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New NAFTA 2.0 – The devil is in the detail

By Dr Sheng Lu 12 Oct 2018 (Last Updated June 3rd, 2021 15:49)

The new United States-Mexico-Canada Agreement (USMCA) – also dubbed NAFTA 2.0 – has finally been agreed, but what does it mean for apparel sourcing? Here Dr Sheng Lu, associate professor at the Department of Fashion and Apparel Studies at the University of Delaware, takes a close look at the new apparel-specific rules of origin.

New NAFTA 2.0 – The devil is in the detail

The new United States-Mexico-Canada Agreement (USMCA) – also dubbed NAFTA 2.0 – has finally been agreed, but what does it mean for apparel sourcing? Here Dr Sheng Lu, associate professor at the Department of Fashion and Apparel Studies at the University of Delaware, takes a close look at the new apparel-specific rules of origin.

The updated North American Free Trade Agreement (NAFTA) – now called the United States-Mexico-Canada Agreement (USMCA) – was finally agreed by the US and Canada, alongside Mexico, on 30 September 2018.

According to the Office of the US Trade Representative (USTR), the new provisions in the textile and apparel chapter are intended to incentivise greater North American production in textiles and apparel. USMCA also will strengthen customs enforcement, and facilitate broader consultation and cooperation among all parties.

However, as the saying goes, “the devil is in the detail.”

USMCA yarns and fabrics eligible for duty-free treatment

HS codeProduct description
51.06 through 51.13Wool yarns and fabrics
52.04 through 52.12Cotton yarns and fabrics
53.10 through 53.11Woven fabrics of jute and other vegetable textile fibres
Chapter 54Man-made filament yarns and fabrics
55.08 through 55.16Man-made filament, staple, fibre yarns and fabrics
60.01 through 60.06Knitted or crocheted fabrics

Products that must to be made by USMCA members to qualify duty-free

Applicable HS chaptersInputs that must be made by USMCA membersTransition period
61, 62Narrow elastic bands: Fabrics of subheading 5806.20 or heading 60.02Effective 18 monthsfrom the date of entry into force of the agreement
61, 62Sewing thread of heading 52.04, 54.01 or 55.08, or yarn of heading 54.02 used as sewing threadEffective 12 monthsfrom the date of entry into force of the agreement
61Pocket or pockets, the pocket bag fabricEffective 18 monthsfrom the date of entry into force of the agreement
62Pocket or pockets, the pocket bag fabric for apparel that made of blue denim fabric of subheadings 5209.42, 5211.42, 5212.24, and 5514.30Effective 30 monthsfrom the date of entry into force of the agreement
62Pocket or pockets, the pocket bag fabric for apparel that made of fabrics OTHER THAN blue denim fabric of subheadings 5209.42, 5211.42, 5212.24, and 5514.30Effective 18 monthsfrom the date of entry into force of the agreement

TPL for Canada apparel imports: NAFTA vs USMCA

ExporterProductNAFTA (current level)TPL utilisationRate in 2017USMCAImpact evaluation
MexicoCotton/MMF apparel6,000,000 SME25%6,000,000 SMENo change from NAFTA
MexicoWool apparel250,000 SME32%250,000 SMENo change from NAFTA
USCotton/MMF apparel9,000,000 SME100%20,000,000 SMEMore generous TPL
USWool apparel919,740 SME28%700,000 SMEMinimal/no impact

TPL for US apparel imports: NAFTA vs USMCA

ExporterProductNAFTA (current level)TPL utilisationRate in 2017USMCAImpact evaluation
MexicoCotton/MMF apparel45,000,000 SME99.98%45,000,000 SMENo change from NAFTA
MexicoWool apparel1,500,000 SME100%1,500,000 SMENo change from NAFTA
CanadaCotton/MMF apparel88,326,463 SME4.46%40,000,000 SMEMinimal/no impact
CanadaWool apparel5,325,413 SME54.25%4,000,000 SMEMinimal/no impact

A detailed understanding of the apparel-specific rules of origin (RoO) provisions set out in the USMCA text is key for companies interested in using the trade agreement for apparel sourcing. In general, RoO criteria determine the “nationality” of a product in international trade, and only apparel products that meet the USMCA RoO are eligible for preferential tariff treatment.

General rules of origin for apparel in USMCA

In general, USMCA still adopts the so-called “yarn-forward” rules of origin. This means that fibres may be produced anywhere, but each component starting with the yarn used to make the garments must be formed within the free trade area – that is, by USMCA members. The “yarn-forward” rule is sometimes called “triple transformation,” as it requires that spinning of the yarn or thread, weaving or knitting of the fabric, and assembly of the final apparel garments all occur within the free trade area.

Specifically, if an apparel item is made of the following yarns and fabrics, these need to be sourced from the USMCA region so that the apparel item can be eligible for duty-free treatment.

Notably, compared with NAFTA:

  • USMCA no longer requires some jute or vegetarian yarns to be sourced from the US, Mexico or Canada (including products under HS code 53.07 through 53.08).
  • USMCA newly requires some additional knitted or crocheted fabrics to be sourced from the US, Mexico or Canada (including products under HS 60.03 through 60.06).

