A Simple and Flexible Dynamic Approach to Foreign Direct Investment Growth: Did Canada Benefit From the Free Trade Agreements with the United States?

This paper asks a simple question: Did Wilfred Laurier’s dream of free trade with the United States, when it came to fruition in 1989, also have a benefit by increasing foreign direct investment (FDI) into Canada by US multinationals? This paper introduces a dynamic framework, rather than the literature’s traditional static framework, and uses a structural break framework, rather than modelling policy changes as an intercept shift alone. Its conclusions are (a) The signing of the free trade agreements between Canada and the United States increased the responsiveness of growth in the Canadian economy on the US FDI decision by a factor of two. (b) Limited dynamics are found in the form of lagged effect of changes in the real Canadian interest rate. (c) The effect of the change in the exchange rate is static and constant over the whole 1955 to 2000 period and was unaffected by the introduction of free trade between the United States and Canada.