Where are you from?
This question is a common conversation starter. Do you answer with where you were born and raised, where you lived during or after college, or where you live now? Which of these geographies and experiences defines you? All of them do, of course.
The stuff we use, eat, and wear has the same dilemma. Every object is stuck with “Made in…” labels that only give us information about the country where that product last underwent some significant change or “substantial transformation”.
But most products today are the result of creative, physical, and intellectual efforts by people in different roles across the globe—they are designed in one country, their materials are procured in another, their components may be made and assembled somewhere else. Manufacturing is a complex process with value added in stages across global value chains.
Why is origin important?
From the perspective of the person or company importing merchandise, an official customs determination about that product’s country of origin can affect whether it can be imported, what rate of duty will be applied, whether it qualifies for special import programs, whether it qualifies for procurement by government agencies, and what marking it must carry (e.g., Made in…).
The main challenge in today’s global economy is that origin determinations rest on the premise that every manufactured product can be assigned a single country of origin – distinguishing them as American, or not – whereas many products are so complex they involve R&D, business services like engineering and industrial design, raw materials, software, and complex components built in along the journey from concept to finished product. A product’s story is influenced and built in layers like the stories of our own lives. But to be practical for trade purposes, we must assign them one place of origin.
Which place influenced you the most?
Is there one place you have lived that had the most impact on your thinking, your way of living, your profession, the way you raised your kids? In the world of traded products, customs officials try to determine where the product last underwent a substantial transformation. But as Marc Levinson of the Congressional Research Service points out in his report, The Meaning of ‘Made in U.S.A.,’ the major shortcoming of this approach is that:
“Physical transformation is assumed to be the means by which manufacturing creates economic benefits. Under a variety of statutes, the fact that other activities related to making a product are conducted in the United States is not relevant to the determination of whether the product is made in the United States.”
If we extended this concept to our personal world, it might go like this: you might feel that your quarter of a century of professional life in Minneapolis, Minnesota created the most value and defines who you are, but a regulation dictates that you are from Des Moines, Iowa because you first became a human being there and your physical self is essentially unchanged since then.
Different tests for origin
When products enter the United States and the importer is not claiming tariff preferences under a special program or free trade agreement, the product’s origin will likely be determined using what’s known as the Gibson-Thomsen test for substantial transformation: whether the product acquired “a new name, character, and use”. As you might imagine, the determinations will vary with the specific facts of the product and processes in question.
When tested in courts, some courts use all three prongs as integral to the test, whereas others view one prong of the test as sufficient to qualify as substantially transformed (note, we’re not using precise legal language here). For example, in a case brought to the Court of International Trade by the National Juice Products Association, the association argued a change in name and use were sufficient transformation, but the court ruled that adding water, orange essences, and oils to imported orange juice from concentrate did not change the fundamental character of the product. In other words, it did not undergo substantial transformation in the United States. In general, minimal or simple assembly operations will not result in substantial transformation.
Is there a better way?
Once the Harmonized Tariff Schedule was put in place in 1989 and the United States began negotiating more preferential trade agreements, we began to implement different methods for determining origin. As described in our Essential on rules of origin, the methods for determining product origin serve a gatekeeper function, aiming to ensure that goods produced in the countries that are parties to the agreement can obtain the benefits of that agreement.
The North American Free Trade Agreement (NAFTA) marked a change from the Gibson-Thomsen test to use of the tariff-shift test under which an article can receive preferential tariff treatment if it transforms enough to result in that article changing classification on the tariff schedule. The good must undergo that shift both upon importation into a NAFTA country and again before export to another NAFTA country. For some products, NAFTA requires use of a “regional value content” (RVC) test where a tariff shift is not considered enough transformation to qualify for tariff preferences. RVC requirements specify the minimum amount of content that must occur within NAFTA countries to receive the benefits of the agreement – 62.5 percent in the case of motor vehicles, for example. To prove their goods qualify, manufacturers must track data on the costs of materials and production.
Growing, harvesting, processing or assembling
These are some of the traditional methods we associate with “manufacturing,” but a great deal of manufacturing today involves complex processes. Levinson’s Congressional Research Service report provides examples of how physical transformation tests of any kind are increasingly anachronistic.
He cites a study of the Nokia N95 mobile phone that found the cost of final assembly came to just 2 percent of the final pre-tax sales price, far short of the value of its integrated circuits, processors, built-in camera, and other inputs. So why then should the place of final assembly determine its origin (or credit that country with the full value of the export – see our Essential, A Deficit of Good Trade Data)?
Salient to the current debate over NAFTA rules of origin for automobiles, consider that 41.1 percent of the value added to the making of a U.S. motor vehicle comes from U.S. services. Here Levinson underscores that newer models of cars, particularly in the premium segment, run on a hundred million lines of software code. An increasing amount of the value of a car is from components and processes that are not physical. Regardless of the rules we apply at the border, it’s time we evolve how we think of the identity of manufacturing to take into account its dynamic journey, not just the last physical operation.
Official guidance: “What Every Member of the Trade Community Should Know About: Textile and Apparel Rules of Origin,” available on the CBP’s website: www.cbp.gov.
Andrea Durkin is the Editor-in-Chief of TradeVistas and Founder of Sparkplug, LLC. Ms. Durkin previously served as a U.S. Government trade negotiator and has proudly taught international trade policy and negotiations for the last fourteen years as an Adjunct Professor at Georgetown University’s Master of Science in Foreign Service program.