without having to scale up estimates from individual agreements.<sup>15</sup> The second part of this section relies on an observation that PTAs may have varying impacts on trade in different products. The implicit assumption of any gravity model that uses total imports or exports as its dependent variable is that all trade flows are affected in the same fashion by the set of independent variables. While this reasoning is likely to hold for the majority of variables usually included in the gravity specification (e.g. aggregate output levels, price indices, etc.), such generalization may not be appropriate for PTA membership variables. There are several reasons why bilateral merchandise trade flows in different tariff lines may respond differently to PTAs. First, tariff lines where the MFN duty is zero have become a large share of the overall number of tariff lines for many countries. Therefore, trade that takes place in these lines cannot be considered preferential since the same (zero) margin of preference is extended to all trading partners, regardless of PTA membership. Second, even if the MFN duty is above zero, an exporter may choose to forego the preferences and bring the goods in under MFN rates if the costs of complying with the relevant rules of origin (ROO) are too high.<sup>16</sup> Thus, trade that takes place in tariff lines where the MFN duty level is low enough to dissuade an exporter from proving origin must also be taken out of the definition of preferential flows. Third, virtually all PTAs in existence limit trade liberalization by means of sensitive lists and product exclusions, and frequently incorporate long phase-in periods and encounter implementation problems. Therefore, the effective liberalization potential of a given PTA is limited to a set of tariff lines where the MFN duty is above a certain ROO threshold, taking

> 15Note that simply including a large number of PTAs in the model may not represent a strict improvement over earlier efforts due to large variation in the size and scope of agreements. In extreme cases (consider a PTA vector that includes both NAFTA and a Georgia-Armenia PTA), the interpretation of an “average effect” becomes quite difficult. Nonetheless, relying on a comprehensive database of PTAs offers several advantages. First, the average effect, if significant, suggests that PTAs of all sizes have a noticeable effect on trade, and second, the richness of the database allows us to test various combinations of PTAs (e.g. North-South vs. South-South, WTO notified vs. unnotified, etc.) and compare these estimates to the average effect.

> 16The rules of origin are the criteria needed to determine the national source of a product. ROO are used to determine whether a shipment falls within a quota limitation, qualifies for a tariff preference, or is affected by an anti-dumping duty. Under any preferential scheme, ROO are required to prevent third parties from exporting to the country with the lowest level of external protection and subsequently re-exporting to other members at preferential rates. Therefore, ROO are present in both bilateral and unilateral preference regimes, and become obsolete only at the highest levels of integration such as a customs union with a common external tariff (since all members have the same level of protection). ROO are implemented through different means, and vary from country to country and from one PTA to the next. It is not uncommon for the same exporter to face very different ROO, such as Mexican firms exporting to the US under NAFTA and to the EU under the EU-Mexico free trade agreement. The most often used ROO criterion is substantial transformation of the product, but other requirements such as change in tariff classificaiton (Harmonized System chapter, heading, or sub-heading), certain ad valorem percentage, or specific manufacturing or processing operation are also common.

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