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Rules of Origin and the Web of East Asian Free Trade Agreements

Working paper by Manchin, Miriam; Pelkmans-Balaoing, Annette O. /World Bank, 2007

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The authors provide an overview of the preferential rules of origin in East Asia, highlighting the aspects that might possibly generate some trade-chilling effects. They review characteristics of existing preferential trade agreements with special emphasis on lessons from the European experience, and analyze some important features of the existing rules of origin in East and South-East Asian regional integration agreements. The empirical analysis of the effectiveness of preferentialism on intra-regional trade flows focuses on the ASEAN Free Trade Area (AFTA), with the aim of providing a rough estimate of the costs of requesting preferences. The results suggest that preferential tariffs favorably affect intra-regional imports only at very high margins (around 25 percentage points). This points to the likelihood of high administrative costs attached to the exploitation of preferences, particularly with regard to the compliance with AFTA's rules of origin.

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Rules of Origin and the Web of East Asian Free Trade Agreements


Miriam Manchin


Centro Studi Luca d’Agliano (Milan)




Annette O. Pelkmans-Balaoing


Erasmus University (Rotterdam)






Abstract. The authors provide an overview of the preferential rules of origin in East Asia, highlighting the


aspects that might possibly generate some trade-chilling effects. The paper reviews characteristics of existing free


trade agreements (FTAs) with special emphasis on lessons from the European experience, and analyzes some


important features of the existing rules of origin in East and South-East Asian FTAs. The empirical analysis of


the effectiveness of preferentialism on intra-regional trade flows focuses on the ASEAN Free Trade Area


(AFTA), with the aim of providing a rough estimate of the costs of requesting preferences. The results suggest


that preferential tariffs favorably affect intra-regional imports only at very high margins (around 25 percentage


points). This points to the likelihood of high administrative costs attached to the exploitation of preferences,


particularly with regard to the compliance with AFTA’s rules of origin.




JEL Codes: F13, F15, F17


Keywords: Free trade agreements, rules of origin, preferential tariffs, ASEAN Free Trade Area




World Bank Policy Research Working Paper 4273, July 2007

The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about
development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished.
The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in
this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or
the countries they represent. Policy Research Working Papers are available online at http://econ.worldbank.org.



This is a background paper for the East Asia Rules of Origin project and was funded by EASPR. An earlier
version of the paper was presented at the Boao Forum for Asia (BFA) “Regional Workshop on the Importance
of Rules of Origin and Standards in Regional Integration” held in Hainan on June 27-28, 2006. We are thankful
to Anne Robeniol and Ahmad Syaukat of the ASEAN Secretariat for providing us with data, and other critical
information for this paper; to Jerzy Rozanski for undertaking the concordance of the AFTA CEPT tariffs with
the WITS tariff data base; to Joseph Francois for his valuable advise and assistance. Address correspondence to:
A. Pelkmans-Balaoing, Erasmus University Rotterdam, Burg. Oudlaan 50, H8-31, 3000 DR Rotterdam,
Netherlands; email: pelkmans@few.eur.nl.


WPS4273


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1. Introduction




The maze of East Asian regional and bilateral free trade agreements (FTAs) that has emerged in the


last few years has triggered fears of what the attendant rules and administrative procedures would


imply for the cost of doing business in the region. If these agreements are mutually consistent,


particularly with regards to rules of origin (ROO), then obviously the marginal costs of a new


agreement will be minimal for all parties. The lack of coordination in rule-setting among countries,


however, ensures that each trade route marked by preferentialism will be differentially governed, thus


leading to mounting information and transaction costs. Moreover, the specter of multiple and


overlapping agreements among countries will only further increase the need to regulate trade so that


preferences do not spillover unintendedly to non-partners via the member with the lowest trade


barriers.


In a sea of preferential agreements, ROO are, in fact, seen as indispensable since they define


the conditions that a product must satisfy to be deemed as originating from the country seeking


preferential access. They are principally meant to prevent trade deflection, whereby products from


non-participating countries destined for the partner country’s market are redirected through free trade


partners of the partner country to avoid payment of the partner country’s customs duties. However,


the problematic intricacies brought about by ROO often work to hinder the flow of goods in the


region and introduce new uncertainties in the conduct of trade.


The complexities surrounding the rules of origin could be traced from two sources. One is


the difficulty of ascertaining origin in an age of globalized trade and at the same time, increasingly


fragmented production processes. When goods are produced in a single production stage then the


origin of the products should be relatively easy to establish. Proof that the product was produced in


the free trade partner should be sufficient. For other cases, ROO are used to define the methods by


which it can be ascertained that the product has undergone sufficient working or processing in the free


trade partner to qualify for preferential access. However, technological progress and globalization have


made possible the further refinement of division of labor among various producers, in order to exploit


scale economies and cost differentials among various countries. Consequently, the production of a


single product often encompasses multiple locations, compounding the difficulties of verifying its


origin. For most cases, therefore, ROO are used to define the methods by which it can be ascertained


that the product has undergone sufficient working or processing in the free trade partner to qualify for


preferential access.


The other reason behind the complex design of many ROOs is the convenience in which


these rules could be used to both accommodate and conceal protectionist intents. ROOs, by increasing


the local content of the product, or by attaching multiple criteria for the satisfaction of origin, could be




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another avenue to effectively exclude product groups from a country’s liberalization commitments.


Rules can also be made product-specific, so that the extent of protection is hidden in the hundreds of


pages of annexes, and coated by technical language not immediately accessible to non-specialists.


Needless to say, the motives underpinning the creation of FTAs, have a direct bearing on the


design and degree of restrictiveness of ROOs. For FTAs which are created largely for political and


foreign policy purposes, cumbersome ROOs provide an effective means of shielding Members from


the economic effects brought about by the removal of tariff barriers. If, on the other hand, the goal of


regional import substitution dominates, then ROO can make the conferment of origin conditional on a


set of minimum regional content targets, which can spur trade diversion, especially in the use of


intermediate manufacturing inputs. The Foreign Direct Investment (FDI) motive, which is present in


some FTAs, can exert two opposing pressures. On one hand, it may lead to more restrictive ROOs, as


a means to entice rules-evasion on the part of non-partner investors. On the other hand, countries


may actually intend to use an FTA to bring down the costs of transactions among members, so as to


create a bigger market and a more attractive production base for foreign firms. In this case, the heavy


requirements set by ROOs become a genuine hindrance to the achievement of regional goals.


With the proliferation of FTAs observed especially in the last 3-4 years in East Asia, it


becomes ever more important to take stock of the implication of these simultaneous agreements on


the integration of regional markets. This paper aims in particular to provide an overview of the


preferential rules of origin in East Asia, highlighting the aspects that might possibly generate some


trade-chilling effects. The paper reviews characteristics of existing preferential trade agreements with


special emphasis on lessons from the European experience. This is followed by a brief analysis of the


important features of the existing preferential rules of origin in East and South-East Asia. The third


part of the paper focuses in on the AFTA and presents an empirical analysis of the effectiveness of its


preferential agreement and also provides a rough estimate for the costs of requesting preferences.




2. Lessons from existing preferential trade agreements


2. 1 Some main characteristics of preferential rules of origin


Origin determination


There exist three main approaches to determining origin: change of tariff heading, value-added criteria,


and specific manufacturing process requirement. According to the change of tariff heading method the


final product has to have a different tariff heading than the inputs used. The second main approach


defines a minimum value-added to be done on the inputs in order for the final product to become


originating. Finally, specific manufacturing processes can be required to be undertaken in the




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production of the good to be eligible for preferences. Each of these rules has certain advantages and


disadvantages with respect to the other rules.


Several agreements require satisfying a combination of two or more methods. For example,


not only a change of tariff heading has to be satisfied but also further specific manufacturing processes


has to be completed in order to obtain the originating status. For instance according to the EU rules of


origin scheme, with the basic rule of change in tariff heading, a country which imports woven cotton


fabric (HS 5208) to produce cotton shirts (6105) would satisfy the rule of origin and qualify for


preferential reduction of the tariff on cotton shirts. However, in this specific case in EU free trade


agreements the change of tariff classification is replaced with a requirement that the product have been


manufactured from yarn. In effect this imposes the requirement that two stages of production must be


undertaken in the partner or qualifying area to confer origin – not only the sewing together of the


fabric but also the production of the fabric itself. Clothing products made in free trade partners of the


EU but which are made-up of fabrics imported from third countries, such as China, will not satisfy the


EU origin rules and will not qualify for tariff reduction. As origin determination rules become technical


they offer scope for the participation of industries in setting restrictive rules of origin (Hoekman,


1993).


