When Free Trade Agreement Meets Competition : The Impact of the Eu-Korea FTA on Japanese Firms’ Investment Behavior

This study analyzes the impact of bilateral free trade agreements (FTAs) on the investment of multinational firms located outside the FTA-covered regions. Specifically, we analyze how Japanese firms located in the European Union (EU) changed their investment behavior in response to the EU-Korea bilateral FTA concluded in 2011. By applying unique Japanese data at the affiliate level, we estimate how the EU-Korea FTA affects the performance of Japanese firms that are already operating in the EU. To mitigate the endogeneity problem due to self-selection into the region, we employed a difference-in-difference method and compared the performance variation of Japanese firms in industries where they competed the most with their Korean counterparts, with that of those with less competition, after controlling for firm and regional characteristics. We find that the EU-Korea FTA reduces the amount of actual amount of foreign direct investment (FDI) but increases the expected amount made by Japanese firms within the EU. Further, we show that such an impact is through the potential channel of trade, supported by the evidence that the FTA positively affects the volume of exports from Japanese affiliates to Japan, especially in industries where Japanese and Korean firms compete intensively. The study reveals that Japan’s trade and FDI into the EU complement each other