Lecture 10: International Trade Transactions ... · Last two digits (HS-6)are even more speci c, e.g. 09.02.10 Green tea (not fermented) Up to the HS-6 digit level, all countries

Lecture 10:International Trade Transactions

International Business Management

Vanessa Alviarez

Sauder School of Business

University of British Columbia

March 13, 2019

Alviarez (Sauder) COEC 498 Lecture 10 1 / 43

Objectives of Today's Lecture:

To realize the gains from trade, buyers and sellers mustincur a variety of costs other than production costs; theseare known as �trade costs�

Trade costs have distance�and border�related components


How National Borders Impede Global Trade

International transaction costs (clear customs, letters ofcredit)

Currency conversion costs

Conversion feesExchange rate volatility ⇒ payment risksLack of relative price transparency

Customs costs (trade policy: duties, etc.)


Clearing Customs

Procedures:

Classi�cation

Valuation

Origin-nation


Tari�s: Basic Issues

Classi�cation

Matching products to tari� itemsCanada has over 8,000 8-digit HS tari� itemsExample: E.U. has 20% duty on imported �sauces� and a288% duty on imported vegetables. Thus exporters to theE.U. tried to call a can of vegetables a �vegetable sauce� toavoid high tari�s. The E.U. countered by requiring that asauce must not contain more than 20% �lumps�

Valuation

Assessing a �customs value,� based on the transaction priceand applying certain adjustments

Origination

Providing documentation establishing the country of originof the product and the �point of direct shipment�


Classi�cation of goods: �Harmonized� System

Harmonized Commodity Description and Coding Systems (HS)is an international nomenclature for the classi�cation of productsin a six-digit code system.

It allows participating countries to classify traded goods on acommon basis for customs purposes.

The HS comprises approximately 5,300 article/productdescriptions that appear as headings and subheadings, arrangedin 99 chapters, grouped in 21 sections. The six digits can bebroken down into three parts:

First two digits (HS-2) identify the chapter the goods areclassi�ed in, e.g. 09 = Co�ee, Tea, Mate and Spices.Next two digits (HS-4) identify groupings within thatchapter, e.g. 09.02 = Tea, whether or not �avoured.Last two digits (HS-6) are even more speci�c, e.g. 09.02.10Green tea (not fermented)

Up to the HS-6 digit level, all countries classify products in thesame way.



The Harmonized System was introduced in 1988 and hasbeen adopted by most of the countries worldwide. It hasundergone several changes in the classi�cation of products.

These changes are called revisions and entered into force in1996, 2002, 2007, 2012 and 2017.

The amendments (split, merge, change in scope) betweenthe latest HS edition and its previous edition (as well asother classi�cation systems: NAICS, NACE, SITC) can bereconcile using the correspondence tables.

Let's take a look to Comtrade website:https://comtrade.un.org/

Justin R. Pierce and Peter K. Schott(http://www.nber.org/papers/w15548.pdf)

https://www.foreign-trade.com/reference/hscode.htm



Chapter 95: Toys, games and sports requisites; parts and accessoriesthereofHeader 9506: Gymnastics, athletics, other sports (including tabletennis) or outdoor games equipment, n.e.c. in this chapter, swimmingpools and paddling pools

First 6 digits are same for all countries

9506.11: Skis9506.21: Sailboards9506.99: Other outdoor sport equipment

Last 4 digits speci�c to each importer

9506.11.1000: downhill skis in Ca, duty: 0%9506.11.9010: x-country skis in Ca, duty: 7.5%9506.11.2000 (x-country skis in US, duty: 0%)9506.11.4010 (other skis in US, duty: 2.6%)

First 8 digits (HS6+2) ⇒ tari� item

For example: 9506.11.10


Tari� Classi�cation: An Example


Valuation

Rules call for �transaction� values between �unrelated�buyers and sellers (in practice: prices on invoices)

Exclude costs of transport from the point of directshipment (PoDS) to the importing country

Note: With ad valorem (%) duties, importers save fromunder-valuation.


Valuation: Rules of Origin

Most-Favored Nation (MFN) �principle�

Many Exceptions:

General Preferential, Least Developed CountriesFree Trade Agreements, Customs Unions

To receive lower duty status, need

Certi�cate of originProof of direct shipment


Valuation: Rules of Origin

Sailboards (9506.21.0000) originating from

WTO member or other MFN origin: 9.5%

General Preferential Tari� (e.g. Algeria, Brazil): 6%

Least Developed Country (e.g. Mali): 0%

FTA (U.S., Mexico, Costa Rica, Chile): 0%

General rate (Libya, North Korea): 35%


Canada's Preferential Trade Agreements

1989: CUFTA Canada-US Free Trade Agreement

1994: NAFTA North-American Free Trade Agreement (US,Canada, Mexico)

