Welfare effects of preferential trade agreements in the presence of foreign direct investment

This dissertation examines how a country's welfare is affected when it joins a preferential trade agreement, such as a Free Trade Area (FTA) or a Customs Union (CU). Chapter one provides the introduction to this dissertation. Chapter two provides a case study of a recent FTA that motivated this dissertation. By studying the U.S. automobile industry under the North American Free Trade Agreement (NAFTA), I show that NAFTA has been successful in increasing intra-regional trade in the sector. However, open investment regimes coupled with strict Rules of Origin (ROO) requirements attracted FDI from nonmember firms and, in turn, created stiffened competition in the U.S. automobile industry. Thus, the U.S. government may have compelling reasons to reevaluate the current trade agreements at the industry level.; Chapters three and four analyze the formal models found in this dissertation. In these models, markets are imperfectly competitive, the location decisions of nonmember firms are endogenous, and member countries choose profit taxes and, in the case of a FTA, external tariffs non-cooperatively. Since some basic elements in this scenario correspond roughly to the situation in the North American automobile industry, chapters three and four may shed light on the changes in the industry's pattern of trade, investment and foreign entry following the implementation of NAFTA.; In the setting considered in this dissertation, the welfare effects of preferential trade arguments are quite different from those in traditional trade models. Chapter three, for instance, shows that a country may have an incentive to participate in a FTA or a CU only if it can discriminate in its tax policy against foreign-owned firms. Chapter four demonstrates, among other things, that a country may gain from joining a FTA but not a CU, if it cannot discriminate in its tax policy between domestically owned and foreign-owned firms. The difference in the welfare effects of a FTA and a CU arises because foreign firms make different location choices in equilibrium.