The Urgent Call for Harmonizing Preferential Rules of Origin

CHAPTER I

INTRODUCTION

While the primary aim of rules of origin is to ensure that preferences accrue only to the signatories of a preferential trade agreement, they are often complex and can act as a barrier to trade¹

World War I severed trade relations. Back then, no organization existed to maintain trade relations or recreate balanced international trade. ² By November 11, 1918, Germany surrendered to the Allied nations. ³ In 1919, Germany and the Allied forces signed the Peace Treaty of Versailles. ⁴ Under such treaty, Germany was obligated to pay war reparations to the Allies, mainly France and Great Britain. These reparations cut into the financial resources of central Europe. ⁵ The recovery of Europe’s economy was hindered, the amount of poverty increased, which led possibly to the emerging of the fascist movement in Italy and Germany in the 1920s and 1930s. ⁶ After World War I, Japan was the first country that practised protectionism on a very excessive level to protect itself from big markets like the United States (US) because it was very difficult for small-sized markets like Japan to globally compete and prosper. ⁷ On the other hand, Great Britain had inefficient production firms and its producers suffered from a low rate of the national demand. Also, when Australia, New Zealand, India and Canada started to practise protectionism, Britain encountered hindrances when it came to exporting to and selling in the commonwealth markets. ⁸ Thus, Britain tried to protect its firms on a national and global level to increase the demand on its products. ⁹ Before World War II and during the period of the Weimar Republic, Germany gave up open trade. ¹⁰ To have a self-sufficient economy (Autarky), Germany’s New Plan of 1934 continued Germany’s introduction of exchange controls that took place in 1931. ¹¹ Between 1929 and 1933, Germany practised protectionism mainly in Agricultural products. ¹² In 1929, the Great Depression (from 1929 until the early 1940s) took place. The inapt financial policies in Europe and the United States and the crash of the US stock market of 1929, commonly known as the Wall Street Crash, are the main triggers to the depression. ¹³ In the 1930s, the practice of protectionism was on the rise. ¹⁴ Following the Wall Street Crash of 1929, the Smoot–Hawley Tariff Act was adopted by the US Congress in 1930. ¹⁵ The Act raised US tariffs on about 20,000 imported goods to mainly protect national farmers against competition from foreign agricultural imports. ¹⁶ Responding to the Smoot–Hawley Tariff Act, Italy and Spain imposed high tariffs on many US goods. ¹⁷ Many European countries were affected by such action and it was the beginning of the trade war against the US. ¹⁸ Subsequently, Switzerland, Canada, Australia, Cuba, Mexico, France and New Zealand participated as well in such trade war. ¹⁹ As a result, the Great Depression was worsened and a severe drop in international trade took place. ²⁰ Towards the end of World War II, in July 1944, the United Nations Monetary and Financial Conference, known also as Bretton Woods Conference, took place at which the Allies gathered for the purpose of establishing institutions that would abolish the economic reasons of wars. ²¹ The conference led to the formation of two international organizations, namely International Bank for Reconstruction and Development (The World Bank) and the International Monetary Fund. ²² In 1947, the General Agreement on Tariffs and Trade (GATT) was established as reaction against the protectionism that hindered international trade and aided the expansion of the Great Depression. ²³

The GATT held eight rounds of negotiations and succeeded in gradually reducing the level of tariffs and urged trade facilitation between the member states. ²⁴ The Uruguay Round of Multilateral Trade Negotiations was the eighth round (1986-1994). It resulted in the conclusion of the Marrakesh Agreement and updated the GATT 1947 to the GATT 1994. The GATT 1994 included 12 additional side agreements. In 1995, the institutional machinery of the GATT was replaced by the World Trade Organization (WTO) under the Marrakesh Agreement.²⁵ Today, the WTO acts as the umbrella for about 60 various agreements²⁶ and over 164 countries are members.²⁷ One of these agreements is the Agreement on Rules of Origin.

1.1 ARTICLE I, III AND XXIV OF THE GATT 1994.

There are two vital principles to the GATT: the Most-Favoured-Nation (MFN) principle and the National Treatment principle. Pursuant to Article 1 (General MFN Treatment) of the GATT 1994, a WTO member state is not allowed to discriminate between its trading partners. Accordingly, when a WTO member state lowers its customs duty rate for one of its goods coming from a particular member of the WTO, the same shall be done for all other WTO members.

Pursuant to Article III of the GATT 1994, WTO members are prohibited to adopt domestic policies designed to discriminate against foreign imported goods in favour of the same or similar locally-produced goods. For example, it is a violation to the GATT national treatment principle when a WTO member state imposes technical standards on imported goods that are more stringent than on similar domestic goods.

With the fulfillment of certain conditions under Article XXIV of the GATT 1994, preferential trade agreements can be formed as a discriminatory exception to the MFN principle. A preferential trade agreement is a trading agreement between certain countries. It gives preferential tariff treatment to certain goods from countries that are parties to the agreement. A preferential trade agreement could be multilateral or bilateral. A multilateral trade agreement is formed between many countries. A bilateral agreement is formed between two countries. Moreover, in 1979, the GATT adopted the Enabling Clause under which unilateral concessions can be formed when a country unilaterally decides to grant preferential access to certain goods from another country or countries, such as the EU (European Union) Generalized System of Preferences (GSP) regime.²⁸ About 800 preferential trade agreements were notified to the WTO as of January 1, 2014.²⁹ Each preferential trade agreement has its own rules of origin.³⁰

Figure 1: Evolution of Regional Trade Agreements in the World, 1948-2024³¹

1.2 RULES OF ORIGIN IN GENERAL.

Rules of origin are those laws and regulations that are applied to determine the country of origin of goods. A good is conferred origin if it was wholly obtained in the exporting country or has undergone a last substantial transformation there.

