A Primer on Transshipment

A sleeper issue in the trade agreements announced so far is the question of transshipment, a term that so far appears to be undefined in the agreements. As this commentary points out, how it is ultimately defined will have a big impact on how the various agreements operate and on the economies of the countries that have signed them.

In its simplest form, transshipment refers to moving an item from country A to country C with an intermediate stop in country B. Much of the time, the intermediate stop is benign—the ship is unloading cargo destined for country B and taking on new cargo heading for country C—or it is being refueled. Sometimes cargo can remain in B for some time if the intended recipient in C has no room for it, or if there are payment issues. In all these cases, the merchandise is properly labeled with its country of origin, and when it eventually enters country C, it is assessed the tariff assigned to country A without dispute.

Increasingly, however, these stops are not benign or at least are more complicated than the above description. For example, at one end of the spectrum, there is the simple relabeling of a product from country A as a product of country B so that when it enters C, the tariff assigned to country B is applied instead of the one assigned to A. That is customs fraud and has been illegal for decades.

At the other end of the spectrum are cases where the product from A is substantially transformed in B into a new product. One example is steel slabs melted and poured in country A, which are exported to country B, where they are rolled into steel sheet, strip, or wire, and are then shipped to country C. Under standard international customs rules, that is a substantial transformation. The processing in country B makes a new product with a different Harmonized Tariff Schedule classification, and that makes it a legitimate product of country B. However, if the administration were to decide that, because the steel was melted and poured in country A, it is a product of that country rather than B, it would upend decades of international customs rules and practices and force the rearrangement of many supply chains.

There are many other examples in between these two extremes. A common one is when a product’s parts and components are manufactured in country A, shipped to B, where they are assembled into the end product, which is then exported to C. That raises the question of how much work has to be done in country B in order to make the product’s origin country B rather than A.

Under existing customs rules, origin is usually determined either by substantial transformation, as described above, or by the percentage of content from the country of final manufacture. Usually, if more than 50 percent of a product’s content by value comes from that country, the product is considered to have originated in that country. That would mean, for example, that a product whose main parts and components are manufactured in country A, but which are assembled in country B, would be considered to have originated in A, absent a substantial transformation. Similarly, a product that is simply painted, refinished, or packaged in B would remain a product of A for customs purposes. It should be noted, however, that sometimes countries impose special rules that go far beyond a normal 50 percent content standard. One example is the auto rules of origin in the United States–Mexico–Canada Agreement. Others are numerous special rules for apparel in multiple countries.

In addition, there are two other potential permutations of the substantial transformation issue going on. First, for a number of years, the World Trade Organization and the Organization for Economic Cooperation and Development have jointly been working on a project to determine origin based on value-added rather than substantial transformation. The classic example is the iPhone, which is assembled in China, India, and Vietnam from parts and components from many other countries. In the case of China, which has been most closely studied, the Chinese components in the phone have often been less than 1 percent of its value, but because it is substantially transformed in China, it is considered a product of that country. A value-added approach would allocate origin based on the proportion of value contributed by each country.

A second approach would be origin on the citizenship of the manufacturer. That would mean, for example, that a product made in Vietnam by a Chinese-owned company would be considered a product of China even if more than 50 percent of its content was Vietnamese.

Neither of these new formulae is operational, but the fact that “transshipment” appears to be undefined in the trade agreements opens the door to the United States demanding nontraditional approaches that would conflict with internationally agreed-upon customs rules and procedures. That, in turn, raises questions of motivation and enforcement.

There are arguably two purposes for aggressively attacking transshipment. The first is to force the development of supply chains that exclude Chinese inputs—essentially a forced decoupling strategy. Derisking by Western firms has been going on for some time, and a popular response from China has been various creative forms of transshipment, usually involving moving the final assembly and part of the production process to a third country, often in Southeast Asia, though Mexico is also a popular location. Dealing with this trend presents an enforcement challenge (see below), and the administration’s inclusion of anti-transshipment provisions in some of the trade agreements is an attempt to deal with it.

The second purpose is to push back on Chinese overcapacity and force them to eat their own surpluses. Recent trade data shows that while our deficit with China declined by $9 billion from 2023 to 2024, it increased by more than $13 billion with Mexico and Vietnam. That suggests that attempting to deal with overcapacity unilaterally is like squeezing a balloon—it simply pops out somewhere else. Success in dealing with it will depend on the United States’ ability to get as many other countries as possible to join the effort. The transshipment penalties are designed to encourage that.

Success in this effort inevitably depends on enforcement. Nobody admits they’re illegally transshipping, so the burden is on customs authorities both in the other countries and the United States to identify it and assess the increased duties. That will be difficult, particularly in countries that have close relations with China and no particular incentive to help U.S. customs authorities, or in countries where bribery and corruption are common. It may also be politically difficult in those countries. While in theory guaranteeing that Vietnamese products, for example, are, in fact, Vietnamese, may be in the long-term interest of the Vietnamese government, in the short-term, cracking down on transshipment will cause job losses and economic disruption.

Of course, the essential element of a successful enforcement strategy will be clear, detailed definitions of transshipment and substantial transformation. The latter is already well-defined in customs rules, but the former has always been elastic. It would be least disruptive if the administration chose to maintain the existing rules on substantial transformation and focused most of its attention on fraudulent transshipment.

William A. Reinsch is senior adviser and Scholl Chair emeritus with the Economics Program and Scholl Chair at the Center for Strategic and International Studies in Washington, D.C.