# **1 Introduction**

Entering foreign markets is costly for firms in terms of information and adaptation costs (Roberts and Tybout, 1997). Empirical evidence shows that firms’ decision to serve new foreign markets depends on their prior export experience. Firms’ new export destinations tend to be similar to their previous export destinations in terms of culture and geography. Such path dependence of firms’ export patterns can be explained by lower export entry costs for firms that previously exported to similar markets. This effect has been called “extended gravity”, since export decisions are not only based on the proximity between the origin and destination countries, but also between past and subsequent destinations (Morales, Sheu, and Zahler, 2019). Studies have shown that firms exhibit export patterns consistent with extended gravity, or that firms are “spatial exporters”, i.e. they are more likely to serve new markets that are geographically close or similar — in terms of language, colonial history, or per capita income — to their prior export destinations (Defever, Heid, and Larch, 2015).

In this paper, we explore another form of cross-country similarity that can affect firms’ entry costs to foreign markets: regional trade agreements (RTAs). The conventional view is that RTAs, by lowering tariffs between members, increase trade policy discrimination faced by firms in third countries leading to a contraction in their exports at the expense of less efficient producers in member countries (trade diversion). However, modern RTAs often go beyond traditional trade policy, covering behind-the-border policy areas such as domestic regulations. “Deep” trade agreements can make member countries more “similar” in terms of the regulatory environment, thus reducing entry costs and increasing exports of firms in third countries -what some have called _negative_ trade diversion (Baldwin, 2014). For example, by harmonizing product and technical standards, a deep trade agreement can generate economies of scale for firms that need to comply with one set of standards to reach multiple destinations. Ultimately, the impact on third-country firms of RTAs is an empirical question that in part depends on the content of these agreements.

Using firm-level data from Costa Rica for the period between 1998 and 2012, we first estimate the effect of RTAs of which Costa Rica was not a member on its exports to member countries.<sup>1</sup> We find evidence of a positive spillover effect, corroborating the view of a negative trade diversion. Firms are more likely to export or start exporting to a new destination market if in the previous year they exported to a destination’s RTA partner. Moreover, we find that this positive spillover effect increases with the

> 1The focus on Costa Rican firms has two main advantages. First, the firm-level data cover an extended period of time. Second, Costa Rica is a diversified economy in terms of export products and number of destination markets. During the 1998–2012 period, 14,253 Costa Rican firms exported 4,939 HS6-products to 211 economies. The quality of the firm-level data thus allows us to investigate the impact of trade agreements on different types of products over a long period of time.

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