ROOs

Evaluating Trade Deals Like NAFTA 2.0

Evaluating Trade Deals Like NAFTA 2.0

Since NAFTA 2.0 builds on the base of the original NAFTA, the new deal had some advantages over the TPP.  For example, tariffs between the parties are already set at zero.  This remains, although do note that there are very complicated tariff rate quotas in place in NAFTA 2.0 that were not scrapped.  Indeed, the level of genuinely new market access granted to partners that have known and worked with one another for decades is vanishingly small.  While much focus, as an example, has been on Canada’s new market access for dairy, the total amount given amounts to barely 0.4%.  And the United States, in return, has an equally complex system of barriers in place to protect its own dairy industry from competition (as well as sugar, oranges, and others). The deeply problematic bits of the agreement can be found buried in the texts.  For instance, the rules of origin (ROO) are incredibly complicated.  Given that tariffs are zero, the only way to keep out goods is to craft ROOs that are impossible to follow. Clearly, for many products, this objective has been met. The level of NAFTA content required in fairly large swaths of products is extremely high.  Commentators keep focusing on the insane requirements for auto production, but note that for a wide range of goods, new NAFTA content rules require 50% or more content.  To make matters worse, in many products, these rules tighten after 3 years, rising to as much as 70% local (ie NAFTA) content.

Special Edition: Why Trade Negotiations Are So Hard—The Details of Orange Juice

The Brexit debate has given rise to many bewildered discussions about the apparent difficulties of negotiating trade agreements.  After all, as at least one commentator said, if we can put a man on the moon, surely the UK can negotiate a few trade agreements?  Of course.  Compared to putting a person on the moon, many things seem easy.  But the complexity of negotiating trade is not to be underestimated either.  To illustrate why this is so challenging, just consider the following example of orange juice. 

Stitching Together Garments With Asian Trade Deals

Shanghai—Participants from more than 250 of the largest textile and garment manufacturing firms and industry associations in the world gathered in Shanghai this week as part of the 2016 China and Asia Textile Forum.   The overall economic picture for textile and apparel is decidedly mixed as overall economic growth is slowing, retail sales are off, yet many important apparel markets continue to show rising sales, including new markets within Asia.

One important panel session covered the benefits for textile and apparel producers coming in the Trans-Pacific Partnership (TPP).  [Assuming, of course, that US Congress does the right thing and approves the deal—but that is a post for next week after critical primary elections in Florida and Ohio.  Keep the calls coming into Congress in the meantime.]

While the TPP does provide significant benefits for many textile and apparel firms in the form of lower tariffs, the complexity of navigating the agreement is substantial.  It will provide job security for many, many consultants and legal firms for a long time to come as firms wrestle with new yarn-forward rules of origin for companies that have never had to grapple with these provisions in the past.

The TPP as a whole is a high-quality agreement.  The textile provisions—particularly for entry into the American market—are not.   It remains needlessly complicated and does not represent anything close to 21st century rules.  It does not foster efficient supply chains, will not encourage smaller firms, and basically goes against most of the general momentum of the rest of the agreement.

Many TPP countries granted duty free access to garments on the first day of the agreement.  The United States did not, except for a narrow range of products, like some categories of dresses.  Some American tariffs will remain in place for a decade. 

Some of the final reductions in important categories like denim can only take place after the United States certifies that labor provisions from elsewhere in the agreement have been fully implemented at the five year mark. 

But the lucrative American market has always been difficult to enter for textile and apparel firms, so even poor quality TPP rules can make substantial bottom line differences to companies willing to invest the time and effort needed to figure out the new system. 

Firms are already moving into Vietnam for spinning and dyeing operations, for example, to take advantage of new opportunities to get into US markets.  [Vietnam has the added appeal of the pending EU-Vietnam trade agreement that will provide improved access to the European markets.]

However, not every textile or apparel company can use the TPP.  Not every firm is located in a TPP market or is able and willing to move to one.  Not all sell products to TPP markets.  Not all are going to be able to easily shift sourcing of fabrics from current suppliers, especially. 

But all is not lost for textile and apparel companies.  Most Asia-based companies may also be able to use provisions in the Regional Comprehensive Economic Partnership (RCEP) negotiations. 

RCEP is an ongoing negotiation that brings together 16 parties in Asia—the 10 member countries of ASEAN, plus China, Korea, Japan, India, Australia and New Zealand.  Talks are targeted for conclusion this year and there is still time for companies to push for better outcomes that cover textile and apparel products of importance to firms in the region.

The garment supply chain for Asia often includes fabrics sourced from China, India, or Korea, sewn in Cambodia, Vietnam or Indonesia, and sold across the region including into Japan, Australia or China.  All these products could be eligible for RCEP benefits, if the rules of RCEP—including tariff cuts and rules of origin—are written to provide better preferences for RCEP member firms.

