The impact of regional integration On foreign direct investment: can closer economic cooperation among countries influence firms' location strategies?

The impact of regional integration On foreign direct investment: can closer economic cooperation among countries influence firms' location strategies?

The paper examines the relationship between the degree of integration in a Regional Integration Agreement (RIA) and the member governments' use of restrictive trade policy to influence the location decisions of firms from outside the RIA. Two cases are investigated: one in which the members of a free trade area (FTA) compete in terms of external tariffs to attract FDI from a firm located outside of the free trade area and one in which the members of the FTA enter into a hub and spoke type arrangement with two countries located outside of the FTA. In the first case each government will impose the same external tariff thereby increasing the degree of integration within the FTA which becomes a customs union. In the second case the two countries located outside of the original FTA will receive the highest welfare if they sign a free trade area agreement with each other, therefore increasing their degree of economic integration.