ECONOMIC EFFECTS OF RULES OF ORIGIN

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ECONOMIC EFFECTS OF RULES OF ORIGIN

• Background
• Free trade areas (FTAs) traditionally seen as
  more trade liberalising than customs unions
• Rules of origin complex, difficult to analyze
• Increased interest in FTAs with NAFTA and
  regionalism in the 1990s
• Research suggests that rules of origin act as
  barriers to trade and affect allocation of
  resources ?
• FTAs more protectionistic than previously
  thought
• Adds to the debate on regionalism -
  multilateralism

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• Structure of the lecture
• Why rules of origin?
• How to determine origin
• Examples of rules of origin
• Economic effects of rules of origin
• Implications
• Empirical evidence

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I. Rules of Origin (ROO)

• To determine where a commodity is produced,
  problem if a commodity produced in more than one
  country
• Differentiate between
• Domestic and foreign producers
• Different foreign producers
• consumer notification
• trade statistic purposes
• trade regulations
• sanctions
• preferences

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• Preferential Rules of Origin
• Define the conditions that a product must satisfy
  in order to be considered as originating in a
  country qualified for preferential treatment
• Customs Unions vs. Free Trade Areas
• Both CUs and FTAs need rules of origin
• Additional function in a FTA avoid trade
  deflection

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II. Methods to determine origin

• 1. Substantial transformation (the US)
• If inputs and processes from two or more
  countries, origin to the country where it last
  underwent a substantial transformation
• Predictable
• Problems
• subjective and imprecise
• difficult to implement at a global level

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• 2. Change in tariff heading (CTH)
• Considered to originate from a country if
  processing enough to change tariff classification
  (Harmonized System)
• More transparent and predictable, less
  subjective
• Problems
• tariff schedules not designed with origin
  determination in mind
• possible for industries to formulate rules that
  suits their interests
• requires that classification kept up to date
• costly

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• 3. Value added
• A certain amount of value must be added to
  imported materials. Often used in combination
  with some other rule
• Simple and clear
• Problems
• difficult to calculate
• affected by accounting principles
• a commodity may change country of origin
  unpredictably
• operations that give origin in one country may
  not do so in another
• incentives for producers to manipulate prices

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• 4. Specified process
• Technical definition
• Advantages and problems similar to CTH
• - risk of manipulation
• - difficult to have a common system for the
  whole world

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• Cumulation
• Allows producers to import materials from
  certain countries without risk of changing the
  origin
• bilateral inputs originating from partner
  countries treated as originating in the exporting
  country
• diagonal inputs originating from another country
  in a specified region treated as originating in
  the exporting country (used in many EU
  agreements, e.g. pan-Euro-Mediterranean
  cumulation zone, not in NAFTA)
• full basically disregard the origin status of
  the inputs (e.g. EEA and ACP)

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• Tolerance Rule
• allows a certain percentage of non-originating
  materials to be used without affecting origin of
  final product (applies to CTH and specific
  processes)
• Absorption principle
• a component that has acquired origin status
  treated as being of domestic origin in further
  processing/transformation (applies to VA)

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III. ROO in practice

• All methods used in agreements involving EU and
  NAFTA, often combination of methods
• detailed and product specific, vary across
  agreements
• CTH most common
• EU basically at 4-digit (heading)
• NAFTA 2-digit (chapter)
• EUs ROO
• Replace rules with a single value-added
  requirement
• Tolerance rule lower for textile and clothing
• Website http//ec.europa.eu/taxation_customs/custo
  ms/index_en.htm

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IV. Analyzing rules of origin

• Earlier Domestic content requirements a
  proportionally distributed quota
• Effects of ROO on resource allocation
• How producers change their choice of inputs and
  production processes to comply to ROO.
• If changes from the producer depend on how ROO
  are defined
• Examples

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• ROO in an FTA could extend protection by each
  country to producers in other member countries
• In general producers of a final good purchase
  more expensive (protected) inputs from another
  member country if effective protection greater
  than in the home country
• FTAs worse than CUs?
• Krueger (1995)
• FTAs can not lead to more trade creation (no
  Single Market as border controls needed)
• If ROO leads to export protection, FTAs imply
  more trade diversion than under a CU

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• V. Implications
• Policy implications
• (Content protection protect input markets)
• Preferential ROO
• exports protection where high-cost country
  protects its producer in partners market
• opportunity for domestic producers to lobby for
  protection

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Other implications

• Changes opportunities for domestic producers
• Exaggerated if there are scale economies
• ROO and developing countries
• Strict rules to promote value-adding activities
  in developing countries? ?
• 1) discriminate against small countries
• 2) makes it more difficult to fragmentize the
  production process

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VI. Empirical evidence

• ROO restrict trade
• Brenton Manchin (2003)
• 1/3 of EUs imports from GSP that fulfilled ROO
  actually payed reduced duties
• Anson et al (2004)
• almost half the value of Mexicos preferential
  access to US market absorbed by administrative
  costs
• Augier, Gasiorek Lai Tong (2005)
• cumulation of ROO important in order to avoid
  negative effects of ROO (increase trade approx.
  50)

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• VII. Regionalisation and harmonization
• of ROO
• Increased numbers of FTA of hub-and-spoke
  character
• Spaghetti bowls and demand for harmonization
• EU
• WTO

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VIII. Concluding remarks

• Costs of ROO
• Administative costs
• Difficulties in satisfying and veryfing rules ? a
  large part of trade eligible for preference
  treatment do not pay reduced duties
• Production costs
• Effects of ROO
• Protectionism
• Lower trade volumes, particularly in intermediate
  goods
• Decreased scope for fragmentation
• Implications for small and developing countries
• Despite increase in number of FTA, trade not as
  liberalized as perhaps assumed