What are the implications of trade agreements on foreign direct investment?

Trade agreements, by nature, seek to foster cooperation and reduce barriers to the movement of goods, services, and workforce between countries. In this open business environment, foreign investors are more inclined to establish a presence in the countries involved. This increases FDI flows, driving economic growth and fostering collaboration between nations. On the flip side, trade agreements can also lead to increased competition. As barriers diminish, businesses face intensified rivalry in foreign markets. This challenges local companies to innovate, enhance efficiency, and adapt strategies to succeed in a more interconnected and competitive global landscape.

There is no simple answer to this question. Many foreign investments rest on established trade relations, de facto and de jure, between host and home countries. Early theories on FDI focused on the substituting nature of these two modalities of international engagement. Later the field now suggests a strong complementary relationship. Deeper trade agreements (such as the EUs Internal Market) are likely to render an increase in cross-border investments. Recently there is a shift towards focusing on what agreements can do now for quality (over quantity) of direct investments - measured on a variety of factors including type of jobs, environment, climate and also national security in hi-tech and infrastructure related projects.

Countries first may think of investing in so-called known counties which are partners of investor's country. Having trade agreement with one country may signal that trust and partnership already established and there is a chance of investment

Many countries do not necessarily work out the real economic (not financial) costs of the products produced excluding all kinds of subsidies provided to local producers, and end of subsidizing overseas consumers excessively. The economic analysis of exports will bring out the true story about the country’s competitiveness and promote repurposing subsidies and policy reforms that will help make the country’s production systems become more efficient.

While true, it is important to recognize that the relationship between FTAs, trade, domestic investment, FDI & is dynamic, complex and intrinsically interlinked. Policy & economic changes at the margin can have a large impact. Investment has long been recognised as a key gredient to economic growth and development. Trade can either substitute for or complement FDI. Market-seeking firms can serve foreign markets through exports or foreign subsidiaries. The latter effectively substitutes FDI for trade. But foreign firm affiliates in turn create new trade flows with their parent companies/ suppliers and can also export to third countries. Hence not surprisingly, greater trade correlates with greater investment flows.

Host countries also have to be careful in their eager to attract FDI, not to end up offering conditions that make it harder for their own SMEs to compete and innovate. While special economic zones have been a popular tool with which to attract and control the micro-locational strategies of investors, it is a policy that can come with high cost. By setting high targets for investors to achieve beneficial treatment, it can potentially mean that local firms without the necessary resources to meet the high targets (just because they are smaller in scale), are disfavoured by the policies. This goes again the principle of national treatment, but in the opposite direction of what we would normally expect.

Trade agreements can both be facilitative as well as obstructive to Foreign Direct Investment or FDI . It is not black and white rather a 'grayish arena'. Trade agreements are usually multiparty/blocks/geographical/geopolitical or bilateral. They are done for addressing mutual trading constraints of countries. In a win-win/ideal scenario they can said to be 'symbiotic relationships'. In actual case they maybe not like CPEC or TTP or NAFTA cases geopolitical trade agreements. They infact lead to sometimes 'barriers to trade and commerce' for certain countries, tools for trade dominance and even sometimes tools for debt trap and currency wars. FDI on other hand is usually driven by conducive open market opportunities in host country (ideally)