__________________________________________________________________________________________

2008/SOM3/CTI/TPD/006 Agenda item: 3

Trade and Investment Effects of Rules of Origin and Convergence

Submitted by: Inter-American Development Bank

Trade Policy Dialogue on Effect of Rules of Origin on Trade

Lima, Peru19 August 2008

Jeremy Harris and Kati Suominen Integration and Trade Sector Department

Inter-American Development Bank

APEC CTI Trade DialogueLima, Peru

19 August 2008

Trade and Investment Effects of Rules of Origin and Convergence

Motivation of Presentation• RoO are here to stay—remain after RTA tariffs

removed

• RoO are a trade policy instrument, and can be an “NTB in disguise”

• Restrictive RoO can choke access to cost-efficient inputs, reduce incentives for preferential trade, and undermine RTAs’ trade-creation potential

• RoO “Spaghetti Bowl” can create undue production and administrative costs

• How to reduce RoO’s negative economic effects while preventing free-riding by third countries?

Organization

I. RoO Goals and Types

II. Measuring and Assessing Restrictiveness of RoO

III. Trade and Investment Effects of RoO– Aggregate trade– Intermediate goods trade– Firms’ production costs– Sectoral FDI flows

IV. Effects of RoO Convergence

IOverview of RoO

• Two types of RoO: non-preferential and preferential– Non-preferential used for definitive determination of origin

(trademarks, antidumping etc. purposes) – Preferential RoO used for determining access to preferential

treatment in an RTA (just that and that alone)

• Preferential RoO define:– Type and/or quantity of inputs that have to be procured; and/or– Production processes that have to be performed within the RTA

area in order for the good to be considered originating

• Justification for preferential RoO: Avoid trade deflection = free-riding on RTA preferences by 3rd parties

Objectives of RoO

• Change in Tariff Classification (CTC)• At Chapter, Heading, Subheading, or Item level

• Exceptions and Additions to CTC• Value Content (VC)

• Technical Requirement (TECH)– Infinite possibilities

• These criteria are used in various combinations for each product in each RoO regime (existing total permutations in the world >200)

• Great potential for administrative difficulty, for both the public and private sector

RoO Criteria

Stylized RoO Families in APEC

• ASEAN, ASEAN-China, Chile-China, Chile-Peru– General: across-the-board classification change or

value content rules– Few technical or processing requirements

• NAFTA, NAFTA members’ RTAs, most trans-Pacific agreements– Complex: different types of CTC w/ VC and/or

processing requirements– High variation across products

APEC RTAs: Many RoO CombinationsNumber of RoO Permutations, Selected APEC RTAs

0

20

40

60

80

Variation also in Regional Value Content

Seven different calculation methods– Transaction Value/Build-Down/Maximum

Non-Originating content– Build-Up– Net Cost– Factory Cost– Allowable Cost– Qualifying Value Content– Value Added Content

IIMeasuring

RoO Restrictiveness

• Definition: Rules are “restrictive” when they increase the costs of producing and trading– Some costs are administrative: documenting and

demonstrating origin– Other costs: derive from material sourcing restrictions

based on the rules

• Restrictive RoO: can dampen trade– Associated production cost and trade cost increases have

the same effect as tariffs

Restrictiveness of RoO

Measuring Restrictiveness

• How to capture restrictiveness? Indices in:– Estevadeordal (2000) (from 1 to 7)– Harris (2007) (from 1 to 21)

• Logic– CC > restrictive than CH, CH > restrictive than CS, etc.– VC, TECH, exceptions to CTC: add to restrictiveness– Alternative rules provide flexibility, lessen restrictiveness– Calibrated using list of alternative rules in many RTAs

• Note: Indices capture only “observed” restrictiveness, not “effective” restrictiveness– However, these are correlated on average

High Variation in RestrictivenessAvg. Restrictiveness, 23 APEC RTAs

2

4

6

8

10

12

JPN

SIN

G

CH

LC

AN

NA

FTA

ME

XJA

P

AU

STH

A

USA

CH

L

USA

AU

S

USA

SIN

G

CH

LK

OR

USA

KO

R

AU

SSIN

G

AU

SNZ

TH

AN

Z

USA

PER P4

PER

TH

A

CH

LM

EX

ASE

AN

CH

N

CH

LC

HN

JPN

TH

A

CH

LPE

R

ASE

AN

JPN

MY

S

Har

ris (

2007

)

Highest Restrictiveness in Textiles, Ag…Average Sectoral Restrictiveness, 23 APEC RTAs

2

4

6

8

10

12

1. Live

Anim

als

2. Veg

etable

Produ

cts

3. Fats

and O

ils

4. Foo

b, Bev

. & T

abac

co

5. M

ineral

Produ

cts

6. Che

michals

7. Plas

tics

8. Lea

ther

Goods

9. W

ood Pro

ducts

10. P

ulp and Pap

er

11. T

extil

e and

App.