While only 13% of tariff lines in the EU Pan-European Scheme currently rely on the value


added criteria (Cadot et al, 2005) due to the outcome of a reform process initiated by the European


Commission (EC) in 2003, there are plans to replace the current rules with a single value-added


method which the EC expects to be clearer and more development-friendly.


On the other hand, the burden of satisfying the restrictive origin requirements can be


alleviated by allowing alternative means to satisfy the rules, thus providing certain flexibility for


producers. For example, allowing producers to choose between a value-added criteria or a change of


tariff heading, could provide greater flexibility for the traders and would allow them to choose the


method which can be satisfied at the least possible cost.


In case the origin requirements are too restrictive then to be able to satisfy rules of origin to


achieve preferential market access requires a degree of sophistication on the part of firms in the free


trade partner to be able to carefully track and show the origin and movement throughout the company


of imported intermediate inputs. It also seems that a modern and efficient customs service is a


necessary precondition for the proper implementation of the complex rules of origin. This suggests


that countries contemplating free trade agreements should carefully take into account the possible


implications of rules of origins for the viability and success of any initiative. The need to avoid


complicated technical rules of origin in order to deliver genuine improvement in market access is


particularly evident in the European (and North American) experience. A web of free trade




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agreements, in say, Asia, with complex and restrictive rules of origin, may in practice, have little impact


on trade flows in final products, and instead bring about a shift in the production and trade pattern of


intermediate products, with possible adverse efficiency consequences for resource allocation. Origin


determination should have a neutral impact on trade after achieving their basic objective of avoiding


trade deflection.


Cumulation


With cumulation, inputs from preferential trading partners can be used in the production of a final


good without undermining the origin of the product. Preferential and free trade agreements can have


three different types of cumulation: bilateral, diagonal and full cumulation. For example, bilateral


cumulation in NAFTA implies that originating inputs, that is, materials that have been produced in


accordance with the relevant rules of origin, imported from the another NAFTA member qualify as


originating materials. However, inputs from Mexico used in the production of a final product in


Canada, for instance, can be counted originating only if the final product is then re-exported to Mexico


but not to the US.


Of greater relevance would be to allow diagonal cumulation on a regional basis so that


qualifying materials from anywhere in the region could be used without undermining duty-free access.


In other words, parts and materials from anywhere in the region that qualify as originating could be


used in the manufacture of a final product which could then be exported duty free within the region.


An example is the Pan-European cumulation area which allows diagonal cumulation between member


countries.


Finally, there can be full cumulation whereby any processing activities carried out in any


participating country can be counted as qualifying content regardless of whether the processing is


sufficient to confer originating status to the materials themselves. Full cumulation is applied, for


example, in the EU’s Cotonou agreement and in AFTA.


Full cumulation could facilitate more fragmentation of production processes among the


members of the free trade area and so stimulate increased economic linkages and trade within the


region. Some argue that under full cumulation more developed countries can outsource labour-


intensive low-tech production stages to less developed partners and lock them into these stages,


therefore ‘blocking’ a more wide-ranging process of development. It is argued that diagonal


cumulation will stimulate more capital-intensive production processes and investments by requiring


more stages of production/higher value-added to be undertaken in the country to fulfil the


requirements of rules of origin and obtain preferences. The experience of developing countries under


the EU’s GSP scheme shows, however, that requiring high levels of value-added or multiple




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processing stages to be undertaken results in lower uptakes of preferences and a lower level of all


activities in the country.


Tolerance or De Minimis rule


These rules allow a specified percentage of non-originating products to be used in the production


process without affecting the origin status of the final product. All EU preferential and free trade


agreements contain de minimis rules. The percentage allowed in most of the EU agreements is 10


percent (exceptions are the Cotonou Agreement and the agreement with South Africa which allow 15


percent). The tolerance rule under the NAFTA allows that non-originating inputs can be used even if


the rule on sufficient processing is not satisfied provided that their value does not exceed 7 percent.


Although the tolerance rule in principle lessens the burden of rules of origin for products with


non-originating inputs, the tolerance rules applied to the textiles and clothing sector are often different


and less favorable than the general rules of tolerance (Brenton, 2003). Nevertheless, tolerance rules can


reduce the often too stringent requirements imposed by the value-added or change of heading


requirement and thus lessen the additional production costs which would have to be borne if no


tolerance would be allowed.




Duty drawback


When non-originating materials are used in the production of a final product geared for exports, duty


drawback provisions provide a waiving or a repayment of duties applicable to the non-originating


material used. However, most preferential agreements do not allow duty drawback thus discouraging


the use of third country inputs in the production processes. Some EU FTAs (for example the Cotonou


Agreement and the GSP scheme) do not prohibit the usage of duty drawback provisions.


Allowing for duty drawback can reduce the magnitude of trade diversion in forming regional


trade agreements. The use of duty drawback can be especially important for countries with intensive


trading and production links with manufacturing networks outside the area of the preferential trade


agreement. In these cases, the elimination of duty drawback when a preferential agreement is


concluded would imply higher production costs for final-good assembly for exports or intermediate


processing to partner countries in the PTA.





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Outward processing


Some preferential and free trade agreements allow for outward processing schemes. Outward


processing procedures encourage processing overseas by providing relief from import duties on the


compensating value of imports1 after processing abroad.


The amount of duty payable is calculated from the value of the product imported multiplied


by the appropriate tariff for that product minus the hypothetical duty that would have been paid on


the intermediate products exported under the processing scheme. Thus, for example a firm which


exports textiles under an outward processing scheme and subsequently re-imports clothing products


would have to pay the (preferential or other applicable) duty on the clothing product but would be


refunded the duty that would be applicable to the value of the textile products exported.


Within outward processing in textiles and clothing the EU has provided for a specific scheme


known as “economic outward processing” where, often up to specific limits and/or subject to


surveillance, imports after processing enter the EU duty free. Under this regime, goods temporarily


exported from the EU for processing must be in free circulation within the Community and must have


EU origin. Although, if products of Community origin are insufficient, derogation can be granted from


these rules, but for no more than 14% of the total value of the goods for which prior authorization is


requested. There are further requirements in the regulation to protect the industry in the Community,


such as, commitments to maintain production and employment in the Community and maximum


processing rules. The latter are the converse of the rules of origin in free trade and preferential trade


agreements, which stipulate minimum processing requirements.


Allowing for outward processing in preferential and free trade agreements could ease rules of


origin requirements and reduce the impact on re-allocating input sourcing. The EU example suggests


that documenting the outward processing scheme is less costly than the documentation requirement of


the rules of origin (see a detailed discussion in Brenton and Manchin, 2003) thus the allowance of


outward processing within the PTA might reduce the administrative costs for outward processing


linkages. Furthermore, outward processing permits greater production fragmentation which can be


crucial for the competitiveness of firms.




Documentation of rules of origin


Administrative costs can vary with different documentation and certification methods. Certification of


rules of origin in the EU is relatively more restrictive involving a two-step private and public


certification. On the other hand, NAFTA and other US preferential trade agreements require a single-


step private certification which does not have to be repeated each time. Cadot et al (2005) estimates



1 Compensating value of imports is in other words part of the imports which was previously exported for
processing.




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that the administrative costs of the Pan-European preference scheme is around 6.8% while the


administrative costs under NAFTA are around 1.9%. The authors argue that the high difference in the


administrative costs between the two regimes is mainly attributable to the different certification


method used in the two schemes implying that the self-certification used in NAFTA is less


burdensome for traders. These results indicate that authorities should be careful in designing the


certification process of rules of origin as it can significantly increase the costs of requesting preferences


and thus reduce the potential positive impact of trade integration.




2.2 Costs of proving and satisfying origin


The complexities of all the above requirements contribute to important costs of satisfying origin


requirements. The restrictiveness of satisfying rules of origin may also be compounded by the costs of


actually proving origin. In a widely quoted study Herin (1986) found that the costs for EFTA


producers of proving origin led to one quarter of EFTA exports to the EU paying the applied most


favored nation (MFN) duties. Herin (1986) estimates the costs of documentation and administration of


origin rules to be equivalent to some 3 percent of the value of the goods traded. A more recent study


by Carrière and de Melo (2004) finds that total compliance costs for Mexican traders exporting to the


US averaged around 6 percent in 2001. Using a double-censored Tobit estimation technique, they


obtained a compliance cost estimate of 3.9 percent for products where the utilization rate is below 100


percent. Estimating the costs for NAFTA, Cadot et al. (2005) estimates the trade-weighted compliance


(administrative) costs to be 6.8% (1.9%) and for the Pan-European preference scheme to be around


8% (6.8%). In another empirical work assessing EU preferences Manchin (2006) finds the costs of


requesting preferences in the case of Cotonou preferential scheme for non-least developed ACP


(African, Caribbean and Pacific) countries to be around 4 percent. The findings of these studies


highlight that the costs of obtaining preferences can be substantial. Thus as the increasing multilateral


liberalization process leads to lower MFN tariffs the benefits offered by preferential trade agreements


are decreasing and become marginal if the costs of obtaining these preferences remain high.


