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UN LDC IV: Reforming Rules of Origin in Preference-Giving Countries

UN LDC IV: Reforming Rules of Origin in Preference-Giving Countries

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Over the last four decades Least Developed Countries have received preferential access to the markets of most of the major developed countries. Rules of Origin were an integral part of this development. Rules of Origin confer an economic nationality on products in international trade and are a necessary and integral part of preferential trade regimes. They define how much processing must take place locally before goods and materials are considered to be the product of the exporting country.
This paper gives an overview on the current status of Rules of Origin for the LDCs. It points out the rationale behind Rules of Origin, identifies Rules of Origin as trade barriers, describes the criteria used for defining them, and shows the strengths and weaknesses of using different Rules of Origin methodologies. Furthermore, it shows how key developed countries handle Rules of Origin with LDCs, makes proposals to their harmonization, and identifies possible improvements of the current Rules of Origin system.
Over the last four decades Least Developed Countries have received preferential access to the markets of most of the major developed countries. Rules of Origin were an integral part of this development. Rules of Origin confer an economic nationality on products in international trade and are a necessary and integral part of preferential trade regimes. They define how much processing must take place locally before goods and materials are considered to be the product of the exporting country.
This paper gives an overview on the current status of Rules of Origin for the LDCs. It points out the rationale behind Rules of Origin, identifies Rules of Origin as trade barriers, describes the criteria used for defining them, and shows the strengths and weaknesses of using different Rules of Origin methodologies. Furthermore, it shows how key developed countries handle Rules of Origin with LDCs, makes proposals to their harmonization, and identifies possible improvements of the current Rules of Origin system.

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08/03/2011

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POLICY BRIEF NumBER 2. mARCH 2011
UN LDC IV: Reforming Rulesof Origin in Preference-GivingCountries
Rules of origin (RoO) confer an economic nationality on products ininternational trade and are a necessary and integral part of preferential
trade regimes. They account for much of the “ne print” associated
with international trade agreements. They are directly linked to anypreferences granted under a trade agreement, whether it is reciprocal or
non-reciprocal. Rules of origin dene how much processing must take place
locally before goods and materials are considered to be the product of theexporting country. Goods that comply with the conditions set by the RoOare rewarded with preferential market access, while non-compliant goodsare subject to a country’s normal treatment of such imports.Over the past four decades least-developed countries (LDCs) have receivedpreferential access to the markets of most of the major developed countriesunder various generalized system of preferences (GSP) programmes. Whilea number of GSP programmes offer duty-free and quota-free access to
the beneciary country for virtually all products, the RoO that underliesuch access are often considered to be overly restrictive and inexible
and not conducive to LDCs taking advantage of the preferences granted.In the absence of a binding World Trade Organization (WTO) agreementon preferential RoO, the make-up of RoO has been left to the countrygranting the trade preferences. To this day, many countries continue toconsider the design of such RoO to be their own prerogative and haveresisted attempts to harmonize them or link them to a common standard.As a result, there continues to be little overlap in the RoO methodologies
employed by developed countries, and LDC beneciaries are faced with a
multitude of different processing requirements depending on the intendedexport market.Part of the reason for the current plethora of RoO regimes and methodologiesrelates to the fact that no single test for substantial transformation standsout as being the most appropriate in conferring origin across all productcategories. Within the framework of the non-agricultural market access(NAMA) negotiations, the LDC Group submitted a proposal on RoO reformthat considers a value-based methodology with appropriate thresholds. Thelatest draft text (Fourth Revision of Draft Modalities for Non-AgriculturalMarket Access) calls on members to use the model proposed by the LDCGroup in the design of RoO for their autonomous preference programmes.Adopting a new standard on preferential RoO in non-reciprocal tradingarrangements will continue to present a major challenge, and anyconsensus and implementation is likely to be a long way off given the lackof appetite among grantors of GSP preferences to harmonize their unilateralpreferences. This is despite the fact that many developed countries have
Eckart Naumann,Associate, Trade Law Centre for Southern Africa
Executive Summary
 
