What’s the deal about rules-of-origin in the RCEP negotiations?

08 Jul 2019
What’s the deal about rules-of-origin in the RCEP negotiations?
In this instalment of Perth USAsia Centre On The Road, our Research Director Dr Jeffrey Wilson explains rules-of-origin from the sidelines of the RCEP trade negotiations in Melbourne.

Last weekend, I had the privilege of attending the 26th round of negotiations for the Regional Comprehensive Economic Partnership (RCEP), hosted by the Department of Foreign Affairs and Trade in Melbourne. RCEP is a mega-regional trade agreement, currently under negotiation between then ten ASEAN governments and their six ‘Plus 1’ trade partners: Australia, China, India, Japan, Korea and New Zealand.

Once completed, RCEP will have a systemic impact on the global economy. Its sixteen members account for approximately one-third of world GDP, making it a larger trade bloc than NAFTA or the EU. It also includes many of the rapidly modernising economies – including India, Indonesia and Vietnam – that will drive the next phase of global growth.

After the World Trade Organisation, RCEP will arguably be the most important agreement in the global trade system. The rules and standards it develops will set important precedents for how governments manage their trade relations in the 21st century.

For this reason, negotiations over RCEP rules have proven quite challenging to complete. The ongoing, and sometime fraught, debates over rules-of-origin provisions help illustrate what is at stake.

What’s this ROO thing all about?

Rules-of-origin (or ROOs) are one of the most boring elements of international trade negotiations. At its most basic, they specify the rules by which a product is considered to be “made in” a country for the purpose of customs clearance. Unless you are an exporter or shipping agent, you have probably never heard of them. Yet this simple administrative matter has great impacts on the quality and effectiveness of an agreements.

Let’s take the recently-completed Indonesia-Australia Comprehensive Economic Partnership Agreement (IA-CEPA) as an example:

Under IA-CEPA, Indonesia has agreed to eliminate tariffs (an import tax) on 10,000 tonnes of Australian oranges per year. To qualify for this tax deduction, an Australian grower needs to prove to Indonesian customs authorities that the oranges in question are actually from Australia.

Unfortunately, simply printing “Grown in Australia” on the box of oranges won’t do. This is because it would expose both countries to so-called ‘circumvention’ problems. These include:
  • Third countries shipping their oranges to Australia, repacking and sending onto Indonesia, in order to pass them off as Australian.
  • Product substitution, where a different product (say, mandarins) are fraudulently packaged and labelled to pass them off as oranges.
These kinds of circumvention are clearly cheating, and defeat the purpose of the trade agreement.

To ensure that goods are bona fide, governments insist that exports carry independently-issued paperwork that guarantees both their content and origin. This paperwork is known as a ‘certificate of origin’, and every trade agreement has an ROO chapter that sets guidelines for how to issue a legitimate certificate. Without ROOs, customs authorities could not manage their trade obligations.
 
So ROOs are just certification paperwork – then what’s all the fuss about?

As ROOs are basically just a “Made In Country X” labelling system, it’s tempting to think they would be a relatively simple issue to manage. Yet in many trade negotiations, they have proven stubbornly hard to resolve. This is because their design has major effects on how trade agreements are implemented in practice.

The first complication arises when issuing the certificates themselves. Not every trade agreement has the same standards for who is authorised to issue a certificate, what checks are required, and what information the certificate must include. Subtle differences amongst Australia’s eleven FTAs mean companies need to get different certificates depending on where they are exporting to.

It is similar to if driver’s licenses were issued by local governments, and to drive from Perth to Fremantle, you had to hold a different license for each of the five councils whose roads you travelled across.

Obtaining these certificates takes precious time and money. In some cases the costs of doing so exceed the benefit of getting a reduced tariff rate, so businesses just don’t bother. Which evidently defeats the purpose of the trade agreement. As a consequence, there are complex negotiations over standardising ROOs so that the transaction costs for businesses are kept as low as possible.

The second complication is over how to decide when product is made in a particular country. For our oranges example above, the problem is not difficult: fruit is entirely grown in one place. But if the product is manufactured in a value chain with goods form different countries – say, bottled orange juice, with concentrate from one country, a glass jar from another, and processing in a third – how do we determine which of the three countries it comes from?

Generally speaking, there are two methods for determining national origin for these tricky products:
  • Change-in-tariff-classification (CTC): If a country takes an imported product, and transforms in into another product that has a different classification code in the Harmonised System (a cataloguing system for international trade), then it should be considered to be ‘made in’ that country.
  • Regional-value-content (RVC): If the percentage of value-added in the final product exceeds a set threshold (often 40 percent), then it should be considered to be ‘made in’ that country.
This discussion has become very technical and esoteric. But it is extraordinarily important in determining whether products qualify or not.

There are many cases where a product which easily qualifies under the CTC method does not qualify under the RVC method, and vice versa. Choose the wrong method and you exclude many legitimate products. And for the RVC method, there is also the vexing issue of how much imported value should be allowed – 40, 50 or 60 percent?

It also means ROOs can be used as a form of shadow protectionism. If a government wants to cheat on a trade commitment, it can agree to lowering tariffs for a product, but then insist on an ROO method that it knows will mean few or no products ever qualify. With FTAs covering tens of thousands of individual products, there are plenty of dark corners where ROOs can be manipulated to dilute agreed reforms.

As hardened trade negotiators will tell you, the quality of a trade agreement is only as good as the quality of its ROOs.

What’s the ROO problem in the RCEP negotiations?

As ROOs are so important, they are one of the hardest components of a trade agreement to negotiate. But in the case of RCEP, they have proven especially difficult.

The complexity of the agreement itself is a challenge. RCEP contains sixteen members, all of whom have different approaches when it comes to ROOs. There is an added complication from the seven pre-existing trade agreements: the ASEAN FTA of 1992, and its six ‘Plus One’ extensions out to the other members. These agreements do not handle ROOs in the same manner, so some kind of compromise between their different approaches has to be negotiated.

With sixteen members, seven pre-existing agreements, and thousands of products to cover, the number of individual ROO issues to consider is staggering. The entire RCEP goods agreement basically needs to be negotiated twice-over: once to set a tariff for each product, then again to decide the corresponding ROO. Spare a thought for our long-suffering trade negotiators.

There are also evident differences in what each government wants. Every party wants to see its key exports covered by a permissive ROO; yet they often favour restrictive rules for the products which they import. The result is a complicated wrangling over who gives what, to whom, and for what products. Bargaining and brinkmanship is the inevitable result.

On top of all this, there are also questions about standard-setting. With RCEP one of the largest trade agreements ever negotiated, the rules it settles on will become precedents for other agreements in the future. No-one wants to agree to an ROO that will set a dangerous precedent down the track, even if it represents a fair bargain today in the context of RCEP.

This means ROO negotiators are scrutinising their gives and takes with a fine-toothed comb, watching closely for future risk and opportunities.

In other words, the seemingly simple trade question of “whose product is this?” is actually diabolically complex. It involves tricky questions of accounting, negotiation and precedent-setting that cut to the very heart of what a trade agreement does. It also helps explain why RCEP has taken twenty-six negotiating rounds so far, and while several more are likely to be required before a complete text can be agreed.

Authors

Jeffrey Wilson
Jeffrey Wilson
Research Director
Dr Jeffrey Wilson is the Research Director at the Perth USAsia Centre. He provides leadership and strategic direction in developing the Centre’s research program across its publications, policy and dialogue activities.
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