How trade and investment agreements affect bilateral foreign direct investment: Results from a structural gravity model

Abstract

foreign direct investment, preferential trade agreements, gravity model 1 | INTRODUCTION We estimate the potential impact of preferential trade agreements (PTAs)-and other bilateral policies that affect trade and investment-on the bilateral FDI stocks and flows between the countries signing these agreements. Our key results are based on a structural gravity model of FDI that is applied to bilateral FDI data from UNCTAD (2014), while controlling for the presence, heterogeneity and depth of preferential trade agreements (PTAs), and other time-varying bilateral policies. Starting in the 1990s, the world economy has experienced a large increase in the number of PTAs, and also in their 'depth'-measured by the number of their operative provisions. 1 While stimulating bilateral trade is the main focus of most PTAs, recent preferential trade agreements increasingly contain provisions on bilateral investment between member states. However, the impact of PTAs on the magnitude of foreign direct investments is not straightforward. Trade and FDI can either complement or substitute each other, depending on the investment motivation (i.e., horizontal and vertical), the specific industry and on the way in which the FDI provisions are shaped in the PTA. From a theoretical point of view, horizontal FDI-where firms replicate domestic activities in a foreign country-is associated with FDI substituting for trade. Thus, in the presence of horizontal FDI, PTAs are expected to decrease FDI flows. On the other hand, vertical FDI-where firms split activities between different geographical regions-creates a complementary relationship between trade, PTAs and FDI (cf. Markusen, 2002). More recently, and, in part, due to the expansion and complexity of global value chains (GVCs), other motives for FDI have been identified. For instance, export-platform FDI where MNEs produce to export to third markets (Ekholm, Forslid, & Markusen, 2007; Hanson, Mataloni, & Slaughter, 2005). Yeaple (2003) classifies mixed FDI motives as 'complex FDI'. Baldwin and Okubo 1 + jit 1 + ijt .

Global Value Chains and Deep Integration

“…Second, our paper is related to a large body of research assessing the effect of PTAs on trade and FDI. With few exceptions (Rose, 2004), this literature has found that PTAs have a large effect on trade flows between partner countries (Baier and Bergstrand, 2007;Büthe and Milner, 2008;Mansfield and Reinhardt, 2008;Baier et al, 2014;Büthe and Milner, 2014;Dür et al, 2014;Egger and Nigai, 2015;Osnago et al, 2017;Miroudot and Rigo, 2019;Laget et al, 2020;Kox and Rojas-Romagosa, 2020). Our results warn scholars that reverse causality is at play, leading to potentially overestimating the impact of preferential liberalization on trade activities.…”

Non-trade provisions in trade agreements and FDI

“…Second, we contribute to the recent literature investigating the non-trade content of trade agreements (Borchert et al, 2020;Lecher, 2016) and its impact on trade (Carrère et al, 2017;Lopez Vicente et al, 2020;Osnago et al, 2020;Raess and Sari, 2018). The paper closest to ours is Kox and Rojas-Romagosa (2020). They investigate the impact of PTAs and bilateral investment treaties on FDI: we follow their approach in specifying our empirical exercise and extend the analysis to how NTIs in PTAs affect FDI.…”

“…Although the research question that we explore is novel to the literature, this paper places itself at the intersection of two main strands of the literature. First, we add to the studies investigating the economic effect of trade agreements (among many others, Baier and Bergstrand, 2007;Egger et al, 2011;Heid et al, forthcoming;Olivero and Yotov, 2012) and the effect on FDI in particular (Anderson et al, 2019;Bergstrand and Egger, 2007;2010;Chen, 2009;Kox and Rojas-Romagosa, 2020;Ramondo, and Rodríguez-Clare, 2013). Second, we contribute to the recent literature investigating the non-trade content of trade agreements (Borchert et al, 2020;Lecher, 2016) and its impact on trade (Carrère et al, 2017;Lopez Vicente et al, 2020;Osnago et al, 2020;Raess and Sari, 2018).…”

Effect of the Utilization of Unilateral Trade Preferences on Foreign Direct Investment flows to Beneficiary Countries

“…[3] These works include for example, Baccini et al (2017); Baltagi et al (2008); Büthe and Milner (2008); Cardamone and Scoppola (2012); Kox and Rojas-Romagosa (2020); MacDermott (2007); Medvedev (2012); Tekin-Koru and Waldkirch (2010) and Zahid (2020).…”