2
acknowledged either explicitly or implicitly that somereform is necessary and that there has been a relativelylimited uptake of GSP, especially by LDCs. This is at leastin part related to the structure of existing RoO.Meanwhile LDCs should push for alternative options toencourage reform of GSP and related RoO. This mayrequire an expansion of the rules related to cumulation,which may be politically more acceptable and defensiblein the short to medium term. To achieve this, existing
regimes would need to be retrotted with the appropriate
technical amendments and should consider extending
cumulation to all beneciaries under a specic GSP as
well all other countries that are parties to a free-tradeagreement (FTA) (with the preference-giving country) aswell as in product categories that already enjoy duty-free access to the preference-giving country undermost-favoured nation (MFN) concessions. In addition,the extension of cumulation between all LDCs should beconsidered, and their respective RoO regimes should beregarded as being of an equivalent nature in order to dealwith likely concerns that may emanate from the fact thatthere are some technical issues related to cumulation inthe face of dissimilar RoO.
1. Rules of Origin in InternationalTrade
1.1 The rationale for rules of origin
Rules of origin (RoO) confer an economic nationality toproducts in international trade. In preferential trade
regimes, RoO dene how much local processing must take
place before a good will be considered to be a productof the exporting country. Thus, they have a direct linkto any preferences offered under a trade agreement.Compliant products are rewarded with preferentialmarket access, while noncompliant products are subjectto a country’s normal import duties.The main purpose of RoO is to prevent trade deflection,which takes place when goods are shipped via thecustoms territory of a country having more favourablemarket access to the destination country. Such ascenario not only undermines any given preferentialtrade arrangement, but also means that little orno processing and thus no economic developmenttakes place in the intermediary country. Therefore,without RoO in place there would be little purpose inestablishing preferential trade areas.Broadly speaking there are two types of RoO: preferentialand non-preferential RoO. The latter are utilizedby countries for purposes such as the application of MFN treatment, statistical record keeping, safeguardmeasures, origin marking, government procurementand so forth and are not the focus of this study.Preferential RoO, however, are linked to tariff (andquota) preferences and include those that form partof a preferential trade area, whether reciprocal ornon-reciprocal. Therefore, they would include non-reciprocal preferential arrangements, such as thegeneralized system of preferences (GSP), or reciprocalbilateral agreements, such as the economic partnershipagreements (EPAs) between the European Union (EU)
and African, Caribbean and Pacic (ACP) countries.
It is sometimes noted that while non-preferentialRoO are used to allocate origin, preferential RoOdetermine origin.Rules of orgin remain relevant as long as there aredifferentiated tariffs and other trade measuresglobally. Differentiated tariffs lead to preferencemargins, which can be defined as the difference inmarket access benefits under a preferential tradearrangement versus exporting goods under normal tariff relations. From a trader’s perspective, the preferencemargin also refers to the difference in tariff and quotaapplicable to shipping from one country versus from acompetitor country. A producer exporting clothing fromLesotho to the United States of America (US) might have a15 percent preference margin compared with an exportershipping the same goods to the US from Bangladesh.It thus stands to reason that the margin of preference isdirectly related to the opportunity cost of not complying
with the relevant RoO. By ensuring that sufcient local
transformation has taken place (sometimes at additionalcost), goods are accorded more favourable entry to the
nal destination. The higher the margin of preference,
the greater might be the willingness of producers to
comply with the specications of these rules. When adestination country’s tariff within a specic product
category is very low or zero-rated, exporters will havelittle incentive to comply with any measures requiredby the RoO that they would not already undertake forcommercial reasons.
Although preventing trade reection is the main and
arguably only legitimate reason for preferential RoO,they have also been widely used as a ‘discretionary’ tradepolicy instrument, or at least to complement existingtrade and industrial policies. When RoO are designed in amanner that imposes an inordinate burden on producersand exporters they become trade barriers in their ownright. This is because restrictive RoO undermine the
uN LDC IV: Reforing Rles of Origin in Preference-Giving Contries march 2011
 
