TWN Info Service on WTO and Trade Issues (Nov14/03)
11 November 2014
Third World Network  

LDCs outline challenges in complying with existing rules of origin
Published in SUNS #7911 dated 7 November 2014
 
Geneva, 6 Nov (Kanaga Raja) -- The Least Developed Countries (LDCs), at a meeting of the WTO Committee on Rules of Origin late last week, outlined the challenges that they are currently facing in complying with preferential rules of origin (RoO) under unilateral preference schemes.
 
According to trade officials, Uganda, on behalf of the LDC Group, presented a new paper (G/RO/W/148) at the Committee meeting on 30 October, which amongst others, analysed the trade effects and utilisation rates from the European Union and Canadian preferential rules of origin that have undergone modifications/reforms.
 
At its meeting, the Committee carried out its first review of new developments concerning preferential rules of origin for the LDCs, and heard a presentation from the WTO Secretariat on its Database on Preferential Trade Agreements.
 
Under the Bali Ministerial Decision of 7 December 2013 on preferential rules of origin for the LDCs, the Committee on Rules of Origin is to "annually review developments in preferential rules of origin applicable to imports from LDCs" in accordance with the guidelines laid out in the Decision and is to report to the General Council.
 
In their paper, the LDCs said that what has been argued by the LDC group is that it is simply anachronistic to maintain unaltered the same rules of origin as if the world trading system was like the one in the 1970s.
 
After more than 40 years, successive rounds of negotiations have substantially lowered the preferential margins, and that dramatic changes in technologies and transport, information technology and communication have occurred.
 
The fragmentation of production and the global value chains approach have defeated any argument for a vertical integration of industrial sectors underpinning the need for strict rules of origin, said the LDC paper.
 
The paper highlighted that the Trade Facilitation Agreement (TFA) demands a series of reforms in the way customs procedures operate including rules of origin to facilitate trade, and yet, with some notable exceptions, the rules of origin of some preference-giving countries are the same as those of the 1970s and the arguments heard to maintain the status quo are almost exactly those of the 1970s.
 
The LDCs noted that a major boost of confidence to the value of the LDCs' proposal and a recognition of the extreme need to reform LDCs' rules of origin (which remained almost unchanged for the last 40 years), has come from the changes in the Canadian rules of origin in 2003, and the EU's own modification of its rules of origin, which entered into force in 2011.
 
The EU and Canada have so far been the only preference-giving countries that have conducted a unilateral reform of their rules of origin for the LDCs.
 
According to the LDC paper, such reform triggered dramatic increases in the utilisation rates of existing preferences and, most importantly, generated an overall increase in trade flows thanks to new investment and manufacturing operations being located in the LDCs.
 
It however noted that other preference-giving countries have yet to do so, while a number of developing countries have introduced DFQF (Duty-Free Quota-Free) schemes containing RoO that need to be assessed.
 
The paper went on to illustrate the difficulties faced by the LDCs in meeting certain origin criteria that are based on percentage criterion, provided some examples of best practices and discussed possible improvements and changes in the light of the Decision on preferential rules of origin.
 
Highlighting some experiences, the LDCs said that the important lessons to be learned are that:
 
* No matter how RoO are designed or drafted, they should reflect global value chains. If not, trade will not be created and trade preferences will be underutilised. RoO should not be used as a disguised form of industrial policy aiming at requiring substantial transformation in LDCs going beyond what is commercially meaningful and viable.
 
* One should begin by considering the desired objective of a given set of RoO separately from the drafting methodology. A distinction has to be made between the "form" of a given RoO and its "substance".
 
The "substance" is the degree of restrictiveness of a RoO with respect to an existing value chain context in which it is expected to operate (in this case, the beneficiaries are LDCs, many of which are landlocked and island countries).
 
For decades, LDCs said that they have complained that the RoO attached to these trade preferences were overly stringent, requiring, for example, a double processing stage in the clothing sectors that does not tally with existing value chains. The restrictiveness of the RoO is the reason why many of the preferences have not been utilised.
 
This being said, there are a number of lessons learned and best practices that have progressively emerged on how to draft a given rule of origin (the "form"), especially the percentage criterion that is still used by a number of preference-giving countries.
 
According to the LDC paper, cumulation is a practice that allows the consideration of products originating in other countries or work or processing carried out in other countries as being a domestic product or work of processing.
 
