilization rate of NAFTA preferences due in part to restrictive RoO

• Brenton and Manchin (2003): low utilization rates of the EU’s trading partners in the textile sector owe to the excessive stringency of EU RoO

• Inama (2004): Evidence on low utilization rates due to restrictive RoO in GSP, ACP, and AGOA

Percent of total U.S. imports from CanadaRules of Origin and Utilization Rates:

Canada-US FTA vs. NAFTA

Summary of Empirical Evidence:RoO and Trade Patterns

• Cadot, Estevadeordal and Suwa (2003): Mexican exports to the US have been undermined by restrictive NAFTA RoO

• Appiah (1999): CGE model shows NAFTA RoO distort trade flows and undercut welfare

• James (2004): NAFTA preferences and restrictive RoO have undercut Asian textile and apparel exports to US

• Flatters and Kirk (2004): Restrictive SADC RoO work against efficiency gains that members would reach through extra-regional outsourcing

• Augier, Gasiorek and Lai-Tong (2004): with no cumulation, trade has been 50% lower than expected; the impact is particularly notable in intermediate goods

Estimating the Effects of RoO on Trade Patterns: A Gravity Model Approach

• Estevadeordal and Suominen (2004): Estimate a gravity model for 156 countries, 100 PTAs and 20 years (1981-2001)

– Preliminary results: restrictive product-specific RoO:

(1) curb aggregate trade and

(2) divert trade in intermediates

– Flexible regime-wide RoO facilitate trade, and hence counter the effect of restrictive product-specific RoO

Gravity Model Estimates:RoO and Bilateral Aggregate Trade

Ln(Bilateral Trade) = b0 + b1ln(GDP_PRODij) +

b2ln(DISTANCEij) +

b3ln(BORDERij) +

b4ln(COMMON_LANGUAGEij) +

b5ln(COLONIAL RELATIONSHIPij) +

b6ln (COMMON COLONIZERij) +

b7ln(FTAij) +

b8ln(RoO_RESTRICTIVENESSij)

+

b9ln(RoO_FACILITATIONij) +

Regression Results: Aggregate Trade and RoO (Cross-Section)

I II0.92 0.93

(155.58) (152.64)-0.99 -0.98(42.01) (41.75)

0.74 0.69(6.72) (6.18)0.64 0.59(11.4) (10.43)1.07 1.10(8.09) (8.3)0.54 0.51(8.62) (8.08)0.89 2.32(13.95) (10.3)

RoO Restrictiveness -1.07(6.61)

-21.03 -21.56(62.12) (62.06)

Observations 13,581 13,581Adjusted R-squared 0.67 0.68

Absolute value of t-statistics in parentheses

Table 1 - Aggregate Trade and RoO, 2001 (OLS)Dependent Variable: Ln Imports

Ln (Yi, Yj)

Distance

FTA

Constant

Border

Language

Colonial relationship

Common colonial past

Regression Results: Aggregate Trade and RoO (Cross-Section)

I II III0.93 0.93 0.93

(152.64) (152.74) (152.74)-0.98 -0.98 -0.98(41.75) (41.65) (41.66)

0.69 0.69 0.68(6.18) (6.2) (6.13)0.59 0.57 0.57(10.43) (10.2) (10.14)

1.10 1.10 1.11(8.3) (8.35) (8.37)0.51 0.53 0.53(8.08) (8.49) (8.5)2.32 2.23 1.74(10.3) (9.87) (3.47)

RoO Restrictiveness -1.07 -1.54 -1.18(6.61) (8.37) (3.15)

Facilitation Index 0.43 0.80(5.35) (2.26)

Interaction RoO*Facilitation -0.09(1.09)

-21.56 -21.58 -21.58(62.06) (62.16) (62.14)

Observations 13,581 13,581 13,581Adjusted R-squared 0.68 0.68 0.68

Absolute value of t-statistics in parentheses

Table 2 - Aggregate Trade and RoO, 2001 (OLS)Dependent Variable: Ln Imports

Ln (Yi, Yj)

Distance

FTA

Constant

Border

Language

Colonial relationship

Common colonial past

Regression Results: Aggregate Trade and RoO (Panel 1981-2001)

I II0.55 0.54(34.36) (33.91)-1.24 -1.23

(187.39) (185.24)0.26 0.24(10.21) (9.24)

0.35 0.33(23.77) (22.52)

1.30 1.30(41.84) (42.16)

0.65 0.62(39.21) (37.77)

0.55 2.30(28.3) (37.19)

RoO Restrictiveness -1.39(29.83)

-1.80 -1.49(2.26) (1.87)

Observations 187,639 187,639Adjusted R-squared 0.73 0.73

Absolute value of t-statistics in parenthesesBoth regressions with year and country fixed effects

Constant

FTA

Language

Colonial relationship

Common colonial past

Dependent Variable: Ln Imports Table 3 - Aggregate Trade and RoO, 1981-2001 (OLS)

Border

Ln (Yi, Yj)

Distance

Regression Results: Aggregate Trade and RoO (Panel 1981-2001)

