Foreign Direct Investment — Global Implications of "America First" Policies

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In a new Citi Research Must C report, Chief Economist Nathan Sheets and team look at foreign direct investment (FDI) and the potential global implications of Trump administration policies. 

As President Trump reconfigures U.S. economic policies, the implications for foreign investment in the U.S. strike us as a pivotal question, with the eventual answer not only influencing the path of the U.S. economy but also having implications for the entire global system. We see several offsetting forces in play. One of President Trump’s explicit objectives is to make the U.S. an attractive target for foreign investment and to incentivize these flows. But the marked rise of policy uncertainty is likely to serve as a disincentive, as foreign investment flows typically gravitate to stable and predictable policy regimes. On balance, we remain cautious about the outlook for foreign investment to the U.S. but also constructive, given our view that the economy’s underlying fundamentals continue to look strong. 

In our Must C report, we explore the features, role and drivers of global FDI flows, with a particular though not exclusive focus on the U.S. Across the various classes of capital flows, FDI is seen as a powerful driver of economic growth and development. While FDI comes in many forms, it generally entails foreign investors taking relatively large, long-term and stable positions in the recipient country.

FDI can be interpreted as a gauge of investor sentiment about a country’s longer-term prospects. FDI is drawn to countries with attractive business climates, a proven commitment to the rule of law, and strong and stable economic performance. But the presence of FDI also helps reinforce favorable economic outcomes and policies, as foreign investors contribute their expertise and resources to bolster an economy’s performance.

We note that the U.S. share of global FDI has risen in recent years. We see this increase as reflecting several factors, including ongoing reshoring flows, investment in the chemicals sector (particularly in pharmaceuticals) attracted by cheap and abundant natural gas, the success of the CHIPS and Inflation Reduction Acts, and pull from the burgeoning U.S. AI sector. Favorable U.S. growth prospects have no doubt also played a role.

Meanwhile, the European Union (EU), UK and China have endured tepid flows in recent years. For the EU this reflects a cocktail of challenges including weak domestic demand, an uncertain energy portfolio and continuing overhang from the Russia-Ukraine conflict. The UK has faced similar challenges, as well as the long positioning post-Brexit. We see the headwinds for FDI inflows to China as more structural, with investment and sourcing systematically moving away from China as a result of geopolitical pressures and related shifts in firms’ production management strategies.

The U.S., EU, UK and China together account for two-thirds of global FDI positions. Our work suggests FDI is drawn to large economies given their generally attractive domestic markets and sizable labor pools. But several trade and financial centers including Luxembourg, Switzerland and the Netherlands hold large positions as well. 

More broadly, global FDI flows have declined markedly as a share of GDP. These flows averaged 2.5% a year from 2005 through 2017, but have stepped down to around 1.5% since 2018. We see this as a signal of slowing in the globalization process.

FDI is ultimately attracted by key features of a country’s economy. These attractors include the size and growth of its markets and the availability of low-cost or highly skilled labor resources. A desire to diversify production or reduce frictions such as transportation costs or tariffs may also be in play.

A looming question is the prospect for these flows going forward. A reasonable expectation is that global FDI flows will continue their flat trajectory and average around $1.5 trillion annually. Around this flat baseline, we see risks as skewed toward a strengthening of FDI. First the decline in EU FDI looks to have a cyclical component that could reverse. Second, while the weakness of FDI to China looks more structural than cyclical, we see more upside than downside risks from current levels. Third, we think countries such as Mexico and India are benefiting from a rebalancing of investments as firms diversify their production from China, an important trend that should become more apparent over time.

Of course, as emphasized above, a related and if anything more critical set of issues involves the attractiveness of the U.S. as a target for FDI and the global implications of Trump administration policies.