Rebuilding Investor Confidence in Times of Uncertainty


Saturday, June 13, 2020 / 10:29 AM / By World Bank Group / Header Image Credit: World Bank Group


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Overall - Main Messages

1. Even before the COVID-19 outbreak, global foreign direct investment (FDI) was in decline due to trade policy uncertainty, rising protectionism, falling rates of return on FDI, and changing forms of international production.


2. The COVID-19 crisis is presenting a new, unprecedented source of investor risk that is depressing business confidence to historic lows, resulting in a projected fall in global FDI by more than 40 percent in 2020.


3. More than two-thirds of multinational investors in developing countries are reporting disruptions in supply chains, declines in revenues, and falls in production as a result of COVID-19-and the impacts are projected to worsen in the coming months-based on a new World Bank survey on the impact of the pandemic.


4. FDI can alleviate the impact of the COVID-19 crisis and boost countries' economic resilience by providing a critical source of external capital for financing public debt and continuing to create more and better-paid jobs, lift people out of poverty, and boost productivity.


5. Foreign acquisitions of local firms in developing countries have doubled as a share of FDI over the past decade, and they have made the acquired companies more export oriented, productive, and diversified in their product offering.


6. At the same time, the possible adverse effects of FDI on income inequality and on lowerskilled workers emphasize the critical mitigating role of labor market and education policies.


7. An extensive survey of more than 2,400 global business executives in 10 large middleincome countries conducted between June and November 2019 shows that government policies can influence FDI location decisions.


8. Government actions-such as reducing investor risk and increasing policy predictability- can rebuild investor confidence, based on the report's new global database of regulatory risk.


9. Investment promotion agencies can boost their countries' investment competitiveness by better aligning their FDI attraction and retention efforts with market signals and changing investor preferences.


10. Governments can leverage FDI for robust economic recovery from COVID-19 by avoiding protectionist policies, seizing new opportunities from changing FDI and supply chain trends, and fostering global cooperation.

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Global FDI Flows Face an Unprecedented Decline

The COVID-19 pandemic is severely impacting multinational enterprises (MNEs) globally. The economic shock of the crisis to the private sector is being transmitted through multiple channels, including falling demand, reduced and disrupted input supply, tightening of credit conditions, a liquidity crunch, and rising uncertainty. The pre-COVID-19 global environment for foreign direct investment (FDI) was already characterized by rapidly eroding investor confidence because of trade and investment policy uncertainty, lagging global growth, falling commodity prices, and rising protectionism. The COVID-19 crisis presents a new, unprecedented source of investor risk that is depressing investor confidence to new lows.


Even before the COVID-19 pandemic upended the global economy, global FDI was sliding to levels even below those last seen in the aftermath of the global financial crisis a decade ago (figure O.1, panel a).1 The decline was more concentrated in high-income countries, where inflows of FDI fell by nearly 60 percent in recent years. Although FDI to developing countries did not decline as steeply, it nonetheless fell to its lowest levels in decades relative to gross domestic product (GDP).2 Compared with the mid-2000s, when FDI reached nearly 4 percent of GDP in developing countries, that share fell to under 2 percent in 2017 and 2018 (figure O.1, panel b).


This worrisome global trend in recent years has reflected a mix of (a) economic factors, including declining rates of return on FDI; (b) business factors, including adoption of digital technologies and increasingly asset light forms of international production; and (c) policy factors, including the erosion of investor confidence due to policy uncertainty and changes in US tax policy that drove repatriation of capital back to the United States.3 More specifically, worsening business fundamentals have driven much of the decline in FDI since 2015, when FDI flows reached their postcrisis peak. The global average rate of return on FDI decreased from 8.0 percent in 2010 to 6.8 percent in 2018 (UNCTAD 2019). While the rates of return have dropped in both developing and developed countries, the declines have been especially large in developing countries.


