Last week, someone wrote an article complaining about the Regional Comprehensive Economic Partnership (RCEP) that managed to miss a key point of the agreement. The author argued that the rules in RCEP needed to be carefully crafted to keep out goods from one member market in favor of production from the domestic market.
Trade agreements, however, are supposed to facilitate trade between the members. They are not really about “free” trade, but about providing preferences to members that non-members do not receive.
Companies that are “inside the tent” get access, protection and guarantees that firms that are “outside” the tent do not. The reason RCEP negotiations have dragged on for so long is that it is hard to decide on exactly what sort of benefits members are willing to grant to other firms that will now be inside the tent.
Domestic firms, it might be argued, frequently have advantages over any foreign firm in their home markets—no matter what sort of arrangements get made in trade deals. Local firms know the market better than anyone. Such local knowledge matters. Local connections often make a significant difference in winning contracts and customers.
Once a trade deal gets signed, local firms are often in higher demand than ever, as new market entrants seek out partners with domestic knowledge and capabilities.
Finally, as this article shows, despite frequent concerns over the strength of foreign competition, it is not the case that distant firms lay awake in their beds at night plotting their entry on the day after a new trade agreement goes into force.
Nevertheless, it is also true that firms that are inside the tent do get privileges negotiated at great cost in time and effort on their behalf. It is important that these benefits are not granted to everyone.
Hence the importance of creating rules to ensure that only member firms can use the agreement.
For goods trade, a key element are provisions called rules of origin (ROOs). The ROOs help ensure that only member firms get to take advantage of benefits like lower tariffs on offer from the trade agreement. Not all products from member firms are eligible—only those that can show they have followed the rules.
Governments care a lot about domestic firms and local employment. They want to make sure that, in the wake of newly signed trade agreements, they will continue to have firms that flourish and grow.
ROOs are designed to ensure that a certain percentage or portion of content of any good has to come “from” the member state firms. This helps ensure that production stays local.
This is not complicated for products that are grown, harvested, dug up or are obviously 100% “from” one of the members in a trade agreement. It is quite clear that something like a carrot is “from” a member.
But it does get more complex when that carrot is squished into juice, or mixed with beets in baby food, or added to a frozen pie. How much of the juice, baby food or pie needs to be “from” the member to count?
In smaller trade agreements, like a bilateral between two countries, it can actually be difficult for firms to create goods with a lot of local content. Think about the frozen pie. Not all pairs of countries have sufficient resources to create a frozen chicken pie with carrots entirely from ingredients “from” just the two members.
This leaves governments in bilateral agreements often creating rules of origin or ROOs for frozen chicken pie with fairly low local content. This allows firms the flexibility to import ingredients from elsewhere and combine them domestically to create the final pie for export to the partner market.
There are several ways to create ROOs but the most common is something called value content (VC). This is a percentage of value that needs to be “added” in the markets (or for companies under the tent, if you will) for a product to qualify as being “from” the members and eligible for benefits under the trade agreement.
In a bilateral agreement, the value level often needs to be low, but as more member states get added, the figure can be increased, as it is easier to source ingredients for the chicken pie from across a larger number of countries. Firms can “cumulate” content across the member countries.
If the pie were made in ASEAN, for instance, the ingredients could come from all 10 member states. This makes it simpler to find carrots and chicken and peas and labor. The flour, however, might still need to be imported. Hence the ROO will not be set at 100%, which would require all of the content to be “from” ASEAN. Instead, it has a lower threshold, to let firms import items like flour for the crust from outside ASEAN if necessary.
Under ASEAN/Australia/New Zealand, the ROO allows cumulation or the adding up of content from 12 members. It should be easier to get the flour, carrots, peas, chicken and labor for the pie in AANZFTA for shipment to customers in the 12 member area.
Under RCEP, with 16 member countries involved, making a chicken pie should be quite easy with content inside members. The ROO threshold could be quite high without unduly hampering the ability of firms to comply with the rules.
Of course, not every product is a chicken pie. This is why RCEP negotiators are working off what are called product-specific ROOs to ensure that the ROOs make sense for different types of products. The rules for chemicals should be different than the rules for textiles which should be different than the rules for pies.
But all should ultimately be crafted to allow firms to source across the 16 member states without too much hassle. The point of the agreement is to facilitate trade in the region. It should help unlock new opportunities for companies to make pies or juice or plastics.
These rules should work for large and small firms by avoiding cumulation rules that add unnecessary complexity by asking companies to calculate value addition by stops in the supply chain.
The ROOs are an important element in getting the final RCEP agreement to do what it is meant to do—facilitate trade better across the 16 members.
***This Talking Trade was written by Dr. Deborah Elms, Executive Director, Asian Trade Centre, Singapore. For our latest RCEP Policy Brief, presented at the 26th round of RCEP in Melbourne, click here.***