From countries just beginning to modernize, to the richest members of the Organization for Economic Cooperation and Development (OECD), the world is awash with opportunities for development. While central bankers have control over an economy’s monetary levels and politicians control fiscal affairs, these two groups often cannot jumpstart growth without outside help. Enter foreign direct investments (FDI). In simple terms they are inflows or outflows of capital from one country to another, with common examples including companies building factories abroad or investing in the development of an oil field.
Global Trends Impacting FDI
Since March 2020, the COVID-19 pandemic has overhauled the way that millions of people and business go about their days. It is an extreme understatement to say that the pandemic has severely hampered the flows of FDI. In fact, FDI inflows to developed and transition economies fell by 58 percent in 2020. Among the developed markets, Europe was particularly hard hit with FDI inflows falling by 80%.
Prior to the pandemic, many nations were already shifting toward protectionist-type policies and were heightening scrutiny around incoming foreign investment. Since the pandemic these themes seem to have been extrapolated due to additional factors such as lockdowns, bottlenecks to global supply chains, and armed conflict. As of June 2022, there doesn’t yet seem 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 flows into countries around the world, but the distribution is far from equal. According to the UN Conference on Trade and Development (UNCTAD), the countries with the greatest share of FDI to GDP in 2020 were:
- Cayman Islands
- Congo republic
- Hong Kong SAR (China)
Economies in the Caribbean, were hard hit by the pandemic and the stoppage of international tourism. Often, reports of FDI exclude financial centers of the Caribbean because inflows from the financial sector can skew the overall picture of FDI often. With regards to FDI, investors are often most focused on cross-border M&A activity and greenfield projects rather than strictly on capital flow.
With this in mind, one highlight on the list in 2020 was Hungary, which has a population of 9.8 million. According to the Bureau of Economic and Business Affairs, Hungary’s central location and high-quality infrastructure have made it an attractive destination for FDI. According to the 2020 Investment Climate Statements: Hungary, to promote investment, the Government of Hungary lowered the corporate tax rate to 9 percent in 2017 and the labor tax to 15.5 percent 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 impact the overall level of foreign investment.
Economies by Total FDI
Viewing FDI as a percentage of GDP does not indicate the size of the economy being invested in. 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 picture changes almost completely.
- China: $253.1 billion
- United States: $211.3 billion
- Hungary: $171.4 billion
- Germany: $142.8 billion
- Hong Kong (China): $117.5 billion
- Singapore: $74.8 billion
- India: $64.4 billion
- Luxembourg: $62.1 billion
- Japan: $61.5 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 approximately one third of the total. While several of these countries do have natural resources that could entice foreign investment, the real draw is the size of their populations. A large population means a lot of consumers, and a multinational company generally wants to be near its consumers. Proximity allows a company to reduce the cost of shipping goods and allows it to keep a close eye on shifting consumer tastes. Sitting in an office halfway across the world could cause a company to lose out.
Trouble With Politics
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 companies can run roughshod over developing countries, breeding corruption and removing a country’s wealth rather than injecting it back into the domestic economy. It is this overwhelming force that spawned the concept of a resource curse.
Globalization, which tends to go hand in hand with FDI, is not the most popular or well-liked economic concept, even if it does benefit consumers in the end. Officials under pressure to fix the economy can earn brownie points by pointing a finger at foreign companies bent on “owning the country,” with “buy domestic” legislation and non-tariff barriers to trade reducing the ability of outsiders to gain market access.
The Positive Side
Foreign direct investment isn’t all bad, however. Inflows are a sign that the outside world considers an economy a worthwhile place to park capital and are a signal that a country has “made it.” FDI allows countries without the domestically grown know-how to develop resources that it may not have been able to otherwise.
Profits from the use of capital can be used to build infrastructure, improve healthcare and education, improve productivity and modernize industries. The trick is to balance the desire to fill state coffers with the knowledge that those funds have to improve the lives of the greatest number of people in the long run. Nothing creates instability quite like kleptocracy.
The Bottom Line
How can a country entice the rest of the world to hand over cash? Countries, such as Hungary discussed above, can increase the inflow of FDI by creating a business climate that makes foreign investors feel as if their capital is safe. Low tax rates or other tax incentives, protection of private property rights, access to loans and funding, and infrastructure that allows the fruits of capital investment to reach market, are a few of the incentives that countries may offer.