The costs of proving origin involve satisfying a number of administrative procedures so as to


provide the documentation that is required and the costs of maintaining systems that accurately


account for imported inputs from different sources to prove consistency with the technical rules. The


ability to prove origin may well require the use of, what are for small companies in developing and


transition economies, but not for companies in developed countries, sophisticated and expensive


accounting procedures. Without such procedures it is difficult for companies to show precisely the


geographical breakdown of the inputs that they have used. The costs of proving origin may be even


higher, and possibly prohibitive, in countries where customs mechanisms are poorly developed. Thus,


even if producers can satisfy the rules of origin, in terms of meeting the technical requirements, they




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may not receive preferential access to the EU because the customs authorities do not accept their


proof of origin or the costs of proving origin are high relative to the duty reduction that is available.


The latter suggests that the economic impact of preferential tariff reduction may be discontinuous.


Initial reductions in tariffs will have little impact since they will be less than the costs of proving origin.


It is only once the gap between the preferential tariff and the MFN rate exceeds the costs of proving


origin that there will be a stimulus to trade.


The burden of production costs induced by restrictive rules of origin can be somewhat


reduced by allowing less restrictive cumulation rules (such as diagonal or full cumulation), allowing


duty drawback, outsourcing and higher de minimis levels. Furthermore, administrative costs can be


also reduced by more trader ‘friendly’ approaches, such as using self-certification methods.


Estevadeordal and Suominen (2005) conducting an analysis on the implications of rules of origin for


trade based on a sample including 155 countries and find that rules of origin regimes with the above


measures foster bilateral trade compared to rules of origin regimes which do not allow duty drawback,


outsourcing, less restrictive cumulation, higher de minimis rules.




3. Rules of origin in East and South-East Asia


3.1 An overview of the main Rules of Origin provisions in East Asian FTAs


In a recent survey of ROOs worldwide, Estevadeordal and Suominen (2004) observed that Asian


FTAs, such as the ASEAN Free Trade Area (AFTA), Australia-New Zealand Closer Economic


Relations Trade Agreement (ANZCERTA)2, Singapore-Australia Free Trade Agreement (SAFTA), and


the South Pacific Regional Trade and Economic Cooperation (SPARTECA) in the Asia-Pacific, stand


out for their generality. However, the propensity to expand the existing FTAs to new members or


create new country-combinations of FTAs, increasingly introduce product-specificities in the design of


ROOs. This can be seen in new arrangements such as the ASEAN-China FTA and the recently signed


ASEAN-Korea FTA.


The relatively ample allowance for imports in the AFTA stems from the realization that for


many heavily-traded products in the region, like electronics, production processes may be so splintered


that the value of local content is often a small percentage of the product’s total value. Very early on in


the formation of AFTA, it was recognized that the 40% ASEAN origin rule may often not be met in


the case of trade in textile and textile products. In 1995, it was therefore decided that either the


percentage value-added or the substantial transformation rule may be used by ASEAN exporters. The


AFTA ROO underwent further overhaul, starting in 2003, when operational procedures were further


clarified and simplified. In the same year, the decision was reached to adopt a change in tariff heading



2 CER (Closer Economic Relations) , CEP (Closer Economic Partnership), SEP (Strategic Economic
Partnership), are all names used interchangeably with FTA.




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rule for determining the origin of the product as a general alternative rule “applicable to all products


which cannot comply with the 40% local/ASEAN content requirement, giving priority to sectors


which are the subject of private sector requests and those sectors prioritized by the AEM for


accelerated integration” (AFTA Council, 2003)3. As of last year, the change of tariff heading rule is


fully endorsed for four sectors: wheat-flour4, wood-based products, aluminum products and iron and


steel5.


The ASEAN-China Free Trade Area (ACFTA) adopts the same general value-added rule


of the AFTA of 40% local/regional content with full cumulation. The Agreement on Trade in Goods


is currently in force, which extends the liberalization commitments from the limited ‘Early-Harvest’


agricultural products (HS chapter 01 – 08), to the rest of the traded sectors in the normal inclusion list.


As in the AFTA ROO, an alternative change of tariff heading criteria can be invoked for a number of


products.6 In the case of ACTFA, the rule applies for 424 (HS6) textile and textile products items, 2


items of preserved fish, 6 items of wool, 22 of leather goods, 14 for furskins and 4 item lines of


footwear. It is only in 5 wool tariff items, that the change of tariff heading is set as the exclusive rule.7


The ASEAN-KOREA Free Trade Area (AKFTA) is the most recent agreement that has


been concluded (May 2006), although Thailand, Cambodia and Myanmar has not yet signed due to the


current political instabilities in Thailand8, and the unfinished negotiations for the inclusion lists for


Cambodia and Myanmar. The general 40% value-added local-regional content of AFTA and the


ACTFA is extended to this free trade area, as well as the full cumulation rule. Surprisingly, AKTFA


emerges now as even more liberal than the AFTA because the change of tariff heading, as an


alternative rule to the 40% content requirement, is applicable to a greater number of products relative


to the coverage in the AFTA and the ACTFA. A novelty has also been introduced in the AKTFA,


namely, the back-to-back Certificate of Origin (CO), which allows the conferment of preferences to


the re-exports of partner A into partner B of products first exported by partner C into A.9 This is


particularly advantageous for countries engaging in substantial entrepot trade such as Singapore.



3 In November 2004, 11 priority sectors were identified for deeper integration where tariffs will be eliminated in
at least 85% of the products in 2007 for ASEAN-6, and 2012 for Cambodia, Laos, Myanmar and Vietnam.
These sectors are: agro-based products, automotive products, electronics, fisheries, rubber-based products,
textiles & apparels, wood-based products, e-ASEAN, health care, tourism and air travel. See
http://www.aseansec.org/15070.htm for AFTA Council reports.
4 For wheat-flour products, change of tariff heading is the sole origin criterion.
5 Product-specific rules are negotiated only upon the request of private sector groups.
6 Negotiations are still on-going for the product specific rules of other sectors. Only the specific ROOs are
finalized in sectors under the normal inclusion list.
7 See Annex 3, Attachment B of the ASEAN-China FTA Agreement
(http://app.fta.gov.sg/data//fta/file/ACFTA_Annex3.pdf).
8 Another reason is the protest issued by Thailand due to Korea’s exclusion of rice in the agreement. Thailand is
the world’s biggest exporter of rice.
9 Singapore imports, say, 10 units of televisions from Korea, where the preferential duties apply under the
AKTFA. A back-to-back certificate allows Singapore to re-export , for instance, 7 of those units to ASEAN, and




11


For Singapore FTAs, such as the one signed with Japan (JSEPA)10, the degree of


restrictiveness of the ROO largely reflects the sensitivities of Singapore’s partners. Agricultural


products and textiles and apparel are characterized by particularly complex rules even if 384


agricultural items are excluded, constituting 90% of total Singapore exports to Japan. ROOs are


product specific, relying mostly on the change of tariff heading rule11. For some products an


alternative RVC rule is allowed, albeit at a high rate of 60%. In cases where RVC is an additional


criterion to be satisfied, the content requirement is lower at 40%. However, about half of the tariff


subheadings in the agreement already have duty-free MFN status, so that in practice, ROOs’ effect is


quite limited. De minimis is permitted, also varying across products. Outward processing is


recognized in all of Singapore’s FTAs, allowing it to count the value of the outsourced part of the


production process as Singaporean production.


The Korea-Singapore FTA follows the same pattern of product specificity of the JSEPA,


also with the change of tariff heading rule as the dominant origin criteria. For some products an


additional RVC of 45%, 50% or 55% is asked, and for a few items, the RVC rule alone will suffice.


The sensitivity of textiles is seen in the added details in the description of transformation rules, and in


its exclusion from the 10% De Minimis rule.


