As geopolitical uncertainty rises – due to events ranging from Brexit and the increasing rivalry between major economies to Russia’s invasion of Ukraine – firms are increasingly factoring political alignment into their investment decisions. This column uses detailed global data on greenfield projects, mergers and acquisitions, and affiliate stocks, and four measures of political alignment, to explore how foreign direct investment has become more sensitive to geopolitical distance. It reveals how friendshoring trends have accelerated since 2011, and how today’s investment flows reflect deepening geoeconomic fragmentation.
The past few years have witnessed an increase in geopolitical distances between groups of countries, initially driven by Brexit, global trade tensions, and further intensified by Russia’s invasion of Ukraine. Such global events have culminated in significant increases in geopolitical risk since 2019 (Caldara and Iacoviello, 2022). A recent report by the Centre for the Future of Democracy (Foa et al. 2022) also shows that the world is now characterised by distinct spheres of governance regimes after a decade of geopolitical polarisation. Other trends include a drop in the liberal democracy index by VDem since 2011 and a rise in unfavourable views of other countries among the public, according to data from the Pew Research Center.
These geopolitical upheavals have prompted policy responses and decoupling strategies that affect foreign investments. Bencivelli et al. (2023) show that many developed economies have recently strengthened their foreign investment screening processes, granting domestic authorities the power to limit foreign acquisitions in key industries. Evenett and Fritz (2021) suggest countries’ investment policies are becoming less conducive to inward foreign investment. These developments have further generated a growing debate about the need for protectionism, near-shoring, or friendshoring, with the latter implying the offshoring of production to geopolitically aligned or ‘friendlier’ countries. A survey by the ECB suggests that more than 70% of 65 European multinationals surveyed are either shifting production to nearby or politically friendly countries or diversifying (Attinasi et al. 2023). Policymakers are increasingly offering stronger incentives for firms to consider friendshoring and reshoring to move production to countries with aligned political preferences. 1
While trade aspects are widely evaluated (e.g. Alfaro and Chor 2023, Freund et al. 2023), the impact of geopolitical differences on foreign direct investment (FDI) is relatively less explored. One recent study by Aiyar et al. (2024) suggests that geopolitical distance, as indicated by UN voting patterns, significantly shapes FDI flows across countries, with this influence becoming more pronounced since 2018, aligning with the friendshoring hypothesis. The study suggests, however, that geopolitics had the greatest impact in the 2000s, raising questions about whether friendshoring is truly a new phenomenon unique to recent years. In fact, Gopinath et al. (2024) suggest that these effects on globalisation flows were sharper during the Cold War era.
Revisiting the evidence on geopolitics and FDI
In a new paper (Grover and Vézina 2025), we contribute to the small but growing literature on the impact of geopolitical fragmentation on foreign investment (Gopinath et al. 2024, Alfaro and Chor 2023, Aiyar et al. 2023, 2024) by verifying the robustness of recent findings across three distinct measures of foreign activity as well as four alternative indicators of geopolitical distance. We use detailed project-level data from fDi Markets on FDI covering greenfield projects, complementing it with information on mergers and acquisitions (M&A) from Refinitiv Eikon and stocks of affiliates from Ahmad et al. (2023). Our four distinct measures of geopolitical alignment or friendship across countries are (1) a measure of bloc alignment from Capital Economics; (2) a dummy for bilateral FDI between high liberal democracy countries and low liberal democracy ones; (3) public favourability from opinion surveys; and (4) the more commonly used measure of UN voting differences. Lastly, we delve into the heterogeneity of friendshoring forces across countries, sectoral attributes, and time periods to deepen the recent findings.
Geopolitical forces shaping FDI is not a new phenomenon, but they matter more today
Our analysis first confirms that FDI being affected by geopolitical forces is not a new phenomenon and was indeed the case throughout 2003-2022. It also confirms that the effect of geopolitical distance has been steadily increasing since 2011, when its significance was minimal, and it currently holds greater dominance than at any point since 2003. For example, the impact of geopolitical distance on greenfield FDI has doubled over the past decade, with a one standard deviation drop in UN voting similarity reducing greenfield FDI by 8% in 2011 compared to 16% in 2022. A one standard deviation drop in public opinion reduced greenfield FDI by 11% in 2011 compared to an overwhelming decline of 38% in 2022. Finally, being in a different bloc reduced the flow of greenfield projects by around 11% in 2011, and by double that in 2021.
