Will the Future EU-UK Free Trade Agreement Affect Foreign Direct Investment?

Federico Carril-Caccia

doi:10.1007/s10272-020-0911-3

Abstract

This article aims to provide new insight on how Brexit will affect foreign direct investment (FDI) into the UK. By estimating an augmented gravity equation which accounts for the depth of free trade agreements (FTAs) as well as for EU and euro area membership, the article gauges the potential impact that different EU-UK trade scenarios might have on FDI flows and stocks. Results show that under a no-deal scenario, FDI flows from the EU into the UK would plunge by 25.9% – 40.6%, and inward FDI stocks would decrease by 49.2% – 53.9%. However, the depth of the future FTA can mitigate this negative outcome. More generally, the article shows that the FDI costs of leaving the EU would be significantly higher for the euro area countries.

Highlights

This article aims to provide new insight on how Brexit will affect foreign direct investment (FDI) into the UK
By estimating an augmented gravity equation which accounts for the depth of free trade agreements (FTAs) as well as for European Union (EU) and euro area membership, the article gauges the potential impact that different EU-UK trade scenarios might have on FDI flows and stocks
Results show that under a no-deal scenario, FDI flows from the EU into the UK would plunge by 25.9% - 40.6%, and inward FDI stocks would decrease by 49.2% - 53.9%

Summary

Data and methodology

The data sources are the OECD bilateral FDI flow and stock BMD3 and BMD4 data, World Bank’s FTA database, World Bank’s Development Indicators, and UNCTAD’s International Investment Agreements database. BITijt is a dummy variable that takes the value 1 whenever a pair of countries have signed a bilateral investment treaty (BIT). Country pair fixed effects (λij ) are included in order to avoid the potential endogeneity between bilateral investment and the likelihood of signing an FTA or BIT (Baier et al, 2008; Bergstrand and Egger, 2013). DepthFTAijt is interacted with a dummy variable that takes the value 1 when a country becomes an EU member (EUjt ) and by a dummy that represents those countries that become EU members but do not belong to the EA yet (EUnvEAjt ) The objective of these interactions is respectively to quantify how the depth of the FTA affected the EU member states inward FDI and see whether the impact is different for those that did not adopt the euro.

Different potential future FTA scenarios

FDI and FTA depth

Leaving the EU if the country is EA

The consequences of leaving the EU

Conclusions