The Distorting Effects of Rules of Origin: A Firm-Level Analysis

Abstract

Recent decades have witnessed the proliferation of free trade agreements (FTAs). Unlike customs unions, these agreements make free trade between members conditional on compliance with rules of origin (RoO). These rules can restrict firms' sourcing decisions, preventing them from sourcing inputs from more efficient suppliers outside the FTA, in order to avoid losing origin status on their final goods. We leverage Brexit as a shock in EU-UK trade relations -- from a customs union to an FTA --- to examine the effects of RoO on firms' sourcing decisions, productivity, and exports. We construct a unique dataset that maps the RoO embedded in the Trade and Cooperation Agreement (TCA). We combine this dataset with rich administrative data from France. Exploiting within-firm cross-product and cross-country variation in treatment over time, we find that the introduction of TCA RoO significantly reduced the probability that French firms source inputs from third countries. The negative effects of RoO become larger over time, suggesting that it takes time for firms to switch suppliers. By distorting firms' sourcing decisions, TCA RoO have also negative effects on firms' exports and productivity. Joint paper with with P. Conconi, F. Gallina and T. Mayer.