The Costs and Benefits of Rules of Origin in Modern Free Trade Agreements

Emanuel Ornelas and John L. Turner

No 9920, CESifo Working Paper Series from CESifo

Abstract: 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.

Keywords: hold-up problem; sourcing; incomplete contracts; regionalism (search for similar items in EconPapers)
JEL-codes: D23 F13 F15 L22 (search for similar items in EconPapers)
Date: 2022
New Economics Papers: this item is included in nep-int
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: The costs and benefits of rules of origin in modern free trade agreements (2024)
Working Paper: The costs and benefits of rules of origin in modern free trade agreements (2022)
Working Paper: The costs and benefits of rules of origin in modern free trade agreements (2022)
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