International Trade and Rules of Origin
February 26, 2018
As trade aficionados know, the field is acronym rich. TPA, TTIP, TPP, TAA, WTO, NAFTA, CAFTA, and so on. It’s almost like speaking a different language. One of the more amusing ones that has gained currency in the North American Free Trade Agreement (NAFTA) negotiations is ROO. To the uninitiated, ROO is Pooh’s friend, but to trade mavens the letters stand for rules of origin.
Historically, ROO was not a particularly important concept for two reasons. First, in the world before globalization, most things were made in one place and then shipped somewhere else. Origin was not complicated. Second, when we were negotiating large multilateral agreements, concessions applied across the board to all World Trade Organization (WTO) members, so determining origin in most cases was not a big deal because the lower tariff applied no matter where the product came from. Fast forward to now, and the situation is very different. Everything is made everywhere, and a complex product like an auto may cross a border multiple times before it is finally assembled. Look, for example, at the rear suspension assembly for a Chevy Equinox:
In addition, post-Doha Round has seen the proliferation of regional trade agreements where concessions are granted only to the participating countries, and products from other countries, even if they are WTO members, do not get the benefit. The result is that now ROO matter because it is necessary to define clearly when a product was made inside the trade agreement area in order to properly allocate the benefits of the lower tariff.
Of course, once something actually matters, you can bet there will be arguments over it and lobbyists trying to influence the outcome. The usual argument concerns third-country suppliers—how much of a product’s content must originate from countries inside the trade agreement versus how much may be brought in from outside and still leave the end product eligible for the tariff benefit.
For example, let’s look at the NAFTA ROO for autos. The current basic requirement is for 62.5 percent content from the three NAFTA countries, with that amount calculated with the use of a list of specific components whose origin must be traced and be subject to verification. Over time, auto manufacturers, both U.S. and foreign, have developed global supply chains that either conform to that standard or ignore it and simply pay the 2.5 percent tariff instead.
The Trump administration has proposed both increasing that number to 85 percent and laying on top of it a requirement that 50 percent of the content come from the United States. American auto producers maintain there is no current model that meets that standard, so clearly there will be major supply chain adjustments if it is agreed to. Beyond the increased cost and confusion, there would also be a policy impact. The concept of NAFTA was to create an integrated North American market. Twenty-four years later we are well on our way to doing that, to the benefit of all three countries. Inserting a specific U.S. content requirement is the opposite of market integration and, I fear, would be a death blow to NAFTA’s long-term prospects. Fortunately, the reaction of Canada and Mexico to the proposal suggests there is little likelihood they will agree to it.
Unfortunately, manipulating ROO to a country’s advantage is not solely a U.S. tactic. It’s becoming global. The European Union has long insisted on ROO to, among other things, prevent transshipment of products—where they are actually made outside the agreement’s area but then entered and are relabeled as a product of a country inside the agreement. Now, however, the shoe is on the other foot, and they are facing demands from both Mexico and Mercosur countries in their respective negotiations for tough ROO on autos. The point there is not so much to keep foreign autos out as it is to encourage the construction of supply chains that include components from Mexico and Mercosur. As Hans von der Burchard reported in Politico.EU:
“‘Tariffs used to be the instrument that politicians had to regulate trade,’ said Manuel García-Santana from the Pompeu Fabra University in Barcelona. ‘Now the focus has shifted toward rules of origin as a non-tariff barrier’ that can help to boost production at home, he said. ‘This affects every industry in which production is fragmented,’ from cars to machines, chemicals and textiles.”
In other words, trade used to be simple: unitary products made in one place and subject to tariffs. Now it’s complicated. Things are made everywhere, and with tariffs at low levels, rules and standards have become the new protectionism, which is one important reason why trade negotiations have become more difficult—standards are simply much harder to agree on. That’s not enough to make me long for the good old days, but it is a reminder that tariffs are neither the cause of nor the solution to our trade problems.
William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies in Washington, D.C.
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