10 Jan 2022

The Post-Pandemic Reality of FDI

Mouza Almarzooqi
10 Jan 2022

The Post-Pandemic Reality of FDI

Mouza Almarzooqi

The Covid-19 pandemic has impacted the global economy in ways we have not seen since the great depression. The implementation of strict measures to contain the pandemic – such as lockdowns and restrictions on movement and travel – and the disruption to economic activities across many industries have caused a major decline in economic output that spared no country.

Global foreign direct investment (FDI) suffered a major decline as the pandemic led to the postponement of many new projects, major delays in existing projects, and the freezing of investment decisions on many other projects as companies, concerned about the uncertainty surrounding the pandemic, adopted a ‘wait-and-see’ approach. As a result,, FDI flows declined from $1.5 trillion in 2019 to $1 trillion in 2020, a drop of 35 percent, which is almost 20 percent below the lowest level of FDI flows recorded after the global financial crisis of 2009. The United Nations Conference on Trade and Development (UNCTAD) predicted a small recovery of FDI flows in their World Investment Report 2021.[1] However, the risk of new virus variants extending the length of the pandemic and the shifting priorities and policy pressures, amongst many other factors, make the future of FDI flows quite uncertain.

This paper will review the regional trends in FDI over the past five years, describe the reasons behind these trends, and discuss the direction it is heading towards.

Importance of FDI

According to the World Bank, FDI is “the net inflows of investment to acquire a lasting management interest (10 percent of stock or more) in an enterprise operating in an economy other than that of the investor.”[2] This can be achieved through mergers and acquisitions, setting up new business ventures in the target country or by expanding existing operations to new countries.

FDI is of paramount importance to target countries and is reflected across many facets of the economy. Firstly, due to direct involvement in the host country operations, FDI contributes to the transfer of capital, skills and technology. Secondly, it acts as an economic and employment booster as it creates opportunities for the local labor force that would not have been available otherwise. It also helps increase workforce productivity as foreign companies implement learning and development programs that help improve the knowledge and skills of the labor force, which reflects directly on the economy. Another benefit of FDI is that it makes international trade easier as import tariffs become more flexible when FDI relationships exist between two countries. FDI also facilitates the transfer of resources that include the exchange of many skills and technologies.

On the other hand, FDI comes with some risks for foreign companies. Countries with higher political and security risks, for example, present a challenge for FDI as the business environment can change at very short notice, which can jeopardize the full investment. To compensate for these increased risks, foreign companies and banks may require higher returns and increase the overall cost of investments in the host country.

FDI flows prefer stable economies with a strong and predictable legal and institutional framework which guarantees that any investment made is protected by international laws and conventions. Consequently, many developing countries that suffered from colonialism in the past make an unstable ground for foreign direct investment and would potentially be vulnerable to the exploitation of foreign companies.[3] On the other hand, developed and open economies attract a large share of companies, as they offer a great growth prospect, skilled workforce and stable environment.

Host countries have seen FDI as a source of modernization, employment and development. FDI flows from developed countries are mostly destined to developing economies, which help the host countries enhance their business environment, provide employment opportunities and grow the economy.[4] Consequently, these countries have implemented reforms to their legal and institutional frameworks and liberalized their FDI regimes in order to attract more FDI.

The reality of FDI in the past five years

Global FDI fell sharply in 2020, reaching its lowest level since 2005. The 35 percent drop in FDI flows from $1.5 trillion to $1 trillion in 2019 was uneven in its distribution, as FDI in developed and transition economies fell sharply by more than 58 percent while developing economies saw their FDI drop by 8 percent only as a result of a relatively stable FDI into Asia.[5]

The following line graphs were generated based on the data collected from UNCTAD[6] for the time period between 2007 and 2020.[7]

Figure 1

FDI inflows, global and by group of economies ($ billion and %)

Figure 1 shows FDI in the world as a whole and its inflows in developed, developing and transition economies. The inflow of FDI in developed countries was fluctuating until 2019, after which developing countries exceeded the inflow rates of developed countries. As regards the FDI of transition economies, the rate was relatively stable between 2009 and 2019, until it reached its lowest level in 2020 due to the pandemic.

