Rules of origin and the profitability of trade deflection

When a country grants preferential tariffs to another, either reciprocally in a free trade agreement (FTA) or uni-laterally, rules of origin (RoOs) are defined to determine whether a product is eligible for preferential treatment. RoOs exist to avoid that exports from third countries enter through the member with the lowest tariff (trade de-flection). However, RoOs distort exporters' sourcing decisions and burden themwith red tape. Using a global data set, we show that, for 86% of all bilateral product-level comparisons within FTAs, trade deflection is not profitable because external tariffs are rather similar and transportation costs are non-negligible; in the case of unilateral trade preferences extended by rich countries to poor ones that ratio is a striking 98%. The pervasive and uncon-ditional use of RoOs is, therefore, hard to rationalize.