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Trade Diversion and Production Sharing

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This paper examines the repercussions of cross-border production sharing for the welfare effects of preferential trade liberalization. In a general-equilibrium context, a free trade agreement (FTA), which incorporates production sharing, raises the likelihood of welfare improvement. Thus, two members of a free trade area, who each have comparative disadvantage in the production of a final product relative to a nonmember, may nevertheless enjoy net trade creation if they jointly possess comparative advantage in key components of that product. At a minimum, cross-border production sharing reduces the trade-diverting elements of an FTA. It follows, that rules of origin, viewed as constraints on cross-border fragmentation, augment the negative, tradediverting elements of free trade areas.

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Sven W. Arndt

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Adapt according to the presented license agreement and reference the original author.