This policy brief will use the hypothetical example of ketchup to show how an FTA like TPP can transform a GVC and its implications.
Shanghai—Participants from more than 250 of the largest textile and garment manufacturing firms and industry associations in the world gathered in Shanghai this week as part of the 2016 China and Asia Textile Forum. The overall economic picture for textile and apparel is decidedly mixed as overall economic growth is slowing, retail sales are off, yet many important apparel markets continue to show rising sales, including new markets within Asia.
One important panel session covered the benefits for textile and apparel producers coming in the Trans-Pacific Partnership (TPP). [Assuming, of course, that US Congress does the right thing and approves the deal—but that is a post for next week after critical primary elections in Florida and Ohio. Keep the calls coming into Congress in the meantime.]
While the TPP does provide significant benefits for many textile and apparel firms in the form of lower tariffs, the complexity of navigating the agreement is substantial. It will provide job security for many, many consultants and legal firms for a long time to come as firms wrestle with new yarn-forward rules of origin for companies that have never had to grapple with these provisions in the past.
The TPP as a whole is a high-quality agreement. The textile provisions—particularly for entry into the American market—are not. It remains needlessly complicated and does not represent anything close to 21st century rules. It does not foster efficient supply chains, will not encourage smaller firms, and basically goes against most of the general momentum of the rest of the agreement.
Many TPP countries granted duty free access to garments on the first day of the agreement. The United States did not, except for a narrow range of products, like some categories of dresses. Some American tariffs will remain in place for a decade.
Some of the final reductions in important categories like denim can only take place after the United States certifies that labor provisions from elsewhere in the agreement have been fully implemented at the five year mark.
But the lucrative American market has always been difficult to enter for textile and apparel firms, so even poor quality TPP rules can make substantial bottom line differences to companies willing to invest the time and effort needed to figure out the new system.
Firms are already moving into Vietnam for spinning and dyeing operations, for example, to take advantage of new opportunities to get into US markets. [Vietnam has the added appeal of the pending EU-Vietnam trade agreement that will provide improved access to the European markets.]
However, not every textile or apparel company can use the TPP. Not every firm is located in a TPP market or is able and willing to move to one. Not all sell products to TPP markets. Not all are going to be able to easily shift sourcing of fabrics from current suppliers, especially.
But all is not lost for textile and apparel companies. Most Asia-based companies may also be able to use provisions in the Regional Comprehensive Economic Partnership (RCEP) negotiations.
RCEP is an ongoing negotiation that brings together 16 parties in Asia—the 10 member countries of ASEAN, plus China, Korea, Japan, India, Australia and New Zealand. Talks are targeted for conclusion this year and there is still time for companies to push for better outcomes that cover textile and apparel products of importance to firms in the region.
The garment supply chain for Asia often includes fabrics sourced from China, India, or Korea, sewn in Cambodia, Vietnam or Indonesia, and sold across the region including into Japan, Australia or China. All these products could be eligible for RCEP benefits, if the rules of RCEP—including tariff cuts and rules of origin—are written to provide better preferences for RCEP member firms.
RCEP will likely be much easier to use than the TPP as well. RCEP should not be using a yarn-forward rule of origin, so manufacturers can source fabrics from across the 16 member countries for inclusion into garments.
Depending on how the rules are written, fabrics might be sourced from outside the region as well, as long as the garments are cut and sewn in RCEP member countries for sale within RCEP member countries. This rule would benefit many garment manufacturers that currently source fabrics from non-RCEP countries like Taiwan. It would allow manufacturers greater flexibility to choose materials from the most suitable source.
Companies from across Asia will have to push their governments to be more ambitious in textiles and garments. Otherwise, important items could be left out of the final provisions and rapidly dilute the utility of the final agreement for firms.
Asian companies are not used to working proactively with governments to shape ongoing trade negotiations. This is, however, a critically important opportunity that ought to be seized by firms. Government officials working on market access for goods, rules of origin and trade facilitation may not know very much about the specific conditions for textile and garment manufacturing in their own country or across the region.
Officials will certainly not know that, for instance, domestic companies could shift an additional 50,000 pieces of dress shirts per month if a key tariff were eliminated into a market. They may not realize that they are fighting to protect a product category that will no longer be manufactured domestically at all or that growth opportunities are best found in a different category that needs the lowest possible tariff or a more favorable rule of origin calculation method.
The rules set down in RCEP are likely to be the rules that govern trade in Asia for the next decade. Using a 16 country agreement will be much easier for companies to use than overlapping sets of existing regional and bilateral agreements. For a start, if the RCEP customs paperwork is consistent, firms will no longer need to fill out six or more different types of customs paperwork to ship products to the 16 markets in Asia.
