Abstract
AbstractAlthough pre‐1990s preferential trade agreements focused mostly on tariff liberalization, recent agreements increasingly contain deep provisions in diverse areas, such as intellectual property rights, investment and standards. At the same time, there has been a remarkable increase in the internationalization of production through foreign direct investment and outsourcing. This paper studies how deep trade agreements affect the international organization of production. Using new measures of the depth and content of preferential trade agreements and of vertical foreign direct investment, the analysis finds evidence that the depth of trade agreements is correlated with vertical foreign direct investment. Furthermore, this relationship is driven by the provisions that improve the contractibility of inputs provided by suppliers, such as standards, while provisions that increase the contractibility of headquarter services, such as intellectual property rights and investment protection, are generally negatively correlated with foreign investment. This finding is consistent with the so‐called “property rights” theory of the multinational firm according to which improving the contractibility of an input reduces the importance of giving incentives through ownership.
Highlights
How are trade agreements and the international organization of production related? The recent wave of Preferential Trade Agreements (PTAs) has brought this question to the forefront of trade research and the trade policy debate
We use the AH model to guide our analysis on the relationship between deep trade agreements and the international organization of production
The positive coefficient may capture the political economy of protectionism, as larger Foreign Direct Investment (FDI) tend to be correlated with the size of the sector in the domestic economy
Summary
How are trade agreements and the international organization of production related? The recent wave of Preferential Trade Agreements (PTAs) has brought this question to the forefront of trade research and the trade policy debate. AH's framework introduces different degrees of contractual frictions across countries in a model of the international organization of production This setting allows us to study the impact of improvements in the quality of contracting institutions, such as the ones brought about by a deep PTA, on firms' location and control decisions. Because ownership is a means to reduce hold-up problems created by contractual incompleteness, it matters if the PTA provisions improve the relative contractibility of different inputs We test this theory using a new data set on the content of PTA provisions and using firm-level information to construct a sectoral measure of vertical FDI.
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