Trade agreement depth, foreign direct investment, and the moderating role of property rights

Abstract

In this study, we theorize that preferential trade agreements (PTAs) send two distinct signals to foreign direct investors. At the first tier, a PTA signals that member states will maintain stable and peaceful relations with one another, making overt host-state hostility toward investors headquartered in member countries unlikely. At the second tier, a PTA can signal that investments will be safe from subtler meddling that infringes on property rights. While any PTA sends the first-tier signal, only deep PTAs with provisions such as investor-state dispute settlement mechanisms and property rights protections provide this second-tier signal. The second-tier signal is especially important to investors in countries where property rights are weak, as the extra protections provided by a deeper agreement can substitute for those that are missing at the domestic level. We find empirical support for our argument: PTA depth is positively associated with FDI between member countries, but the association weakens as property rights laws in host countries increase in strength. These findings suggest that governments can attract higher levels of FDI through comprehensive trade agreements, as opposed to shallow PTAs, when domestic policies are not sufficient. However, shallow agreements suffice where domestic policy already protects property rights.