Regional Economic Integration and Foreign Direct Investment: The Case of NAFTA

By Feils, Dorothee J.; Rahman, Manzur | Management International Review, April 2008 | Go to article overview

Regional Economic Integration and Foreign Direct Investment: The Case of NAFTA


Feils, Dorothee J., Rahman, Manzur, Management International Review


Abstract and Key Results

* We examine the impact of NAFTA on FDI into the region and the individual member countries. The literature on FDI and regional economic integration suggests that the implementation of NAFTA makes the entire area a more desirable investment location. However, insofar as individual member countries are concerned, the a priori effects are not necessarily unambiguously positive.

* We find that the implementation of NAFTA had a generally positive effect on inward FDI into the entire region, with the benefits accruing only to the United States and Canada.

Key Words

Regional Economic Integration * NAFTA * Foreign Direct Investment * FDI * Canada * Mexico * United States

Introduction

Foreign direct investment (FDI) has increased significantly over time, driven by wide-ranging economic and technological forces (Buckley et al. 2001, Dunning 1998, Anand/ Kogut 1997). These forces, however, cannot explain the increase in FDI entirely. "[I]t is also driven by the ongoing liberalization of FDI and trade policies. National policy regimes are converging towards a more welcoming stance on FDI, as competition for investment intensifies" (UNCTAD 2002, p. 3). Countries compete for FDI, and regional economic integration may provide them with additional location-specific advantages that serve to attract it (Ethier 1998). However, not all countries in the integrated region may benefit to the same degree (Dunning 1997, Ethier 1998). In fact, some countries may lose FDI to other partner countries in the regional integration pact. This fear has been expressed in all three member countries of the North American Free Trade Agreement (NAFTA), Canada, Mexico and the United States, which are very directly involved in the competition for investment (e.g., Love/Lage-Hidalgo 1999).

NAFTA came into effect on January 1, 1994. Canada, Mexico, and the United States agreed to eliminate tariffs on 99 percent of internally traded goods by the end of 2004 and significantly liberalize FDI policy (Hejazi/Safarian 2005). Investors from within NAFTA are generally guaranteed equal treatment with domestic investors for most manufacturing and a few service sectors and transparent regulations (see Rugman/Gestrin 1994 for a more detailed description of the treatment of the various sectors in each country). In addition, NAFTA contains dispute settlement procedures and provisions regarding government procurement, intellectual property and rules of origin regulations (Blomstrom/Kokko 1997).

This study examines the impact of regional integration of the three NAFTA countries on inward FDI for the entire region as well as for each member country. Theoretically, the expected impact of NAFTA on inward FDI in the entire area is positive, but ambiguous for individual member countries (Dunning 1997, Eden 2002, Ethier 1998, Buckley et al. 2001). Current empirical evidence is limited to single country studies and thus cannot address the issue of the effect of the implementation of NAFTA on FDI for the entire area, as well as examining for any potential differential effects among the three member countries (Buckley et al. 2001, Feils/Rahman 1998, Globerman/Shapiro 1999, Hejazi/Safarian 2002, Buckley et al. 2004, Ramirez 2002, Thomas/Grosse 2001). Our results using a comprehensive data set spanning a 21-year period (1981 2001) and 14 extra-NAFTA home countries show that NAFTA had a positive impact on total inward FDI into the region as a whole. We find that these gains went to the United States and Canada and not to Mexico. In the next section, we present a brief literature review and then develop the key hypotheses. The data and the methodology employed in the study are discussed subsequently, followed by a presentation of the results. Concluding remarks are included in the last section.

Literature Review and Hypotheses

The selection of a suitable location is an integral part of the FDI decision of a firm. …

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