RCEP will likely be much easier to use than the TPP as well.  RCEP should not be using a yarn-forward rule of origin, so manufacturers can source fabrics from across the 16 member countries for inclusion into garments. 

Depending on how the rules are written, fabrics might be sourced from outside the region as well, as long as the garments are cut and sewn in RCEP member countries for sale within RCEP member countries.  This rule would benefit many garment manufacturers that currently source fabrics from non-RCEP countries like Taiwan.  It would allow manufacturers greater flexibility to choose materials from the most suitable source.

Companies from across Asia will have to push their governments to be more ambitious in textiles and garments.  Otherwise, important items could be left out of the final provisions and rapidly dilute the utility of the final agreement for firms. 

Asian companies are not used to working proactively with governments to shape ongoing trade negotiations.  This is, however, a critically important opportunity that ought to be seized by firms.  Government officials working on market access for goods, rules of origin and trade facilitation may not know very much about the specific conditions for textile and garment manufacturing in their own country or across the region.

Officials will certainly not know that, for instance, domestic companies could shift an additional 50,000 pieces of dress shirts per month if a key tariff were eliminated into a market.  They may not realize that they are fighting to protect a product category that will no longer be manufactured domestically at all or that growth opportunities are best found in a different category that needs the lowest possible tariff or a more favorable rule of origin calculation method. 

The rules set down in RCEP are likely to be the rules that govern trade in Asia for the next decade.  Using a 16 country agreement will be much easier for companies to use than overlapping sets of existing regional and bilateral agreements.  For a start, if the RCEP customs paperwork is consistent, firms will no longer need to fill out six or more different types of customs paperwork to ship products to the 16 markets in Asia. 

Firms should plan to attend the next round of RCEP talks in Perth, Australia, during the last week of April and should be talking to their own market access for goods and rules of origin RCEP negotiating officials now.

RCEP helps textile and garment firms that are sourcing and supplying to customers across Asia.  But it is also not a panacea.  Most of the final customers for companies remain consumers in North America and Europe.  RCEP provides benefits for neither market.

***Talking Trade is a blog post written by Dr. Deborah Elms, Executive Director, Asian Trade Centre, Singapore***

Initial TPP Impressions: Market Access for Goods

I will post materials over the next few days devoted to unpacking the texts and schedules in different elements of the TPP agreement.  In an overall document with more than 1200 pages of texts, plus thousands of additional pages of schedules, plus 58 special “side letters,” a fuller explanation and understanding of different provisions will take time.  Nevertheless, I will do what I can to provide an early analysis of some striking points from goods, services, investment, and other chapters.  For specific information on how the TPP may affect your business, please contact us to start preparing an individualized analysis.

Overall, for many goods firms, the TPP should produce substantial net benefits.  Tariffs are dropping across the board.  If these rates are translated into retail price reductions, consumers stand to win--sometimes with significant savings possible on future purchases.  

Many currently high rates fall as low as 0 as soon as entry into force (EIF).  Even drops in lower tariff rates can be critical for companies if they trade in low margin or high volume goods.  Most of the tariff reduction benefits for goods from one TPP member country into another TPP member country happen quite rapidly, with the vast majority of tariffs for all members falling to 0 on entry into force.  The rules of origin are the same for all (with a few exceptions) TPP countries—once a firm has qualified a product as TPP content, it can ship anywhere across the TPP without reformulation and receive the lower TPP tariff rates or preferences from the agreement.

TPP trade in goods is not free.  There are a host of potentially complicated issues that must be sorted out.  For sensitive sectors like agriculture, textiles and certain machinery products, using the TPP will provide benefits that may take longer to phase in and are often extremely complicated to understand and use.  However, since many of these highly sensitive products are normally just excluded or carved out of trade agreements, firms may still receive significant cost savings from the agreement compared to the status quo.  Benefits of the TPP are also substantial, as might be expected, for specific markets like Vietnam where tariff rates have been much higher overall (regularly set at 10, 20, or 40%) than other markets. 

There are three key elements of the TPP for any firm trading goods between TPP members.  First, the specific rules related to trade in goods.  This is shown in Chapter 2 of the agreement.  Second, the individual tariff schedules for each of the TPP member countries, plus any other country-specific annexes (that explain, for instance, the tariff rate quotas used by some members and explained further below).  Finally, tariff cuts do not matter if the rules of origin (ROOs) employed in the deal make it difficult or nearly impossible for firms to qualify for tariff benefits.  Hence, firms also need to check the associated ROOs for their goods in Chapter 3 (and any additional annexes related to ROO issues). 

