North–South Integration and the Location of Foreign Direct Investment

Abstract

We investigate how North–South integration affects the location of foreign direct investment (FDI) between the two regions. The theoretical analysis suggests that integration affects the incentives of partner and nonpartner Northern countries to locate in the South differently and may lead to investment diversion from the Northern partner. We test our propositions using data from the North American Free Trade Agreement (NAFTA), the first major North–South integration scheme. We find that NAFTA partner FDI in Mexico has increased since the inception of NAFTA above what is implied by other determinants of FDI and the global upward trend during this time. Other countries have not increased their use of Mexico as an export platform. We also find no evidence that inward US FDI has been diverted. The results are robust to a number of different model and econometric specifications as well as the skill data used.