In contrast, a general value-added rule of 40% is applicable to all products under the


Agreement of New Zealand – Singapore for Closer Economic Partnership (ANZSCEP). Both


countries are parties to yet another FTA, the Trans-Pacific Strategic Economic Partnership


Agreement (TRANSEP), which was formed in June 2005 together with Brunei and Chile12. Under


this agreement, ROOs contain product specific change of tariff heading rules, with some products


having an additional RVC provisions ranging from 45% to 50%, as in the case for textiles and


footwear. Still, for some products, the CTC and RVC are alternative rules. Goods that are unable to


meet any of the ROO criteria, origin may still be conferred provided that the non-partner content do


not exceed 10% of the goods’ value. In effect, the product specific rules apply only to the trade


between Chile and the rest of the TRANSEP countries, and between Brunei and New Zealand, since a



still be able to avail of the same preferential rates any ASEAN member would impose on Korean-made
televisions.
10 Japanese FTAs are incorporated in an ‘Economic Partnership Agreement ‘ (EPA), which has a broader scope
than the typical FTA, such as e-commerce, financial services, information and communication technology and
Human Resource Development.
11 Heading changes are needed for HS 01- 24, HS 38 (chemical products), HS 85 (machinery), while subheading
or value content requirements for liquor and cordials apply. For the rest a RVC requirement of 60% with a
combination of subheading changes is needed. The yarn-forward rule applies for textile fabrics and articles (HS
59).
12 Trans-Pacific SEP was previously known as the Pacific Three Closer Economic Partnership (P3-CEP). Its
negotiations was first launched at the 2002 APEC Leaders Summit by leaders of Chile, Singapore and New
Zealand. Brunei first took part as a full negotiating party in the fifth round of talks in April 2005.




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general value-added rule apply for the other pairs of countries under the ANZSCEP agreement


between Singapore and New Zealand, and also under the AFTA between Brunei and Singapore.


Australia’s FTA with Singapore (SAFTA), is less general than the ANZSCEP since a value-


added requirement of 30% is imposed for some products (110 HS8 tariff lines mostly in HS 84-85)


while for the rest a higher 50% local/regional content is required. For some 152 tariff lines an


additional requirement is imposed that the last process in the manufacture of the product must take


place within the territories of the party seeking the preference.


As opposed to the generality and the broad scope of the Singapore- New Zealand FTA, the


agreement between Thailand – New Zealand (THAINZCEP), and Thailand- Australia


(TAFTA) contains specific rules for all products. The CTC rule is once again predominant, with


some products allowing a change in subheading. Additional RVC requirement of 50% for


THAINZCEP and 55% for TAFTA are imposed mostly for textiles and textile materials. Clothing is


further restricted by making origin conditional on the performance of essential processes, such as


cutting and sewing. In the case of TAFTA, transformation from specific headings and subheadings is


excluded for some products.


The ROO of the Australia – New Zealand CER (ANZCER) has undergone a major


revision early this year (to take effect in January 2007).13 The RVC rule of 50% previously applies to all


products. The new CTC/ change of tariff heading approach has been adopted, although the RVC rule


of 45% is still the exclusive criteria for some textile sectors such as those in men’s and boys’ apparel.


The new bilateral agreements reached by Japan with individual ASEAN Members are


intended to be incorporated (as annexes) in the ASEAN-Japan FTA (AJEPA), which will not be open


to renegotiation once the negotiations for the ASEAN-Japan FTA are completed. The Japan-


Malaysia Economic Partnership Agreement (JMEPA), is the first to be concluded under this


foreseen trajectory towards an AJEPA. It is, as the JSEPA (with Singapore), largely based on the


change of tariff heading rule, and with a high degree of product specificity. Even the De Minimis rule


varies according to product categories. Once again, for some sectors the RVC rule (40% - 50%) is an


alternative, while for some, it is the sole criterion for conferring origin. The novelty in the JMEPA is


that for some products the change of tariff heading rule is only valid if the non-originating material is


sourced from any of the ASEAN country. This is most likely done in anticipation of possible


cumulation rules under the future AJEPA.


Table 2 describes the main features of the rules of origin described above, covering the FTAs


in East Asia that has been signed, and those whose full documentation has been released to the public,


including annexes.



13 Under the agreement, exporters can still choose to use the old RVC rule till 2012.




13


3.2 Some problems surrounding the use and implementation of ROOs




The test of the efficacy of a FTA in inducing intra-bloc trade is the extent in which preferences are


taken up by the business sector. In AFTA, no data on the utilization rate is available because of the


lack of proper reporting of intra-ASEAN imports that were given origin certifications (i.e. imports


accompanied by Form D14). According to the Bureau of Economic Integration of the ASEAN


Secretariat, there is not one single year since the CEPT Scheme began in 1993, where Form D data is


available for all 6 original AFTA countries15. However, estimates based on firm interviews conducted


for the ASEAN Secretariat, show a low utilization rate of about 5% of total trade. Although preference


under-utilization is not unique to ASEAN, this estimate is certainly low relative to the known record of


other discriminatory schemes. Brenton and Manchin (2003), for instance, reported that 35% of eligible


exports from the CEEC countries enter the EU using the available preferential rates. Inama (2003),


examined the utilization of the General System of Preferences (GSP) of the QUAD countries, and


found that of the 62% of imports of Quad countries originating from all beneficiaries of GSP schemes


covered by preferences, 39% of these were effectively traded under the lowest available rates.


For AFTA and ANZCER that relies on the RVC rule, one reason may be traced in the


inability of exporters to cumulate the necessary local / regional content given the degree of process


fragmentation in highly globalized sectors such as electronics. Table 1 provides an indication of the


extent of this problem, showing the import content of key manufacturing sectors in ASEAN and other


East Asian countries. Calculations are based on data taken from the GTAP 6 database for 2001, the


latest year available. As expected the import content of electronics and machineries are the highest for


ASEAN, the sum of the direct and indirect import content being 67.8% and 60.6%, respectively. The


share of imports is particularly high in these sectors for Singapore and Malaysia. The figures reported


here are most likely understated since the data do not differentiate between output destined for local


consumption and output for exports. One would expect the import content for exports to be higher


than for those sold in the local market because of various fiscal incentives (i.e., import duty


drawbacks), which is available for export production in most countries.




Another main culprit tagged as being responsible for the under-utilization of preferences is the


complexity of administering and complying with the ROO. LDC exporters are particularly burdened


by high compliance cost, not to mention the more fundamental difficulty of local sourcing to meet


whatever RVC requirements are imposed. Brenton (2003), for instance, partly attributes the under-



14 The total amount of intra-ASEAN imports seeking preferential rates under the CEPT Scheme can be extracted
from the Form D certificates.
15 Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand.




14


utilization of the EBA agreements to ROO, which are generally stricter relative to those contained in


the ACP preferences.


The initial trend in East Asia, as shown by the AFTA and ANZCER agreements is an


application of a value-added content rule across all products. In terms of transparency and clarity, a


general rule is clearly more desirable relative to specific product rules. Feedback of AFTA exporters,


however, reveals the difficulties posed by the computation of costs, the invoicing and other


documentation demands inherent in the RVC rule. Customs valuation that differ across countries is


another problem, and while continues efforts are being made to address the problem,16 it will take a


considerable amount of time before the decision to harmonize, undertaken in the highest policy level,


is translated into daily practice in all trading ports.


In the AFTA, the emphasis is on pre-export inspections, usually performed by the local trade


ministries. Exporters are usually expected to submit a cost analysis of the product with accompanying


invoices and documentation and the actual certificate (i.e. Form D, in AFTA’s case) needed to request


for preferences will then be issued by the Trade Ministry upon verification of the product costs.17


Transactions remain very time-intensive, as face-to-face contact with various ministry and customs


officials is still the norm, rather than the exception. Once origin is established in the exporting country,


preferences are conferred to incoming goods, which would then be randomly subjected to post-audit


checks. In theory, coursing products in ASEAN through the “green lane”18 provide traders in AFTA


goods substantial benefits in the form of expeditious release of cargo, and overall lower administration


costs. In practice, however, some traders avoid the green lane on purpose because products entering


through this window are said to be more likely to be subjected to extensive post-audit checks.19 The


so-called “red lane” with ordinary clearance examinations is preferred instead. This is an example of a


trade-facilitating device, such as the post-audit system, turning into a source of uncertainty that hinders


trade.


