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Recent research on trade and multinationals highlights that multinational firms’ integration strategies are complex and the degree of vertical integration varies in a multilateral world with many possible locations of activity. In particular, multinationals control a large fraction of trade within the block of developed countries. The most important regional trade agreements (RTAs) are signed between members of the very same block of economies. This gives rise to the question asked in the present paper: what is the impact of RTAs on FDI in an interdependent world? Recent spatial HAC estimation techniques are applied to both estimation and testing.

The second half of the last century was characterized by a surge of “bilateralism” in trade policy. The foundation of the European Union (EU, formerly referred to as European Community), the European Free Trade Area (EFTA), and the North American Free Trade Area (NAFTA) are some of the most sizeable regional trade agreements (RTAs) that were signed and implemented within this period. As observed by authorities in empirical research on trade issues, this process resulted in a significant increase in bilateral trade volumes among the member countries (see Baier and Bergstrand (2007), or Glick and Rose (2002)). At the same time, foreign direct investment (FDI) increased much faster than trade, even within the OECD and among the members of the mentioned RTAs. While numerous studies on the impact of RTAs on bilateral trade are now available, the question of how the bilateralism of trade policy affects FDI seems under-researched.

This paper analyzes the role of the Europe Agreements on bilateral FDI within Europe. These agreements were designed to liberalize trade between the EU member countries on the one hand and the Central and Eastern European countries that had applied for EU membership on the other hand. Our analysis indicates that regional trade agreements are important for bilateral FDI. General equilibrium theory points to the interdependence of economies. By and large we would expect FDI activities across adjacent host markets to be complementary, if local foreign market seeking motives dominate (i.e., if horizontal FDI prevails and the multi-plant economies of scale are huge). By way of contrast, if low-cost seeking motives are the driving force behind FDI (i.e., vertical motives or export-platform FDI dominate), we would expect the activities to be substitutive across adjacent host markets since multinational firms will tend to supply their goods not only to consumers in that host market.