The fluctuations in portfolio capital flows to emerging markets over the past year have been well documented. But foreign direct investment (FDI) has also plunged in those countries as well as in the advanced economies. Moreover, FDI faces more long-term challenges than other forms of capital flows.
In October the Organization of Economic Cooperation and Development (OECD) reported FDI data for the first half of the year. The OECD found that global FDI flows fell by half in the first six months as compared to the second half of 2019. Inflows to the OECD area countries fell by 74%, driven by lower flows to the U.S. and reverse flows from Switzerland, the Netherlands and the United Kingdom. Outflows fell by 43%. FDI inflows to the non-OECD members of the Group of Twenty (G20) decreased by 30% and outflows decreased by 60%.
These declines followed a period of reduced FDI flows (see here and here). The OECD had reported in April that FDI flows in 2019 were below the levels recorded between 2010 and 2017. U.S.-based firms were reassessing their foreign operations in the wake of changes in the U.S. tax regulations governing the taxation of foreign profits. The tariffs imposed by the Trump administration on Chinese goods affected multinational activities in that country, while Chinese acquisitions of U.S. firms came under much stricter government scrutiny. Similarly, the vote in favor of Brexit forced firms to reconsider supply chains that linked the U.K. with the rest of Europe.
Pol Antrás of Harvard provides an insightful examination of the future of global supply chains in a recent NBER working paper, “De-Globalisation? Global Value Chains in the Post-Covid-19 Era.” He points out that rapid pace of globalization that began in the late 1980s and extended through the early 2000s was unsustainable, and that some slowdown was inevitable. The rapid expansion reflected the development of information and communication technology, as well as a fall in trade costs due to declines in government barriers as well as faster methods of shipping. He also cites the expansion of the global economy to include the former Communist countries, as well as the Asian countries that expanded the market-based sectors of their economies.
Could these developments be reversed? Antrás writes that while the impact of automation and 3D printing on globalization is unclear, there are digital technologies that may give a new impetus to trade and investment. Moreover, the economies of scale associated with global supply chains make their dismantling unlikely.
On the other hand, the policy and institutional factors that fueled the previous expansion of globalization could come to a halt or be reversed. Antrás attributes the fall in support for international trade to its impact on income distribution. While technology and other factors have contributed to the rise in inequality, there is sufficient evidence that trade integration has been a factor as well. Recent studies have linked support for protectionist measures to trade-induced inequality.
Antrás also provides some conjectures about the consequences of COVID-19 on globalization. Once the pandemic is behind us, international travel will most likely be more expensive, and this may affect the initiation of new enterprises, although the increased use of technology to provide contacts between people may offset that effect. On the other hand, the political response to the pandemic threatens to exacerbate already existing tensions between China and the U.S., and could lead to a global partition. Moreover, the cost of the pandemic has been borne disproportionately by low-wage earners, and any increase in inequality will further weaken support for global trade.
The pandemic heightened the awareness of global supply chains, and last spring there was a great deal of discussion of “reshoring,” i.e., bringing foreign operations back to the home countries of multinationals. The Economist reports that to date there is little sign that U.S. firms are replacing operations in other countries with domestic production. However, the article points out that the expansion of global production networks was based in part on the belief that governments would not hamper their activities since interference would hurt importers and exporters. But recent events have shown that political divisions can affect trade policy in unexpected ways. The steps that the Biden administration to reengage with international agencies, such as the World Trade Organization, and trade partners, particularly China, will be carefully watched.
