With the quantity of trade at stake, such terms should not be the sole preserve of customs specialists.
First published as a Prospect blog available here.
Those working on Brexit now know more about “rules of origin” than we ever thought we would. For trade negotiators, they are one of the most contentious areas in talks, although to be fair, there is stiff competition in that category. For companies, rules of origin are one of the most crucial areas of customs which determine whether they can trade under the lower tariffs provided by a trade agreement. A favourite topic for many trade wonks, for those who follow the news “RoOs” is one of those obscure trade terms that they might hear will somehow impact our daily lives as of 2021.
What is traditionally referred to as rules of origin are specific conditions that each product needs to meet to be eligible for lower tariffs under free trade agreements (FTAs). But origin is much more than just rules on specific products. And over the last four years, and especially since the UK started rolling over the EU’s trade agreements to apply post-Brexit, another origin provision has been stealing the spotlight—cumulation. Unfortunately, there is still much confusion as to how exactly cumulation could help. This is worth understanding because cumulation has quietly become a crucial component of the UK’s trade strategy.
So what is it? Cumulation is all about which materials can be considered “domestic” if used as inputs in the production of another item. There are different types of cumulation. All FTAs include the basic bilateral cumulation, where parts produced by an FTA partner are treated as if they were produced domestically. But higher tariffs still apply for products which do not originate in the FTA partner. Larger agreements use diagonal cumulation, which is exactly the same as bilateral cumulation but involves more countries. A good example here would be a regional organisation such as the Association of Southeast Asian Nation, while an example closer to home would be the Pan-Euro-Med (PEM) European system of cumulation. The UK has shown little interest in joining this agreement for now. However, that could potentially still change at the last minute if the current “origin strategy” was to fail. There is also full cumulation, which differs from diagonal cumulation in what you can cumulate—even if goods start off originating from a non-partner, they can obtain “originating status” through being sufficiently processed within the territory covered by the FTA.
These are the main types of cumulation that have been around for a while. Diagonal cumulation, in particular, seems to be causing a significant amount of confusion. Many media articles, organisations and politicians frequently refer to it as a UK demand, as a way forward, or as a provision under the UK’s roll-over agreements. Diagonal cumulation comes with two crucial conditions attached: 1) all countries involved need to be joined by FTAs and 2) rules of origin in these FTAs need to be identical. In the simplest terms, if these two conditions are not fulfilled, it’s not diagonal cumulation. Still with me?
But there is yet another type of cumulation, referred to by the EU as extended cumulation and by other regions as third-party cumulation or cross-cumulation. It’s relatively new and has only ever been used for some products. This type of cumulation is all about flexibility. There are no strict rules: there is no requirement to have an FTA with the country you want to cumulate with and if you happen to have one, there is no need for rules of origin to be identical. If there is more than one FTA in place, countries can decide which set of rules of origin to use when determining whether the inputs traded can qualify. Extended cumulation is based on a different approach to product-specific rules of origin—instead of requiring them to be the same, it allows countries to assume that the level of protection offered by their respective rules of origin is equivalent. This allows for greater flexibility.
For example, under the UK’s roll-over deal with South Korea, both parties agreed to allow, for a limited time, their respective manufacturers to use inputs from the EU freely for the purpose of bilateral UK-South Korea trade. Extended cumulation makes this possible whether or not the UK has an FTA with the EU. In principle, it could also work if neither party had an FTA with the EU, although such a solution is less common and would be a higher-risk option.
The UK has attempted to include extended cumulation in a number of its roll-over deals as well as in the proposed draft deal with the EU. It is likely to be requested as part of the UK-Japan talks. Why is this part of the UK’s current strategy? Extended cumulation helps to maintain supply chains, and to be more specific, could allow the salvaging of parts of the UK’s integrated supply chains that will inevitably be severed as a result of Brexit. UK producers could still purchase from their current EU suppliers and the final product could still be eligible for a lower tariff under trade deals with third countries. Cumulation doesn’t alleviate the administrative burden of the new border between the UK and the EU, nor does it help with the related cost—it only means that once the goods cross the border, they can be considered “originating” when used in the production of other items.
Why isn’t diagonal cumulation sufficient? Because it is virtually impossible for the UK to fulfil the two conditions of diagonal cumulation with all its trading partners. For example, even if the UK, the EU and South Korea all had bilateral trade deals in force, and for some reason, the UK and the EU decided to copy the product-specific rules of origin under the EU-South Korea FTA (which would make very little sense), that would still only permit diagonal cumulation between these three countries.
The UK’s current strategy, of opting for extended cumulation with as many trading partners as possible, is not without challenges. Extended cumulation has only ever been used for some product lines, never as a general rule. The UK roll-over agreements were an exception in that respect. It is also uncertain whether it would be considered WTO compatible if it was to be challenged. Since it has been used so sparingly until now, the question has not yet been officially raised. Finally, it is not likely that the EU will agree to apply extended cumulation in its FTA with the UK nor in its existing FTAs with third countries. Without all parties applying extended cumulation, the UK could end up being at a slight disadvantage. Even if the UK and the EU apply extended cumulation between them, if the EU and South Korea don’t, their respective manufacturers would not be able to purchase inputs from the UK and use them in the production of goods for each other’s markets, leaving UK producers at a potential disadvantage vis a vis their counterparts in South Korea and the EU.
But ultimately, the UK’s plan is quite bold. If successful, and not challenged at the WTO level, it could have a positive impact on post-Brexit supply chains. That is why it is worth getting your head round—but you are entitled to a breather now.