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

Emanuel Ornelas and John L. Turner

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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)
Pages: 54 pages
Date: 2022-08-31
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 (1)

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http://eprints.lse.ac.uk/117981/ Open access version. (application/pdf)

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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