Good for some, bad for others: US investors and non-trade issues in preferential trade agreements

Abstract

Preferential trade agreements (PTAs) trigger investment through their commitment to a liberal market economy. Increasingly however, PTAs go far beyond liberalizing trade and investment flows. Especially controversial features included in most modern PTAs are environmental and labor standards. Do these standards affect business activity? If so, how do investors react to such non-trade issues in trade deals? The literature provides inconclusive findings about the impact of standards on foreign direct investment (FDI). Some contributors argue that strict standards decrease FDI, whilst others claim that environmental and labor protection increases productivity and, in consequence, inward investment. In all likelihood, the usage of aggregated FDI data, as is the case for most studies, causes confusion. I expect standards to influence investors’ decisions – but heterogeneously across sectors. Environmental and labor standards should reduce FDI in polluting and low-skilled labor endowed industries, but increase investment in environmentally clean and high-skilled labor abundant sectors. Based on an original dataset of environmental and social standards in trade agreements and at the sector-level disaggregated US-FDI data, I find robust support for my argument. The paper provides a more nuanced picture on the standards and investment nexus: Standards have no uniform effect on multinationals. Instead, they are good for some, but bad for other industries.