The expansion of firms to foreign countries can be traced back to the establishment of the British East India Company and the Dutch East India Company (VOC) at the beginning of the 17th century. U.S. based firms have been involved in foreign operations for over a century. In the 1990s the improvement of information and communications technology allowed managers in the home countries of multinationals to coordinate the activities of their production units in developing economies. FDI flows to those economies grew and their activities contributed to the profits of their parent firms. But recent analysis shows that there has been a slowdown of foreign corporate expansion and changes in its allocation and destinations.
The OECD’s FDI in Figures for April 2024 reports that global FDI flows fell by 7% in 2023, continuing a downward trend following the pandemic. Australia and the U.S. were among the OECD countries with the largest decreases of inflows. Despite this drop, the U.S. remained the largest recipient of FDI inflows ($341 billion) among all countries, followed by Brazil ($64 billion) and Canada ($50 billion). The report also noted that FDI inflows to the G20 countries fell last year by 34%, and by 46% to the non-OECD members of the G20. The latter figure included major reductions in inflows to China.
The IMF examined the changes in the allocation of FDI in a chapter of the 2023 World Economic Outlook. The authors of the chapter note that the recent fragmentation of trade and capital flows along geopolitical fault lines is a new phenomenon. If these changes in the allocation of direct investment continue (“friend-shoring”), FDI will become more concentrated within blocs of politically aligned countries. Moreover, other forms of capital flows, such as portfolio flows, are not immune to this reallocation.
This relocation of multinational activities will have negative effects on emerging markets and developing economies, which are less likely to be politically aligned with the U.S. or China. These countries depend on FDI for capital and technological deepening, and their own companies benefit from the entry of foreign firms into the domestic economy. Changes in FDI related to vertical integration, which is associated with economic growth, are particularly most costly for these countries. Simulations undertaken by the IMF’s economists project a drop in long-term global GDP of 2%.
The authors looked at FDI flows that included “strategic FDI,” i.e., FDI linked to national and economic security concerns. The flows of strategic FDI to Asian countries, and particularly China, have fallen sharply. On the other hand, this type if FDI was more resilient in Europe and the U.S. The allocations point to a growing gap between Europe and Asia in this sector.
The issue of fragmentation also appeared in a 2024 IMF Working Paper, “Changing Global Linkages: A New Cold War?” by Gita Gopinath, Pierre-Olivier Gourinchas, Andrea F. Presbitero and Petia Topalova. The authors note that the reallocation of trade and investment flows among countries is taking place, triggered in part by the tensions between the U.S. and China. They report that trade flows and FDI between a U.S. centered bloc and a China centered bloc has declined by 12–20%, more than trade and investment within countries in the same bloc. However, several nonaligned countries, such as Mexico, Canada and Vietnam, serve as connectors, receiving Chinese goods and reexporting them to the U.S. The global economy, therefore, is not cleaving in half, but it is showing symptoms of fragmentation.
Many of the themes developed in the IMF papers also appear in a recent UNCTAD report, Global Economic Fracturing and Shifting Investment Patterns. These authors also find evidence of fracturing in global FDI along geopolitical lines and evidence of instability in investment relationships. There is also a gap between investment in the manufacturing and services sectors, with the latter growing in importance. In addition, the authors find evidence of increased FDI in environmental technologies.
A similar assessment of the changes in global trade and investment is offered by Barry Eichengreen in a working paper, “Globalization and Growth in a Bipolar World.” He points out that investment that might have gone from the U.S. to China and vice-versa now is directed to third countries that serve as bridges between the two. This (supposedly) leads to an improvement in national security in exchange for less efficiency. But it may take years to form a quantitative assessment of that tradeoff.
Limitations on FDI flows due to security concerns are a relatively recent phenomenon. They are part of a larger transition to new manifestations of industrial policy. The downside with such policies is that protectionist motives can guide their imposition and continued use. Imposing restrictions is always easier than removing them.