Using RCEP: Creating products for Asia

To appreciate why this single item is so important, it worth stepping back to understand in a simplified way how companies make goods without any trade deals and how they struggle to manage production across multiple trade agreements.

Take the example of a bottle of shampoo (HS3305).  This is a useful example for many reasons.  First, both large and small companies compete to sell shampoo to customers.  Second, this is an item that has universal appeal, where local or regional variations are likely to be relatively modest.  Third, shampoo can have a lot of ingredients which are rarely found in just one country.

Finally, it tends to be subject to an interesting variation in protection at the domestic level in Asia.  Perhaps surprisingly, shampoo often faces relatively high tariff barriers at the border.  Applied MFN tariffs (those actually charged on imported goods) can be 10-20% into many markets in Asia. 

Without any trade agreement in place, a company that wants to send shampoo into a new foreign market will need to create the product and pay the Most Favored Nation (MFN) tariff rate for shampoo. 

Depending on the market, some shampoo firms may have access to lower tariffs by using free trade agreements (FTAs).  These FTA agreements are typically designed to give preferences or benefits to member country firms that non-member firms do not receive.  This usually includes at least lower tariffs, or even zero tariffs (duty-free access), on most or all products between member countries.

The size and scope of these preferences depends on the negotiations.  Higher quality agreements, in general, give deeper tariff cuts on a bigger set of goods.  The best FTAs aim for duty-free treatment on all goods. (To see a nice illustration of how these benefits work, check out Australia’s DFAT FTA portal which is outstanding.)

For firms, however, these benefits can come with a catch.  Lower tariffs do not come automatically.  Companies have to demonstrate that they qualify for preferences.  Typically, products need to be either 100% “from” the member countries in the agreement (grown, harvested, or dug up as an example) or show that the product has been “substantially transformed” in the member countries to qualify.

If the item is 100% “from” the members of the FTA, this seems straightforward.  Most people intuitively grasp that a carrot or potato traded between two parties in an FTA should qualify for lower tariffs in a bilateral trade deal. 

Shampoo, of course, is not grown or harvested. Ingredients are probably sourced from outside one market and may include items from outside both (or all) of the parties in the FTA. How much of the total content in the bottle of shampoo needs to be ‘from” the members to count for lower tariffs?

Trade negotiators spend a lot of time negotiating the rules of origin to account for these problems.  While not getting into the technical details here, basically the members often agree on a threshold that has to be satisfied to allow a product to “count” so the product qualifies for lower tariffs under the trade agreement.

A bottle of shampoo may have 20 ingredients on the label.  Depending on the rules, in an agreement with just two members, it can be tricky for some countries to create a bottle of shampoo with enough content from just the two members to ever meet the thresholds to qualify for origin and get the benefits of the lower tariffs on offer.  Smaller economies, especially, struggle to find enough domestic resources to satisfy content for products, as so many raw materials, parts and components are imported.

This is partly why firms do not often use FTAs, even if they might appear to benefit from the agreement.  If firms find the FTA rules too bothersome, if the tariff preferences are small compared to MFN rates, or if products simply don’t qualify, companies can always ship products under the MFN tariff levels and avoid using an FTA at all.

For many companies that have the ability to use different FTAs, the world is both full of benefits and more complicated. 

Take the example of a small firm in Singapore trying to make shampoo for shipment across Asia.  Singapore currently has more than 20 different FTAs in place that each provide special preferences, including potential for shampoo tariff reductions. 

However, the rules of origin are going to be a problem.  The Singaporean firm relies on imported materials to create the final product.  Even if the Singaporean company gets many items from within ASEAN and has a huge potential advantage with using six existing ASEAN trade agreements, it could still struggle to ship across Asia.  Depending on where it sources all the other materials from, it may or may not qualify for lower tariffs into different markets.

To illustrate the problem, if the firm wanted to send a bottle to South Korea, it may need to ensure that it adds more Korean ingredients to meet rules of origin under ASEAN/Korea. 

If the company got an order from Japan, it may not be able to use the same bottle, because the Korean “content” would not count.  It may need to be swapped out for Japanese raw materials instead to qualify for lower tariffs under ASEAN/Japan. 

If a staff member in Singapore accidently shipped the Japanese content bottle to Korea and claimed FTA preferences under ASEAN/Korea, the firm could be liable for mis-declaration with potentially significant fees and penalties. 

Under RCEP, however, the shampoo company can make shampoo safe in the knowledge that—as long as the content in the bottle comes from anywhere in the 15 markets in Asia meeting the ROOs for RCEP—it can be shipped to any of the 15 markets in Asia without any changes in formulation.  Given the size and diversity of these markets, this is a significant advantage to all Asia-based firms. 

Even better, under RCEP, firms will need to fill out only one sheet of paper to prove that their products “qualify” for origin.  The new RCEP certificate of origin (CO) should reduce costs and time for companies. 

 The extent of the benefits, ie, the lower tariffs on offer, will vary in RCEP.  In some instances, the gap between the MFN rate or existing FTA benefits and new RCEP rates may be small.  But the ability to ship products, like shampoo, across all of Asia without change in formulation, is still extremely significant.  It means that firms will be competitive in markets that they may never have considered in the past.

This apparently small element of RCEP is likely to be game changing.  Companies should start preparing now to use this trade agreement.