Rules of Origin and the Profitability of Trade Deflection
Authors: Gabriel Felbermayr, Feodora Teti and Erdal Yalcin (Journal of International Economics, 2019, Vol. 121)
When a country grants preferential tariffs to another, either reciprocally in a free trade agreement (FTA) or unilaterally, rules of origin (RoOs) are defined to determine whether a product is eligible for preferential treatment. RoOs exist to avoid that exports from third countries enter through the member with the lowest tariff (trade deflection). However, RoOs distort exporters’ sourcing decisions and burden them with red tape. Using a global data set, we show that, for 86% of all bilateral product-level comparisons within FTAs, trade deflection is not profitable because external tariffs are rather similar and transportation costs are non-negligible; in the case of unilateral trade preferences extended by rich countries to poor ones that ratio is a striking 98%. The pervasive and unconditional use of RoOs is, therefore, hard to rationalize.
Keywords: trade deflection, rules of origin, external tariffs, free trade agreements
JEL: F10, F13, F15