North American Integration and Canadian Foreign Direct Investment

We investigate how economic integration in North America has altered the pattern of foreign direct investment (FDI) to and from Canada. The theoretical analysis suggests that while the Canadian-U.S. free trade agreement should generate less FDI, the addition of Mexico in the North American Free Trade Agreement (NAFTA) produces the opposite e¤ect. The fall in trade costs results in investment diversion from the U.S. and Canada, yet lower \u85xed costs may increase FDI even in those countries via an increased incentive to locate production facilities abroad rather than only domestically. Using a di¤erence-in-di¤erences estimator, we \u85nd that U.S. FDI in Canada as well as Canadian FDI in the U.S. have expanded disproportionately since NAFTA, suggesting that the latter e¤ect dominates