The implementation of the RVC criteria is particularly problematic in the absence of


automation, clear, harmonized rules and readily accessible conciliation or objection procedures. The



16 In AFTA, the different tariff classification adopted by members is a particular problem. This was addressed in


2004, when a common ASEAN tariff nomenclature (ASEAN Harmonized Tariff Nomenclature, or AHTN)
came into force. Another project is the ASEAN Single Window which involves the computerization of
clearance procedures with common formats fulfilling the requirements of the international rules of WCO
(World Customs Organization) and WTO. The project is still currently being pilot tested between Malaysia
and the Philippines.


17 Pre-export inspections are meant to check the conformity of the product with the rules of origin. It must also
verified whether statements in the Certificate of Origin correspond to the supporting documentary evidence
submitted. Finally the descriptions, quantity and weight of goods, marks and number of packages, as specified
must be seen to be conforming to the products to be exported.


18 The ‘Green Lane’ system allows the importation of ASEAN-origin products without extensive examination.
19 Based on interviews done by the Japan External Trade Organization (JETRO) of Japanese firms active in the


region (JETRO, 2004).




15


actual valuation of costs thus heavily depends on the judgment of individual customs officials, and this


even more in an environment where contesting the rulings would imply more costly delays without any


certainty of neutral arbitration. Self-certification is one solution, which was in fact, proposed by


Australia, Korea, China and Japan in their respective FTA negotiations with ASEAN. However, the


notion of self-certification is alien to the culture of customs inspection in ASEAN.


The potentially cumbersome procedures involved in the valuation and certification of declared


costs under the RVC rule, may have prodded ASEAN to follow the example of ANZCER in shifting


to the CTC criteria for all products. As mentioned earlier, the ASEAN-Korea FTA (AKFTA) is now


more flexible than the AFTA since the change of tariff heading alternative is available for all products.


For products where the preferential tariffs under the AKFTA approximate the levels found in AFTA,


then preferences in the latter will be eroded by the more liberal rules offered by the former.


This trend towards product specific rules is not without risks, however. What may begin as a


facilitating measure may eventually be used to introduce protectionist restrictions. This can be done by


excluding inputs from certain tariff headings, attaching an essential process in the transformation of


the product or turning the RVC as an additional instead of an alternative rule to satisfy origin. Bilateral


FTAs with restrictive product specific rules will also most likely define the parameters of wider FTAs


formed later on, as in the case of the Japan-ASEAN EPA.


For FTAs such as AFTA which group together relative high-tariff countries with a duty-free


member such as Singapore, avoiding trade deflection will always be a difficult challenge, given the


complexities of verifying the origin of goods produced or assembled from multiple locations


worldwide. The burden of proper verification becomes all the more taxing in an environment where


the proliferation of bilateral FTAs lead to numerous potential ‘backdoors’ that need effective policing.


Clearly, the likelihood of trade deflection increases when relatively high tariff countries like Thailand or


the Philippines also acquire pockets of low barriers. This in turn might lead to more intensive or


heavy-handed verification procedures that will further hike administrative and waiting costs. If


implementation indeed becomes too difficult, leading to the inability to arrest a significant amount of


trade deflection, then this may have a direct adverse consequence on the level of domestic political


support for the FTA.


The lack of coordination in setting ROOs amidst the proliferation of FTAs also has a political


cost attached to it, namely the cost of choosing favorites among favorites. It is not surprising that


different permutations in the exchange of concessions among countries result to ROOs with varying


degrees of restrictiveness, which in turn lead to a sort of hierarchy of partners not unlike the EU’s so-


called pyramid of preferences. History is replete of examples of how differentiating partners into


friends, lesser friends and foes has bred all sorts of animosities, and has certainly not created an


environment conducive to the development of closer or strategic economic partnership. The recent




16


surge of FTAs in East Asia is said to be less about trade and more about issues like trade facilitation or


regulatory barriers involving investments and services, where negotiations have bogged down in the


multilateral arena. It is not unlikely that irritations stemming from contentious ROO negotiations, or


the uneven restrictions applied to trade among different partners, could spill-over to more important,


high-stake negotiation areas.




4. Empirical analysis of the importance of preferences in AFTA


The objective of this empirical analysis is to explore the effects of preferences on trade flows


and to provide an approximate estimate for the costs of requesting preferences under AFTA by


concentrating the analysis on disaggregate trade flows which are eligible for preferences. Due to the


non-availability of data which would distinguish between trade flows which obtained preferences and


flows which did not we carry out the analysis using normal trade flows. While the obtained estimates


do not provide a precise quantification of the costs of preferences due to these data limitations, we


nevertheless are able to obtain an estimate of the importance of preferences for trade flows and of the


minimum level of preferences needed in order to have a positive trade stimulating effect on intra-


AFTA trade flows.


Data availability constrains us to limit the analysis to the period of 2001 – 2003. The analysis


is conducted at 6-digit HS level and includes Indonesia, Malaysia, Philippines and Thailand as reporting


countries and the same four countries and Singapore as partner countries. The decision to focus on


only four countries is due to the fact that preferences no longer matter for Singapore and Brunei given


the predominance of zero MFN tariffs. The new members, on the other hand, are yet to fully


implement the CEPT scheme20, and together account for a small share in intra-ASEAN trade. Thus we


excluded those trade flows for which the third country tariffs were zero or equal to the preferential


tariff. The data covers the period 2001-2003 which yields a database of 42,268 observations on bilateral


trade flows.21 Data on geographical variables were obtained from the Paris based Centre d'Etudes


Prospectives et d'Informations Internationales (CEPII).


To measure the importance of trade preferences on intra-ASEAN trade flows we use a gravity


model which explains the volume of bilateral trade flows between countries. The origins of the model


date back to Tinbergen (1962) and Pöyhonen (1963) and the theoretical derivation of the gravity model


has been further developed by Anderson (1979), Bergstrand (1985), Deardorff (1995), Eaton and


Kortum (2002), Anderson and van Wincoop (2003). Anderson and Wincoop (2003) argue that bilateral


trade flows depend on the destination and origin price effects, which are themselves related to the



20 Cambodia, Laos, Myanmar and Vietnam have later deadlines to implement the CEPT scheme: Vietnam by
2006, Laos and Myanmar by 2008 and Cambodia by 2010.
21 Data for Thailand for the year 2001 is not available.




17


existence of trade barriers, which they call “multilateral resistance”. They propose a method which


consistently and efficiently estimates gravity equations by controlling for price effects in both the


destination and origin markets (and for other regional specificities which would be omitted) by


including origin and destination fixed effects in all equations. Since our dataset ranges over time, prices


should also change over time. To control for these changes, we therefore include origin and


destination fixed-effects, interacted with time dummies.22


The analysis requires a variable which would capture the otherwise omitted price effects.


Prices are expected to be different in each sector, thus to correctly account for price effects we include


time varying country specific fixed effects interacted with sectoral dummies.23 The following


specification is used for the regression:


ijktk


tjtkitkijtijijktijkt


uS
TIELanguageDPREFX


++
+++++++=


7


654321 lnlnln


β
ββββββα


(1)


The dependent variable Xijkt, is the bilateral import from country i to country j in period t of


product k. Country i and j are limited to 5 ASEAN countries, namely, Indonesia, Malaysia, Philippines,


Singapore and Thailand and products k are limited to those for which there is an applicable


preferential tariff according to the AFTA. The specification is very similar to those of the aggregate


regressions. The main difference is that instead of using bilateral preferential tariffs or MFN tariffs, we


include the preference margins (the difference between MFN and preferential tariffs relative to MFN


tariffs) in the regressions. The variable PREF captures the impact of different preference margins on


bilateral trade flows, and is constructed in the following way:


Difference
MNF


PTMFNPREF *
)1(
)(ln +


−= (2)
where PT is the preferential tariff, MFN, the third country tariff, and Difference stands for


several dummy variables which capture the difference between MFN and preferential tariffs. A total of


fifteen dummy variables were interacted with the preference margin, each created for every 5%


differential in MFN and preferential rates, all the way up to 50% margin, after which dummies


correspond to margins of 10%.24 The coefficient of the preference margin interacted with these


dummy variables, thus indicates the region of tariff differentials where an impact on bilateral trade


flows can be expected to take effect. Etik and Iitk are time varying reporter and partner fixed-effects



22 See Francois and Woerz (2006) using similar specification.
23 Chen (2004) also uses sector and country specific fixed effects to capture price effects in each sector and
country, however she has a cross-section data and therefore she does not use time varying fixed effects.
24 In other words the fifteen dummies capture when the difference between third country tariffs and MFN tariffs
are 0-5%, 5-10%, 10-15%, 15-20%, 20-25%, 25-30%, 30-35%, 35-40%, 40-45%, 45-50%, 50-60%, 60-70%, 70-
80%, 80-90%, or more than 90%.