Figure 2

FDI flows by region – Americas, Asia and Europe

FDI flows trends have varied greatly from one region to another as a result of economic and geopolitical factors. Europe historically attracted the largest share of global FDI until 2017 when it was overpassed by Asia. There has been seen a steady decline in FDI flows since 2016 and a major drop of 80 percent was recorded in 2020 as the Covid-19 pandemic compounded this trend. The Americas has also seen a steady decline in FDI flows since 2015 and following a small growth in 2019, FDI flows dropped by 42 percent in 2020, suffering the same pandemic-generated issues as Europe. The Americas has also overtaken Europe as the second largest host of FDI flows, after Asia, since 2017.  Asia’s FDI flows have been steady over the past five years and have showed resilience to the pandemic as the region saw an increase of 4 percent in FDI flows from 2019 to 2020. This growth was driven by an increase in FDI flow in China and India and some other developing economies in Asia.

It is clear from all the figures presented in this paper that the Covid-19 pandemic,[8] which has caused the worst global economic downturn since the great depression, has given rise to the highest year-on-year decline in FDI flow. With global FDI flows dropping close to 35 percent in 2020, the world merchandise trade also fell by 30 percent during the same year.[9] Many FDI projects were delayed or completely canceled as a result of the economic repercussions of the pandemic and the continued uncertainty about the new waves of infections and new covid variants.

Furthermore, geopolitics has always had a direct connection with the economy, which has consequently impacted FDI. The US-Chinese economic competition and trade conflict has negatively affected FDI flows in the US. Chinese investment in the US dropped by close to 90 percent between 2016 and 2018, mainly due to the previous US administration position on the US-China trade relationship.[10] There is continued public concern about the increasing levels of Chinese investment in US companies, driven by the belief that such investment poses serious threats to national economic security. Commercial exchange between the two nations has been a geopolitical concern since both have historical connections and complex economic ties. Despite what has been mentioned, Chinese companies have increased their investments in the United States in industries like artificial intelligence, pharmaceuticals and, in recent years, military applications. This has given China – which is a US rival in many fields – a competitive advantage over the US.[11]

Figure 3

FDI flows by region – Africa and Oceania

Oceania and Africa had the lowest FDI flows of all the regions between 2015 and 2020. FDI flows to Africa declined from 2015 to 2017 and then steadily increased until 2019. Most of the countries in Africa have structurally weak and vulnerable economies and the Covid-19 pandemic has further weakened FDI flows to the continent. Africa FDI flows dropped close to 16 percent between 2019 and 2020. Oceania attracted the highest level of FDI flows in 2018, but saw a sharp decline in 2019, which was further exacerbated in 2020 by the impact of the pandemic.

Figure 4

FDI flows in Ethiopia

Taking Ethiopia as an example of geopolitics in Africa, a rise in FDI is followed by a steady decline. Foreign investment began in Ethiopia with the agricultural sector and increased steadily to a peak in 2015. However, protests against farms owned by foreign companies led to many of them being burned down, which reduced the attractiveness of investment in Ethiopian agriculture immensely. Companies investing in Ethiopia faced another challenge in 2020 with the outburst of the civil war and the political transition of the country.[12] As shown in figure 4, the flow of FDI in Ethiopia is at its lowest in 2020. Recently, the telecommunications sector has become the major attraction for foreign direct investment in Ethiopia, so a rise in FDI flow in Ethiopia is expected.[13]

Figure 5

FDI stocks by region – Americas, Asia and Europe

The stocks of FDI in general in all regions have been increasing throughout the years except for the Americas, which decreased from the year 2017 to 2018. The stocks of both Europe and the Americas have been increasing at the same pace and has a meeting point in 2019. Asia stocks increased at a slow rate every year and was more or less stable between 2017 and 2018. Europe, despite the major fall of its flow in 2020, had the highest FDI stocks among the three regions that year.

Figure 6

FDI stocks by region – Africa and Oceania

The flow of FDI stocks for Africa and Oceania are shown on a different chart because they have very low inflow rates compared to the other regions. Oceania stocks had a growth rate of 38.8% from 2015 to 2020. While Africa stocks decreased by 0.3% in 2016, the following years witnessed an increase in stocks until 2020 when the growth of stocks increased by 22%.

Future Direction of FDI

Global FDI flows faced the worst impact of the pandemic during the first half of 2020 and started showing signs of recovery towards the end of the year. UNCTAD predicted a small recovery of FDI flows in 2021 in their World Investment Report 2021. The organization has estimated a growth of 10 to 15 percent in 2021. However, according to UNCTAD Investment Trends Monitor, global FDI flows showed a stronger than expected recovery during the first half of 2021, reaching $852 billion. This rebound is equivalent to 70 percent of the loss of FDI caused by the Covid-19 pandemic in 2020.[14] The recovery is expected to continue in 2022, with asymmetric growth between regions and between developed and developing countries.

Obstacles and challenges are expected on the path of FDI recovery. Future FDI flows will remain challenged by the continued uncertainty surrounding the Covid-19 pandemic and the speed of the global economy’s recovery.