In short, cumulation is not a substitute for introducing rules of origin allowing global sourcing from the most competitive supplier.
 
In a manufacturing world dominated by the existence of supply chains, LDC companies and investors should be allowed to source their inputs from the most competitive supplier rather than be provided incentives through cumulation to restrict sourcing and indulge in trade diversion practices, it said.
 
Cumulation is a viable tool for regional integration arrangements at a high or advanced industrial stage like ASEAN where cumulation has been mostly utilised.
 
In other regions like Sub-Saharan Africa or island LDCs with a low industrial base and high cost of freight, cumulation offers limited possibilities and cannot replace liberal rules of origin.
 
The paper noted that the lessons learned from drafting "the form" of rules of origin are mainly related to the percentage criterion.
 
The paper said that the limitations in using the percentage criterions are well known. It summarised them as follows:
 
(a) Percentages calculations are easily affected by movements in exchange rates for finished products that have imported raw materials, in that, when a local currency appreciates, the percentage value added tends to decline, and vice-versa;
 
(b) The level of percentage threshold may be arbitrarily set and it is difficult to set it up even with consultations with the private sector given the number of variable costs and products to take into account;
 
(c) The costs of labour in developing countries is relatively cheap and in a value added calculation, it may turn an asset into a penalty; and
 
(d) The calculations may be difficult entailing some accountancy expertise and a certain amount of discretion in assessing costs that may lead to dispute. Accountancy skills are generally not available in most small firms in LDCs.
 
In the light of the lessons learned and best practices that are progressively adopted, the LDCs are of the view that a calculation methodology based on a value of materials calculation should be preferred when preference-giving countries are using a percentage criterion.
 
This methodology eliminates most of the shortcomings of a value added calculation. The value of material calculation is based on the WTO Customs Valuation Agreement anchoring the rules to a multilateral instrument in use by WTO Members.
 
According to the paper, this method of calculation is similar to the one used by the US in recent FTA agreements with Australia, Singapore, Chile, Central America and other countries. The EU and Japan are also using a value of material calculation in their GSP scheme and in their FTAs.
 
The paper argued that another intrinsic limitation of the percentage criterion is in setting the level of percentage.
 
The first criticism is derived from the fact that, even if determined through consultations with the private sector, setting an adequate level of percentage tends to be arbitrary as it may change from time to time due to variations in the cost of the inputs and currency fluctuations.
 
Moreover, the level of the percentages may be different from product to product and the stringency or leniency of a given percentage depends on the calculation methodology.
 
The LDCs consider that a level of percentage of 15-25 per cent or even lower for certain category of products calculated according to the build-down formula (highlighted in the paper) would guarantee that substantial transformation takes place and genuine manufacturing operations have been carried out in LDCs.
 
The majority of LDCs have a very basic, in most cases, barely existent industrial base. It is clear that in such a situation, LDCs, especially land locked and island countries, are relying on inputs imported from third countries to manufacture their finished products.
 
The paper said that the mere granting of tariff preferences or duty-free market access to exports originating in LDCs does not automatically ensure that beneficiary countries effectively utilise the trade preferences.
 
Preferences are conditional upon compliance with rules of origin requirements mainly consisting of (a) compliance with origin criteria, (b) documentary evidence (certificate of origin form A or declaration by exporter/importer), (c) transport requirements in case the products have not been shipped directly.
 
As a result, even when a wide product coverage suggests potential benefits in terms of preferential market access to LDCs, the actual utilisation of such preferences could be limited.
 
A clear indicator of the effectiveness of trade preferences is the utilisation rate. Such an indicator is the ratio of the amount of imports, which actually received trade preferences at the time of customs clearance in the preference-giving country, to the amount of dutiable imports eligible for preferences. This is the most realistic measurement of the effectiveness of trade preferences.
 
The paper said that records of high utilisation rates, on average or for some product categories, do not always mean that market access at preferential rates and rules of origin exists and has been effective.
 
High utilisation rates may be easily obtained for very low amount of trade due to the fact that trade preferences and associated rules of origin have been incapable of generating trade and investment effects in LDCs.
 
For instance, the paper noted that UNCTAD has recorded that the United States had record very high utilisation rates on textile and clothing products (94.8 per cent) since 2001.
 
