Rising trade barriers and uncertainty are choking FDI inflows, hitting low and middle-income investors hardest in a fragmented global economy.

In the context of rising economic fragmentation, trade restrictions have become as a much-used policy instrument, justified on grounds of national security, support for domestic production and jobs or a corrective response to perceived unfair trade practices. Alongside rising restrictions, trade policy uncertainty has reached historically high levels across a broad set of economies, resulting in a less stable and less predictable global trading environment. Using bilateral foreign direct investment (FDI) flows data and dynamic gravity-based local projections, we show that trade restrictions and trade policy uncertainty in host countries trigger economically significant and persistent declines in FDI inflows, especially from low-and middle-income source countries. Adverse effects are mitigated by countercyclical fiscal policy and stable exchange rates, but are amplified by greater capital account openness. Stronger global value chain integration amplifies the impact of trade restrictions and uncertainty shocks, while greater geopolitical distance strengthens the effects of trade restrictions but reduces the sensitivity to trade policy uncertainty. Results are robust to a range of specifications, including instrumental variable and difference-in-differences approaches.

Source : Bruegel