Rules of Origin in International Trade:”Spaghetti bowl” to “Kill rules”!

Rules of origin in international trade is like a passport required for travel overseas. These are used to determine the “nationality” of goods traded in the global market place. Yet, ironically no internationally agreed-upon rules of origin exist.

By Ravi Bangar

Rules of origin in international trade is like a passport required for travel overseas. These are used to determine the “nationality” of goods traded in the global market place. Yet, ironically no internationally agreed-upon rules of origin exist.

Products exported by member states of the World Trade Organization (WTO) generally face lower import barriers in other member states than do the exports of countries that do not qualify for Most Favoured Nation (MFN) treatment. Many bilateral and regional trade agreements exempt the products of member countries from various requirements.

Rules of origin are needed in all such cases because the identity of the producing country cannot be reliably inferred from the point of entry. These can also be used to interpret statutes governing labelling requirements, such as “Made in…” stickers, and to assist in compiling bilateral trade statistics.

Each country or jurisdiction that administers a regional trade agreement e.g. the USMCA and the EU, has established its own rules of origin. These are divided into two categories: (1) rules relating to preferential treatment and (2) rules relating to non-preferential treatment. The former has two additional subsets: (1) rules on general preferential treatment for developing countries, and (2) rules relating to regional trade agreements.

With respect to trade, rules of origin should theoretically play a neutral role. However, they sometimes are used for protectionist ends: origin rules that are too restrictive or that are enforced arbitrarily expand improperly the coverage of trade restrictions.

In general, rules of origin have not been adequately addressed at the international level. For many years, the GATT contained no specific provisions on rules of origin other than Article IX, which deals with marking requirements (i.e., “marks of origin”). The Agreement reached in the Uruguay Round provided a programme for harmonizing rules of origin and applying them to all non-preferential commercial policy instruments, including MFN treatment, anti-dumping and countervailing duties. It also established disciplines that individual countries must observe in instituting or operating rules of origin, and provided for the framework for harmonizing rules and dispute settlement procedures.

Aside from the GATT, the International Convention on Simplification and Harmonization of Customs Procedures (the Kyoto Convention), concluded under the aegis of the WCO, contains an Annex on rules of origin. In 1999, the WCO amended the Kyoto Convention for the first time in around 25 years.

The WTO has sought to render those restrictions more precise and to harmonize rules across countries by building on the Agreement on Rules of Origin adopted by the GATT in 1994. The GATT, which the WTO superseded, required that rules of origin be transparent and administered in a consistent, uniform, impartial, and reasonable manner. Since 1995, the WTO expanded its perspective on rules of origin.

In the recent past, when there was an increased push by several countries to pursue Foreign Trade Agreements (FTA) throughout the world, concern mounted over the so-called ¨spaghetti bowl phenomenon¨ where varying rules of origin and varying tariff schedules based on origin around the world as noodles in a bowl.

The tariff reductions in several rounds of trade negotiations and strengthening of disciplines in anti-dumping sectors and others, rules of origin could potentially be used as hidden trade-restrictive measures. It raises concern that these are increasingly being formulated and administered in an arbitrary fashion to achieve protectionist policy objectives.
The running joke in Geneva was that an entire rainforest in Indonesia could have been saved if it wasn’t for the writing and production of tomes of Rules of Origin negotiations reports!Many accused Customs officials (negotiators) of having a vested interest in continuing these interminable discussions as these provided perks of free travel to Alpine sojourns and would not be surrendered that easily – pure gallivanting.

NAFTA was designed primarily to benefit firms and workers in North America, it was clear that goods manufactured elsewhere could not be allowed to circumvent tariffs simply by being trans-shipped through one NAFTA member country on their way to another. In an era of global manufacturing, final products are frequently assembled from components originating in many different countries. Precise legal standards—specific rules of origin—vary widely across countries, but most use an ad valorem criterion based on the percentage of value-added and computed in a prescribed manner.

