From countries just beginning to modernize to the wealthiest members of the Organization for Economic Co-operation and Development (OECD), the world is full of development opportunities. While central bankers control an economy’s monetary levels and politicians control fiscal affairs, these two groups often cannot revive growth without outside help. Enter foreign direct investment (FDI). In simple terms, it refers to capital inflows or outflows from one country to another, with common examples such as companies building factories abroad or investing in the development of a oil.
Global trends impacting FDI
Since March 2020, the COVID-19 pandemic has upended the way millions of people and businesses go about their days. It is an extreme understatement to say that the pandemic has severely hampered FDI flows. In fact, FDI inflows to developed and transition economies fell by 58% in 2020. Among developed markets, Europe was particularly hard hit, with FDI inflows falling by 80%. Before the pandemic, many countries were already moving towards protectionist-type policies and stepping up scrutiny of inbound foreign investment. Since the pandemic, these themes appear to have been extrapolated due to additional factors such as lockdowns, global supply chain bottlenecks and armed conflict. As of June 2022, there does not yet appear to be a catalyst on the horizon to reverse these negative FDI trends and only time will tell when and how these trends will change.
Countries with the most FDI
Each year, more than $1 trillion in FDI enters countries around the world, but the distribution is far from equal. According to the United Nations Conference on Trade and Development (UNCTAD), the countries with the highest share of FDI in GDP in 2020 were:
- Cayman Islands
- Republic of Congo
- Hong Kong SAR (China)
Caribbean economies have been hit hard by the pandemic and the shutdown of international tourism. Often reports on FDI exclude Caribbean financial centers as inflows from the financial sector can often distort the overall picture of FDI. When it comes to FDI, investors often focus more on cross-border M&A activity and greenfield projects rather than strictly on capital flows. With that in mind, one of the highlights of the list in 2020 was Hungary, which has a population of 9.8 million. According to the Office of Economic and Trade Affairs, Hungary’s central location and high-quality infrastructure have made it an attractive destination for FDI. According to Investment Climate Statements 2020: Hungary, to promote investment, the Hungarian government lowered the corporate tax rate to 9% in 2017 and the labor tax to 15.5% in July 2020 , which is among the lowest in the European Union. FDI in Hungary is a good example of how factors such as government economic policy and underlying market fundamentals combine to influence the overall level of foreign investment.
Savings per total FDI
Considering FDI as a percentage of GDP does not indicate the size of the economy in which the investment is made. Some of the economies listed above are much larger/smaller than others in terms of GDP alone, and when you rank economies by total FDI dollars received the image changes almost completely.
- China: $212.5 billion
- United States: $211.3 billion
- Hungary: $168.9 billion
- Hong Kong (China): $117.5 billion
- Germany: $112.6 billion
- Singapore: $87.4 billion
- India: $64.4 billion
- Japan: $62.7 billion
- Luxembourg: $62.1 billion
- British Virgin Islands: $39.6 billion
These 10 countries together received the bulk of global FDI, with the United States and China accounting for around a third of the total. Although many of these countries have natural resources that can attract foreign investment, the real attraction is their population size. A large population means a lot of consumers, and a multinational generally wants to be close to its consumers. Proximity allows a business to reduce the cost of shipping goods and allows it to closely monitor changing consumer tastes. Sitting in an office on the other side of the world could make a business lose out.
Problem with the policy
Foreign investment is often used as a political scapegoat for the world’s ills, and there are certainly times when it deserves a bad rap. Big business can trample on developing countries, fueling corruption and taking away a country’s wealth rather than putting it back into the national economy. It is this overwhelming force that spawned the concept of the resource curse. Globalization, which tends to go hand in hand with FDI, is not the most popular or valued economic concept, even if it ultimately benefits consumers. Officials under pressure to fix the economy can earn brownie points by pointing the finger at foreign companies bent on ‘owning the country’, with ‘buy domestic’ legislation and non-tariff barriers to trade reducing the ability of foreigners to gain access at the market.
The Positive Side
Foreign direct investment isn’t all bad, however. Inflows are a sign that the outside world sees an economy as a valid place to park capital and a signal that a country has “succeeded”. FDI allows countries that do not have the locally developed know-how to develop resources that they might not otherwise have been able to develop. Profits from the use of capital can be used to build infrastructure, improve health care and education, improve productivity, and modernize industries. The trick is to balance the desire to fill state coffers with the knowledge that those funds should improve the lives of as many people as possible over the long term. Nothing creates so much instability as kleptocracy.
How can a country encourage the rest of the world to hand over money? Countries, like Hungary discussed above, can increase FDI inflows by creating a business climate that gives foreign investors the impression that their capital is safe. Low tax rates or other tax incentives, protection of private property rights, access to loans and finance, and infrastructure that allows the fruits of capital investment to reach the market, are some of the incentives that countries can offer.