Foreign direct investment flows are experiencing severe difficulties as a result of the pandemic. The worst effects are probably to be found in developing nations.
Globalization of the economy is being displaced by COVID-19. Global industrial networks are facing disruptions on a scale never before seen as a result of supply and demand being shocked at the same time as a result of containment efforts. As a result of the pandemic’s revelation of how internationally interwoven the flow of goods and services has become, nations are currently reevaluating their international trade policies in an effort to lessen their vulnerability to shocks to the global economy.
Foreign direct investment (FDI) disruptions, which are a common occurrence as a result of economic globalization, are no exception. The COVID-19 problem has resulted in the largest-ever capital flight from developing nations, according to data released by the International Monetary Fund in late March. The UN Conference on Trade and Development (UNCTAD) projects that during 2020–21, global FDI flows will decline between 30% and 40%. All industries will be impacted, but abrupt reductions in FDI are particularly noticeable in consumer-cyclical businesses like travel, hospitality, and leisure, as well as manufacturing and the energy sector.
The decline in FDI will be especially detrimental to poorer nations.
The COVID-19 issue has resulted in the highest capital outflow ever seen, as measured by the IMF, of 83 billion US dollars from developing nations.
The reasons for this are as follows: first, given that the pandemic has had a greater impact on certain industries than others, FDI inflows to developing nations are anticipated to decline even more than the world average. Second, over the past few decades, FDI has become a more important source of funding for developing nations. Between 1985 and 2017, FDI inflows to underdeveloped nations rose from 14 billion to 690 billion US dollars (current prices). This increases the share of FDI inflows around the world from 25% to 46%. A surge in both offshore and the global dispersion of economic activities, particularly in the manufacturing and services sectors, underpins the increase in FDI to emerging nations. Therefore, there is a strong connection between the decline in global FDI and the worldwide supply chain disruptions brought on by the COVID-19 epidemic.
Neither in terms of amount nor in terms of quality, FDI inflows to developing nations are uniform. The growth over the past few decades has been driven by Asia’s rapidly expanding economy and massive populations, particularly China but also Cambodia, India, Indonesia, Malaysia, Myanmar, the Philippines, Thailand, and Viet Nam. Manufacturing and services account for the majority of the investments going into these nations. African nations come into play if we consider reliance on FDI inflows rather than their volume. Comparing FDI inflows to developing Asian nations with those to Africa reveals a different picture. The majority of FDI inflows to Africa go to the extractive industries, like mining and oil. The irregular fluctuations in FDI inflows in the situations of Congo and Mozambique are explained by the tendency of this sort of direct investment to be more variable. With the increase in FDI inflows being primarily centered in the manufacturing sector, Ethiopia stands out as an exception.
The effects of declining (and increasing) FDI on emerging countries
It is a tedious effort to anticipate the economic effects of COVID-19. We do not yet know when economic activity will pick up, the extent of the harm caused by the decline in global demand and supply, or the makeup of prospective future fiscal stimulus plans.
We may be able to predict future global investment flows by comparing recent statistics on business confidence in China and the United States, two nations that have a significant impact on those flows. According to the graph below, China is on a different trajectory than the United States: business confidence there is returning to pre-pandemic levels.
Why does this matter? It essentially means that China is starting to produce and labor again earlier than other nations (business confidence in most other countries are showing trends similar to the United States). This pattern is supported by China’s monthly production figures, which show that manufacturing output sharply increased in March.
When considered collectively, this may suggest that we are witnessing the beginning of a global V-shaped rebound of commercial activity and that, provided other nations experience recoveries, the global FDI downturn will not be as severe as some have predicted. Or it might mean that Chinese businesses are taking advantage of the crisis to extend their influence around the world. In truth, FDI outflows from the Global South, particularly from China, have been increasing for a while. Therefore, it is not impossible that this pandemic will affect the makeup of future global FDI flows.
However, it should be noted that the Purchasing Managers Index (PMI), which we are using to represent corporate optimism in China, has come under fire. The PMI also shows a trend, and that trend shows that production levels are improving rather than returning to their pre-pandemic levels, which is even more significant. In addition, we should be ready for a gradual recovery given the nature of FDI. In many cases, cross-border commercial relationships need to be re-established; investors are typically more risk-averse abroad than at home, and beginning manufacturing in a foreign country involves a variety of challenging operational and logistics issues.
The effects on developing nations will be severe if the decline in global FDI continues for a time. However, it will have a distinct effect on each of them.
For developing nations with a more diverse portfolio of FDI inflows, the effects of a global FDI reduction may be more severe due to the potential economic advantages of those inflows.
First and foremost, countries with extractive industries that depend on FDI inflows—many of which are in Africa—will see a decline in export income (which many already have due to the plunge in prices for primary commodities, especially oil).
For developing nations with a more diverse portfolio of FDI inflows, the effects of a global decline in FDI could be much more severe because the potential advantages of such inflows are greater: In addition to increasing export revenues, FDI inflows also increase employment, have a generally more favorable effect on infrastructure development, and have the potential to transfer technology to the host economy, particularly in the manufacturing sector. We may anticipate that many investors would suspend their expansion plans in addition to losing their capital.
A successful FDI strategy requires more than just attracting investors as its initial step. Getting investors to stay and grow their businesses is essential for attaining economic development objectives.
Concerning the decline in FDI to poor nations is the nature of competition in the global economy of the twenty-first century.
More than ever, poor nations compete fiercely to entice FDI from high-income nations.
Particularly in manufacturing, the competition between developing countries to draw FDI from high-income countries and/or function as suppliers for their consumer markets has been more strong than ever. Both the worldwide pool of unskilled labor and the share of low-tech manufacturing exports coming from emerging countries have increased significantly since 1980. This means that restarting manufacturing as soon as possible—possibly even prematurely—after the epidemic has been contained can give you a competitive advantage. For instance, Bangladeshi garment producers are under pressure to resume manufacturing despite the resulting health risk. If they do not swiftly resume production, factory owners worry that foreign shops may simply source goods from nations like China, Viet Nam, or Cambodia.
In other words, it appears that maintaining a competitive edge must be sacrificed in order to protect employees from the health dangers posed by COVID-19.