Back to BITs and Bites: Do Trade and Investment Agreements Promote Foreign Direct Investment within Latin America?

Abstract

In this paper we investigate the impact of regional trade agreements (RTAs) and bilateral investment treaties (BITs) on intra-regional foreign direct investment (FDI) across Latin American countries from 1995 to 2012. We use an augmented gravity model in which we control for cross-country heterogeneity, multilateral resistances and endogeneity of RTAs/BITs. This study empirically reveals that belonging to a well-established RTAs, such as MERCOSUR, is significantly more effective than the enforcement of BITs in fostering intra-regional FDI. We observe heterogeneous impacts within the bloc: BITs exert a positive but small effect, with an estimated increase in FDI stocks between 4-7.25%, for middle income countries such as Argentina, Brazil, Chile, Costa Rica, Mexico and Uruguay. However, we observe a non-significant effect on middle-low income countries as Bolivia, Colombia, Ecuador, Peru and Paraguay. Our results suggest that political risk and the level of institutional development in the host country act as strong determinants of BITs effectiveness. Furthermore, we find that the main determinants affecting intra-bloc FDI are factor endowments and market potential. These findings shed clarity into the current debate on the effectiveness of BITs versus RTAs as an adequate mechanism to attract foreign investment.

Keywords: Foreign Direct Investment, Regional Integration Agreements, Augmented Gravity Model, Horizontal and Vertical FDI Models

JEL Classification: F21, F40, O11, O54