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The costs and benefits of rules of origin in modern free trade agreements

Ornelas, Emanuel and Turner, John L. (2022) The costs and benefits of rules of origin in modern free trade agreements. CEP Discussion Papers (1867). London School of Economics and Political Science. Centre for Economic Performance, London, UK.

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We study the welfare impact of rules of origin in free trade agreements where final-good producers source customized inputs from suppliers within the trading bloc. We employ a property-rights framework that features hold-up problems in suppliers' decisions to invest, and where underinvestment is more severe for higher productivity firms. A rule of origin offers preferred market access for final goods if a sufficiently high fraction of inputs used in the production process is sourced within the trading bloc. Such a rule alters behavior for only a subset of suppliers, as some (very-high-productivity) suppliers comply with the rule in an unconstrained way and some (very-low-productivity) suppliers choose not to comply. For those suppliers it does affect, the rule increases investment, but it also induces excessive sourcing (for given investment) within the trading bloc. From a social standpoint, it is best to have a rule that affects high-productivity suppliers. The reason is that the marginal net welfare gain from tightening the rule increases with productivity. Therefore, when industry productivity is high, a strict rule of origin is socially desirable; in contrast, when industry productivity is low, no rule of origin is likely to help. Regardless of the case, a sufficiently strict rule can (weakly) ensure welfare gains.

Item Type: Monograph (Discussion Paper)
Official URL:
Additional Information: © 2022 The Authors
Divisions: Centre for Economic Performance
Subjects: H Social Sciences > HD Industries. Land use. Labor
H Social Sciences > HB Economic Theory
JEL classification: F - International Economics > F1 - Trade > F13 - Commercial Policy; Protection; Promotion; Trade Negotiations; International Trade Organizations
F - International Economics > F1 - Trade > F15 - Economic Integration
L - Industrial Organization > L2 - Firm Objectives, Organization, and Behavior > L22 - Firm Organization and Market Structure: Markets vs. Hierarchies; Vertical Integration; Conglomerates; Subsidiaries
D - Microeconomics > D2 - Production and Organizations > D23 - Organizational Behavior; Transaction Costs; Property Rights
Date Deposited: 23 Jan 2023 16:00
Last Modified: 15 Sep 2023 23:58

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