Measuring rules of origin

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In the modern global economy, most barriers to trade do not come in the form of tariffs or quotas. Indeed, as early as 1970, Robert Baldwin described non-tariff protection as a big challenge following the Kennedy Round: “lowering of tariffs has, in effect, been like draining a swamp. The lower water level has revealed all the snags and stumps of non-tariff barriers that still have to be cleared away.” In fact, as Chad Bown notes, draining the swamp may have not just revealed non-tariff barriers, it “may have stimulated growth in levels of old and new forms of nontariff protection”.

This fact about modern protectionism is a bit inconvenient for economists. It’s pretty straightforward to teach the partial-equilibrium economics of tariffs and quotas to students. The supply-and-demand story can be taught with one diagram containing a few rectangles and triangles, like in this video. Moreover, the analysis of an ad valorem tariff is not sensitive to the sector or good being discussed. Given supply and demand elasticities, a tax is a tax, whether it’s applied to apples or autos. Technical barriers to trade like product regulations are necessarily sector-specific. A discussion of the fact that US automobiles must have amber front turn signals while in the EU those lamps are white does not necessarily yield general principles that could be applied to other sectors.

This difficulty also pops up in research. A lot of trade-policy theory treats tariffs as the relevant instruments. For example, Grossman and Helpman’s “Protection for Sale” model describes a government that may impose trade taxes and subsidies. In their empirical assessments of this theory, Goldberg and Maggi and Gawande and Bandyopadhyay used non-tariff barriers as their measures of protection rather than tariff rates, because tariffs are negotiated at the WTO, not determined unilaterally. But non-tariff barriers come in many different forms and therefore raise a host of measurement issues (what is the tariff-equivalent of requiring amber vs white turn-signal lamps?), particularly for making cross-sector comparisons (does comparing the fraction of two sectors’ products covered by any non-tariff measures reveal their relative restrictiveness?). I think we would see a lot more research on non-tariff barriers if they were as easy to measure as tariff rates.

Another prominent feature of modern trade policy is the huge role played by preferential trade agreements. Proposed US trade agreements like the TPP and TTIP mostly concern non-tariff issues like intellectual property rights and regulatory harmonization, not the single-digit ad valorem tariffs that remain for most manufactures. But the preferential tariff rates that define PTAs like NAFTA, customs unions like the EU, and GSP schemes like AGOA rely on a non-tariff barrier called “rules of origin”.

Rules of origin are the criteria used to define where a good was produced. Preferential trade policies necessitate defining goods’ origins so that imports from preferred partners are eligible for lower tariff rates while imports from non-members cannot qualify through mere transshipment. But when goods are produced using intermediate inputs, saying “where” a good was made can get quite difficult. In dictating how to determine the national source of a product, rules of origin can discourage firms from using intermediates imported from sources that aren’t eligible for preferential tariffs. That is, “they prevent final good producers from choosing the most efficient input suppliers around the world, in order to avoid losing ‘origin status’ and the tariff preference it confers.”

We suspect that rules of origin matter. When they’re absent, transshipment occurs. Rotunno, Vezina, and Wang attribute a surge of African textile exports to AGOA’s weak rules of origin, which led Chinese textile manufacturers to exploit AGOA-eligible countries as transshipment corridors to the US. When rules of origin are present, firms find them costly. In a survey of manufacturing firms in developing economies, rules of origin and related paperwork represented the most troublesome type of non-tariff barrier for exporters.

But there has been little research quantifying these rules’ consequences, since measuring rules of origin seems a daunting task. A recent paper by Conconi, Garcia-Santana, Puccio, and Venturini tackles the measurement challenge:

First, the rules contained in the NAFTA agreement are written at a disaggregated level, with specific rules for each product (defined at the heading or sub-heading level of the Harmonized Schedule). Second, they are mostly defined in terms of change of tariff classification, with few instances in which these rules are combined with valued added rules. These features allow us to construct a unique dataset, which maps the input-output linkages embedded in NAFTA RoO. For every final good, we can trace all the inputs that are subject to RoO requirements. Similarly, we can link every intermediate good to the final goods that impose RoO restrictions on its sourcing.

They find that rules of origin matter:

Our results show that NAFTA RoO on final goods led to a significant reduction in Mexican imports of intermediate goods from non-NAFTA countries. As expected, the magnitude of this effect depends on whether the sourcing restrictions were strict or flexible (i.e. whether change in tariff classification rules were combined with alternative value added rules) and on the extent to which Mexican producers had incentives to comply with them (i.e. on the size of the preference margin and the importance of NAFTA export markets).

Here’s a VoxEU column summarizing their research.

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