The fine print is important.  For example, buried in the 67 pages of texts for market access for goods is a provision to allow Vietnam to continue to prohibit the importation of a wide range of used items.  Malaysian firms may be able to access new markets overseas, but will have to check carefully the long list of allowable export duties, taxes and other charges that may negate any new tariff savings.  Food and beverage producers will need to be aware of rules around food and food safety (SPS) in Chapter 7 that may impact their goods.

With these caveats in mind, many of the textual provisions in the agreement are quite helpful for companies.  For instance, firms can receive, repair and return goods without having to pay new duties and companies can more freely temporarily import goods for trade shows or performances.  The rules tighten up the procedures for countries that want to impose import or export license requirements.  There are many provisions related to trade in food and agricultural products intended to provide greater certainty for farmers and producers.

The tariffs schedules are extraordinarily complicated in the TPP.  Every country has their own format for showing the tariff benefits.  For some countries, like Malaysia, the schedule shows basically four columns:  the HS or product code, the product description, the current or base rate of tariffs, and a staging category that applies to all TPP members (with some variations in TRQs).  Many other schedules break out the TPP members specifically, with columns for each individual member country.  While most of these columns are blank (same benefit applies to the whole lot), some have country-specific commitments.

Equally confusing, because the TPP negotiators cannot currently say when the TPP will come into force (fastest schedule could be late 2016 or 60 days after last of the 12 parties finish domestic ratification or potentially 2018 or beyond—see entry into force rules in Chapter 30), the schedules are written with codes.  A bewilderingly complex set of codes is explained in the country specific general notes to each member’s annex.  A notation like B4 in the American schedules means that whatever the current tariff is, it will be cut down in four equal stages to arrive at 0 duties on the first day of the 4th year of the agreement.  [I assume that, during the 60 day period between signing and entry into force, all these notations will be converted to actual dates in the document, making them easier to understand.]

For many firms, the level of tariff reductions is impressive.  Vietnam, for instance, will drop tariffs to 0 on entry into force for items currently set at 18-20% on most fish varieties; fruits from 30%; or many paints with 24% tariffs.  Mexico’s numbers look extremely impressive with many categories dropping from 20% or higher to 0 on entry into force.  [Of course, since Mexico has so many existing FTAs, not all firms currently pay MFN rates, making some of these tariff cuts less impressive in practice.]  Australia appears to have been highly ambitious, with nearly all tariffs dropping to 0 immediately and fewer complicated mechanisms for the remainder. 

And then we get to the United States and Japan.  While there are some very impressive tariff reductions included in these schedules (note that Japan’s schedules as posted are incomplete with tariffs ending at product category 65 out of 99), there are also a host of complications embedded within the schedules. 

For example, both countries take substantial advantage of tariff rate quotas (TRQs) to shield domestic producers.  Under TRQs, TPP members will have a set quantity of a good that can be sold at a lower tariff.  Everything above this rate is charged a significantly higher duty.  For both in- and out-of-quota rates, the TPP does cut down the levels and usually provides some (or all) of the TPP members with additional access to the in-quota allocation.  The complexity of this system can be shown by a quick glance at the TRQ annexes for various individual members.  Japan’s TRQ schedule is 79 pages long.  The annex for the United States is 49 pages in length.

To make matters worse, both countries also have a separate document, an annex on tariff differentials.  These are essentially the marking rules first used in NAFTA that are intended to provide an additional layer of protection to sensitive sectors.  I am way over my own word count quota for this post and cannot go into more detail here, but just note that companies will also need to examine these annexes carefully to determine how they might apply to their inventory for shipment into the U.S. and Japan.

Most of the rules of origin (ROOs in Chapter 3) are product specific.  This means that product categories have a corresponding ROO shown in the annex that must be followed to receive the tariff cut.   In many cases, the TPP requires that the good be classified into a different tariff category (usually at the 4 or 6 digit level which is less helpful for firms) than the original inputs to qualify.  In others, the agreement requires a certain percentage of content from TPP members to be included in the final product.  Note that textiles and footwear into the U.S. (in particular) have very complicated ROOs that must be followed to qualify for some very substantial reductions in tariff levels.

To sum up, the TPP is likely to provide a range of benefits for many firms.  The cost savings for some companies could be significant and firms might become highly competitive in new, untapped markets.  But the complexity of the agreement means that firms will also have to expend significant effort to comb through this massive agreement to determine which benefits apply and which might not.  Firms may have to shift sourcing and production to take full advantage of the TPP, which means that companies should start planning for TPP entry into force now.

***Talking Trade is a blog post written by Dr. Deborah Elms, Executive Director, Asian Trade Centre, Singapore***