1997: Israel (CIFTA), Chile (CCFTA)

2002: Costa Rica (CCRFTA)

2008: Colombia*

2009: European Free Trade Association (EFTA), Peru,Jordan*

2010: Panama*

2015: Korea (CKFTA)

2017: European Union (CETA)

Negotiations with the Carribbean Community, DominicanRepublic, Central America Four, Singapore, Ukraine;exploratory discussions with European Union, Morocco,India, Turkey

* signed (not in force yet)Alviarez (Sauder) COEC 498 Lecture 10 13 / 43

Rules of Origin

Rationale: rules of origin are required to determineeligibility for preferential treatment in free trade areas, orapplicability of restraints or disciplines

Types:preferential rules of origin: used to determine whethergoods traded in a preferential trading area are eligible forpreferential tari� treatmentnon-preferential rules of origin: all else

Under GATT 1947, each country had di�erent rules oforigin. Minimum standards are set under GATT 1994 Rules

of Origin Agreement. NAFTA sets similar standards

Problem: how to treat intermediate products.A good is originating if:it wholly originates within a speci�c territory;it is produced entirely from originating materials;it contains non-originating materials but satis�es speci�crules of origin (ie, minimum content requirements)


Rules of Origin (II)

For a product which has been produced in more than onecountry the product shall be determined to have origin inthe country where the (last) substantial transformationtook place

To determine exactly what was the last substantialtransformation, three general rules are applied:

Change of tari� classi�cation (on any level, though 4-digitlevel is the most common)Value added-rule (ad valorem)Special processing rule, the minimum transformation isdescribed

According to the non-preferential rules a product alwayshas exactly one country of origin

The non-preferential rules may di�er from country tocountryUsually it is the rules of the importer country that apply


Rule of Origin: Eligibility for Preferential Treatment


Rules of Origin (Example I)

Example of rules of origin (U.S.- Australia FTA)

Rule of origin: A change to heading 1902 through 1905 from anyother chapter.

Product: Breads, pastries, cakes, biscuits (HS 1905.90)

Non-U.S. or Australian Input: Flour (classi�ed in HS Chapter11), imported from Europe

Explanation: For all products classi�ed in HS headings 1902through 1905, all non-U.S. or Australian inputs must beclassi�ed in an HS Chapter other than HS Chapter 19 in orderfor the product to obtain preferential duty treatment.

Note: These baked goods would qualify for tari� preference becausethe non-originating goods are classi�ed outside of HS Chapter 19.(The �our is in Chapter 11.) However, if these products wereproduced with non-originating mixes, then these products would notqualify because mixes are classi�ed in HS Chapter 19, the samechapter as baked goods.


Rules of Origin (Example II)

Rule of origin: A change to subheading 9403.10 through 9403.80from any other heading; or A change to subheading 9403.10through 9403.80 from any other subheading, provided there is aregional value content of not less than: (a) 35 percent based onthe buildup method, or (b) 45 percent based on the builddownmethod.

Product: Wooden furniture (HS 9403.50)

Non-U.S. or Australian Input: Parts of furniture (classi�ed in9403.90), imported from Asia

Explanation: Because the non-U.S. or Australian input isclassi�ed in the same heading (9403) as the �nal product in thiscase, the good does not meet the �rst rule. The good can meetthe second rule because the non-originating component is from adi�erent subheading than the �nal product. For the good toqualify as originating, however, it must also pass the RVC test.


yshijun

Sticky Note

it seems like the rule of origin is applied to the foreign input

Rules of Origin (Example I)

Let's assume the adjusted value of the good is 1,000 and that thevalue of non-originating materials in this case is $500.

Method Based on Value of Non-Originating Materials(Build-down Method)

RV C =AV − V NM

AV× 100 = (1000− 500)/1000× 100 = 50%

Method Based on Value of Originating Materials (Build-upMethod)

RV C =V OM

AV× 100 = (500)/1000× 100 = 50%


International Transaction Costs

Contracts involving international transportation oftencontain abbreviated trade terms that describe matters suchas the time and place of delivery and payment, when therisk of loss shifts from the seller to the buyer, and who paysthe costs of freight and insurance

The International Chamber of Commerce has de�ned anumber of international commercial terms for quotingprices: E-terms (departure), F-terms (shipment, maincarriage unpaid), C-terms (main carriage paid), andD-terms (arrival)

This terms are standardized and internationally recognized


Incoterms - Overview


Shipping Costs and Incoterms



yshijun

Sticky Note

this is very useful

Incoterms - Details

The most important of these 41 terms are shown below:

EXW -ex works: prices quoted ex-work apply only at thepoint of origin. The seller agrees to make the goodsavailable to the purchaser at a speci�ed place and date.The buyers carried all charges

