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

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  • Emanuel Ornelas
  • John L. Turner

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.

Suggested Citation

  • Emanuel Ornelas & John L. Turner, 2022. "The Costs and Benefits of Rules of Origin in Modern Free Trade Agreements," CESifo Working Paper Series 9920, CESifo.
    • Handle: RePEc:ces:ceswps:_9920
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    References listed on IDEAS

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    Cited by:

    1. Pamela Bombarda & Elisa Gamberoni & Irene Iodice, 2023. "Rules of Origins Relaxation and Regional Supply Chains: Evidence from Europ," THEMA Working Papers 2023-13, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.

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    More about this item

    Keywords

    hold-up problem; sourcing; incomplete contracts; regionalism;
    All these keywords.

    JEL classification:

    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F15 - International Economics - - Trade - - - Economic Integration
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights

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