ADB Economic Working Paper: EU reviewing rules of origin to facilitate LDCs

04 Oct, 2008

The European Union (EU) is currently reviewing its rules of origin as many of the Least Developed Countries (LDCs) have been unable to comply with the double jump or double transformation rule, while Pakistan has seen its market access erode as a result of a successful challenge to its special GSP access to the EU market under the special arrangements to combat drug production and trafficking in the WTO.
This was disclosed in Asian Development Bank (ADB) Economics Working Paper "Extra-EU Imports of Clothing and EU Preferential Trade Policies in the Post-Quota Era", which was prepared by two International experts William E. James and Juan Paolo Hernando.
They highlighted the Position of Asian Suppliers in the Largest World Market for Clothing Imports and said that a number of Asian suppliers are competitive in the sense that they are exporters of clothing to the EU with at most a small reduction in MFN tariffs under GSP and in the case of the People's Republic of China (PRC) with no preference whatsoever. India and Viet Nam have performed well despite having less beneficial market access than other non-Asian suppliers under ACP/EBA or FTA/CU preferences.
Sri Lanka has also done well even though it has difficulty complying with rules of origin in the GSP and EBA/GSP schemes. However, a number of Asian suppliers that are potentially strong competitors have faltered in the EU market since the ATC was implemented and quotas eliminated including among the competitive Asian suppliers (Indonesia, Malaysia, Pakistan, Philippines, Thailand) Cambodia and Lao PDR have also experienced a retreat in their share of the EU market for clothing.
Looking ahead to 2008, they hoped, as the PRC is freed from current quotas, it is very likely that competition will become even fiercer in the EU marketplace. In particular, other than low cost suppliers in Bangladesh, Pakistan, and Viet Nam, most Asian suppliers will have to compete on the basis of quality and service orientation.
The ASEAN and SAARC member countries have some advantages that could be more fully taken advantage of if their own internal barriers to trade in intermediate textile products and related accessories could be relaxed or removed. This would enable them to locate production activities in the most efficient locations within each grouping using the right to cumulate production under the two-step rule of origin. The use of outward processing arrangements has perhaps been somewhat of a luxury in the past but is now becoming a necessity as unit prices are set to decline in the EU market.
Exchange rate movements in a number of Asian countries such as India, Philippines, and Thailand may have some important impacts in this regard and will drive some relocation of production activity to other countries that have remained more firmly pegged to the US dollar, such as Indonesia and Viet Nam, they added.
Exchange rate movements in some of the former large quota holders may also lead to outward investment in clothing at the high end of the market in other more competitive Asian economies. The EU is currently reviewing its rules of origin, as many of the LDCs have been unable to comply with the double jump or double transformation rule. For example, about 90 per cent of firms that export garments in Bangladesh are cut-make-trim producers, and only about 20 per cent of woven fabric can be sourced locally. Hence, most export shipments are unlikely to benefit from duty-free access to the EU market.
In contrast, Canada's GSP scheme for LDCs requires only 25 per cent value-added content, and almost all garment exports from Bangladesh to Canada enjoy duty-free access. Hence, it would be in the interest of Asian LDCs to lobby for a low value-added rule, and to also have it cumulate value across the region. This appears to be a realistic prospect as the EU is currently reviewing its GSP rules of origin and is likely to implement a single value-added rule that permits broad cumulating in the region sometime in 2008.
Some Asian countries are also exploring more formal reciprocal preference agreements with the EU in order to "lock-in" market access, including India, which is engaged in free trade negotiations and ASEAN as a group. Pakistan has seen its market access erode as a result of a successful challenge to its special GSP access to the EU market under the special arrangements to combat drug production and trafficking in the WTO. It may also, therefore, bilaterally negotiate improvement in access through a free trade agreement.
The EU is closely monitoring imports of clothing products from the PRC and may find that new measures are warranted in order to restrain shipments of clothing in 2008 and beyond, including countervailing duties and antidumping measures. While these may provide windfall relief to other Asian suppliers, they cannot afford to sit idly by. Efforts to improve services, facilitate trade and investment, and upgrade product quality and speed delivery times are all likely to be necessary to remain competitive in the EU market, they added.
It may be recalled that the European Union (EU) became the largest importer of clothing in 2007 after overtaking the United States (US), which was the largest market through 2006. The EU market is roughly twice as large as the US market for clothing (using a broad definition) if one includes intra-EU trade, reaching $42 billion in 2006. However, the relevant indicator of size for non-member suppliers is extra-EU imports. Exchange rate movements and the expansion to 27 members in 2007 reinforced the trend toward extra-EU clothing imports exceeding US imports in dollar value.
In this study both experts use HS Chapters 6 and 62 as the (narrow) definition of clothing in order to make it comparable to US Office of Textiles and Apparel (OTEXA) data. Under this definition, EU clothing imports actually first exceeded those of the US in 2006 at $75.4 billion versus $73.9 billion. Working paper revealed that the EU market for extra-EU clothing imports has expanded since the full implementation of the Agreement on Textiles and Clothing (ATC) on 31 December 2004.
Imports by the EU grew to $70.96 billion compared with $80.07 billion in the US in 2005 according to the International Trade Statistics 2006 (World Trade Organisation 2006). The extra-EU market expanded further to $79.6 billion in 2006 compared with $83.0 billion for the US (World Trade Organisation 2007). The expansion of the extra-EU market in volume terms was robust in 2005 and 2006 at 9 per cent and about 7 per cent respectively, although volume was flat in 2007 compared with 2006.
Asian competitive and least developed country (LDC) suppliers have availed of the opportunities the EU market has offered since quotas were eliminated, despite some initial difficulties experienced in 2005 by a majority of the Asian countries. The EU imposed some restrictions on shipments from the People's Republic of China (PRC) beginning in the latter half of 2005, and these restrictions remained in place until January 1, 2008. Future growth opportunities appear to be good, although the complex system of EU preferences and rules of origin may complicate efforts of Asian suppliers to remain competitive.

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