12. F

ootw

ear

13. S

tone a

nd Glas

s

14. J

ewell

erly

15. B

ase M

etals

16. M

ach. &

Elec

Eq.

17. T

ransp

ortat

ion E

q.

18. O

ptics

19. A

rms &

Ammun

20. D

ivers.

Mer

ch. a

nd Pro

d.

21. W

orks o

f Art,

Misc

.

…and similar patterns in most RTAsSectoral Restrictiveness, 4 APEC RTAs

0

2

4

6

8

10

12

14

16

1. Live

Anim

als

2. Veg

etable

Products

3. Fats

and O

ils

4. Foo

b, Bev

. & Tab

acco

5. M

ineral P

roducts

6. Chem

ichals

7. Plas

tics

8. Lea

ther Goo

ds

9. W

ood Pro

ducts

10. P

ulp an

d Paper

11. T

extile

and A

pp.

12. F

ootw

ear

13. S

tone a

nd Glas

s

14. J

ewell

erly

15. B

ase M

etals

16. M

ach. &

Elec

Eq.

17. T

rans

portat

ion E

q.

18. O

ptics

19. A

rms &

Ammun

20. D

iversi

fied M

erch.

21. W

orks o

f Art,

Misc

.

Asean Japan-Thailand P4 USA-Korea

Think of It This Way: Trade with Restrictive RoO = Limited between RTA and ROW

ROW Pool of Inputs

RTA Pool of Inputs

Trade with Flexible RoO = Freer between RTA and ROW

ROW Pool of InputsRTA Pool

Similar Effects if employ a larger Cumulation Zone = Expanded Pool of Inputs, Smaller Pool Excluded

ROW Pool of Inputs

RTA Pool of Inputs

3 Preliminary Policy Prescriptions

• Relax RoO in existing RTAs

• Create a larger cumulation zone by connecting RTAs

• Do both• But are restricive RoO really that

important?

IIITrade and Investment

Effects of RoO

Policy Implications of RoO• RoO can be employed to political ends• Restrictive RoO can

– Protect intra-RTA intermediate goods producers by favoring intra-RTA supply links

– Insulate an entire industry from the consequences of an RTA

• If RoO are restrictive enough to increase production and/or admin. costs vis-à-vis pre-RTA world, they can– Impede sourcing from the globally efficient producer– Undermine firms’ utilization of RTA preferences (take the MFN route

instead)– Divert trade and investment– Dampen RTAs’ liberalizing and trade-creating potential

Empirical Evidence:Political Economy of RoO

• Estevadeordal (2000): In NAFTA, restrictive RoO driven by same factors as are high tariffs and long tariff phaseouts

• Suominen (2004): This is also true in EU-Mexico FTA. RoO were arguably used as substitutes for exclusions: rather than excluding sectors from the FTA, parties put in tough RoO

What Are the Trade Effects of RoO?Exploring through the Gravity Model

Country A Country B

Distance AB(-)

RTA(+)

Tariff Preferences(+)

Restrictive RoO(-)

GDPB

(+)

Other country B

characteristics

(+/-)

GDPA

(+)

Other country A

characteristics

(+/-)

Bilateral Total Trade

Trade Effects of RTAs with Restrictive RoO (Global sample)

-2

-1

0

1

2

3

RTA Effect RoO Effect

Source: Suominen (2004).

-2

-1

0

1

2

3

RTA Effect RoO Effect

Restrictive Rules of Origin Can Dampen RTAs’ Potential

Net RTA effect

Source: Suominen (2004).