Firms should plan to attend the next round of RCEP talks in Perth, Australia, during the last week of April and should be talking to their own market access for goods and rules of origin RCEP negotiating officials now.
RCEP helps textile and garment firms that are sourcing and supplying to customers across Asia. But it is also not a panacea. Most of the final customers for companies remain consumers in North America and Europe. RCEP provides benefits for neither market.
***Talking Trade is a blog post written by Dr. Deborah Elms, Executive Director, Asian Trade Centre, Singapore***
I will post materials over the next few days devoted to unpacking the texts and schedules in different elements of the TPP agreement. In an overall document with more than 1200 pages of texts, plus thousands of additional pages of schedules, plus 58 special “side letters,” a fuller explanation and understanding of different provisions will take time. Nevertheless, I will do what I can to provide an early analysis of some striking points from goods, services, investment, and other chapters. For specific information on how the TPP may affect your business, please contact us to start preparing an individualized analysis.
Overall, for many goods firms, the TPP should produce substantial net benefits. Tariffs are dropping across the board. If these rates are translated into retail price reductions, consumers stand to win--sometimes with significant savings possible on future purchases.
Many currently high rates fall as low as 0 as soon as entry into force (EIF). Even drops in lower tariff rates can be critical for companies if they trade in low margin or high volume goods. Most of the tariff reduction benefits for goods from one TPP member country into another TPP member country happen quite rapidly, with the vast majority of tariffs for all members falling to 0 on entry into force. The rules of origin are the same for all (with a few exceptions) TPP countries—once a firm has qualified a product as TPP content, it can ship anywhere across the TPP without reformulation and receive the lower TPP tariff rates or preferences from the agreement.
TPP trade in goods is not free. There are a host of potentially complicated issues that must be sorted out. For sensitive sectors like agriculture, textiles and certain machinery products, using the TPP will provide benefits that may take longer to phase in and are often extremely complicated to understand and use. However, since many of these highly sensitive products are normally just excluded or carved out of trade agreements, firms may still receive significant cost savings from the agreement compared to the status quo. Benefits of the TPP are also substantial, as might be expected, for specific markets like Vietnam where tariff rates have been much higher overall (regularly set at 10, 20, or 40%) than other markets.
There are three key elements of the TPP for any firm trading goods between TPP members. First, the specific rules related to trade in goods. This is shown in Chapter 2 of the agreement. Second, the individual tariff schedules for each of the TPP member countries, plus any other country-specific annexes (that explain, for instance, the tariff rate quotas used by some members and explained further below). Finally, tariff cuts do not matter if the rules of origin (ROOs) employed in the deal make it difficult or nearly impossible for firms to qualify for tariff benefits. Hence, firms also need to check the associated ROOs for their goods in Chapter 3 (and any additional annexes related to ROO issues).
The fine print is important. For example, buried in the 67 pages of texts for market access for goods is a provision to allow Vietnam to continue to prohibit the importation of a wide range of used items. Malaysian firms may be able to access new markets overseas, but will have to check carefully the long list of allowable export duties, taxes and other charges that may negate any new tariff savings. Food and beverage producers will need to be aware of rules around food and food safety (SPS) in Chapter 7 that may impact their goods.
With these caveats in mind, many of the textual provisions in the agreement are quite helpful for companies. For instance, firms can receive, repair and return goods without having to pay new duties and companies can more freely temporarily import goods for trade shows or performances. The rules tighten up the procedures for countries that want to impose import or export license requirements. There are many provisions related to trade in food and agricultural products intended to provide greater certainty for farmers and producers.
The tariffs schedules are extraordinarily complicated in the TPP. Every country has their own format for showing the tariff benefits. For some countries, like Malaysia, the schedule shows basically four columns: the HS or product code, the product description, the current or base rate of tariffs, and a staging category that applies to all TPP members (with some variations in TRQs). Many other schedules break out the TPP members specifically, with columns for each individual member country. While most of these columns are blank (same benefit applies to the whole lot), some have country-specific commitments.
Equally confusing, because the TPP negotiators cannot currently say when the TPP will come into force (fastest schedule could be late 2016 or 60 days after last of the 12 parties finish domestic ratification or potentially 2018 or beyond—see entry into force rules in Chapter 30), the schedules are written with codes. A bewilderingly complex set of codes is explained in the country specific general notes to each member’s annex. A notation like B4 in the American schedules means that whatever the current tariff is, it will be cut down in four equal stages to arrive at 0 duties on the first day of the 4th year of the agreement. [I assume that, during the 60 day period between signing and entry into force, all these notations will be converted to actual dates in the document, making them easier to understand.]
