Foreign Direct Investment and Host-Country Trading Blocs

Abstract

We consider the impact of preferential trade agreements (PTAs) on horizontal foreign direct investment (FDI) coming from parent countries outside the PTA. While easier access to a larger market due to a PTA may justify new FDI, pre-existing investments may be rationalized as firms concentrate production in a single plant in the PTA. Which effect dominates depends on the extent of pre-PTA tariff jumping. The number of firms in the industry and non-PTA welfare may rise or fall. PTA welfare increases regardless of PTA-induced changes in inward FDI.