Integral Logistics Management — Operations Management and Supply Chain Management Within and Across Companies

2.1.3 RoO (Rules of Origin), Value Content Requirements in a Global Supply Chain — Global Trading

Intended learning outcomes: Produce an overview on terms such as tariff, free trade agreement (FTA), and free trade area. Explain the concepts of rules of origin (RoO), value content, and tariff heading.

Globalization trends in recent decades have exposed companies to inter­natio­nal competition and high cost pressure, but they also make savings possible through global sourcing. From the point of view of a local economy, this is not always favorable, since shifting value adding elsewhere also entails loss of jobs, which can also result in negative impacts on gross domestic product. That is why there are now increasing attempts at the political level to tie multi­national companies to the local economy, but without inhibiting trade flows between economies. Possible tools for resolving this conflict of aims are free trade agreements and free trade areas in combination with Rules of Origin (see below).

A tariff is, according to [ASCM22], an official schedule of taxes and fees imposed by a country on imports or exports.

As a result of a free trade agreement (FTA), a free trade area (FTA) is a form of preferential trading area where there is fully free trade among members, but each country is free to levy different external tariffs against nonmember countries.

FTAs are used to stimulate trade among member countries and there­fore support the local companies and economies. Two of the most prominent FTAs are the European Union (EU) and the North American Free Trade Agreement (NAFTA — replaced by the USMCA agreement since July 2020) (see also Figure and [LiLi07]).

Fig.        Some of the most important FTA.

When there is no common external tariff among the member countries of an FTA, companies can enter the FTA at the lowest tariff entry point. Goods can then be shipped to the final destination within the FTA without additio­nal tariff costs. This results in tariff revenue transfer effects, since this trade deflection transfers tariff revenue to the country with the lowest external tariff within the FTA. To reduce trade deflection, Rules of Origin are used.

Rules of Origin (RoO) define the extent of a product’s local content needed to be regarded as local and therefore the prerequisites for trading goods tariff-free within the FTA. Additionally, RoO are used to induce companies from nonmember countries to shift value-adding activities toward the FTA to be able to benefit from the preferential tariff treatment.

There are two ways to treat a good as “local.” First, it can be “wholly obtained or produced,” meaning the good has been wholly grown, harvested, or extracted from the soil of the member country or has been manufactured from any of these pro­ducts. This type of RoO is not further examined here. Second, the good has gone through a “substantial local transformation.” This criterion is im­por­tant for global SCM. It has three aspects that can be used in a combination or on a stand-alone basis (see also [EsSu05]):

  • Value content (VCFTA): Value content defines, for a specific FTA, the minimum percentage of local value added that is required for the product to be considered local.
  • Change in tariff heading (CTH): This criterion is fulfilled as soon as the imported good has been processed in a way that alters the tariff code in the harmonized system (HS).
  • Technical requirements (TECH): This criterion defines a list with processes and/or inputs that are prohibited or that need to be realized within the FTA.

Continuation in next subsection (2.1.3b).

Course section 2.1: Subsections and their intended learning outcomes