Transshipment is the new dirty word of trade

Where is it from? It's one of the top questions customs officials must ask of every shipment, alongside what it is and how much it is worth. Donald Trump's trade war could turn this inquiry on the origin of $3.3 trillion of US goods imports into a quagmire.

The dizzying spread of tariffs the US president is imposing on American trading partners – ranging from a baseline duty of 10 percent secured by the United Kingdom to the threat of a punitive 50 percent charge on imports from Brazil –  a large arbitrage. Exporters, particularly in China, have a big incentive to misrepresent where their goods are from.

The president is attempting to counter this risk by saying goods that are "transshipped" through lower-tariff countries will face higher charges. For example, the US has imposed a 20 percent import duty on products originating in Vietnam, but will charge double that figure for goods routed via the Southeast Asian country.

Transshipment is not a new word or concept. In trade, it simply means moving goods between vehicles such as airplanes, trains and lorries. Trump, however, is using it as a shorthand for tariff evasion or fraud.

He has good reasons to be concerned. Just look at what happened when the president slapped duties on China in 2018. The share of US imports arriving from the People's Republic fell by 8 percentage points to 13.4 percent between 2017 and 2024. However, China's total share of total global merchandise exports rose about 1.5 percentage points to 14.2 percent over a similar period. One reason is that some Chinese manufacturers dodged US duties by re-routing everything from electronics to footwear through other countries, in particular Mexico and Vietnam.

The exact size of the problem is a subject of intense debate and study among economists. Trump's new trade regime makes it even more complicated. The existing global trading system is based on applying a standard tariff on imports, and then granting goods from certain countries, or groups of countries, preferential access.

Under Trump's new system, however, the US will no longer have a standard non-preferential tariff, nor one of the world's lowest tariff regimes. Instead, the charges on goods arriving from different countries could vary by as much as 40 percentage points, depending on where US tariffs end up. Separate levies that Washington intends to apply on semiconductors and pharmaceuticals will add further complexity.

This raises the stakes for customs officials trying to determine where a product is from. So-called "rules of origin" were first introduced to help countries collect statistical data, and have proliferated over the past 30 years to support bilateral and regional free trade agreements. These rules are also supposed to help countries implement other policies, such as anti-dumping measures.

The classic rule of origin is based on the concept of "last substantial transformation". This means the correct tariff depends on the country where the character of the product was last changed.

This principle sounds simple but is anything but. Take clothing. Say a company sends a Chinese-made shirt to Hanoi, adds a "Made in Vietnam" label, and then ships it to the United States while paying the lower Vietnamese tariff. Most trade lawyers would agree that is fraud. But what if brands making clothing in Vietnam like Nike, Lululemon Athletica and Fast Retailing's Uniqlo, use dye, cotton, buttons or zips from China? Determining a product's true origin becomes a complex and ever-changing mystery.

The US Department of Commerce tries to clarify the difference using the example of mixed frozen vegetables and cookies. Vegetables which are grown in various places and taken to another country to be mixed and frozen were not substantially transformed, so the mixture must be labelled with the origin of each ingredient. But if sugar, dairy products, and nuts from different countries are made into a cookie, the country of origin is the location where the ingredients are baked or processed.

Today's supply chains are much more globalised and complicated. For motor vehicles produced by Ford Motor, General Motors and Stellantis, origin depends on the value of the contents. To qualify for the United States-Mexico-Canada Agreement, for example, at least 70 percent of a vehicle producer's steel and aluminum purchases must originate in North America.

Tariffs can also vary depending on a product's American content. US Customs and Border Protection says for imports where at least 20 percent of the value is from the United States, the reciprocal tariff will not apply to the US components.

Verifying the origin of goods requires cooperation. US customs officials will get some help from countries including Malaysia, Thailand and South Korea, which are stepping up their effort to crack down on blatant re-labelling of goods. This is in their interest because cheap Chinese products are threatening to hollow out local industries.

Support for the US measures will drop, however, if Trump is serious about trying to squeeze China out of supply chains. The People's Republic accounts for nearly 29 percent of value added in US imports from Cambodia, and almost 19 percent of those originating in Vietnam, according to research by Sonal Varma and Si Ying Toh at Nomura. Chinese investors are also big owners of factories across Southeast Asia.

Despite the proliferation of rules of origin, the World Trade Organization estimates that 74 percent of global trade still flows under its "most favoured nation" terms, a principle whereby member countries treat imports equally regardless of their origin. For now, it looks like other economies are moving in the opposite direction from the United States. The European Union and Indonesia are moving ahead on finalising a free trade deal; China has extended zero-tariff treatment to 53 African countries; while talks over an EU-India trade pact are slated to continue in September.

Trump could have satisfied some of his stated goals of reducing US trade deficits, raising money and isolating China by imposing high duties on the world's second-largest economy, and a single lower tariff on the rest of the world. Indeed, that may yet be where the president's tariffs end up: On Wednesday, he said he would send letters to more than 150 "smaller" countries notifying them their tariff rates could be 10 percent or 15 percent. But that would still potentially leave more than 40 countries facing wildly diverging rates. Expect the new dirty word in trade – transshipment – to be used much more often in future.