Trade Diversion and Production Sharing

Abstract:     
This paper examines the repercussions of cross-border production sharing for the welfare effects of preferential trade liberalization. In 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 non-member, may nevertheless enjoy net trade creation if they jointly possess comparative advantages 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, trade-diverting elements of free trade area.

Number of Pages in PDF File: 14

Keywords: Trade diversion, free trade areas, fragmentation, production networks

JEL Classification: F11, F13, F15

Accepted Paper Series