18


interacted with sectoral dummies, while Tt and Sk, correspond to time fixed effects and sector specific


fixed effects, respectively.




Results


From the results presented in table 4, it is apparent that distance has a smaller negative effect


on intra-ASEAN trade than what is usually found in the literature. Although high internal land


transport costs are said to characterize much of ASEAN, port logistics between the main regional


trade routes (largely involving Singapore) are believed to be cost efficient.


Turning to the role of preferences, fifteen variables were included in the regression to capture


the importance of preference margin on trade flows. Results reveal that the preference margin has a


negative significant effect on trade when the difference between third country tariffs and preferential


tariffs are lower than 5 percent. This might be because of the costs of requesting the preferences, such


as administrative costs, and the costs of complying with the rules of origin requirement of the


preferences are higher than the benefits would be from obtaining preferential treatment. When the


difference between preferential and MFN tariffs are between 5 to 10 percent, the coefficient remains


negative but becomes insignificant. While margins of 10 to 25 percentage points register a slightly


positive effect, the coefficient is insignificant. Preferences start to have a trade stimulating effect only


when preferential tariffs are at least 25 percentage points lower than the MFN rates. These results


suggest that the costs of requesting preferences within AFTA might be in the range of 10-25%.


Nevertheless, one has to bear in mind that these results are not based on actual utilization rates but


normal intra-regional trade flows which do not take into account whether preferential tariffs were


actually applied or not.


The cost estimates obtained are somewhat larger than those found in the literature for other


preference schemes. Estimates for EFTA countries by Herin (1986) are around 3%, for other EU


schemes the range of estimates is between 4-4.5% (see Manchin 2006) and 6-8% (see Cadot et al.,


2005). Cost estimates for NAFTA are around 6% (see Carrère and de Melo, 2004). Estimates that the


costs of documentation and the administration of origin rules, which is the principal part of increased


costs for preferential trade, impose costs on exporters equivalent to some 3 percent of the value of the


goods traded in the case of EFTA countries. Manchin (2006) finds that costs of requesting preferences


for ACP countries under the Cotonou preference scheme of the EU is around 4-4.5 percent of the


value of goods traded. More recent work on NAFTA by Carrère and de Melo (2004) finds that average


total compliance costs were 6.2% in 2001. Using double-censored Tobit estimation techniques, they




19


obtain a compliance cost estimate of 3.9% for products where the utilization rate is below 100%.25


Estimating the costs for NAFTA, Cadot et al. (2005) estimates the trade-weighted compliance


(administrative) costs to be 6.8% (1.9%) and for the Pan-European preference scheme to be around


8% (6.8%).




Interestingly, for products with very high preference reduction, the impact of preferences is


reversed and turns negative. The immediate explanation that comes to mind are the presence of


NTMs that inhibits trade, the negligible supply of the product within the region, or redundancy due to


other regional import substitution instruments in place.


A dummy variable was included in the regression (see second column in Table 4) capturing the


effects when traders can choose between satisfying the value-added requirement or an alternative rule


requiring specific production processes to be performed in order to obtain the originating status for


the product. The variable is significant and the coefficient is negative indicating that trade in these


products is lower than what would be normally expected. The results imply that even with providing


an alternative rule for origin determination the requirements for obtaining originating status for these


products might still be too restrictive. It is also true that ASEAN sources its textiles imports largely


from outside the region such as China, US, EU and South Asia. This would imply that the amount of


preferential margins given textiles, are insufficient to alter the competitive position of regional


producers vis-à-vis their non-ASEAN counterparts.


Table 5 examines in detail some of the products that register the highest margin of


preferences, looking at the incidence of non-tariff measures, and the value of imports as a share of


total intra-ASEAN trade. For Thai imports of women’s / girls’ silk blouses (HS 620610) from


ASEAN, for instance, a preference margin of 60 percentage points is applicable, but out of the total


imports of Thailand for this product, only 5.58% is sourced from ASEAN. In fact, for half of the


product groups in this list, trade shares hover around the 1 percent range. This propensity to extend


high preferences on products where little or no intra-ASEAN trade takes place is sometimes referred


to as the ‘snow-plough’ effect (Menon, 2005), referring to the failed ASEAN Preferential Trading


Arrangement26 where preferences are given mostly to trade-irrelevant products such as snow-ploughs.


Incidentally, a remnant of this proverbial example can still be seen here: (HS 870310), vehicles


especially designed for traveling in snow.





25 See also Anson et al. (2005), who estimate that in the case of NAFTA average compliance costs are around 6
percent, offsetting the preferential tariff differential of about 4 percent. Administrative costs chewed up about
half of the value of preferential access for Mexican firms.
26 The ASEAN Preferential Trading Agreement (PTA) was instituted in 1977.




20


Countries that confer the highest margins also appear to be the ones that impose non-tariff


measures on these same products. Indonesia, Malaysia, Philippines and Thailand, for instance, offer


high margins for vehicles in the HS 870310 category, but all four countries likewise impose non-tariff


measures on that product. Malaysia also imposed quantity control measures on vehicle products, some


of which register the highest margins found in ASEAN (148%). The coincidence of large tariff


discounts and NTMs, clearly reveal the remaining areas of import substitution which are resistant to


liberalization even if limited to AFTA countries.


The only high margin item in table 4.5 with a large share in total intra-ASEAN imports is


vehicle bodies (HS 870710), 97% of which consists of Malaysian imports from Thailand. Here,


imports are mainly driven by an industrial complementation scheme27, wherein the buyer, source, and


brand are pre-specified under the terms set by the said regional program. Other than tariff


preferences, products included in this program also enjoy local-content accreditation, and other non-


tariff incentives. The large margins observed here for vehicle bodies are therefore likely to be


redundant, and moreover, they originate not from the importer, which is Malaysia, but from the


principal exporter, Thailand. The substantial differential in preferences in this case therefore merely


reflects Thailand’s import substitution policy in this sector, as shown by the high MFN rates of 80% .


Mapping trade values into various categories of differentials between MFN and CEPT rates,


one notes that the largest bulk of intra-ASEAN5 imports fall into category for which preferences do


not have a significant effect on trade. This can be gleaned in table 6 which presents the share of


imports eligible under three ranges for preferential tariffs margins: 60% and above; between 60 and


25%; and more than 0% but less than 25%. Only about 8% of eligible trade flows fall into the


category where preferences may have a positive trade stimulating effect, representing about 3% of total


intra-ASEAN28 imports of Indonesia, Malaysia, Philippines and Thailand.


One important reason for preference underutilization in ASEAN may be found in the nature


of the regional production chains where non-ASEAN import content could be very high. Significant


part of the manufacturing sector in ASEAN has been established through FDI by multinationals who


bring in major components from parent companies outside the southeast Asian region. Although the


rules of origin of AFTA requiring at least 40% cumulative regional content could be considered


relatively liberal compared to some other regional agreements due to full cumulation and the relatively


lower value-added required, electronics and electrical products, for instance, which make up approx


40% of intra-ASEAN trade, typically have an ASEAN value added component of only 8 – 15%


(Dennis and Yusof, 2003).

27 The Brand-to-Brand Complementation Scheme was set in 1988 to encourage joint production in ASEAN.
This was later phased out in 1995 and incorporated into a new ASEAN Industrial Cooperation (AICO) Scheme.
28 Intra-ASEAN imports are limited to imports from Indonesia, Malaysia, Philippines, Thailand, and Singapore.




21


5. Conclusions


Proliferating preferential trade agreements in East Asia containing different rules of origins have


important implications for economic integration in the region. The expansion of separate FTAs is


likely to increase administrative costs for traders. If rules of origins are considerably different between


agreements, not only administrative costs but also production costs would be higher for firms. Costs


caused by these differences are likely to be higher for small producers than for large producers


operating in the hubs. The costs of operating in several preferential trade agreements might become so


high that producers in the spoke countries might only be able to trade under one single preferential


channel. Extending the same cumulation and origin determination rules between FTAs could greatly


reduce the costs for traders.


Lessons from EU experience indicate that there are a number of factors which could further


lessen the negative effects of restrictive rules of origin schemes. The burden of production costs


induced by restrictive rules of origin can be somewhat reduced by allowing less restrictive cumulation


rules (such as diagonal or full cumulation), allowing duty drawback, outsourcing and higher de minimis


levels. Furthermore, administrative costs can also be reduced by more trader ‘friendly’ approaches,


such as using self-certification methods.