Furthermore, changing business models resulting from technological advances have driven declines in FDI levels and returns. In particular, increases in labor costs and the rise of advanced manufacturing technologies have eroded or decreased the significance of many developing countries' labor cost advantages. At the same time, the increasing importance of the digital economy and services is shifting businesses toward more asset-light models of investment (UNCTAD 2019).


In addition, commodity price slumps have adversely affected returns on FDI in more commoditydependent markets (such as many economies in Latin America and the Caribbean, the Middle East and North Africa, and SubSaharan Africa). Uncertainty Has Been Rising and FDI Rules Tightening Even before the COVID-19 crisis, the number and magnitude of various global economic, geopolitical, technological, and social shifts have increased uncertainty for citizens, businesses, and policy makers. These changes are reflected in the high values registered in 2019 by various indicators such as the World Uncertainty Index, the Global Economic Policy Uncertainty Index, and the Trade Policy Uncertainty Index (Baker, Bloom, and Davis 2019; Caldara et al. 2019).


In 2020, these indexes have reached unprecedented levels. Citizens are increasingly attributing growing economic disparity and losses in local economic opportunities to globalization. Less than half the citizens in some of the world's largest 27 countries believe that trade and globalization help create jobs, and less than one-third find that they are good for wages, recent data from the Pew Research Center indicate (Gramlich 2019).4 The antiglobalization sentiment is also heightened by the ongoing shifts in economic and geopolitical power as well as concerns about national security. Such anxiety and discontent are fueling a rise in economic nationalism and protectionism. Recent events such as withdrawals from global trade agreements, tariff escalations, and other trade tensions have contributed to a new rise in trade and investment policy uncertainty (Baker, Bloom, and Davis 2019).


Free trade, unhindered investment, and open markets are under threat. Although these fears are particularly pronounced in the industrialized world, a growing number of developing country governments are also building their policy agendas along similar themes. The growing protectionist views have gradually translated into more restrictive rules on the entry of FDI. The United States and the European Union have enacted strict screenings of foreign acquisitions in response to perceived risks to national or economic security. Cases of investment withdrawals- investments that are either rejected or withdrawn over security concerns-tripled in 2018 alone, often receiving high publicity (UNCTAD 2019). Governments have also become increasingly anxious about the potentially noncommercial objectives of foreign investment by state-owned enterprises or sovereign wealth funds. Of particular concern has been foreign ownership of core technologies, manufacturing of health care products, sensitive business assets, and critical infrastructure.


Various governments blocked mergers and acquisitions (M&A) deals worth more than US$150 billion in 2018 (more than 10 percent of total global FDI) on the basis of national security concerns (UNCTAD 2019). Member countries of the Organisation for Economic Co-operation and Development (OECD) on both sides of the Atlantic are tightening-or proposing to tighten-their rules governing the entry of FDI. In fact, a global cross-country analysis of policy trends shows that the share of restrictive and regulatory measures against FDI is the highest it has been in more than 20 years-and the trend may be worsening. The United Nations Conference on Trade and Development's data on FDI policy trends around the world show that 55 countries undertook at least 112 policy measures related to FDI in 2018 (UNCTAD 2019). Of these, more than one-third restricted or regulated FDI more tightly, whereas the share of measures that liberalized and promoted FDI fell to less than two-thirds (figure O.2). In contrast, it was only the previous year (2017) when around 80 percent of the measures promoted FDI.


High-income countries have been the primary drivers of the trend toward more restrictive rules on FDI. In 2018, more than 70 percent of new FDI policy measures in developed countries were aimed at restricting or regulating FDI (UNCTAD 2019). Although most developing countries have so far largely resisted increasing the restrictiveness of their FDI regimes, there is a growing concern that the actions of the governments of developed countries will either set a precedent for the developing countries to follow, or that developing countries will do so as a retaliatory measure. For example, China and South Africa have recently introduced new regulatory frameworks for FDI screening for national security concerns (UNCTAD 2019).

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