Other than the source of yarns and fabrics, USMCA now requires that some specific parts of an apparel item need to use inputs made in the USMCA region so that the finished apparel item can qualify for the import duty-free treatment. Meanwhile, the new trade agreement also creates a transition period ranging from 12 to 30 months for the implementation of these new requirements (as shown in the table below).

Exceptions to the “yarn-forward” rules of origin in USMCA

Since the yarns and fabrics needed to make apparel are not always available in the free trade agreement (FTA) area, it is common for FTAs to include exceptions to the “yarn-forward” rule to provide more flexibility to users. USMCA will keep most of the exceptions to the “yarn-forward” rule allowed by NAFTA – but also makes some changes to the details of these exceptions. Specifically:

De minimis
According to USMCA, apparel may still qualify for duty-free treatment under the agreement if all non-originating fibres and yarns make up less than 10% of the total weight of the garments, of which the total weight of elastomeric content must not exceed 7%. In comparison, NAFTA only allows up to 7% of the total weight of the garments to be made by non-NAFTA members. NAFTA is also more strict in its requirement that all elastomeric yarns must be sourced from within the NAFTA region.

Tariff Preference Level (TPL)
TPL allows for a certain quantity of textile and apparel goods (usually yarns, fabrics and cut pieces) from a third country (that is, a country that is not a party to the agreement) to qualify for the benefits. For a long time, the US textile industry has regarded TPL as a damaging loophole. In its testimony before US trade negotiators, the National Council of Textile Organizations (NCTO), which represents US yarn and fabric producers, strongly called for complete elimination of TPL in the renegotiated NAFTA.

According to NCTO, TPL “circumvents the yarn-forward rules of origin and directly undermine benefits for NAFTA regional textile manufacturers. Worse yet is the fact that TPL transfers lucrative benefits to non-signatory countries, such as China.” Not surprisingly, NCTO’s request to eliminate TPL in the NAFTA renegotiation met strong opposition from US fashion brands and retailers, represented by industry associations such as the American Apparel and Footwear Association (AAFA) and the United States Fashion Industry Association (USFIA). According to these groups, eliminating TPL would disrupt supply chains in the NAFTA region that have been in place for more than two decades. 

On the other hand, the TPL mechanism has played a critical role in facilitating exports of Canada’s wool suits to the United States and US cotton and man-made fibre apparel to Canada. Statistics show that in 2017 more than 70% of the value of Canada’s apparel exports to the United States under NAFTA utilised the TPL provision, including almost all wool apparel products. Over the same period, the TPL fulfilment rate for US cotton or man-made fibre apparel exports to Canada reached 100%, suggesting a high utilisation of the TPL mechanism by US apparel firms too. Not surprisingly, the apparel industry in Canada also strongly supported the TPL mechanism in the NAFTA renegotiation. 

USMCA seems to be a “balanced deal” that has accommodated the arguments from all sides regarding the TPL mechanism. As shown in the tables below: 

  • Compared with NAFTA, USMCA will cut the TPL level, but only to those product categories with a low TPL utilisation rate. For example, for cotton or man-made fibre (MMF) apparel exported from Canada to the US, the TPL level will fall from its current 88,326,463 square metres equivalent (SME) to only 40,000,000 SME per year. However, with the actual TPL utilisation rate as low as 4.46% in 2017, the lower TPL level set by USMCA should have minimal or no impact on sourcing. 
  • Compared with NAFTA, USMCA will expand the TPL level for a few product categories with a high TPL utilisation rate. For example, for cotton or man-made fibre (MMF) apparel exported from the US to Canada, the TPL level will substantially expand from 9,000,000 SME to 20,000,000 SME per year. With a TPL utilisation rate as high as 100% in 2017, the more generous TPL level could help expand trade flows and allow more companies to take advantage of the rule.   

Note: SME refers to square metres equivalent (SME); MMF refers to man-made fibre

Commercial availability/short supply list
Similar to NAFTA, USMCA also allows textile inputs (fibres, yarns and fabrics) that are not available in commercial quantity in the FTA region to be sourced from anywhere in the world – and the finished garments can still enjoy duty-free treatment under the agreement. In general, the request to add a product to the short supply list will be assessed within 90 days, followed by a no-more-than 60-day consultation among all USMCA members.

Conclusion

Most companies currently using NAFTA for apparel sourcing should be able to continue to do so when USMCA comes into effect. However, it remains to be seen whether the new agreement will boost Made-in-the-USA fibres, yarns and fabrics by limiting the use of non-USMCA textile inputs.

Around 15% of US apparel imports from the NAFTA region in 2017 did not claim duty-free benefits, largely because of the strict yarn-forward rules of origin. To produce and source apparel in the least expensive way possible often means companies use non-NAFTA textile inputs despite being hit with higher tariffs. The utilisation rate of USMCA will be important to watch in the future.