Figure 1 The effect of geopolitical distance on FDI
Notes: The y-axes measure the effect of geopolitical alignment on FDI, both greenfield (left) and M&A (centre), as well as the stock of affiliates (right), over time. These are Poisson Pseudo Maximum Likelihood (PPML) estimates from a gravity model, controlling for origin and destination fixed effects as well as geographic distance, shared borders, common language, and common colonial empire.
While our findings are robust across various measures of FDI and geopolitical fragmentation, they also suggest that the impact of differences in geopolitical alignment on brownfield investments (M&A) is more pronounced in recent years relative to their effect on greenfield investments. By comparison, the negative effect of geopolitical non-alignment on the stock of affiliate activity has remained relatively stable over the years, especially when geopolitical differences are measured using bloc alignment.
Friendshoring patterns are largely observed among companies originating from advanced Western economies
Second, to discern broader patterns in friendshoring forces, we separately consider the impact of geopolitical differences on FDI originating from the main source countries. Our gravity estimations reveal that friendshoring activities in recent years (2020-2022) are largely observed among companies originating from advanced Western economies. This is in line with the comparison of FDI from the US to that from China. The top destinations for US FDI over the last ten years have changed a lot. China was the second largest destination for US greenfield FDI in 2012 but dropped to 15th place in 2022. In addition, both Brazil and Russia dropped out of the top 15, while Costa Rica and Poland climbed into the top 15. China was the 7th destination for US M&A activity in 2012, but was no longer in the top 15 in 2022. By comparison, outward FDI from companies in China shows no sign of shifting away from the US due to geopolitical differences between the two countries. There are remarkable differences compared with East Asian countries such as China, Japan, the Republic of Korea, and Singapore, which are now increasingly investing in geographically distant countries. Not only do Chinese companies invest more in geopolitically distant countries, but they also invest more in countries that are geopolitically closer to the US. This result underscores the challenges associated with decoupling value chains in an interconnected globalised world.
Figure 2 The different effects of UN voting differences on US versus Chinese FDI
a) US FDI
b) Chinese FDI
Notes: The y axes measure the effect of geopolitical alignment on FDI fomr the US and from China separately. We look at greenfield projects (left) and M&As (center), as well as the stock of affiliates (right), over time. These are Poisson Pseudo Maximum Likelihood (PPML) estimates from a gravity model, controlling for destination GDP, geographic distance, shared borders, common language, and common colonial empire.
Figure 3 The effect of geopolitics on FDI, by country of origin
Notes: The coefficients (dots) measure the effect of the different geopolitical alignment measures on different countries’ outward FDI, whether greenfield (left), M&As (center), or affiliates (left) in 2020-2022 on average. Capped bars are 95% confidence intervals. These are estimates from gravity models, controlling for geographic distance, shared borders, common language, common colonial empire, and destination GDP.
It’s more than national security or strategic considerations
We also explore the strength of the relationship between geopolitical differences and FDI for certain sector attributes, such as strategic sectors characterised by national security concerns or high-tech intensity; GVC-intensive sectors that are increasingly vulnerable to global trade shocks; and contract-intensive sectors that typically have high relationship-specific investments and are potentially more exposed to trade policy changes. While the motivation behind inward-looking responses to FDI appears to stem from national security concerns and efforts to enhance supply chain resilience against global shocks and environmental risks, our findings indicate that friendshoring is not confined to strategic sectors or those characterised by high participation in GVCs. We observe comparable effects of geopolitical differences on foreign investments across strategic, GVC-intensive, and contract-intensive sectors. These effects align closely with the average impact of geopolitical differences on FDI across all sectors, suggesting that these phenomena may extend beyond national security or strategic considerations.
Conclusion
Using three datasets on global FDI, covering greenfield projects, brownfield FDI (that is, M&A), and number of affiliates, and four measures of countries’ geopolitical alignment or friendship, we find an increasing role for political alignment or differences in shaping companies’ location decisions. Geopolitical differences, measured by UN voting, bloc alignment, the liberal democracy index, and unfavourable public opinion, have a larger negative impact on foreign investments today than they did ten years ago.
As companies engage in friendshoring activities, primarily investing in countries with similar geopolitical alignments could potentially lead to the formation of economic blocs. This extension of fragmentation can hinder global economic integration and cooperation, potentially exacerbating geopolitical tensions. Importantly, geoeconomic fragmentation may also prompt countries to adopt industrial policies, as observed in a recent surge in protectionist measures, and add to the rising fragmentation of global value chains. This would reduce efficiency and increase costs for firms operating across borders. Navigating the current geopolitical forces may therefore require careful consideration of the trade-offs between protecting domestic industries and maintaining open and interconnected global markets.
Source : VOXeu