The empirical analysis conducted in this paper aimed to assess the potential impact of


preferences on trade flows under AFTA and to provide an approximation for the costs of requesting


preferences. Although the empirical analysis could not be carried out using data on utilization of


preferential tariffs, nevertheless the results suggest that CEPT tariffs might be expected to be exploited


when difference between third country tariffs and preferential tariffs are higher than 10-25 percent.


According to our estimate the positive effects of preferences becomes significant when the preference


margin is higher than 25 percent which covers 9.2% of total sum of tariff lines in Indonesia, Malaysia,


Philippines and Thailand, and accounts for 7.8% of the aggregate value of their joint imports. The


rough utilization rate estimate of 5% (of total import value) based on firm interviews thus comes


rather close to the regression estimates derived here.


The effects of margins below 5%, and those above 80% have a significant negative effect on


trade flows; the former implying that administrative and other costs related to obtaining preferences


exceed the benefits due to margins; and the latter due to the larger incidence of NTMs in these


products, or the simultaneous implementation of a regional program which is exerting a more


determinant role on production and trading patterns.


The proliferation of overlapping FTAs, and the resulting increase in the potential back-doors


through which preferences could spill-over to non-partners, have made the imposition of rules of


origin an ever more important instrument to ward off trade deflection. The findings in this paper,


however, highlight the complexities and the consequent costs brought about by the implementation of




22


these rules. Whether or not the rules of origin as they are now, will be kept as a necessary good, or


discarded as an unnecessary evil inevitably depends on whether FTAs are motivated by regional


import-substitution or by a truly outward-oriented trade policy strategy.




23


References


Brenton, P., 2003. ‘Notes on Rules of Origin with Implications for Regional Integration in South East
Asia’, World Bank, Washington DC, mimeo


Brenton, P., Manchin, M., 2003. Making EU Trade Agreements Work: The Role of Rules of Origin.
World Economy, May 2003, vol. 26, no. 5, pp. 755-769


Cadot, O., Carrere, C., De Melo, J., Tumurchudur, B., 2005. Product Specific Rules of Origin in EU
and US Preferential Trading Agreements: An Assessment, CEPR Discussion Paper No. 4998


Carrière, C., de Melo, J., 2004. Are Different Rules of Origin Equally Costly? Estimates from NAFTA.
CEPR Discussion Paper No. 4437.


Estevadeordal, A., Suominen, K., 2005. Rules of Origin in Preferential Trading Arrangements: Is All
Well with the Spaghetti Bowl in the Americas? Economia 5(2): 63-92.


Herin, J., 1986. Rules of Origin and Differences Between Tariff Levels in EFTA and in the EC. EFTA
Secretariat, Geneva.


Hoekman, B., 1993. Rules of Origin for Goods and Services, Conceptual Issues and Economic
Considerations, Journal of World Trade, 27 (4):81-99.


Inama, S., 2003. Trade Preferences for LDCs: An Early Assessment of Benefits and


Possible Improvements. UNCTAD, ITCD/TSB/2003.


JETRO, 2004. “ASEAN’s FTAs and Rules of Origin,” Japan External Trade Organization Overseas
Research Department


Manchin, M., 2006. Preference utilisation and tariff reduction in EU imports from ACP countries.
World Economy, forthcoming.


Manchin, M., Pelkmans-Balaoing, A., 2006. Clothes without an Emperor: Analysis of the Preferential
Tariffs in ASEAN. Tinbergen Institute Discussion Paper Series. Rotterdam.


Zedillo, E., P. Messerlin, Nielson, J., 2005. Trade for Development Task Force on Trade. UN
Millennium Project, London.




Web Sources used for FTA Rules of Origin Agreements:


http://app.fta.gov.sg/asp/fta/ourfta.asp (for Singapore- Australia; Singapore – New Zealand;
Singapore-Japan; Singapore-Korea; Singapore- New Zealand; Transpacific SEP)


http://www.aseansec.org/12025.htm (for AFTA; ASEAN-China; ASEAN-Korea)


http://www.bilaterals.org/article.php3?id_article=3564 (for Japan-Malaysia EPA)


http://www.dfat.gov.au/geo/new_zealand/anz_cer/anz_cer.html (for Australia-New Zealand CER)


http://www.dfat.gov.au/trade/negotiations/aust-thai/tafta_toc.html (for Thailand-Australia Free
Trade Area)


http://www.mfat.govt.nz/tradeagreements/thainzcep/thaiindex.html (for Thailand-New Zealand
CEP)




24


Tables


Table 1: Import content of selected sectors in East Asia, 2001
Sectors


country textiles clothing leather chem
motor
vehicles


transp
equipt.


elect.
mach.


mach &
equipt


other
mfg,


Indonesia 27.42 6.56 8.44 29.33 25.12 40.09 23.09 56.88 9.37
7.78 15.52 5.51 4.52 6.01 3.25 6.83 2.52 2.05
Malaysia 38.04 39.24 73.23 27.36 35.95 29.53 44.08 34.10 39.92
10.02 9.37 4.70 4.93 7.25 5.62 2.83 7.99 6.13
Philippines 37.80 40.71 26.72 38.67 44.94 23.72 70.23 56.62 18.67
13.02 14.30 8.46 13.23 17.14 7.28 45.02 31.26 4.14
Singapore 51.15 44.35 34.56 42.19 41.75 36.17 83.19 58.24 46.29
6.57 5.71 6.28 3.07 4.68 7.37 1.42 2.51 0.00
Thailand 23.26 12.95 26.08 22.72 38.07 63.94 57.22 48.86 27.60
6.64 10.50 5.05 2.33 8.53 5.67 5.23 3.85 0.00
ASEAN 35.53 28.76 33.81 32.05 37.16 38.69 55.56 50.94 28.37
8.81 11.08 6.00 5.62 8.72 5.84 12.27 9.63 2.46
rest of
ASEAN 23.26 12.95 26.08 22.72 38.07 63.94 57.22 48.86 27.60
5.37 6.13 4.29 2.89 5.05 5.45 3.75 2.44 3.31
China 11.00 10.60 8.33 12.84 12.69 11.50 35.65 13.46 8.63
4.78 5.11 3.72 3.63 5.47 5.13 7.57 3.89 2.78
Japan 10.17 6.95 11.10 8.44 1.67 5.11 8.23 5.29 6.12
3.26 2.83 2.41 2.87 1.66 1.69 2.49 1.48 1.43
Korea 19.31 16.02 35.11 19.51 10.13 18.26 36.50 17.81 15.48
8.17 8.31 6.41 8.73 7.41 5.33 6.41 4.62 5.16
Australia 14.15 29.72 22.08 17.98 24.02 24.91 32.46 20.25 13.01
13.82 20.96 21.00 18.84 16.81 15.89 11.20 12.89 10.25
New Zealand 14.15 29.72 22.08 17.98 24.02 24.91 32.46 20.25 13.01
13.82 20.96 21.00 18.84 16.81 15.89 11.20 12.89 10.25
Source: Authors’ calculations based on WITS trade data




25


Table 2: Rules of Origin in East Asian FTAs
Change of


Tariff
Classification


Value Added
Dom. or
Import Content


Specific
Manufacturing
Process


Cumulation


Tolerance


ASEAN FTA
(AFTA)


Yes29 Regional (40%) diagonal


ASEAN-China
(ACFTA)


Yes Regional (40%) diagonal


ASEAN-Korea
(AKFTA)


Yes Regional (40%) diagonal


Singapore –
Japan (JSEPA)


Yes Dom. (60%) Yes Bilateral product specific


Singapore -
New
Zealand
(ANZSCEP)


Dom. 40% Bilateral


10


Singapore –
Australia
(SAFTA)


Dom.
50% (30% for
some
products)


3%


Singapore-
Korea (KSFTA)


Yes 45-55% Bilateral 10%30


Thailand-
Australia
(TAFTA)


Yes 40-45% Yes Bilateral 10%


Thailand- NZ
TNZCEP


Yes, product
spec.


Yes Bilateral 10%


Malaysia-Japan
(JMEPA)


Yes, product
spec.


Dom. 40%
(product
specific)


Bilateral Only from
ASEAN
(product
specific)


Trans-Pacific
TRANSEP31


Yes 45-50% Yes Diagonal 10%


Australia – NZ
(ANZCER)


50% Bilateral 2%





29 Applicable for textiles, and wood-based products, iron & steel as an alternative rule, and for wheat & flour as


an exclusive rule.
30 For yarns and fibres used for clothing and textiles products 8% applies; the de minimis rule does not apply to


agricultural products or applies with restrictions.
31 Strategic Economic Partnership (SEP); members: Brunei, New Zealand, Chile and Singapore.




