The Political Economy of Rules of Origin

• In Event: Geography and the Political Economy of Trade

Abstract

What is the political economy of rules of origin in preferential trade agreements (PTAs)? Recent decades have witnessed a rapid proliferation of PTAs and the emergence of global value chains. With the fragmentation of production processes across countries, rules of origin largely determine the degree of liberalization of any PTA. Further, the legal complexity of these rules often obfuscates their distributional consequences, which allows firms to exert a significant amount of influence over their design and creates a powerful policy tool to provide hidden protection. Surprisingly, the existing literature on PTAs has largely ignored the underlying politics of rules of origin. In this project, I examine the political economy of rules of origin. Theoretically, I emphasize the cleavage that emerges between upstream suppliers and downstream producers. On the one hand, upstream suppliers should, on average, want their inputs restricted for downstream products because it allows them to increase their market share in the PTA region and extract rents. On the other hand, downstream producers should prefer less restrictive rules in order to minimize the costs of inputs. However, there are important exceptions. I use this cleavage as theoretical leverage to evaluate when an input is most likely to be restricted for a given output. Specifically, since upstream firms should always favor strict rules on downstream products, an input is likely to be restricted for an output when the preferences of downstream producers converge with upstream suppliers. I focus on how preferences of downstream producers vary depending on comparative advantage, arm’s length sourcing of intermediate inputs, and product differentiation. Empirically, using input-output tables to match all outputs with every required input, I construct a dataset that identifies whether an input is restricted for a specific output under U.S. trade agreements. Preliminary findings suggest that the likelihood an input is restricted increases as 1) the competitiveness of the downstream industry decreases, 2) imports of the input from PTA members increase, and 3) the degree of product differentiation in both the input and output increase. These results highlight how rules of origin in preferential trade agreements can create stumbling blocks to multilateral trade liberalization.

Author

• Dillon Laaker, University of Wisconsin, Madison