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By Dan Ciuriak

Lowering the rules of origin hurdle would boost trade, and enable more SMEs to enter into exporting

Most of Canada’s international traders are SMEs. Canada’s main trade policy tool today is the bilateral or regional free trade agreement (FTA), but FTAs come with administrative requirements, which put small and medium sized enterprises (SMEs) at a disadvantage in accessing their benefits compared to larger domestic competitors.

One important administrative requirement is to provide the necessary documentation to show that products satisfy the rules of origin provisions that restrict access to the reduced or zero tariffs of the FTAs. For some products, this is easy – a Canadian crop is Canadian. But for products that use imported inputs things get more complicated. En route to the producer’s factory gate, the inputs may have been transhipped through multiple countries, receiving some degree of processing in each that may or may not have changed their origin status. Moreover, the rules require an enforcement regime. This means rules for documentation, rules for logistics, rules for verification, rules for retention of records for audit, rules for appeal and adjudication of disputes, and so forth.

The costs of complying with rules of origin vary across FTAs, depending on the complexity and transparency of the specific regime adopted. They also vary by size of shipment, falling for larger shipments as the fixed costs of compliance are spread over larger value flows, hence the bias against small shipments. And they vary across products, depending on the specific type of origin rule that is applicable to the product. They generally become more onerous in line with the complexity of products and the extent of international sourcing – and thus for products produced through global value chains.

For an SME to access the tangled web of FTAs that Canada is putting in place can thus involve learning a lot of ropes.

Lowering this hurdle to accessing the benefits offered by Canada’s FTAs would boost trade, enable more SMEs to enter into exporting, and provide an additional boost to domestic and international competition. Can this be done without undermining the restriction of the benefits of FTAs to production within FTA partner economies?

FTA chapters routinely include a de minimis margin, usually US$1,000, for the value of shipments that do not require certificates of origin. This seems absurdly small, especially as this value is typically not indexed to inflation. It is below commercial scale and equivalent to the value that Canadian consumers can bring in from abroad on vacation.

Recasting this existing de minimis rule in terms of face value of duty paid would make it commercially meaningful. For a tariff rate of 5 per cent, a $1,000 duty payable waiver implies waiver for shipments of $20,000. For a tariff rate of 20 per cent, the $1,000 duty payable waiver reduces the scale of shipment that can enter without origin certification to $5,000. For a tariff rate of 1 per cent, the waiver rises to include shipments of up to $100,000. Regardless of the size of shipment, the incentive to circumvent the rules remains limited to $1,000.

The sharpened competitive sword of FTAs structured in this way would cut two ways of course: Canadian firms – large and small – would feel greater competitive pressure in the Canadian domestic market from foreign SMEs. Further, the competition they face in the vital U.S. market would be sharpened by third-party exporters taking advantage of the same provisions, if the United States were to embrace the proposal and apply it in its FTAs with third parties. To adopt this proposal, Canada would have to have the courage of its stated convictions that trade and competition are good for its economy.

We live in an age of FTAs. This proposal would improve their economic performance and their political acceptability, based on improved access to their benefits by SMEs.

There is still time to get reforms into the agreements currently being negotiated. The TPP is well advanced and its chapter on rules of origin may still be open to reform. It would not be difficult for countries, practically at the stroke of a pen, to switch to a new approach or even to apply it to agreements already ratified.

All reforms meet with resistance. To succeed, this proposal will require a champion to promote it and to refine the details in multiple forums: the WTO; specialized origin units within the World Customs Organization; the trade facilitation arms of the International Chambers of Commerce and small business associations; express carrier trade associations; e-commerce organizations; and others worldwide. I believe it is in Canada’s interest to be that champion.

Dan Ciuriak is director and principal, Ciuriak Consulting Inc., and fellow in residence with the C.D. Howe Institute. This is adapted from his study, “Making Free Trade Deals Work for Small Business,” published today by the C.D. Howe Institute.

Published in the Financial Post on August 6, 2015