For many firms, the level of tariff reductions is impressive. Vietnam, for instance, will drop tariffs to 0 on entry into force for items currently set at 18-20% on most fish varieties; fruits from 30%; or many paints with 24% tariffs. Mexico’s numbers look extremely impressive with many categories dropping from 20% or higher to 0 on entry into force. [Of course, since Mexico has so many existing FTAs, not all firms currently pay MFN rates, making some of these tariff cuts less impressive in practice.] Australia appears to have been highly ambitious, with nearly all tariffs dropping to 0 immediately and fewer complicated mechanisms for the remainder.
And then we get to the United States and Japan. While there are some very impressive tariff reductions included in these schedules (note that Japan’s schedules as posted are incomplete with tariffs ending at product category 65 out of 99), there are also a host of complications embedded within the schedules.
For example, both countries take substantial advantage of tariff rate quotas (TRQs) to shield domestic producers. Under TRQs, TPP members will have a set quantity of a good that can be sold at a lower tariff. Everything above this rate is charged a significantly higher duty. For both in- and out-of-quota rates, the TPP does cut down the levels and usually provides some (or all) of the TPP members with additional access to the in-quota allocation. The complexity of this system can be shown by a quick glance at the TRQ annexes for various individual members. Japan’s TRQ schedule is 79 pages long. The annex for the United States is 49 pages in length.
To make matters worse, both countries also have a separate document, an annex on tariff differentials. These are essentially the marking rules first used in NAFTA that are intended to provide an additional layer of protection to sensitive sectors. I am way over my own word count quota for this post and cannot go into more detail here, but just note that companies will also need to examine these annexes carefully to determine how they might apply to their inventory for shipment into the U.S. and Japan.
Most of the rules of origin (ROOs in Chapter 3) are product specific. This means that product categories have a corresponding ROO shown in the annex that must be followed to receive the tariff cut. In many cases, the TPP requires that the good be classified into a different tariff category (usually at the 4 or 6 digit level which is less helpful for firms) than the original inputs to qualify. In others, the agreement requires a certain percentage of content from TPP members to be included in the final product. Note that textiles and footwear into the U.S. (in particular) have very complicated ROOs that must be followed to qualify for some very substantial reductions in tariff levels.
To sum up, the TPP is likely to provide a range of benefits for many firms. The cost savings for some companies could be significant and firms might become highly competitive in new, untapped markets. But the complexity of the agreement means that firms will also have to expend significant effort to comb through this massive agreement to determine which benefits apply and which might not. Firms may have to shift sourcing and production to take full advantage of the TPP, which means that companies should start planning for TPP entry into force now.
***Talking Trade is a blog post written by Dr. Deborah Elms, Executive Director, Asian Trade Centre, Singapore***
In the past, governments mostly protected local markets by using tariff barriers. Tariffs, which act like a tax on imports, can raise the cost of foreign goods. If the tariff level is set high enough, foreign companies will simply avoid shipping goods across a customs border since it can be impossible to remain competitive with domestic goods in the face of high tariff levels.
Countries have reduced tariffs after multiple rounds of reductions at the global level. In fact, many people argue that tariffs are no longer an especially big issue. In ongoing free trade agreements (FTAs), the focus has largely shifted from goods to other chapters and different kinds of “sexier” market commitments like services, investment, e-commerce, or intellectual property rights.
Yet tariffs continue to matter. For some sectors—like agriculture—tariff rates charged at the border can be 100%, 330% (some dairy into Canada) or as high as 1400% (for a particular kind of potato into Japan).
Even in sectors where tariffs are generally low or set to zero, such as electronic goods, tariffs can still be important. For example, while global commitments in the Information Technology Agreement (ITA) have eliminated tariffs entirely on some classes of goods, many of the raw materials, parts and components used in the manufacture of more complex electronic goods may continue to be charged tariffs at the border.
Research shows, in fact, that the cumulative effect of even very low tariffs can be quite high—as semi-finished parts and components go back and forth across borders in supply chains, a 2, 5 or 10% tariff can add up quickly.
Tariffs are leveled on the gross value of the good and not on the value-added amount. Firms with long international chains can face significant costs from very low tariffs. Ferrantino showed that a 10 percent tariff across a five stage chain results in a tariff equivalent of 34 percent—and doubling the chain again drives tariff levels up to the equivalent of 75 percent.
Robert Koopman, now chief economist at the WTO, and his colleagues have reported that the effective tariff rate for the United States is 17 percent higher than the nominal rate, 71 percent higher in Hong Kong and 171 percent higher in Mexico. Developing countries, overall, include more intermediate goods into final products, making the impact of tariffs more significant.