26


Table 3: Importance of preferences in 2001/2003 (in thousand US$)


0 0.5 - 5 6 - 10 11- 15 15< excl/spt 0 0.5-5 6 - 10 11- 15 15< 0 3 5
Indonesia


2001 40.58 53.06 2.91 0.36 0 3.21 52.28 37.54 5.16 0.43 1.38 40.58 20.01
29.41 66.59 3.23 0.74 0.63 29.41 49.06


2003 38.38 44.35 3.19 4.17 0 9.92 51.38 25.21 6.99 1.49 5.9 38.38 30.00
28.59 66.62 3.86 0.87 0.04 28.59 51.84


Malaysia
2001 68.57 27.91 1.81 0.54 0.09 1.08 80.19 5.39 4.32 5.38 3.64 68.57 9.9


49.29 7.25 2.33 0.74 0.04 49.29 32.03
2003 66.79 28.9 1.7 0.36 1.38 0.88 78.67 4.92 4.7 5.84 3.92 66.79 9.4


49.13 43.53 4.25 2.01 0.9 49.13 31.98
Philippines


2001 43.6 52.08 2.46 0.82 0.18 0.86 64.33 26.97 4.91 1.23 0.65 43.6 33.25 10.4
17.89 77.5 3.93 0.36 0.34 17.89 40.34 31.07


2003 52.59 41.76 3.49 0.21 0.3 2.95 65.97 24.38 4.77 2.60 1.63 52.59 30.04 11.16
18.46 76.53 4.08 0.45 0.49 18.46 39.14 31.28


Thailand
2001 35.93 59.19 2.36 2.43 0.09 0.01 54.31 13.26 1.97 19.37 11.00 35.93 32.00


4.68 84.71 5.85 4.62 0.33 4.68 61.02
ASEAN-4


2001 47.17 48.06 2.38 1.04 0.09 1.29 62.78 20.79 4.09 6.60 4.17 47.17 18.08
25.32 59.01 3.84 1.62 0.34 25.32 43.3


2003 52.59 38.33 2.79 1.58 0.56 4.58 65.34 18.17 5.49 3.31 3.82 52.59 16.85
32.06 62.23 4.06 1.11 0.48 47.78 44.39


CEPT Rates Preference Margins Most common CEPT


Note: Shares in terms of total tariff lines (HS6) are reported in italics.
Data for Thailand is incomplete for the year 2003.
Source: Manchin & Pelkmans-Balaoing (2006)




27


Table 4: OLS regressions results
dependent variable: log of imports
Ldistance -0.211 -0.214
(0.041)*** (0.041)***
Common language 0.188 0.188
(0.055)*** (0.055)***
Difference1 (0-5)* -0.059 -0.057
(0.026)** (0.026)**
Difference2 (5-10) -0.034 -0.031
(0.036) (0.036)
difference3 (10-15) 0.018 0.018
(0.047) (0.047)
difference4 (15-20) 0.045 0.049
(0.057) (0.056)
difference5 (20-25) 0.092 0.094
(0.070) (0.070)
difference6 (25-30) 0.194 0.197
(0.081)** (0.081)**
difference7 (30-35) 0.392 0.392
(0.119)*** (0.119)***
difference8 (35-40) 0.339 0.337
(0.181)* (0.181)*
difference9 (40-45) 1.080 1.085
(0.333)*** (0.333)***
difference10 (45-50) 0.968 0.934
(0.277)*** (0.277)***
difference11 (50-60) 0.700 0.695
(0.352)** (0.351)**
difference12 (60-70) -0.310 -0.300
(1.119) (1.119)
difference13 (70-80) 4.020 4.044
(2.259)* (2.258)*
difference14 (80-90) -11.106 -11.067
(4.455)** (4.451)**
difference15 (90- -5.155 -5.176
(2.329)** (2.327)**
Substantial transformation -0.932
(0.112)***
Observations 42268 42268
R-squared 0.11 0.11
*Difference between preferential and MFN tariffs (in % points) in parenthesis
Time fixed effects; sectoral dummies and time varying sector-specific reporter and partner fixed effects are
included in the regressions. Standard errors in parentheses


* significant at 10%; ** significant at 5%; *** significant at 1%





28


Table 5: Incidence of non-tariff measures on products with high preferential margins (2003)
high margin products HS6


code
preference
margin of
(in %)


share of intra-
ASEAN4 trade


NTM incidence*


Compound alcoholic preparations


330210 87.5
IDN
(0 SGP,
MYS)
(1 PHL)
(5 THA)


10.96
(2.06)**




women’s/girls’ silk blouses 620610 60.0
THA
(0 SGP;
13.75 IDN;
15 MYS)


5.58
(5.48)


Thailand – import license


Vehicles specially designed for
travelling on snow, golf cars &
similar vehicles


870310 70.0
IDN
(23.36
MYS)


1.7
(0.0)


Indonesia – 6100 , 8100
Malaysia – 6170


Vehicles w/ spark-ignition internal
combustion reciprocating piston
engine, of a cylinder capacity
exceeding 1,500 cc but not
exceeding 3 000 cm3


870323 100.6 MYS
65.0
THA
36.67 IDN
25.0 PHL


10.74
(10.7)


Indonesia – 6100 , 8100
Malaysia – 6100
Philippines – 6100
Thailand – 6170


Vehicles w/ spark-ignition internal
combustion reciprocating piston
engine, Of a cylinder capacity
exceeding 3,000 cc


870324 148.85 MYS
57.5
THA
40.0 IDN


0.7
(0.6)


Indonesia – 6100 , 8100
Malaysia – 6100
Philippines – 6100
Thailand – 6170


Vehicles w/ compression- ignition
internal combustion piston engine
(Diesel /semidiesel), Of a cylinder
capacity exceeding 1,500 cc but not
exceeding 2 500 cm3


870332 36.67 IDN
25.0 PHL


1.4
(1.4)


Indonesia – 6100 , 8100
Malaysia – 6100
Philippines – 6100
Thailand – 6170


Vehicles w/ compression- ignition
internal combustion piston engine
(Diesel /semidiesel), Of a cylinder
capacity exceeding 2,500 cc


870333 148.33 MYS
40.0 IDN
25 PHL


0.9
(0.9)


Indonesia – 6100 , 8100
Malaysia – 6100
Philippines – 6100
Thailand – 6170


Components, parts, accessories for
assembly of motor vehicles


870390 100.6 MYS
75.0 IDN


10.3
(9.6)


Indonesia – 6100 , 8100
Malaysia – 6100
Philippines – 6100
Thailand – 6170


Bodies (incldg cabs), for the
vehicles of hdg. 8703


870710 75.0 THA
25.0 MYS


45.69
(45.69)


Malaysia – 6170


Bodies (incldg. cabs), for the
vehicles of hdg. 8701 to 8705, excl.
8703


870790 75.0 THA 7.3
(6.0)




Motorcycles w/ reciprocating
internal combustion piston engine


870020 67.0 THA
36.45 MYS
25.0 IDN
25.0 PHL


7.3
(7.3)




* Source: ASEAN Secretariat database of Non-Tariff Measures
* *Share of intra-ASEAN10 trade in parenthesis
Note: NTM codes: 6100 – non-automatic licensing (quantity control measure); 6170 – non-automatic licensing
(discretionary import license); 8100 – Technical regulations.





29


Table 6: Breakdown of intra-ASEAN trade according to preferential margins


Above 60% Between 60 and 25% Below 25%
value Share of


total
value Share of


total
value Share of


total


Total eligible
trade


Indonesia
number of product codes 15 0.2% 60 0.9% 6261 98.8% 6336
value of imports 13892 0.3% 277840 5.9% 4390452 93.8% 4682184
Malaysia
number of product codes 17 0.1% 1367 10.8% 11288 89.1% 12672
value of imports 8023 0.1% 784266 5.0% 14843424 94.9% 15635714
Philippines
number of product codes 0 0.0% 96 0.8% 12077 99.2% 12173
value of imports 0 0.0% 86117 1.7% 4952212 98.3% 5038329
Thailand
number of product codes 16 0.1% 2365 21.3% 8706 78.5% 11087
value of imports 211705 2.1% 1651128 16.0% 8449928 81.9% 10312761
Total
number of product codes 48 0.1% 3888 9.2% 38332 90.7% 42268
value of imports 233620 0.7% 2799351 7.8% 32636016 91.5% 35668987





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