Rules of origin and consumer-hurting free trade agreements*

Abstract

This study examines how the rules of origin (RoO) of a free trade agreement (FTA) affect firms' pricing strategies. The value-added criterion (VAC) of the RoO requires firms to add more than a certain level of value within an FTA when firms use inputs originating from outside the FTA. The VAC may work as a price floor, and the resulting increases in prices can benefit all firms if it induces an offshoring firm to manipulate its output price. Meanwhile, a consumer-hurting FTA formation is possible, even if all firms make tariff-free exports. Furthermore, such an FTA formation may worsen total welfare.