Free trade agreements do not entirely solve this problem either. Sebastien Miroudot and colleagues have shown how the amplification of tariffs still takes place under free trade agreements.
The continuing importance of tariffs makes some of the news coming out of regional talks in the Regional Comprehensive Economic Partnership (RCEP) particularly worrying. At the ministerial meeting last month, leaders agreed to cut tariffs on 65% of goods at the launch of the agreement and raise this level to 80% by the time the deal is fully implemented in 10 years.
This news could also be presented another way—RCEP officials have agreed to leave 35% of tariffs untouched at the introduction of the agreement and not address 20% of tariffs even when the agreement is finished.
I am trying to get research underway to determine the actual impact of such policies. I suspect that trade between many RCEP members is currently limited to a small set of tariff lines. If these lines are part of the “excluded” groups of tariff lines, the net impact of RCEP cuts will be modest indeed.
The example I frequently give is to say that snow removal equipment will undoubtedly be “fully liberalized” across RCEP. Given the tropical nature of many RCEP countries, such a concession is basically meaningless—they do not produce, sell, buy, export or import many snow shovels, snowplows, or even snow boots. However, things that are actually traded, including many key agricultural items, will surely be left off, or “carved out,” of the final agreement.
More disturbing still, India has apparently won permission to continue with a “3 tier” offer in tariff cuts. Under the tiered approach, ASEAN countries will receive the 65/80 offer (start at 65% coverage and increase to 80%). South Korea and Japan, in tier two, will be stuck at 65%. Finally, China, Australia and New Zealand will receive tariff cuts on only 42.5% of tariff lines at the outset into India.
Think about that for a moment. India is promising to cut tariffs on less than half of tariff lines. Snow shovels and boots are in. Most commercially meaningful goods are not.
New Zealand, in particular, is trying to fight back and require that India's offer include goods tariff lines that account for 55% of the value of goods traded between the two members. This is more helpful, but still complicated and of less value to businesses than greater liberalization across the board.
Note that India’s coverage levels are not automatically reciprocal. Apparently, China will offer India 42.5% of its domestic market, but Australia is going to be more generous at 80% coverage and New Zealand will start at 65% coverage.
Tariff cuts have to be viewed in tandem with rules of origin (ROOs). It is possible to have relatively modest cuts, but easy-to-use rules of origin and broad cumulation. This makes it more likely that firms will take advantage of RCEP in the future since items produced with content from across the 16 member countries can be more easily included and often receive reduced tariff benefits into RCEP members. A future post will consider where officials seem to be heading in the ROO chapter.
On the bright side, if these provisions remain for trade in goods, the Asian Trade Centre and a host of other consulting firms across the region are likely to have enormous demand in the coming years as companies come to grips with the potential benefits arising from RCEP commitments. To successfully use an RCEP agreement with modest tariff cuts, different levels of commitment, and at least a 10 year phase in period, firms will need very savvy advice and support.
We are standing by to help.
Nay Pyi Taw, Myanmar— The ninth round of negotiations is wrapping up in Myanmar for the Regional Comprehensive Economic Partnership (RCEP). The unbelievably massive convention centre (and Nay Pyi Taw has two convention centres!) is full of serious looking delegates sporting various colored country badges.
Talks are ongoing in a wide variety of working groups, sub working groups, expert groups and the main negotiating committee. Some sessions meet with just ASEAN officials, others with the ASEAN Foreign Partners (AFPs: Australia, China, Japan, India, New Zealand, and South Korea), and others with all 16 parties in the room. Topics include goods, services, investment, rules of origin, customs, intellectual property, competition, legal affairs, and economic and technical cooperation.
I’m even delighted to report that e-commerce has finally moved beyond discussions into a negotiating phase! We attended two previous rounds to promote the inclusion of this agenda item into RCEP.
The mood overall appears to be mixed. Many delegates expected to be attending this round in the wake of provisional agreement of the Trans-Pacific Partnership (TPP) negotiations. Seven countries are involved in both negotiations: Australia, Brunei, Japan, Malaysia, New Zealand, Singapore and Vietnam.
The closure of the TPP would have put considerable pressure on RCEP negotiations. At the moment, talks here remain at a relatively early stage, despite having been underway for more than 2 years.
The original intention was to complete the agreement by the end of this year. The timing had been chosen to link up RCEP with the introduction of the ASEAN Economic Community (AEC). However, when RCEP ministers met in Kuala Lumpur last month, they finally agreed that closure in 2015 was not possible. No new deadline has been announced (which is frankly an excellent idea, given the problems attached to “missing” a deadline).
