TAILIEUCHUNG - Lessons from NAFTA_chap7

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. | Chapter 7 The Impact of NAFTA on Foreign Investment in Third Countries 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 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 . 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 284 285 286 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

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