The Effect of Trade Liberalization on Export-Oriented Output and FDI: A Case Study of the Mauritian EPZ, 1971-1998

Abstract

The export-processing zone in Mauritius has existed side-by-side with a highly protected importcompeting sector. The enclave status of an EPZ is supposed, in theory, to insulate the zone against the extra-zone protectionist regime. In that case, will trade liberalization affect EPZ activity? This is the question that the paper seeks to investigate: theoretically, by constructing models of exported-oriented FDI and an EPZ-based economy à la Heckscher-Ohlin and considering the feedback effects between the two when trade is liberalized and empirically using data from the Mauritian economy over the period 1971-1998. It is shown that a tariff cut leads to an initial expansion of EPZ activity that is subsequently magnified by induced FDI flows and domestic investment in the zone. The paper finds that the most important phase of trade reform – that started in 1984 – had a marked impact on both domestic and foreign investment in the EPZ, resulting in a significant increase in EPZ production and export in line with the predictions of the theoretical model.

Keywords: Foreign Direct Investment, Trade Liberalization, Export-Processing Zone, Mauritius
JEL Classification: F13 F14 F21