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Sébastien Miroudot
has been overlooked, in large part because of lack of data and of methods for precisely assessing the impact of PTAs on flows of trade and investment. Recent developments in economic theory, as well as new empirical tools, have to some extent enabled economic analysis to catch up. There is now empirical evidence on the positive impact of bilateral investment measures in PTAs. Studies have, however, shown that not all PTAs improve the investment climate and that other determinants of FDI are important as well and may condition the positive impact of PTA provisions. Economic Benefits of PTAs with Investment Provisions: Theory Trade and investment can be seen as two sides of market access. Firms have different means of serving foreign markets; in particular, they can choose between exporting (trade) and creating a subsidiary within the foreign economy for local production (international investment). The recent literature on firm heterogeneity and global sourcing (Antràs and Helpman 2004; Helpman 2006) focuses on the choice between exports and FDI. Not all firms follow the same path. Depending on their productivity, size, and structure of production, firms adopt different strategies that lead to different types of international activities such as offshoring, outsourcing, or vertical specialization. The least productive firms tend to stay in the domestic market, while more efficient companies can engage in international investment and become multinational enterprises (MNEs). There are also differences across sectors in the way firms organize their production, based on product characteristics and technologies. The “proximity-concentration tradeoff ” (Brainard 1997) describes a substitution effect between trade and investment. Market-seeking MNEs face trade costs when they export (all those costs related to sales overseas) but can save on production costs because of scale economies, as all the production is done in the home country. When they invest abroad and manufacture locally, MNEs no longer incur trade costs, but production costs can increase because production is now split between the home country and the host, diminishing scale economies. The outcome of this trade-off depends on the relative sizes of trade costs and investment costs. High border barriers such as tariffs may encourage the company to produce close to the consumers in the foreign economy—that is, to engage in tariff-jumping FDI. In this theoretical framework, PTAs affect firms’ strategies at several levels. First, the trade liberalization provisions in PTAs have an impact on trade costs. Reduced trade
costs can encourage trade rather than investment within the region where the PTA is signed. Conversely, to the extent that the PTA increases trade costs vis-à-vis thirdparty countries, it can promote tariff-jumping investment by these parties. An implication is that even an agreement with no investment provisions is likely to influence firms’ decisions because of its impact on the trade-off between investment costs and trade costs. If, in addition, a PTA includes provisions that lower investment costs, it is likely to further encourage FDI over arm’s length trade. Because of the link between trade costs and investment decisions, the concepts of trade creation and trade diversion can be transposed into the realm of investment. A PTA that increases trade barriers relative to third countries can be investment creating, by encouraging FDI from these third countries. The same PTA can be investment diverting intraregionally because arm’s length trade is less costly and firms liquidate former tariff-jumping FDI. Restrictive rules of origin for goods within the PTA can also lead to investment diversion, as manufacturers using third-country inputs concentrate their production in the country with the largest market and the lowest external tariffs (Estevadeordal and Suominen 2005). The proximity-concentration trade-off is only one side of the complex relationship between trade and investment and is relevant only with respect to horizontal FDI. In the case of vertical FDI and vertical specialization leading to global value chains, trade and investment are complements rather than substitutes. Vertical FDI is associated with efficiency-seeking strategies whereby firms intend to benefit from locational advantages such as better or relatively cheaper factors of production or strategic resources. In this context, a PTA is likely to increase FDI through both its trade and its investment provisions. In particular, the reduction of barriers to imports of intermediate goods and services can encourage FDI (Ferrantino and Hall 2001). The picture is further complicated by network effects and third-country effects that arise because firms choose their production location from among several countries that belong to different regional integration schemes. When economic integration is deepened in a group of countries, trade liberalization can have a redistributive effect on intraregional investment patterns; one country might attract more FDI and other countries, less. In brief, whether a PTA eventually increases or reduces FDI flows is an empirical question. The answer depends on the relative strength of the decreases in trade costs and investment entry costs, as well as FDI motives (efficiency seeking or market seeking). Whether FDI is positive for the host country, and for developing countries specifically,