Explaining Bilateral Trade in Intermediate Products

Country A Country B

Distance AB(-)

RTA(+)

Tariff Preferences (+)

RoO in Final Goodsin Sector X

(+)

GDPB

(+)

Other country B

characteristics

(+/-)

GDPA

(+)

Other country A

characteristics

(+/-)

Bilateral Intermediate TradeIn Sector X

Restrictive RoO in Final Goods May Divert Trade in Intermediate Goods

Effects of RoO on Intermediate Trade, Selected Sectors

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

Vehicles TV and RadioTransmitters

Machinery Textiles Chemicals

New IDB Study in LAC - % of firms that say: “costs of RoO on production are ‘medium high’ or ‘high/very high’”

0%

20%

40%

60%

Chile -

Food

Chile -

Meta

l

Chile -

Tex

tiles

Colombia

- Foo

d

Colombia

- Meta

l

Colombia

- Tex

tiles

Mex

ico - F

ood

Mex

ico - M

etal

Mex

ico - T

extil

es

Panam

a - Foo

d

Panam

a - M

isc.

High or very high

Medium

60

70

80

90

100

1990 1991 1992 1993 1994 1995 1996 1997

Textile sector

Chemical sector*

Iron/steel sector*

Products experiencing equal or less restrictiveRoO under NAFTAProducts with more restrictive RoO underNAFTA

% of total U.S. imports from Canada

Canada’s Utilization Rates of US preferences: dropped from Canada-US FTA to NAFTA in sectors with restrictive RoO

Sectors with less restrictive RoO under NAFTASectors with more restrictive RoO

Cadot et al. (2006): Restrictive RoO cost a total of 2% of Mexican exports to US

What of RoO’s Investment Effects?

• 2 hypotheses: with RTA tariff preferences as a carrot, – Restrictive RoO can propel RoO-jumping, market-

seeking FDI (which subsequently source from withinthe RTA)

– Flexible RoO attract efficiency-seeking FDI from companies with global supply chains

• Very little empirical work– Estevadeordal, Lopez-Cordova, Suominen (2006):

Sectoral FDI in Mexico in 94-01 significantly related to flexible NAFTA RoO => Liberal RoO = good for FDI

Results in Sum

• Restrictiveness of RoO dampen aggregate trade flows

• Restrictiveness of RoO in final goods can significantly boost trade in intermediates– And may result in trade diversion of

intermediate goods

• Complex and restrictive RoO add to the costs of exporting firms

• Flexible RoO can help attract globalized, efficiency-seeking FDI

IVEffects of RoO Convergence

APECUnited States

CanadaMexico

NAFTA

CAFTA-DR

Costa Rica, Guatemala, El Salvador, Honduras, Nicaragua & Dominican Republic

ANZCERTA

AustraliaNew Zealand

ASEAN (AFTA)

BruneiPhilippines

VietnamMalaysia

Thailand SingaporeIndonesia

China, Korea Japan

Bangkok

Laos

Cambodia Myanmar

BangladeshSri Lanka

India

BhutanNepal

MaldivesPakistan

SAFTA

Northeast Asian

ASEAN + 3 (EAFTA)

ASEAN + 6 (CEPEA)

How to Build on RTA Spaghetti Bowl => toward REI

Peru

Chile

Through Convergence?

A

B C

RTA 1

RTA 2

RTA 3

Common cumulation zone

Input

Assembly

Final goodRoO x RoO x

RoO x

Modalities for Convergence• Expanded Cumulation

– Allowing third party cumulation (A,B in a common RTA allow from C)

– Common RoO not a requisite– Possible even when not all economies linked by RTAs– Sectoral examples in Japan-Thailand and Japan Malaysia,

more generalized in Canada-Peru (subject to reciprocity by cumulation zone)

• Full Convergence– Allowing cumulation among zone ABC– Common RoO necessary– Easier when all economies linked by RTAs– PANEURO case

Why Do This? Costs of “Missing Convergence”

• APEC Customs– Management of differing verification procedures– Information management costs

• APEC Companies– Transactions costs across multiple RTA theaters– Inventory management costs (materials and products)– Uncertainty and delays in customs– Under-utilization of RTA preferences due to lack of/too

expensive inputs

• APEC Economies– Potential trade and investment diversion

Potential Effects of RoO Convergence/Cumulation

• Trade between two countries A,B that can suddenly cumulate from a third country C:– Greater supply of cumulable materials from C for final goods

production and trade between A,B – If C allows A,B cumulate among each other for final goods exports

destined for C: A,B can experience greater final goods exports to C

• If inputs from C are cheaper than inputs in A,B: – Positive effects on C-AB trade (more input imports to AB from C)– Reduced trade diversion in input trade between A and B – Increase final good trade between A,B (containing C inputs)

• The bigger the cumulation partner C, the greater the likelihood of reduced trade diversion between A and B– Larger partner C => larger pool of inputs!

