Free Trade Areas and Rules of Origin: Economics and Politics

Incorporating an intermediate input into a simple small‐union general‐equilibrium model, this paper first develops the welfare economics of preferential trading under the rules of origin (ROO) and then demonstrates that ROOs can improve the political viability of Free Trade Agreements (FTAs). Two interesting outcomes are derived. First, a welfare‐reducing FTA that was rejected in the absence of ROOs can become feasible in the presence of these rules. Second, a welfare‐ improving FTA that was rejected in the absence of ROOs can be endorsed in their presence, but upon endorsement it can become welfare inferior relative to the status quo.