Endogeneity and dynamics in the impact of free trade agreements on trade and foreign direct investment
In the study of the impact of Free Trade Agreements on Foreign Direct Investments and on trade flows, there are some econometric issues that have not been fully addressed. This research aims to provide a discussion of these econometric issues and to present, using the most advanced econometric tools, new empirical results useful for understanding the relationship among regional integration, FDI and trade of goods. The research results in three self-contained, closely related papers. The first paper analyzes the relationship between FTA and FDI, focusing on the estimation bias that arises when the researcher does not consider the endogeneity of FTA, the fact that the relationship between FTA and FDI is dynamic, and the potential correlation between the current level of FDI and future participation in trade agreements as an additional source of endogeneity. This source of endogeneity did not receive attention in the international trade literature. Using the dynamic panel estimation method, the results show that, when the sources of bias are controlled for, trade agreements do not promote FDI in the way supported by previous empirical analysis and some theoretical arguments. The second paper focuses on the relationship between FTA and trade flows. Also in this case, not controlling for the econometric issues presented above produces a biased estimation of the impact of trade agreements. The paper addresses endogeneity, combining matching and difference-in-differences estimation. In addition, it applies two modifications of this methodology to evaluate the delayed impact of FTA and to control for the correlation between the current level of trade and future participation in trade agreements. The results show that the impact of trade agreements depends on the anticipated policy environment and that the benefits of trade agreements extend over time. The third paper analyzes the impact of FTA on FDI using a different methodology in order to strongly support a result in contrast to standard findings. Using matching combined with dynamic panel models, the results confirm that FTA does not promote FDI. This paper also illustrates the necessity of a dynamic specification, because the non-reversibility of the investments affects the impact of other variables.