Rules of origin
Rules of origin are the rules to attribute a country of origin to a product in order to determine its "economic nationality". The need to establish rules of origin stems from the fact that the implementation of trade policy measures, such as tariffs, quotas, trade remedies, in various cases, depends on the country of origin of the product at hand. More stringent rules of origin requirements are associated with less trade.
Rules of origin have become a challenging topic in international trade, not only because they constitute a highly technical area of rule-making, but also because their designation and application have not been harmonized across the world. The lack of harmony is even more remarkable in the era of regionalism, when more and more free trade agreements are concluded, creating the spaghetti bowl effect.
Definition of rules of origin
The most comprehensive definition for rules of origin is found in the International Convention on the Simplification and Harmonization of Customs procedures, which entered into force in 1974 and was revised in 1999. According to Specific Annex K of this Convention:The definition makes it clear that rules of origin are basically the "criteria" to determine the origin of goods. Such criteria may be developed from principles in national legislation or international treaties, but the implementation of rules of origin is always at the country level. It is also important to note that the purpose of rules of origin is to define the country of origin, not a geographical area such as region or province. The country of origin is often found in the label or marking of a good, for instance "product of China", "made in Italy", etc.
Considering the modest number of Members of the World Customs Organization acceding to Specific Annex K, the Kyoto Convention has a rather insignificant impact on the application of rules of origin in international trade. However, this Convention does provide many important definitions and standards, which serve as a harmonized basis for national laws and trade agreements to formulate origin. Apart from the definition for rules of origin, it also provides definitions for "country of origin", "substantial transformation", and a number of recommended practices.
Classification of rules of origin
Rules of origin can be classified into non-preferential rules of origin and preferential rules of origin. Non-preferential rules of origin are those primarily designated in order to sustain the most-favored-treatment within the World Trade Organization. Preferential rules of origin are those associated with "contractual or autonomous trade regimes leading to the granting of tariff preferences going beyond" the MFN application. This separation is stipulated in Article 1 of the WTO's Agreement on Rules of Origin.It is important to understand the difference between these two categories of rules of origin. Non-preferential rules of origin are deemed "non-preferential" because they are applied in a non-preferential basis to determine the country of origin for certain purposes of application within the multilateral trading system. In contrast, rules of origin in FTAs and in the Generalized System of Preferences is considered preferential because they help to determine the country of origin in order to grant preferential and special treatment to products originating in a contracting party or a beneficiary country.
In principle, FTAs as well as their rules of origin must be notified to the WTO as an obligation of Members. However, rules of origin in FTAs and autonomous trade regimes are not subject to any substantive requirement from the WTO. This is because the Agreement on Rules of Origin does not govern how rules of origin in an FTA or a GSP scheme should be formulated and implemented. There is only a brief Common Declaration with Regard to Preferential Rules of Origin, which sets out some standards and recommendations for the formulation of preferential rules of origin. The fact that preferential rules of origin do not fall within the realm of the WTO adds more divergence to the "spaghetti bowl" of rules of origin: each FTA and each autonomous trade regime may formulate its own rules of origin. As a consequence of the rapid growth of regionalism, hundreds of rules of origin are currently applied in hundreds of FTAs. According to the WTO, as of 4 January 2019, 291 RTAs are in force - counting only those notified to its Secretariat. Whereas, according to the International Trade Centre, more than 440 FTAs are in force up to the end of March 2019.
Indeed, within the WTO, non-preferential rules of origin are not more harmonized than in FTAs. Despite tremendous effort, the work program to harmonize non-preferential rules of origin has not made significant progress to date, which means there is not yet a common set of rules of origin for non-preferential purposes within the WTO. During the so-called "transitional period", the formulation and implementation of non-preferential rules are literally at the discretion of Members. The only difference as compared to preferential rules of origin is that non-preferential rules of origin are subject to more binding requirements in WTO agreements, particularly the Agreement on Rules of Origin and the Agreement on Trade Facilitation.
So far, the most successful initiative to harmonize this area of rule-making at the multilateral level is the WTO's implementation of preferential rules of origin in favor of least developed countries. The 2015 Nairobi Decision on Preferential Rules of Origin for LDCs, which is built upon the decision adopted earlier at the Hong Kong Ministerial Conference, has for the first time laid out general guidelines and detailed instructions on specific issues to determine the status of products originating in an LDC country. Moreover, preference-granting Members are required to notify to the Secretariat of their prevalent origin criteria and other origin requirements. To enable transparency and comparability, such notifications must also follow a template adopted by the WTO's Committee on Rules of Origin.
The role of rules of origin in international trade
Being the criteria to determine the economic nationality of goods, the role of rules of origin is inherently derived from the fact that a number of trade policy measures are applied based on the source of the imports. For instance, if country A wants to impose anti-dumping duties on steel products originating from country B, it is when rules of origin come into play. Without rules of origin, country A cannot apply this measure properly because it cannot determine whether or not the steel in a certain consignment is "made in country B". Beyond this fundamental issue, when steel products originating from country C only transit through country B, they should not be subject to this trade remedy measure; but when steel products of country B opt to transit through country C before being entering country A, it should be considered a circumvention of the anti-dumping duties. All these issues give rise to the need to formulate and implement rules of origin. Basically, rules of origin allow the application of trade measures to the right subject-matters whenever their nationality is taken into account. Likewise, rules of origin are crucial to trade statistics because a country may need to keep track of their trade balance with partners.Rules of origin are particularly important in FTAs, which are established to provide preferences exclusively to products of preferential origin. In this context, rules of origin are indispensable to differentiate between goods originating in contracting parties and those originating in third countries. Such differentiation serves two purposes: it allows the importing party to determine whether a product is eligible for preferential treatment under the FTA at hand; it avoids the scenario where exports from third countries enter the FTA via the member with the lowest external tariff. This explains why in a customs union, there is no need to establish rules of origin among its contracting parties - members of a customs union are required to maintain a common external tariff imposed on imports from third countries.
Due to such role, rules of origin also help to create trade among members of a preferential trade arrangement. Such trade creation effect may happen through two channels. Firstly, because preferences are destined exclusively for goods originating in partner countries, it follows that one party tends to increase its imports from another party of an FTA. To illustrate, if country A signs an FTA with country B, due to lower duties, product X originating in country B now becomes cheaper than similar product X' originating in country C; therefore, country A has the incentive to import a higher volume of X. Secondly, inputs originating in a partner country are also preferred because they are normally considered as originating in the other party where it is incorporated in production. It means country A has the incentive to use inputs originating in country B because this will allow its products to qualify for the originating status under the FTA with country B more easily. Both channels may lead to an increased trade between country A and country B, but may also have an adverse effect on their trade with country C. Therefore, although rules of origin help to overcome trade deflection and encourage trade creation, it also causes trade diversion, which in many cases is not economically efficient.