FDI is in big trouble: Insights from the 27th Global Trade Alert report

Simon Evenett, Johannes Fritz 03 June 2021

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Properly guided, foreign direct investment (FDI) has transformed the prospects of certain firms, sectors, regions, and even economies. While there is a vibrant and necessary debate about the mechanisms through which FDI affects host economies, on the whole developing countries have benefited from greenfield investments and re-investment in the existing stock of FDI (Moran et al. 2007).

As multinational corporations are perceived as having ever-growing reach, and now that sophisticated international value chains criss-cross the planet, governments and civil society are demanding that international business does more to advance sustainable development and to tackle climate change (OECD 2021, Sachs and Sachs 2021). The begs the question of what private sector engagement – through FDI decisions and other business conduct – have contributed to the globally agreed Sustainable Development Goals.

Looking back over the past quarter of a century, the 27th Global Trade Alert report puts current FDI dynamics in perspective, uses the latest data from the Global Trade Alert on policy interventions to assess the degree to which governments continue to favour FDI, and points the spotlight on the limited contribution of FDI to advancing sustainable development in emerging markets (Evenett and Fritz 2021). What follows is a summary of the key findings.  

FDI in developing countries falters

Companies are resorting less and less to foreign direct investment. Once a hallmark of globalisation, FDI has been in trouble for some time – a fact compounded by the ongoing pandemic: 

  • Even before last year’s 42% drop, sensibly benchmarked annual inflows of FDI have been in decline since the Global Financial Crisis (UNCTAD 2021, World Bank 2021). 
  • The economic fallout from COVID-19 has witnessed new FDI flows retreating to levels not seen for 25 years (see Figure 1). 
  • New greenfield investments into developing countries have been particularly hit last year, falling 57% year-on-year in the fourth quarter of 2020. 
  • Globally, the average return on FDI fell during the past decade. Mean FDI returns fell more in developing countries than in higher income countries. 
  • Outside of the Middle East, since 2015 US multinationals have earned at most meagre additional returns from FDI in developing countries when compared to investments in less risky European Union economies (see Figure 2). 
  • Returns on US FDI in educational services are so low it would take 40 years to recoup their outlays. Worse, the payback period for investments in health and telecoms is over 90 years. Fortunately, returns from investing in manufacturing are healthier. 

Figure 1 Sensibly benchmarked, FDI inflows have retreated to levels last seen in 1995

Figure 2 Outside the Middle East, returns on US FDI in emerging markets earn little or no premium on investments in the EU

Even the 7.1% annual average (nominal) growth rate of the FDI stock in developing countries from 2010 to 2019 looks a lot less impressive once the 3.9% median rate for capital depreciation in developing countries is factored in.1 

An alternative perspective on capital depreciation is the following. According to the World Investment Report 2020 a total of US$11.3 trillion of foreign direct investment have been made in developing countries up until the end of 2019 (UNCTAD 2020). Each year some of that capital will depreciate and need to be replaced. With a 3.9% depreciation rate, this implies that annual FDI inflows into developing countries must exceed $440 billion just to replace the FDI capital that has worn out and ceased to be commercially useful.2 In light of the low FDI premia reported earlier, whether multinational enterprises are prepared to commit to such substantial outlays in the future is the central question. 

Falling returns on FDI in developing countries are the canary in the coal mine— they call into question the commercial viability of setting up shop in foreign markets and retaining operations there. Risk-adjustments would lower FDI returns in emerging markets even further (Drabek and Payne 2002). 

Less friendly policies towards FDI

By and large, public policy has created headwinds for FDI, especially over the past five years. In the latest Global Trade Alert report we show that:

  • Governments have introduced fewer public policies conducive to FDI. This is true of the G20 nations and other nations, including the Least Developed Countries (see Figure 3). 
  • Policies encouraging barrier-jumping FDI are declining in importance. 
  • Localisation requirements affecting foreign direct investors became more far-reaching over the past five years, as have policies affecting the entry, screening, and regulation of FDI.
  • Fewer policies in service sectors encourage FDI when compared to goods sectors. 
  • Businesses have faced mounting regulatory risks over the past decade. 

