Optimal Rules of Origin with Asymmetric Compliance Costs under International Duopoly

We examine the optimal rules of origin (ROO) in a free trade area/agreement (FTA). We incorporate compliance costs of the ROO into the model. In particular, compliance costs are higher for a firm located in a non-member country of the FTA than for a firm located in an FTA member country, whereas marginal production costs are lower for the former. An importing country within the FTA imposes tariffs on imports that do not comply with the ROO. We show that the optimal ROO may have a protectionist bias or cause low utilization of FTAs depending on parameter values.