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Rules of origin and the profitability of trade deflection

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  • Felbermayr, Gabriel
  • Teti, Feodora
  • Yalcin, Erdal

Abstract

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.

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  • Felbermayr, Gabriel & Teti, Feodora & Yalcin, Erdal, 2019. "Rules of origin and the profitability of trade deflection," Journal of International Economics, Elsevier, vol. 121(C).
    • Handle: RePEc:eee:inecon:v:121:y:2019:i:c:s0022199619300662
    DOI: 10.1016/j.jinteco.2019.07.003
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    5. Gnutzmann, Hinnerk & Gnutzmann-Mkrtchyan, Arevik, 2020. "The Cost of Borders: Evidence from the Eurasian Customs Union," Hannover Economic Papers (HEP) dp-664, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
    6. Foellmi, Reto & Hepenstrick, Christian & Torun, David, 2022. "Triangle Inequalities in International Trade: The Neglected Dimension," Economics Working Paper Series 2201, University of St. Gallen, School of Economics and Political Science.
    7. de Lucio, Juan & Mínguez, Raúl & Minondo, Asier & Requena, Francisco, 2024. "The negative impact of disintegration on trade: The case of Brexit," European Economic Review, Elsevier, vol. 163(C).
    8. Föllmi, Reto & Schetter, Ulrich & Torun, David, 2022. "Gravity with History: On the Aggregate Implications of Incumbency Effects in International Trade," VfS Annual Conference 2022 (Basel): Big Data in Economics 264136, Verein für Socialpolitik / German Economic Association.
    9. Merchan Alvarez, Federico Alberto, 2023. "International managerial skill and big Colombian exporting firms' performance, 2006-2014," Kiel Working Papers 2226, Kiel Institute for the World Economy (IfW Kiel), revised 2023.
    10. Jaime de Melo & Jean-Marc Solleder, 2022. "Patterns and Correlates of Supply Chain Trade in MENA and SSA," Working Papers hal-03649085, HAL.
    11. Sonali Chowdhry & Gabriel Felbermayr, 2023. "Trade liberalization along the firm size distribution: The case of the EU‐South Korea FTA," Review of International Economics, Wiley Blackwell, vol. 31(5), pages 1751-1792, November.
    12. Hiroshi Mukunoki & Hirofumi Okoshi, 2021. "Tariff elimination versus tax avoidance: free trade agreements and transfer pricing," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 28(5), pages 1188-1210, October.
    13. Naoto JINJI & Kazunobu HAYAKAWA & Nuttawut LAKSANAPANYAKUL & Toshiyuki MATSUURA & Taiyo YOSHIMI, 2020. "A New Approach for Quantifying the Costs of Utilizing Regional Trade Agreements," Discussion papers e-19-010, Graduate School of Economics , Kyoto University.
    14. Ornelas, Emanuel & Turner, John L., 2024. "The costs and benefits of rules of origin in modern free trade agreements," Journal of International Economics, Elsevier, vol. 147(C).
    15. Lukaszuk, Piotr & Torun, David, 2022. "Harmonizing the Harmonized System," Economics Working Paper Series 2212, University of St. Gallen, School of Economics and Political Science.
    16. Martin Richardson, 2023. "An Elementary Tariff Reform for a Free Trade Area," Foreign Trade Review, , vol. 58(1), pages 38-44, February.
    17. Sergii Meleshchuk & Yannick Timmer, 2024. "The price of capital goods, investment and labour: Micro‐evidence from a trade liberalization," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 57(3), pages 799-835, August.
    18. Ana Margarida Fernandes & Hiau Looi Kee & Deborah Winkler, 2022. "Determinants of Global Value Chain Participation: Cross-Country Evidence," The World Bank Economic Review, World Bank, vol. 36(2), pages 329-360.
    19. Martin Braml, 2020. "Beggar-thy-Neighbor or Favor thy Industry? An Empirical Review of Transatlantic Tariff Retaliation," ifo Working Paper Series 326, ifo Institute - Leibniz Institute for Economic Research at the University of Munich.
    20. Dzmitry Kniahin & Jaime de Melo, 2022. "A Primer on Rules of Origin as Non-Tariff Barriers," JRFM, MDPI, vol. 15(7), pages 1-23, June.
    21. MUKUNOKI Hiroshi & OKOSHI Hirofumi, 2021. "Wake Not a Sleeping Lion: Free Trade Agreements and Decision Rights in Multinationals," Discussion papers 21036, Research Institute of Economy, Trade and Industry (RIETI).
    22. Shuyao Yang, 2020. "Technical Barriers to Trade and Firms' Export Decisions," CESifo Working Paper Series 8693, CESifo.
    23. Hayakawa, Kazunobu & Mukunoki,Hiroshi & Kimura,Fukunari & Urata,Shujiro, 2023. "Determinants of the rules of origin in regional trade agreements in Asia," IDE Discussion Papers 882, Institute of Developing Economies, Japan External Trade Organization(JETRO).
    24. Legge, Stefan & Lukaszuk, Piotr, 2024. "The firm-level costs of utilizing free trade agreements," International Economics, Elsevier, vol. 178(C).

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    More about this item

    Keywords

    Trade deflection; Rules of origin; External tariffs; Free trade agreements;
    All these keywords.

    JEL classification:

    • F10 - International Economics - - Trade - - - General
    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F15 - International Economics - - Trade - - - Economic Integration

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