Figure 3 Irrespective of level of development, governments are adopting less favourable policies towards in FDI

So while governments demanded more from FDI, they’ve been making life more difficult for international business. Something had to give – reduced FDI inflows is the likely result (Evenett and Fritz 2021). 

Three suggestions to reset policy towards FDI

Discussions on the contribution of international business to pressing global challenges need a reset. FDI cannot make a meaningful contribution to sustainable development and to tackling climate change unless sufficient FDI happens in the first place. Deliberations on the quality of FDI and on business conduct are important, but the quantity of FDI matters too. 

At the time the Sustainable Development Goals were adopted, many governments made clear they have neither the money nor the capabilities to deliver and so private sector participation is needed. Policymakers would do well to revisit the business case for choosing FDI over other corporate projects or returning money to shareholders. 

Implementing the following three steps will improve the commercial prospects of FDI in development-sensitive sectors: 

  • Having evidenced why returns on FDI are so low in a developing country, or why such returns are falling, dialogue between the World Bank and regional development banks and host government should identify which policies and corporate practices must change and the technical support required to effect policy change. 
  • Target any state provided financial support for FDI at priority sectors where sustainable development benefits are deemed greatest by host government in developing countries. This applies to financial incentives for outward as well as inward FDI. 
  • Governments should progressively de-risk FDI by thoroughly reviewing and benchmarking existing regulatory policy and enforcement practice (Buckley 2018). Particular attention should be given to the implementation of recently approved FDI screening policies (Evenett 2021). 

With over $11 trillion invested in developing countries, both international business and governments have a huge stake in reviving the commercial fortunes of FDI. To date, too much of the onus has been on international business. For example, the private sector has been told by advocates of sustainable development to “align” with the global and societal transformations needed to accomplish the Sustainable Development Goals (Sachs and Sachs 2021). 

Those advocates and policymakers must reflect and act on why the returns to FDI in key sectors are so low and why only a trickle of FDI inflows has occurred in them. Enhanced corporate contributions to sustainable development should be balanced by policy reforms to restore the commercial viability of FDI in developing countries—a proven mechanism to transfer management expertise, people, capital, and technology. 

Urgently needed is a reset in deliberations on what international business can realistically deliver, especially if there is no reversal in the worsening policy treatment of FDI that is documented in this report.

References

Buckley, P (2018), “Towards a theoretically-based global foreign direct investment policy regime”, Journal of International Business Policy 1: 184-207. 

Drabek, Z and W Payne (2002), “The impact of transparency on foreign direct investment”, Journal of Economic Integration 17(4): 777-810.

Evenett, S (2021), “What caused the resurgence in FDI screening?”, paper prepared for the Austrian Central Bank. 24 March.

Evenett, S and J Fritz (2021), Advancing Sustainable Development With FDI: Why Policy Must Be Reset, 27th Global Trade Alert Report.

Moran, T, L Alfaro, and B Javorcik (2007). “How to Investigate the Impact of Foreign Direct Investment on Development and Use the Results to Guide Policy”, Brookings Trade Forum: 1-60.

OECD (2021), FDI Qualities Policy Toolkit: Rationale, building blocks and methodology, March.

Sachs, J., and L. Sachs (2021), “Business alignment for the ‘Decade of Action’”, Journal of International Business Policy 4: 22-27.

UNCTAD (2020), World Investment Report 2020: International Production Beyond the Pandemic, United Nations. 

UNCTAD (2021), “Global FDI Flows Down 42% in 2020. Further weakness expected in 2020, risking sustainable recovery”, Investment Trends Monitor 38, United Nations. 24 January

World Bank (2021), FDI Watch: Quarterly Report, Issue 2, March.

Endnotes

1 This is the median depreciation rate of developing countries for 2016-2018 obtained from the Penn World Tables.

2 For reference, UNCTAD estimates that during 2020 the total FDI inflow was US$ 616 billion, implying that less than one-third of this inflow adds to the net FDI stock.

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Topics:  International trade

Tags:  FDI, foreign direct investment, GTA, Global Trade Alert

Professor of International Trade, University of St. Gallen; Research Fellow, CEPR

CEO, St Gallen Endowment for Prosperity Through Trade

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