Free Trade Areas and Rules of Origin: Economics and Politics

IMF Working Papers, November 1, 2003

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Incorporating intermediate inputs into a small-union general-equilibrium model, this paper first develops the welfare economics of preferential trading under the rules of origin (ROO) and then demonstrates that the ROO could improve the political viability of Free Trade Agreements (FTAs).
Two interesting outcomes are derived:
- A welfare reducing FTA that was rejected in the absence of the ROO becomes feasible in the presence of these rules.
- A welfare improving FTA that was rejected in the absence of the ROO is endorsed in their presence, but upon endorsement it becomes welfare inferior relative to the status quo.

The model incorporates intermediate inputs within a small-union general-equilibrium framework to analyze preferential trading under ROO.
ROO can alter political viability and equilibrium outcomes of FTAs:
- ROO can convert previously rejected, welfare-reducing FTAs into feasible agreements.
- ROO can lead to endorsement of FTAs that would otherwise be rejected even if such endorsement may result in the FTA being welfare inferior to the status quo once adopted.
The paper frames results in terms of welfare economics, political economy, and standard trade concepts such as trade creation and trade diversion.

Subject: Exports, Imports, International trade, Tariffs, Taxes, Trade in goods
Keywords: A. ROOs, binding ROO, Exports, FTA, FTA endorsement, FTA equilibrium, FTA in the absence, FTA price, FTA viability, Imports, North America, Political economy, ROO inclusion, Rules of Origin, supply curve, Tariffs, trade creating FTA, trade diversion, Trade in goods, Welfare, welfare-reducing FTA, WP