I II III0.54 0.54 0.54(33.91) (33.93) (33.89)-1.23 1.23 1.23

(185.24) (184.27) (184.16)0.24 0.24 0.24(9.24) (9.47) (9.3)0.33 0.33 0.33(22.52) (22.71) (22.5)

1.30 1.30 1.30(42.16) (42.14) (42.16)

0.62 0.63 0.63(37.77) (38.2) (38.29)

2.30 2.23 1.94(37.19) (35.6) (15.54)

RoO Restrictiveness -1.39 -1.59 -1.36(29.83) (30.1) (13.41)

Facilitation Index 0.19 0.39(7.91) (4.9)

Interaction RoO*Facilitation -0.05(2.65)

-1.49 -1.20 -1.18(1.87) (1.63) (1.61)

Observations 187,639 187,633 187,633Adjusted R-squared 0.73 0.73 0.73

Absolute value of t-statistics in parenthesesAll regressions with year and country fixed effects

FTA

Constant

Table 4 - Aggregate Trade and Rules of Origin, Panel 1981-2001 Dependent Variable: Ln Imports

Border

Language

Colonial relationship

Common colonial past

Ln (Yi, Yj)

Distance

RoO’s Effects on Trade in Intermediate Goods

Ln(Bilateral Trade in Inputs) = b0 + b1ln(GDP_PRODij) +

b2ln(DISTANCEij) +

b3ln(BORDERij) +

b4ln(COMMON_LANGUAGEij) +

b5ln(COLONIAL RELATIONij) +

b6ln (COMMON COLONIZERij) +

b7ln(RoO_REST. FINAL Goodsij) +

b8ln(RoO_FACILITATIONij) +

RoO’s Effects on Trade in Intermediate Goods: Key Variables• Dependent variable: total imports at the 6-digit level of

intermediate products = products classified as intermediates by section of the Harmonized System and that are used particularly intensely in the HS section in question (as opposed to being used in other sectors)– Examples: man-made filaments in textile products; conveyor

belts in vehicles

• Key independent variable: Average sectoral RoO restrictiveness of the 6-digit level final goods = key products classified as final by section of HS – Five sectors: chemicals, machinery, TV and radio transmitters,

textiles, vehicles

Regression Results: Trade in Intermediates by Sector and RoO

RoO Restrictiveness 1.26 0.14(80.61) (3.89)

Facilitation Index 0.81(32.72)

Adjusted R-squared 0.32 0.32Observations 241,591 241,591

RoO Restrictiveness 1.19 0.32(82.72) (8.99)

Facilitation Index 0.66(26.52)

Adjusted R-squared 0.32 0.32Observations 241,598 241,598

RoO Restrictiveness 1.30 0.13(78.3) (5.225)

Facilitation Index 0.70(3.89)

Adjusted R-squared 0.33 0.33Observations 241,591 241,591

RoO Restrictiveness 0.49 0.13(59.36) (6.47)

Facilitation Index 0(18.99)

Adjusted R-squared 0.19 0.19Observations 241,598 241,598

RoO Restrictiveness 1.37 0.56(78.17) (12.8)

Facilitation Index 0.63(20.25)

Adjusted R-squared 0.38 0.38Observations 241,591 241,591

Absolute value of t-statistics in parenthesesAll regressions with year fixed effects

Machinery

Television and Radio Transmitters

Textiles

Vehicles

Table 5 - Trade in Intermediates and RoO, 1988-2001Dependent Variable: Ln Imports + 1

Chemicals

Preliminary Results: Summary

• Both the restrictiveness and complexity of rules of origin reduce aggregate trade flows

• Regime-wide RoO—and particularly the combined effects of such RoO—designed to add leniency to the application of product-specific RoO boost aggregate trade

• Both the restrictiveness and complexity of rules of origin in FINAL goods significantly boost trade in INTERMEDIATES

- Restrictive RoO in final goods may thus result in trade diversion in intermediate goods

• EU and NAFTA-based RoO regimes will likely predominate in the future, particularly across Europe and the Americas

• Maybe an emerging Asian/trans-Pacific regime type?

• However, (1) harmonization of non-preferential RoO and

(2) the possible de facto harmonization of preferential RoO due to the spread of the PANEURO and NAFTA models could facilitate future de jure harmonization of preferential RoO

Conclusions: Future Clash or Harmonization of RoO Regimes?

• Countries’ operating in two or more RoO theaters simultaneously will:– Complicate firms’ supply relations– Force specialization of production to a certain market(s) when RoO are strict– Increase transaction costs when certification methods diverge

• This is particularly the case for small exporters in small countries that are spokes to different RoO hubs (PANEURO model, NAFTA model, etc.): even slight differences in RoO can have a big impact on production decisions

• Thus, Doha’s mandating harmonization of preferential RoO could benefit smaller developing countries in particular

Conclusions: Why Harmonize Also Preferential RoO?

• Harmonized non-preferential RoO would provide a readily available baseline for harmonizing preferential RoO

• Preferential RoO are restrictive only as long as there are MFN tariffs: the ultimate key to countering RoO’s negative trade effects will lie in the success of multilateral liberalization

Conclusions: How to Harmonize Preferential RoO and Further Mitigate RoO’s Impact ?