Regional economic integration initiatives among countries may play an important role in the locational choice of MNEs. The ensuing increase of market size theoretically makes it more interesting for firms to invest in the enlarged area. According to
regional economic integration promises economic benefits for the integrating countries and stimulates investment in the short run. It is expected, in the long run, that the combined effects—larger market size, stronger competition, more efficient resource allocation, and various positive externalities—will raise growth rates of the participating economies. This implies that regional integration is likely to attract FDI from outside the integrating zone as it becomes more attractive for foreign investors when the combined market grows in size and becomes more accessible. Based on previous work, Kreinin and Plummer (2008) concluded that the effect of regional integration on FDI is not clear-cut as it could lead, on the one hand, to an increase in FDI flows into a member state and, on the other hand, to a decrease in FDI outflows from partner countries in the preferential trading agreement. Empirically, they found that regional integration generates both positive and negative effects on FDI, pointing to both FDI creation and diversion effects.
established that regional investment agreements result in an autonomous expansion in FDI between the member countries.
Hypothesis 7. The more a country takes part in regional integration and the more the host economy is integrated into the rest of the world economy, the higher will be the level of FDI.