Trade Policy Subtlelies with Multinational Firms

Regional trade blocks must specify domestic-content rules that define the conditions under which a good qualifies as ‘domestic’ and so may be freely traded within the block. This paper analyzes such rules, focussing on oligopolistic industries in which foreign multinationals rely much more on imported intermediate inputs that do domestic firms. In such a situation, we argue that domestic content provisions are anti-competitive, reducing overall final output of the industry, and shifting rents to domestic firms. These ideas are examined analytically and then numerically using an applied general-equilibrium model of the North American auto industry.