Do regional trade agreements stimulate FDI? Evidence for the Agadir, MERCOSUR and AFTA regions

Mondher Cherif and Christian Dreger

Review of Development Economics, 2018, vol. 22, issue 3, 1263-1277

Abstract: The integration of emerging markets into the global economy is heavily promoted by foreign direct investment (FDI) inflows. Among the factors explaining the location of FDI, regional trade agreements (RTAs) can be relevant for emerging markets, as they can promote economic integration and increase the attractiveness of the region for foreign investors. This paper investigates the impact of South–South trade agreements on the FDI decision of multinationals, where the Agadir, mercado comun del sur (MERCOSUR), and ASEAN free trade area (AFTA) agreements are considered. Three panels of countries are defined, where the members joined a specific agreement or not. Non‐Gulf Arab states are compared to better performing regions in Latin America and Southern and Eastern Asia. The analysis provides evidence that openness to foreign trade and financial markets are among the main catalysts to attract FDI, provided that business‐friendly institutions exist in the host country. Other variables, like the size of the industrial sector, urbanization rates, and external debt appear to be important in some cases. The integration of China into the world economy is a specific trigger for FDI to Asian destinations. Since RTAs influence the market size by reducing barriers to trade, their impact operates via GDP growth and openness. Gains from the agreement are striking for Latin America and Asia, but not for Arab states. To attract more FDI, business‐friendly institutional reforms and mechanisms to support new firm foundation should be implemented in this region.

Date: 2018
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