Regional integration and production location: what theories (do not) tell us

There is broad empirical evidence showing that regional integration considerably influences the choice of firms over the location of production; nevertheless, the theoretical literature on this issue is rather limited. Traditional preferential trade theory does not include the driving force of these changes, that is, economies of scale. The paper surveys recent contributions from the new economic geography and the multinational enterprise literature addressing the issue of the effects of preferential trade, with the aim of examining the main features of the models, and assessing their predictions and policy implications critically. The paper shows, among other things, that the findings are often contradictory, depending upon the underlying hypotheses of the models used. Overall, there is a need of further research on the welfare implications of preferential trade agreements when location effects are considered; policy implications may be relevant, especially for small countries joining preferential trade areas with the expectation of benefiting from the location of economic activity in their territory.