FCA: free carrier: the seller is responsible for loading thegoods; the buyer is responsible for all other carrier charges.If a port of exportation is named, the cots of transportingthe goods to the named port are included in the price.There are two types of �free carrier�: (a) at named inlandpoint of departure, and (b) at named port of shipment


Incoterms - Details

FAS: the exporter quotes the price that includes charges fordelivering the goods alongside a vessel at the port. Theseller handles the cost of uploading and wharfage. Thebuyer handles the cost of unloading, ocean transportation,and insurance

FOB -free on board: applies only to vessel shipments. Theseller quotes a price that includes all expenses up to andincluding delivery of goods on an overseas vessel providedby or for the buyer. FOB is also used for export statistics

CFR -cost and freight: the seller quotes a price thatincludes the cost of transportation to a named port ofdebarkation


Incoterms - Details

CIF -cost, insurance, freight: the seller quotes a price tatincludes the cost of overseas transportation to a namedport fo debarkation, including all miscellaneous chargesThese changes include: (a) port charges (unloading,wharfage handling, storage, cartage [transport], heavy lift,demurrage). CIF is also used for import statistics

DDU/DDP -delivery with delivery duty unpaid/paid: theseller delivers the goods to the destination, with customsduties and taxes either unpaid or fully paid


Why are transaction costs higher for international trade?

Payment problem

Seller does not want to incur production and transportcosts to serve a buyer who does not payBuyer does not want to pay for goods that are neverdelivered or delivered late or defectiveNeeded: trust or...

Payment options

Open Account: exporter bills customer, who is expectedto pay under agreed terms at a future dateDocumentary Draft (D/P, D/A): similar to �cash ondelivery�, buyer gets goods when he pays (with a bankdraft)Letter of Credit (L/C), �documentary credit�Payment in advance


Contractual Trade Costs

Trade requires trust

Trust requires reputation that is established either by pastperformance or through a trusted third party

Without direct trust exporters require a trust intermediarywho can establish indirect trust

Method: (in ascending orders of exporter's risk)

Cash in AdvanceCon�rmed Letter of CreditLetter of Credit (L/C)Documents against Payments /Cash on Delivery


Payment Options


Letter of Credit (L/C)


Letters of Credit (L/C) vs. Documentary Draft (D/P)

With a documentary draft (D/P), the seller sends thegoods without a guarantee that the buyer will be willing orable to pay when goods arrive, in which case, seller retainsgoods but must �nd another buyer

With L/C, seller assured of payment if the stipulateddocuments are presented to issuing bank on time

Buyer does not pay until documents received


Letter of Credit Procedure

The buyer goes to his bank a obtains a �letter� in which thebank promises to pay for goods upon delivery of certaindocuments

The seller receives the letter and ships the goods

The shipper (or carrier) completes the trip and presents thestipulated documents to the bank. The most important ofthese is the �bill of lading� which will turn over ownershipof the goods to the buyer

The bank pays the seller (often trough a second bank)


yshijun

Underline

Letter of Credit ProcedureExporting - Phase 1: Initiation and L/C


Letter of Credit ProcedureExporting - Phase 2: Shipment and Payment


Letter of Credit ProcedureExporting - Phase 3: Completion


Letter of Credit � Functions

is issued by (the importer's bank)

substitutes the credit of a recognized bank for that of abuyer (importer)

allows an exporter to obtain quicker payment for a deliveryby becoming collateral for a �nancial instrument (draft)

is not an application for an instant loan, but is to bethought of like an application for a credit line

is used in conjunction with the bill of lading to obtainpayment

transfer the risk of importer's default to issuing bank

obliges the issuing bank to check authenticity, but does notoblige the issuing bank to take on liability for shipment

often requires importer to make cash deposit(≈ 0.5%− 2.0% of shipment's value) as collateral


Advantages and limitations of the L/C

Replaces situation of mutual distrust (between buyer andseller) with mutual trust in the intermediaries (the banks)

Rare Problem: what if you cannot trust the banks?

Occasional Problem: false or misleading documents


Top ten world importers and Exporters

For each of these countries, the �gure displays the share ofinternational shipments that is settled with LCs or DCs in 2011,based on SWIFT message values and export values in that year.


Evolution of aggregate trade �nance and U.S. exports


Trade �nance and export shares by world region


The �Documents�

Invoice

who sold what to whom for how much

Bill of Lading

Carrier's statement to shipper that goods were loaded�key that unlocks the door to the �oating warehouse� ⇒gives the holder title to the goods

Certi�cate of Origin

Certi�cates of Inspection/Quality/Weigh, etc.


Bill of Lading


Bill of Lading

is issued by a carrier to the exporter

as a receipt for shipping services and legal document of title(ownership), which can be negotiated and traded if neededas a contract and invoice for shipping services

and must name the consignee (recipient)

can be used as collateral to obtain advance payment from abank by means of a �nancial instrument (e.g., a draft)