Trade Effects of Cumulation• Gasiorek et al. (2007) on PANEURO System

– Cumulation: significant positive effect on spoke-spoke (among East European countries) trade

– Highest positive effects in sectors with restrictive RoO = cumulation allowed for greater availability of inputs (from EU)

• Harris and Suominen (in progress): effects of cumulation on bilateral trade globally 1965-2005– Access to inputs from a large cumulation partner C increases

trade esp. between two smaller countries A,B – If cumulation partner is 10 percent world GDP: Trade between

2 small countries A,B up by a net of 3 percent– Net effect: reduction of trade diversion, increase of bilateral

trade in final goods with C inputs

What do companies think? IDB Study% of firms that say: “savings from harmonizing RTAs would be

‘high’ or ‘very high’”, by country and size of firm

0

20

40

60

80

100

Chile Colombia Mexico Panama

SMEs

LargeFirms

% of firms that say: “savings from harmonizing RTAs and permitting cumulation across them would be ‘high’ or ‘very high’”,

by country and size of firm

0

20

40

60

80

100

Chile Colombia Mexico Panama

SMEsLarge Firms

% of firms that say: “savings from harmonizing RTAs and permitting cumulation across them would be ‘high’ or ‘very high’”,

by country and sector

0

20

40

60

80

100

Food Products Metal Products Textiles

ChileColombiaMexicoPanama

Concurrent ADB Study (IDB-ADB Joint Project)

• Complex rules: barrier to using FTA preferences

• Administration costs & delays often significant when seeking to comply with rules of origin– Firms often prefer to pay MFN tariffs rather compliance

cost of RoO

• Large national firms and MNCs: greatest problems complying with multiple RoO regimes– Large firms frequently trade among more countries and

thus operate through various FTAs than SMEs

0%

20%

40%

60%

80%

100%

Europe

Mex

ico USA

Trans-P

acifi

c

America

s

Chile

APECJa

pan

Global

Singapo

reAsia

Africa

RTA Family

What Prospects for Covergence in APEC? Similarity Index of RoO within Selected RTA Families

Source: Estevadeordal, Harris, Suominen (2007), IDB “Regímenes de Origen de las Americas” Database

Sectoral Similarities: Highest in Wood, Ag.Similarity Index of RoO within APEC RoO Family

0%

20%

40%

60%

80%

1. Live

Animals

2. Vege

table

Products

3. Fats

and O

ils

4. Foo

d, Bev.

& Tab

acco

5. Mine

ral Prod

ucts

6. Che

michals

7. Plas

tics

8. Leat

her Goo

ds

9. W

ood Prod

ucts

10. P

ulp and P

aper

11. T

extile

and App.

12. F

ootw

ear

13. S

tone a

nd G

lass

14. J

ewelr

y

15. B

ase M

etals

16. M

ach.

& Elec Eq.

17. T

ranspo

rtatio

n Eq.

18. O

ptics

19. A

rms &

Ammun

20. D

ivers.

Merc

h.

21. W

orks o

f Art,

Misc

.

In Sum: RoO in APEC RTAs

• Diversity in RoO across APEC RTAs– But 2 broad RoO families - Americas vs. Asian-style

• RoO Restrictiveness also varies– But sectoral similarities across RTAs: Agriculture, food, textiles,

footwear most restrictive

• Economic effects clear– Restrictive RoO can dampen RTAs’ trade-creating potential– Restrictive and complex RoO increase firms’ production costs– Flexible RoO attract efficiency-seeking FDI from producers with

globalized supply chains

In Sum: To REI from APEC RTAs• Convergence + Cumulation could significantly facilitate

trade and production across APEC

• Convergence + Cumulation are useful as long as there are MFN tariffs = incentive to use RoO

• Ways of attaining Convergence, Cumulation, REI– Small steps first: APEC origin certificate and verification

cooperation mechanisms– Copy best practices: EU experience, Canadian and Japanese

cumulation “experiments”– Define and analyze the modalities for getting to FTAAP

• Important: When undertaking RoO convergence, converge toward a flexible model!

Jeremy Harris and Kati Suominen Integration and Trade Sector Department

Inter-American Development Bank

APEC CTI Trade DialogueLima, Peru

19 August 2008

Trade and Investment Effects of Rules of Origin and Convergence