Abstract

We study the relationship between regional integration and foreign direct investment (FDI) flows. We suggest that FDI flows are attracted by a host country's intrinsic real option value to join a larger economic union. The option grants the investing firms the possibility to secure a strategic advantage in servicing the enlarged market, should the host country join the economic union. The strategic advantage comes from market preemption and learning effects. We develop a model for the FDI flows into countries that wish to join an economic union and we empirically test the model by studying the FDI flows into the countries that were candidates to the successive enlargements of the European Union. We find that the FDI flows do not behave accordingly to our real options model.