Firm Behavior and Market Access in a Free Trade Area with Rules of Origin

We develop a model to study the behavior of firms in a Free Trade Area with Rules of Origin and the consequences of this behavior on the market equilibrium and outcome. We show that firms will choose to specialize, and that an FTA with strict ROOs on the intermediate good raises imports and hence improves market access in the final good market reduces imports and hence harms market access in the intermediate good market. More restrictive ROOs on the final good first raise and then lower imports of the final good lower than raise imports of the intermediate good. Their turning point is common so that imports of the final good are maximized and imports of the intermediate good are minimized at a common level of restrictiveness of the rules of origin. We show that our model can be reinterpreted to show that more restrictive ROOs on the final good first improves and then harms the fortunes of labor, and to cast light on a particular policy to improve market access. Other problems with a similar structure could also be analyzed using our techniques; we expect similar results.