Rules of origin and gains from trade

Free trade areas (FTAs) involve unharmonized tariffs and rules of origin that have prevented proving the formal general equilibrium existence of a welfare-enhancing FTA. This paper identifies the most restrictive limit that rules of origin can enforce and still continue to guarantee gains from trade for FTA formation. We note that many commonly used rules of origin exceed this condition in practice. We apply the identified welfare-supporting rules of origin and prove the existence of a FTA general equilibrium involving only within-FTA transfers that is at least as satisfactory for every consumer as an arbitrary original world trade allocation. The analysis also helps to explain why hub-and-spoke extensions of FTAs cannot be expected to guarantee gains from trade for all participants in general.