Trade policy has become a major source of macroeconomic risk. The sharp rise in trade restrictions and the growing unpredictability of trade rules are reshaping firms’ incentives to invest across borders. This column argues that both trade restrictions and trade policy uncertainty significantly depress bilateral foreign direct investment flows, with uncertainty exerting particularly large and persistent effects. The consequences are most severe for investors in emerging markets and developing economies and countries deeply embedded in global value chains. By contrast, macroeconomic stability – supported by countercyclical fiscal policy and stable exchange rates – helps cushion the blow.

The long phase of global economic integration, supported by regional and multilateral trade agreements (OECD 2025, UNCTAD 2020), has stalled. Since the Great Recession, geopolitical tensions and concerns about economic security have placed the global trading system under strain (Gourinchas et al. 2026). Trade restrictions have risen sharply – especially during the US–China trade dispute and the COVID‑19 pandemic – while trade policy uncertainty has reached historically high levels (Caldara et al. 2020, Ahir et al. 2025).

In a recent paper (Ahir et al. 2026), we estimate the impact of trade restrictions – measured through the Measurement of Aggregate Trade Restrictions (MATR) index developed by Estefania‑Flores et al. (2025) – and trade policy uncertainty – measured by the World Trade Uncertainty Index (WTUI) developed by Ahir et al. (2019, 2022) – on bilateral foreign direct investment (FDI) flows. The analysis uses annual bilateral FDI flows from 243 source countries to 35 host countries over 1985–2023.

The results show that both trade restrictions and uncertainty significantly reduce FDI inflows (Figure 1). A one‑standard‑deviation increase in the MATR index – similar in magnitude to the tightening of non‑tariff barriers implemented by Colombia in 1995 – reduces FDI inflows by about 10% of their sample mean on impact, rising to around 15% after one year. Although the effect gradually fades, it remains statistically significant four years after the shock. These findings underscore a broader point: when governments raise trade barriers, firms do not simply adjust their trade flows – they reconsider where they place their capital.

Figure 1 The impact of trade restrictions and trade policy uncertainty on FDI flows

Notes: The charts show the dynamic effects of trade restrictions (MATR, panel a) and trade policy uncertainty (WTUI, panel b) on inward FDI. Solid lines denote point estimates; shaded areas indicate 68% and 90% confidence intervals. Estimates are based on annual bilateral FDI flows from 243 source countries to 35 host countries during 1985–2023.

Uncertainty is the main deterrent. Because FDI involves large sunk costs and long planning horizons, investors often respond to unpredictable policy environments by delaying or cancelling investment projects altogether (Bloom 2009). A one standard deviation increase in trade policy uncertainty – comparable to that experienced by the UK following the Brexit referendum – reduces FDI inflows by around 40% on impact. The decline peaks at about 50% after one year and remains negative and statistically significant even five years after the shock. In other words, uncertainty acts as a much stronger brake on cross‑border investment than trade restrictions themselves, and its effects are both deeper and more persistent.

Who gets hit hardest?

The aggregate results conceal sharp differences across countries (Figure 2). Some investment relationships absorb trade shocks; others are highly exposed.

• Investors from low- and middle-income economies pull back the fastest. Tighter financing constraints and greater macroeconomic volatility make investors in these countries more sensitive to rising trade barriers and uncertainty.
• Host countries with open capital accounts experience larger declines. Openness allows investors to adjust positions quickly, which becomes a channel for rapid retrenchment when trade policy deteriorates.
• GVC‑integrated economies are the most vulnerable. Stronger cross‑border production linkages amplify the impact of both trade restrictions and uncertainty, highlighting how deeply integrated production networks magnify exposure to policy fragmentation.
• Macroeconomic policies help mitigate the costs. Countries with countercyclical fiscal policy and more stable exchange rates see smaller drops in FDI inflows, underscoring the role of credible macro frameworks in dampening the effects of trade shocks.

Figure 2  The impact of trade restrictions and trade policy uncertainty on FDI flows depending on host and source country characteristics

a) MATR

b) WTUI

Notes: The chart shows the one-year response of FDI inflows (as a percentage of their sample mean) to trade restrictions (panel a) and trade policy uncertainty (panel b). Results are reported for different source- and host-country characteristics, including source-country income level, capital account openness (KAO), fiscal policy cyclicality, and exchange rate stability (ERS). The final bar reports the differential effect for country pairs with above- versus below-median GVC intensity. ** denotes statistical significance at the 10% level.

Trade shocks increase downside risks, not just averages

Trade policy shocks do not only lower average FDI inflows – they also make investment outcomes more fragile (Figure 3). Using a location‑scale framework (Adrian et al. 2019, Furceri et al. 2025), we show that major trade restrictions and trade policy uncertainty significantly widen the distribution of future FDI inflows. As a result, trade shocks disproportionately increase the likelihood of very weak investment outcomes, with the most vulnerable investment relationships experiencing the sharpest declines. This means that fragmentation raises not just expected losses but also downside risks, while the largest FDI flows are comparatively less affected.

In short, rising trade restrictions and uncertainty do not merely depress FDI – they make global investment more volatile and more uneven, increasing the probability of severe investment shortfalls.

Figure 3 Quantile effects of trade restrictions and uncertainty on the distribution of FDI inflows

Notes: The chart shows the effects of trade policy restrictions and uncertainty on the 5th, 25th, and 50th quantiles of the FDI inflows distribution. ** denotes statistical significance at the 10% level.

Policy implications

The recent rise in trade fragmentation has implications that extend well beyond trade flows. Our results show that both trade restrictions and trade policy uncertainty reduce cross-border investment, with uncertainty exerting particularly large and persistent effects.

The results highlight the importance of transparent and predictable trade policies. In an increasingly fragmented global economy, reducing uncertainty may be as important as lowering trade barriers themselves in sustaining international investment and economic integration.

The findings also suggest that stable macroeconomic frameworks can partly mitigate these effects. Countercyclical fiscal policy and exchange-rate stability reduce the sensitivity of FDI to trade shocks, while countries that are highly integrated into global value chains are especially exposed to policy fragmentation.

Authors’ note: The views expressed in this column are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Source : VOXeu