A wholly obtained good is a good that is produced entirely in the exporting country. It is either a natural product or a good produced from natural products, like minerals extracted from soil or water, live animals, harvested vegetables or goods produced thereof.

The last substantial transformation is the concept used to determine the country of origin of the good when more than one country is involved in the production of the good, i.e. the importation of inputs from one or more country was needed to produce the good. The last substantial transformation is indicated by three means: the change in tariff classification, the value added and the specific manufacturing operation.³² These three means are also recognized in the Agreement on Rules of Origin.

The change in tariff classification method relies on the Harmonized System (The Harmonized Commodity Description and Coding System or the HS).³³ The HS has been developed by the World Customs Organization (WCO) to classify the goods being traded between all participating countries by using names and numbers.³⁴ The goods in the HS are classified under up to 6-digit codes. However, WTO member states are free to add more digits for more specific classification of products, like 8 or 10 digits.

Under the change in tariff classification method, origin could be conferred when a product has undergone a change in tariff classification at 2, 4, 6 or 8 to 10-digit levels. While the 2-digit level is called the tariff chapter, the 4-digit level is called the tariff heading, the 6-digit level is known as the tariff sub-heading and the 8 to 10-digit level is called the tariff item.³⁵ A change in tariff classification rule of origin could look like this:

Figure 2: Change in Tariff Classification at a 2-Digit Level (Chapter Level).

Source: Author’s example

Under the mentioned rule of origin, a manufacturer in an exporting state (state A) could produce woven fabrics by using cotton yarn imported from another state (state B) which falls under sub-heading 5206.25 of the HS. Thus, according to this example, origin would be conferred by a change in tariff classification from chapter 52 (which includes sub-heading 5206.25) for cotton-yarn to sub-heading 5806.31 (woven fabrics) , i.e. the exporting producer’s woven fabrics would be considered to originate in State A.

The value added criterion is different from the change in tariff classification because it does not rely on the HS when applied. It is in principle very straight forward, but often complicated to operate in practice since the methods of valuation differ from one agreement to another (discussed in chapter 3). In general, the value added criterion could be either the maximum allowed percentage of imported inputs or the minimum percentage of local inputs used to produce the good.³⁶ The imposition of the value added criterion could look like this:

Figure 3: An example for the Value Added Criterion.

Source: Author’s example

So, if an exporter in state A manufactured rails using inputs imported from other states, the rails would be considered to originate in state A if the value of the imported materials was no greater than 40% of the value of the manufactured rails.

The specific manufacturing operation method is straight forward in principle just like the value added, but sometimes requires too much technicality related to the operation that the product shall undergo. The manufacturing operation test could be either positive, by requiring certain materials to have been used or operations to have occurred in the exporting state if the goods are deemed to originate there, or negative, when the rule of origin prohibits the usage of certain inputs or certain operations to take place. Sometimes the positive or negative tests are clarified by clear statements and sometimes they are clarified by using the change in tariff classification method. The following is an example showing what a positive test might look like:

Figure 4: An Example for the Change in Tariff Classification Test in a Positive State.

Source: Author’s example

The following example shows how a manufacturing operation test could rely on the change on the change in tariff classification test in a negative state:

Figure 5: An Example for the Change in Tariff Classification Test in a Negative State.

Source: Author’s analysis based on the Australia New Zealand Closer Economic Agreement (ANZCERTA) Annex G: Product Specific Rules of Origin

900211 is the sub-heading number under which the product is classified. The first two digits (90) represent the chapter. The first four represent the tariff heading (9002). According to the table, the product (objective lenses) classified under sub-heading 900211 could be conferred origin when goods classified under any other sub-heading are used in its production, except goods classified under heading 9001 (negative test).

Upon the importation of a product, each country applies its own rules of origin to determine the origin of the product. That is why rules of origin differ from country to another. Such origin rules are known as non-preferential rules of origin. Non-preferential rules of origin are mainly used for gathering trade statistics, government procurement, carrying out origin marking and labeling requirements and the application of trade policy instruments such as anti-dumping duties, countervailing measures and quantitative restrictions. However, there is another type of rules of origin called preferential rules of origin. Preferential rules of origin deal with preferential trade agreements. They are used to stipulate whether a good is deemed to originate in a preferential trade agreement partner country and consequently eligible for preferential tariff treatment.

1.3 RULES OF ORIGIN IN PREFERENTIAL TRADE AGREEMENTS.

Free Trade Areas and Customs Unions (CUs) are two forms of preferential trade agreements. A Free Trade Agreement (FTA) is an agreement under which two or more countries agree to preferentially grant tariff free access to goods being traded between only them. However, each party to the agreement is imposed on the goods imported from countries who are not members of the