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This chapter shows that the rules of origin, which are meant to protect against the trans-shipment of foreign goods in free trade areas, are instead being used to promote particular industries. Strict rules of origin add to production costs by forcing firms to use more expensive parts and pay administrative costs. They also prevent firms from exporting to markets governed by different trade agreements and disproportionately hurt small firms. The ongoing renegotiation of NAFTA highlights the potential to expand the use rules of origin as a form of trade protection. The WTO currently has only limited disciplines on rules of origin. Clear and enforceable international regulations would help thwart the spread of complex rules.
More than 200 regional trade agreements are currently in force. More than half of these agreements were implemented after the conclusion of the Uruguay Round in 1995, and many new agreements are currently under negotiation. In contrast, multilateral liberalization through the WTO has stalled: after seven years of negotiation, agreement among members on further multilateral trade liberalization remains unattainable. These facts speak for themselves; regionalism has been the dominant force for negotiated trade liberalization in recent years. This has led economists to reexamine the implications of regionalism both theoretically and empirically for trade, welfare, and the world trade system. Many concerns have arisen, leading many prominent trade economists to oppose regionalism as a means of trade liberalization.
At issue is the discriminatory nature of regional trade agreements (RTAs). Although tariff preferences stimulate trade among bloc members, they can have deleterious effects on nonmembers, potentially even on members, and on the political economy of trade policy formation. There are three main concerns. The first is trade diversion: RTAs may lead to diversion of imports away from the most efficient global producers to regional partners. This means that the formation of trade blocs can be welfare reducing (even for the member countries) if little new trade is created. The second concern is that regionalism may hinder unilateral and multilateral tariff reduction, leading to a bad equilibrium, with several trade blocs maintaining high external trade barriers.
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