The year 2015 marked the 20th anniversary of the establishment of the World Trade Organization (WTO). Over the past 20 years, notwithstanding certain difficulties in concluding the Doha Development Agenda (DDA) negotiations, the WTO to a certain degree has achieved one of its original missions: promoting trade liberalization through bilateral free trade agreements (FTAs) and regional or plurilateral FTAs. Since the global financial crisis in 2008, however, the growing criticism of globalization based on neo-liberalism has created the need for a new trade paradigm. In particular, Brexit and the election of Donald Trump as the 45th US President in 2016 have fueled the uncertainty hanging over the global economy and rising protectionism, which could eventually provoke trade war. Upon his inauguration, President Trump withdrew from the Trans-Pacific Partnership (TPP) and the United States introduced a new set of trade policy measures that could adversely affect world trade volume and the existing global trade system.
Recent changes in the international trade environment have presented new challenges for policymakers, particularly for those in Korea, which is highly interconnected with the world economy through an extensive network of global value chains (GVCs). Korea has regarded itself as the most benefited member of the WTO multilateral trading system (MTS). By adopting a simultaneous and multiple FTA negotiations strategy, Korea has increased its economic expansion and grown into a global FTA hub. However, it is time for Korea to consider revising its current trade policy centered on the expansion of bilateral FTAs, which may cause a spaghetti-bowl effect where a host of bilateral FTAs increase trade costs due to the complexity and diversity of rules of origin (ROO). As such, plurilateral FTAs have emerged as a viable alternative to the multilateral trading system or bilateral FTAs.
This study investigates the effect of rules of origin on trade costs. In particular, we examine different types of cumulative rules of origin adopted by various FTAs across the world ‒ how they are arranged and how they work. Existing literature on the effect of ROO on trade costs provides mixed results. Theoretically, allowing cumulation in FTAs should bring trade costs down. Nevertheless, some practical issues in complying with the rules of origin and certification and verification requirements may prevent companies from taking advantage of cumulative rules of origin. Research methods employed by this study include both the conventional way of indirect estimation in calculating trade costs through the trade creation effect, and direct estimation of trade costs which employs the methodology recently made available by Novy (2013). Then we use these estimated trade costs in the computable general equilibrium (CGE) model of the Global Trade Analysis Project (GTAP) to analyze the economic effects of ROO on trade costs. We apply the analysis to mega-FTAs in the Asia Pacific region such as the Regional Comprehensive Economic Partnership (RCEP) and TPP-11 (TPP without the United States), as well as a potential FTA between Korea and Mercosur. Our results show that all three different types of cumulation (bilateral, diagonal, and full) reduce trade costs with the magnitude greatest for full cumulation.
Our empirical and policy simulation results suggest that policymakers should make efforts to simplify and harmonize various ROOs and pursue single ROO with full cumulation in FTA negotiations. In addition to simplification and harmonization of ROOs, institutional support and assistance in the areas of ROO and cumulation are essential for small and medium enterprises (SMEs) to reduce trade costs and fully entertain the benefits of FTAs. Finally it would be desirable for Korea to participate in negotiations of plurilateral FTAs rather than bilateral FTAs.