The 'New Regionalism': Integration as a Commitment Device for Developing Countries

Abstract

Increasingly, developing countries embrace foreign direct investment (FDI) and simultaneously pursue economic integration with developed countries. Foreign investment is subject to sovereign risk and it has been suggested that free trade agreements may serve as a commitment mechanism in order to achieve higher sustainable levels of FDI. This paper shows that such agreements, by inducing sunk investments in expanding export sectors, can indeed increase the level of self-enforcing FDI. The main source of investment is the partner country, which suggests that developing countries maximize the amount of inward FDI by integrating with their main trading partners, not necessarily their geographic neighbors. Keywords: Foreign Direct Investment, Economic Integration, Commitment