27 based on bilateral cumulation (for explanation, see Box 2 below). Full liberalization of trade in industrial products among them will be completed in 2008. In addition, SEE-5 economies have preferential access to EU-25 but on asymmetrical base, i.e., the EU-25 does not have similar to access to their markets.

# **Box 2.** _Pan-European Cumulation of Rules of Origin_

_Rules of origin_ are used to determine the national/territorial provenance of goods for trade purposes. The EU has two types of such rules: non-preferential and preferential. Non-preferential rules define the origin of a good for trade statistics, import quotas and use of safeguards. Preferential rules are stricter. They are to ensure that only goods originating in one of the member countries enjoy the low tariffs or other benefits laid down in the agreement. Such rules ensure that goods from countries not party to the preferential arrangements cannot be diverted via a preferential partner to circumvent the EU tariff. Under the rules products acquire origin if they are wholly produced or if they are sufficiently processed in the preferential partner. For manufactured goods the basic criterion is a change of tariff heading at four-digit level. However, for many products alternative criteria must be observed. For example, there may be a limit on the value of non-originating materials used, often 40% (effectively a 60% added value rule), or a rule specifying a process.

The concept of _cumulation_ is an important element of preferential rules of origin. It allows inputs originating in one party to a preferential agreement to count as originating in another when those goods are used in further processing. There are various types of cumulation. Bilateral cumulation is the simplest form and applies in preferential trade between the EU and a preferential partner. Diagonal cumulation applies in preferential trade between EU and groupings of countries where the parties to an agreement share identical rules of origin. It allows materials originating in the EU or in one or more of the country groupings to count towards fulfillment of the rules of origin. Full cumulation represents an extension of diagonal cumulation. It provides for the aggregation of all processing, whether or not origin conferring, undertaken anywhere in the preferential area. The concept of pan-European cumulation introduces diagonal cumulation across a Europewide free trade area encompassing the EU, EEA, EFTA, the Central and Eastern European countries, the Baltic States and Turkey.

Source: UK Department of Trade and Industry <u>(http://www.dti.gov.uk/ewt/rules.htm)</u> Bulgaria’s foreign trade policy has two dimensions: that of actively pursued regional liberalization in the context of the EU Eastern Enlargement project and rather passively pursued multilateral liberalization under the umbrella of WTO agreements. Since the track of regional liberalization encompasses Bulgaria’s major potential trading partners including one of the world’s economic superpowers, the EU-25, the multilateral track is of secondary significance to Bulgaria’s economic interests. Bulgaria is now part of one of the largest, if not the largest in the world, free trade areas for industrial products. In consequence, Bulgarian producers have duty-free access to most of its markets and, on the other hand, Bulgaria’s markets for most goods are fully contestable.

The deep tariff reductions under the aegis of regional integration agreements combined with relatively high MFN applied tariff rates imply high reverse discrimination and significant potential for trade diversion. High preference margins provide a strong incentive to home consumers to switch from a low-cost supplier outside the FTA to a high-cost one from FTA partner country. However, there is one factor limiting the scope for trade diversion. The extent of trade diversion hinges not only on preference margins, i.e., the differences between MFN rates and preferential tariff rates, but also on the level of pre-FTA trade with FTA partner. And Bulgaria’s pre-FTA imports from the current preferential partners were high.

Yet, there are strong reasons for reducing reverse discrimination through lowering MFN applied tariff rates to the levels of the EU CET (common external tariff) on industrial products. High tariff protection is always a bad trade policy. Bulgaria’s MFN tariff schedule for manufactured goods is both redundant and harmful. Its redundancy stems from limited, if any at all, protection afforded to domestic producers by high and dispersed MFN tariff rates. Pan-European suppliers already have duty-free access and government resorts to tariff exemptions if these products are not readily available in pan-European free trade area for industrial products. But if they are available, high MFN tariffs merely protect FTA suppliers from MFN