NAFTA Trade with East Asia: Rules of Origin and Market Access in Textiles, Apparel, Footwear and Electrical Machinery

Abstract

Rules of Origin and Market Access in Textiles, Apparel, Footwear and Electrical Machinery I. Introduction Rules of origin are among the most controversial aspects of the North American Free Trade Agreement (NAFTA). Early assessments of NAFTA indicated that its rules of origin, contained in a nearly two hundred page compendium, were one of the agreement's most disappointing features (Hufbauer and Schott 1993).(1) Preferential trading arrangements must employ such rules in order to determine whether or not a good entering the customs territory is entitled to preferential treatment. In negotiations leading to the NAFTA, industry interests were well represented and were particularly involved in the design of detailed and product specific rules of origin (Krishna and Krueger 1995). The possible use of rules of origin as a protectionist device in a FTA was first pointed out in the seminal paper on this topic (Shibata 1967). It has now been shown that rules of origin may be used as tools of commercial policy in a customs union as well (Vermulst and Waer 1990; James 1997) in the context of the European Union (EU).(2) Awareness of the possible protectionist uses of such rules in the context of free trade areas (FTAs) has created new interest among economists in examining the welfare implications of FTAs. Some economists have regarded free trade agreements favorably, on the grounds that they, on balance, lead to lower trade barriers among members without raising barriers to nonmembers as is required by Article XXIV of the General Agreement on Tariffs and Trade.(3) Bhagwati (1991) has taken up the cudgel in opposing discriminatory regional and other preferential trading arrangements on the grounds that they undermine multilateralism and the principles of GATT/WTO. Others have taken a middle ground, arguing that agreements such as NAFTA have desirable and undesirable features that need to be carefully weighed.(4) The arguments for and against FTAs have been largely based on non-empirical theoretical analysis and on ex ante judgements regarding the likely magnitude of trade and investment creation versus diversion.(5) It is too early to judge whether or not NAFTA as a whole is beneficial in terms of world economic welfare or to comment on the overall distribution of gains and losses. However, it is now possible to begin an empirical assessment of the performance of trade components of NAFTA. Based on UN Commodity Trade Statistics, this paper examines trade in textiles and apparel among NAFTA members (Canada, Mexico and the United States). Textiles and apparel have the strictest rules of origin and, therefore, have the greatest potential with regard to trade diversion and protectionism (Hufbauer and Schott 1992 and 1993, Krueger 1997, and Krishna and Krueger 1995, Stephenson 1998). East Asian countries that have rapidly expanded market share in global markets for textiles and apparel, including members of the Association of Southeast Asian Nations (ASEAN) are most likely to be harmed by any trade diversion resulting from NAFTA's rules of origin. II. Triple-Transformation -- NAFTA Rules of Origin for Textiles and Apparel Special rules of origin governing trade in fibers, yams, fabrics, made-up textiles and clothing are set out in NAFTA Vol. II, annex 401 (HS chapters 50-63), and pp. 401-30 and 401-51. In essence these rules establish that most items of textiles and apparel must be produced from yam-forward to be conferred origin within the FTA. Some items must even have the fibers used to produce yarn originate within NAFTA (a fiber-forward rule). Some apparel items that require fabrics not generally available in NAFTA (such as silk, certain types of linen and shirt-making fabric) are allowed to qualify for preferential treatment, provided that otherwise they meet NAFTA labelling and origin requirements. These items, however, constitute a very small share of NAFTA trade in apparel.(6) The requirement of yarn-forward production of textiles and apparel practically requires apparel items to use only fabrics produced with yam from a NAFTA member and further requires that the cutting and sewing operations wholly occur within NAFTA. …