Tài liệu The Impact of NAFTA on Foreign Investment in Third Countries

The Impact of NAFTA on Foreign Investment in Third Countries
7.1 Introduction


Chapter 4 examined the effects of FTAs on foreign investment in member countries, focusing on
the case of Mexico under NAFTA. As discussed in that chapter, an FTA may both raise the profitability
and reduce the risk from investing in FTA member countries, prompting an increase in their investment
inflows. Some evidence of this effect was found in the case of Mexico.


However, this also means that, other things equal, an FTA makes nonmember countries relatively
less attractive investment destinations. From the perspective of international investors, this may prompt a
portfolio reallocation away from these countries and thus a significant change in the allocation of
investment across countries—an ‘investment diversion’ effect analogous to the trade diversion effect
analyzed in Chapter 6.283


Has the rise in FDI to Mexico implied a reduction in FDI to other Latin American countries? If
so, which countries and why? And what can they do to remedy this situation? While the investment
creation effect of FTAs has attracted increased attention in recent years, few studies have examined the
impact on investment flows to nonmember countries. On a priori grounds, the redirection of FDI inflows
is likely to be more marked for those host countries most ‘similar’ to (i.e., closer substitutes for) the FTA
members in terms of location, endowments and overall investment environment. Thus, like with trade
diversion, in the case of NAFTA the neighboring countries of Central America and the Caribbean would
be among the prime candidates for investment diversion, since from the location perspective they are
relatively close substitutes for Mexico as FDI destinations.284


Like with FDI to FTA member countries, the impact on FDI to nonmembers depends also to a
large extent on whether investment flows are horizontally or vertically motivated. As explained in
Chapter 4, horizontal FDI is aimed at serving the local market of the host country, and is usually
motivated by trade costs such as transportation and tariffs. Vertical FDI is typically aimed at exporting the
production to third countries or back to the source country, and aims to exploit a cost advantage of the
host country. Obviously, many intermediate forms of FDI are possible.


If FDI into nonmember countries is mainly horizontal, it is unlikely to be strongly affected by the
creation or enlargement of an FTA.285 If FDI is vertically motivated instead, then flows to host countries


excluded from the FTA are likely to decline as source countries substitute investment within the FTA for
investment outside it. This applies to all investors, both from within and outside the FTA, who export
back from their host to the FTA, since now it will be cheaper to do so from member countries than from
nonmember countries.


While foreign investment into industrial countries is primarily of the horizontal variety, in
developing countries vertical investments account for a significant share of FDI.286 Historically, both


forms of FDI have been present in Central and South America. The early waves of FDI were directed to
the most traditional sectors of the region (agricultural and mineral goods), which constituted the main
exports of the host countries. Copper, bananas, oil, etc. were originally produced across Latin America by


283 The concepts of foreign investment creation and diversion in the context of trade integration date back to
Kindleberger (1966).
284 See Leamer et al (1995) for an ex-ante assessment of the potential effects of NAFTA on investment in Central


America, including an evaluation of the location similarities between Mexico and Central America.
285 If the FTA does have an impact, it is likely to be negative, as the relative size of the local market of nonmember


countries decreases vis-à-vis the now enlarged local market of the FTA.
286 See Shatz and Venables (2001).


269