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Streamlining NAFTA’s Rules of Origin

Posted July 07, 2017

As the governments of Canada, the United States and Mexico sift through a flood of public input from concerned stakeholders and interest groups regarding next month’s talks on modernization of the North American Free Trade Agreement in order to formulate their respective negotiating positions, updating the pact’s fundamental “rules of origin” is certain to top the list of priorities being considered by each country.  

A timely new research paper from the Peterson Institute for International Economics examines the agreement’s existing rules of origin – that were designed more than 25 years ago, before the global supply chain revolution – to determine whether they need to be tightened to prevent foreign goods from illegitimately using NAFTA trade preferences or loosened to improve efficiency.

The report’s author, economist Caroline Freund, finds that NAFTA rules of origin are already extraordinarily strict and highly complex, as compared with rules in other free trade agreements. Therefore, she concludes that tightening the rules would negatively impact producers and result in higher prices for consumers, without necessarily guaranteeing more regional content will end up in final products.

Such a move Freund contends could even perversely lead to lower content from NAFTA countries in final goods and disrupt regional supply chains, as more importers would likely avoid the costly compliance burden associated with NAFTA preferences and instead opt to simply trade under the standard Most Favored Nation tariff structure.

Given the existing complexity of the NAFTA rules of origin, Freund argues in favour of radically streamlining them, with regional content requirements for all goods uniformly set at one rate of, for example, 40-50%, as opposed to the current product-by-product rules in NAFTA.  Replacing the agreement’s cumbersome 304-page Annex describing rules at the product level with a simple regional content rule that can cut across all NAFTA trade would be a huge improvement to the agreement’s mechanics, she maintains.

Another reform proposed by the report is to expand the de minimis threshold under which products do not need to be formally certified, especially for low-tariff products, in order to help small businesses that find compliance with rules of origin too costly and overly burdensome.

Drawing on her experience as a former researcher with the International Monetary Fund and World Bank, Freund also suggests that a modernized NAFTA would benefit significantly from a move towards a global norm that would make it easier for exporters to conform to the rules of origin in different trade agreements and that would also allow for “cumulation” when regional agreements expand to include other countries.

Going forward, Freund advocates coordination on rules of origin among member countries of the World Trade Organization to achieve one simple set of rules that all free trade agreements follow would be a dramatic improvement on the current system, where companies must learn the intricacies of a growing number of unique trade agreements, each with its own product-specific rules, and obtain a corresponding certification. Ideally, the report suggests that a single certification for goods with value added of say at least 50% from the source country could be used for all trade agreements to which the source country is a signatory.