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that can be use, or on the imported products which can be used in the process of
production, or on the nature of the production process itself. In each of these cases
the rules can be established such that there is a direct impact on the choices that
firms make in terms of their sources of supply of intermediates and / or the
production process they use. Consider the extreme case where a good in order to
be originating has to be produced entirely from material originating in the
exporting country (wholly obtained). In that case if the firms wish to export the
good duty free to the EU, then they cannot use any imported intermediates
whatsoever.
The nature of the rules, therefore, can easily impact on patterns of trade. In effect
where rules of origin are constraining or restrictive, their effect is to establish barriers
to trade between the PTA countries and the non-PTA countries. Formally,
constraining rules of origin can be seen as equivalent to simultaneously imposing an
import tariff between partner and non-partner countries, as well as granting domestic
partner country producers a production subsidy (Krishna & Krueger, 1995, Krishna
2005) 1 .
Constraining rules of origin are thus likely to either:
• Encourage the exporting producer to source more intermediates domestically - in
which case trade suppression has occurred.
• Encourage the exporting producer to source more intermediates from the partner
country – in which case trade diversion has occurred. In this case the rules of
origin are likely to negatively impact on trade between the spokes, while
encouraging hub-spoke trade.
• Result in the exporting producer deciding to continue to source the intermediates
from the most competitive supplier in the knowledge that the rules of origin will
not be satisfied, and that tariffs will then be applicable on exports to the EU.
Whether the firm choose this or not will depend on the trade off between lower
costs arising from cheaper intermediates, and the tariff which is then imposed; or
the higher cost from using domestic or partner country intermediates but with
tariff free access to the export market.
What is important is to that the rules may serve to protect certain sectors from the
degree of liberalisation that might otherwise be implied by the free trade agreement
(see also. Brenton & Machin (2003), Falvey & Reed (2002), Burfisher, Robinson &
Thierfelder (2001), Hoekman (1993)) 2 The extent of any such impact will then
depend on a number of further factors, such as the nature of the underlying market
structure [eg. Vousden (1987), Krishna & Krueger (1995)], or on how “sufficient
working or processing is defined” [Krishna & Itoh (1988)], and of course of the costs
of not being able to fulfill the originating requirement, and in particular the height of
the importers’ tariff [Hoekman (1993), Gasiorek et.al. (2002)].
It is also worth underlining that for any given PTA the rules of origin are perceived as
being very technical. This appears to arise largely from high level of disaggregation at
which they are defined (eg HS 4 or 6 digit) and from the criteria combinations
1 Examples that are often cited here concern the role of the US automobile industry in drawing up the relevant NAFTA rules of orgin, or the
role of textile producers in both the EU and the US rules.
2 There is also a literature which examines the welfare impact of rules origin and considers issues such as the circumstances under which
restrictive rules of origin may be welfare increasing [eg. Mussa (1984), Falvey & Reed (1998), Panagariya & Krishna (2002)], the interaction
between the wefare effects and the political viability of a given FTA [Duttagupta & Panagariya (2007)], as well as the impact on firm
behaviour [Ju & Krishna (2005)].