The EU-Ukraine Deep and Comprehensive Free Trade Agreement and the Importance of FDI

To analyze Ukraine’s deep and comprehensive integration with the EU we develop a multiregional general-equilibrium simulation model incorporating heterogeneous firms and FDI in business services. This allows for consideration of a.) trade growth in new varieties; b.) aggregate productivity changes attributed to reallocation of resources across and within an industry; c.) productivity growth in manufacturing due to increased access to business services. The results indicate relatively small gains for the EU, whereas Ukraine benefits with a welfare increase over 8%. The deindustrialization impact, previously found by Olekseyuk & Balistreri [2014] in a comparison of different modeling structures, is supported by our findings. Ukraine’s welfare gains are higher under an Armington structure compared to monopolistic competition due to a movement of resources into Ukraine’s traditional export sectors producing under constant returns. Implementation of the FDI modeling approach and liberalization of barriers to FDI, however, mitigate the deindustrialization impact as multinational firms enter the Ukrainian market, which increases the number of available varieties and, consequently, induces productivity growth of manufacturing sectors due to an improved access to business services.