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Customs Unions And Foreign Investment: Theory And Evidence From Mercosur’s Auto Industry

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  • Çaglar Özden
  • Francisco J. Parodi

Abstract

This paper demonstrates how regional trade agreements (RTAs) can lead to both foreign direct investment expansion and relocation effects. These two effects, in return, impact the endogenous formation of RTAs. The investment expansion effect results from foreign firms’ ability to serve a larger market from a single facility. The relocation effect occurs due to the firms’ desire to move their initial plants from high-cost member countries to low-cost ones. The relocation effect can overwhelm the expansion effect for the high-cost members and lead to the collapse of socially efficient RTAs. The auto industry in Mercosur is a great example to study these phenomena. Argentina was worried that low-cost Brazil would attract all of the foreign investment and dominate both markets. To convince Argentina to agree to free trade in automobiles (and to Mercosur), the auto sectoral agreement included the Compensated Trade Clause (CTC) which requires each firm to balance its trade between these countries. This mitigates the relocation problem by forcing firms to produce some models in Argentina and entices the governments to sign the RTA..

Suggested Citation

  • Çaglar Özden & Francisco J. Parodi, 2004. "Customs Unions And Foreign Investment: Theory And Evidence From Mercosur’s Auto Industry," Working Papers Central Bank of Chile 282, Central Bank of Chile.
    • Handle: RePEc:chb:bcchwp:282
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    File URL: https://www.bcentral.cl/documents/33528/133326/DTBC_282.pdf
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    References listed on IDEAS

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    Cited by:

    1. Waldkirch Andreas & Tekin-Koru Ayça, 2010. "North American Integration and Canadian Foreign Direct Investment," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 10(1), pages 1-40, August.
    2. Thangavelu, Shandre M. & Narjoko, Dionisius, 2014. "Human capital, FTAs and foreign direct investment flows into ASEAN," Journal of Asian Economics, Elsevier, vol. 35(C), pages 65-76.
    3. Anatoliy Spitsyn & Galiya Kulubekova, 2016. "Eurasian Economic Union and Prospects of Development of Transnational Corporations in the Frame of the Globalization," Economy of region, Centre for Economic Security, Institute of Economics of Ural Branch of Russian Academy of Sciences, vol. 1(3), pages 695-702.
    4. Sokolovskyi, Dmytro & Sokolovska, Olena, 2013. "The problem of arising the Pareto inefficient norm in relations “investor – government” type," MPRA Paper 44745, University Library of Munich, Germany.

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