FTA and Export Platform Foreign Direct Investment: Evidence from Japanese firm level data

This paper examines the choice of foreign direct investment (FDI) among four types—traditional horizontal FDI, traditional vertical FDI, export-platform horizontal FDI, and export-platform vertical FDI—focusing in particular on the recent phenomena of the export-platform type FDI. The theoretical discussion shows a prediction of the effect of free trade agreements (FTAs) on the FDI type chosen. The empirical discussion provides descriptive statistics which point to the growing importance of export-platform type FDI. It then shows supportive evidence for the model's prediction, using Japan's firm-level FDI data. More specifically, it is shown that regional trade agreements (RTAs), such as the Association of Southeast Asian Nations (ASEAN) or the North America Free Trade Agreement (NAFTA), drives horizontal export-platform-type FDI, whereas bilateral FTAs (Japan's economic partnership agreement in the context of the data used in this paper) in some cases induce vertical export-platform type FDI. The findings suggest some policy implications for FDI recipient countries. First, the obvious positive effect of an RTA on horizontal export-platform type FDI is an encouraging finding for countries forming them in that it leads to a reduction in production costs and a concomitant rise in production/consumption. Even more importantly, the finding is a testament to a rarely mentioned benefit of smaller countries joining RTAs. Second, the positive effect of a bilateral FTA between Japan and Malaysia on the vertical export-platform type FDI is also reassuring in the same reason of cost reduction and production/consumption increase.