joint with Keith Head and Thierry Mayer

Free trade agreements have rules of origin (ROO) that determine whether imports are eligible for tariff preferences. While necessary to prevent goods made outside the area from evading the normal tariffs, such rules may also have protectionist intent. A case in point is the 2020 revision to the North American Free Trade Agreement known as the USMCA. The acknowledged purpose of the USMCA was to promote production within the region, especially in the auto industry, where the main changes were introduced. But rules of origin impede cost minimization, making the region less attractive for assembly. We establish in a continuum-of-inputs model the existence of a ROO Laffer curve, where stricter content requirements initially expand production but can eventually contract it if carried beyond the curve’s peak. Then we adapt the model to the case of auto parts, focusing on the two most high-value inputs: engines and transmissions. Estimates of the sourcing decision point to the roles of cost differences and geographic impediments as push and pull forces. In the next step we will simulate changes in ROOs to determine whether it is empirically likely that the USMCA will put the regional industry on the wrong side of the Laffer curve.

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