Globalization conjures thoughts of trade in goods, but it has also opened up tremendous flows of capital. The trade balance tends to grab the most attention as it forms part of the gross domestic product (GDP) equation, but foreign investments have a significant effect on recipient nations.
Foreign direct investment (FDI) brings overseas capital into a domestic economy. Providers commit to a lasting presence and act as a catalyst to economic development. It is more of a marriage than a fleeting friendship.
But the landscape for FDI, once a hallmark of globalization, has been changing. Global FDI growth has stagnated since 2010, failing to keep pace with trends in merchandise trade and GDP. The bigger concern is the recent drop in flows to developing countries, given their reliance on foreign investments as a driver of growth.
FDI into emerging markets (EMs) declined 9% to $841 billion in 2023, with falling or stagnating flows across most regions. Major Asian markets witnessed the largest fall of 12% last year. China reported a rare 6% drop in FDI inflows last year. Flows to the Association of Southeast Asian Nations, which were supposed to benefit from reshoring, declined by 16%.
Despite the euphoria surrounding the Indian economy and improving ties with the West, India has also been falling out of favor and struggling to become a “plus one” country as investors diversify away from China. India saw a 47% drop in FDI inflows in 2023. Repatriation and divestment by direct investors has surged.
Higher financing costs partly explain the weaker flows to EMs last year. Easier monetary conditions should support investments in 2025, though high debt burdens will continue to cast a shadow over the global investment landscape.
Geopolitics are another major driver realigning investment decisions and destinations. Increased scrutiny and restrictions on activities are discouraging flows to recipient nations. Investments between geopolitically distant countries – those with divergent political interests or foreign policies – have decreased from 23% in 2013 to 15% in 2023. Research shows that geopolitical tensions between an investing and a recipient country reduce bilateral cross-border portfolio and bank allocations.
Advanced economy governments are embracing industrial policy, steering capital to domestic destinations. For example, the U.S. is providing large subsidies to attract investment in semiconductors, solar, and other futuristic industries. This explains the recent reversal in flows from developing towards richer economies.
ECONOMIC CONSIDERATIONS ARE NO LONGER THE SOLE DRIVER OF INVESTMENT DECISIONS.
The changing geography of industrial investment will be most harmful to emerging markets. Due to inadequate domestic resources (savings, capital markets and currency reserves), these nations rely heavily on foreign investments for sustainable development. A lack of economic heft is forcing these states to pick a geopolitical side or face the risk of losing access to funding.
Partners in a strong marriage can communicate, persevere and grow through their inevitable ups and downs. Cross-border investments must build on foundations of trust, shared values and a commitment to growth—in sickness and in health.
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