Instead, ministers suggested that they should redouble their efforts in an attempt to move talks along. Offers have now been exchanged in services and investment.
But this forward progress is partly obscured by difficulties in negotiating market access for goods. These discussions are still stuck in a dispute over modalities. This is trade-speak for the procedures or process under which members will conduct the talks—in other words, at the end of the RCEP negotiations, are the members ready and willing to have one offer that is extended to everyone else or can members offer up different types of commitments for different parties?
At the start of discussions this week, India was pushing for a three-part offer in goods with differing levels of market access or openness to different members. China, Australia and New Zealand, for instance, would have the worst amount of access to the Indian goods markets as members of India’s third tier. Some of ASEAN, by contrast, would enjoy improved access.
The difficulties in locking down the procedures for negotiating in goods is somewhat ironic, given the origination story for RCEP. This megaregional trade agreement got underway as a mechanism to improve supply chain integration in Asia by stitching together the five existing ASEAN+1 agreements (that brought ASEAN together with Japan, South Korea, China, India and Australia/New Zealand). While not all five of these agreements have commitments on services and investment, all did include market access for goods. Thus, the goods negotiations in RCEP should have been the easiest to get underway (even if getting closure could be difficult).
But a multi-part schedule for market access in goods does not provide the kind of seamless integration benefits that make the most sense for companies.
As it stands now, a company that wishes to use either ASEAN agreements or (some) of the ASEAN+1 agreements will struggle to find specific market access schedules. While most goods between ASEAN members can be shipped duty free now, there are some deviations. These exceptions are hard to find.
When it gets to determining market access commitments for services and investment within ASEAN, the situation is even worse. (If you think I am making this up, try to see if your favorite service like chiropractic care or tour guides or opening a 4 star hotel is listed as opened to investment/services access on the ASEAN website or member state websites. The only good news about the lack of clarity is that it leads to a surge of services activities for consultant firms trying to sort these things out for firms.)
But I digress a bit. The general point is that RCEP was intended to make integration easier by linking up 16 important markets in Asia. As we get close to the end of Round 9, the jury is still out on whether this is more or less likely in RCEP.
One thing that has become quite apparent from this meeting, however, is that officials have dramatically expanded the scope of coverage for the negotiations. Working groups are now underway in important areas like sanitary and phytosanitary (SPS) to help (potentially) sort out inconsistent rules around food and food safety standards, and another group is examining standards, technical regulations and conformity assessment procedures. Officials are discussing trade remedies and members even held an experts meeting to start a conversation about government procurement issues.
All of this activity is, I would argue, excellent news. It means that the final agreement is more likely to contain provisions that address the issues on the ground for firms in the region. For instance, companies frequently run into problems with testing procedures for products that vary from country to country and from even entry port to entry port. A product that qualifies as safe in one country may have to undergo expensive and lengthy qualification procedures again in another country. Not all of these tests are strictly necessary and RCEP efforts to streamline and remove duplicative testing procedures could be more important for many firms than cuts in tariff levels.
However, increasing the complexity of the final agreement could make it more difficult to conclude negotiations. With 16 members at very diverse levels of economic development, these talks have already proven challenging to manage. Expanding the agenda sometimes makes it easier to find win-win outcomes than more narrowly focused agreements. But adding more topics can also increase the risks of collapse.
One of the best pieces of news from negotiations this week was the inclusion of a discussion on stakeholder engagement to the leader agenda. In a complex environment with multiple parallel sessions, I think it is more critical than ever to get feedback from participants on the ground. There is no point in flying officials all around Asia to various hot spots like Nay Pyi Taw for a week or more at a time if the deal under discussion does not meet the needs of stakeholders.
In Asia, the connections and formal feedback loops between government and business are weak and often inconsistent. Thus it is not automatic that officials here have a clear sense of what issue areas ought to be top of the agenda and which can be safely discarded or at least minimized.
Finally, as the hiccup in the TPP negotiations have just clearly shown again, failure to line up stakeholder support in advance of closure can lead to disaster. At the end of the day, even countries with varying degrees of responsiveness to constituents will struggle to approve and properly implement an agreement that runs contrary to sentiments on the ground.
If the stakeholder consultation process gets approved, it will fall to companies to step up their own engagements with officials in future negotiating rounds. Otherwise, if the final agreement fails to deliver sufficient benefits to companies and consumers across Asia, firms may share part of the blame.
***Talking Trade is a blog post written by Deborah Elms, Executive Director, Asian Trade Centre, Singapore***