The Trade and Investment Effects of Preferential Trading Arrangements

Abstract

This study quantifies the impact of traditional and new age' provisions of preferential trading arrangements (PTAs) on merchandise trade and investment. It does so by estimating gravity models of bilateral trade and investment. It finds that recent and some past PTAs are not as benign as some contemporary empirical assessments have suggested. A careful consideration of the analytical issues including controlling comprehensively for other observable and unobservable factors, and testing explicitly for whether the trade and investment effects are significantly different after PTA formation than before accounts for less favourable finding in this study. It is also possible for PTAs to have adverse effects on investment flows. If investment responds in beachhead' fashion to the trade provisions of PTAs, the trade carried out from those beachheads could constitute traditional trade diversion. However, the paper finds little evidence of beachhead investment. Instead, it finds evidence of net investment creation in response to the new age', non-trade provisions of PTAs. Thus the finding on investment is more positive than for trade, but not without qualifications, since trade diversion is still possible from the new investment positions.