As these became increasingly controversial as the preferential tariff regions and antidumping arrangements that require them mushroomed. This led to specific criteria being negotiated for specific products in trade negotiations.
To counter China and EU taking benefits of NAFTA, in the area of textiles the US amended rules of origin and came up with “Fabric Forward Policy” to make clothing eligible under the agreement. As long as the particular goods are originating in the NAFTA territory, the goods were quota-free and duty-free when they entered U.S. customs territory. Under USMCA this provision has been further strengthened, it still adopts the “yarn forward” rules of origin. This means that fibres may be produced anywhere, but each component starting with the yarn used to make the garments must be formed within the free trade area. Further, USMCA now requires that some specific parts of an apparel item (such as pocket bag fabric) need to use inputs made in the USMCA region so that the finished apparel item can qualify for the import duty-free treatment. As far as fabric forward provisions in NAFTA/USMCA are concerned, this is not exclusive to these agreements. In respect of other FTAsAndean Trade Preference Act, African Growth and Opportunity Act, Caribbean Basin Initiative, U.S.-Singapore Free Trade Agreement, US-Chile Free Trade Agreement have similar provisions.

India’s apparel import from Bangladesh in 2016-17 was the US $ 140 million, while in 2018-19 the same was the US $ 365 million – that’s an incredible jump of 161 per cent. The Indian textiles industry has been recently requesting the Government that it is essential to impose necessary safeguard measures like Rules of Origin, Yarn & Fabric Forward Rule to prevent the cheaper imports. Efforts are on explore how India’s fabric export to Bangladesh can be increased as far as import of apparel from there into India under SAFTA is concerned.

The USMCA includes important protections and updated rules of origin. In order to qualify for duty-free treatment under the USMCA, goods imported into the United States must conform to the Rules of Origin set forth in Chapter 4 of the USMCA. Imported goods that “originate” in Canada or Mexico and those otherwise meet USMCA requirements are extended preferential treatment.

For textiles, under USCMA the Uniform Regulations provide further guidance on the treatment of various textile and apparel products. They establish a de minimis rule for non-originating materials, whereby a good will be treated as originating in the USMCA territory if the total weight (and not value) of the non-originating materials is 10% or less of the total weight of the good and the foreign elastometric content does not exceed 7% of the total weight. USMCA’s textile and apparel rules of origin are some of the most complex. Additionally, USMCA fixes the Kissell Amendment Buy American loophole, ensuring that a significant amount the Department of Homeland Security spends annually on clothing and textiles for the Transportation Security Administration benefits domestically produced products.
Welcoming USMCA, Kim Glas, president of the National Council of Textile Organizations (NCTO) said, “Sustaining the $20 billion in apparel and textile trilateral trade between the U.S., Mexico and Canada is absolutely critical at this time. USMCA, which makes several key improvements over the former North American Free Trade Agreement (NAFTA) will go a long way to increasing the textile industry’s exports, as well as investments and capacity in the U.S. We need to maintain and expand a Western Hemisphere supply chain to meet national emergencies head-on in the future.”

The requirements for eligibility are very complex and technical. Countries and articles are periodically added to or removed from the eligible countries and products lists. Duty rates and quota limits can change from time to time. However, in an increasingly globalised world, supply and value chains becoming a reality it is often difficult to have precise Rules of Origin. GATT and WTO have long grappled with this issue with limited success.

During the Uruguay Round, participating countries recognized the necessity to provide transparency of regulations and practices regarding rules of origin, in order to prevent unnecessary obstacles to the international trade flow.In his keynote speech at the WCO Council in June 2011, Pascal Lamy, then Director-General of the WTO, highlighted preferential rules of origin as an area of critical importance. He noted that as long as the origin of a good has a great impact on the duties to be collected, the door is open to fraud. He added that the solution could be to “kill the rules of origin”. He focused on the WTO initiative “Made in the World” and stated that at present, international trade flows are computed by attributing the full commercial value of a product to the last country of origin. This needs to change as business increasingly locates the different stages of its activities in a way that optimizes its value-added chain.
The WTO Agreement on Rules of Origin lays down the work programme to harmonize non-preferential rules of origin within three years from the initiation, i.e. by 20 July 1998. Due to the complexity of many issues raised during the work, the intended time schedule in the agreement was extended several times. The negotiations are still on-going but without a formal deadline or time schedule.

In this age of “save paper, save tree & save the world”, unfortunately, many more rainforests of not just Indonesia but elsewhere will be lost too until the cows come home on Rules of Origin!