Foreign direct investment (FDI) plays a critical role in the world economy. Global FDI flows averaged almost $2 trillion per year during the past decade, up to one-half of which have been directed to emerging market and developing economies (EMDEs) in recent years (figure 1.A).
FDI inflows are an important source of private capital, especially for countries with scarce domestic capital resources. External capital is critical for EMDEs to help bridge their investment gaps: by some estimates, EMDEs need to invest at least an additional 1.4 percent of GDP through 2030 just to address climate change and the energy transition. The positive effects of FDI extend far beyond the provision of private capital. FDI can spur technology spillovers, help create new jobs, foster productivity gains, and help recipient economies to integrate into global production networks.
However, FDI flows have been trending down since the global financial crisis of 2008-09. On average, FDI inflows to EMDEs have fallen to about 2 percent of their GDP in the last several years—less than half the level at the peak in 2008 (figure 1.B). The decline was widespread across EMDEs, with FDI-to-GDP ratios declining in about 60 percent of these economies.
Figure 1. FDI trends
Note: EMDEs = emerging market and developing economies. A. Sample includes 36 advanced economies and 153 EMDEs. B. Annual median and interquartile range of the FDI-to-GDP ratio. Balanced sample of 134 EMDEs.
FDI Inflows to EMDEs Likely to Remain Subdued
Both global and domestic factors have contributed to the decline in FDI flows. FDI flows are positively correlated with output growth and international trade. On the other hand, trade fragmentation and rising tariffs are associated with weaker FDI flows. The global recessions triggered by the 2007-09 financial crisis and by the COVID-19 pandemic worsened conditions: sharp growth declines were accompanied by deteriorating investor sentiment and strained corporate balance sheets, curtailing firms’ ability to fund investment projects and depressing cross-border capital flows. More recently, the weak macroeconomic backdrop was further aggravated by heightened trade tensions and associated geopolitical fragmentation and risks, weighing heavily on investors’ confidence in EMDEs (figure 2.A).
Global trade growth also weakened significantly in 2020-24, to the slowest pace since 2000. The number of new trade and investment agreements implemented dropped significantly, while economic policy uncertainty has reached the highest levels since the turn of the century (figure 2.B). With global GDP projected to remain below the pre-pandemic average in the medium term—and with global trade hindered by trade tensions—FDI inflows to EMDEs are likely to remain subdued.
Figure 2. Headwinds to FDI inflows to EMDEs
Note: EMDEs = emerging market and developing economies; RHS = right-hand side. A. Diamonds show five-year averages of the monthly Caldara and Iacoviello global geopolitical risk index and bars show five-year averages of the quarterly Fernández-Villaverde, Mineyama, and Song fragmentation index, where the last observations are April 2025 and 2024Q1, respectively. B. Period averages of the monthly Baker, Bloom, and Davis (2016) economic policy uncertainty index. Last observation is March 2025.
Policy Priorities for EMDEs
Given this outlook, policymakers in EMDEs need to follow a three-pronged strategy to attract FDI, amplify the benefits of FDI, and advance global cooperation to support FDI flows. Although specific policies depend on country circumstances, broad priorities for all EMDEs include reforms that foster a favorable investment climate, macroeconomic stability, strong institutions, human capital development, financial deepening, and reduction of economic informality. These factors have been found to be especially important for facilitating FDI inflows and maximizing the benefits of these inflows. However, EMDEs significantly lag advanced economies in many of these dimensions, and especially in institutions important for a strong investment climate (figure 3.A). Further, reducing barriers to international trade and investment—still high in many EMDEs—including through investment treaties, is important to attract FDI (figure 3.B).
These policies are becoming even more important as EMDEs face rising global economic fragmentation. At the global level, policies that strengthen international cooperation to uphold a rules-based international system for investment and trade, channel FDI toward countries with the largest investment gaps, and provide technical and financial assistance for the necessary structural reforms are essential.
Figure 3. Policy priorities
Note: EMDEs = emerging market and developing economies; LICs = low-income countries. A. Bars show group medians of ICRG’s investment profile index. Sample includes 36 advanced economies and 102 EMDEs, of which 18 are LICs. B. Averages of indexes for overall FDI restrictions and foreign equity limits for FDI. Sample includes 32 advanced economies and 51 EMDEs, and covers the period 2016-20.
Source : World Bank
