EPA Rules of Origin and Value Added Methodology

My article on Tralac website republished here. (original dated March 2007)

In a March 2005 communication, the European Commission (EC) proposed a radical change to its origin rules and suggested that the reform would simplify processes and make the rules more development friendly. The EC envisages sweeping away the present multiplicity of rules of origin and replacing them with a single rule, based on value addition in the beneficiary country. Under this methodology, a product resulting from the working or processing of imported non-originating materials would be considered as originating if the value added in the country (or in a region where cumulation is permitted) amounted at least to a certain threshold (a minimum "local of regional value content") expressed as a percentage of the net production cost of the final product. 

Value addition is one of the three major criteria to determine last substantial transformation for non-originating inputs in the ACP-EU Cotonou Partnership Agreement. The other two criteria are the Change in Tariff Heading (CTH) test which requires that the tariff-heading of the final product should be different from the tariff-headings of its inputs at the four HS digit code and the Specific Process (SP) test, which requires a product to undergo certain stipulated processes before originating status can be conferred. 

As agreed by ACP Ministers in Port Moresby, Papua New Guinea in June 2006, the negotiating mechanism for the rules of origin in the EPA negotiations will be at the level of the ACP-EU. In this regard, while the harmonisation of the methodology for determining substantial transformation in the EU rules of origin regime is understandable, given that the EU has about forty preferential arrangements with third countries or groups of third countries in total, a proposed move to a single value addition methodology in the ACP-EU EPA negotiations would undermine the ACP negotiating position given its less frequent usage as a sole criteria and comparatively infant stages of regional integration in the ACP.

With regard to the usage of the value added methodology, the recent study by ODI Creating Development Friendly Rules of Origin in the EU found that the value added test has been aplied as the originating test for only about one tenth of the products that poor countries such as ACP countries actually export to the EU. Furthermore the study indicates that the value added test is the second most frequently applied sole substantial transformation criterion after specific processes, with a utilisation of 23.5% across all EU agreements. Taking this into account, a move to this single approach within the ACP could erode the benefits accruing in the EPA negotiations, unless the methodology can accommodate the CTH rules and SP and production methods already triggering trade within the Cotonou Agreement.

Given that the future ACP-EU rules of origin are expected to be an outcome of the EPA negotiations, a single value added approach by the EC would still need to accommodate ACP interests as part of the outcome of the negotiations. The ACP-EU negotiations would therefore need to take into account sound regional economic analysis that meets the objectives of the EPAs, which is development. Any benchmarks under consideration would need to enhance and stimulate trade for this methodology to be feasible across the sectors of interest to the ACP.

In addition, the ACP countries may also consider the following in their negotiations:

The value addition criteria, where it is utilized would rather be costs based rather than the ex-works price. The ex works price currently applied in the Cotonou Agreement may compromise the value of the EPA preferences particularly for landlocked and LDC countries.

Methodology for the valuation of non-originating materials will need to consider that some ACP States to date, still do not have the capacity to implement and apply the WTO or WCO customs valuation agreements.

The methodology should provide reduced local value added thresholds for LDCs and small, vulnerable, island and landlocked States given their unique challenges.

Value added thresholds where they are agreed upon should be as low as necessary to accommodate the diverse objectives of the different EPA regions and sectors of interest given that high or low wages and rents can conceal the true value added levels.

Thresholds will need to be achievable by firms and enterprises across the board and be based on EPA regional economic analysis and specific sectors of interest given that percentages for minimum value addition thresholds can vary significantly between products and sectors. This may arise due to the prevailing labour costs, capital and technology, cost of inputs and the import dependence of the region in terms of intermediates.

Reciprocity in rules of origin will need to be considered given that thresholds will need to accommodate the variance between developed, developing and least developed countries. This may need to be sector specific, such as clothing, textiles and fisheries, given that the ODI study on rules of origin has indicated that value added is not always lowest in low-income countries with some EU countries meeting lower value added thresholds than ACP States in certain sectors in light of technological advances for instance.

ACP defensive rules of origin will need to complement the objectives of ACP sensitive sectors vis a vis the EU and hence the value added methodology may need to consider EU sectoral processes and production advantages as well.

Detailed regional analysis will need to supplement the ACP-EU level negotiations both on the substance and objectives of EPAs. The negotiations should therefore take into account the highly unequal levels of the Parties with regard to regional integration. The concerns around overlapping membership in regional trade agreements and thereby overlapping rules of origin are relevant, if EPAs are to promote regional integration and enhance competitiveness.

The task ahead is indeed momentous. Rules of origin have frequently been identified as the root cause of underutilization of the long standing ACP-EU preference regime. Fortunately, the ACP States now have a historic opportunity to improve upon these rules in order to expand trade and development in their economies. However given the complexity of this issue, divergence in the negotiating strength of the two Parties and ACP regional variances, one wonders if ACP countries will be adequately prepared this year to negotiate reciprocal rules of origin using the value added methodology as the cornerstone of the negotiations.