However, such a high utilisation rate was obtained in a few tariff lines with minimal trade value since textile and clothing are in general excluded from the product coverage of the US GSP.
 
The LDCs underlined that changes and reform of rules of origin may have a significant impact on the trade and investment decisions of companies located in LDCs or neighbouring countries that may be attracted by favourable rules of origin and market access conditions to relocate in LDCs.
 
However, the paper noted that there are marked differences in utilisation rates and trade dynamics in preference-giving countries that embarked on reform of their rules of origin like the EU and Canada and those like the US and Japan that have yet to do so.
 
In the case of the reform of the EU and Canadian rules of origin, the LDC paper found that when fuel and agricultural products are excluded, the figures of total imports of the EU from the LDCs show a steady increase in utilisation rates from 2010 to 2013, rising from 89 per cent to 99 per cent.
 
According to the paper, the figures highlighted provide evidence that the Canadian and EU reform of rules of origin undertaken respectively in 2003 and 2011 have significantly impacted both utilisation rates and the import values, the former reacting faster.
 
In the case of Canada, imports from the LDCs increased exponentially and the utilisation rate immediately reached 100 per cent.
 
The EU reform substantially liberalised the rules of origin not only for clothing but also in a variety of other sectors, allowing up to 70 per cent of non-originating materials for bicycles and easing ASEAN cumulation.
 
Figures show that the utilisation rate of bicycles exported by Cambodia to the EU has increased to around 80 per cent in 2011, from 33 per cent in the previous year.
 
Moreover, between 2010 and 2013, import values have been multiplied by a factor of 5.4, increasing from US$60 to US$325 million (+442 per cent).
 
The paper also highlighted the evolution of imports from the LDCs, excluding AGOA beneficiaries, over time in the case of preferences granted by the US to LDCs, where no reforms to rules of origin have been made.
 
Between 2008 and 2013, the total imports have decreased from US$10.2 billion to US$8.9 billion.
 
Over the same period, imports receiving GSP treatment and MFN treatment (while covered by the GSP scheme) have also significantly declined, from US$3 billion to US$137 million and from US$550 million to US$77 million, respectively.
 
The paper summarised that US imports from non-AGOA LDCs are notoriously highly concentrated in the textile and clothing sector.
 
The paper highlighted that (1) the US rules of origin seems to have so far been unable to trigger a diversification of exports and the value of trade covered by the US GSP is abysmally low; and (2) it seems that in the industries other than textile and clothing that are mostly covered by the US GSP scheme, preferences are not fully utilised with relatively high values of imports receiving MFN treatment.
 
In the case of Japan, the paper said that there are some data limitations that have not permitted the analysis for a longer observation period than 2008-2011.
 
During this period, the overall trade performance of the LDCs under the GSP scheme of Japan seems to have followed a cyclical pattern with a decrease of overall imports following the financial crisis of 2009.
 
Overall utilisation rates are relatively high showing however a rather stagnant linear approach with an average figure between 84 per cent and 85 per cent.
 
There are no significant differences in the pattern of utilisation of the Japanese GSP scheme when fuels and non-agricultural products are excluded. Utilisation rates range from 88 per cent to 86 per cent in 2011.
 
These figures show that even after significant improvements in terms of coverage to the Japanese GSP scheme, there has not been a significant modification in the trade patterns and utilisation of the Japanese GSP.
 
The paper went on to suggest some initial practices based on the LDCs' experience:
 
(1) Preference-giving countries when using a percentage criterion for determining substantial transformation should use a value of materials methodology.
 
(2) A level of percentage of 15-25 per cent or lower for certain categories of products calculated according to the build-down formula should be considered appropriate when using a percentage criterion.
 
(3) Percentage criterion-based rules of origin should adequately take into account the costs of freight and insurance when determining the value of materials especially for landlocked and island LDCs.
 
According to trade officials, at the Committee meeting on 30 October, Uganda invited the US and Japan, whose preferential rules of origin remain largely unchanged since the 1970s, to review the substance and form of their systems in this area.
 
Canada, Brazil, India, Switzerland and the EU welcomed the LDC paper. They said that they will need additional time to study the paper in detail, trade officials said.
 
The Chair of the Committee, Ken Chang-keng Chen of Chinese Taipei, said that the Committee will continue discussions on the paper at its next meeting in April 2015. +