Three essays on the impact of preferential trade agreements on development, trade, and investment

This dissertation consists of three essays on the trade and investment impacts of preferential trade agreements (PTAs). The first essay shows that total trade within PTAs is a poor proxy for truly preferential trade, defined as trade in tariff lines where preferences are likely to matter. While total intra-PTA trade amounted to one-third of global trade in 2000-02, preferential trade was only between one-sixth and one-tenth of world trade. Our gravity model estimates indicate that using total rather than preferential trade to assess the impact of PTAs leads to a significant downward bias in the PTA coefficient, and that the removal of product exclusions and long phase-in periods could as much as triple preferential trade. The second essay finds that PTA membership is associated with an increase in net FDI inflows, and the FDI gains are increasing in the market size of the PTA partners and their proximity to the host country. We identify several channels through which preferential trade liberalization may affect FDI, and confirm that both threshold effects (signing the agreement) and market size effects (joining a larger and faster-growing common market) are important determinants of net FDI inflows. The estimated relationship is driven by North-South and South-South PTAs, and is most pronounced in the late 1990s and early 2000s, which is the period when most "deep integration" PTAs have been formed. The third essay quantifies the likely benefits of trade and investment liberalization in a small, poor, open economy, using the accession of Honduras to the Dominican Republic-Central American Free Trade Agreement (DR-CAFTA) as a case study. We find that bilateral trade liberalization with the US is likely to have almost no effect on Honduran welfare, while the reciprocal removal of protection vis-a-vis the rest of Central America would lead to significantly larger gains. Potential gains from increased net FDI inflows overwhelm those expected from trade reform alone, particularly if the new FDI generates productivity spillovers. These results suggest that the focus of PTA negotiations should rest with formulating provisions that are likely to result in increased net FDI inflows.