After the study of FDI data in different regions over the past five years, the future direction is clear. Developing regions are more prone to internal and external conflicts due to instability and weaker institutions. However, they have been showing a stable level of FDI flows. Asia has been and will remain the largest recipient of FDI flows in the near term, driven by increased investment in India and China as well as other smaller developing Asian economies.

Competition for FDI will increase as countries shift to the digital economy and start competing for global talent and technology. Policy makers will have to accelerate reforms to digitalize government services and streamline policies to attract FDI into the technology industry. For example, obstacles in conducting businesses the traditional way can be overcome by adopting digital services in investment.[15]

Recommendations

After having witnessed the effects of the pandemic on FDI, countries should take protective measures to prevent fluctuations in stocks and flow. Establishing a legal framework can make the environment more stable for investors and limit the risk of expropriation, regardless of the ongoing challenges in the world.[16] Moreover, minimizing the restrictions on FDI can provide a more flexible labor market which will allow an increasing inflow.

Conclusion:

The pandemic, alongside other factors like geopolitics, has led to a noticeable change in the growth rates of FDI over the past few years. Post-pandemic recovery is happening through stages and will lead to greater development of FDI in many regions and industries. Finally, adaptation to changes, flexibility and advanced policies which create a safe investment environment will ensure the prosperity of FDI.

 

References 

[1] UNCTAD, World Investment Report 2021, https://unctad.org/system/files/official-document/wir2021_en.pdf

[2] World Bank. (n.d.). Databank. Retrieved from https://databank.worldbank.org/metadataglossary/jobs/series/BX.KLT.DINV.WD.GD.ZS.

[3] Bartels, F., & Crombrugghe. (2009, January). FDI policy Instruments: Advantages and Disadvantages. Retrieved from https://www.unido.org/api/opentext/documents/download/10081425/unido-file-10081425.

[4] OECD. (2002). Foreign Direct Investment for Development. Retrieved from https://www.oecd.org/investment/investmentfordevelopment/1959815.pdf

[5] UNCTAD, World Investment Report 2021, https://unctad.org/system/files/official-document/wir2021_en.pdf

[6] The United Nation Conference on Trade and Development collects data of FDI from all the countries around the world.

[7] Foreign direct investment: Inward and outward flows and stock, annual. Beyond 20/20 WDS – table view. (n.d.). Retrieved from https://unctadstat.unctad.org/wds/TableViewer/tableView.aspx?ReportId=96740.

[8] The topic of Covid-19 effect on FDI is done in previous studies. However, it is crucial to mention it when trying to look at the future of FDI after the pandemic.

[9] G20 extraordinary trade and investment ministers telecon on covid-19. UNCTAD. (2020). Retrieved from https://unctad.org/osgstatement/g20-extraordinary-trade-and-investment-ministers-telecon-covid-19.

[10] The New York Times, Chinese Money in the U.S. Dries Up as Trade War Drags On, https://www.nytimes.com/2019/07/21/us/politics/china-investment-trade-war.html

[11] Zeng, K., & Li , X. (2019). Geopolitics, Nationalism, and Foreign Direct Investment: Perceptions of the China Threat and American Public Attitudes toward Chinese FDI. Chinese Journal of International Politics.

[12] Meester, J., & Lanfranchi, G. (2021, October). Foreign Direct Influence? Trade and investment on the Red Sea’s African shores. Hinrich Foundation. Retrieved from https://www.hinrichfoundation.com/research/article/fdi/foreign-direct-influence-trade-and-investment-on-the-red-sea-s-african-shores/.

[13] FDI flow data of Ethiopia was taken from https://www.lloydsbanktrade.com/en/market-potential/ethiopia/investment

[14] UNCTAD, Investment Trends Monitor, https://unctad.org/system/files/official-document/diaeiainf2021d2_en.pdf?utm_source=UNCTAD+Media+Contacts&utm_campaign=64e5f12ae2-EMAIL_CAMPAIGN_2020_06_10_03_40_COPY_02&utm_medium=email&utm_term=0_1b47b7abd3-64e5f12ae2-64981361, October 2021

[15] Stephenson, M. (2020, September). Digital FDI Policies, regulations and measures to attract FDI in the digital economy. World Economic Forum. Retrieved from https://www.weforum.org/whitepapers/digital-fdi-policies-regulations-and-measures-to-attract-fdi-in-the-digital-economy

[16] Protection of Foreign Direct Investment in a New World Order: Vietnam. A Case Study. (1994). Harvard Law Review107(8), 1995–2012. https://doi.org/10.2307/1341765

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