Policy Issues for the ASEAN Economic Community: the Rules of Origin

Striking a balance between trade facilitation and preventing trade deflection is the single most difficult challenge with regard to the issue of rules of origin (ROO). ASEAN ROO is already considered as among the simplest in the world and still, in practice, results fall short of expectations. Haddad (2007) made the following observations about the ASEAN ROO: (1) low AFTA preference utilization rate, (2) difficult compliance even for supposedly simple value-added rule, (3) administrative cost of compliance to prove origin acting as deterrent, (4) low margin of preference for goods traded within ASEAN, and (5) the bulk of intra-ASEAN trade occurring in commodities where preference margins are below the threshold that would justify the cost of compliance.
Lessons from the EU experience indicate that there are a number of factors which could further lessen the negative effects of restrictive rules of origin schemes. This is related to the wide spectrum of ROO among the various East Asian FTAs. According to Manchin and Pelkmans-Balaoing (2007), the burden of production costs induced by restrictive rules of origin can be somewhat reduced by allowing less restrictive cumulation rules (e.g. 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 self-certification methods.
The reforms in ASEAN ROOs are indeed heading toward the direction of less restriction and simplification as described by Manchin and Pelkmans-Balaoing (2007): 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 products total value. Very early on in the formation of AFTA, it was recognized that the 40 percent 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 rule for determining the origin of the product as a general alternative rule applicable to all products which cannot comply with the 40 percent 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. As of last year (2006), the change of tariff heading rule is fully endorsed for four sectors: wheat-flour, wood-based products, aluminum products and iron and steel.
Forging ASEAN in an effective regional economic bloc and eventually an economic community, however, would entail more fundamental structural reforms. The argument by the 2003 McKinsey report that market fragmentation lies at the heart of ASEANs competitiveness challenge is rather simplistic. Fortunately, the six projects currently being undertaken by the Economic Research Institute for ASEAN and East Asia (ERIA) address these fundamental issues. These studies deal primarily with supply side constraints focusing on enhancing the capability of ASEAN member countries to engage with each other and other countries more effectively and meaningfully.
In the medium term, ASEAN member countries can push for an East Asia Free Trade Area that will consolidate the various bilateral and sub-regional FTAs and therefore overcome the noodle bowl syndrome. This would be a direct result of harmonizing the various ROO. It goes without saying that the ultimate or long-term objective would be an equitable and efficient multilateral trading system anchored on lower MFN rates under the auspices of the WTO.