Making RCEP successful through business-friendly rules of origin

The massive Regional Comprehensive Economic Partnership presents a major trade opportunity for Asia but there are still critical details that need to be worked out.

Expectations are high for the benefits to be gained from Regional Comprehensive Economic Partnership (RCEP), which partners Southeast Asian nations with Australia, the People’s Republic of China, Japan, New Zealand, and the Republic of Korea.

This massive deal, which includes 15 nations and 2.2 billion people who account for 29% of global gross domestic product, offers the classic benefits of a free trade agreement: the elimination of tariffs. However, these potential tariff-cutting “quick wins” are conditional on compliance with a key component in the pact: the “rules of origin”.

By determining the origin of a product, rules of origin are the plumbing of a free trade agreement. Only goods originating in the RCEP region will be granted duty free or reduced rate of duty when exported to regional partners. Compliance with the rules of origin is subject to substantive and administrative requirements that a product is genuinely originating in RCEP area.

These requirements include a certain amount of value added within the RCEP area and a related certificate of origin, or self-certification. Whenever these requirements are not complied with at the time of customs clearance, duty free treatment is denied, dashing the expected benefits of the deal.

Consider the example of a laser manufactured in the Republic of Korea from parts originating in Japan. With no RCEP agreement in place, the parts to manufacture such a laser are subject to a most favored nation duty of 8% when imported in the Republic of Korea from Japan.

In addition, a duty of 2.4% is applied when the finished laser is exported from the Republic of Korea to the People’s Republic of China, assuming that the rules of origin under their free trade agreement are met. With a full implementation of RCEP commitments, no duties will be collected in this value chain as long as rules of origin and related procedures are in compliance. In contrast, if rules of origin requirements are not met, the most favored nation tariff of 6% will be paidhttps://flo.uri.sh/visualisation/5224852/embed?auto=1A Flourish chart

This raises essential questions.

Are the potential savings from RCEP duty reduction sufficient incentive for the private sector to comply with rules of origin?

Most-favored nation tariff rates currently vary from 0.3% in Brunei to 13.1% in Korea with an average of 5.6% for all RCEP countries. At the end of the tariff phasing down period, most of these tariffs will be down to zero within the RCEP region. Combined with high intra-regional trade values, this leaves no doubt that these significant preference margins – the difference between the most-favored nation applied rate of duty and the preferential rate (3.6 percentage points in the People’s Republic of China-Republic of Korea free trade agreement example above) – could trigger substantial tariff savings. This in turn could be highly profitable for the Asian small and medium-sized enterprises that have suffered the most from the pandemic.

Are the RCEP rules of origin business-friendly enough to ensure that firms will find profitable to comply with such rules?

Previous studies showed that successive iteration of the rules of origin in the Association of Southeast Asian nation countries have not materialized into a rules-of-origin business friendly environment. Thus, the Asian region has yet to demonstrate the capacity to lead this area. So what about RCEP?

RCEP has adopted the concept of product specific rules of origin and regional value content, similar to other regional trade agreements. RCEP rules of origin provide ample scope for cumulation, a facility that allows inputs from the RCEP region to be counted as local when manufactured in a RCEP party. Yet, there are other key determinants to gauge how business friendly are the RCEP rules of origin.

Human beings travel with passports, and goods with a certificate of origin provided by government authorities or by self-certification of exporters or importers. Documentary evidence of origin has affected the implementation of various free trade agreements for decades. In this area, the RCEP has not fully embraced the trade facilitating principle of self-certification.

In addition, other ancillary documentary requirements are playing a fundamental role in the decision of firms to utilize RCEP as well as in the effective implementation of tariff phase out. These include direct consignment, third country invoicing, and back-to-back certificates.

Are RCEP rules of origin providing incentives to the private sector to make use of RCEP trade preferences above concurrent free trade agreements in the region?

Firms are profit seeking. A tariff free environment in RCEP provides them an incentive to source inputs within the region in order to enter duty free in the target RCEP partner. However, if these benefits are uncertain or conditional upon administrative costs, firms may decide to forfeit such opportunity, despite potentially high preference margin.

In RCEP, several provisions leave scope for interpretation to implementing authorities and RCEP has not fully embraced the principle of self-certification and other related best practices. This may reduce the predictability of the concessions under RCEP and its economic effects in the long run, especially in comparison with existing free trade agreements in the region.

Based on the above, to maximize the benefits of RCEP, we recommend the following policy actions:

RCEP trade and customs specialists should draft uniform regulations on the implementation of rules of origin borrowing from the experience of the North American Free Trade Agreement and the United States-Mexico-Canada Agreement on trade. These uniform regulations should have legal value and complement the RCEP agreement.

RCEP members should activate as soon possible the built-in review of the rules of origin certification procedure with a view to converge on self-certification and related business friendly provisions. The review should be supported by analytical studies on best practices to eliminate grey areas on rules of origin and ensure that the potential benefits in terms of trade and economic development of the Asian region are maximized.

As a monitoring tool of the RCEP agreement effectiveness, member states should make public utilization rates of RCEP using the concept adopted at the World Trade Organization.

Free trade deals like the Regional Comprehensive Economic Partnership are impressive at first glance but if rules of origin are not worked out in a business-friendly manner, they won’t succeed.  The RCEP agreement provides a built-in mechanism to resume unfinished business without going back to the drawing board. This great opportunity should not be missed.

This blog post is part of a series by the Asian Development Bank and Thinking Machines Data Science, Inc.