3
ability of producers to source inputs in an efcient
and commercially sound manner. In the process, theycanprevent or undermine trade expansion and in effectact as a form of protection for incumbent producers inthe destination country. This would happen when thedynamics within supply chains and the availability of 
certain raw materials changes signicantly over the years
without any changes in the RoO (this could be construedas inadvertent protectionism), or when countries imposeparticularly restrictive local processing requirements to
protect local rms from the competition of competing
goods exported from preferential trade partners.
1.2 Rules of origin as a trade barrier
RoO can act as a trade barrier by imposing variouscosts on producers and exporters. RoO can have anegative impact on production cost as they affectbusiness and production decisions to the extentthat they lead to an outcome that is different thanwhat would otherwise be the case given commercialrealities unencumbered by RoO restrictions. WhereRoO directly restrict producers in sourcing inputsfrom the most competitive sources globally, this maylead to economically sub-optimal outcomes, oftenresulting in products no longer being internationallycompetitive. International competitiveness is after allthe cornerstone of successful exportation.Where RoO differ depending on the target market,producers are obliged to adapt their manufacturingprocesses in order to comply with the various conditionsthat they impose, which often undermines potentialeconomies of scale. As will be discussed later, thereis still no binding standard on preferential RoO, andtheir design - particularly in non-reciprocal schemes -remains the prerogative of preference-giving countries(and usually the stronger negotiating partner in abilateral arrangement).Preference-giving countries can also design RoO inways that promote their own interests, both throughbilateral cumulation arrangements (dealt with later)and RoO designed to favour the sourcing of donorcountry raw materials and semi-processed goodsfor further processing in the recipient country. Inthat sense RoO can also act as indirect subsidies fordomestic exporters, with producers in the preference-receiving country being encouraged - through the RoO- to utilize inputs from the donor country.For example, there is evidence that US exports of yarn and fabric and semi-processed garments areboosted by arrangements that reward their use whenfurther processed by the beneficiary country. Underthe Caribbean Basin Initiative (CBI), a number of RoOcategories of clothing receive preferential marketaccess if they are manufactured from (alone or incombination) US manufactured thread, yarn, fabricand cut fabric and re-exported to the US. Full-year2010 data show, for example, that 45 percent of qualifying garment consisted of knit apparel fromregional or US fabric from US yarn, and 23 percent of qualifying garments were T-shirts made from regionalfabric from US yarn. Similar evidence exists under theAndean Trade Preference Act (ATPA) although less sounder the African Growth and Opportunity Act (AGOA),presumably because the logistics of the distancesinvolved make this unfeasible.Rules of orgin also impose administrative compliancecosts. Traders are required to adhere to onerousrequirements for making declarations on compliancewith the relevant RoO, based on (at times) complicatedcost accounting and apportionment, detailed andlengthy record keeping, exporter registration andso forth. While some of these processes are clearlycommensurate with doing business internationally,others are a burden directly related to the applicableRoO regime. Administrative costs are not limitedto traders, but also represent a burden to customsauthorities. Particularly in less developed countries,customs administration is often far less developedthan in developed countries, which increases the timeand cost factor related to international trade. Whereverification procedures are required, they place anadditional burden on the trade process and can raisethe cost of doing business internationally.When RoO are designed in a way that clearly goesbeyond the prevention of trade deflection, this willresult in exporters from partner countries (recipientsof preferences) being less likely to comply whileincumbent producers in the preference-giving countrywill be protected from additional competition. Thisprotection is through an absence of (or lower) imports,or a price premium resulting from duties levied onnoncompliant imports.
1.3 Criteria used for defining rules of origin
A number of different criteria may be used to determine(local) origin. There is no universally recognized “best
practice” with respect to the design of RoO, except for
some guiding principles (transparency, administrationin a consistent manner, uniformity, impartiality and

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